Sterling Infrastructure Inc (STRL) 2008 Q2 法說會逐字稿

Good day, everyone, and welcome to Sterling Construction's second-quarter 2008 conference call. At this time, I would like to inform you that this conference call is being recorded and that all participants are currently in a listen-only mode. I will now turn the conference over to Mr. James Allen, Chief Financial Officer. Please go ahead, sir.

Thank you, Christie. Good morning, ladies and gentlemen. This is Jim Allen. I am Chief Financial Officer of Sterling Construction Company, Inc. I would like to welcome you to this, our conference call this morning to discuss the results of our second quarter of 2008 and the first six months of 2008, which we released this morning in a press release.

I would also like to apologize for the confusion on the time of the conference call this morning. We're used to dealing in two time zones. Previously before RHB, that was Eastern and Central; with RHB, that is now Pacific, Central, and Eastern, and we got a little confused. I promise you it will not happen again.

I am joined today by Pat Manning, our Chairman and Chief Executive Officer, and Joe Harper, our President and Chief Operating Officer.

First, I must remind you that 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 2008 guidance are subject to risks and uncertainties including overall economic and market conditions; competitors', customers' and suppliers' actions; weather conditions; and other risks identified in our filings with the Securities and Exchange Commission, which could cause actual results to differ materially from those anticipated. Accordingly, any such statements should be considered in light of those risks.

Although we may give guidance about future results, this is only a statement of management's belief at the time the statement is made. Predictions that we make may not continue to reflect management's belief, and we do not undertake to publicly update guidance.

Turning to the financial results, I am pleased to report that the Company results for the second quarter and first six months of 2008 were much improved over the comparable periods of 2007. Revenues were $192 million in the first six months of 2008, including $106.7 million in the second quarter. This represents a 37% and a 50% increase, respectively, over the comparable periods of 2007.

Gross profit was 10.4% and 11% of revenues in the first six months and second quarter of 2008, respectively.

Operating income was $12.9 million in the first six months of 2008, including $8.2 million in the second quarter. This represents an increase of 49% and 55%, respectively, over the comparable periods in 2007. Net income was $8.3 million in the first six months of 2008, including $5.1 million in the second quarter, versus $6.3 million and $5.3 million in the comparable six months and second quarter of 2007.

Diluted earnings per share were $0.60 for the first six months of 2008, and $0.37 for the second quarter of 2008, as compared to $0.54 and $0.32 for the first six months and second quarter of 2007. The respective increases of 11% and 16% for the six months and second quarter of 2008 over the 2007 are after giving effect to the 16% increase in average diluted shares as a result of our public stock offering in December 2007. These results include those of Road and Highway Builders LLC, our Nevada operations which we acquired on October 31, 2007.

Our effective tax rate was 33.6% for the second quarter of 2008, which is approximately the same rate for the comparable period in 2007.

The non-GAAP measurement of funds provided by operation was $18 million the first six months of 2008 versus $14 million for the comparable period of 2007. Our principal investing and financing activities were $11 million of property and equipment additions and $5 million of net reductions of our credit facility for the first six months of 2008, respectively.

At June 30, 2008 we had working capital of $85 million with a current ratio of 2.2-to-1; borrowings of $60 million under our $75 million long-term credit facility; and shareholders equity of $147 million -- all of which gives us the resources required for bonding, bidding, and executing projects as we go forward. Additional financial and business information may be found in our second-quarter 2008 Form 10-Q which we filed with the SEC this morning.

I would like now to turn the call over to Joe Harper, our President and Chief Operating Officer, to talk about operating results in more detail.

Good morning, everybody. This has been a good quarter from an operational sense in most of our markets. We had very high levels of resource utilization throughout Texas, including our concrete and crushing plants. Most of our contracts are ahead of schedule, and our expectation is that we will have a high level of achievement of incentives available.

We have experienced some operational challenges in the Dallas region, where we have increased both backlog and resources at a very rapid rate. Over the last two quarters, we have increased personnel and associated resources by about 50%. Pat and I met with all managers involved and are confident that this issue is being addressed.

