Dycom Industries, Inc. (DY) Q2 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Dycom Results Conference Call. [Operator Instructions] As a reminder, today's call is being recorded. With that being said, I'll turn the conference now to Mr. Steve Nielsen. Please go ahead, sir.

Thank you, John. Good morning, everyone. I'd like to thank you for attending our Second Quarter Fiscal 2012 Dycom Results Conference Call. During the call, we will be referring to a slide presentation which can be found on our website, www.dycomind.com, under the heading Events. Relevant slides will be identified by number throughout our presentation. Going to Slide 1. Today, we have on the call Tim Estes, our Chief Operating Officer; Drew DeFerrari, our Chief Financial Officer; and Rick Vilsoet, our General Counsel. Now, I will turn the call over to Rick Vilsoet. Rick?

Thank you, Steve. Referring to Slide 2. Except for historical information, the statements made by company management during this call may be forward looking and are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations, estimates and projections, and involve known and unknown risks and uncertainties, which may cause the company's actual results in future periods to differ materially from forecasted results. These risks and uncertainties are more fully described in the company's annual report on Form 10-K for the year ended July 30, 2011, and other periodic filings with the Securities and Exchange Commission. The company assumes no obligation to update forward-looking statements. Steve?

Thanks, Rick. Yesterday, we issued a press release announcing our second quarter results. As you review this release, please note that we have included adjusted EBITDA and certain organic revenue amounts, both non-GAAP financial measures, to our release and comments. In addition, during the second quarter of fiscal 2011, we recorded a $5.7 million pretax loss on debt extinguishment and incurred $200,000 in pretax acquisition-related costs. See Slides 11 through 15 for a reconciliation of the non-GAAP measures to the GAAP measures in the slide presentation provided for this call. For clarity and to enable comparability between periods, my comments will exclude the effect of these items. Moving to Slide 3. Revenue for the quarter increased year-over-year to $267.4 million, an organic growth rate of 19.2% after adjusting for revenues from acquired companies. Volume during the quarter were strong for telephone companies as a whole. With most companies growing meaningfully, they're carefully managing routine capital and maintenance expenditures. Spending by cable customers were steady year-over-year. Gross margins increased by 87 basis points year-over-year, reflecting improved operating performance despite significant growth. General and administrative expenses declined by 83 basis points year-over-year, reflecting improved operating leverage and tight cost controls. All of these factors produced adjusted EBITDA of $24.7 million for the second quarter, an increase of 53% from last year. Net income of $0.10 per share for the second quarter improved significantly from last year's loss of $0.03. Liquidity increased in the quarter sequentially with cash and availability under our credit facility totaling $272 million. And meaningfully, total backlog continued to increase sequentially for the fifth quarter in a row to $1.819 billion. Going to Slide 4. During the quarter, we experienced the effects of a robust and improving industry environment. Revenue from CenturyLink was $38.8 million or 14.5% of revenue. CenturyLink was our largest customer and grew over 70% organically year-over-year. AT&T was our second largest customer at 13.5% of total revenue or $36.1 million. Revenue from Comcast was $33.4 million or 12.5% of revenue. Comcast was our third largest customer. Verizon was Dycom's fourth largest customer for the quarter at 9.9% of revenue or $26.4 million. Of note, Verizon grew over 57% organically year-over-year. Revenue from Windstream was $21.2 million or 7.9% of revenue. Windstream, our fifth largest customer, more than doubled organically year-over-year. Altogether, our revenue grew organically 19.2%, with our top 5 customers combined representing 58.3% of revenue and growing 14.9% organically, while all other customers increased 25.8% organically. Now moving to Slide 5. Backlog at the end of the second quarter was $1.819 billion versus $1.442 billion at end of the first quarter, an increase of approximately $377 million. Of this backlog, approximately $967 million is expected to be completed in the next 12 months. Both backlog calculations increased dramatically year-over-year and sequentially, reflecting an extremely productive quarter, during which we continued to book new work and renewed existing work. With AT&T, we secured a 3-year wireless construction services turf agreement covering portions of Florida and Georgia. For CenturyLink, we renewed existing and secured additional construction and maintenance agreements in Oregon, Washington, Utah, Ohio, Tennessee, Pennsylvania, New Jersey, Virginia, North and South Carolina. From Windstream, we received 2-year construction and maintenance agreement renewals in Alabama, Georgia, North Carolina and South Carolina. With Frontier Communications, we secured a construction and maintenance services agreement for 3 years in West Virginia. For SaskTel, a construction and maintenance agreement in Saskatchewan, Canada for 2 years. And finally, we secured a number of rural broadband projects in the states of Wyoming, Missouri, Kentucky, Tennessee, North Carolina and South Carolina. Headcount remained steady during the quarter at 8,288. Now I will turn the call over to Drew for his financial review.

