SLND - AMEX

Good day, ladies and gentlemen, and welcome to the Southland Holdings, Inc. Second Quarter 2023 Earnings Conference Call. [Operator Instructions] This call is being recorded on Tuesday, August 15, 2023. I would now like to turn the conference over to Alex Murray. Please go ahead.

Good morning, everyone. This is Alex Murray, Director of Corporate Development and Investor Relations. Welcome to the Southland Second Quarter 2023 Conference Call. Joining me today are Frank Renda, President and Chief Executive Officer; and Cody Gallarda, Executive Vice President and Chief Financial Officer. I'd like to begin with a gentle reminder. This conference call may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934, and the Private Securities Litigation Reform Act of 1995. Forward-looking statements are neither historical facts nor assurances of future performance. Forward-looking statements are uncertain and outside of Southland's control. Southland's actual results and financial condition may differ materially from those projected in forward-looking statements. Therefore, you should not rely on any of these forward-looking statements, and we do not undertake any duty to update these statements. For a discussion of some of the risks that could affect results, please see the Risk Factors section of our Form 10-Q we filed last night and our Form 10-K for the year ended December 31, 2022, and filed with the SEC on March 21, 2023. We also refer to non-GAAP financial measures, and you will find reconciliations in the earnings release related to this conference call, which may be found on the Investor Relations page of our website. With that, I'll now turn the call over to Frank.

Thank you, Alex. Good morning, and thank you for joining Southland's Second Quarter 2023 Conference Call. We had a disappointing second quarter with revenue of $257 million, a decrease of $16 million compared to last year. We reported a gross loss of $34 million in the quarter, which compares to a gross profit of $38 million in the same period last year. In this quarter, we generated $24 million of operating cash, driven by new project starts, which are performing well. We faced adversities this quarter, primarily driven by unfavorable charges related to the legacy materials production and paving component of our transportation segment. We made the decision to exit this business so that we can focus on the unprecedented opportunities in our core market. We are pursuing work in key markets with teams that have historically executed well and are no longer pursuing large-scale paving work or aggregate production. Our core business is strong and we remain confident in our backlog. It is important to provide insight into our Materials & Paving business and the changes we have made as a company over the past few years. In 2016, we developed a plan to produce our own asphalt and concrete to sell to third parties and to support our paving business. We made large CapEx investment in aggregate quarries, pits, and batch plants while pursuing large-scale roadway paving projects. By the end of 2019, our paving projects accounted for approximately 39% of our then, $2.3 billion backlog. Over the last several years, our Materials & Paving business underperformed due to poor execution, unprecedented inflation, challenging geographical locations, and supply chain issues. This end market became increasingly less attractive and we decided to substantially shrink the size of this business to focus on more profitable end markets. At the end of the second quarter of this year, our large-scale paving work was only 12% of our $2.7 billion backlog. In the second quarter, in an effort to wind down our Materials & Paving business, we disposed of several assets, including asphalt batch plants, which supported a small amount of third-party sales and multiple large-scale paving projects. As a result, we recognized unfavorable charges in the quarter related to additional expected future cost to complete these projects. These additional costs are related to procuring, transporting materials from third parties. We did these paving projects several years ago with the intention to produce our own materials. Now that we are no longer producing materials for the existing paving work, we must pay elevated and inflated market prices from vendors. We took the charges this quarter for the future expected cost of completing the work. It was best to lock in prices with vendors now and mitigate the long-run cost uncertainty associated with producing our own material. Large scale materials production tied up our key people, including members of our management team and would require significant resources to maintain. We have also shrunk the paving business to the point that it no longer made sense to continue to operate the production assets. Ultimately, divesting from large-scale materials production and reallocating resources to our core operations is best for the long-term success of the business. We look forward to putting this legacy work behind us as we focus on the unprecedented opportunities in our core business. As a result of record awards last year, our backlog increased 36% to $2.7 billion from $2 billion at the end of the second quarter last year. Now turning to upcoming bidding opportunities in our Transportation segment. We've been shortlisted on 3 large projects in the Northeast with combined engineers' estimates exceeding $1.5 billion, which include; the Livingston Avenue Bridge replacement in Albany, the RFK Suspended Span Retrofit in New York, and Connecticut River Bridge for Amtrak. We expect these projects to bid in the fourth quarter of this year. Two of these projects only have 2 bidders shortlisted. We are also pursuing over $2.5 billion of new pursuits on the West Coast, some of which include the earthquake ready Burnside Bridge in Oregon, which is expected to bid this month and the Golden Gate Bridge seismic retrofit in California. Notable opportunities in our Civil segment with combined engineers' estimates of approximately $1.4 billion include; the San Juan Lateral Water Treatment Plant for the Bureau of Reclamation bidding in late summer; the Department of Defense Ansol Tank Farm Facility project bidding this fall; and Phase 2 of the North End Treatment Plant project in Winnipeg. We are currently working on Phase 1 of this project. We continue to be excited about what new federal funding will do for our business over the next decade. That being said, the new federal spending is yet to have a major impact on our financial results. We have seen an elevated amount of bidding, but have not seen a large impact in our backlogs from these funds. At this point, we expect to begin to see the impact to revenue in late 2024 into 2025. With that, I will now turn the call over to Cody for a financial update.