In Nevada, through the second quarter, all projects continued to progress on or ahead of schedule. Due to weather patterns in Northern Nevada and normal sequencing of construction, most of our asphalt plants were not in production in the first half.

Based on our internal forecasts, we believe the first-half results positioned us well to achieve the midpoint of our full-year guidance issued last year. The normal fluctuations and estimated individual job profitability, the level of achievement of incentives on contracts, the weather conditions in all of our markets left us in good shape to hit or exceed the levels of profitability indicated in our initial full-year guidance.

The volatility of the commodity markets did not. As indicated in our press release in more detail than our 10-Q, we have been negatively impacted by upward pressure on commodity prices in fuel, steel, and oil for asphalt.

Since the end of the first quarter, the price we pay for off-road diesel has increased from $38.2 to $4.69 a gallon or an impact of close to 23%. Over the first half of this year, we have adjusted our gross profits on contracts in process downward by more than $2.7 million to reflect our current forecasts.

Fluctuations in pricing for petroleum products has presented new challenges. Just last week we received diesel fuel for a job in Houston priced at $3.74 a gallon lower than a few months ago. At this time, we believe we have very conservative estimates in our estimated job costs for fuel.

For the first time in our 50-plus years of building contracts, a supplier has refused to deliver product for the price quoted at bid time. A supplier of paving steel informed us he would be unable to survive the negative financial impact of fulfilling his contract. We have few options available for availability or price and have negotiated an increase in price at a cost to the Company of approximately $1 million on a contract which was 60% complete at June 30.

About two weeks ago, SemMaterials filed for bankruptcy. For those who may not be familiar with the situation, Sem is a major player in several states out West, certainly including Nevada and Utah, for the supply of oil used in the production of asphalt. Their bankruptcy has caused delays on many projects in both states, as contractors and the state DOTs determine what action to take.

Mr. Butting, our CEO, along with the presidents of two of the largest asphalt paving contractors in Nevada, attended a meeting with the director of the Nevada Department of Transportation to discuss the financial and operational challenges. The DOT expressed a willingness to cooperate with all the contractors and to give serious consideration to potential redesign, whether to other asphalt products, concrete paving, or some other combination.

At this time it is too early to determine what solutions we will propose. But we are confident that the outcome will not likely cause a material impact on future profitability.

However, the disruptions of continued production on two projects in Southern Nevada will have an impact on the timing of revenue recognition. In the guidance issued today, we have reduced the expected revenue and associated gross profit from these projects by approximately $25 million. It's important to realize that this will result in a deferral of revenue and gross profit, not a loss thereof.

The disruption to productivity in the two Nevada projects mentioned above will cause some underutilization of certain plants and manpower in that region, but we expect this to be a temporary situation. At this time, our resource schedules in Texas indicate full utilization through the end of the year, with some availability showing up in the first quarter of 2009. We are very comfortable with visibility six to nine months out.

Before I pass this call to Pat to discuss backlog in our markets, I want to emphasize a couple of things. Historically, we have not had to deal with dramatic price fluctuations and resulting bankruptcies of suppliers. We are taking steps to mitigate this possibility and believe it to be another manageable risk.

I want to emphatically reiterate that had it not been for the Sem bankruptcy, our forecasts indicated results for the full year very close to the midpoint of guidance. Pat?

Thanks, Joe. Our markets continue to provide us with the ability to replace backlog. We added almost $30 million more in new projects this quarter than we worked off, concurrent with a record quarter in revenue. This puts us at over $500 million in backlog for the first time in our history.

With two recent wins last week, we added to that backlog and already have almost $300 million on hand for construction beginning 2009. As I mentioned last quarter, we see opportunities in various segments of our markets, and they have added more backlog in Houston on the municipal side than in the state highway.

We are cautiously optimistic on both the state and federal level for additional funding for TXDOT. The state is considering the immediate issuance of $1.5 billion in previously-approved bonds; and the legislature will consider in January of 2009 the approval of $5 billion of new bonds voted for in November of last year.

On the federal level, the legislation has been proposed in Congress to restore $8 billion in funding previously removed, which would mean more than $800 million to Texas. This has the potential of restoring the Highway Fund back to its historical levels.

