Knife River Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
November 4, 2024

There are 10 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Knife River Corporation Third Quarter Results Conference Call. At this time, all lines are in a listen only mode. Following the presentation, we will conduct a question and answer session. Also note that the call is being recorded on Monday, November 4, 2024. And I would like to turn the conference over to Nathan Ring, Chief Financial Officer.

Operator

Please go ahead, sir.

Speaker 1

Thank you, and welcome to everyone joining us for the Knife River Corporation Third Quarter Results Conference Call. My name is Nathan Ring, Chief Financial Officer of Knife River, and I'm joined by our President and Chief Executive Officer, Brian Gray. Today's discussion will contain forward looking statements about future operational and financial expectations. Actual results may differ significantly from those projected in today's forward looking statements due to various risks and uncertainties, including the risks described in our periodic reports filed with the SEC. For further detail, please refer to the legal disclaimers contained in today's earnings release and other public filings, which are available on our website and the SEC website.

Speaker 1

Except as required by law, we undertake no obligation to update our forward looking statements. During this presentation, we will make references to certain non GAAP information. These non GAAP measures are defined and reconciled to the most directly comparable GAAP measure in the appendix of today's presentation. These materials are also available on our website. Brian Gray will begin today's call with a high level overview of our Q3 2024 results, followed by an update on our competitive edge plan and a segment recap.

Speaker 1

Following his remarks, I will provide a product line summary, a capital update and a review of our revised 2024 financial guidance. At the conclusion of our prepared remarks, we will open the line for a question and answer session. With that, I'll now turn the call over to Brian.

Speaker 2

Thank you, Nathan. Good morning, everyone, and thank you for joining us. We're pleased to report record 3rd quarter revenue, gross profit and net income as we continue to demonstrate the fundamental strength of our business. Our geographic segments consisting of the Pacific, Northwest, Mountain and Central combined to achieve a record EBITDA of $225,000,000 for the quarter, a 6% increase from the same period last year. EBITDA margin at these segments improved nearly 100 basis points to a record 22.5%.

Speaker 2

Growth at the geographic segments helped us overcome year over year decrease for the quarter of $12,000,000 in EBITDA at our Energy Services segment. This reduction in Energy Services was anticipated and included in our guidance. A strong public funding backdrop contributed to our results and so did our competitive edge strategy. During the quarter, we continued to implement edge initiatives intentionally focused on quality of work over quantity of work. Our team secured higher prices for our products and higher bid margins, while also successfully executing on projects to optimize the value of our services.

Speaker 2

These initiatives offset volume declines and contributed our record Q3 revenue of $1,100,000,000 Another key component of our Edge plan is growth. And I'm excited to announce that Knife River has invested nearly $130,000,000 on 6 acquisitions this year. The majority of this capital was spent in September, October November, so we have yet to benefit from revenue and EBITDA impact that we expect to see from these acquisitions in 2025. I'll talk more about them in just a minute. Adjusted EBITDA for the quarter was down slightly from last year's record, primarily from the anticipated reduction in Energy Services.

Speaker 2

Higher SG and A costs also apply some downward pressure. These costs were largely related to our M and A activity, including acquisition expenses on the deals I mentioned, as well as due diligence on our current pipeline of opportunities. But these expenses are an investment in our future. Our corporate development team has been active getting deals across the finish line and adding to our near term pipeline. All in all, our teams performed well in the quarter at or near record pace and we believe we are in a great position for long term profitable growth.

Speaker 2

We remain focused on achieving our edge goals including continued progress towards our long term goal of 20% adjusted EBITDA margin. The materials we produce and the work we perform are crucial to our local, state and national economies. We have continued to refine our sales practices to optimize the pricing of our products to better recognize their full value. Average sales prices of aggregates for the quarter improved 7.6% from 2023. We rolled out new tools and training across each region to emphasize our dynamic pricing model and track progress.

Speaker 2

We see pricing momentum continuing into 2025 and we expect to benefit from price increases exceeding costs. At the same time, we are finding efficiencies and improvements at our plants. Our process improvement teams or pit crews visited 26 plants in the 3rd quarter, continuing to identify opportunities for us to remove production bottlenecks, increase plant capabilities, improve uptime and control costs. They have now been to 58 plants in 2024 standardizing best practices, developing field training and building on the momentum from last year's success. Our local management teams wholeheartedly support our pit crews and feel there is significant margin expansion opportunity to be realized from this initiative.

Speaker 2

While the material side of our business was busy optimizing prices, finding efficiencies and sharing best practices, our contracting services teams were actively pushing margins in the bid room and out in the field. Gross profit margin for contracting services improved 120 basis points in the quarter compared to last year. We continue to bid strategically and find opportunities in the field to successfully execute on work and maximize margins. The Q3 is our busiest of the year and I'd like to thank our teams for their hard work and for truly doing a tremendous job. For the 6th consecutive quarter, we have seen year over year contracting and service margins improve.

Speaker 2

This dates back to the launch of our Edge plan and we could not have accomplished it without bidding discipline, job execution and our dedicated construction crews. Price optimization, cost controls and margin improvement are key components of our Edge strategy, so is growth both organic and through acquisitions. We have closed on 6 deals so far in 2024 with a focus on aggregate reserves and construction materials. In September, we acquired the assets of Frank B. Marks and Son, a small aggregate producer in California's Central Valley.

