Sterling Infrastructure Inc (STRL) 2010 Q3 法說會逐字稿

Greetings, and welcome to the Sterling Construction Company third quarter conference call. At this time, all participants are in a listen-only mode. A Question-and-Answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded. And now, I will turn the call over to Jim Allen, CFO, for Sterling Construction Company. Thank you, Mr. Allen, you may begin.

Thank you, Rob. Good morning, ladies and gentlemen. This is Jim Allen. I am Sterling's Chief Financial Officer, and I'd like to welcome you to this Sterling Construction Company conference call, to discuss our results for the three and nine months ended September 30, 2010, which we released this morning. I am joined today by Patrick Manning, our Chairman and Chief Executive Officer; Brian Manning, our Executive Vice President and Chief Business Development Officer; and Joseph P. Harper, Sr., our President and Chief Operating Officer.

This is the first time for Brian to join us on our investor call; however, you may have met him, as he has presented at several of our investor conferences and road shows sponsored by firms whose analysts follow Sterling. Brian has been with Sterling for 16 years. Prior to joining the Company, Brian was with a Houston engineering firm and is a registered Professional Engineer. He has also served this past year as President of the Construction Institute of the American Society of Civil Engineers, a national construction industry organization.

Now, a very important message. 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 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 these risks. Predictions that we may make at any time may not continue to reflect Management's belief, and we do not undertake to publicly update them.

Turning to the financial results. I am pleased to review our results of operations for the third quarter and the first nine months of 2010 with you. Revenues were up 14.4%, or $14.9 million, to $118.9 million, for the third quarter of 2010, from the 2009 third quarter, and up 0.9%, or $2.7 million, to $321.9 million, for the nine months ended September 30, 2010, as compared to the comparable nine-month period in 2009.

The increase in revenues reflects the inclusion of revenues from our Utah operations, which we acquired in December 2009, offset by the weakness in our Texas and Nevada markets. The lower revenues in Texas and Nevada during 2010 were due primarily to competition and the bidding climate in those markets.

The 27.7% decline in our gross profit in 2010 nine-month period to $34 million from $42 million for the comparable 2009 fiscal period, and the decline in our gross margin to 10.5% in the 2010 nine-month period from 14.7% in the 2009 nine-month period, were due to the reduction in revenues in Texas and Nevada, reduced margin on backlog that was worked-off during the period, differences in the mix in the state of completion and profitability of contracts during the 2010 period versus 2009. Approximately $2.3 million in unabsorbed equipment overhead in 2010; that is approximately the same amount as the end of the first half of 2010. And, the equipment overhead was fully absorbed in 2009. These causes of the reduction in gross profit were partially offset by the gross profit in margin earned by our Utah operations, again, acquired in 2009.

The decrease of 54% in our operating income in the nine months ended September 30th, 2010, was due to the decrease in gross profit that we have just discussed, and because of higher G&A expenses, which increased by $6.9 million in the 2010 nine-month period, over the comparable 2009 nine-month period. Such increase in G&A was due in part to G&A of our Utah operations, which we acquired in December. The increase was also caused by increases in outside consulting, legal and accounting fees, as well as some one-time adjustments in the third quarter. As I have said before, G&A does not vary directly with the volume of revenues. However, I expect G&A to be in the range of $5.5 million to $6 million during the fourth quarter.

Net income and net income per share attributable to Sterling common stockholders were $9.7 million and $0.59 per share, or per weighted average diluted share, for the nine months ended September 30, 2010, as compared to $22.9 million and $1.67 per share in the comparable 2009 period. And, was $3.5 million and $0.21 per share in the third quarter of 2010, as compared to $8.1 million and $0.59 per share in the third quarter of 2009.

The decrease in net income attributable to Sterling common stockholders was a result of the matters we've already discussed, i.e., the reduction in revenues and related margins, differences in the mix of our contract, unabsorbed overhead, and higher G&A, as well as the increase in noncontrolling owners' interest in higher net income of subsidiaries and joint ventures in 2010 than 2009. As to net income per weighted average diluted share attributable to Sterling common stockholders, the decrease was a result of all the matters we've so far discussed, that decreased net income attributable to the Sterling common stockholders, as well as to a higher number of weighted average diluted shares attributable to the sale of 2.76 million shares in December, 2009.