Thanks, Steve, and good morning, everyone. As a reminder, in the conference call materials for today's call, we have provided disclosure and reconciliation of non-GAAP measures such as organic revenue growth, adjusted EBITDA and non-GAAP net loss for Q2 2011 to the comparable GAAP measures. Going to Slide 6. Contract revenues for the second quarter of 2012 were $267.4 million compared to $218.2 million for the second quarter of 2011. Q2 2012 included approximately $13.6 million of revenues from businesses acquired in fiscal 2011. On an organic basis, revenue increased by 19.2% year-over-year after adjusting for acquired revenues for both periods. Telecommunications customers totaled approximately 83.8% of revenue in the current period, up slightly from the prior year. Q2 2012 adjusted EBITDA grew to $24.7 million or 9.2% of revenue compared to $16.2 million or 7.4% of revenue in Q2 2011, reflecting a stronger performance and improved operating leverage. Net income for the current quarter increased to $3.5 million or $0.10 per share compared to a non-GAAP net loss of $1.2 million or $0.03 per share loss for Q2 2011. Turning to Slide 7. Organic revenue was driven by growth within existing contracts and rural broadband projects. Higher revenue and improved cost trends resulted in adjusted EBITDA of $24.7 million or 9.2% of revenue, which is an increase of over 180 basis points compared to Q2 2011. On the cost side, we experienced improved labor efficiency and maintained cost control to obtain greater leverage on our G&A year-over-year, despite our growth in operations. Our year-to-date effective tax rate was approximately 40% and our effective tax rate for the quarter was slightly lower, reflecting some minor tax benefits recognized. For the remainder of the fiscal year, we anticipate an effective tax rate of approximately 40% overall. Turning to Slide 8. Our balance sheet remains strong. We ended the period with approximately $86.2 million of cash on hand, and we generated approximately $51.4 million of operating cash flows during the quarter to support our growth. Capital expenditures, net of disposals, were $20.1 million for the quarter. Gross CapEx for the quarter was approximately $22.6 million. On our $225 million senior credit facility, there were no borrowings outstanding, and we ended the period with full availability of $185.9 million after accounting for $39.1 million of outstanding letters of credit. At the end of Q2 2012, we had approximately 33.95 million shares of common stock outstanding. On a fully diluted basis, weighted average shares were approximately 34.6 million. We expect fully diluted weighted average shares to increase modestly during Q3 2012. Now I will turn the call back to Steve.