Speaker 2

In October, we acquired the assets of 2 additional aggregate producers, Rock Products Incorporated in Central Oregon and a high quality sand reserve to support our operations in Sioux Falls and South Dakota. Also in October, we finalized a lease agreement to operate 3 existing ready mix plants in California, where we'll be able to leverage our local aggregates. And just 2 days ago, we acquired the assets of Albina Asphalt. Albina is a liquid asphalt supplier with terminals in Washington, Oregon and California. Albina has a leading market position and will increase the capacity of our Energy Services segment by approximately 25%.

Speaker 2

This is an exciting deal that expands the footprint of our high margin liquid asphalt business on the West Coast and supports our vertical integration. With these acquisitions, we are adding strategic assets to our portfolio that enhance our market positions and align with our strategy of acquiring materials based companies within or adjacent to our current operations. These acquisitions are expected to generate an attractive financial return with purchase multiples between 6 to 8 times the projected 2025 EBITDA. We have several other deals in our pipeline that range in size and our focus remains on materials based acquisitions in mid sized high growth markets. As we did in the Q3, we expect to see higher corporate development costs in the Q4 compared to last year.

Speaker 2

While closing on deals during the off season can create a headwind, we have accounted for those costs in our updated guidance and we view these expenses as an investment in our future. The pipeline of acquisition opportunities remains strong in our markets and we look forward to continuing our business development activity. In addition to acquisition growth, our existing operations are performing well and are benefiting from our Edge initiatives and strong funding for public projects. Each of our segments is seeing continued opportunities to bid on projects with record or near record budgets at our State Departments of Transportation. We have a very good schedule of DOT bid lettings coming up for 2025 across our states, including some sizable projects with significant pull through of aggregates, rate of mix and asphalt.

Speaker 2

Without 50% of IAA funding yet to be allocated, public work continues to be the main driver for our contracting services. We believe we are still at the beginning of what looks to be a long period of growth in the construction industry. The roads, bridges and airports that are so vital to our economy needs fixing and that doesn't happen overnight. We expect to continue benefiting from the build out of the nation's infrastructure for years to come. Each of our segments had a solid 3rd quarter.

Speaker 2

At geographic segments, price increases helped drive our record revenue. Again, in total, these segments achieved record EBITDA and EBITDA margins. I'll briefly discuss a few highlights from each segment. In the Pacific, 3rd quarter revenue increased to a record $165,000,000 driven by price increases across all product lines and continuous construction activity in Northern California. There is strong funding support for road and highway projects where wildfires have damaged the local infrastructure and require rebuilding.

Speaker 2

We have a significant backlog of work there, which includes an emphasis right now on more earthmoving and heavy construction than it does paving. This has contributed to a temporary asphalt volume decline in the segment. As I mentioned, we added to our ready mix capacity and added aggregate reserves in California. In the Northwest, revenue was up 4% and EBITDA was up 15% to a quarterly record of nearly $56,000,000 This region has strong public agency work primarily in Central and Southern Oregon. Gross margin for contracting services in the Northwest improved 4.90 basis points from the same period last year.

Speaker 2

The region also benefited from having its prestressed plant fully operational. Efficiencies at the plant in Washington combined with demand for prestressed projects positively contributed to both EBITDA and EBITDA margin. On October 18, the region purchased the assets of Rock Products Inc. Bolstering its aggregate reserves in Central Oregon and adding a new ready mix operation. Switching to Mountain, revenue and EBITDA were in line with last year's records.

Speaker 2

For the 1st 9 months of the year, EBITDA in the Mountain region is up 12% year over year. Record revenue in the quarter was driven by higher pricing and continued contracting activity. Idaho Falls had several jobs that drove revenue growth, including highway work and a de icing project at the Jackson Hole Airport. Backlog is also up 12% year over year and continues to grow with very strong bid schedule. Overall, the work is there and this continues to be one of our fastest growing markets.

Speaker 2

In our Central segment, we have fully embraced the Edge initiatives. This segment continues to see the most improved EBITDA margins with trailing 12 month EBITDA up 200 basis points compared to the same period last year. For the quarter, EBITDA margins hit an all time high of 22.5%. Pricing improvements outpaced costs and contributed to a 7% increase in EBITDA for the quarter. Also contributing to our record EBITDA and pickup in margin was disciplined project bidding and favorable project execution on contracting services.

Speaker 2

We're looking forward to several good bidding opportunities across the segment, including positive news from Iowa, Nebraska, Minnesota and Texas, which have all pointed to more projects and more total paving tonnage for the 2025 season. This region has identified several organic growth opportunities and we look forward to sharing more information on these exciting projects at the appropriate time. Finally, our liquid asphalt product line is having its 2nd best year ever. It's on track to hit its EBITDA guidance for the full year. For the quarter, revenue and EBITDA were both down from record highs, primarily driven by lower raw materials cost and subsequent lower pricing.

Speaker 2

We have a strong book of business for 2025 and we anticipate adding to it during the Q4 as our state adds more paving projects to their bid schedules. Over the past weekend, we purchased the assets of Albina Asphalt, a liquid asphalt business with terminals in Washington, Oregon and California. As I mentioned earlier, this expands our footprint within markets where we have aggregates and asphalt operations, further strengthening our vertical integration. We are very excited to welcome Albina's 80 team members to the life at night. Before turning the call over to Nathan, I'd like to reiterate that we believe we are in the early days of a long infrastructure build out in our country.

Speaker 2

Knife River is well positioned to capitalize on this growth. The work our teams do is essential for our cities, our states and the nation. We are performing at record levels and we are taking intentional steps to keep getting better. We are focused on optimizing prices and controlling costs. We are focused on strategic bidding and solid project execution.