Thank you, Frank, and good morning, everyone. My prepared remarks will cover our financial performance for the second quarter of 2023. You can find additional details and information in the financial statements, footnotes, and management discussion and analysis that was filed on Form 10-Q last night. I would first like to address the select preliminary financial information we pre-announced last Thursday evening. As you are aware from previous filings with the Securities and Exchange Commission, or the SEC, there were a significant number of shares issued in private placements to certain founders of Legato Merger Corp. II, now known as Southland Holdings, Inc., prior to or in connection with the initial public offering of Legato Merger Corp. II. We refer to these shares as sponsor shares. In addition, there were a significant number of shares issued to the sellers of Southland Holdings LLC as part of the business combination with Southland Holdings LLC. We refer to these shares as target shares. Pursuant to the terms of their respective agreements, the sponsor shares and the target shares were subject to lockup provision that expired 180 days after the closing of the business combination, with respect to the sponsor shares and 6 months after the closing of the business combination with respect to the target shares. As a result, the first trading day on which markets were opened after the expiration of these lockup provisions was yesterday, Monday, August 14, and the company had reason to believe that non-affiliate shareholders may have had a desire to sell sponsor shares upon such expiration of the lockup period. Pursuant to a registration rights agreement that was executed in connection with the business combination with Southland Holdings LLC, we were obligated to file and maintain an effective resale registration statement on Form S-1 with the SEC, which we filed on March 31, 2023, and which went effective on May 15, 2023. As we previously announced, the company plan to, and subsequently did, file the second quarter's earnings information and Form 10-Q after trading hours yesterday on Monday, August 14. In order to preserve the availability of this resale Form S-1 for selling shareholders on Monday, August 14, after the expiration of the lockup period, the company decided to pre-announce select preliminary financial information on Thursday in order for the market to have enough time to properly digest the information. Now to discuss our financial results for the period. Revenue for the second quarter of 2023 was $257 million, a decrease of $16 million or 6% from the same period in 2022. Both of our segments contributed lower period-over-period revenues. We won a record amount of new awards last year and this work and these new starts continue to make an impact, albeit at a slower pace than initially expected as we progress through the year. As we mentioned on the last call, we always have the risk of revenue slipping into subsequent quarters from project delays, weather, permitting and many other factors. Given the slower progress we have made through the first half of the year and certain unfavorable charges that significantly impacted revenue in the second quarter, it will be difficult to grow revenue for the full year 2023 as compared with last year. Gross profit for the second quarter of 2023 was negative $34 million, a decrease of $72 million from the same period in 2022. Our gross profit margin was negative 13% in the second quarter. The majority of this decrease was driven by our decision to discontinue the Materials & Paving line of business. Selling, general and administrative costs in the quarter were $16 million, an increase of $3 million from the same period in 2022. This increase was primarily driven by costs related to being a public company. Operating income for the second quarter was negative $50 million, a decrease of $74 million from the same period in 2022. The majority of this decrease also was driven by our decision to discontinue the Materials & Paving line of business. Interest for the quarter was $4 million, an increase of $2 million from the same period in 2022. The majority of this increase was driven by increased borrowing costs and higher debt balances. Income tax benefit for the second quarter was $19 million compared to an income tax expense of $2 million for the same period in 2022. The primary driver for the income tax benefit was negative gross profit from operations, as previously discussed. I'd like to point out that the majority of Southland subsidiaries had an S-corp tax selection in 2022 and earlier years, resulting in non-comparable tax treatment when comparing 2023 to prior years. On a go-forward basis, we expect the tax rate to be in the 20% to 24% range, depending on certain tax credits, non-deductible items, and certain state and local taxes. We recorded a GAAP net loss of $13 million or negative $0.27 per share in the second quarter compared to net income of $19 million in the same period in 2022. Our weighted average basic share count was 46.9 million shares. Today, our basic shares outstanding are 47.9 million. We recorded an adjusted net loss of $35 million or negative $0.76 per share after backing out other income from changes in the fair value of the earn-out liability for 2023, offset by transaction-related expenses. This compares to an adjusted net income of $19 million in the same period in 2022. In the second quarter, we produced EBITDA or earnings before interest, taxes, depreciation and amortization of negative $19 million and adjusted EBITDA of negative $42 million after reversing out the benefit from changes in the fair value of the earn-out liability for 2023 and transaction-related expenses. This compares to EBITDA and adjusted EBITDA of $35 million for the same period in 2022. Now to touch on segment performance. For the quarter, our Civil segment had revenues of $66 million, a decrease of $9 million from the same period in 2022. Our Civil segment gross profit was $6 million, a decrease of $6 million from the same period in 2022. As a percentage of revenue for the quarter, our Civil segment had a gross profit margin of 9% compared to 17% in the same period in 2022. For the quarter, our Transportation segment had revenues of $191 million, a decrease of $7 million from the same period in 2022. Our Transportation segment gross profit was negative $40 million, a decrease of $65 million from the same period in 2022. As a percentage of revenue for the quarter, our Transportation segment had a gross profit margin of negative 21% compared to 12% for the same period in 2022. The Materials & Paving business line contributed $37 million to revenue and negative $49 million to gross profit in the second quarter. Our core operating results in this segment or results excluding Materials & Paving, would have been $154 million of revenue and $9 million of gross profit for a gross profit margin of 6%. Turning to the balance sheet. As of June 30, 2023, we had net debt of $230 million, inclusive of cash and restricted cash of $54 million. We paid down $15 million on our secured notes this quarter before considering additional borrowings. Regarding backlog, our backlog decreased slightly from $2.9 billion at the end of the first quarter to $2.7 billion at the end of this quarter. During the second quarter, we had $92 million in new awards, which compares to $255 million in new awards in the second quarter last year. For the first half of the year, we had new awards of $262 million. This compares with $295 million in the first half last year. Year-over-year, our backlog increased 36% from $2 billion at the end of the second quarter last year. Thank you for your commitment and time in Southland. I'll now pass the call back to Frank for closing remarks.

