Dycom Industries, Inc. (DY) Earnings Call Transcript & Summary

Hey. Good afternoon. I'm Steve Fisher, UBS machinery engineering and construction analyst. We are really pleased to have Dycom here with us to wrap up the conference. We have Steve Nielsen, the CEO; Drew DeFerrari is back in the -- back of the room, CFO. And just as a reminder, you can use the question function to submit any questions that you might have. And just before we get started, as always, as a research analyst, I'm required to provide certain disclosures relating to the nature of our own relationships and that of any company on which we express a view on this discussion today. And you can find those disclosures at ubs.com/disclosure or reach out to me. So Steve, thank you very much for being here. Really appreciate it.

Good to be here, Steve.

Maybe if you can just start off giving a few quick minutes overview of the company. And now that we're almost 5 months into the year, how is the year shaping up relative to what you would have thought at the beginning of the year?

Sure. And before we get started, we have our own safe harbor disclosure. Just want to remind everybody that in the course of today's conversation with Steve, we may make some forward-looking statements, which are subject to risks and uncertainties that are more fully outlined in our SEC filings, which we recommend for your review. So Steve, happy to be here. I think the way we think about the business is we made a decision a long time ago to be intensely focused on providing services to telephone and cable companies and wireless carriers. And so we're really focused around providing those services in the U.S. We've at times done a little bit of work in Canada. But today, we're focused in the U.S. And we've really organized the business around the thesis that if traffic on communications networks grows at a kind of 30-plus percent compound annual growth rate, that over time that our customers will -- to take advantage of that growth and to support it, they will go through technology upgrades in the network that are bread and butter and that, as applications, migrate to the network and to the cloud that the value of those networks to consumers and businesses will increasingly -- will increase in value. And that will up the value to our customers of maintaining the network even better than they have in the past. And so traffic growth supported by the migration of lots of things to the cloud has created lots of opportunity for the company over a long period of time. So just to size the business, just reported a quarter, $876 million -- $877 million in revenue. That was up, call it, 20%, a little over 20% year-over-year. We have about 15,000 employees across the United States and really do everything from planning and engineering and design through construction, installation and maintenance.

Great. And so maybe the second part of the question in terms of now that we're 5 months in, how is the year kind of shaping up relative to what you would have thought 5 months ago?

Well, certainly, the first quarter was ahead of expectations. Of course, seasonally, that can always be a little bit of a challenge because with an April quarter, it's always back-end loaded. But I think we're pleased with what we see. I wouldn't say we're surprised. I think last year was really a year where a number of our clients made very clear their strategies around fiber deployment in particular. There were -- there was a -- one strategic transaction where one of our customers, Lumen, has an agreement to sell about 20 states of their franchise territory to Apollo in a new venture called Brightspeed. I think that was helpful last year to both see that as well as Lumen's commitment to a pretty substantial fiber program. And then on the -- also last year, the emergence of Frontier out of bankruptcy and really a laser-like focus on a fiber deployment strategy to create real value out of the reorganized business. So I think things are tracking this year the way we expected. And of course, the third thing that occurred last year was the Infrastructure Investment and Jobs Act, which is the largest pool of federal support for the deployment of communications networks across rural America that we've ever seen. And so I think that's still developing. As with any government program, it takes a little bit of time to get it wound up, but it is a tremendous opportunity.

Okay. So you just mentioned a few areas, but there are definitely a number of areas of growth that you see. How unique would you say is the opportunity that you see ahead of you in its breadth and its scale relative to what you've experienced in your tenure with the company?

Yes. I think and we've talked about this on our calls. There's a real strategic clarity around customer spending plans around the network that I would say the last time that the entire industry had a very similar view about what they should do around network deployment, it was probably in the late '90s. In that period of time, in the '90s, the cable operators were aggressively upgrading their plant to facilitate broadband access to the Internet. The phone companies were doing DSL and not -- a part of the network that we deployed, but there were certainly lots of activity. There was lots of fiber deployment point-to-point, city-to-city. And so I guess what I would say is we always think about when customers think strategically about network deployment investments. And when we can provide those services at scale to facilitate those plans, that's a good time to be in any industry.