Speaker 2

We are focused on growing our company both organically and through acquisitions. Our edge strategy is working and we're looking forward to a strong finish to 2024 and good things in the years to come. I'll now turn the call back over to Nathan for his remarks. Nathan?

Speaker 1

Thank you, Brian. I'd like to begin with an overview of our consolidated results and product line performance, then provide a summary of our capital position as well as our capital allocation priorities, and end by outlining our updated 2024 guidance. As we look at our consolidated results, we reached another 3rd quarter record with revenue increasing to $1,100,000,000 This includes record revenue at our geographic segments. We are proud of these records as our operations continue to focus on higher profit and higher margin work. This is further demonstrated by our record gross profit of $273,000,000 for the quarter, driven by a 7% improvement across the geographic segments.

Speaker 1

Adjusted EBITDA was down for the quarter due to the expected decline at Energy Services as well as higher SG and A costs. SG and A for the quarter was $64,000,000 a $5,000,000 increase over the prior period. Approximately half of the increase was related to acquisition costs that Brian mentioned. Looking ahead to the Q4, we anticipate a similar increase in our SG and A expenses of $6,000,000 primarily from due diligence costs currently in progress. Moving to product line performance, our core product lines continue to benefit from the adoption of our Edge initiatives.

Speaker 1

Aggregates, ready mix and asphalt have all seen healthy pricing improvements for the quarter and for the year. Year to date, average selling prices for aggregates increased 8%, ready mix 10% and asphalt 2%, driven by our dynamic pricing effort. With the continued adoption of a dynamic pricing across our footprint, we are confident in our ability to optimize pricing and profitability beyond 2024. As anticipated, our initiative to capture pricing over volume led to volume declines across our product lines for the quarter the year. Year to date, we have seen aggregate volume decline 5%, ready mix 10% and asphalt 5%.

Speaker 1

In addition to the effects of our pricing strategy, we have seen some private work get delayed as developers navigate interest rates and uncertainty in the market. We expect that money will come back into play as rates improve. All in all, as we look ahead to 2025, we see volumes beginning to increase again now that we have mostly completed the hard work of resetting our customer base and narrowing the type of projects we bid. Despite the lower volumes, strong pricing improvement and cost control initiatives led to improved gross margin in the quarter, including 120 basis point improvement in ready mix and a 230 basis point improvement in asphalt. Although aggregates gross margin was flat for the quarter due in large part to lower volumes, our aggregates gross profit per per ton increased 7.7% for the quarter and 11.5 percent year to date.

Speaker 1

Moving from materials to contracting services, gross margins improved 120 basis points year over year to 12.9% in the 3rd quarter, directly related to our pursuit of higher margins on bid day and then once in hand successfully executing on this work to capture the value. Our backlog as of September 30 was $755,000,000 a 3% increase year over year at slightly higher expected margins. 87 percent of the backlog is public work with secure funding that has already been dedicated. We believe the type of work we do coupled with this reliable public funding lowers our overall risk profile and provides pull through demand for our upstream higher margin product lines. Moving to our balance sheet and capital allocation priorities, we ended the quarter with $220,000,000 in unrestricted cash and no amount drawn on our $350,000,000 revolver.

Speaker 1

Year to date, we have generated approximately $150,000,000 in cash from operations and anticipate this number will grow through year end as we tend to generate more cash flow in the Q4 than the other quarters. Additionally, our teams have done a great job bringing down our day sales outstanding from 38 days in 2023 to 34 days in 2024, which also contributed to improved working capital and our cash position. With our available liquidity and a net leverage position of 1 times trailing 12 month adjusted EBITDA, we are in a strong position to execute on our capital allocation priorities. We look at those priorities in 2 major categories, which align with our edge strategy. The first category is disciplined use of capital, which includes maintenance of fixed assets and internal improvements from our Edge initiatives.

Speaker 1

We estimate 2024 capital expenditures for our disciplined category to remain between 5% and 7% of revenue with $127,000,000 spent as of September 30. The second category is growth, which includes organic and acquisition opportunities. Brian highlighted our recent acquisition activity and our investment of $129,000,000 through today. He also noted that we have additional deals in our near term pipeline that would be incremental to this amount. Also within the growth category, we anticipate spending $23,000,000 for the remainder of 2024 on the initial stages of greenfield projects.

Speaker 1

Lastly, we remain focused on quality investments that will help us achieve our edge goals. Based on our Q3 results and what we see ahead in the Q4, we are revising our full year estimates to account for the increased SG and A costs, which largely related to corporate development and healthcare expenses. We are tightening our consolidated revenue guidance range to $2,850,000,000 to $2,950,000,000 For adjusted EBITDA, we are bringing in the top end of our guidance, which now reflects a range of $445,000,000 to $465,000,000 This consists of geographic segments and corporate services contributions between $390,000,000 to $405,000,000 and Energy Services remains unchanged with contributions between $55,000,000 $60,000,000 Our full year 2024 guidance includes the following assumptions. We anticipate average selling prices for our aggregates and ready mix product lines to increase high single digits and asphalt pricing to be up low single digits. We expect aggregate and asphalt volumes to be down mid single digits and ready mix down high single digits.

Speaker 1

And finally, guidance is based on normal economic and operating conditions for the remainder of the year. In conclusion, we are proud of the work our teams have done in the Q3 and we look to finish the year with another adjusted EBITDA record. Our geographic segments are producing excellent results. We have a strong backdrop of dedicated infrastructure funding and we're excited about the contributions we expect to see from our acquisitions. Knife River is growing and we are committed to achieving our edge goals and delivering long term shareholder value.

