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

Welcome to this session. We are very pleased to have Dycom with us. We have Steve Nielsen, who is the CEO of the company. We do have some disclosures at ubs.com/disclosures. Please check them out. They can give the information on any nature of the relationships between us and the companies that we're talking about today. So Steve, thanks for being here. Maybe you want to just start off and give just a very brief profile of the company, highlight the opportunity that you see ahead and specifically, how does your strategy kind of blend with the opportunity you see ahead?

So Steve, just before we do that, we have a slide coming up to just remind everybody that we, in the course of this discussion with Steve, we may make some forward-looking statements, which are subject to risk and uncertainties that may cause future results to differ materially from those statements. And we recommend that you review our safe harbor in our SEC filings. But with that out of the way -- a little longer than your disclosure, Steve. So we provide engineering, construction and maintenance services to wireline, telephone and cable companies and wireless carriers. We do a few other things in addition, but a little over 90% of the business is targeted to those industries. And as we thought about the strategy of the company over the last 25 or 30 years, it's really run in parallel with the growth of traffic on communications network. So I go all the way back to first-generation dial-up Internet access, where we had a big part of the business, which was installing second copper lines to homes. For those of you who might remember, so that when somebody signed up for AOL, they didn't monopolize communications. So think about the -- how simple the network was in those days. And then as that traffic has grown in the last -- I saw some industry data, as it's grown something like 25% to 30% on a compound annual growth rate over 25 years that, that growth in traffic has generated 2 opportunities that we have built the business around. First, with that level of exponential growth, there's always going to be an opportunity every so often to upgrade either the type of the network, so from copper to fiber; or the capacity of the network. So for a coax fiber network, pushing fiber deeper, installing smarter electronics; or in wireless going from 2G to 3G to 4G to now 5G technology. So that kind of communications growth, traffic growth drives opportunity around capital investment. The second trend that is, I think, somewhat underappreciated, is as we've all migrated so much of our lives from analog physical forms to digital forms, all of that migration of information from analog to digital goes on the network. And so that means that we are all looking for reliability in a way that we would not have even 20 years ago. So for those investors who've had one-on-ones on the 11th floor, I think the universal complaint is very poor WiFi access. Well, if I was doing this conference 20 years ago, people would not have worried about WiFi access. And so I just think that the centrality of the network to the way we live means that our customers have to provide highly reliable service, and that requires maintenance of the infrastructure that we install. So really, that's the 2 strategic drivers, those 2 strategic opportunities that are enabled by the growth in traffic over a generation.

And so as you're building on that, talk a lot about fiber opportunities. Over the next few years, it's also cable. How do you see the kind of the specific opportunities developing? And are you targeting certain aspects of the market more so than others? [ Anything ] for regions? Are you trying to be a little more specific in your focus area? Or do you just approach the market at large?

So at a high level, we have always been over-indexed or focused more on wireline than wireless. We do have about -- right now, about 5%, 6% of the business that is providing services to the wireless carriers. But our primary focus is on wireline. We'd like some more wireless open due time. We hope that, that happens. But when you look at the wireline business, the installation of fiber to replace copper, the creation of more capacity on fiber coax networks through more fiber and more intelligent electronics, it is really the way we see the next 8 to 10 years. And to zoom out as kind of the overall opportunity, sources differ, but we use typically about 140 million homes in the U.S. And of those, we think, ultimately, something like 75% or 80% of those homes, so think about urban and suburban America, will be passed by at least 1 high-capacity fiber optic network. We think that, that's where the trends are. We think for those companies who have been deploying fiber the longest, that's where their terminal penetration rates appear to be headed. So if you take today, that means something like 110 million homes, ultimately, will be served with at least 1 fiber optic network. And today, I think the numbers are something just short of 60 million homes, which is a result of about 20 years' worth of effort. And so we see over the -- let's call it, 8 to 10 years, we see that doubling from where it is today to that number, so as much in the next 10 years as the last 20, so a doubling in the rate. If you look at the remainder of the country, the pandemic has been very clarifying as to how important adequate residential bandwidth is or whether it's remote learning or medicine, just how important it is in rural America. And so there's been a number of pools of public capital that have been dedicated over the last 3 years to deploying to the other, call it, 15 million to 20 million homes. And what's interesting about that is if you think about that, that's the portion of the country that really has not been the focus of anyone's attention because of the lack of density, just the expense of deploying network to a part of the country that may only have 8 or 10 homes to the mile versus 50 to 125 in suburban America. And so through a result of the CARES Act of April of 2020, RDOF, the Rural Digital Opportunities Fund of, I think, January, February 21, ARPA in April of '21 and then a whole host of state funds and then all leading to the broadband equity access deployment element of the IIJA, there's just huge amounts of public capital going to that portion of the map, as we look at the map, that really had not had a dedicated pool of capital to enable broadband. And so you can quibble with the cost per homes passed a little bit this way or that way, but at least in my mind, we think that, that public capital really has doubled the addressable market over the entirety of the country because those 15 million or 20 million homes will cost at least as much to deploy fiber to than the remaining, call it, 50 million, 55 million homes in urban and suburban America. That's a big deal.

