Sterling Infrastructure Inc (STRL) 2007 Q2 法說會逐字稿

Good day, everyone. Welcome to the Sterling Construction Company second-quarter 2007 conference call. At this time, I would like to inform you that the conference is being recorded and that all participants are currently in a listen-only mode. I will now turn the conference over to Mr. Maarten Hemsley. Please go ahead Mr. Hemsley.

Thank you. Good morning, ladies and gentlemen. That is Maarten Hemsley, Chief Financial Officer and welcome to the Sterling Construction Company conference call to discuss results for the second quarter and first half ended June 30, 2007, which we announced this morning.

I am joined by Pat Manning, Chairman and Chief Executive and Joe Harper, our President and Chief Operating Officer. Also, we have Jim Allen available on the call. As you may have seen in our press release this morning, Jim will be taking over from me as Chief Financial Officer of Sterling.

First, I must remind you this call may include certain statements that fall within the definition of forward-looking statements under the Private Securities Litigation Reform Act of 1995. Any such statements, including our 2007 guidance, are subject to risks and uncertainties, including overall economic and market conditions, competitors, customers and suppliers' actions and weather conditions and other risks identified in our filings with the SEC, which could cause actual results to differ materially from those anticipated. Accordingly, any such statements should be considered in light of these risks.

Also, although from time to time we give guidance about future results, these are only statements of management's beliefs at the time they are made. These predictions may not continue to reflect management's beliefs and we do not undertake to publicly update guidance.

Because of the variability of results in the construction industry from quarter to quarter, especially due to weather, our policy is to provide guidance only for annual results. We do not issue guidance in our quarterly results and we encourage readers of our financial information to view quarterly results in the overall context of our annual results guidance. For the purposes of this conference call, all figures discussed are for continuing operations, which is our construction business.

Turning to the second-quarter financial results, I'm very pleased to report that the Company achieved new quarterly records both in revenues where we posted our 12th consecutive quarter of year-on-year revenue growth and in operating income. As was the case for much of the first quarter, we encountered exceptionally wet weather in our markets during the second quarter, especially in May and June.

Although this depressed revenue is below the levels we had hoped to achieve, it obviously lead to lower overall productivity. We achieved some notable gains, which were not weather-related, on several contracts. As a result, gross margins improved to 11.3% in the second quarter from 8.2% in the first although this fell short of last year's second-quarter level of 12.2%.

Pretax income was a quarterly record at $5.7 million compared with $4.8 million in the second quarter of 2006. Net income was $3.8 million, up from $3.2 million last year and diluted earnings per share were at $0.32 against $0.27 last year.

For the first half, revenues also achieved a record level, rising 20% to $140 million. Net income was $6.3 million, representing a new first-half record as the strong second-quarter profitability overcame the first-quarter profit weakness.

Both this year and last, we reported a full tax charge. Our tax loss carryforwards offset most of our federal tax liability. Although at the half-year, these were almost all used up. With the benefit of these tax losses and depreciation of $4.7 million, operating cash flow was almost $15 million in the first half, about in line with capital equipment and plant purchases, which were a bit over $16 million in the period.

The balance sheet continues in good health. Quarter-end cash and short-term investments were $45 million and we had $10 million of unused capacity on our revolver. The current ratio continued at slightly over 2.0 and stockholders' equity rose to $98 million. Total debt was about $27 million.

Now I will turn the call over to Joe and Pat to talk about the operating results in more detail.

Thanks, Maarten and good morning, everyone. We are very pleased to report such a good quarter despite the rainfall that affected virtually all of our projects throughout much of the second quarter. As Maarten said, without that rain, we would have achieved still higher revenues and profits.

Gross margins on several projects showed improvement primarily due to redesign of traffic control and project sequencing resulting in the better margins achieved during the quarter. These numbers reflect the continuing strong increase in the state highway business. In the second quarter, approximately 68% of revenues came from state highway contracts.

We are supporting this revenue growth with further equipment and plant purchases and increases in the labor force. In the second quarter, we spent about $9 million on equipment and this month, we will put in place another concrete plant.