Okay. And you mentioned you grew 20% in Q1. You're calling for order of magnitude something similar to that in Q2. Would you say this is really kind of an inflection point for the company as you see this opportunity ahead?

Well, certainly, from a growth perspective, I -- last -- in the October quarter of last year, we grew at 6% organically, a little over 10% in the January quarter, now 20%. So 6%, 10% and 20%, that sounds like a pretty textbook definition of some inflection. But at the same time, we are continuing to see lots of potential growth catalysts that we can see, particularly on the rural side, entering into the business even as we go ahead the next 12 or 18 months.

We were talking a little bit earlier today about sort of the layers of the cake. And maybe you could just kind of describe that and how you see this opportunity playing out? Because I think a lot of people think AT&T is important customer, but there's a lot behind that, that can...

Sure. So one of the things that we've observed over periods of time in the business is that investors oftentimes think of a discrete set of catalysts. And then, let's say, they come up with 5 catalysts for any business, but certainly our business. And then they try to keep score on how we're progressing against those catalysts. And when 1 catalyst seems to be slowing or perhaps rotating out of the business, their presumption is there's nothing coming in behind. And what I've seen over my career is that there are lots of surprises when you're in an industry that has, as its fundamental foundation, this growth on networks, this growth in applications, this growth in analog, physical applications going to the cloud and going digital. And so what that means is that we have seen what I call the layer cake of opportunity where you have a layer. So let's talk today the growth that we saw last quarter with AT&T, Lumen and Frontier as a catalyst or a foundation for the growth in the business as well as the growth that we saw with rural electric utilities that was 47% as a group in the quarter. And we look ahead and we're not providing guidance for next year. But certainly, if you look to what all of those customers and industries have talked about, they talk about next year being bigger than this year. And then you sit there and say, okay, we have a foundation of the cake that's there and growing over time. And then we think about our wireless business, which is -- last quarter was about 6% of the business, down slightly. We think that will be up nicely in the second half of the year. We see some good opportunities around C-band deployments in '23 and '24. And that's another layer in that cake of potential growth opportunities. And then finally, the opportunities around rural, which are not only the federal infrastructure act in facilitated investments, but the FCC's Rural Digital Opportunity Fund as well as a number of state-level broadband funds that right now in aggregate are in excess of $12 billion or $13 billion, separate and apart from the $42 billion that's been set aside in the Infrastructure Act. So lots of layers to the cake.

Quite a bit of opportunity. Maybe you can talk about -- I think a lot of people do get focused on the telcos. What about cable companies? Do you see them as sort of an important capital spender on fiber coming forward?

So the cable companies have been very clear. They are fearsome competitors. They've had great flow share for beyond a decade now around residential and small and medium enterprise businesses. They believe through a new protocol or newer protocol called DOCSIS 4.0 as well as some technical services that they'll be able to grow the capacity of their existing network with a modest amount of construction. So certainly, those are folks that we work for. There are some opportunities there. But from a construction standpoint, the cable operators and probably because they're blessed with some pretty robust infrastructure, that's the result of literally decades of investment, they have a different path to get there that they've outlined in their investor presentations.

Okay. So in your base case thinking, it sounds like that's not necessary...

Well, never say never, but that's the view that they've been expressing.

Okay. Makes sense. How do you think about the longevity of this opportunity? And we talked about multiple layers. And I mean is this a decade do you think there's visibility to? Or is it kind of curve over time?

I think, historically, if we look at the industry as a whole and our business, too, it tends to be a sine curve with an upwardly sloping trend line. So you like it all to be linear and tightly correlated and just be up into the right, like every other public company. But I think what we've seen is that because of the traffic growth, because of the changes in technology and because of the migration of applications to the network that it continues to grow, but with some -- there's going to be some volatility around that trend line. In terms of longevity, one of the interesting things, the government support through both the FCC, the state and the federal government, is it's opening up the map of the entire country to investment in telecommunications networks. So if we look at, call it, 20 million to 30 million homes passed, out of roughly most people estimate around 140 million, those 20 million or 30 million [ apps ] in a subsidy were really tough for private capital to serve. Very low densities, 8, 10 homes to the mile. That means that cost per home is quite high, even though the construction in rural America can be cost effective, but just not as many homes spreaded over. And so with the addition of the subsidy, the 3 subsidies actually or 3 sources of funding from the government, that's really opened up that map in ways that we've just not seen in anywhere near the same magnitude. And so we think that the opportunity in rural America, if you do the arithmetic, is probably less homes, but about the same or maybe even a little more potential opportunity for us is building out the next 50 million or 60 million homes in suburban and urban America with fiber. So it's really opened up the map.

