Badger Infrastructure Solutions Ltd. (BDGI) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Badger Infrastructure Solutions Limited 2021 Third Quarter Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Trevor Carson, VP of Investor Relations.

Thank you, and good morning, everybody. Welcome to our third quarter 2021 earnings call. On the call this morning are Badger's CEO, Paul Vanderberg, and CFO, Darren Yaworsky. Badger's 2021 third quarter earnings release, MD&A and financial statements were released after market close yesterday and are available on the Investors section of our website and on SEDAR. We are required to note that some of the statements made today may contain forward-looking information. In fact, all statements made today which are not statements of historical fact are considered to be forward-looking statements. We make these forward-looking statements based on certain assumptions that we consider to be reasonable. However, forward-looking statements are always subject to certain risks and uncertainties, and undue reliance should not be placed on them as actual results may differ materially from those expressed or implied. For more information about material assumptions or risks and uncertainties that may be relevant to such forward-looking statements, please refer to our 2020 MD&A along with the 2020 AIF. Further, such statements speak only as of today's date, and Badger does not undertake to update any such forward-looking statements. I will now turn the call over to Paul.

Thanks, Trevor, and good morning. As always, we'd like to start the call today with health and safety. The Badger team continues to manage the COVID-related operating challenges quite well, and we always put the safety of our employees and customers as job #1. We've been promoting health and safety of employees very strongly and encouraging vaccination. We've begun to see work site vaccine mandates from a number of customers and governments in the quarter, which we support. The U.S. government announced the vaccine mandate a few weeks ago and provided an update yesterday, which requires a significant amount of work before it can be administered by businesses across the country. At some point, we expect that the health and safety regulators will sort out all the details, and we will implement it along with all other companies. We worked on one very high-profile project in the quarter that was directly linked to health and community safety, and that was the emergency response to Hurricane Ida. We want to publicly recognize our leadership team for a job very well done in supporting the recovery work in Louisiana. We balance delivering services to help restore critical power grid infrastructure while protecting our employees while the Delta variant was surging, not an easy task. We were recognized by many other contractors on this emergency response for our efforts and in leading health and safety protocols. At one point, we had up to 100 units on this project, with people pitching in from all across Badger. Badger is the only hydrovac operator in North America who can provide this level of service and response. Now on to the quarter. We were pleased with the improved revenue in Q3 and the sequential improvement that's been made as the year has continued to progress. Market activity levels improved across many of our regions over the quarter, reflecting continued progress in the overall recovery from COVID. When compared to the U.S. construction put-in-place statistics, our revenue growth continued to outperform the reported activity levels in nonresidential construction put-in-place year-over-year. Q3 market activities was supported by approximately $14 million in emergency response work related to Ida that I mentioned earlier. This compares to approximately $7 million last year. Severe weather events continue to highlight the need for strengthening North America's critical infrastructure. We are also pleased with the gross margin and EBITDA margin improvements that have been achieved as 2021 has progressed and specifically as the quarter progressed. As we shared in Q2, we've expected that margins will return toward historical levels as revenue improves. Rob Blackadar, who joined Badger in July as COO, has been a great addition to the senior leadership team. And Rob and his team are pursuing revenue, cost control and efficiency initiatives across the organization to further drive results. The team continues to work hard to recruit and retain operators, which continues to be a challenge in the current labor market. We've seen some labor cost inflation as we discussed last quarter and have been working to implement price increases to offset. We're also pleased with the improved fleet utilization. Revenue per truck per month improved to nearly $34,000 in the quarter, a significant improvement from the $26,600 in Q2 of this year and $28,300 in Q3 of last year. With fleet utilization improving, we are evaluating the ramp-up of our manufacturing activities. We are positioned for a busier fourth quarter compared with last year. With the numerous delays the industry has experienced in projects and nonresidential construction in general over the last 1.5 years, we continue to see pent-up demand across many markets. This demand, and especially the pent-up demand, could positively impact the traditional winter seasonality in some of our Northern markets this year. But of course, what actually transpires will depend on the type of winter weather we experience. This work will need to get done at some point. And as always, we continue to focus closely on activity levels with our customers and reviewing all aspects of our business and operating expenses to manage expenses in the short term while ensuring our service capacity is always in place when needed. Now on to operations. In addition to Rob and his team continuing to pursue business improvement initiatives, Rob is working to strengthen our sales and marketing function at Badger to address the meaningful growth opportunity in the North American nondestructive excavation industry. There will be more to come on this in future quarters. On fleet, during the quarter, we built 4 new hydrovacs and retired 11, ending the quarter with 1,360 units. We've been pleased also with the improvements in utilization, as I mentioned, with RPT, a minute ago. And we are evaluating the ramp-up of production looking into next year. For 2021, we anticipate building 33 hydrovacs, slightly above the previously shared build range of 20 to 30 units for the year. We continue to plan to retire 60 to 70 units this year. As in the past, we plan to provide more details on anticipated 2022 production and retirement ranges along with our Q4 disclosures. And now I'll turn things over to Darren to take us through our financial results.