The Texas economy remains a bright spot in the entire nation. Harris County continues with plans to bid and build over $1 billion in total roadwork in 2009. We bid our first project over $200 million on Thursday to TXDOT and finished a competitive third. We submitted a price to the Corps of Engineers two weeks ago on a design-build a bridge in San Antonio; and are currently looking at five other design-build projects both in Texas and Nevada.

The North Texas Toll Road Authority has two projects bidding in the next 30 days, one valued at approximately $100 million, and the other valued at over $200 million. We are bidding a road project for the Department of Energy next week outside of Las Vegas, and later in the month a $70 million highway project on I-80 in California not far from Reno.

We continue to add a potential clients and expand the geographies where we compete. We are beginning to explore the possibilities of joint venturing larger projects with some of our bigger competitors.

On a final note, RHP has performed better than respected in regards to both earnings revenues and earnings. We congratulate Rich Butting and his team on their commitment and continued hard work.

With all the opportunities we see, and with the anticipation of the TXDOT program returning to its former workload, we are on track to continue our growth in both earnings and revenues well into the future. Now, if there are any questions, we would be happy to answer them.

(Operator Instructions) Richard Wesolowski of Sidoti & Company.

Thanks. Good morning. Under the -- on the steel subject, aside from just the attractive price that I was assuming you would get from the supplier, I was also under the impression that they were providing firm quotes for periods into the future, which helps you out on multiyear bids. Is that still the case?

It is the case, Rich; but the way the steel industry functions is through distributors who, as I understand it, are most of the time not able to get firm pricing from the mills. So in this case, that order was placed with a supplier with whom we had done business for over 25 years, and the change in steel price was so dramatic that we were convinced he would not survive it financially. He told us -- I can't do this or I am bankrupt; and we renegotiated with him.

Okay. I look at that situation; I compare it to what looks to be a surprisingly strong bidding environment for these $100-million-plus type of jobs. Do you think you will have to shoulder more commodity risk in order to bid these now?

Yes, we turned in a $220 million last week that had very large steel component on it. And we were able to obtain from a Texas steel manufacturer pricing that was firm but had escalators built into it. That is a pretty comfortable situation, because we are able to lay out our schedules, and determine when we can take delivery of the steel, and therefore build into our pricing those kind of impacts.

But because it was a two and a half or three-year project, there was a lot of commodity risk in our perception; and we put very comfortable pricing in there, in our opinion.

Say you win the job, so long as it goes on schedule, you wouldn't have any real commodity risk?

We believe in that.

Yes, that's correct.

Okay. I was a little confused by the press release. Were the less than satisfactory results on the Dallas projects connected with the steel? Or was that a separate issue?

No, that was a separate issue, Rich. You know, we expanded very, very rapidly up there and, frankly, we just didn't put enough management oversight in place fast enough to recognize some production and build issues.

Are you at liberty to put any sort of numbers around what that cost you in the quarter?

Total impact was around $2 million, about $1 million of that reflected in the June 30 numbers.

Okay. Then you mentioned the quick shift to Dallas. Can you talk about your labor resources? You spoke in the past about the potential to put some in Dallas away from Houston? Is that happening, or is there some alternative?

We have sent one crew so far up to San Antonio, because of how busy we were up there. We have not had to send any crews out to Dallas. We are currently looking for probably eight to 10 people on a workforce of 280-plus.

Yes, Rich, we had some good things happen for us in the municipal markets in the Houston area. So the resources I was talking about last quarter on our call --

It seems far less.

Yes.

That's right.

Great, thank you.

Craig Bell of SMH Capital.

I just wanted to follow up on the issue you had in Dallas. I guess you said it's like a a $2 million cost, with $1 million of that in Q2. Do you think that is your total exposure on that? Or is this something that we should be concerned about going forward?

I think that will probably be our total exposure, and we are hoping that that will be reduced as time goes on here in the next two quarters.

Okay. So it's not a situation where you have got a fixed-price contract, and you got out of line on your costs, and this is going to be a lingering issue until it is completed. It should be something that you can rectify just with better oversight. Is that correct?

