Construction Partners, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. This discussion and analysis of our financial condition and results of operations is intended to assist in understanding and assessing the trends and significant changes in our results of operations and financial condition during the period covered by this report. Historical results may not be indicative of future performance. This discussion includes forward-looking statements that reflect our plans, estimates and beliefs. Such statements involve risks and uncertainties. Our actual results may differ materially from those contemplated by these forward-looking statements as a result of various factors, including those set forth under the headings “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements.” This discussion should be read in conjunction with our unaudited consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and notes thereto included in the 2022 Form 10-K. In this discussion, we use certain non-GAAP financial measures. Explanations of these non-GAAP financial measures and reconciliations to the most directly comparable GAAP financial measures are included in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Investors should not consider non-GAAP financial measures in isolation or as substitutes for financial information presented in compliance with GAAP. Overview We are a civil infrastructure company that specializes in the building and maintenance of transportation networks. Our operations leverage a highly skilled workforce, strategically located HMA plants, substantial construction assets and select material deposits. We provide construction products and services to both public and private infrastructure projects, with an emphasis on highways, roads, bridges, airports and commercial and residential sites in the southeastern United States. Our public projects are funded by federal, state and local governments and include projects for roads, highways, bridges, airports and other forms of infrastructure. Public transportation infrastructure projects historically have been a relatively stable portion of state and federal budgets and represent a significant share of the United States construction market. Federal funds are allocated on a state-by-state basis, and each state is required to match a portion of the federal funds that it receives. Federal highway spending uses funds predominantly from the Highway Trust Fund, which derives its revenues from fuel taxes and other user fees. In addition to public infrastructure projects, we provide a wide range of large sitework construction and HMA paving services to private construction customers, including commercial and residential developers and local businesses. Recent Developments Inflationary and Supply Chain Trends During the three months ended December 31, 2022, we continued to experience an upward trend in several inflation-sensitive inputs that we use to provide our products and services, including upward pressure on wages and increases in the cost of raw materials used to produce HMA and other items that are critical to our business, including fuel, concrete and steel. In addition, we continued to experience some disruptions from various participants in our supply chain, including subcontractors, materials suppliers and equipment manufacturers, who provide the raw materials, equipment, vehicles, construction supplies and other services we require in order to manufacture HMA and perform our construction projects. To date, we have been able to mitigate some of the effects of inflation, supply chain disruptions and labor constraints on our business by increasing prices for our products and including the anticipated cost increases in the construction projects on which we bid. However, we are limited in our ability to pass through increased costs for projects already in our backlog and, under those circumstances, may be unable to recoup losses or diminished profit margins by passing these costs through to our customers. Tennessee Acquisition On November 18, 2022, we acquired three HMA manufacturing plants and certain related assets located in the Nashville, Tennessee metro area for $8.4 million. As part of this transaction, we disposed of a quarry located near Goldston, North Carolina, resulting in total cash proceeds of $36.4 million and a gain on the facility exchange of $5.4 million. For further discussion regarding this transaction, see Note 4 - Business Acquisitions and Disposition to the unaudited consolidated financial statements included elsewhere in this report. North Carolina Acquisition On December 1, 2022, we acquired all of the capital stock of the Ferebee Corporation, an HMA manufacturing and paving company headquartered in Charlotte, North Carolina. The transaction established our second platform company in North Carolina and added three HMA plants in the greater Charlotte/Rock Hill metro area. For further discussion regarding this transaction, see Note 4 - Business Acquisitions and Disposition to the unaudited consolidated financial statements included elsewhere in this report. 