Arcosa Inc

NYSE:ACA

Earnings Call Transcript 2018-Q3

[Operator]

Good day, everyone. Before we get started, let me remind you that today's conference call contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995 and includes statements as to estimates, expectations, intentions and predictions of future business and financial performance and financial condition. Statements that are not historical facts are forward-looking. Participants are directed to the information statement filed as an exhibit to Arcosa's registration statement on Form 10 as amended for a description of the risks and uncertainties, which could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements.

It is now my pleasure to turn today's call over to Antonio Carrillo, President and CEO of Arcosa. Please, go ahead.

[Antonio Carrillo, executive]

Good afternoon, everyone, and thank you for participating on today's call with such short notice. Joining me on the call today is Scott Beasley, our CFO; Reid Essl, President of the Construction Product segment; and Gail Peck, Senior Vice President of Finance and Treasurer.

After market closed today, we issued our third quarter earnings release, our first earnings release as an independent public company. And we announced the acquisition of the ACG Materials business, which I believe is an excellent strategic fit for our Construction Products segment. We reported most of the details of Arcosa's third quarter earnings results on October 25 as part of Trinity Industries conference call, prior to our formal spin-off on November 1.

Just to recap, our Construction Products and Transportation Products segments both reported higher revenues and operating profit in line with our expectations.

In Construction Products, growth in Specialty Materials and Construction Site Support more than offset the impact of challenging weather conditions in Texas on our aggregates operations.

In Transportation, our book-to-bill ratio in our inland barge business was 1.24 during the third quarter. And increased backlogs as well as strong order and quoting activity point to signs of an early recovery underway in the barge market, supporting our decision to reopen 1 of our 2 idle facilities.

In our Energy segment, after taking a substantially impairment charge due to the divestiture of subscale businesses, incurring an inventory reserve charge related to canceled projects and completing a large manufacturing order that created significant inefficiencies and pressured margins in our utility structure business, we are confident we have taken the first steps in our journey to start improving margins.

We're happy to answer any additional questions you may have on third quarter financial results either on this call or offline, but now, I will move ahead to discuss the new news which is our acquisition of the ACG Materials business, and there is a presentation located on our website that accompanies my remarks.

Let me start by saying that during the spin-off process businesses continue to operate normally, and this includes working on M&A pipelines and processes. Our management team has known the ACG for some time, and we performed significant due diligence, which, as you know, for this type of businesses includes reserve testing and environmental aspects. The due diligence process takes some time to be performed. Last week, after the spin-off was completed, we finalized our due diligence. We are pleased our due diligence confirmed what we had always believed about the value of this business, and we were able to reach a definitive agreement. It is important to mention that ACG was one of the larger investments we had in our pipeline of potential projects. Near term, our team's energy will be focused on a successful and smooth integration.

Now let me explain to you why we're so excited about this acquisition. Please move to Slide #4. ACG is a fast-growing and well-established producer of specialty materials and aggregates, with revenues of $152 million and adjusted EBITDA margin of 21% for the trailing 12 months period ended on August 31. The acquisition is strategically important in multiple ways. From a business standpoint, it adds significant scale to both our specialty materials and aggregates businesses, transforming each one of them into competitive growth platforms. The addition of ACG gives us increased end market diversification, adding energy infrastructure, agriculture, food and pharmaceutical customers. At the same time, ACG provides geographic diversification. Importantly, ACG has a top-notch leadership team that we have known for a long time and who have proven their ability to grow their business both organically and through acquisitions. One of the most exciting aspects of ACG is the list of growth opportunities that Paul, the President, and his team bring to the table.

Moving to Slide #5. You can see how this acquisition aligns with Arcosa's long-term vision and the stage 1 priorities that we have shared with investors over the last several months. In terms of our long-term vision, ACG fits each of our strategic objectives. It positions us to grow in attractive markets and gives us the scale in specialty materials. It adds to our existing portfolio categories and gives us access to a diversified customer base. It reduces cyclicality without adding complexity and over time, we expect it to be an important component of our ability to drive higher returns on invested capital.