Got it. So maybe we can talk about that rural opportunity in a little bit more. Can you talk about how you see the next steps of this playing out, both from the RDOF opportunity that's already been sort of funded? Where are we in that? And how is that playing out? And then what are the steps to get the Infrastructure Investment Act and Jobs Act kind of funding flowing through the system?

Yes. So the first -- and we're already seeing in the business is the FCC has a fund, the Rural Digital Opportunities Fund, of which the first phase went through an auction process that determined recipients and the amounts that were awarded out of that fund. Now it's been an elongated process to get some of it out the door, but particularly for work that we have seen for electric cooperatives, so these are small rural electric utilities, we've already seen a pretty significant impact in the business. As I said, last quarter, did just under $70 million in the quarter. That was up 47% organically year-over-year. So as an aggregate, something like 8% of the business. So when 8% of the business is growing 47%, that's a good thing. And there is more -- there will be other auctions that come. As part of that process generally, the FCC is creating a national broadband map that will identify those homes that are unserved based on a certain level of bandwidth that's currently not available to them or underserved, which means that there is some bandwidth available but is not really up to, what I would say, is modern requirements. And so when that map is completed, I think it's expected now sometime late October, early November, then that will trigger, not only federal dollars, but also make it easier for both the RDOF and state funds to sit there and say we really want to be targeted where we spend the money so that we're sure that we're addressing the greatest need. In terms of state funds, there's a number of states that have decided that the federal dollars are going to be important to them, but they also have their own resources. And so states like California and North Carolina, Maine, Wisconsin, New York, there's just a number of states that have already dedicated from their own budgets a little -- I think it's $12 billion or $13 billion of broadband funding. We're already seeing a little bit of that in our business. And then lastly, the $42.5 billion that's been set aside from last November's Infrastructure Investment and Jobs Act, which is also contingent on the broadband map identifying where the unserved and underserved homes are because, by statute, that's where Congress wanted the money to be spent. So lots of activity looking ahead that comes there. And all of these programs have some element of private capital, so that it's not just a subsidy where the government is providing all the funds but there are varying requirements for matches or auction processes that encourage private participants to kick in some of their own capital. So there's a leveraging effect on all of the government funds that have been provided for.

Got it. I want to go back to just the broadband mapping for a second. It sounds like October is a time frame where we should get some update, and then it sounds like the funds would flow after that. To what extent is there any sort of political process or controversy around that, that are we going to get to October and it's before an election? And then does that -- is there any -- how debatable is that?

I mean that's a great question, Steven. I don't have any particular insight other than to say when the funding for deployments in rural America was somewhat limited, I think, there was perhaps more potential for differing perspectives on where it ought to go. When there's enough arguably to do everything, then I think it's perhaps less likely. I think there's also great political consensus from both sides of the aisle that this is a good thing for the country. Certainly, the whole digital divide between rural and suburban and urban America has been highlighted by the pandemic in a way that hopefully everybody will be on their best behavior and will be able to get this funding moving. One of the interesting things that I think generally the industry believes is that a number of the incumbent providers of connectivity in rural America today will be active participants in these programs. And that's encouraging for us because through our master service agreements with a lot of incumbent telephone companies, we serve lots of rural America. And those areas have not seen lots of investment for obvious reasons over the last 10 or 15 years, but I think that may change.

Okay. You mentioned the state funds. You're seeing a little bit of that flow through your business. Can you talk about how does that flow through your business? Who is the customer? And is there anything keeping that from being a more robust flow of dollars?