You talked about 8 to 10 years for the remaining homes that have not been passed outside of this 15 million to 20 million. How do you see the timing differences between how that 15 million and the other homes would play out?

So there's lots of the public funding that's already in the marketplace, so the CARES Act funding from 3 years ago. The states collectively have appropriated out of their own funds, separate for many federal programs, something like $18 billion. And so that money is working its way into the system. And so I think the right way to think about the [ BEAD ] of the federal fund, which is about $40 billion with a statutory match of at least 25%, so about $50 billion of public and private capital at a minimum, I think that comes into the marketplace, continues to line up into the right, but in some ways, will be offset some of the natural slowing under the prior programs. And so I think that's good for us. I think it's good for the country that it comes in and takes a very substantial program and extends it and makes it larger, just insofar as the BEAD program is probably in line or bigger than all the other programs in total program to date.

So we're 4 months into the year, what has surprised you both to the positive and the negative this year?

I don't know that surprise is the right way to think about it. I've been doing this a long time. I try not to be too surprised. I think we've gained confidence that the customers that are committed to that, 75% or 80% of America see the deployment of fiber as absolutely strategic, something that can modulate over time. That's the way big programs are, even DOT and Defense spending and everything else moves over time. But that, that ultimate goal of getting there is an objective that I wouldn't say is beyond question, but certainly subject to very little question by the folks that are -- have these programs underway. And so I think we're encouraged by the durability of the strategic focus on the importance of fiber. And our customers are very good at explaining how important fiber is to the future of their businesses. I think we're also encouraged in a development that over the winter, where we saw the cable operators become very clear about their path to what they call the road to 10G or 5G, so their plans for improving their network capabilities to keep pace or maybe even get ahead shortly on fiber, show a broadening of the base. And then again, just the continued commitment by the states to fund rural broadband with their own funding. Sometimes you can have these big federal programs and everybody pays attention to the headline. But when you have a state like North Carolina, that I may have the numbers wrong, it's either $700 million or $800 million of their own funds committed to closing the digital divide and deploying high-capacity networks in rural America, I think that's really indicative of how much value the folks who live there see in the services that we provide. And I think that's encouraging.

That's great. You mentioned the BEAD program. Can you talk a little bit more about how you see this playing out over the rest of this year and then next year?

So the way the BEAD Program was designed is the first element of the program is to get a good map of those locations in the country that are unserved. And by unserved, that meant unable to receive at least 25 megabits bandwidth down and 3 megabits up, or after that's determined underserved, which is network unable to support 100 megabits down and 20 megabits up. And so they've been going through a pretty extensive mapping process. The latest iteration of the map came out a couple of weeks ago. The final map is due the end of June. Once the map is completed based on the relative percentage of that pool of unserved locations by state, then the money will get allocated. And so they haven't quite got all the numbers. There's lots of speculation about who gets how much, but these are significant programs in a number of states, really, across the country. Once the money is allocated, and I may get the details just off a little bit, but I think by the end of the year, about 20% of the funding is actually dispersed to the states once the state broadband offices need a number of things that they have to do to demonstrate for the federal government and then a year later, 80%. And 20% of the big numbers, a big comfort, 80% is a really big number a year later.

And just to clarify, when we think about this BEAD program, is that specifically designed for rural opportunities well or it can be urban...

Theoretically, there could be unserved homes in urban America. I think there'll probably be some investment there. But the way most people are thinking about these programs and certainly around the allocation to the state offices, it's predominantly seen as a rural initiative.

And so as you approach this business relative to the work that you've done in the past, which has, I guess, been a little bit less on the rural side of things, does it require a bit of a different approach or investment from your side?