With top-line growth of 20%, overheads were virtually unchanged for both the quarter and the first half, falling from 4.4% of revenues in the first half last year to 3.6% this year. As a result, even though we had lower gross margins this year, operating margins were 7.4% in the second quarter, about the same as last year. Pat, do you want to discuss the bidding climate?

Thanks, Joe and good morning, everyone. In our second quarter, we added $66 million of new projects, which replaced our contract backlog of $394 million at the end of the first quarter, as well as year-end despite achieving record revenue for both this quarter and the six months ended June 30, 2007.

Although we only announced one contract award over $20 million in each of the first and second quarters, we have been successful at winning many smaller municipal contracts, including two 42-inch water main projects for the city of Houston and one 48-inch water main project for Northwest Harris County, as well as many others in all three of our offices.

The last two days, we have bid over $350 million worth of work at the state highway letting, comprising of six jobs spread over the state. While we were unsuccessful, we were second on three jobs and third on another. This gives you an idea of the infrastructure spending in all markets, both at the state and municipal levels and their continuing and even improving strength.

Although with this core market of ours, we continue seeing many opportunities in public, private partnerships, light rail and pass-through tolls. Add to that the recent catastrophe in Minnesota and the fact that Texas has over 48,000 bridges, 57% of which are over 30 years old, we are very positive about our future growth. I will now turn the call back over to Joe to discuss expectations for 2007.

The wet weather in May and June continued through most of July, but with the strength of our markets, the solid backlog, the very good second-quarter performance, we remain confident of achieving our goals in 2007.

Over the past 12 months, we have significantly increased our capacity to build work. We have invested over $26 million in plant and equipment, increased our labor force by over 22%, about 200 men and added to the ranks of superintendents and project managers.

Our backlog will keep over 90% of all resources busy for the next six plus months and as Pat indicated, our markets are continuing to indicate good opportunities moving into 2008. You saw in our press release this morning, we affirmed our 2007 guidance, which anticipates revenues between $285 million and $310 million with diluted earnings per share between $1.13 and $1.26. Pat, do you want to wrap it up?

Sure, Joe. We thought you would like to know that we will again be presenting at the D.A. Davidson Engineering and Construction Conference, which takes place on September 20 at the Omni San Francisco hotel. We hope to see many of you there, but for those who cannot make it, we will post a webcast link to our website.

Before we turn this over for questions, you will have seen in our press release this morning that Maarten is stepping down as Sterling's CFO, although he will be remaining on the Board. We greatly appreciate Maarten's efforts over the years and all his help in bringing Sterling to the position we are now in. While his daily input will be surely missed, we are happy to have his continuing wisdom available to us as a Board member.

With that being said and as we look to the future, I am pleased to be welcoming Jim Allen as our new CFO. Jim was a partner for many years in the Houston office of Arthur Andersen where he headed the construction practice. Most recently, he was CFO for Continental Carbon Company. Now we would be pleased to answer any of your questions.

(OPERATOR INSTRUCTIONS). Richard Paget, Morgan Joseph.

Good morning, everyone.

Hi, Rich.

Good morning, Rich.

I wondered if you could characterize more on how you guys would participate in this potential bridge market. 20% of the bridges in Texas are defined as deficient or structurally obsolete. So I mean it's potentially a big market. Now would you guys be doing the bridge work directly? Would you sub it out? Would it just eat up capacity? Wondered if you could maybe characterize it a little bit better.

Yes, there hasn't been any definition of changes in any programs we are aware of, Rich, so we start off with the assumption that it will be low fixed price con -- we don't [roll bid] fixed price contracts much like ours are now.

In Houston and Dallas combined, we have I will say 18 -- it might be 16 to 20 -- structural bridge crews, so we have a fair amount of capacity there. We have been adding to that pretty steady over the last two years and I think it is apparent to us at least that if there is a push on the bridge side for rebuilds, we will be participating in that market. It is too early I think for us to define any better than that. We just don't have any sense of the program.

It certainly is a hot topic here. It is in the papers in Houston every other day and for the politicians, it is obviously a button they want to cover.

Okay. So do you see it unfolding -- first, it would be probably more the upfront engineering work and inspections and all that and then I mean maybe there is something that would unfold over the next couple of years?