Speaker 1

With that, I'd like to open the call for questions.

Operator

Thank And your first question will be from Kathryn Thompson at Thompson Research. Please go ahead.

Speaker 3

Hi. Thank you for taking my questions today. Yes, solid geographic performance in the quarter. Thanks. And you had noted that the quarter saw a 6% EBITDA gain just from your geographic specific performance.

Speaker 3

How did EBITDA margins perform in Q3 for your geographies? And how has that trended year to date?

Speaker 2

I appreciate the question. Yes, so when we talk about our geo segments, just a quick level set, we're talking about the Pacific region, the Northwest region, the Mountain region and the Central region. And that houses all of our products other than energy services liquid asphalt. And so that includes aggregates ready mix asphalt contracting services in all of those geographic segments. And so you're right, our EBITDA was up 6% for the quarter.

Speaker 2

And within that, if you look at our EBITDA margins in those geographic segments alone, we actually improved 90 basis points for the quarter. If you look at for the full year through 9 months, our actual EBITDA contribution is up 15% and the EBITDA margin in those geographic segments is up 170 basis points. And so we're both performing on the EBITDA and EBITDA margin at that geographic segment. And obviously that's been partially offset by the headwinds that we knew about at Energy Services coming into this year. So performing very well in those geographic segments and all of the major product lines.

Speaker 3

Okay. Thanks. And a follow-up and more of a clarification on some of the growth initiatives in the quarter. What are or not included in terms of type of assets acquired? And you noted that the increase in SG and A was related to M and A and healthcare cost.

Speaker 3

If you could segment what was M and A related versus healthcare related? Thank you.

Speaker 2

Yes. So just to clarify, so year to date, we have purchased about $129,000,000 of new companies that consists of 6 companies. 2 of those were back in the 2nd quarter, the Weidenbach and the Graves operation. In the Q3, we closed on FB Marks and Sons, an aggregates operation in Central California. And then as of late here in Q4 in October November, we closed on the sand operation there in South Dakota, Rock Products which is a quarry and ready mix operation in Central Oregon.

Speaker 2

And then just over this past weekend closed on the assets of Albina Asphalt that's got the 4 terminals, 1 in Washington, 2 in Oregon and 1 in California. So we have continued to be focused on aggregates led materials based companies that are within or adjacent to our existing markets, which are those midsize high growth markets. You're right, we did have some additional SG and A expenses this quarter. And I'll just let Nathan touch specifically on the SG and A bucket that you asked about, Catherine.

Speaker 1

Good morning, Catherine. Thank you for the question. Yes, for the SG and A piece, the corporate SG and A piece, it is up 8% as I shared in the prepared remarks. About half of that relates to our acquisition costs, as Brian talked about. The other half does relate to health and welfare claims that are higher in the quarter.

Speaker 1

And it's probably important to note that as we look at the Q3 and going forward, we really are now comparing like for like. What I mean by that is, if you think back to last year, Q3, that's when we set up these departments that were previously provided by MDU. And so we have those set up successful with that coming in at lower than expected costs. So now you have a fair comparison year over year, but we are up. And it really is of that 8% split between those two main categories of acquisition costs about half of that and health and welfare about half of that.

Speaker 1

As we look into the Q4, as I shared earlier, probably pretty comparable to that in terms of about $6,000,000 compared to the $4,000,000 in the 4th quarter of higher corporate SG and A costs. Most of that relates to the acquisition costs we've been talking about that is due diligence for the quarter, some integration costs for the acquisitions we made here in the beginning of Q4 and the end of Q3. So Catherine, hopefully that helps you give you a little more color on the split of the SG and A both for the 3rd Q4.

Speaker 3

It does. Thanks very much and best of luck.

Speaker 2

Thank you.

Operator

Thank you. Next question will be from Trey Grooms at Stephens. Please go ahead.

Speaker 4

Hey, good morning, everyone. Good morning. So I guess I wanted to touch on the guide. If you kind of look at the aggregates, the volume guidance there, the ready mix volume guidance as well have both kind of been taken down a little bit from where they were. I think volume now is mid single digits that you mentioned, and I think it was low single digit, flat to low single digit in aggs and then low single to mid single in ready mix.

Speaker 4

Can you talk about some of the drivers there? I know you're clearly pushing pricing over volume, but then you also mentioned maybe some projects being pushed out. If you can help us kind of dissect some of that and I'll just start with that. Thank you.

Speaker 2

No, I appreciate that. And you're right, most of our volume declines this year, Trey, have been intentional as we take on the quality of work over quantity and that has had a big part of that. And we've done a lot of the difficult work, the hard work of resetting our customer base and really narrowing the type of projects that we are bidding. And so as we look forward going forward, little bit in here in the Q4, primarily into next year, really we need to level set and look at the year over year comparison and a lot of that hard work is behind us. For instance, we've got 2 portable asphalt plants in the central region that previous year last year was out chasing some of that higher volume lower margin work and we've parked those plants in stationary operations and they're literally doing about 300,000 tons of less volume this year compared to last year.

Speaker 2

Well, those plants are going to be parked in the same pits next year and so that year over year comparison going forward into 2025 really is going to be a new level set that we're looking at. And so most of the volume declines have been intentional and we've been very close to our guides on that. I will say that there has been some timing of projects, some larger impact jobs that we had last year that we did not have this year in Q3. Some of those that we thought we were going to have in the Q3 have been pushed out into next year, a fairly large windmill project in Wyoming. And just if you look at how we started this year, we came out of the gates very fast.