I will now turn the discussion of our results over to Pat Manning.

Thanks, Jim, and good morning, everyone.

The weather overall in the third quarter was somewhat wetter than normal, but for the three quarters, was consistent with historical levels. Considering the challenges that we have faced in our markets, we are pleased to have produced 10.5% in gross margin, even though it was notably less than the same period last year. Our acquisition in Utah continues to perform well, as does our Nevada operation, and while revenues are down significantly in Texas, our project managers and division heads are making every effort to improve individual [debts].

We have seen improvements in some of our markets while others are still quite challenged, and we are pleased not only to have slightly increased backlog in the third quarter, but also to have added already $137 million this quarter. The challenge is far from over, and all our markets remain very competitive, but we are bidding at higher margins than we previously have, and we are picking-up work faster than we are working it off.

That being said, we still need an increased five or six year federal highway bill before we can expect our margins to return to our historical levels, and our backlog to increase significantly. We continue to keep a watchful eye on CapEx while adding job-specific pieces for the I-15 CORE project in Utah, and certain maintenance CapEx to keep the fleet in proper running condition.

Finally, the balance sheet continues to get stronger. We are remaining profitable, we are generating cash, and we have paid off all borrowings under our credit facility. That has left us with $92 million in working capital, sufficient to cash flow all operations, and $75 million available on our line of credit.

With that, I'll turn it over to Brian to let you know about upcoming opportunities and the bidding climate.

Thank you, Pat.

We are pleased that already in the fourth quarter we were able to pick-up $137 million in backlog, and that we have other large bidding opportunities left in the quarter. The fourth quarter has typically been our slowest quarter for picking up backlog, because it is early in many of the owners' fiscal years. [Texas] fiscal year begins in September, and owners typically avoid bidding projects during the holiday season.

We continue our efforts on M&A and expect to see favorable deals from a pricing perspective. We have a strong cash position; it gives us the opportunity to make an acquisition of appropriate size without dilution. We will continue to explore acquisitions, mindful of the lack of visibility of long-term infrastructure funding to sustain those potential acquisitions. As Pat mentioned, we are waiting on a comprehensive transportation bill that will give each State Department of Transportation long-term visibility to funding, and the ability to plan for multi-year projects. The champion of the Transportation Bill on the House Transportation and Infrastructure Committee, James Oberstar, lost his re-election bid, and the chairmanship will change as the Republicans take control of the House.

With the uncertainty of federal funding, local agencies were proactive on the last ballot, and put forward propositions for funding of their own infrastructure. The initiatives had broad local support, and 75% of the ballot initiatives that proposed local funding of transportation infrastructure were approved by the voters. In Houston, Proposition 1 was supported by the voters. This ballot initiative will provide $8 billion to $12 billion over the next 20 years for street and drainage improvements. The referendum establishes a dedicated street and drainage renewal fund that captures current levels of spending, and requires that new drainage fees collected can only be spent on street and drainage projects. We'll begin to see new construction projects as a result of this new program in 2012.

As we have stated on previous calls, we have seen competition entering our markets from the residential and small utility markets. We also stated thats these contractors were bidding work at little to no margin. We are beginning to see some signs of competition failure, as this practice cannot be sustained. We are finding more opportunities with surety companies that bonded their work. These opportunities have presented themselves in the form of completion contracts for owners on behalf of the sureties. We expect more completion contracts in the first half of next year as contractors report audited financial statements, and their sureties further restrict their bonding lines.

We continue to explore new markets for growth and diversity. These new markets include geographic diversity such as Louisiana and Oklahoma, as well as alternative delivery methods such as design-build, Construction Management at-Risk, and joint ventures on projects over $200 million. We are actively pursuing projects in Baton Rouge, where they have a $1.2 billion sewer program that was mandated by the EPA, and in Oklahoma, where they have the largest highway program in their state's history.