Thanks, Drew. Going to Slide 9. In summary, within an improving economy, we experienced the effects of a solid industry environment and capitalized on our significant strengths. First and foremost, we maintained solid customer relationships throughout our markets. We continued to win projects and extend contracts at attractive pricing. These successes were reflected in a large number of significant contract awards, which meaningfully increased total backlog and sustained our organic growth. Secondly, the strength of those relationships and the extensive market presence they have created has allowed us to be at the forefront of evolving industry opportunities. The end market drivers of these opportunities are strengthening. Industry participants continue to aggressively extend fiber network for wireless backhaul services. Broadband stimulus funding has meaningfully increased world telecommunications network construction. Recent federal regulatory changes are expected to further support this trend. Cable operators are accelerating the deployment of fiber to small and medium businesses. Wireless carriers are upgrading to 4G technologies, creating meaningful growth opportunities in the near to intermediate term. And finally, telephone companies are deploying fiber-to-the-home or node technologies to enable video offerings. Across all of these opportunities, we have increased profitable market share as our customers are consolidating vendor relationships and rewarding scale. Consequently, we have expanded the portion of our revenues, which is occurring. In sum, we believe that our leading presence enables us to clearly foresee how our industry develops. Among service providers of our size or larger, we believe we are uniquely positioned, managed and capitalized to meaningfully experience a strong industry recovery to the benefit of our shareholders. Now moving to Slide 10. As we look ahead to a solid industry environment, our expectations are shaped by the following: revenues over the next several quarters will continue to exhibit consistent seasonality and grow at a high-single digit to low-double digit percentage when compared to the prior year's quarterly revenue, excluding storm restoration services. Please note that last year's fourth quarter ending July 2011 included $14.1 million of storm restoration services. Accordingly, a forward-revenue assessment for that quarter should be based upon approximately $290 million in revenues. Furthermore, margins and earnings would reflect operating efficiencies at higher revenue levels; strong cash flows, which will be dedicated as projected returns direct to support organic growth, accretive acquisitions, opportunities, which will enhance our scale and service offerings and share repurchases; and finally, we are confident that solid operating trends will continue for a sustained period. Accordingly, we expect for the third quarter of fiscal 2012: revenues, which grow at a high-single digit to low-double digit percentage year-over-year; gross margins, which improved year-over-year by approximately 100 basis points; general and administrative expenses influenced by performance-based incentive plans, equity awards and reflecting in part new project ramp-ups, all resulting in a sequential quarterly increase approaching 10%; depreciation and amortization, which increases slightly on a sequential basis; other income, which increases approximately $2 million year-over-year, reflecting increased asset sales and pricing; and fully diluted share count, which increases modestly on a sequential basis. As the nation's economy improves, we remain encouraged that our major customers possess significant financial strength and remain committed to a multiyear capital spending initiatives. We remain confident in our strategies, the prospects for our company, the capabilities of our able employees and the experience of our management team who have grown our business and capitalization many times before. Now, John, we will open the call for questions.

[Operator Instructions] And first in line is Simon Leopold with Morgan Keegan.

This is Victor Chiu in for Simon Leopold. I just had a couple of housekeeping questions. First, can you round out the top 10 customer list?

Victor, this is Drew. Charter was #6 at 6.8%. Time Warner Cable at 4.9%. Farmers Telephone at 1.6%. Xcel Energy at 1.6%. And Cablevision at 1.4%.

Great. And the cable-telco split?

Sure. Telco was 56.6% and cable was 27.2%.

Great. I just wanted to ask if you could speak about the progress of the incremental contributions from the wireless opportunities that you've spoken about in the past. And if the run rate is still on track. What you disclosed last time, I think you said maybe about [indiscernible] by year end?

Yes. Calendar year end. Yes, Victor, this is Steve. So we're underway with AT&T, we did not recognize any revenues in the January quarter. But we have recognized some revenues at the beginning of this quarter. Clearly, AT&T has talked about how they're reformulating the plan, absent T-Mobile. And we see that they're -- we believe there'll be increased activity as they indicated around cell site splits and some other opportunities. And so we we've hired folks, we've got systems that we're putting into place and we've started work and we feel real good about the opportunity.

And the large jump in backlog this quarter, is the wireless opportunity kind of...

The wireless was a portion of that, although not a major portion. We certainly had some good renewals but we also had a productive quarter on footprint expansion, so with CenturyLink, the state of Utah, portions of Pennsylvania and North and South Carolina and a portion of Ohio. The new SaskTel contract is an expanded opportunity with them. The new contract in Frontier, which is really just getting started at this point in this quarter, but we secured it in January. So I would say more a combination of good renewals, but also footprint expansion across a number of customers, as well as some consolidations.

And next in line we'll have Saagar Parikh with KeyBanc Capital Markets.

Looking at your cash, Drew went through the cash. You guys had strong free cash flow in this quarter and in the previous quarter. Just wanted to see where you guys are targeting that now in a more share repurchases or acquisition on the wireless or wireline side?

Sure. I think we did have good strong operating cash flow. We expect that to continue. And I think that we will, as always, we are looking at acquisitions on a continual basis. We'll see what we find attractive there and we'll compare that to what's available to us in repurchasing shares. And we're going to be driven by where the shareholders get the highest returns. So no particular direction, we're going to be driven by valuation.

All right. Great. And then one more question. Looking at your firm, what's the biggest opportunity in the medium to long term that everyone on the Street isn't thinking about or isn't looking at?