Yes, that's sort of what I think, Rich. Right now, there are 10 bridges in Harris County that TxDOT has slated to be rebuilt, but that is such a tiny percentage of those that would need it under the definitions they are talking about in the press now that obviously there is a lot more opportunity to come.

Well, I would think 2008, 2009 both.

Okay. And then you guys had mentioned that you had reduced cost in some of your projects through redesigning and traffic control. Could you get a little bit more specific about what you were doing there and is this something you could do across a lot more projects or was it just -- it was a benefit on some particular ones in this quarter?

The traffic control plant that we -- that is designed before we bid the project is the state's concept of how they think the project should be built and it is pretty detailed in terms of sequencing and this and this and this has to be done before you can go to the next stage, etc., etc. Often times, we find ways, sometimes with additional cost, sometimes without it, to change the sequencing in a way where we can be working multiple phases of the job at a time or where we can extend phases to longer sections of the highway and that gives us the ability then to produce the work faster.

Most of the time, the state is willing to accommodate those changes and a lot of it is particular to the project manager assigned by the state to the jobs, but we have had really good working relationships with most of our PMs.

Okay. And then finally looking at the first quarter, which also had a weather impact, but you were able to get much better gross margins in the second quarter. I mean was it actually less rainy in the second quarter or did you just happen to manage it a bit differently?

No, I think the big change in margins came from those positive impacts on the contracts that Maarten mentioned and that I touched on. The mix changed a little bit too and it was to our benefit.

With the plants now all in place and ready to produce, the mix of the work -- I mean you saw that it moved to the highway side and we had positive margin changes on the highway side. I mean I think that is what resulted in this quarter being as strong as it was.

Will that mix then shift again given that you recently won some muni water work?

No, I think -- I mean 68% is a little strong, but I think we are clearly going to be above 60% of revenues from highway contracts throughout the year.

Okay. Thanks. I'll get back in queue.

Richard Rossi, Ferris, Baker, Watts.

Good morning, everybody. Good performance in a tough environment. Just get back to the bridge work for one moment. Obviously a lot of work is necessary. Would you suspect though that even the great state of Texas has only a finite amount of money to spend that if they start focusing on some bridge work that it may take away from some of the highway work that they were planning to do?

I don't think that's true. The great state of Texas has a lot of money. Seriously though, they have -- they are in the process of moving forward on a $5 billion bond issue that will come out of general funds as opposed to coming out of state highway funds. So we continue to be extremely proactive and I think that they will be proactive on the bridges and it won't diminish the regular funds that we see coming out.

Okay. And to beat the weather to death, how much of a spillover in the third quarter have you seen as far as weather problems?

Well, I think I said -- yes, I did -- July was very, very wet and the pattern that we have seen down here, Rich, has just been different than anything I have seen since I came here and I have been here since '82. But we had high pressure move in and it has been -- we are back up in the high 90s and the sun shining and everything baking dry and this is the kind of pattern that we would normally have this time of year.

So we are pretty optimistic going forward that that low pressure -- we virtually had a low pressure system sit here for 2.5 months and all that flooding up through the middle part of the country was a result of Gulf water going straight north on the backside of the low. So we are pretty optimistic. July clearly was impacted in a negative way, but with where we sit on the contracts and with the resources we have available as we indicated, we think guidance is clearly correct.

Right. So can I assume that, especially in the third quarter with the bad weather happening in the beginning of the quarter, that you might have a better chance of catching up through the rest of the quarter than you did in the second?

Yes.

It has been dry all August.

Okay, all right. And looking at just one other thing about that second quarter, were there any unusual incentives that you received in the quarter that if you looked at one or two of them it made your quarter?

Maarten, do you recall?

No, I think -- I mean we earned some incentives, Rich. They were similar to past patterns. There was not any significant one item that accounted for this.

All right. Looking forward, in the past, you have talked about possibly acting as a sub on some very large projects. I think you may have mentioned a granite project in the last conference call. Is there anything on that side that is stirring that we might be seeing coming up?

Nothing new to report. We are still working on all those things and obviously the more things you have out in front of you, the better your chances are.

And you said you bid on $350 million and placed instead of won on several of them. Looking forward, what does the bidding calendar look like over the next couple of months?