I would like to express my gratitude to the incredible men and women who are part of our team and are making it happen day in and day out. We remain confident and positive on the outlook for our industry. Southland has deep-rooted industry experience, and I put our capabilities in specialty infrastructure, construction up against all others in our industry. Our history in bridges, tunneling, transportation and facilities, [marine], steel structures, water and wastewater treatment, and water pipeline end markets is second to none. I'll now pass the call back to the operator for questions.

[Operator Instructions] Your first question comes from Adam Thalhimer from Thompson Davis.

Good morning, guys. Tough quarter. Frank, can you talk about -- you said you're no longer going after large paving jobs. It might be helpful if you just break down what you mean by that and how that differs from your ongoing focus after this incident?

Yes. Thanks, Adam. So, large paving jobs where we have to produce our own materials, that are just roadway projects, we're not going after. We're going to stay on our core markets on the transportation side and focus on highly technical bridges and structures.

Okay. You had a couple other jobs that were in a loss position also in Q2. Can you give me the details on that? There was an American Bridge job, and then also, I think it was a Midwest bridge job. Are those projects done?

So, those projects are not done. So, on one of those projects, Adam, we started the project, and we had to go to a different method to get into this project. Both of these projects were bid pre-COVID. They're legacy projects and we expect them to be winding down over the next year or so.

Yes, Adam, maybe to further bucket the impact there. We picked up $2.2 billion of our $2.7 billion over the last 6 quarters. And so, you can infer into the rest of that $500 million or so in the pre-COVID pre-inflation era. And we expect that a large majority of that to burn at 0% margin over the duration of those project lasts.

Okay. That's good color Cody. I sort of missed, we kind of went fast and furious through the bidding in the back half of the year. Maybe you can just kind of sum that up for us and bracket where you think backlog could end the year.

So we're really excited about the market. We talked on the prepared remarks, 3 bridge opportunities in the Northeast, 2 in the West Coast, several in the Midwest and in the Civil side as well. Those projects are starting to come out, but those are just a few of the highlight projects that we're really looking at, Adam. On some of these larger contracts, you don't know exactly when they're going to award, but the projects are out for bid in the third and fourth quarter. We also had 6 jobs that totaled around $400 million that we were the low bidder on; 5 of these jobs, we were the only bidder on that did not get awarded in the quarter as well. And we expect those to be out...

Why is that?