So interestingly, Steve, historically, activity in the service business around infrastructure over indexes to where population is. Now maybe not big downtown urban environment, so not so much New York City or downtown Los Angeles or Chicago, but generally towards urban and suburban portions of the country. That being said, we've always had a pretty significant maintenance business, particularly for the home companies, in rural America. And so we certainly have infrastructure and a familiarity with those markets. One of the things that comes up in these rural deployments that is just table stakes, you have to understand is that if you're going to go deploy a couple of thousand miles of network in a rural county in the middle of Nebraska, the labor is not going to be available locally or anywhere nearby. And so you have to have both the ability to train the labor that you can secure locally as well as move labor around. And so we have some training platform schools, where we bring folks in and we'll train them and then move them back from project to project. And that's something that in rural America is certainly something that other industries have dealt with. If you're building a transmission line or a pipeline across Nebraska, you have the same issue. You have to bring the labor in. But other than that, it's not materially different than what we do in other places, the technologies for installing the fiber optic cable for splicing it for all of the ways you manage the project really don't care whether it's rural or urban, suburban.

Okay. So no major step-up in CapEx in particular to these projects other than what you would just invest in?

What we invest in, if it's not useful on a rural project, it's as useful in a suburban project.

Okay. Got it. In terms of the overall customer share of wallet, how would you describe the diversity of services in your mix today versus a few years ago? And where do you see that kind of going forward?

So when you do rural deployments for smaller providers, there's typically a greater opportunity to perform some of the technical services around splicing, not always, but certainly that's an opportunity. Some of the smaller carriers have more ability to outsource. And so we get a bigger portion of the budget dollar that flows through to outsourced services. And then finally, as we deploy more and more infrastructure that's constructed underground, that just requires more labor per mile to do that type of work versus the installation of cable on telephone poles. And so that's just something that is just natural to that evolution of the business that it becomes more labor-intensive.

And were you speaking call to the rural opportunity there? Or what about for your established business? Are there more maintenance services opportunity? You've talked a little bit about that in the past.

Sure. So one of the interesting things is as you deploy more infrastructure in the ground, and if you go back to our -- the beginning of our conversation around how important the network is, there's clearly increased opportunities, the more infrastructure that you place, the more maintenance there is because there's always in this country, there's highway projects and bridge projects and new sources of demand like subdivisions or office buildings or shopping centers, where all of that incremental economic growth that takes place where you've installed more network means there's more to maintain and more to move around. And I think that's something that as we have more people deploy more network, there's more maintenance opportunity, there's just more on the ground.

And do you see that becoming more of a material thing that we'll hear you talk more about over time?

I think that's always been core to the business. That's the essential element of a master service agreement, is a commitment to do everything from constructing new network to repairing the existing network, to dealing with things like unfortunate circumstances where an existing cable or conduit system may be damaged and somebody has to repair it. So I think that's really in the core DNA of the company. We've had some contracts. Literally, one contract we have serving a phone company in the Southeast. We've had continuously since 1954, except for one 3-year period in the '80s when they tried somebody else. And if you think about the number of iterations of technology, the number of iterations of customer management, customer ownership because the customers changed over that time, as well as management on our side, I think that just goes to the long-term nature of the services that we provide. Certainly, a network in 1954 is a little different than it will be in 2024.

For sure. In terms of backlog, I think you've been fairly pretty careful in the last year or 2, I mean, maybe always, but in particular in the last year or 2 about kind of how much you put in backlog, how far you want to go out to commit things. Can you talk a little bit about kind of the visibility you have of things coming into the backlog? Should we expect that there's going to be any type of inflection? Or is this more sort of a controlled kind of quarter-by-quarter modest growth as this opportunity plays out?

So the way we think about backlog in the service business and because it is a service business, it is not a big individual project business for the most part, is we look backwards to calculate a run rate and then we extend that run rate towards the remaining term of the agreement. And so by definition, you have to think about -- as you enter into agreements, you've got to think about your forward costs. And nothing like the last couple of years have caused the industry to refocus not on exactly what it would cost to do something today, but what do you think it's going to cost a year from now, 2 years from now, 3 years from now? And I think that, that focus on the future has been helpful for us to make sure that when we commit to a customer that our view of the future will allow us to serve that customer well. That doesn't do anybody any good that you provide a solution to a customer that has a short shelf life. That's not good for anybody. And so we've been careful to make sure that we can think about the future in the right way. There are some contracts where we get some inflation protection, that's always helpful. There are others where we can revisit certain items that, that's really important. And then there are others where the term of the agreement, we have to factor in the current cost climate and again, what we think the future is. I think we've been working through the backlog on a steady basis. We're not there. But that's okay because this is a long-term business. We're here to serve customers for long periods of time. And we found that historically, in periods of increasing costs, they've been fair with us, and we try to be fair with them.

Okay. Fair enough. Obviously, a very big broad opportunity to play out over the next, you talked about 8 to 10 years. It will require a lot of labor. To what extent is labor a restraint on growth? And how is your labor sourcing changing? Are you doing anything differently? Do you feel the need to do anything differently?