24 Table of Contents How We Assess Performance of Our Business Revenues We derive our revenues predominantly by providing construction products and services for both public and private infrastructure projects, with an emphasis on highways, roads, bridges, airports and commercial and residential sites. Our projects represent a mix of federal, state, municipal and private customers. We also derive revenues from the sale of HMA, aggregates, and liquid asphalt cement to customers. We recognize revenues derived from projects as we satisfy our performance obligations over time (formerly known as the percentage-of-completion method), measured by the relationship of total cost incurred compared to total estimated contract costs (cost-to-cost input method). Changes in job performance, job conditions and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to estimated costs and income, and are recognized in the period in which the revisions are determined. Revenues derived from the sale of HMA, aggregates, and liquid asphalt cement are recognized when the risks associated with ownership have passed to the customer. Gross Profit Gross profit represents revenues less cost of revenues. Cost of revenues consists of all direct and indirect costs associated with construction contracts, including raw materials, labor, equipment costs, depreciation, lease expenses, subcontract costs and other expenses at our HMA plants, aggregates mining facilities, and liquid asphalt cement terminal. Our cost of revenues is directly affected by fluctuations in commodity prices, primarily liquid asphalt and diesel fuel. From time to time, when appropriate, we limit our exposure to changes in commodity prices by entering into forward purchase commitments. In addition, our public infrastructure contracts often provide for price adjustments based on fluctuations in certain commodity-related product costs. These price adjustment provisions are in place for most of our public infrastructure contracts, and we seek to include similar provisions in our private contracts. Depreciation, Depletion, Accretion and Amortization Property, plant and equipment are initially recorded at cost or, if acquired as a business combination, at fair value. Depreciation on property, plant and equipment is computed on a straight-line basis over the estimated useful life of the asset. Amortization expense is the periodic expense related to leasehold improvements and intangible assets. Leasehold improvements are amortized over the lesser of the life of the underlying asset or the remaining lease term. Our intangible assets were recognized as a result of certain acquisitions and are generally amortized on a straight-line basis over the estimated useful lives of the assets. Our unfavorable contract liabilities were recognized as a result of certain acquisitions and are amortized as the associated projects progress. Mineral reserves are depleted in accordance with the units-of-production method as aggregates are extracted, using the initial allocation of cost based on proven and probable reserves. General and Administrative Expenses General and administrative expenses include costs related to our operational offices that are not allocated to direct contract costs and expenses related to our corporate offices. These expenses consist primarily of salaries and personnel costs for our administration, finance and accounting, legal, information systems, human resources and certain managerial employees. General and administrative expenses also include acquisition expenses, audit, consulting and professional fees, stock-based compensation expense, travel, insurance, office space rental costs, property taxes and other corporate and overhead expenses. Gain on Sale of Property, Plant and Equipment In the normal course of business, we sell assets for various reasons, including when the cost of maintaining the asset exceeds the cost of replacing it. The gain or loss on the sale of property, plant and equipment reflects the difference between the carrying value at the date of disposal and the net consideration received from the sale during the period. Gain on Facility Exchange As part of our continued growth strategy, we may exchange or sell other facilities in order to generate capital for use in connection with other strategic initiatives. The gain or loss on the exchange or sale of a facility reflects the difference between the net carrying value of the facility at the date of disposal and the consideration received from the exchange or sale during the period. Interest Expense, Net Interest expense, net primarily represents interest incurred on our long-term debt, such as the Term Loan and the Revolving Credit Facility, as well as the changes in fair values of interest swap agreements and amortization of deferred debt issuance costs. These amounts are partially offset by interest income earned on short-term investments of cash balances in excess of our current operating needs. 25 Table of Contents Other Key Performance Indicators - Adjusted EBITDA and Adjusted EBITDA Margin Adjusted EBITDA represents net income before, as applicable from time to time, (i) interest expense, net, (ii) provision (benefit) for income taxes, (iii) depreciation, depletion, accretion and amortization, (iv) equity-based compensation expense, (v) loss on the extinguishment of debt, (vi) certain management fees and expenses and (vii) nonrecurring legal settlement costs and associated legal expenses unrelated to the Company’s core operations. Adjusted EBITDA Margin represents Adjusted EBITDA as a percentage of revenues for each period. These metrics are supplemental measures of our operating performance that are neither required by, nor presented in accordance with, GAAP. These measures have limitations as analytical tools and should not be considered in isolation or as an alternative to net income or any other performance measure derived in accordance with GAAP as an indicator of our operating performance. We present Adjusted EBITDA and Adjusted EBITDA Margin because management uses these measures as key performance indicators, and we believe that securities analysts, investors and others use these measures to evaluate companies in our industry. Our calculation of Adjusted EBITDA and Adjusted EBITDA Margin may not be comparable to similarly named