Yes. I think all of the -- and I'll lump together the state and the federal. Typically, these are going to be existing entities. They sometime can be start-ups, but as the most recent notice of funding opportunity that came out from the federal government a couple of weeks ago, there are collateral requirements. There are some reasons to believe that more established companies will have what will be considered actively in the process. And so it's really our customers or other industry participants like the rural electrical cooperatives, who are the recipient of the funds, can be cable companies. Certainly, the cable companies are also very aggressive here. So really, the entire industry. So hopefully, it will be those companies that we have good relationships with, and it's really just incremental demand through established relationships.

Got it. Okay. We talked a little bit about maintenance opportunities, and this came up a little bit on the earnings call. And I'm not sure if this is something you view as a new initiative or a separate service or if it's just something that, as part of your master service agreements, there's naturally menace. Is there any additional opportunity outside of as we think about -- because there's going to be a lot of fiber installation. Is there any other adjacencies or maintenance that kind of gives the business a more stable core and potential other growth avenues?

So our business really is fundamentally aligned around master service agreements. I think last quarter, something on the order of 70% of the business was master service agreements. Another 20% were long-term agreements. So when we think about ourselves as more of a business services provider than a traditional E&C bid and build and then find something else. And some of these master service agreements, I always highlight. We've had the master service agreement that covers the Knoxville, Tennessee area for whoever the phone company was since 1954. They tried somebody else from 1981 to 1984, and we've been back ever since. And that may be a very long relationship, but we have a number of these agreements that are decades long in continuous service. And so what we see coming out of the fiber deployments is to the extent that we have new providers building fiber, say, like the rural electrical cooperatives, they will ultimately have to build maintenance organizations, of which we hope we can be a part because they will have new plan. When we have more plant deployed just generally in the network, every time there's a new bridge or a new lane added to a highway or just unfortunate accident where cables are cut. Because there's more plant in the ground or in the air, there's just more need for it to have it maintained. And then on the fulfillment side, in a business that it looks like it will develop over time, at least a couple of providers in most geographies, there's always churn-related fulfillment activity that grows behind the business. And then lastly, what I would say, and we've seen this at other times, is that we get involved with a customer who has a large fiber deployment. And as we build relationships in new geographies facilitated by that fiber deployment, we say, "Hey, look, we also have this maintenance business." And because we're so intensely focused on our industry, we want to make sure that we get our fair share of that follow-on business that comes after the fiber deployments, even though those fiber deployments are going to take a long time, but geography at a time, we want to be part of maintaining what we've installed.

Got it. So a lot of different opportunities across a lot of different types of services. So maybe shifting gears a little bit in terms of now the operational side and the execution piece. In terms of margins on the last conference call, you said that you want to be better than your historical average as you address these new opportunities that you see. Can you talk a little bit about how you see that evolving? And maybe when that will become evident to investors?

Well, I think we had margins that were up year-over-year. In the first quarter we've guided that, that's certainly possible in the second quarter. And generally, as we have seen broadly distributed growth across a number of customers, which we're beginning to see, that's always been an environment where we can be very careful about matching our capabilities and our ability to execute well for customers to the available opportunities. And when we do that, we tend to get better operating leverage in the business. Oftentimes, it's helpful to us if we have an existing master service agreement, and that particular customer in that geography rolls out a new program, then obviously any time we can increase, what I call, revenue per square mile or the density of the business, that helps us leverage our physical and our administrative infrastructure. And so that's certainly helpful. We have performed somewhat below average. That hasn't been a great place to be. And so we're working hard to address our performance with the caveat that we are in an environment where costs are increasing, particularly around labor, fuel and capital equipment. And we just need to be careful that as we take on work that we appropriately reflect those costs in the way we think about opportunities.

Got it. So investors may be a patient group, but sometimes we, analysts, get a little bit impatient. And so thinking about how the margins might evolve over the next several quarters, and you may not want to put it in these terms, but the way I'm thinking about it is, might we get to a point where there's sort of like a breakout kind of quarter? I know we're talking now about sort of modestly growing year-over-year margins. Might we come to a point at some point over the next year where it's -- becomes a much bigger step-up?