Other active pursuits include the Central Texas Regional Mobility Authority, where we are short-listed on a joint venture for a $300 million design-build project. We recently announced that we were low on a bid for the North Texas Toll Road Authority for $91.2 million, and will bid another two projects later this month with engineers' estimates of $90 million and $137 million.

We are also bidding a $60 million project at Dallas Love Field, where we are currently performing taxiway repairs. Our subsidiaries Ralph L. Wadsworth and Road and Highway Builders were short-listed on the I-80 design-build project in Nevada, and RXV had two wins which were included in the $137 million in backlog that I mentioned earlier. Finally, RLW was short-listed on the [Geneva Road and Bangerter Highway] design-build project in Utah.

Now, if there are any questions, we'd be happy to answer them.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Thank you. Our nurse question today is coming from the line of Rich Wesolowski of Sidoti & Company. Please state your question.

Thanks, good morning, how are you guys?

Fine.

I was a little confused by the press release. Do your comments signify a new reduction in headcount and idling of equipment or something that has been discussed in previous calls?

They do, I'm sorry, Rich, you asked a question whether they do or do they?

I'm sorry, my question was has the headcount reduction and the idling of equipment discussed here in this press release represent something new that you've just undertaken or something that we've discussed in the past?

No, it's what we've discussed over the past six months I guess it is, but it's still affecting obviously the nine months for the year.

Okay. Now that both Sterling and Wadsworth are presumably working off backlog that was booked during a very tough competitive climate, how wide has the gap been in margins for those two companies and have the margins for Wadsworth specifically been up to your expectation?

Margins for Wadsworth have definitely been up to our expectations and even beyond so they're doing real well. What was the other part of the question?

How wide is the gap between what they're putting out and what your traditional or pre-Wadsworth business recorded?

I can't really comment on the gap, but as we have mentioned all along, the margins that they obtained are typically better than what we do here in Texas.

Right. Okay. When conditions were strong in the market generally, Sterling had a relatively narrow geographic footprint. Now that business is tougher you're stretching out to both surrounding states and far away areas. Would you discuss the risks in bidding jobs in new territories during a period when competition really doesn't allow for typical margins on the work and what you're doing to limit those risks?

Rich, this is Brian. And as we look at these new geographic areas, we're mindful of increased risks with entering into a new market. So we do quite a bit of research on the front end and approach these projects carefully and monitor the projects that are bidding before we actually enter in and bid the new projects.

The project in Montana that RLW bid was a specialized project and there was really nobody that had any closer proximity to it than RLW. In Louisiana, we're looking at work because there's a $1.2 billion EPA mandated program, so the competition hasn't been there historically to service that kind of marketplace.

Right. And then just to expand the theme, lastly, give us even greater confidence, let us know how the Hawaii project is going. Thank you.

Yes, it's going very well. I would say better than it was originally bid at.

Appreciate it.

Our next question is coming from the line of Kathryn Thompson with Thompson Research Group. Please state your question, ma'am.

Hi, thank you so much for taking my questions today. What are the margins on the two large new projects that Sterling recently won and how are these bid versus what's been reported in the quarter?

Kathryn, if I understand your question, -- this is Jim. If I understand your question, the margins we bid there have been more aggressive than we were bidding, say, a year to two years ago. We don't get into discussions with margins on specific contracts at all. And then you had a second part to your question, which I really didn't get.

Well, really, I mean basically cutting to the chase, are the margins bid for these large projects better than, say, a project that you bid 12 to 18 months ago?

No.

No.

Okay.

As we said, we're getting more aggressive.

Yes, and then on infrastructure, where it's traditionally been a good high-margin business for Sterling. There's not been many jobs. Is it just they're not as many jobs to bid or has competition just remained intense?

Kathryn, this is Brian. I would say that competition has remained at a high level.

Okay.

We're seeing some softening, but it's sporadic on different jobs, but I agree with Brian overall, the competition is stiff.

I know that we've been waiting a while to see some Companies fail and you alluded in your prepared comments about greater restriction with bonding lines as we go into the next spring. Are you seeing a pick-up of even more aggressive bidding as they go into spring and what do you think realistically in terms of failures of some of your peers as we go through these winter months?