Speaker 2

We had very favorable weather. We were up 22% after the first half of the year as it relates to our EBITDA performance. So a little bit is timing of projects. And then there is a softening and the pull through of aggregates that we use in ready mix is definitely having an impact, in our aggregates operations as well. And we continue to see that softening in that private side of the work.

Speaker 2

Fortunately for us, we don't have as much exposure to the private work, especially on our contracting services, but we are noticing that in ready mix. The type of work that we're doing in contracting services, again for the quarter, we saw a little bit more heavier civil and dirt work than we did paving specifically in the California markets, saw that in the Idaho markets. And so really nothing alarming as far as backlog and things going forward. But I would say Trey that the good news for us is that we think a lot of that hard work that we did of resetting our customer base and kind of level setting on the type of work that we're bidding is behind us and you will see favorable comps going into next year, kind of more reflective of the overall market, which we think is still very strong.

Speaker 4

Okay. All right. That's helpful. And I guess it's is it fair to say then that the revision to the volume guide is more on the kind of the end market or actual demand side of things softening incrementally versus the competitive landscape becoming more difficult to push price or anything like that. Is that a fair assumption?

Speaker 4

Because there was kind of this reduction there trying to figure out how much of that would really be due to you guys taking a more or maybe it even becoming more difficult to push the price than it was before?

Speaker 2

No, I don't think it's more difficult to push our price. I think what you're seeing is, I mean, so through 9 months, I mean, through the Q3, our volumes are down 5%. And we've kept that for the rest of the year at 5%. As you know, our 4th quarter because of our seasonality does not is not going to push those numbers directionally very far from where they currently are sitting. And so really I think that year to date our guidance is built in for the full 12 months is very reflective of where we sit today after 9 months and frankly after we sit we looked at our October sales and feel comfortable that those volume guides are for the full year knowing that the Q4 has very little impact of where we sit year to date.

Speaker 4

Okay, that's helpful. Thank you for all that. And then, on acquisitions, I mean, clearly, you guys have stepped it up in several acquisitions over the last few quarters. Can you talk a little bit about how those fit into the longer term strategy? How they fit into the dynamic pricing?

Speaker 4

And do they help in those efforts? And then any color you can give us on the contribution. We can kind of back into the EBITDA given what you've the multiple you gave us, but any other details around that would be great. Thank you.

Speaker 2

I appreciate that. And so yes, we're very excited about our activity. Those acquisitions that we executed in the last 9 months, 10 months now. Very excited about the pipeline. It remains full.

Speaker 2

Our team continues to be very active and working on due diligence this quarter. And so very excited about both the pipeline and the deals we've gotten across the finish line. Those deals are exactly what we've said that we wanted to do, our materials based aggregates led in our existing markets. And so the majority of those are those smaller deals that we are very good at acquiring and integrating and capturing those synergies immediately, which includes our ability to do dynamic pricing. So if you look at Weidenbach and Graves and FB Marks and Sons and the Parker pit and the Rock Resources, I mean all of those are heavy on the material side adjacent, I mean well they're not adjacent, they are in our existing strategic market areas.

Speaker 2

And so yes, those will complement our continued efforts as we implement dynamic pricing and other synergies that are right in those existing markets. The one over this last weekend in Energy Services is a company that we've been looking at for quite some time. As you know, as you've seen in our performance, liquid asphalt is one of our better profit margins businesses and this happens to be in one of the areas where we consume and use a lot of liquid asphalt in a region, the Northwest region having terminals in Washington and Oregon of one of our highest profit regions that we've got EBITDA margins. And so yes, it will definitely complement our vertical integration as it relates to our asphalt and contracting services. So Albine is going to be a great addition to our group of family of companies.

Speaker 2

So very excited about it, Trey.

Speaker 4

Sounds good. Thank you, Brian. I'll turn it over. Yes.

Operator

Thank you. Next question will be from Garik Shmois at Loop Capital. Please go ahead.

Speaker 5

Hi, thanks. Wondering if you could speak to with a little bit more detail just your observation that you expect pricing to remain above costs moving forward. As we get closer to 2025, any thoughts as to how you expect pricing and cost to track next year?

Speaker 2

Yes. Thanks, Gerrick. So yes, directionally, I can just share kind of what we've mentioned in our prepared remarks and we'll be giving a more detailed formal guidance in February. But the demand, the fundamentals are still there. You look at our backlog, I mean it's up and overall.

Speaker 2

And you look at the funding levels at all the state DOTs and the local public works departments and we sit down and talk to some of those directors in the states that we're working in and the budgets are strong. And so the demand environment is very healthy. And the challenges that we had this year in our volumes was really that fundamental change at how we're looking at work, what jobs we're bidding, which customers that we're doing business with and we really did to needed to reset that as part of our quality over quantity at the same time of raising our prices for materials in those high single digits. So we see that momentum carrying forward. We talked about that hard work of resetting our customer base and narrowing the projects behind us.

Speaker 2

We're going to maintain a very disciplined approach to bidding and continue to have our quality over quantity. And we do see that we've we're still in those I would consider early innings of implementing our dynamic pricing and more sophisticated rollout of our sales training and dashboards that we're working on. That's all still in play. That self help is absolutely something that we're very focused on at Knife River. So directionally, we feel like volumes are going to be more reflective over the overall market and we think the market is very healthy by looking at our backlog and DOT budgets.