I think we've talked about these consolidation opportunities where we see a number of customers across, really, our entire geography. That as they simplify the way they administer their businesses, they're looking to reward larger vendors. They're reducing the number of vendors that they have. And so we think there's a substantial capability because we're focused on our customers to grow market share at good prices. We've had subsequent events to the end of the quarter where we picked up a little bit share with a core customer. So I think that's there. And I also think that we see, really, the convergence of wired and wireline -- wired and wireless networks because of spectrum shortages and just the explosion in wireless data that, quite candidly, the growth in wireless traffic is driving the deployment of fiber. And so we think that's a good opportunity.

Our next question is from the line of Alex Rygiel with FBR.

Any chance you could be a little bit more specific on either revenue from wireless or backlog associated with wireless in the quarter?

There's a backlog for wireless, Alex, at this point, was up 10% of the total number, but closer to 5% than 10%. So that's still a developing business. We're taking a conservative view as the backlog. So it was a nice addition. But really, it was the strength across a broad number of businesses that drove the backlog.

That's very helpful. And you commented a couple of different times on the expansion of revenue coming from reoccurring contracts. Can you help us to think about that as it stands today versus maybe 3 or 4 years ago? What percent of your revenue today is coming from that? Has it increased as a percent of total? And maybe what the traditional growth rate of that revenue stream looks like?

Yes. The traditional master contracts in long term as a percentage of revenue drew 75%, 80% as it always has, Alex. So I think, maybe a better anecdotal way to think about that is we've had some nice growth, for example, with CenturyLink. And so 2 years ago, we went to a process with Qwest, prior to CenturyLink, where it just didn't work for us in part of the state of Utah. We've just gone through a process with CenturyLink where we resecured that work, as well as picked up the balance of the state. And so now, if you just think about the potential embedded in the state of Utah for us, it's $15 million, $20 million in revenue that we didn't have in the business 2 months ago. And if we do a good job, we think that we'll be able to pursue that business for a long time. So I think about the footprint expansions with CenturyLink, with Frontier. The Canadian opportunities has not a big part of our business, but the phone company up there is pursuing a fiber-to-the-home strategy that's essentially identical to Verizon's FiOS program. We have lots of expertise on how that will work, as well as routine maintenance up there, and a strong, strong economy. So I just think the broader the footprint, the more concentrated the clients want their vendor base, but we just had better embedded potential.

And one last question. You stated that you are "confident" that solid operating trends will continue for a sustained period. That's a pretty bullish comment. What is most important in driving that? Is it the breadth of opportunities? Is it the wireless opportunity? Is it the pricing environment? Is it the lack of competition? What's most important about that comment?

I would say all of it except the lack of competition. I mean, this is a business that's competitive. We have folks that we compete with all the time. We think we do so favorably. But if you think about we have this emerging wireless opportunity in the business that we acquired last year. We're experiencing some opportunities on Sprint's network visions plan that would not have been there 15 months ago. They have a good relationship with T-Mobile. In fact, T-Mobile was their largest customer over the last 12 months. And T-Mobile just announced $1.4 billion of incremental CapEx on 4G over the next 2 or 3 years. There's just a number of things on the wireless side that we see. We also just think that there are strong trends in the rest of our customer base that we can get in front of.

And next we'll go to Adam Thalhimer with BB&T Capital Markets.

Steve, do you think we're at a point where the economy is now additive to the cycle that you're seeing?

I wouldn't say that we have seen it to date, Adam. I will tell you that, anecdotally, as I travel and as I talk to our subsidiaries in some regional pockets around the country, we're seeing some pickup in housing. It's not significant yet. It's not a driver to the business. But clearly, we're seeing some things. I was visiting the operations in Northern Virginia about 1 month ago, and we were working in some subdivisions in the first phase of what clearly was going to be much larger projects. Haven't seen those kind of opportunities. And my experience in other cycles, and this has been a long down cycle for housing, is that when the market firms, it generally recovers more quickly than people expect. As people begin to see housing as an attractive investment because prices begin to go up rather than something that they can worry about the moment they close, it's worth less than what they paid for. So not there yet, but certainly leaning in that direction.

Now that's helpful. And I also wanted to ask about the larger telcos, larger cable companies, seeing this dichotomy between the AT&Ts, Verizons, Comcasts of the world where CapEx is down. And the CenturyLinks and the Windstreams and the Charters where CapEx is up double digits. Why do you think you're seeing that...