I don't think the large competitors are going to fail. They'll realize as they move along that they're not generating any profits and rethink their position. On the smaller competitors, I would think those are imminent. We have picked up one project in Corpus Christi for about $7 million, plus or minus, to complete a project for a bonding Company and I certainly expect more to come.

Do you feel like you're finally seeing some failures that you would have expected, say, a year ago?

Yes, I would say that's what's happening. We are at least mildly optimistic that the market over the next 12 months will start to return to normal.

Okay. Final question. Any update on cement or aggregate or any other basic material pricing trends?

I'd say that the cement and the aggregates have stayed pretty steady. Show some tendency to be increasing.

Great. Thank you so much.

Our next question is coming from the line of Todd Vencil with Davenport & Company. Please state your question.

Thanks so much.

Good morning, Todd.

Good morning. On the SG&A, Jim, you talked about that a bit on the call and you mentioned that there were some one-time -- I think you said one-time costs or one-time charges that affected the third quarter. Can you talk about how much those were and what was in there?

Well, I don't want to get into discussing specific charges. I will say, though, I think our fourth quarter G&A will be legs less than the third quarter. It will be I would think closer to, say, the first quarter of that and if you start following the quarter, you can see where I'm headed.

So if we -- and you said in the prepared comments $5.5 million to $6 million. I mean, is that a pretty good run rate for the quarterly SG&A next year too?

We haven't got around to planning for next year but I don't -- other than some normal increases that we suffer because of whatever, I'm told there's no inflation out there, but whatever we suffer because of the lack of inflation and maybe some well-deserved salary increases to some of our people, I don't see a large increase in G&A.

Got it.

I think our expectation for next year would be that we're going to add a couple of positions, so I think there will be a little bit of upward pressure. We think there's some really good talent out there and as we're moving into larger projects, we've got a couple of holes to fill.

Got it. Got it. And on that bonding job that you mentioned or the bond Company job you mentioned you won in Corpus Christi, what are the margins on that project or other sort of boomerang projects that you pick up from bonding companies? How do those compare to original bid margins? Are they any different?

They would be typically higher because of the risk profile is a little different than our standard bidding situation and when the project gets to that point, they require immediate attention. It's different issues that we typically wouldn't have to -- would be able to plan and schedule in our normal contracts.

Got it. And you mentioned that you expect to see more in the first half of next year. Was this the first one of these jobs, this type of work that's come back around from the bonding Company that you've seen and are you seeing any more that are coming up now? Is it just -- do you think it's going to happen next year?

This is Brian. And this is one of the first that we have seen. We expected more in the last half of 2010 but just haven't realized those. I think the surety companies had more restrictions on the contractors in place and as a result we're not seeing the failures that we had expected. But again, we're looking to the first half of 2010 and those projects that were bid with little to no margin we're keeping an eye on them.

Got it.

The bonding Company with whom we negotiated that contract specifically asked us at the end of the meeting how much capacity we had left. It was very clear to us that they have other contractors who they're fearful are going to have completion contract availability. So, plus, we're hearing of some competitors' checks bouncing, all the indications are there, Rob, that some of our municipal competitors are not likely going to make it.

We did bid one other small project, it was only $300,000 and we were not successful on it. I spoke to one of my competitors here in Houston last week and they are doing a takeover contract for another bonding Company, so it's beginning to happen.

Got it. Just a couple more. You mentioned a couple of bids that are coming up I think you said later this month. One for $92 million, one for $137 million. Could you talk about where those are, who the owner is?

They're in Dallas and it's the Toll Road Authority up there.

Okay.

Expansion program.

Got it. And then final one from me. Jim, -- and you alluded to this in the prepared remarks a bit, but I'm not 100% clear on it. Was there no unabsorbed overhead in the third quarter?

Very little.

Okay. So $2.3 million for both the six months and the nine months?

Yes.

All right, then. Thanks so much.

Thank you. Our next is coming from the line of Saagar Parikh with KeyBanc Capital Markets. Please state your question.

Hi, guys, this is Saagar Parikh on behalf of Tahira Afzal. Just a couple questions. With the tax rate, the tax rate was on 27.8% this quarter. Do you expect it to stay at that level going forward in 4Q and 2011 or should we see a little bit of an increase?

