Sterling Infrastructure Inc (STRL) 2017 Q3 法說會逐字稿

Greetings, and welcome to the Sterling Construction Third Quarter 2017 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Jennifer Maxwell, Director of Investor Relations. Please go ahead.

Thank you, Kevin. Good morning, everyone, and welcome to Sterling's Third Quarter 2017 Earnings Conference Call. I'm pleased to be here today with Joe Cutillo, Sterling's Chief Executive Officer; and Ron Ballschmiede, Sterling's Chief Financial Officer. Joe will provide some commentary on the performance of the company and market trends. Ron will walk us through a detailed discussion of the financial results for the quarter and then we will open the call up for questions.

We would like to begin with an overview of the company's Safe Harbor language. Some of the discussion today may include forward-looking statements. Actual results could differ materially from statements made today. Please refer to Sterling's most recent 10-K and 10-Q filings for a more complete description of risk factors that could affect these projections and assumptions. The company assumes no obligation to update forward-looking statements as a result of new information, future events or otherwise.

And now I'd like to turn the call over to Joe.

Thanks, Jennifer. Good morning, everyone, and thank you for joining us today. I'd like to start off the call by saying how proud I am of the entire Sterling team and what a great job they did in the third quarter to deliver amazing results in some very adverse conditions. Everyone is aware of the hurricane that hit Texas but what most people are unaware of is the amount of time and effort that was made by the Texas team to ensure our employees and neighbors were taken care of during these devastating times. While the Texas team was getting back on their feet, the remaining Sterling teams stepped up to cover any potential shortfall. The combined quick recovery of the Texas team, the outstanding performance of the remaining Sterling business units and the record performance of our recent Tealstone acquisition enabled us to have the best earnings quarter in over 6 years.

Compared to the third quarter prior year, our revenue was up 48%. Our gross profit was up 25%, our net income was up 195% and our cash balance grew to over $66 million. We made our workplace safer by reducing our recordables by 34% and having 0 lost time incidents. Overall, a pretty amazing job. Our overall market remains robust. Even though our total backlog dropped in the third quarter, we bid on more jobs and won a higher percentage than the prior year.

In addition, our mix of non-heavy highway backlog grew to 40%. The main driver to the backlog drop was a mix of jobs bid compared with a 28% increase in heavy-highway revenue in the quarter. Looking ahead to the fourth quarter, which is our busiest bid quarter, we are currently working on over $1 billion of projects that we'll bid in the fourth quarter. Based on the scheduled bids and our historical win rates, I believe we will end the year with a nice year-over-year increase in backlog.

Moving onto the full year. As a result of the strong third quarter results and our fourth quarter outlook, we are raising our full year net income guidance range from $9 million to $11 million to $11 million to $12.5 million.

Now I'd like to turn it over to Ron to discuss our full year and the results in more detail. Ron?

Thanks, Joe, and good morning, everybody. I'm pleased to discuss another strong quarter of operating results, the strongest quarterly performance in over 6 years. As a reminder, our 2017 financials include the financial results for our Tealstone acquisitions -- acquisition since its close date of April 3, 2017. I will be discussing the specific Tealstone financial performance shortly.

Additionally, beginning with the acquisition, we moved from our historical single-reporting segment presentation to 2 segments: heavy civil construction and residential construction. Heavy civil construction contains our historical single-reporting segment plus the commercial construction business of Tealstone. The residential construction segment includes Tealstone's residential concrete foundations for single-family homes.

At September 30, 2017, our heavy civil construction segment backlog was $804 million compared to $823 million at the beginning of 2017. The gross margin in our September 30, 2017, backlog was 8.4% compared to 8.2% at the beginning of the year. We finished the quarter with total backlog, including projects where we were the apparent low bidder but contracts were not yet signed, totaling $912 million with an overall gross margin of 8.5%. Just a reminder that our backlog figures are comprised entirely of heavy civil construction projects. Residential construction does not report backlog, reflecting the short-term performance cycle of residential slabs, which is typically less than 2 weeks.

Our book-to-burn factor was 94% and 52% for the 9 months and 3 months ended September 30, 2017, respectively. Our low third quarter 2017 book-to-burn factor reflects the significant revenues generated by several Rocky Mountain area construction contracts, which were rewarded in late 2016 and early 2017, coupled with delayed bidding on projects in Texas resulting from Hurricane Harvey. As Joe mentioned, we are bidding on numerous significant opportunities in the fourth quarter which, if we are successful, would result in an improved backlog position at the end of the year.