Slide #6 provides a look at how ACG fits in the current structure of our Construction Products segment, which, as you recall, is comprised of aggregates, Specialty Materials and construction site support. ACG will provide scale to both our specialty materials and aggregates business.

On Slide #7, you can see that ACG adds 29 locations to our existing 18 and provides us with new locations in Oklahoma, where the company is located, along with Kansas, Missouri, Florida, Washington State as well as additional locations in California, Texas and British Columbia.

More specifically on Slide #8, we give you a closer look at the various products and their uses. The key takeaway here is that our Construction Products segment will become significantly more diversified with ACG. We're building a substantial specialty products business at aggressive growth markets that tend to be less cyclical.

On Slide #9, we note that ACG management has successfully completed 9 bolt-on acquisitions since 2013, buying a mix of aggregates and specialty materials businesses, and they have an active pipeline of additional bolt-on opportunities. ACG has also proven that they can grow their business organically and have a very interesting pipeline of organic projects that should provide high returns as they get implemented. So with potential bolt-on opportunities, an interesting list of organic projects, attractive markets and a dynamic and proven management team, ACG should help accelerate Arcosa's growth.

Moving to Slide 10. The purchase price of $315 million is approximately 9.8x trailing 12 months adjusted EBITDA, roughly in line or slightly below some of the current valuation analysis that we have seen on our Construction Products segment. We plan to fund the acquisition through a combination of cash on hand and advances under our $400 million 5-year credit facility. Depending on the timing of the regulatory approvals, we expect the transaction to disclose sometime between December and the first quarter of 2019, and we expect ACG to be slightly accretive to our earnings in the first year following the completion of the transaction.

With respect to our EBITDA guidance, let me first say that the business conditions in the third quarter support the revenue and EBITDA guidance ranges we provided at Investor Day in early October and reaffirmed on November 1. We expect to revisit guidance upwards after closing when we have additional clarity on the purchase price accounting.

To sum up on Slide 11, as a backdrop, ACG has been in our acquisition list for some time, and we are pleased to finish due diligence and reach a definitive agreement. We see ACG as an excellent fit for our Construction Products segment for all the reasons listed here. In addition to strategic alignment, it means the criteria we use to assess potential acquisitions: serving as a platform for additional growth opportunities, providing exposure to fast-growing submarkets, promising attractive returns on invested capital over economic cycles and having the culture to thrive within Arcosa operating model. As one of the largest investments in our pipeline of potential projects, the successful integration of ACG will become part of our Stage 1 priorities, which will now include: #1, integrating ACG while continuing to grow Construction Products segment organically and with small bolt-on acquisitions, improving the margins in our Energy Equipment segment, increasing the throughput of our transportation businesses and reducing our SG&A expenses. That concludes my prepared remarks.

Operator, please open the call for questions.

[Operator]

[Operator Instructions] And we'll take our first question from Craig Bibb with CJS Securities.

[Craig Bibb, analyst]

Looks like you guys are off to a fast start with acquisitions. Is this going to be it for a little while? Or -- I mean you've been talking about a pretty full pipeline.

[Antonio Carrillo, executive]

Yes, Craig, thank you for joining on a short notice. We mentioned during the Investor Day and during this -- our roadshow, acquisitions sometime have a life of their own, and they normally don't happen when -- in the best timing. And we were going through the spin-off and everyone was super busy, but this -- and we have, as I mentioned, the business was continuing to run their own processes. We were very interested in this business. We were doing due diligence, so it just turned out that it happened at this time. It's -- we're really happy that it happened, but the team is a little overwhelmed. So I can tell you that, yes, for the moment you shouldn't expect anything in the short term, anything additional. This is, as I mentioned in my script, on the larger side of what we wanted to do, so we're going to take a pause. We're going to integrate it. We're going to continue to grow organically, and we're going to be focusing on increasing our margins, growing our barge business, growing our Transportation Products, et cetera. So yes, we'll take a pause.