Well, to begin with, in the larger companies, Adam, there are certainly pockets inside of their businesses where CapEx is up. And they spend on data centers, they spend on international assets, there are a lot of things that run through the budgets of the large telcos that are multinational that you don't see in the more targeted, smaller participants. So there's one state that we work in for Verizon, where in terms of FiOS, this will be the largest plan that we've ever worked, and we've been there since 2004. So there are always pockets inside these larger companies where you see growth. I think it terms of the themes that we outlined, even the large telcos are spending on 4G. They're spending on wireless backhaul. Verizon has certainly continued to commit to spending on FTTP and their FiOS. So I just think, they're big companies, we don't work for them everywhere. But there are pockets of growth that are similar in theme across all the companies.

Okay. A couple on the trends here. I'm just curious what inning you might think that we're in? We're the only one that seems like we might be getting towards -- the midpoint of the cycle is fiber-to-the-cell, is that kind of how you would describe that opportunity?

Clearly, the companies are talking about visibility into 2013, and I think that's what they've talked about. I will also tell you that we've had customers where we had visibility for 5 years and we're now in year 9 or 10 of that program. So sometimes these things always take a little bit longer than people expect. And as long as the economy continues to grow, I think there are a number of other opportunities that may become more growth-y, so to speak. And so there's always going to be a rotation in the growth cycle. In fact, it'll be the same themes across the entire cycle. And in fact, that makes for a better balance to our business. To Alex's earlier question, when I look at our top 5 customers and nobody's over 15%, that's a good thing. That allows us to manage across the cycle and across some of the more secular drivers like vendor consolidation in more predictable ways.

And I guess, that's a good segue to my last question. I mean, what are the emerging themes? When you look at world fiber/stimulus metro ethernet from the cable companies. Seems like we're still pretty early in those buildouts?

I read comments that Time Warner had at a conference just yesterday, where they sized the small and medium enterprise businesses 10x the size of what they currently are prosecuting. So certainly, the cable company, that's a long runway as they compete for that business. I saw comments from another customer last week on rural on the universal service reforms that they were looking to secure, potentially, some additional monies there. I think the whole area of cloud computing, and the fact that, that really relies on extremely robust, both wireline and wireless network connections to be effective. I think that's there. I mean, we're deploying some cloud technologies inside our business that's creating more data traffic on our networks than we had last year. So certainly, cloud computing is something that I think continues to strengthen.

Our next question is from John Rogers with D.A. Davidson.

So Steve, in terms of your market share or looking at that, I'm just kind of -- think about the 20% plus revenue growth you saw on the quarter and it looks like it's going to stay strong for a little bit. How much of that do you think is market share gain versus market expansion?

Well, we certainly have had some footprint expansion. But I would tell you in the last quarter that they were both strong, but the renewals and the activity level increases are really what drove last quarter's results, because a number of these contracts really just started in January or starting this quarter. So the activity in the last quarter, was really just driven through the existing footprint. We are also seeing...

But Steve, sorry to interrupt. But even within the existing footprint where you have -- with existing clients, don't a lot of these clients also have like 2 or more vendors that they work with?

It depends on the customer. But I would tell you, prominently on the telephone, our customers, if you look at Windstream and CenturyLink and Verizon and AT&T, we're generally the sole supplier. So when we talk about market share gains, we're really talking about geographic footprint expansion. Now on the cable side of the business, we are seeing vendor consolidations, and there is, more to your point, where there may be 3 or 4 suppliers in the market and they may narrow that down to 2, and so that we gain through that consolidation. So you can have consolidation on 2 axes, right? You can have less vendors in the same geography or you can have a vendor with more geography. And we're seeing both as opportunities.

Okay. So when you talk about the 19% organic growth, I mean, that's more than just expansion of existing offices getting more business in a local territory. It's expanding out.

That's exactly right.

Okay. And then the second thing, in terms of your margins. I mean, obviously, the climbing and growing in the past, I think it was last quarter, the quarter before you talked about long term -- longer-term aspirations there. And could you just refresh us on that? I mean, how far away are we from getting back? I don't want to get too far ahead but I mean, the...