Yes. I always remember a friend of mine who is receiving an Emmy for some new technology, and he said it was a overnight success that was 8 years in the making. So I think the way we look at the business is, you work every day very hard. It's an execution business. I kind of think about it as football, 3 yards and a cloud of dust. So it's a business we're working hard at all these things. The challenge, of course, is somewhat more difficult because of the cost environment. But we do think that we can, over time, alter the mix of the business in a way that's helpful to margins. And I've been speaking with analysts for a long time, and I always remind them. Half the business is below average, and half the business is better whatever we're reporting in the current quarter. And we're going to work hard to improve the bottom half and move the average up. And that's really the way you go about making a business better.

Makes sense. So you mentioned inflation. Can you maybe talk a little bit about how you're seeing inflation in your business and how you're managing that at the moment?

Well, clearly, fuel is something that we called out. Last quarter, I think we called out 58 basis points of year-over-year cost drag, something we're working hard to reduce, idle time, get more efficient in routing, do all the things that probably every fuel-intensive or logistics business is doing right now anywhere in the world. We also have seen some cost push on capital equipment. If you have trucks that have specialty equipment on it, it's made out of steel and hydraulics. It's going to go -- it's gone up in cost. Probably some of your covered universe maybe build some of those things. If you can find hydraulic pumps right now, they all have a home for them. And then lastly, and we started talking about this last year, we want to make sure that we reflect in our own business the current market pricing, particularly for unskilled or semiskilled labor that we're bringing in the door. And that's just something where we're out there competing every day. We're in a good place to work, but we've got to get them there first to make sure they realize that. And so we have to be able to meet the market to do that. And particularly when you're building capacity for a number of customers that have big programs, you really owe it to the customer to make sure that as you're looking to meet their needs that you're doing it in a sustainable way that appreciates the facts of the marketplace. And we've been through this before. And as long as we go about that in the right way, we want to make sure that if we commit to delivering a program that we've got it -- the economics right so that we can deliver. And that's all about making sure you get what you pay folks in line with the marketplace and make sure you're an attractive place to work.

And one of the things you mentioned on the last quarter was, I think, you had 70 basis points of operating performance against that 58 basis points of fuel. Is that effectively a way of saying you're pricing better than your cost at the moment, and that's something you can -- we can kind of carry forward?

Yes. I think the way -- in this kind of environment, it's so important with customers that have strategic programs that we do reflect as we have opportunities with new programs that we make sure that we get the economics right so that we can attract all the resources. No customer wants to hear that we've committed to something and then we can't deliver. We certainly don't want to be there either. And so one of the advantages, and we had some discussion of that on the earnings call a couple of weeks ago, is one of the blessings of the scale that we have developed over time and the talents of our folks that are out running businesses every day is that we have a pretty broad look across the country at where labor costs are going, where the economics of new projects are going. And we certainly have lots of visibility around the cost of capital assets given that we have a budget approaching $200 million a year, which means we have lots of visibility with the OEMs. And so I think that's one of the things that we try to leverage is to synthesize all that data and make sure that we come up with, particularly for new endeavors that we get the numbers right.

Now as we talked about in the beginning of the conversation, there's a lot of great opportunity ahead of you from the end market perspective, and that may attract some investors that may not be familiar with your business model. And maybe you can talk a little bit about operationally kind of what are the things that you're pleased with in your operations. What do you think still needs to maybe be improved a little bit so that you can kind of have a consistency and maybe some new investors coming to the story, kind of, know what to expect or can get some reliability quarter in, quarter out?