I would like to see a big increase because that means we're making more money. The reason it decreased so much in the third quarter was that the noncontrolling interest share of net income was proportionately higher than in the earlier quarters, and when that happens, since they pay the taxes on that interest, not us, that drives down your overall tax rate. So if Texas and Nevada come back real strong, taxes would be going up. It's hard to predict. We've gotten quite a bit of work recently. Like the $91.2 million job, although that doesn't start until next year. The more work we get, then the greater the comeback in Texas, Nevada and we'll see of what you just mentioned.

Sounds great. Thank you. One more. You mentioned a project award from the Department of Transportation in Montana.

Yes.

And then you mentioned Louisiana and Oklahoma as other areas that you're looking into for projects. Anything else on the West Coast? You mentioned Montana. Anything in Washington State, Oregon, California?

We have a small project in Idaho through RLW, but nothing else in the states you mentioned.

We continue to look at California close to Nevada and we did bid one there recently. We were not successful in our bid. But it's one of those things, we're going to keep a close eye on.

Sounds great. Thank you very much.

Thank you. Our next question is coming from Rich Wesolowski of Sidoti & Company. Please state your question, sir.

Thanks a lot. Say we do not get a new highway bill next year for whatever reason, would you expect the Texas DOT and the local authorities with whom you do business to let more work in 2011 than you saw in 2010? Less work? Or about the same?

What I've heard is that 2011's pretty safe. Brian may have heard something different, that without the highway bill 2012 still has a high degree of uncertainty. What have you heard, Brian?

I think we're going to see a little bit of an uptick in -- we're starting to track Texas highways as opposed to just Tex DOT, because there's other funding sources such as the Toll Road Authority that we mentioned earlier that are funding their own transportation needs.

Right.

We also may see a trend more towards public/private partnerships as the federal funding picture is unclear.

Okay. Do you think Sterling has the bench of project managers to bid the different contracting forms that you're going after, the design build construction, Manager at Risk, PPPs, et cetera, or will you need to add a significant number of these managers in order to really get into that market.

Typically on the public/private partnership, we are grouped with a concessionaire and they handle quite a bit of the activities, the bidding activities and the financing activities that are required with the public/private partnership. As Jim mentioned earlier, we are adding key positions to help us pursue some of the design build work.

Great. Thanks again.

Thank you. (Operator Instructions). Our next question is from Avram Fisher with BMO Capital Markets. Please state your question.

Good morning, guys.

Good morning.

Good morning.

Could you talk a little bit about if there is any margin differential between projects, large projects you're bidding versus the small projects you're bidding? I assume those are less -- there are fewer bidders bidding on it. Does that improve the margin profile of it?

Well, it depends on the -- like all the jobs that we bid, it depends on the degree of difficulty, the location whether it's adjacent to work that you're doing and whether it's potentially a design build or something like that. And the other thing that's prevalent is that on larger projects where you can concentrate more personnel in the single given location, you have more opportunity for increasing the margins.

I guess -- I appreciate that. Comments you made earlier about projects you're looking now and the margins in them relatively the same as they were 12 to 18 months ago, does that same apply to the big projects, the Tarrant County project or is that a different beast?

It varies, again, from individual projects, so one that you might bid that we bid last week and one that we might bid next week might be varying significantly and as we pick up backlog, which we've done this quarter so far, we will tend to raise those margins and see if we can still be successful.

In terms of backlog burn, if you look at it on a gross basis, looks like the burn rate on backlog is below what it's been historically. What's driving that?

Just our competitive markets and our lack of ability to pick up work at prices that we believe are appropriate. So as Jim mentioned earlier, that has caused us to reduce headcount to underutilize our equipment and so forth.

Another element to that is reduced overtime. We've reduced the overtime and that's helped profitability but it also extends the work out a little bit.

Okay. That's helpful. You mentioned acquisitions before. One of your -- one of the large E&C competitors hasn't historically been in the Texas market has said they're acquiring a Texas contractor. I wondered if you could talk about what kind of multiples you're seeing there, in that market, whether they're changing at all materially.