Yes, there are a few different reasons, they didn't get awarded. We were the only bidder on a majority of these projects, and some of our customers are required to re-advertise these projects one more time before awarding. Some of these projects were bid with engineers' estimates set almost with pre-COVID and pre-inflation prices. And in some cases, engineers' estimates simply, you know they just weren't correct. And we expect these jobs to come out for re-bid. Two of them, like I said, are already out for re-bid. We're in communication with the owners. So these jobs aren't going away. It's unusual for this many jobs not to award, but we feel confident that budgets are being adjusted quickly and especially on the highly technical projects that we're pursuing in the next 2 quarters.

Okay. And lastly, I'll turn it over to Cody. Can you just talk a little bit about the back half of the year in terms of free cash flow expectations?

Certainly. So, this quarter, we generated $24 million of positive cash flow from operations. The timing on free cash flow conversion is really dependent on so many different items with respect to billing milestones as well as change order settlements. So, difficult to predict. You heard in our opening comments that it will be difficult to have year-over-year revenue growth, but we do look forward to continuing the trend of positive cash flow from operations.

Your next question comes from Christian Schwab from Craig-Hallum.

So, just on the remainder of the legacy backlog, thanks for the color on how much is left. But how -- is all of this stuff done by the end of '24?

So, we shared that M&P work has about a 1 to 2 year completion horizon on it. So that would take us out to mid-'25 with the tail being towards the end of that 2-year period, Christian. The rest of that work is in a similar category. We have one project that may tail off beyond that, but we expect substantially all of it to be complete within the next 12 to 24 months.

Okay. And then, there's always surprises in large construction projects, in the bidding process. Do we believe that the remaining backlog has been vetted and bid as profitable as you think it was when you originally bid it? Or is there any potential geographies or work that may not be in line with kind of historical EBITDA targets?

Yes, Thanks, Christian. Great question. So, the $2.2 billion of the $2.7 billion backlog that we have remaining, we've picked up over the last 6 quarters. We picked that up at a time frame coming off of record inflation, coming out of COVID, so much uncertainty in a very limited bidding field. We knew exactly what our crews were producing on the jobs and in the areas with owners that that we knew and had successfully completed projects with in the past. So we're extremely confident in that work. The remaining work, you know the legacy projects that we have, we kind of touched on. We've got those at a 0 margin go forward. But as far as vetting the backlog that we have for the $2.2 billion and the remaining work and completion, we're confident in bringing -- being able to bring that home, at the numbers that were bid or adjusted to.

Christian, maybe just to add a little bit of color on the cadence of the burn. We mentioned the 12 to 24 months on that legacy backlog. Certainly, over time, you'll see a larger pro-rata contribution from this new work takeover. Just didn't see those projects ramp up and have the activity at the time -- in the timeframe we expected, still coming, still feel very positive about that new work.

Okay. Last quarter, we talked about the CHIPS Act and the infrastructure, and middle mile work and laying fiber and the potential to use your crews and your skill set for that, even though you didn't have a material business doing that previously, we didn't hear much about that on this conference call. Is that -- should we take that as, we're not going to pursue that as aggressively and stick to the knitting kind of like we just talked about and not get into projects we don't understand, like potentially we got over our skis in paving -- or how should we be thinking about that?

Now, for some of these projects, the chip manufacturers, they continue to move forward. And Christian, we're not going to do anything that's not in -- exactly in our core competencies right now. So the portions of these plants that we're looking at are the pipelines, the excavations, water, wastewater treatment plants, and that's exactly what we do. These jobs are moving forward. As far as the middle mile, we're really excited about that market. It's another piece of our underground. And we've done quite a few of these projects in the past. They were just with a large water pipeline or something of that nature. But with the amount of money that is going to be spent in these areas, we're geared up for it. We're ready to go. We haven't picked up a lot of these projects as of yet, but it helps us when our competition, when these projects move forward, it helps us in these areas where our competition gets tied up. We all have a certain amount of resources. So, it's benefiting us in indirect ways as well right now.

Yes. And Christian, it's Cody. I'd also add, the skill set crossover between the underground work, Frank mentioned in the middle mile stuff is fairly -- is much more homogenous than being in large-scale paving work. There's also a risk mitigation component on the contract deliveries -- on the project delivery side of these contracts where they're geared to CMGC awards. So we're not locked into completing the scope of work beyond the design phase. It's likely, and we will certainly take a hard look at pursuing it, but we're not locked into a several hundred million dollar contract in these middle mile awards under a CMGC model.

Your next question comes from Brent Thielman from D.A. Davidson.

