Business Context and Reporting Period
Construction Partners, Inc. is a Southeastern U.S. infrastructure and road construction company operating in Alabama, Florida, Georgia, South Carolina and North Carolina. Its services include site development, paving, utilities, drainage systems, hot-mix asphalt and aggregates for public and private customers. This unaudited Form 10-Q covers the three and nine months ended June 30, 2018, the company’s fiscal third quarter and first nine months of fiscal 2018.
The period included the company’s May 2018 initial public offering, adoption of a dual-class common-stock structure and completion of the $51.3 million acquisition of The Scruggs Company on May 15, 2018.
Key Financial Metrics
| Metric | Three Months Ended June 30 | Year-over-Year Change | Nine Months Ended June 30 | Year-over-Year Change |
|---|---|---|---|---|
| Revenue | $195.1 million | 31.7% | $464.4 million | 22.0% |
| Gross profit | $29.5 million; 15.1% margin | Margin down from 16.2% | $66.0 million; 14.2% margin | Margin down from 15.0% |
| Operating income | $14.8 million; 7.6% margin | 25.8% | $41.4 million; 8.9% margin | 60.7% |
| Net income | $13.4 million; 6.9% margin | 109.0% | $35.6 million; 7.7% margin | 158.8% |
| Adjusted EBITDA | $22.7 million; 11.6% margin | 28.7%; margin down from 11.9% | $47.2 million; 10.2% margin | 10.2%; margin down from 11.3% |
| Diluted EPS | $0.29 | Up from $0.15 | $0.81 | Up from $0.33 |
For the nine-month period, net cash provided by operating activities was $23.7 million, compared with $21.3 million in the prior-year period. Capital expenditures were $33.5 million, versus $18.8 million, and cash used in investing activities was $82.3 million, including the Scruggs acquisition.
Cash increased to $75.2 million at June 30, 2018 from $27.5 million at September 30, 2017. Total debt was approximately $67.0 million, consisting primarily of a $60.9 million term loan and $5.0 million drawn on the revolving facility, before deferred debt issuance costs and current maturities. Revolving-facility availability was $25.0 million, less $9.5 million of outstanding letters of credit.
Material Changes Versus the Prior Comparable Period
- Revenue growth reflected stronger backlog and available work in existing markets, plus contributions from acquisitions and greenfield expansions. Scruggs contributed $11.4 million of revenue and $1.0 million of net income after its May 15 acquisition date.
- Gross margins declined because of lower contract margins and rising asphalt cement prices, although public contracts generally include commodity-price adjustment provisions.
- General and administrative expense increased 18.5% in the quarter and 19.3% for the nine months, primarily from higher management payroll, growth-related costs and $0.6 million of public-company reporting and regulatory expenses.
- Interest expense declined substantially following the June 2017 refinancing, despite higher average debt. The prior-year period included a $1.6 million loss on extinguishment of debt.
- The company recorded a $14.8 million pre-tax settlement gain during the nine months. The related settlement provides approximately $15.7 million of net cash payments in four installments from January 2019 through July 2020.
- The Tax Cuts and Jobs Act reduced the effective tax rate to 9.5% for the quarter and 13.1% for the nine months, versus 32.1% and 34.9%, respectively. The 2018 results also included a $1.3 million permanent tax benefit related to employee option exercises.
- The May IPO generated approximately $98.0 million of net proceeds for the company. The offering increased Class A shares outstanding to 11.95 million at June 30, while Class B shares outstanding were 39.46 million and carry ten votes per share compared with one vote per Class A share.
Guidance, Outlook, Commentary, Risks and Unusual Items
The filing does not provide a clear numerical revenue, earnings or EBITDA guidance range. Management states that backlog, growth in existing markets, acquisitions and geographic expansion support continued growth, but emphasizes that historical interim results may not indicate full-year performance.
Management expects operating cash flow and available revolving-facility borrowings to fund operations for at least the next twelve months. Future liquidity needs will depend on working-capital seasonality, capital expenditures and acquisitions. The Compass Credit Agreement matures July 1, 2022, requires quarterly term-loan installments of approximately $3.6 million and includes leverage and fixed-charge coverage covenants. The company was in compliance at June 30, 2018, with a fixed-charge ratio of 1.54 to 1.00 and consolidated leverage ratio of 0.92 to 1.00.
- Key operating risks include reductions in public infrastructure funding, competition, project-estimation risk, contract cancellations, adverse weather, commodity-price inflation, labor and supply-chain constraints, bonding capacity and acquisition integration.
- The business is seasonal, with generally higher activity in the third and fourth fiscal quarters and lower activity in the first and second quarters.
- Floating-rate debt creates interest-rate exposure; a hypothetical 1% change in borrowing rates would affect annual interest expense by approximately $0.7 million before considering swaps.
- The company’s disclosure controls were not effective as of June 30, 2018 because of previously disclosed material weaknesses involving information-technology general controls and closing and financial-reporting processes, including significant and unusual transactions. Remediation was ongoing.
- Construction revenue is recognized using the percentage-of-completion method and depends on estimates of total contract costs. The filing states that no material amounts from claims or unapproved change orders were recognized in the periods presented.
- The company has recurring related-party transactions, including approximately $8.6 million of subcontract costs with an entity owned by a senior vice president’s family member during the nine months.
Important Facts for Investors to Verify
- Whether gross-margin pressure from asphalt cement prices and contract mix persists despite revenue growth.
- The quality, timing and concentration of backlog, including exposure to state Departments of Transportation, which represented 40.9% of nine-month revenue.
- Integration and performance of Scruggs and the financial impact of future acquisitions and greenfield expansions.
- Settlement payment timing and collectability, since most of the approximately $15.7 million is scheduled for future periods.
- Progress in remediating the material weaknesses in internal control and whether disclosure controls become effective.
- Debt amortization, covenant compliance, floating-rate exposure and remaining revolver availability.
- The effect of the planned adoption of ASC 606 revenue guidance beginning October 1, 2018; the filing states that the impact had not yet been determined.