Yes, that's correct. We had some just on yield issues, on concrete placement; and those are correctable problems.

Okay. How much more work on those projects do you have left?

On those three specific projects -- well, they are each in different phases of completion, Craig. One is over 80, one is about 50. I don't remember.

I don't remember on the third one. They are in various stages of completion. But for instance where we had the yield problems on the concrete, that is the job that was half done. So we have to go forward.

We don't typically have those problems in the Houston area, and I believe they are corrected up there.

Okay. Then I guess you touched on in your prepared remarks a little bit, but I think outside of this issue with the SemMaterials, it certainly looks like you have a very strong environment out there. I mean I would have put you at the upper end of your previous revenue guidance. Then obviously with what we have seen bidding-wise at TXDOT in the last couple months, looks very encouraging.

Then you said that you had the two upcoming bids at NTTA. I mean overall, it certainly doesn't look like there is a whole lot of weakness in the Texas market. Is that a fair assessment?

Yes, I think that is a fair assessment. I mean, you listen to what I read off and we are seeing lots of opportunities. We, like I say, picked up two projects last week, and up over $500 million in backlog. So, and still bidding.

Okay. One last question on the bidding. Looking at some of the results from the TXDOT letting last week over both days there, it seemed like that there was a diversity on the contracts between the larger and the smaller ones.

Are you seeing more competition at the lower-valued contracts? Because those ones seem to be going -- in general, it seemed like they were going for at or lower than the estimate out there. Whereas the larger contracts seemed to be at or above on the estimated cost. Is that something you are seeing out there, maybe from more competition?

Yes, I would say that is typically the situation. The larger the contract, the more vertical integration you need; the more bonding capability, etc.; so more equipment. So it narrows the field of play and generally you see less competition and better pricing.

I think we had five bidders, five bidders on the $200-plus-million; and the rest of the jobs ranged from seven to 10.

Yes.

Okay, great. Thanks a lot, guys.

Richard Paget of Morgan Joseph.

Good morning, everyone. You know, I think you guys did a good job outlining why you lowered guidance. But I was just kind of curious about the range. I mean, the old range had a spread of about $0.14; but the newer one is a bit wider at $0.25.

So I wondered what are the kind of key uncertainties which are out there right now that caused you to widen this guidance as we have moved along in the year.

Rich, it took us a while to sort of understand why the numbers played out that way ourselves, at least for me. There are several issues that go into it. But as we drop revenue lines, we have impacts on fixed costs, so we end up with a more dramatic potential impact on margin. With the visibility for only a six-month period, it really gets harder on a longer range.

The other impact or another impact is the comfort level of achieving incentives and that impact, again, on a shorter six-month period of total operations versus a longer period. So what you are seeing in the low end is pretty conservative numbers in terms of percents of incentives likely to be picked up.

We have one incentive on a Dallas project that is $1 million, and it's a drop-dead date. So it is not so much a day; it is either achieve it and collect the $1 million, or it is not achieve it and do not. So again, when that was included or not included in a 12-month period, it had a way lesser impact than what you are seeing in a six-month.

Okay. Then any updates on the Houston light rail project?

Only to the extent that they say they are continuing to move forward. But we have not seen what the plan is and they have not published that yet.

Okay, thanks. I will get back in the queue.

(Operator Instructions) John Rogers, D.A. Davidson.

Good morning. Could you just give me a little more clarification on the Sem deal or the SemMaterials impact? The $25 million that is at risk here, are you assuming that is pushed out into 2009?

Yes.

Okay.

That is exactly what we did, John, and there is frankly some guesswork in that. You know, it is very unclear how soon we will make our own decision for what we would like to propose to the DOT. Then there will be a negotiating period, I'm sure, concerning the types of products that we would like to put in place instead, etc., etc.

So I think what we have put out there is again on the conservative side for anticipation of what will get achieved in '08 versus '09. But I think it's important to realize it is not gone; it is only a question of timing of recognition.

Joe, would you have to pay market for the oil? How big of an earnings risk is that?

We don't believe at this point, John, that that will be an issue. Again, it is not just a single contract with us with the state of Nevada. It is multiple contractors who are being affected on long-term projects, as well as other states.