Speaker 2

And that the pricing momentum coupled with the efforts that our pit crews have been out working on and really uncovering, Gerrick, is that there are some opportunities for us. And I think if you talk to our local management teams, the boots on the ground out in these operations, they would tell you that they think there is more upside in margin expansion from our pit crew activities and really focusing on our production costs and reducing our downtime. And that's as much of a focus as dynamic pricing has been. So all that to say is that directionally we feel very comfortable, confident that next year that we will see a regain in volumes and that our pricing discipline will outpace the costs.

Speaker 5

Okay. That's encouraging. Then just 2 volume follow ups. 1, was there any weather impacts in the quarter just given it's been such a theme here over the last several weeks in earnings season? And then just a clarification on the revenue guidance, you kept the midpoint unchanged.

Speaker 5

Is it fair to assume that the acquisitions in the Q4 are kind of the offsets of the lower volumes?

Speaker 2

Okay. Yes, so we absolutely I mean, we have operations down in Texas and as you've heard for the last week, it was very wet, very bad weather down there. So yes, I mean, our sales that we had forecasted when we updated our guidance at the end of the second quarter did have an impact from lower sales out of our Honey Creek facility. It is overall operations both ready mix and contracting services, asphalt production down in Texas. It's not a huge piece of our portfolio, but absolutely it had an impact.

Speaker 2

And so that did play into our lower volumes for the quarter. And so as far as the guide on the acquisitions, Nathan, do you want to take that question?

Speaker 1

Yes. Garrick, I think your question was along for the revenue guide, we do have that still at the same midpoint. And so the question there, acquisitions, do we see revenue in the Q4? Really, as we talked about a little bit in the prepared remarks, in the Q4 for us when we bring these deals on, oftentimes this is towards the end of the year, the off season for us. So the revenue related to those acquisitions would be nominal in the Q4.

Speaker 5

Okay. No, that's helpful. I'll pass it on. Best of luck.

Speaker 2

Thank you.

Operator

Next question will be from Ian Zaffino at Oppenheimer. Please go ahead.

Speaker 6

Hi, great. Thank you very much. I wanted to ask you on the M and A front. As you're looking and as you're talking, how do we think about maybe the mix of potential acquisition targets that you're looking at? Is it going to be more services, materials?

Speaker 6

If so, what type of materials? Is it going to be vertically integrated? Maybe any color you could kind of give there, so we know where the business is heading? Thank you.

Speaker 2

Thanks, Ian. Yes, so we've got a slide in the deck that kind of shows what our pipeline looks like both in deal size and markets, but I'll talk specifically about what product lines that we're looking at. So, Ian, we have a robust pipeline with frankly deals in every part of that pyramid from the smaller less than $25,000,000 deals to deals that are in excess of $200,000,000 And so we are those are in our pipeline and we currently have due diligence being completed on a number of those. In the markets, we absolutely again continue to be focused on those markets that we're currently in or adjacent to one of our existing states. And as we've discussed in the past, oftentimes you look at the markets that we play in that our local competitors are typically those regional family owned vertically integrated type of companies.

Speaker 2

And so contracting services does not at all scare us. In fact, we look forward to those types of opportunities because of the pull through of either existing aggregates that come with the deal or that we can supplement and complement with our existing operations. And so I would say that the pipeline is very diverse both in project size. I can tell you that we have deals that we're looking at in every one of our regions and that we've got deals that have one of our product lines whether that's aggregates, ready mix, asphalt, contracting services as you saw over the weekend liquid asphalt. All of those are in play and that they all are in our current pipeline with really an emphasis as it has been with our Edge strategy all along is to continue to grow those higher upstream material as a higher margin upstream material businesses as with aggregates being leading that pack.

Speaker 2

So that's kind of a glimpse into our pipeline and our strategy.

Speaker 6

Okay. Thank you. And then, I guess we're kind of touching upon a 20% margin in this past quarter. Obviously, it's a strong part of the year for seasonality. But how are we thinking now about that 20% margin, both in what you've been able to generate and then large expansion you're looking to do, but then maybe offset by some of these higher SG and A costs and some other costs?

Speaker 6

Thanks.

Speaker 2

Yes. Well, I think we continue to be very pleased with the progress we're making with the Edge initiatives. I mean, we laid out that we wanted to be at 15% by 2025 and we achieved that goal 2 years early. If you look at our year to date performance, we're up 50 basis points year to date overall. And obviously, we've had the tail or the headwind that we knew about in Energy Services.

Speaker 2

If you take out Energy Services and look at the geographic segments, I mean, our EBITDA margin improvement for the 9 months has been 170 basis points. So we absolutely feel committed that 20% target that we've set for our long range goal is achievable. I can tell you that all of our initiatives internally are geared to drive towards that flag of 20%. We've talked about there's multiple paths to get there. We're focused on all of them.

Speaker 2

Growth is a part of that. Our pit crews is a big part of that. Continuation of dynamic pricing is a big part of that. And so we're looking at all regions, all product lines. And yes, we are committed to that 20% long term knowing that we continue to make progress this year and have made tremendous amount of progress in the short amount of time since we've really rolled out the Edge initiative.

Speaker 2

So very focused on that, Ian.

Speaker 6

All right. Thank you very much.

Operator

Thank you. Next question will be from Sherif Ghislavathi at Bank of America. Please go ahead.