[Craig Bibb, analyst]

Okay. I mean, the margins on this look really attractive. So I can understand why you wanted to close on it. What's the underlying organic growth rate at ACG?

[Antonio Carrillo, executive]

So this business has been growing relatively fast, and I don't want to give you specific number but they -- as I mentioned, this gives us additional exposure to different markets. A lot of the growth has been coming from the energy segment and the energy infrastructure segment in Texas. They've also grown in some other segments, so they have a very healthy organic growth for the last 5 years, I would say. Plus, they've been acquiring businesses. So they've done a great job, and that's one of the things that really attracted us for the business and for the management team.

[Operator]

We'll take our next question from Brent Thielman with D.A. Davidson.

[Brent Thielman, analyst]

On ACG, we're just curious about any operating efficiency synergies you might get from the transaction as you sort of integrate it into your own platform. Is there any site -- anything significant there to discuss?

[Antonio Carrillo, executive]

I'll let Reid Essl, who's running the business answer that.

[Reid Essl, executive]

The nice thing about this deal is, again, it really expands our geographic footprint. As you can see from the presentation there with the map. So it's hard to really put a finger on the exact operational efficiencies, let's just say, that the team is going to experience, especially because the team and the group that ACG has in each location is positioned to grow that business in each of those areas. But we will be working together to share best practices and to learn from one another as we move through the integration.

[Antonio Carrillo, executive]

And let me give you an additional 30,000 feet view of why ACG is so important to Arcosa at this moment. As I mentioned, as we discussed during the Investor Day, we decided to separate our construction segment into 3 different businesses: aggregates, specialty materials and construction site support. And when we called that business Specialty Materials, it was really aspirational because we only had one. So what we're going to be doing with ACG is that they're going to become our specialty materials platform, and they're going to be focusing on growing that. So that's what's so exciting about it.

[Brent Thielman, analyst]

Okay. And then question on the Energy business. One of your competitors, particularly in the utility side, has talked about a larger proportion of sort of smaller structures in demand right now. And I'm curious, are you guys seeing that? How does that affect the margin profile of the business? And is there more planning through bidding or larger structures out there?

[Scott Beasley, executive]

Sure. This is Scott. I'll take that one, Brent. Yes, it's true. We are seeing a number of smaller projects move to the pipeline of our backlog and then our inquiry level. That hasn't necessarily changed over the last 18 to 24 months. Going back a few years, it was a lot bigger projects. Those were great from efficiency standpoint. We've been learning to operate with these smaller jobs and I think getting better at it, but they do challenge your efficiencies, and it's something that we need to continue to get better at.

[Antonio Carrillo, executive]

But -- to add to Scott's comments, if you look at the margins for that business over the last 3 quarters, we were starting to get much better at it in the first quarter. And then second, third quarter, we had an order that was sold that had a lot of complexities in it and dropped our margins significantly in the second and third quarter. And I mentioned in my script, we are done with our orders. So we're confident that even though the orders are smaller, we can get back to relatively healthy margins that we had in the first quarter.

[Operator]

And we'll take our next question from Justin Bergner with Gabelli & Company.

[Justin Bergner, analyst]

A couple of quick questions. First off, is there a reason why the timing of this deal came about now from the seller's perspective, given that it's something you guys have been eyeing for a while?

[Antonio Carrillo, executive]

I'm not sure exactly what the seller's situation is, but I can tell you it's a fund that's -- IAG, it's a private equity. They have a fund. They've owned this business. My understanding from 7 years, 6 or 7 years. So this -- I think they only have a couple of other companies in their fund that they have. But I don't know the specifics, so I don't want to get into the reasons. But I also think that they have taken the business -- they have done an incredible job. Paul, the President of the group, and his team have done an incredible job in growing the business. And I think it was approaching the size and the structural work, where it became a really, really interesting platform. And I think all the combination of that helped.

[Justin Bergner, analyst]

Okay. That's helpful. And then secondly, could you give us some guidance as to the depreciation, amortization expense that you're expecting going forward? And make us a bit comfortable, I guess, the adjusted EBITDA reconciliation is $5.7 million and other adjustments to get to that $32 million. Could you just make us comfortable that those adjustments are sort of stuff that will not recur.