measures reported by other companies. Potential differences may include differences in capital structures, tax positions and the age and book depreciation of intangible and tangible assets. The following table presents a reconciliation of net income, the most directly comparable measure calculated in accordance with GAAP, to Adjusted EBITDA and the calculation of Adjusted EBITDA Margin for the periods presented (unaudited, in thousands, except percentages): For the Three Months Ended December 31, 2022 2021 Net income $ 1,892 $ 5,511 Interest expense, net 3,960 1,264 Provision for income taxes 510 1,800 Depreciation, depletion, accretion and amortization 18,375 15,903 Equity-based compensation expense 2,480 1,504 Management fees and expenses (1) 367 375 Adjusted EBITDA $ 27,584 $ 26,357 Revenues $ 341,779 $ 284,964 Adjusted EBITDA Margin 8.1 % 9.2 % (1) Reflects fees and reimbursement of certain out-of-pocket expenses under a management services agreement with SunTx (see Note 12 - Related Parties to the unaudited consolidated financial statements included elsewhere in this report). 26 Table of Contents Results of Operations Three Months Ended December 31, 2022 Compared to Three Months Ended December 31, 2021 The following table sets forth selected financial data for the three months ended December 31, 2022 and 2021 (unaudited in thousands, except percentages): Change From the Three Months Ended For the Three Months Ended December 31, December 31, 2021 to the Three Months Ended 2022 2021 December 31, 2022 Dollars % of Revenues Dollars % of Revenues $ Change % Change Revenues $ 341,779 100.0 % $ 284,964 100.0 % $ 56,815 19.9 % Cost of revenues 311,283 91.1 % 252,000 88.4 % 59,283 23.5 % Gross profit 30,496 8.9 % 32,964 11.6 % (2,468) (7.5) % General and administrative expenses (29,725) (8.7) % (24,946) (8.8) % (4,779) 19.2 % Gain on sale of property, plant and equipment 168 — % 441 0.2 % (273) (61.9) Gain on facility exchange 5,389 1.6 % — — % 5,389 — % Operating income 6,328 1.9 % 8,459 3.0 % (2,131) (25.2) % Interest expense, net (3,960) (1.2) % (1,264) (0.4) % (2,696) 213.3 % Other income 34 — % 116 — % (82) (70.7) % Income before provision for income taxes 2,402 0.7 % 7,311 2.6 % (4,909) (67.1) % Provision for income taxes 510 0.1 % 1,800 0.6 % (1,290) (71.7) % Net income $ 1,892 0.6 % $ 5,511 1.9 % $ (3,619) (65.7) % Adjusted EBITDA $ 27,584 8.1 % $ 26,357 9.2 % $ 1,227 4.7 % Revenues. Revenues for the three months ended December 31, 2022 increased $56.8 million, or 19.9%, to $341.8 million from $285.0 million for the three months ended December 31, 2021. The increase included $32.1 million of revenues attributable to acquisitions completed subsequent to December 31, 2021 and an increase of $24.7 million of revenues in our existing markets from contract work and sales of HMA and aggregates to third parties. Gross Profit. Gross profit for the three months ended December 31, 2022 decreased $2.5 million, or 7.5%, to $30.5 million from $33.0 million for the three months ended December 31, 2021. The decrease in gross profit was primarily due to (i) increases in the costs of raw materials, fuel, labor and trucking and (ii) supply chain disruptions resulting in project delays and the need to use alternative suppliers and vendors. General and Administrative Expenses. General and administrative expenses for the three months ended December 31, 2022 increased $4.8 million, or 19.2%, to $29.7 million from $24.9 million for the three months ended December 31, 2021. The increase was the result of (i) a $1.0 million increase in equity-based compensation expense, (ii) a $1.4 million increase attributable to general and administrative expenses associated with the businesses acquired subsequent to December 31, 2021, (iii) a $1.4 million increase in management personnel payroll and benefits, and (iv) a $1.0 million increase in other professional fees, primarily driven by expenses incurred in support of acquisition activities, information technology expenses and increased accounting and consulting fees. Gain on Facility Exchange . Gain on facility exchange for the three months ended December 31, 2022 was $5.4 million compared to $0.0 million for the three months ended December 31, 2021. The gain was the result of the disposition of a quarry located near Goldston, North Carolina. In connection with this transaction, the Company acquired three HMA manufacturing plants and certain related assets located in the Nashville, Tennessee metro area. Interest Expense, Net. Interest expense, net for the three months ended December 31, 2022 increased $2.7 million, or 213.3%, to $4.0 million compared to $1.3 million for the three months ended December 31, 2021. The increase in interest expense was due to a $150.7 million increase in the average principal debt balance outstanding and higher interest rates during the three months ended December 31, 2022 compared to the corresponding period in 2021. 