Thanks, Paul, and good morning, everybody. Our revenue in the quarter was $171.8 million or about 15% higher than prior year when normalizing for changes in FX. Gross margin was 27.4%, a marked improvement from gross margins of 19.2% in Q2. As Paul mentioned, Rob and his team are continuing to pursue other cost control and efficiency initiatives across the organization to return gross margin levels to levels achieved last year. I should also mention that our direct costs in the current year included the benefits of $2.8 million in COVID-related government assistance in Canada compared with $1.9 million last year. G&A expenses were $11.2 million, which includes approximately $2.1 million in onetime costs related to our strategic initiatives to enhance our organizational design and management structure. We continue to anticipate our 2021 G&A run rate expenses to be approximately $40 million, excluding onetime costs related to these initiatives. Of course, we always review costs for additional efficiency opportunities. Adjusted EBITDA for the quarter was $35.8 million, again, a marked improvement from adjusted EBITDA of $14.4 million in Q2. As a percentage of revenue, adjusted EBITDA margins improved to 20.8% in Q3 from 10.6% in Q2. We're also reviewing all G&A costs across the organization to support more efficient operations and return to prior year adjusted EBITDA and adjusted EBITDA margin levels. Now on to the balance sheet. Badger maintains a focus on ensuring the strength of its balance sheet and its financial flexibility. We have continued to make meaningful progress in accounts receivable management, particularly in the collection of long aged receivables. As at the end of the quarter, approximately 75% of our receivable portfolio was aged less than 30 days. We also renewed our syndicated credit facility for a 5-year term, providing us with a total of $400 million in committed credit facilities, with a flexible financial covenant, ensuring that we have the financial resources and the capacity to fund both near-term and long-term growth and thoughtful capital allocation. I'd also like to highlight a couple of changes coming in 2022, which you may have seen in our earnings release last night. Effective Q1 2022, reporting will begin -- we'll begin to report our results in U.S. dollars to improve the comparability of year-over-year results and to minimize the foreign exchange fluctuations, given that approximately 80% of our revenues are generated in U.S. dollars. We will also be changing the frequency of our dividend payments from monthly to quarterly, effective with the March 2022 dividend. This will simply -- simplify the administration and the dividend-associated costs. I'd like to turn the call back to Paul for some final comments. Paul?

Thanks, Darren. So just before we open it up for questions, a couple of quick comments. Q3 continued our recovery from COVID, with activity levels picking up, and we are able to put our people to work effectively and generate better results. We're very pleased with that. We remain focused on our markets and customers, managing expense levels while ensuring that we have trucks available for our customers. Our view of the significant long-term U.S. and Canadian opportunity for nondestructive excavation services and Badger's growth prospects is unchanged. We believe that increased focus on infrastructure in the U.S. supports demand for nondestructive excavation over a long period of time. We stand ready to help maintain and strengthen that infrastructure and also support the need to adapt infrastructure to newer and sustainable technologies. Badger's business model, our operating scale and flexibility, our diversification of end-use and geographic markets, combined with our operating track record across all stages of the economic cycle, all support achieving our long-term growth aspirations. We're making the business moves today to position Badger to take advantage of this long-term opportunity. And in the past, Badger has always managed for the long term. So with those comments, let's turn it back to Francie for questions.

[Operator Instructions] We have a question coming from the line of Daryl Young from TD Securities.

Just the first question around the margin outlook and the direct labor as we head into Q4 and Q1. Obviously, those are seasonally weaker periods. And I'm just curious if you want to share what kind of magnitude of margin impact you think would exist just as we carry the higher levels of labor through that over a few years.

Yes. No. Great question, Darren (sic) [ Daryl ]. You probably were in our Board meeting yesterday, but certainly a real focus of ours. And Badger has traditionally had a seasonal business where Q4 and Q1, because of the cold weather states and provinces we operate in, have lower volumes. So we're very closely focused on managing direct labor to volume in those cold weather periods just like we have in the past. Last year, it was a bigger challenge because we were also trying to gauge recovery from where COVID was bottoming. And if you recall, the market activity with COVID really did bottom about last -- this time last year, October, November. So we had multiple factors underway to manage. But from my view, this year is getting back to more of a traditional winter season with continued COVID recovery growth. But we have a lot better run rate right now going into this winter season and a lot better visibility about where the COVID bottom is. I mean that's obviously behind us now. So we're thinking about managing it more like we have in past years, where our local and regional folks are very focused on that. And Rob and his team will certainly be very focused on that. So a much better set of circumstances with better visibility this year.

Okay. Great. And then on the emergency response work, it's great to see the contribution that Badger was able to make. I'm just curious if you'd be willing to share what the EBITDA contribution of that was. I mean it was about 8% of revenue. But just -- I think it's historically been higher margin work from emergency response.

Yes. I can comment. Historically, it has been higher. It continues to be. And this is a capability that Badger has that no other company in our business has. And I could not be more pleased with the performance of our operations team, led by Liz Peterson and her group in the Eastern U.S., to take advantage of this. It's a unique service we provide to our customers and a huge differentiator in the electrical utility customer segment for us.

Okay. And then one last one, just with respect to working capital. As you move into next year and hopefully much higher activity level, how big of a working capital draw would you anticipate, Darren, moving to the next year?