[Scott Beasley, executive]

Yes, this is Scott. So -- as you see in the back, there was roughly $15 million of depreciation and amortization over the last 12 months. We'll see as we work through the purchase price accounting what that number goes to. You'd expect it to be higher as you revalue the assets. Secondly, on the question of the other adjustments, we are comfortable that those are kind of nonrecurring expenses related to some of the things we called out were management fees, debt refinancing fees. And so we're comfortable with the cash flow of the business. I will say the purchase price accounting challenges you on the, call it, EPS accretion in the first year. But we're very comfortable with the operating cash flow of the business. It's a -- to give you additional color, it's kind of a maintenance CapEx in the 5% to 7% of sales consistent with the rest of our Construction Products business. And so it throws off a very healthy level of cash flow, and we expect that to continue starting year 1 and then -- and grow as we continue to grow the business.

[Operator]

[Operator Instructions] And we'll go next to Bascome Majors with Susquehanna.

[Bascome Majors, analyst]

Just to hop back on the prior question. Is there any way you can be a little more granular on the EBITDA adjustments? It's just a fairly large number compared to the overall EBITDA number. And I think investors would like to get through in a little more detail.

[Scott Beasley, executive]

I think once we get pass through the closing, we'll be able to share more details on historic financials. Like I said, it's something that we're comfortable with. We -- I'll say, we went through line by line all the adjustments. We're very comfortable with them. There were plenty of adjustments that other people take that we didn't take and included in that total of $32 million adjusted EBITDA, so it's something we're comfortable with that's not a recurring part of the business.

[Bascome Majors, analyst]

All right. And you said maintenance CapEx and ongoing free cash flow are very attractive at 5% to 7% of sales. The growth CapEx, I imagine that's a little skewed because they've been somewhat acquisitive over the last years. But did you have a sense of what it takes to grow the business on kind of a normalized basis? Or anything you could share on that would be helpful.

[Scott Beasley, executive]

Yes. It's a good question. This is Scott. So the 5% to 7% of revenue or, call it, $8 million or $9 million of CapEx, that's recurring is maintenance. I think there's a big variability in the growth CapEx depending on which projects we decide are worth pursuing. I'd say Paul and his team have a long list of organic projects that extend from a few hundred thousand dollars to several million, and it's -- that's one of the things we'll be focused on in the next month or 2, figuring out which of those projects we want to pursue. So I wouldn't expect it to be -- I don't want to give guidance because, if it makes sense, we clearly have plenty of liquidity and we want to grow the business.

[Bascome Majors, analyst]

Okay. And one more on the accretion, you kind of alluded to the amortization versus price allocation being a bit of a wild card. But when you said you believe the deal will be slightly accretive, is that a GAAP accretion number you're speaking to?

[Scott Beasley, executive]

Yes, it is.

[Bascome Majors, analyst]

And last piece, the acquisition pipeline. I mean, Antonio, you were pretty clear about wanting to focus on this integration, this being a fairly large deal in the short term here? What about share repurchase and dividend, the other side of the capital sort of distribution? Any thoughts on that? I know you said that you intend to do both.

[Antonio Carrillo, executive]

Yes, so Bascome, this is Antonio. Let me add a couple of things. One, let me go back to the adjustments. One of the things to take into account with this deal, the fact of ownership that -- when you bring a company from a private equity to a public company, private equity treat the companies that they have very differently. And there's a lot of, let's say, fees and things that happen between the owner and the company, and part of that goes into these adjustments. So we'll have to understand that we did a very deep due diligence into the strength of the numbers and that's why Scott's been saying, we feel comfortable with this. Going back to the question on the integration. And the one thing that's interesting -- one of the things about ACG, this pipeline of acquisitions, as you know, when you go through -- since we are in the same industry, we know that they have great ideas. We just don't know the details yet because we haven't been able to share all the details on those of the ideas. It's a competitive process in terms of, when you're selling the business you don't show all your cards. So we'll want to go in and understand their growth potential and the opportunities as, let's say, Stage 1, during the integration process. On the dividends and share repurchase, that's on the agenda for our next board meeting to discuss with our board and we'll go through that. But we've said that we'll have a small dividend, and we will have a share repurchase program. We just -- we'll have to discuss that with our board in a -- in the next few meetings, but it's on the table.