As always, John, I mean, what I always say is directionally as we expand in a period of organic growth, that we can improve margins, that the composition of those margins may change over time. So, for example, right now, we're getting good growth with CenturyLink and Windstream. And in those cases, we supply materials. Now we earn a margin on those materials but it's a less risky margin than in the labor side. And so that's great business for us. We're really appreciative of that opportunity, but it's going to have a slightly different margin profile. We're just getting involved on the wireless side and we think that, that may have very good margin attributes. So we think it can go up. As always, we're going to say we're going to work hard to make it better this time than say, 4, 5 years ago and we see no reason why that can't happen at this point.

Okay. And lastly, if I could. Just the increase in nonoperating income that you're seeing this next quarter and -- I mean, is that just some timing of some asset sales?

It's an interesting thing, John. And it goes back to our balance sheet strength and liquidity. I mean, we are identified, and actually Tim and his equipment folks, identified that there were some equipment model year changes where it made sense for us to accelerate some capital asset purchases in the fourth calendar quarter last year. And now we're disposing of those assets. And I would tell you based on sales so far this quarter, we're getting very good prices. And that's always been a good indicator for me of where the general economy is because folks did buy our assets when they're 5 and 6 years old, are very broadly distributed across all kinds of activities, economic activities. So we're seeing better prices, we're seeing that we sold -- are going to sell things on an opportunistic basis to have lower cost going forward. And then we did have a small non-core asset in a small cable system that we have in Alabama that we sold this month to Charter. And so we're going to have a little bit of other income realized on that sale. So that's really what's driving it.

[Operator Instructions] And we'll go to Alex Cook [ph] with Land Advisors.

Why are unbilled receivables growing faster than revenue? And when will these receivables be billed and collected?

Okay. So unbilled receivables, in our case, are not estimates. They are a portion of the work that's completed, documented and there's an approval cycle with the clients. And so that goes through a seasonal turn where clients are focused on accounts receivable. And they also are focused on getting next year's program engineered. So it's not unsurprising. I think what we always think about is the total day sale outstanding, which is the accounts receivable and the unbilled. And if you put those 2 together, they were at 63 days, which is actually an improvement for the quarter.

Okay. And then inventory has been growing, what's driving the increase there?

As we talked earlier on John's question, we have an increasing portion of our business that is with CenturyLink and Windstream. Whereas part of that business, we supply the equipment and cables, as well as on some of the broadband stimulus projects, we also do the same. And so inventory is just reflecting that growth with those 2 clients. And you may recall, CenturyLink grew organically north of 70%, Windstream doubled. So very straightforward connection to inventory from that growth.

Okay. And I think you guys mentioned that the supply materials had a lower margin. Could you quantify the impact of...

It's slightly lower than the labor margins. We have risk in that business, but it's not as risky as the labor. And so historically, there's a slightly lower margin associated within materials. There's not a significant difference.

And we'll go to Alan Mitrani with Sylvan Lake Asset Management.

Can you talk about your CapEx plans for the rest of the year?

Yes. Alan, as we just mentioned earlier, we had taken up our CapEx to $60 million to $65 million on a net basis. So gross CapEx less disposals. At this point, because of this non-sale, non-core asset that we sold to Charter, we're now expecting $55 million to $60 million. We realized $5.6 million, $5.7 million of cash under that asset in February. And so we're going to take down the guidance by about $5 million.

Okay. And also, could you just speak a bit to the guidance? It seems like you're guiding to less than normal seasonality for next quarter. Can you just talk about maybe what the conservatism is? Or also how weather impacted you this past quarter positively, if possible. Maybe that's behind a little bit of that?

Sure. Certainly, the weather was better, generally, across the country. Not everywhere, but most places. And so clearly, we just want to -- we always have a seasonal upturn. But we're doing it off of probably a little bit of better base because of the weather. I think the other thing to keep in mind is in the -- in this quarter, from an organic perspective, we will now have the businesses that we bought last year in the second quarter in both periods. So our total revenue guideline is with those businesses in both periods. And so that has a little bit of effect. Not much, but a little bit.

Okay. I was talking more sequentially, but I appreciate that. Can you talk about the environment for acquisitions? It seems like, in following you for years, whenever you see a new opportunity, whether it's geographic or end market, in this case, wireless or maybe up in Canada, footprint-wise, you tend to be -- dip your feet in and then over time you tend to get aggressive. Can you talk about where you are in that stage as it relates to acquisitions and expanding further to be able to capture more business?