Great. Frank or Cody, on that zero margin backlog going forward, can you give us any sense for the average size of those jobs you're still working to complete? I'm just trying to understand if you have some relatively larger projects embedded in that or series of smaller projects just as we think about kind of the future potential cost risk as you continue to work through these?

Yes. Brent, great question. Let me ask a clarifier. Are you talking about initial contract size or remaining backlog on each individual project?

I guess I'd say remaining, Cody?

Yes, there -- it's a fairly even distribution. There isn't any one that has a larger number of backlog to complete materially different than the others.

Okay. And then, Cody, I heard you say it'd be tough to grow revenue for the full year compared to last year at this stage. I mean, it looks like based on what you've got in the Q, you're going to burn call it, $1.2 billion in revenue over the next 4 quarters. So should we still think that's, I guess, of that $1.2 billion, is that still going to be heavier weighted to the back half of this year or to the front half of next year? Just trying to get a sense around that.

Yes. So, that backlog burn off or that RUFO liability burn off, that 44% is what we're projecting over the next 12 months, subject to the permitting issues, time delays, project delays that we also mentioned. Brent, I'd like to give you a little bit of a different color perhaps on a related note, but to give a feel for the reduction in top line revenue. When you look at what M&P's contributions have been where it was once nearly 40% of our backlog several years ago, it's shrunk down to about 12% now. The M&P business line had revenue in 2022 of $244 million with a negative margin as projects were completed of $32 million. And year-to-date, being $95 million with a $59 million loss as disclosed in the Q. So there's certainly a component of that reduced top line volume that we'll have to replace in our other end markets as we pick up new awards, to Frank's point, and the timing around those awards can slide from one quarter to the next as we've discussed.

Okay. Yes, I guess just the last one, Cody, just on -- looks like you made some changes to the capital structure subsequent to the end of the quarter. Maybe you could just talk through that, how that gives you sort of adequate liquidity for what you need to do going forward? Just would be helpful to hear those changes.

Sure. Yes, thanks Brent. So we disclosed in the subsequent events about our refinance of equipment term notes. This was just taking existing term notes that were a little over halfway through their amortization life and taking advantage of the equity, the significant equity that we have in our PP&E. So normal cadence for us, as you'll see financing and refinancing equipment because we do have a significant amount of consistent, dependable value in our construction equipment.

Got it.

Was there any component of that, Brent, that I didn't answer?

No, Cody. I'm sure we could talk offline, but appreciate the update.

Your next question comes from Julio Romero from Sidoti & Co.

Good morning, Frank and Cody. I appreciate the color you guys gave on the historical M&P business, but was hoping for some more granularity into how much that business made up recently? Maybe what percentage of sales and profits didn't M&P make up in 2022, either from a dollar perspective or a percentage of sales and profits?

Yes. Julio, thanks. Let me, I guess, repeat to clarify those numbers for 2022 and year-to-date 2023. M&P in 2022 was $244 million of revenue with a negative margin of $32 million. That was entirely within our Transportation segment in both periods. And year-to-date, it was $95 million of revenue with negative gross profit of $59 million. So you can take that and that will get you to those numbers you were looking for.

Okay, got it. Really helpful. And I guess, you mentioned you locked in prices with vendors now for some of the materials for the M&P business. But as far as the other costs that you've estimated within that $49 million, I guess, just how would you have us think about the confidence in that number fully capturing the potential variable costs?

Yes. Good question, Julio. We do feel confident. We look at all known and estimable impacts and take that assessment on future work. The nature of these being firm third-party price commitments. We feel very good about those, capturing what the increased material and delivery cost will be for this third-party provided material. And that area of additional recognized future costs being booked in Q2 made up predominantly all of that $49 million charge in Q2 for MMP.

Got it. And then, Cody, you talked earlier about the cadence of the M&P work and how over time the new work will make up a larger percentage of the overall sales, which makes sense. But maybe from a dollar perspective the, I think, implied $324 million through mid-'25 of M&P work you've got to do. Do we just divide that number by 8 quarters and model it that way? Or just how would you have us think about the cadence of the revenue dollars?

Yes. I mean, it's certainly not going to be an even 8 quarters. There will be some seasonality influences as well as some of those projects being finished off earlier than others. But I don't have a definitive cadence that I'd provide over the next 8 quarters for that work.

Okay, got it. Really appreciate the color, guys. I'll hop back in queue.

Thank you. [Operator Instructions] There are no further questions at this time. Mr. Renda, you may proceed.

Thank you all for joining us today. Talk to you next quarter.

Thanks, everybody.