27 Table of Contents Provision for Income Taxes. Our effective tax rate decreased to 21.2% for the three months ended December 31, 2022, from 24.6% for the three months ended December 31, 2021. Our lower effective tax rate during the three months ended December 31, 2022 was due to differences in state tax rates at our operating subsidiaries. Net Income. Net income decreased $3.6 million, or 65.7%, to $1.9 million for the three months ended December 31, 2022, compared to $5.5 million for the three months ended December 31, 2021. The decrease in net income was a result of lower gross profit and increases in general and administrative expenses and interest expense, net, partially offset by the gain on facility exchange, all as described above. Adjusted EBITDA and Adjusted EBITDA Margin. Adjusted EBITDA and Adjusted EBITDA Margin were $27.6 million and 8.1%, respectively, for the three months ended December 31, 2022, compared to $26.4 million and 9.2%, respectively, for the three months ended December 31, 2021. The increase in Adjusted EBITDA was the result of higher depreciation, depletion, accretion and amortization and equity-based compensation expense, partially offset by a decrease in net income. The lower Adjusted EBITDA Margin was primarily a result of lower gross profit margins, as described above. See the description of Adjusted EBITDA and Adjusted EBITDA Margin, as well as a reconciliation of Adjusted EBITDA to net income, under the heading “How We Assess Performance of Our Business”. Inflation and Price Changes During the three months ended December 31, 2022, we continued to experience an upward trend in several inflation-sensitive inputs that we use to provide our products and services, including upward pressure on wages and increases in the cost of raw materials used to produce HMA and other items that are critical to our business. Liquidity and Capital Resources Cash Flows Analysis The following table sets forth our cash flows for the periods indicated (unaudited, in thousands): For the Three Months Ended December 31, 2022 2021 Net cash provided by (used in) operating activities, net of acquisitions $ 28,884 $ (577) Net cash used in investing activities (70,670) (80,274) Net cash provided by financing activities 49,736 67,461 Net change in cash and cash equivalents $ 7,950 $ (13,390) Operating Activities During the three months ended December 31, 2022, cash provided by operating activities, net of acquisitions, was $28.9 million, primarily as a result of: • net income of $1.9 million, including $18.4 million of depreciation, depletion, accretion and amortization and $2.5 million of equity-based compensation expense; • a decrease in contracts receivable including retainage, net of $47.1 million due to normal fluctuations resulting from the timing of processing transactions in our accounts receivable cycle; • an increase in inventories of $3.5 million due to increased inventories from acquisitions, growth in existing markets, higher inventory costs and normal fluctuations in our inventory cycle; • a decrease in accounts payable and accrued expenses and other current liabilities of $33.2 million due to the timing of processing transactions in our accounts payable cycle; and • a net decrease in the difference between costs and estimated earnings in excess of billings on uncompleted contracts and billings in excess of costs and estimated earnings on uncompleted contracts of $0.2 million due to the timing of performing and closing projects. 28 Table of Contents During the three months ended December 31, 2021, cash used in operating activities, net of acquisitions, was $0.6 million, primarily as a result of: • net income of $5.5 million, including $15.9 million of depreciation, depletion, accretion and amortization and $1.5 million of equity-based compensation expense; • an increase in inventories of $2.5 million due to acquisitions and normal fluctuations in our inventory cycle; • an increase in prepaid expenses and other current assets of $3.5 million due to the timing of payments for various insurance policies and expenses; • a decrease in accounts payable and accrued expenses and other current liabilities of $24.2 million due to the timing of processing transactions in our accounts payable cycle; and • a net increase in the difference between costs and estimated earnings in excess of billings on uncompleted contracts and billings in excess of costs and estimated earnings on uncompleted contracts of $5.8 million due to the timing of performing and closing projects. Investing Activities During the three months ended December 31, 2022, cash used in investing activities was $70.7 million, of which $77.2 million related to acquisitions completed in the period and $31.7 million was invested in property, plant and equipment, partially offset by $1.6 million of proceeds from the sale of property, plant and equipment and $36.4 million of proceeds from the facility exchange. During the three months ended December 31, 2021, cash used in investing activities was $80.3 million, of which $65.9 million related to acquisitions completed in the period and $15.1 million was invested in property, plant and equipment, partially offset by $0.7 million of proceeds from the sale of property, plant and equipment. Financing Activities During the three months ended December 31, 2022, cash provided by financing activities was $49.7 million. We received $53.0 million of proceeds from our Revolving Credit Facility, which were primarily used for acquisitions completed in the period. This cash flow was partially offset by $3.1 million of principal payments on long-term debt. During the three months ended December 31, 2021, cash provided by financing activities was $67.5 million. We received $70.0 million of proceeds from our Revolving Credit Facility, which were primarily used for acquisitions completed in the period. This cash flow was partially offset by $2.5 million of principal payments on long-term debt. Credit Agreement We and each of our subsidiaries are parties to the Credit Agreement, which provides for the Term Loan and the Revolving Credit Facility. At December 31, 2022 and September 30, 2022, we had $268.8 million and $271.9 million, respectively, of principal outstanding under the Term Loan, $158.1 million and $105.1 million, respectively, of principal outstanding under the Revolving Credit Facility, and availability of $156.9 million and $208.6 million, respectively, under the Revolving Credit Facility, including reduction