Speaker 7

Hi, good morning. I just wanted to touch on capital allocation. You noted that the M and A pipeline is quite robust and diverse. But with leverage as it stands well below the long term average target and substantial cash on hand, should we think of that as earmarked for M and A that you have in the pipeline? Or is there any shifts on the margin with regards to capital allocation priorities?

Speaker 1

Yes. Thank you for the question. So first of all, again, very excited about what we've seen here in the 3rd Q4 with where we're putting our dollars and putting those to work with both maintaining our assets and improvements for them and then as well as the growth that we've got identified. So the question being do we anticipate any shift in where those dollars would go to, with what we've got as far as net leverage and cash on the balance sheet. As I mentioned in the prepared remarks, very strong position for the company to put those dollars to work in both of those categories.

Speaker 1

So what you'll see going forward most likely is for us to continue to maintain our assets in those improvements and we've indicated that 5% to 7% of revenue for the year. And then also looking to grow, we mentioned the $129,000,000 for our acquisitions and then $20,000,000 for organic. Incremental to that, so for the Q4, if we have additional acquisitions coming in that would be incremental to the 129 As far as shifting to capital returns, cash returns, I think the best dollars for us to spend are those on maintaining our business and growing our business with the opportunities we see forward. So really not a shift in any priority for us in capital allocation.

Speaker 2

Thank you.

Operator

Thank you. Next question will be from Chris Ellinghaus at Seyburt Williams Schenck. Please go ahead.

Speaker 2

Hey, everybody. How are you? Good, Chris.

Speaker 8

Brian, can you just talk about the Northwest backlog and what's contained in the decline? Is it timing? Is there some product mix stuff, what's going on there?

Speaker 2

Yes. So we had a large impact job down in Southern Oregon called the Foothills project. And so really if you look at our last year's backlog, it's the one that's abnormally high. You look at where we were at in 2022 at the end of the Q3 or 2021, we're actually higher today than we were in those years. And so it's not alarming that where our backlog is at.

Speaker 2

I think as we're comparing it to a year where we had a large impact project down in Southern Oregon. And so I think our teams are very focused. The work that we've got is very diverse in the Northwest region. And we've talked about before, Chris, we have that unique ability to flex between private and the public work. And we also have a lot of work right now coming up out of our prestressed facilities.

Speaker 2

And so nothing over alarming on where we are as it sits today on backlog.

Speaker 8

Okay. Do you have any color on when this Wyoming wind project might come back around?

Speaker 2

Yes, it's not been canceled. It's just been delayed. We thought we were going to start some aggregate production and supply in the Q3. And typically in the Q4 that part of the world, you're not doing a lot of work anyway. Sometimes you might get a little bit of work in there, but it's really just been shifted into next year, Chris.

Speaker 8

Okay. Sometime next year.

Speaker 2

Yes.

Speaker 8

Nathan, can you talk about in the M and A, what's your funding strategy and what are the targets seeking in terms of compensation?

Speaker 1

Yes. So our funding strategy really does relate to 2 areas as of now. As we've talked about, first, we've got cash on the balance sheet. We started the year with $200,000,000 some in cash. We produced cash flows from operations.

Speaker 1

I think you can use EBITDA as a guide for that, where we have utilized a good portion of that for the 2 buckets I talked about earlier. So anticipating ending the year here, absent any incremental acquisitions we do, with cash on hand. So that would be one funding source. Ended the quarter at 1x net leverage, our target there is 2.5x. So again, having that availability of utilizing the balance sheet and debt to grow.

Speaker 1

Would we look at other options in that if the deals were larger or if the owner was interested in that? That's a hypothetical, we potentially would. But really our funding sources would come from cash sitting on the balance sheet, put that to work and then moving towards our target of 2.5 times as we grow our acquisitions.

Speaker 8

I guess another way to ask the question, historically,

Speaker 2

you've done a

Speaker 8

lot of these family owned businesses, right? There must be some tax considerations in how they're seeking to be paid. Are they looking for any stock in their transactions or other tax advantages?

Speaker 1

We have had instances in the past where we have done deals that some owners have been interested in stock. We have accommodated that. So if there was an owner that came forward with that interest again, we would take a look at it or if the deal, but we'll certainly be looking at the metrics of the transaction to make sure that it makes sense for us. But yes, there are times when that makes sense and maybe for them too to have a continued interest if they're part of it, the deal going forward to see how we perform and benefit from that as well. So yes, Chris, we are open to that also.

Speaker 8

Okay. One last question. About the due diligence and M and A fee expense portion of the last few periods, Have you considered excluding that from your calculations given that they're sort of irregular and sort of non I guess just not they're not regular. So have you thought about excluding them from your adjusted numbers?

Speaker 1

Yes. I think if a deal was transformational or there were certain adjustments that need to be made for GAAP purposes, we would maybe consider doing adjusting. For the deals that we currently have, those are right within the size that we would expect, as Brian mentioned earlier. And so for those, they're recurring as we take a look at the rules. And so for those, we have not done an adjustment.

Speaker 1

But Chris, going forward, depending upon the size of the deal, we take a look at that and of course communicate that to the investing public as to why we're making that change or that adjustment.

Speaker 8

Same as Chira, I presume, of your thoughts on transition costs?

Speaker 2

Yes.

Speaker 9

Okay.

Speaker 1

Yes. So if there's integration I think what you're getting at there, Chris, if there's integration costs or something with transitioning to bringing one of these acquisitions on board, it would be encompassing to not just be, for example, 3rd party due diligence. We would look at what the total cost is associated with that acquisition.