The degree of -- I mean, they went down for like a $2.5 billion loss on the oil.

$3.2 million.

$3.2 million on Sem. So it is not just a local thing where Nevada DOT might not consider it. They have assured us that they will work with us.

Okay, but --

John, I would rather not quantify it. I mean, just in the last two weeks we have seen a diminishment in that number of about 20%. We don't believe we are going to build the product that was quoted.

Based on the meeting that Mr. Butting had with the director, along with other contractors, there was a very high level of comfort not only on Rich's part but on the other officers of our competitors that a redesign would be readily acceptable outcome.

From the aspect -- from the state's side, in order to move these projects forward, they are going to need to do that. Some materials not only lost $3-plus-billion in the futures market, but apparently they were not acquiring products throughout the year, so their tanks don't have the inventory they would need to be able to supply. I mean, it is just not going to happen.

Then, secondly, Pat or Joe, can you update us on acquisition activity? What you are looking under, anything (multiple speakers)?

Yes, we are continuing to move along on that vein. Like we have said all along, we are trying to do one every 12 to 18 months, so that requires that we look at several in kind of the areas that we have talked about and continue conversations. So that is proceeding along as we would like to see it.

We have got three potentials in the pipeline right now, John, one of whom I am pretty hopeful on, at least.

Great, thank you.

Mark Rogers of Gagnon Securities.

Good morning. Very broad-brush question on municipalities. Just wondering how you guys are looking at municipal budgets going forward? What has changed, I guess you could say, in the first half of the year?

We picked up about $200 million in new work in the first half. As opposed to what we have typically seen, where that has been running 65% to 75% state highway and 25% to 35% municipal, that was closer to 65% municipal with 35% state highway.

You know, whether it -- I don't believe that will be typical moving forward. But you know, we take advantage of the markets that we see where we see them.

This is Joe, Mark. San Antonio has spent I would say -- or they have let contracts in the range of $60 million to $80 million out of a $700 million bond issue. So we are very positive about the San Antonio markets.

Houston, both the City of and Harris County, revenue stream is holding up fine. We are expecting -- I mean in their five-year plan, they are showing continued growth in spending, and we have no reason to question that.

Dallas has availability and have sold the bonds in excess of $600 million. But we have seen nothing, and it's been over a year since those bonds hit the market. So we expect a program to begin in Dallas soon. But frankly we haven't built any work for the City of Dallas for two or three years, so it would be a plus for us, but we are not real zeroed in on it.

Okay. So as far as municipals being able to shoulder some of the cost involved in input cost fluctuations and bankruptcies you guys have seen, do you see that being a problem? Or I mean, what do you see going forward?

Well, I think the typical municipal project is not near as large as a state highway project. So we have not seen any difficulty in them either pulling jobs from the marketplace or not issuing work orders.

Okay, so it's more of a state problem than it is municipal?

Yes, I think so.

Okay, great.

Yes, Mark, and going forward my expectation at least would be that the mix of highway versus municipal, we might see municipal taking a little bigger piece in the first quarter or so of next year. We would expect to return to sort of what we have been running the last year or so, with 65% to 70% of our business being on the highway side.

Great, thanks a lot, guys. Best of luck.

(Operator Instructions) Richard Wesolowski of Sidoti & Company.

Thanks a lot. You guys have talked in the recent past about the possibility of hedging the fuel costs. Does the expected change in the 2008 numbers accelerate that effort?

Yes and no, Rich. We are sort of struggling with that a little bit. We have Board approval to go ahead with that, and Jim and I have spent quite a lot of time on it. But the timing of putting those hedges in place is a little bit of an issue.

We were at the very peak of the market when the Board said okay, go ahead, guys; and I was very reluctant to jump in then. We are continuing to look at it, and I would expect we will be doing some hedging within the next six months or so.

Okay. Can you give some perspective on how many of the Dallas tollway jobs have been let and how many of those you have bid on?

I would say we have bid on three so far, three, maybe four. We have got one of them. There's two more coming out within the next month. Then, quite frankly, I'm not sure how many after that.