Our total revenue for the third quarter of 2017 was $304 million, $98.6 million or 48% higher than the third quarter of last year. This increase reflects strong growth in the heavy civil market as well as the residential market. Heavy civil construction revenues increased $57 million or 28% compared primarily due to an uptick in several projects. The $41 million increase in revenue coming from the residential constructions segment for the third quarter resulted from the Tealstone acquisition.

The residential market continues to see steady growth in the low double-digit range. Dallas housing starts increased 13% in the third quarter of 2017 over the quarter -- same quarter in 2016. Our principal operating market for residential construction business continues to perform in excess of the aforementioned growth rates.

Gross profit was $30.6 million in the quarter, an increase of $14 million from the prior year third quarter. Gross margin grew 200 basis points to 10.1%, primarily as a result of the acquisition of the residential -- of residential construction, which provided approximately 160 basis points of that increase. The balance was derived by higher gross margins from the heavy civil construction project segment.

G&A expense for the quarter was $13.1 million or 4.3% of revenues. The third quarter 2017 G&A expense increased $4 million over the comparable 2016 period while the percentage of revenue decreased 13 basis points. The Tealstone acquisition added $2.3 million of G&A expense. The remainder -- the remaining increase resulted from increased recruiting and pre-bid contract costs. The pre-bid costs relate to several large projects which we are bidding in the fourth quarter of 2017. Third quarter operating expense was $4.9 million compared to $3.8 million in the prior year. The increase was primarily due to increased earnings from our two 50%-owned subsidiaries.

Interest expense for the quarter was $3.6 million versus $0.5 million in the same quarter of 2016, reflecting the acquisition-related financing. Finally, noncontrolling owners' interest totaled $1.7 million for the third quarter of 2017. The $954,000 increase over the third quarter of '16 is a reflection of additional increased activity related to our Rocky Mountain construction joint venture projects.

The net effect of all these items resulted in third-quarter net income attributable to Sterling's common stockholders of $7.1 million and a net income per diluted share of $0.26 compared to the third quarter of 2016 income of $2.4 million or $0.10 per share.

By many measures, the Tealstone acquisition has been a quick success. One additional measure from a financial perspective is that for the third quarter, the results of the Tealstone business was accretive to our net income per diluted share by approximately $0.10. Importantly, our legacy heavy civil business also produced significantly improved net income of $4.1 million, an increase of 68% over the comparable 2016 period.

Moving to our balance sheet. We ended the quarter with a cash balance of $66.5 million compared to $60 million at the end of the second quarter of 2017. This amount includes our corporate cash balance of $30.7 million, $20.7 million of cash accumulated for our 2 majority-owned construction joint venture projects and the remaining balance of $15.1 million attributable to our 2 less than wholly owned subsidiaries. Our debt totaled $88.6 million at the end of the third quarter, primarily consisting of the -- of our 5-year $85 million term loan.

Shifting to our guidance for the full year, we are increasing our revenue guidance to a range of $915 million to $935 million. We are also increasing our net income attributable to common stockholders to $11 million to $12.5 million from our previous guidance range of $9 million to $11 million. We expect our weighted average diluted shares outstanding to be 27.4 million shares in the fourth quarter and 26.6 million for the full year ended December 31, 2017.

Now I'll turn the call back to Joe.

Thanks, Ron. Overall, we are very pleased with the financial results and the progress we've made towards transforming the business in the third quarter. As we go into the fourth quarter, we will remain focused on executing our 3-phase strategy and further prepare for 2018. For the first phase of the strategy, solidifying the base, we will remain disciplined at the bid table and continue our focused efforts to reduce costs and optimize our asset base and business lines. We will increase our focus on human capital at all levels and have programs to recruit, develop and retain the best talent in the industry as seen in our recent announcement of Rich Chandler, our new General Counsel.

The second phase of the strategy, growing high-margin products, we have improved the mix of non-heavy highway backlog to 40%, and are on track to have 50% of our revenues in 2019 come from non-heavy highway work. The final phase, expansion into adjacent markets, we continue the integration of Tealstone and are focused on the expansion of that business into the Houston market during the first half of 2018. In addition, we continue to look for incremental adds or opportunities in these adjacent markets that fit within our strategy.

With that, we would be happy to take your questions.

(Operator Instructions) Our first question today is coming from Brent Thielman from D.A. Davidson.

Joe, I heard a lot about the terrible weather in Dallas the first couple of months of the quarter. Contributions look great but just curious, kind of, how that impacted Tealstone?