for outstanding letters of credit. The Company also had $25.0 million available under the Delayed Draw Term Loan at December 31, 2022 and September 30, 2022. The Credit Agreement requires the Company to satisfy certain financial covenants, including a minimum fixed charge coverage ratio of 1.20-to-1.00 and a maximum consolidated leverage ratio of 3.50-to-1.00, subject to certain adjustments. At December 31, 2022 and September 30, 2022, our fixed charge coverage ratio was 1.87-to-1.00 and 2.56-to-1.00, respectively, and our consolidated leverage ratio was 2.96-to-1.00 and 2.79-to-1.00, respectively. From time to time, the Company has entered into interest rate swap agreements to hedge against the risk of changes in interest rates. At December 31, 2022 and September 30, 2022, the aggregate notional value of the interest rate swap agreement was $300.0 million, and the fair value was $23.4 million and $24.7 million, respectively, which amounts are included within other assets on the Company’s Consolidated Balance Sheets. For more information about the Credit Agreement, see Note 8 - Debt to the unaudited consolidated financial statements included elsewhere in this report. 29 Table of Contents Capital Requirements and Sources of Liquidity During the three months ended December 31, 2022 and 2021, our capital expenditures were approximately $31.7 million and $15.1 million, respectively. Our capital expenditures are typically made during the fiscal year in which they are approved. At December 31, 2022, our commitments for capital expenditures were not material to our financial condition or results of operations on a consolidated basis. For fiscal 2023, we expect total capital expenditures to be $85.0 million to $90.0 million. Our capital expenditure budget is an estimate and is subject to change. Historically, we have required significant amounts of cash in order to make capital expenditures, purchase materials and fund our organic expansion into new markets. Our working capital needs are driven by the seasonality and growth of our business, with our cash requirements increasing in periods of growth. Additional cash requirements resulting from our growth include the costs of additional personnel, production and distribution facilities, enhancements to our information systems, integration costs related to any acquisitions and our compliance with laws and rules applicable to public companies. We have historically relied on cash available through credit facilities, in addition to cash from operations, to finance our working capital requirements and to support our growth. We regularly monitor potential capital sources, including equity and debt markets, in an effort to meet our planned capital expenditures and liquidity requirements. Our future success will depend on our ability to access outside sources of capital. We believe that our operating cash flow and available borrowings under the Credit Agreement will be sufficient to fund our operations and planned capital expenditures for at least the next 12 months. However, future cash flows are subject to a number of variables, including the potential impacts of inflation and supply chain constraints, and significant additional capital expenditures will be required to conduct our operations. There can be no assurance that operations and other capital resources will provide sufficient cash to maintain planned or future levels of capital expenditures. In the event that we make one or more acquisitions and the amount of capital required is greater than the amount of cash on hand we have available for acquisitions at that time, we could be required to reduce the expected level of capital expenditures and/or seek additional capital. If we seek additional capital, we may do so through borrowings under the Credit Agreement, joint ventures, asset sales, offerings of debt or equity securities or other means. However, our ability to engage in any such transactions may be constrained by economic conditions and other factors outside of our control. We cannot guarantee that additional capital will be available on acceptable terms or at all. If we are unable to obtain the funds we need, we may not be able to complete acquisitions that may be favorable to us or finance the capital expenditures necessary to conduct our operations. Contractual Obligations The following table summarizes our significant obligations outstanding as of December 31, 2022 (unaudited, in thousands): Payments Due by Fiscal Year Total 2023 2024 2025 2026 2027 2028 and Thereafter Debt obligations $ 426,851 $ 9,375 $ 13,438 $ 17,188 $ 20,625 $ 366,225 $ — Operating leases 21,475 2,130 2,517 2,137 2,118 2,010 10,563 Purchase commitments 5,869 3,720 1,893 256 — — — Royalty payments 2,656 236 246 207 182 170 1,615 Asset retirement obligations 2,372 — — — — — 2,372 Total $ 459,223 $ 15,461 $ 18,094 $ 19,788 $ 22,925 $ 368,405 $ 14,550 Off-Balance Sheet Arrangements As of December 31, 2022, the Company had aggregate letters of credit outstanding in the amount of $10.0 million, future purchase commitments of diesel fuel and natural gas of $5.4 million and $0.5 million, respectively, and $2.7 million of minimum royalty payments related to aggregates facilities. Other than the letters of credit, future purchase commitments and minimum royalty payments, we do not currently have any off-balance sheet arrangements that have, or are reasonably likely to have, a material current or future effect on our financial condition, changes in our financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources. See Note 17 - Commitments to our unaudited consolidated financial statements included elsewhere in this report for additional information. 30 Table of Contents