I don't think I would see much of a big draw. We've been -- we've really cleaned up the -- both the credit granting and the collection procedures, so it's the -- and cleaned out all of the aging buckets. So we turned the receivables. And we've shortened the cash collection, our cash conversion cycle quite a bit. So at the maximum, I'd look at probably 15 to 30 days worth of sales, which would be your ramp-up of working capital requirement. But like I said, like the way we're managing our receivables now is night and day from where we were not too long ago.

Your next question comes from the line of Jonathan Lamers from BMO Capital Markets.

On the U.S. gross margin percentage, about 24% this quarter, on revenue per truck, close to $37,000. Can you help us bridge that gross margin to historical periods when it was 8% to 10% higher at times when RPT was this high? I understand that there's been a lot of price inflation since then. So utilization is probably still too low compared to what the RPT would suggest. But can you help us bridge the rest of the gap there?

Yes. Great question, Jonathan. In my mind, it's pretty simple. We've still got work to do in our cost structure and passing through factor cost increases in our pricing. And we did make really good progress in the quarter. But there's still work to do, and we have lots of focus on that and our operations team. But we are very confident that as we continue to have the advantages of higher and steadier volumes more traditionally and we've experienced historically, that we'll continue to drive those margins back toward those historical trends. But fact of the matter is we still got work to do, Jonathan. I'm not going to beat around the bush.

Fair enough. On the pricing, Paul, are there any indications that you have that the ability to pass through pricing is improving? I'm thinking about maybe MSAs you might be setting up for next year, for example, compared to prior year MSAs or just normal course work into October?

Yes. Well, there's certainly opportunities when MSAs come up for renewal. So we'll be looking at that and are looking at that very closely. And on the other side is, with Rob coming in, great background in marketing and commercial strategies, so we have some fresh eyes at the table, which is certainly going to benefit us as we go forward. I can tell you there's lots of focus on it, especially with the cost factors that we've seen in fuel and labor. So lots of focus on it. And it's certainly a very significant business improvement area for us, and we're all over it.

The driver shortage situation is something facing many industries in the U.S. There's an article in The Wall Street Journal this week saying the U.S. is short about 80,000 drivers. Is there anything that you can do? I know over time -- it was a major issue this quarter. Or do you just -- is it really that margin will be depressed until the labor situation improves?

Yes. Well, the labor is, in the short term, going to continue to be a challenge. And we're pulling all the levers that we have available to us. You asked a very good question linked to labor a minute ago, which is what type of pricing opportunities are there. And we're convinced that there are a number of opportunities in that area. And the other thing we're looking at longer term is the design of our trucks and the type of trucks and the type of drivers required. Early days, but this is something that we think about very closely because we design our equipment. We're vertically integrated, and we design it to use it. So we think about things like labor cost when we design our equipment because that's a much bigger expense year-over-year than the capital cost in the trucks. So we're looking at longer-term things on truck design to help expand the driver pool. So more to come in the future on that, but it's an advantage that Badger has that we're working on.

One last question for Darren, if I can. The strategic investment expenses, I believe part of that is related to the legal reorganization. Could you expand on what those are and whether there's anything that will be relevant for the business next year?

So the legal reorg, there's broadly 2 components to the -- 3 components that we're doing to the work. One is the legal reorg structure. The second is expanding our shared services model now with -- specifically with HR and with -- not-too-distant future, with the back office support of the operations as well. And then the final component is working on the implementation of Rob's target operating model for sales and marketing operations and fleet, which is pretty exciting. And as Paul mentioned, we'll share some more stuff in the coming quarters. But specifically, your question on the legal entity reorg, we announced this earlier this year. That's where we're stratifying our structure and purifying the pillars of responsibilities and operations. The primary goal in doing that is to achieve tax efficiency so that we don't have drag on sales tax when we move units around. And then the second, which is a byproduct of that, is removing any kind of obstacles and being able to have fluidity and velocity in our fleet and being able to move the fleet where the demand is needed without having to re-register the vehicles, and like I said, be attached to any kind of sales tax. So that's the background. The cost savings, and I think we shared this previously, we anticipate, on a normalized build program, that we can have a cash tax savings of around $6 million a year. That is a combination mostly of sales tax. But there is a small component of income tax that's related to the Hungarian financing structure that we put in place. I'm hoping I covered off your question. But if there is more details, happy to give you more clarity.

And Darren, you did say that the SG&A would be $40 million, excluding those expenses. So is that a fair run rate for next year? Or will some of these continue?

There might be a little bit of continuation of costs, but I think $40 million is the right number. We are looking at some cost and efficiency improvements over -- that we'd like to implement in Q4. So I think probably an all-in run rate of $40 million is a good number to work with.

[Operator Instructions] Your next question comes from the line of Maggie MacDougall from Stifel. [Operator Instructions] Speakers, we don't have any questions over the phone. I'll turn it back to you for the closing remarks.

Okay. Thanks, Francie. On behalf of all of us at Badger, we want to thank our customers, our employees, suppliers and our shareholders for your ongoing support that helps us all drive Badger's success. So Francie, you can end the call, please.

Thank you. And ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.