So we did a good job last quarter of managing our G&A. I think it was up $2 million, $3 million year-over-year in a quarter where we grew over $150 million organically. So we know how to tightly lever or tightly manage our G&A. We have a number of -- like every business, we have a number of initiatives underway to digitize the business so that we can take cost out. I think, for us, and maybe take a little bit of a different tact, and we've been clear with investors for a long period of time, we understand that when we decided strategically to focus on telephone and cable companies and wireless carriers that we were going to inherently have a concentrated business because our end markets are pretty concentrated. We have a couple of phone companies that represent a pretty significant portion of the country or 2 or 3. We have a couple of cable operators that are the same way. And so, for us, what we've always strategically said is, we'll deal with a little bit of customer concentration risk, which can be expressed as volatility as long as we deliver a premium to the market in terms of margins. Now we haven't been there for a couple of years, but we were there for a long period of time. And so as we get back to doing that, I think that's where we've always come down on the -- if we get the right premium for being concentrated and finely tuned to an industry, then we'll take a few bumps along the road because, ultimately, we get good returns on capital, which allows us to grow the business organically without having to have lots of financing, external financing and also over time has allowed us to reduce share count. So over the last, I guess, 17 years, we've taken out about 40% of the stock outstanding. And so obviously, that creates the risk for some more volatility, right? We'd have less -- nominal volatility in earnings if we had more shares. But I think since -- and Drew would have to keep me straight here. I think our basis in our shares is something like $30 a share. So far, we're pretty good on the $26 million or $27 million we bought back.

Sounds great. I wanted to maybe pick up on the labor discussion again. And I think you've been growing your head count more recently around 6% or so year-over-year. Not calling it an arbitrary number, but looking out, you're doing now roughly $3.5 billion plus -- or if you want to get to $4 billion, $4.5 billion of revenues, what's the -- how do we think about what's the growth rate of labor and head count you need to get to do to get that number?

Yes. And the answer is, Steve, it really depends on the mix of the growth. So we have some businesses that are technician businesses. We typically perform almost all that work ourselves. And so to the extent that they grow, head count could grow faster than revenue growth because those are businesses where every dollar of revenue is something that we self-perform. There are other parts of the business, particularly around civil construction to underground construction, where there is a more ready pool of subcontractors. And typically what we do is we flex the business using a mix of in-house and subcontractors. And then over time, we optimize that mix based on how we move from construction into maintenance and other activities. And so we don't really think about in-house labor as a constraint in those businesses because we have an ability to supplement from the market. On the technician businesses, that's true. There's probably 3,000 employees dedicated to those businesses. And if we're going to grow those rapidly, then we're going to see lots of head count because we don't use any outsourced partners.

Okay. So in the event that we were to continue to grow 15% to 20% on the top line, well, 6% of the...

Maybe another way to think about it, and I'm running these numbers off the top of my head, but we grew about $1 billion organically in our fiscal '15, '16 and '17. I think head count went up a couple thousand, and it was never a constraint. And so I guess, from our perspective, if the economics are right, so that we can create supply at a good return, then we've not seen the ability to manage head count to be a constraint. Now we can't deal with hockey sticks up into the right over a weekend. But if you work at it hard and that's the 1 good thing about -- well, there's lots of good things about our customers. But one of those good things about our customers, these are big customers. They know what it is to staff up. These are multiyear commitments that they're making to themselves and to their investors. And so as long as you demonstrate that you have the training plans in place, you have the ability to grow your head count, both from a craft labor as well as a project management staff that they understand that these are things that every industry goes through. If we looked at our rural electric business, so annualized short of $300 million, that's a business that essentially wasn't there 6, 7 years ago. So we built that entire book of business organically, and we've got a lot of employees that we had to hire in rural America in order to do that.

So just a last question here. Backlog, I know you're being very judicious about how you book a backlog. In this past quarter, you did have a couple of 3-year type agreements in there. Should we expect kind of every quarter to have some of that multiyear-type activity in there?

Steve, there's about a couple hundred master service agreements of all sizes and shapes on the backlog schedule, maybe even a few more than that. And we are careful about the way we bring it in. But it's important to remember, as we talked earlier about these master service agreements, where in Knoxville, Tennessee, we've been there since 1954. So I guess we would have 1 heck of a booking quarter, the first quarter of 1954 when we put up almost 70 years' worth of backlog, right? So it's just a business where we -- it's important. We manage it hard. We don't win them all, right? We don't retain them all. If we did, we wouldn't be optimizing our returns, but we've been able to serve customers for a long period of time. And backlog is one reflection of the durability of those relationships.

Great. Any last message you want to leave investors?

We just appreciate everybody's time and attention. And Steve, good to be here.

Thank you so much, Steve. Really appreciate it.

Thank you.

Thank you.