We have got lots of things to bid. Both in the state highway next month and for the rest of the year and on the municipal side. So we are optimistic about picking up and increasing that backlog level.

Okay. So that was my final question really and that was would you speculate that the backlog as we move out of this year will probably be somewhat higher than the good level you already have?

I am not sure that I want to say that, Rich, on the one hand. On the other hand, we don't need backlog at this level to keep resources deployed very profitably.

Right. Clearly you would be pressed to produce an awful lot more in a given period with the capacity you had.

Well, that's right. So it really depends on how successful we are on the larger size projects because that would be what would cause backlog to take a leap or move upward significantly from where it is. Two of the jobs we bid yesterday and Tuesday were over $150 million each with about a 3.5 year build time. So when we are bidding on those projects and we were second on one and third on the other, pretty darn close to the market. If lightning were to strike on a project like that, you would see a big jump in backlog, but that doesn't have any near-term -- doesn't have any significant near-term impact.

Right, right. Right. Okay. Again -- I just -- I hate to say this, I had a senior moment, I just lost my train of thought. All right. So as we look out in the second half, third quarter, you should have a good solid performance. As you move into the fourth quarter, you're sort of -- on weather -- just remind us again since this year sounds like it is going to be a historic weather year for Texas, what type of a normal weather pattern would you see in the fourth quarter if it were normal?

October is normally very good for us. November can be spotty and then as you get further into the start of winter, we are subject to six, eight days of rain and that would be relatively typical for December through February or March.

Okay. All right. And that is it and also Maarten, I wish you the best.

Thanks, Rich.

Sorry to see you go in the operating position, but I am sure you are going to have a hand at the Board.

Okay. It's been a pleasure working with you, Rich.

Rich Wesolowski, Sidoti & Co.

Thanks a lot. Good morning.

Good morning, Rich.

Can you guys just give some sort of idea on how much of the benefit or the profit that you recognize in the quarter from the bonus incentives and also from the redesign on projects? I mean how much of that came from jobs already completed versus jobs that are ongoing?

Maarten, you want to take that?

I think the majority of it was projects that are ongoing. I mean we have got projects at all sorts of phases. These weren't the result of specific end-of-contract milestones being accomplished. We had a fairly typical round of several incentives that we earned and in one of the redesign situations, we were able to get some significant benefits from the way we rephased the job and that was pretty important, but that job is nowhere near complete and it was because of those changes we were able to significantly reduce anticipated costs on that job.

So how does that redesign hit the income statement? I mean do you recognize a windfall or recuperation of the profit as you change the overall cost estimate and hence, how much of that project or costs you have already recognized?

Well, you are looking at the revised expected cost for the whole project and to some degree, that is going to flow into later periods and to some degree, it's going to hit the current period.

Okay. But there is some sort of a catch-up income that you did recognize in the quarter due to that redesign?

It wasn't so much income as refiguring how much it was going to cost to build.

Okay. The expected progression of backlog, say it is flat through the rest of the year at $394 million, that would suggest that you are going to be entering 2008 with a flat backlog from where you ended last year. Does that suggest that we are going to see sales growth well below even a mid teens rate that perhaps we will see this year?

No, I don't think so, Rich. Again, when we came into this year, I don't have handy right in front of me the percent of backlog that was going to be built in '08 and '09, but there was a very (technical difficulty) piece of it. I am thinking it was close to half.

It was about $150 million, Joe, I think.

Okay. So I think that is likely to still be the case, but that doesn't mean that revenue can't grow by 20% or 25% next year. I mean I really -- I understand why you all would like to see backlog growing and I think over a long period of time, we have increased backlog faster than revenues pretty consistently, but I don't think you should be concerned about that in short intervals. I think you have to look at it on a long trend.

Okay. Well, first, I don't like to see anything. I just judge what I see and I just wanted to hear you reiterate the point you made in the past.

On the CFO change, how long had that been planned and what prompted the timing of the announcement now?

Do you want me to answer that, Joe?

Yes, jump in right behind me. Maarten gave us an indication several months ago that by the end of the year he would like to be phasing out and we realized that we needed some overlap. So we have been in the process for maybe five or six months.