Speaker 8

Right. Got you. Thanks a lot.

Speaker 2

Thank you, Chris. Yes.

Operator

Thank you. And your next question will be from John Ramirez at D. A. Davidson. Please go ahead.

Speaker 9

Looking forward, do you mind walking through perhaps your 5 4 or 5 large states and seeing where some of that growth for 2025 will come and where do you see some challenges perhaps in context of DOT large projects being announced as well as some of your initiatives of looking for pricing over volume?

Speaker 2

Yes, John, I appreciate that. And so I can tell you that's an easy one at the end there is we're looking for price over volume and continue to roll out our dynamic pricing in all of our states, all 14 states. Obviously the Northwest region is the furthest along in that initiative, but we are rolling that out in every of our all of our product lines, major product lines, aggregates, ready to mix and asphalt in all 14 of our states. If you look at specifically contracting services, we've got a slide in our deck on backlog and the Mountain region continues to see a very healthy bid letting schedule. They've got 12% more backlog than they had at this time last year.

Speaker 2

And those states in particular are looking very strong as do a lot of the central states, Nebraska, Iowa, Minnesota, Texas. Those have very strong DOT budgets. I mean, if you look across the entire country and all including all fourteen of our states, I mean, they're all at or near record levels. I mean, there's going to be some timing of DOT budgets as they work through some legislative issues and up their funding in states like Oregon. And so there could be a low for a year or 2.

Speaker 2

But keep in mind, John, as you all know, the roads have got to get repaired, the bridges have got to get repaired. And more important thing there to look at is what is the scorecard, what is the your report card look like for infrastructure in these states and you talk to the DOT directors and the IIJ money is helpful as that's been far from fixing the problem. And so these states that might have a little bit of a dip for a year or 2 are practically looking working with their legislators to try to figure out how to fund the next batch of projects. And many of the states, I mean, like Texas and Minnesota have just recently done that. So every one of the states, I mean, I could go state by state, but I won't.

Speaker 2

But they look strong when it comes to infrastructure funding. Keep in mind, I mean, we have a heavy influence in Hawaii and Alaska from military spending and that continues to be a very bright spot for us. And some of those projects that we thought would maybe get going this year in a little bit larger way have been delayed. They're not postponed, they're not canceled. The big dry dock, submarine dry dock in Hawaii is a few months delayed, but certainly going to have a lot of volumes going on that project as well as the base up in Anchorage.

Speaker 2

And so good funding, military, public funding and then as we've talked about data centers, windmills, private work is kind of changes as you look at each individual state, each individual region. But overall, next year, certainly looking to see strong tailwinds in funding and volumes returning back to more of the market conditions.

Speaker 9

Got it. And you mentioned something about your prestress activity contributions. Could you talk more about that and see what the ramp looks like going forward?

Speaker 2

Yes. We're very excited about the progress that our new facility in Spokane, Washington has been making. We commissioned that earlier in the year. It's up to full operation. I think it's actually outperforming some of the models that we've put together both from a capacity standpoint, our labor costs.

Speaker 2

And the good news with that is that the demand continues to be strong in pre manufactured concrete building solutions, whether that's for structural bridge girders or architectural wall panels. We really are seeing contractors gravitate towards that as a very affordable, sustainable building solution. And so anxious to host our Board of Directors actually out in Spokane, Washington next week and show off that facility. So it's performing exceptionally well and it really is helping contribute to those record EBITDA margins, EBITDA performance in the Northwest region.

Speaker 9

And one before I get to Nathan, the industry has suggested mid single digits in 2025. What's your view on those comments?

Speaker 2

Jan, you broke up a little bit. Industry suggested what for 2025?

Speaker 9

Pricing increases of mid single digits from what we've heard from your peers. I'm just wondering what are your thoughts on that?

Speaker 2

Yes. I think directionally we would agree that the pricing momentum that we've seen this year and the continuation of our dynamic pricing focus in markets that we enjoy a number 1 or number 2 market position in which is about 75% of our volume. No, I think we would agree that that pricing momentum is going to continue into 2025 and that we feel that it will outpace inflationary cost. So would agree with that.

Speaker 9

Thank you. And Nathan, just last one for me. From you've just had $267,000,000 cash as of Q3. Is that taking into account what you guys spend on acquisitions during that month of the last month in September?

Speaker 1

It does take into account. So what you see on the balance sheet there and the cash flows through ninethirty does take into account what we spend through ninethirty, but these transactions that Brian mentioned earlier in October November would be additional CapEx that would reduce that cash balance.

Speaker 9

And do you okay, see sorry, go ahead.

Speaker 1

Well, I was going to say you can see from there, I mean, we spent essentially $15,000,000 in CapEx through $930,000,000 and the remainder of the $129,000,000 we mentioned would have been spent in October November, if that kind of helps you with the numbers, the $115,000,000 then.

Speaker 9

Perfect. Appreciate it. Thank you guys so much for the time. I hope I can take your questions. Thank

Operator

you. And at this time Mr. Gray, we have no other questions. Please proceed sir.

Speaker 2

Yes. I just want to thank everyone again for joining us today. We're proud of our results and are excited about the long term opportunities at Knife River. We continue to make good progress on our edge goals and are well positioned to grow our company and deliver long term value for our shareholders. So we appreciate the interest and support.

Speaker 2

And with that, I'll turn the call back over to you.

Operator

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Enjoy the rest of your day.

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Earnings Conference Call
Knife River Q3 2024
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