Okay.

We have bid on all of them, Rich. We were second on one, we were third on two, and we got one. So we have been very competitive on all of them.

Okay. What is the latest market sentiment for those in the industry on the prospect of the Governor actually selling the big slug of debt next year?

Gee whiz, the only thing I can do is tell you what we hear from the AGC, and I have several officers to serve in various capacities with the AGC, so we think we are pretty well connected there. The AGC political action guys are telling us that the Governor is going to be reluctant; but they believe the legislature has the headcount to override a veto if that is what they have to do.

So I think the pressure on the Governor not only from the industry and from a lot of the citizens' groups but from the legislature is going to be really high. I am very, very confident that is going to happen. But politics is politics.

One thing that I think everybody recognizes in Texas is that there is a need, and you saw that when the voters passed the $5 billion bond issue. The most recent article that I have read, they are suggesting that Texas will have somewhere between a $10 billion and $17 billion overage in the total state coffers.

So you know, I mean, it is hard to say that we can't fund the state highway program. It's hard for the Governor to say, I think.

Do you think that if that money is sold, then the budget has a chance of getting up to where it was in F06 and F07?

Yes, I think it may even get stronger. Supply that potential.

The numbers we are seeing -- I mean the other question mark there is $800 million to $900 million for the reinstatement of the federal money, and indications out of Washington are strong on that. But there is an $800 million to $900 million pickup for Texas if they reinstate that piece. When you add the sale of the bonds, Rich, I think we are north of '06 or '07.

Okay. This quarter looks like the most work you have ever booked. So you'd presumably be as up to date on the competitive environment as you could be.

You mentioned that the competition, of course, is greater for smaller jobs. But how much tougher is the competition, regardless of the size of the jobs, versus say a year ago?

It is sort of hard to look back and see. The only thing we see is sort of like month-to-month fluctuations, and on the municipal side the margins have been improving. We picked up a couple nice jobs here recently in the eight to -- well, one $18 million, one $8 million or $9 million. So the market looks fairly good right there.

But again it is kind of the same thing for everybody. It is a resource utilization, as contractors are busy or the jobs are tougher, they bid less numbers. As they begin to come out of work, they tend to bit tighter. So we have been fortunate of late. I don't know that specifically answers your question.

No, that is exactly what I was looking for. Then finally, has RHB completed many projects out in California?

Road and Highway Builders has never worked in California. We have bid three projects now in California, all of them in close proximity to either Reno or Carson. We expect to continue to do that where relatively close in geography, Rich.

Great, thanks again.

Richard Paget of Morgan Joseph.

Last couple quarters G&A is running about $3.5 million. Is that a good run rate to think about going forward?

It's pretty good. I expect to see some increase as we increase in volume. But certainly is [as] not varied directly with the volume. I sort of look at the percentage also, and so I think you will see it running around 3.5%, 4% most.

Okay, that's it for me.

Craig Bell of SMH Capital.

Just wanted a clarification on something you said earlier in regards to the SemMaterials bankruptcy. You had said that if that had not occurred you would have reached the midpoint of your guidance. I assume that you're talking about your previous guidance. Does that go for the revenue and the EPS guidance as well?

Yes.

(multiple speakers) Like a midrange, I mean it is hard to say exactly. But yes, we were generally on target in meeting our guidance.

Craig, I think --

Because looking at obviously the $25 million, you can get the revenue side of it. I was just curious if that was the impact on earnings as well, since you had these other items that you listed out for impacting the guidance.

Certainly not the impact on earnings itself. Obviously, gross profit on that $25 million is only somewhere in the neighborhood of $2.5 million to $3 million. So, we don't get that this year, obviously.

Then you look at these other items, but I really think had SemMaterials and Sem group not filed for bankruptcy we would have been very much on target for our midpoint of our original guidance.

Yes, Craig, I think what would have happened is we would have beat the revenue line and margin would have pulled back less than a point, and we would have still been there on an EPS basis.

Okay, great. Thank you.

There are no further questions. I will now turn the conference back to management.

Thank you, everyone. We appreciate your time. Look forward to talking to you next quarter.

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