Okay. Oh, I skipped one question I meant to ask you. You guys announced on the press release $66 million of new awards, but the backlog was flat and you recognized $71 million of revenue. What accounts for that $5 million difference? Does not all the work flow through backlog or was something put --?

No, no. Partly the effect of change orders and other changes in contracts, which of course is not a contract addition as such and also you have changes in billings and excess that fluctuate.

Okay, great. Thanks a lot.

Brent Thielman, D.A. Davidson.

Hey, good morning, guys and congratulations. Just a quick question. On some of these $150 million jobs, I mean, that I can remember, it seems unusually large than what I can remember you guys bidding for. I mean are there more of these in the pipeline or is this going to be sort of a more usual thing for Sterling to chase?

If the skill sets of the type of work that those jobs are entailing are ones that we are comfortable with and we are getting pretty comfortable with most of the work down here then the answer would be yes. We are building currently a $90 million job. We have in the past bid several jobs over the $100 million. We are pretty careful when we are bidding jobs of that size and it was very heartening yesterday, at least for me, that we were as close to market as we were. We are running with some contractors who have been building those size projects for dozens of years and to be running in that group competitively is very heartening to me.

It is a continuing evolution. We joint ventured a job of $180 million a little over a year ago because we didn't have the capacity or the equipment possibly to do it on our own.

Or the stomach.

Yes, or the stomach, that's right. And now we have bid two projects competitively in the $150 million range on our own.

Right. And I guess just a follow-up to that, I mean have you seen the competitive landscape change much I mean in the Texas market in terms of what you are seeing in the bidding environment?

No, I mean it's pretty much the same. There was three, four, five bidders on all those projects. I don't know that it is typical that we will see a lot more $150 million projects out to bid, but as we do, we are certainly going to take a run at them and are in the position that we now can do that.

Great. Great job, guys. Thanks.

J.T. Rieck, Cross Capital Management.

Good quarter, guys. My questions have been answered. Thank you.

Jeff McElroy, Private Investor.

Good morning, gentlemen. Great quarter. Just to follow up on a couple of threads regarding the bidding environment. Coming in second is -- it's short movement shows progress, but obviously the goal is to win the bids. How optimistic are you that you are going to be able to succeed at these level bids in the near future?

I think extremely optimistic. I only pointed those out just to give everybody an idea of the marketplace that we are in and the opportunities that we have, but yes, we are going to work on increasing backlog and increasing the same way we have been doing over the last number of years.

Right. And I mean what is going to be different going forward in terms of the bidding process to put you over the hump so to speak on these bigger projects?

Well, I don't want to leave anyone, Jeff, with the impression that these big projects are an important part of our future. They could be. And it is going to depend where the opportunities lie as we go forward. When we look -- three years ago, if we looked at $100 million project, we likely didn't bid it. We may have looked for a way to JV it like Pat was talking about or whatever. We have now grown to the size and have the confidence level that we will participate in those size jobs, but it is not a mandate from Pat and I that by God we have got to pick up that kind of work. I am very happy to build these $10 million to $50 million jobs and make the kind of money we are making.

Right. And just to follow up on something you said earlier. What are the levels of backlog that you foresee needing to continue to 20% to 25% revenue growth that you were talking about?

If we were going into '08 with that kind of growth plan and I expect we will be, I am very comfortable with the $400 million and even lower than that depending on the mix. On our municipal contracts, we have got about a four-month lead time from bid to the time they begin and then it is usually about a 12-month build-out. On the highway side, they range from that same kind of a time period to as long as three years. So backlog in the necessity of having a certain dollar volume can be very misleading depending on the mix.

Okay. Thank you. And one last question. Are you still looking -- in terms of acquisitions, are you making any progress on that front?

Yes, we are actively pursuing an acquisition and we will continue to do so and believe that is part of our growth plan in the future.

And are you in discussions or do you have any leads or any reason to think that short term versus long term?

I don't know that I can go into like exact --.

I think as Pat said, we are actively working on that front.

Right. Okay. I mean because it has been -- for the last several quarters, this has been something you have been working on. I am just wondering whether there's -- well, I'm just trying to look for some guidance here as to whether that is something you are hoping to do or something you are actually pretty confident is going to happen.