[Operator]

And we'll take a follow-up question from Craig Bibb with CJS Securities.

[Craig Bibb, analyst]

I was seeing the 10-Q which was just filed earlier, so I'm just seeing it. So -- that has all the -- more detail on the breakdown of the segment data. I know it's the first time you reported, but can I get ag tons or will you likely report that going forward?

[Scott Beasley, executive]

So we didn't report it in the quarter. We're some -- as an independent company, we're looking at what we report and what stats we give you all. And if we do that in the future, we will include it.

[Craig Bibb, analyst]

Okay. And can you give me kind of organic ag growth in the quarter?

[Scott Beasley, executive]

So what we said on the last Trinity call, we can reiterate here, is we did have some challenges in our aggregates business related to wet weather conditions. September was the wettest record -- year on record in the Dallas-Fort Worth area. That volume decreased in Dallas, and aggregates was more than offset by the growth in our lightweight aggregates business and then our Shoring Products business. And that shows you the strength of our balanced portfolio in our Construction Products Group.

[Antonio Carrillo, executive]

And just to give you a little more color, the drop in volume in aggregates, aggregates is a much higher volume business than the lightweight aggregates or Specialty Materials. So there's a bigger drop in volume, and it was compensated financially in terms of profit and EBITDA from the other businesses, not in volume wise.

[Craig Bibb, analyst]

Okay. I mean you must had it, given the weather in Dallas must have been outstanding on the lightweight ag side.

[Scott Beasley, executive]

Yes, in the lightweight business, the lightweight and the Shoring Products are nationwide footprints, so that any weather conditions in a certain geography can be offset with the nationwide footprint in the other 2 businesses.

[Craig Bibb, analyst]

Okay. And I'm going to ask you about one of the things you didn't add back. So the $6.1 million in costs related to canceled order in the trade right off, can you maybe give us a little background on that and why you didn't add it back?

[Scott Beasley, executive]

Yes, so the -- that was related to an inventory reserve we took on a finished goods inventory for a single project in the utility structures business line in Mexico. And it was something where a project has been canceled, we felt like taking the reserve was the appropriate measure to take, and that's why you see it in the quarter. You could add it back in your calculations. I think that could be appropriate because we do see it as more of a onetime event, but we didn't add it back in our adjustments.

[Operator]

And we'll take a follow-up question from Justin Bergner with Gabelli & Company.

[Justin Bergner, analyst]

Just one follow-up here. I mean, my understanding was that your lightweight aggregates business was closer to sort of the mid-20s EBITDA margins. And so I was just curious, if there's a structural reason why the business is requiring, which is of scale, only has 21% margins. And if not, do you think you can get it more towards the mid-20s?

[Scott Beasley, executive]

So this is Scott. I'll take a stab at it, and Reid can give some color. So it's a specialty materials business but it's a different set of end market, so there's specialty agriculture markets, specialty building products. So fundamentally, they're different markets in our lightweight business, and the market supports a different level of margin. That being said, still a 20%-plus EBITDA margin, which we feel like is very healthy and improves our overall Arcosa EBITDA margins and should lead to higher returns on capital in the future.

[Operator]

And it appears that we have no further questions over the phone at this time. I'll return the floor back to Mr. Antonio Carrillo.

[Antonio Carrillo, executive]

I want to thank you for joining us today on short notice. We are excited about this acquisition, and the Arcosa team is available for additional follow-up. A replay of the call will be available using the dial-in number provided in the press release or by visiting the Investor Relations sections of our website. Thank you very much.

[Operator]

This will conclude today's program. Thank you for your participation. You may now disconnect and have a wonderful day.