Yes. I think that's a fair assessment, Alan. And we continue to look at a number of opportunities. We're going to be very return directed. And I think the only thing that I would add to your characterization is we're a larger company. We have a very good presence with a number of key customers, and we like organic growth rates where we're forecasted or providing guidelines, because that's great return business when we when can do it like that. So we're going to be balanced in how we look at it.

Okay. And then lastly, on gross margins. Just talk a bit about gas, maybe, for the quarter because we see prices going up at the pump. How much was that for you in terms of basis points and do you think that will impact you next quarter? And then you're going to hit a level, it seems like in the fourth quarter of revenues that you haven't hit for a long time, where does the covering your nut level come in such that the incremental margins really start stepping up?

Well, Drew, why don't you take the fuel and also on the third quarter, talk about the pro forma from last year.

Sure. Alan this is Drew. Just on the fuel side, it was just over 3% of revenue for the period. It was certainly -- take a look at where the fuel prices were going. I think the one thing to consider is that as we maybe deemphasize some of the technician-intensive businesses, the use of fuel has gone down and also from a mix of work perspective or less sensitive on the price changes on fuel.

Okay. So it was 3% of revenue this quarter and do you know where it was 1 year ago?

It was about -- it was about 3.2% this year and about 3.4% to 3.5% in Q2 of last year. Certainly an improvement from the mix of work shift.

Okay. And in terms of covering your nuts such that incremental margins has just start hitting a little bit more, I mean more of the step function. I realized there is that inventory sale piece that's bigger, that's a bit of a drag on the gross margin side but come where your number should be in the fourth quarter once the weather gets better and given where your backlog and the guidance is, can you just give us a sense as to what kind of incremental margins you look at?

I think one thing to keep in mind as you look at Q3, when we talked on the outlook, margin-related, just look back, we had a non-GAAP disclosure there last year, where there was an add back item in it. So when we discuss that, we're thinking about the adjusted number there.

And then Alan, to your fourth quarter number, I mean, we've got a number of contract starting up in this third quarter. We feel good about the pricing and we'll do our best to bring it through all the way down to the bottom line. Other than that, it's -- we feel good about what's in the backlog.

Our next question is from Christian Schwab with Craig-Hallum Capital.

Just a few questions that I have left. Would you expect the operating expenses in Q4 to be relatively flat then, with Q3?

No. The operating expenses are going to have a somewhat linear relationship to the increases in revenue. I mean, we're in the services business, we're going to have labor -- direct labor expense and sub-contractor expense that's going to vary with the revenue. So clearly, they're going to go up as revenue goes up.

Perfect. And then would we expect a similar improvement in gross margin then, Q3 to Q4, given the increase in revenue?

We think they'll be up and that's what we said. As we get closer, when we talk in May, we'll be more detailed about the fourth quarter.

We do have a follow-up from Saagar Parikh.

A quick question on the impact of the more modest weather conditions over the last 3 months. What sort of impact does that have? I mean, we can definitely see the bottom numbers that you guys have this quarter, but other than the strong organic growth, how much of a benefit was there from better weather?

Saagar, we can't identify that. I mean, better weather doesn't help you on Thanksgiving, the day after Christmas, New Year's or Martin Luther King Day, right? So it's always a quarter where you got a cost impact due to the holidays and a cost impact due to the week between Christmas and New Year's, where generally activity levels are reduced pretty much across the board. So it was nice to have, it didn't materially change the numbers.

Perfect. And just wanted to clarify how you guys account for MSAs in the backlog? Is it done on a rolling 4 quarter average basis or is it a longer timeframe?

The way we account for it in the same way in both periods. Where we have an existing contract and we've had the contract for a full year, we take a trailing 12 month look, come up with the average revenue per month and multiply that by the number of months remaining on the contract. And we do not forecast in price increases even though they're in the contract. We don't forecast activity levels changing even though we're growing organically. We just look back 12 months, come up with a monthly rate and multiply that by the balance of the contract period. With new contracts, we will work with the customer and we generally will bring those in at a conservative assessment of what we see for the first 12 months, and use that for the entire contract period. And then as we get deeper into it, we'll make adjustments to that as we have actual activity levels.

And Mr. Nielsen, there are no further questions in queue.

Well, we thank everybody for your time and attention today. And we look forward to speaking to you on our next quarter's results which will be the end of May. Thank you.

Ladies and gentlemen, that does conclude your conference. Thank you for your participation. You may now disconnect.