So it's interesting, Steve, in a service business, no matter what line you're in, if you're in a 4% or below unemployment environment, it's going to be difficult to source new labor, unless you're attractive on a relative basis compared to where that unskilled or semi-skilled labor can be employed. So clearly, one of the things as unemployment has ticked down in the pandemic is we've had to address starting wages to bring people into the industry. We think once we get them in the industry, if they show a talent for what we do, that they can progress relatively quickly and can earn a pretty competitive wage. But to get people to see that opportunity, we had to compete to get them in. And so there are lots of tools that we're using for online recruiting and social media and a whole bunch of things that are incredibly important with today's younger workers to get them interested in what we do. But at the end of the day, you have to offer a competitive wage in order for them to consider you versus someone else. So I think that's clearly something that we're -- that we always have work to do. I would say that the environment is a little better today than it was 9, 12 months ago, it was really tough. But it is getting a little bit better, but not solved in any way long term. Now, I think in any industry, there's a natural rate of growth in any industry that the investment of internal cash flows can grow capacity. And that -- also the investment in people can grow capacity. When you're growing faster than that because customers would like you to do that, it's almost inevitable that you're not going as quickly as anybody would like, yourself included. But I do think that over time, if you lean into it and continue to make investments in growing capacity and have the right economics to fund those investments that over time, we can grow. If you look at the 4 quarters ending this April because we're in April quarter, we grew $698 million organically year-over-year. Well, obviously, there had to be some real capacity that was created and labor that was sourced in order to do that because otherwise that would not have happened.

Okay. Maybe lastly on the growth area. To what extent are you seeing any impact from credit tightening?

So I think about credit tightening in a couple of ways. So luckily, we work for very large customers that have pretty substantial operating cash flows. And so there's always a source of investment capital that comes out of their operating businesses. Now we have some smaller clients that are more reliant on the capital markets. But in general, most of the people we work for have an ability to fund some level of capital expenditures out of their own operating cash flow. So we're always encouraged by our customer base when they can do that. That being said, there are certainly lots of people that are being attracted to the industry. And for those that are more reliant on the capital markets, I think that the effort and the higher cost of capital just requires them to be more disciplined in what we do -- in what they do and what we do for them. And I think that's a good thing, long run. An undisciplined 5-year cycle is not better than an 8-year disciplined cycle. We've been through that before. I think in terms of a more direct impact to the industry, there's certainly, particularly for private competitors that historically have banked in the community banking, I think they are challenged to get growth capital from the traditional bank markets, have probably fine with the levels that they're at, but more difficult to raise incremental capital. And I think that's just a natural evolution of where interest rates are. The other constraint that cost of capital has impacted is we are making capital commitments to buy trucks and printers and directional drills and aerial placing units much earlier than we would have prior to the pandemic. And I think that becomes more difficult in an environment for private companies that are relying on bank capital, where it's a little more difficult than it was even 6 months ago.

Got it. Shifting gears a little bit. In terms of margins, can you talk about some of the things that you're doing internally to help overall improve the business, but in particular, improve and drive margins?

So we've always focused on things like productivity and safety. When you're in a service business and a hazardous occupation, there's no level of productivity that's worth for safety, and there's no level of good safety that if you're not productive, that will be successful. And so we always think about those two initiatives together. We're constantly refining not only how we produce the product we do, so upgrading our capital equipment, but we're also looking at how we can incent the folks that work for us and how we can do a better job in the field for the customers. Because just as safety without productivity doesn't work and productivity without safety doesn't work, neither gets you the next job if you're delivering poor quality. And so those are always the things that you work on. I think as we've scaled the business now to approaching $4 billion in a fairly focused way, I think there's some scale of opportunities for us to take cost out of our -- the administrative part of the business, both in the field and in the back office. So we've got a number of initiatives there. We have tools where we record field data on iPhones and iPads in ways that at least we have not been able to define commercially. So we've developed them ourselves. And so I think you just always focus on ultimately, what's good for us is what's good for the customer. And that's where the focus is.

Okay. And in terms of maybe outside of your internal efforts, maybe can you just discuss some of the market conditions that would allow for margin expansion? And I know you've talked before about margins being able to get back to where they were historically. What are some of the factors that you need to see those margins...