I would say they're going down and we typically several years ago said four to five times EBITDA was a reasonable model and I think now we would be looking at under four.

And finally, just a quick question on the tax rate which has come down pretty substantially year-over-year. What's driving that decline in the tax rate? What's to think about it going forward?

Well, as I mentioned earlier, if you look at the proportion of net income that's attributable to the noncontrolling interest owners, it is greater in the third quarter than in previous quarters and, therefore, it has driven the tax rate down.

So should we look at it as like 35%, roughly, when you exclude the minority interest, pretax?

Well, that and there's a few other permanent items such as the domestic production activities deduction you get which turns into credit and a few other smaller ones but yes, generally speaking, if you -- the one way to look at it, I say, is take the pre-noncontrolling interest income which is called net income, subtract from it -- I'm sorry, take the pretax, precontrolling, noncontrolling interest. Take that times 35%, and then subtract your noncontrolling interest at 35%. You're going to come down to where our taxes are.

Got you. Okay. I appreciate it. What projects are creating the minority interest?

Well, our operations in Utah are 20% owned by the noncontrolling interest.

Got you.

Operations that are performed out of Nevada are 8.33% owned by the noncontrolling interest. So any projects those two operations do is going to have a noncontrolling interest. In addition, in Utah they have historically been more involved in joint ventures and were we involved in a joint venture and it's a -- we have a controlling interest, then we have a noncontrolling interest in the joint venture for some other parties and it's handled the same way as subsidiaries.

Has RLW been a majority partner in any major contracts right now, are they?

We've got a couple, three.

Okay.

That we're the majority partner on.

Super. I appreciate the color. Thanks a lot.

There is a footnote which describes the , I'm sorry, that's on the noncontrolling interest we have but they are the majority partner.

Thank you.

Thank you. Our next question is from the line of Craig Bell of Sander Capital Partners. Please state your question.

Good morning. Just want to kind of follow up on some of the comments and questions from earlier. As you look at funding sources specific to Texas, with the new legislature coming in in January, just wondering how you're viewing the outlook there? Do you have any real concerns about funding? Some of the funding sources for highways in Texas are not as likely to be cut with the budget just from where they're coming from. I'm just wondering do you have any major concerns about what's going to come out of the legislature in this session?

Through 2011, so through August of 2011 which is the DOT year end, we don't have any concern. We've got project visibility funding in place, we believe, Craig.

Okay.

After that we're going to have to wait and see what the ledge the legislature does in fact do. Perry got reelected as governor by a pretty substantial margin, and he has always been in favor of infrastructure.

I also say there's still $2 billion left under the November 2007 bonds that were approved by the voters that could be dedicated to 2012 and 2013.

That was going to be my follow-up question, on the bonds, and whether or not that's likely to happy, because I know there's concern about how much debt Tex DOT has taken on, and what that might mean in terms of their service relative to their ability to fund roads, and see if there was any concern on that. Sounds like --

With respect to that debt, that's general obligations funding that will repay it. Not gasoline taxes.

Okay. And then sort of looking ahead, based on what you have in your backlog, we've had a conversation here about what margins are looking like. Is there any reason for us to expect the next couple of quarters that your gross margins are going to be materially different than what you've put up here recently? Your margins have generally held up pretty well throughout this downturn. I'm just wondering -- and we keep hearing you talk on the calls about margins are being bid a little bit lower. But then you keep putting up pretty decent margins. Just wondering if there's any reason to suspect that we should see a significant dropoff.

We had a significant dropoff for the 14% point some odd to 10.5% or so in the period for -- let me just take a look at it. Gross margin. In the nine months we had a significant dropoff, nine months of last year, from 14.7% to 10.5%. And as we continued to work the jobs where we have been more aggressive, obviously would expect to see some further reduction.

Okay. Great. Thanks a lot, guys.

Thank you. There are no further questions at this time. I would now like to turn the floor back over to management for further or closing comments.

Anybody got anything to say?

No, we appreciate your attention and thanks for coming. We look forward to talking to you next quarter.

I say Amen to that.

Thank you.

Thank you.

This concludes today's teleconference. You may now disconnect your lines at this time and thank you for your participation.