I'll couch it another way. We are working very hard at it, Jeff. It is consuming an awful lot of Pat's and my time and we are optimistic I guess.

Okay, great. Thanks, gentlemen. Thanks very much.

(OPERATOR INSTRUCTIONS). Richard Rossi, Ferris, Baker, Watts.

I remembered the question I was going to ask.

I knew it would come back to you.

And god, I hope you haven't already talked about this, but did this weather in the quarter create any emergency work that you might be getting in this quarter and would that be better margin business as it often is?

No, it wasn't near the level of emergency type rain. It was just steady consistent inch, two inch, three inches.

Yes, I don't know that it made the national news. I mean there was a day or two that there was short-term flooding situations in San Antonio. North of Dallas, there was a fair amount of flooding in Texas and I think it is going to lead to some major rebuilds of both highways and bridges, but there wasn't any emergency work. We had one bridge failure here in Houston and it was bid and we were second on it. But they gave you the criteria and three days later you turn in your bid and that weekend you start working. And you are right, margins are expected to be higher on that. We gave a good shot at it, but we didn't get it.

Which brings along one final question. How is the mix of work that you have and are looking at in terms of geography -- Dallas-Fort Worth -- which is a growing market in Houston, which I think in the last quarter you said wasn't getting as much new funding as Dallas-Fort Worth was?

We are going to see in the '08 TxDOT budget a rotation of some pretty serious funds coming back down to Houston. Dallas -- the toll authority up there potentially has a tremendous amount of work. I mean we think in the next 12 to 18 months, there is going to be close to $1 billion worth of work up there. And that is not TxDOT. That is going to come through the toll authority. So the markets are all looking really good, Rich.

Okay, very good. Thank you.

Rich Wesolowski, Sidoti & Co.

Thanks. In the past, you guys have always been pretty positive on the bidding outlook in Texas, but now I mean it appears you are outright bullish. Are the opportunities better than you thought say six, nine months ago?

Yes, I think they are. I mean the closer we get to the time that the toll road projects are actually going to come to fruition and start bidding up in Dallas and the addition of funds that the state is talking about by issuing of bonds, the bridge situation, there is a lot of things out there that portend to a good marketplace.

Okay, good. And secondly, I had a company report yesterday a higher tax rate due to some changes in the corporate tax law in Texas. Does that sound familiar or was that specific to their business?

No, that is something, Rich, that will start to affect us from next year, only very marginally, less than 1%, but we will for the first time be paying taxes in Texas.

Okay. Great. Thanks again.

That impacts us for the next two quarters, doesn't it, Maarten?

I think you may be right, yes.

So should we adjust our tax rate assumptions for the second half?

They are very, very marginal.

Okay, great.

Craig Bell, SMH Capital.

Good morning. I just had a question on sort of the toll roads up in the Dallas area and with everything that has gone on with the 121 project and back and forth between the Toll Road Authority and Cintra, does that impact you at all? I mean do you have any preference I guess on who ultimately wins that and how that plays out?

Yes, that was a good thing for us. They took $1 billion worth of work away on a public/private partnership from Cintra and are going to put it in $50 to $100 million contracts coming out from the Toll Road Authority direct. So albeit the contract was already sort of lost, that's really good for us and when it is coming out in smaller sections where we don't have to be a subcontractor, that is great.

Okay. Do you see any longer-term impacts from everything that has gone on with that in terms of do you think there is going to be maybe less interest from private companies on that or how do you see that playing out? It seems like there was a lot of back and forth over the last couple of months on that particular project and like the politicians were really not happy with giving the deal to Cintra.

Well, the whole program still has a lot of question marks surrounding it and because we have participated in preparing proposals and playing on a team, we do have an input or a way to participate on the private side on the one hand. On the other hand, our preference would be that that work come out in the public bid forum as long as the funding is there for it. So I don't know that that answered your question, but if the toll authority can find the funding sources to build that work, that would certainly be our preference. If they can't or choose not to, then I think that work will be built by the private sector.

Okay, great. Thanks a lot.

(OPERATOR INSTRUCTIONS). There are no further questions. I will now turn the conference back to management.

Thanks, everyone and we will look forward to reporting to you in the future. Thanks for your interest in the Company.

Ladies and gentlemen, this concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.