So largely getting margins in the right place is a function of having fairly ubiquitous operating leverage. So there are times where you can have good organic growth as a whole. But if you have large shifts in terms of some customers are growing quite rapidly and others are declining, the net of that is less operating leverage than if you have good growth across a broader array of customers. And so we're always doing -- always looking at how we can spread the business, the growth opportunities across our business units, across geographies, where -- we don't work in Alaska, but -- and have a small presence in Hawaii. But other than that, we do address work in the lower 48. And so we always want to make sure that we're matching our capabilities with customer growth opportunities in a way that we can do well for the customer, so meet their expectations, and they have high expectations and should; and at the same time, match that up with where we have resources. And so it's always encouraging when you can increase what I call revenue density per square mile. So if you can grow with an existing customer, inside your existing footprint, that always leads to better operating leverage than when you're planting the flag someplace new.

And with that in mind, how do you see that revenue density per square mile opportunity set in the next couple of years? Is that...

Well, if we look back over the last 7 or 8, it's probably 2x what it was because the company has doubled in size. And I think given the opportunity set, we continue to grow, have -- certainly have great opportunities for growth looking ahead. And there's always areas that we could expand geographically, but at least the distance with which we have to travel is less now than at any time in the company's past.

Very helpful. Any particular factors restraining margins at this point? I know there was a period of time that inflation was a bit of a drag. Anything else that you kind of see as a restraint at the moment?

We're in a very competitive industry. Customers expect to pay a fair price and not more than that, and we understand that. And so it's always a balancing of the economic flows that we need to support the growth of the industry and of the customers versus a reasonable expectation on their part that we earn a fair return, but not too fair a return. And we understand that, having been in the business a long time. So I think it's a balancing act. We have good returns on invested capital. We have good returns on equity. Obviously, we'd like them to be a little bit better, but we'd also like to sustain them for a very long period of time because I think ultimately, that's what creates value for shareholders.

Okay. Great. In terms of cash flow, you had a couple of nice years of cash flow the last 2, 3 years, I guess, I would say. And then it's come down a little bit. I'm guessing some of that has been a function of just growth in working capital needs, maybe a little bit of CapEx. How do you see this trend of cash flow over the next couple of years?

So just strategically, the way we balance the business and the way we invest in the business is as we're growing EBITDA, we should be growing that EBITDA more quickly than we're investing in working capital and fixed assets. And so over time, we should delever the business on a ratio basis, not on an absolute quantum of debt basis because our customers expect us to invest in supporting their initiatives. And in order to do that, we're going to support accounts receivable and work in progress. We're going to support a growing CapEx budget. But what that means is there are other periods of time where for whatever reason that growth slows and then because of the way we've structured the business, then we generate lots of free cash flow. We pay cash for our capital assets. We have a 5-year note coming due in April of 2029 and then a term loan. So we're not heavily indebted. I think last quarter, we were something like 1.8, 1.85 in terms of net debt to EBITDA. And so when we're growing, we should be investing, that ratio should decline over time. But it doesn't mean we're going to generate free cash flow because we're investing in the business to support its growth.

Got it. In terms of capital allocation then, what are some of the closest adjacencies to your business? And you've basically had very little interest in M&A, so...

Well, we've had a lot of interest in M&A over the years. I think we've -- in my time, we've acquired 48 different businesses. So we have done a fair amount of M&A when the time was right. The first thing that we always want to make sure we do is that we have sufficient capital to support the growth plans of our customer. You never want to have to go to a customer and say, "I'd love to invest more in growth with you, but I did some other capital allocation away from organic growth that's not supportive of being able to do that." So we always want to make sure we can support organic growth. And then we'll look opportunistically between M&A and share repurchases. And that's a relative judgment. Although when you're buying back your own shares, you don't have integration risk, you don't have point-in-time financing risk. You don't have lots of things that do come with M&A. And so I think we take a balanced approach. Again, when you're growing almost $700 million over the last 4 quarters, we want to always make sure that we can support that with the right levels of capital.

This is obviously a very robust opportunity again over the next 10 years or so. It does seem to be drawing a number of additional competitors. How do you see that competition landscape changing? Are the bidding processes changing at all that your customers are going through? How do we think about sort of competitive opportunity or competitive challenges?

I think any time that we do well or others in our industry do well, you're going to attract competition. A long time ago, when I was -- before I was CEO, I was complaining about new competitors coming into the market. And my CEO at the time said, "Well, you can fix that." I said, "How is that?" He said, "Just do less well." I think we can probably deal with the competition. We don't want to do less well. So I think it's natural to do that. Competition is good. It keeps you sharp. It demonstrates your value, on a relative basis, to others. The customers have lots of very finely tuned administrative systems, the way they like to operate the contracting process, and those have been pretty stable. It doesn't mean they never change, but the overall level has been pretty consistent over a long period of time.

Great. Well, with that, we out of time. Thank you very much.

All right. Thank you.

Thank you, everybody, for joining the session.