Yes. Hats off to the Tealstone team. They -- the quarter started off really rough for them. One of the worst rain months in -- more than a month, a couple months, in many years. But the team really picked it up strong, worked through weekends to get their customers back on track and their business back on track and recovered really well for the quarter. So, Brent, it -- I kind of say it in the overview but really a Herculean effort by all elements of the business in this quarter to overcome some adverse conditions in multiple markets.

Sure, okay. Joe, you mentioned TxDOT with some pause in recent activity. I guess, how about some of the other markets you're in? It sounds like 4Q could be a busy schedule in terms of bidding opportunities. Is it predominantly Texas or, kind of, a combination of markets year-end?

Yes, the Texas market, we're seeing the bid activity pick up nicely in the fourth quarter. But through the Mountain states, Brent, we have several very, very nice design-build projects that we will have a combination of design-build and some joint ventures that all seem to hit the fourth quarter and first quarter of 2018. So we're pretty optimistic on those markets and seeing the best bid activity in Utah and Colorado that we've seen in probably 5 or 6 years.

Okay, that's great. One more if I could. The Houston rollout of Tealstone, I mean I know you want to be careful about how you, kind of, execute this. Any financial targets you're looking to hit or willing to share?

We're starting -- we're in the process of finalizing plans for 2018 as you can imagine. But so far, the reception we've received from the key customers in the Dallas market, which are the (inaudible) the Hortons and the history makers of the world have been very cordial and receptive of us coming into the Houston market. We've added what we've taken one of our best high potentials internally and put them on a team and hired one individual from the outside to start building the team out for the Houston market. They are located in Houston as we speak and laying the groundwork to -- for our first slabs, hopefully by the end of the first quarter 2018.

Our next question is coming from Bobby Burleson from Canaccord Genuity.

So I'm just curious -- there's a lot of talk about labor shortages in the Houston market, particularly for construction. I'm wondering how you guys are addressing that and whether or not you have any advantage, having tried to kind of prepare to access Tealstone expansion a little earlier on?

Yes. To the labor market for the Tealstone piece, very different from the labor market for our heavy civil side with a little more steel on the operator piece. A couple of things. To date, we've been fine. We certainly see the market tightening. The way that we measure that is if it normally took us, say, 5 days to fill an open position for an operator, it's now taking us 8 to 10 days to do that. So we -- we're certainly seeing the up -- the market tighten.

But in parallel, one of the things I touched upon as we go into 2018, is we are spending a lot of time putting together what we call a human-capital strategy and that's not only for the operators but it goes through the operation. We're working -- we've got a program that we're putting in place in Texas where we're working back with the high schools and some of the community colleges to start developing the next generation of operators early on.

So as this thing continues to tighten, we're populating some of the pool with those individuals. But labor, frankly, over the next 2 years, if another infrastructure bill comes through, it's certainly going to be tight and it's going to be a tougher thing and a bigger challenge for us. But right now we're fine across the country, but we certainly see it tightening.

Okay, great, that's helpful. And just switching to the heavy civil opportunity to rebuild. Wondering if you can give us any kind of metrics there in terms of the scale of the rebuilding efforts, maybe relative to [half] the hurricanes that you guys have experienced?

Ron, you want to handle it?

Sure. So, so far, we've received some, what we call the emergency-type work. Those projects tend to start with a pretty small number and, by example, a $250,000 task, if you will. And they tend to expand as the teams are in the field and move forward. So we probably suffered costs out of the hurricane of somewhere in the $1 million range in our Texas market, which was really driven by the Houston and Gulf Coast side, and we probably made a good part of that up in the third quarter and expect to recover the rest before the end of the year. So those aren't huge jobs but they come in small chunks and pretty easy to execute and get on with.

The larger projects are pretty much undefined still. It's -- we haven't got far enough along -- TxDOT hasn't got far enough along to scope out, engineer, and prepare for the bids at this point in time. We know there's a lot out there. We still have some inspections going on, on bridges and other places but I'm not sure we have a beat on how big that could be.

Yes, they're just starting, Bobby. Last week, they had that a big conference down in Houston where they're pulling together multiple entities to really look at what happened with the event and what they can do to prevent a lot of the areas from flooding. Now obviously, if you get 50 inches of rain in 2 days, you're not going to prevent everything from flooding. But there are certainly a lot of bigger projects, longer-term projects, that have been talked about for several years and I think this has brought it to the forefront. I don't think realistically we'll see those projects coming out until probably mid-2018 or so. But the good news is, they're talking about that and the types of projects that would be needed if they're related to storm water and underground, really fits our sweet spot well in the Houston market.

Great, thank you. And just, if I can sneak one more in there. In terms of the bid environments or the bid process with some of this reconstruction, do you think it'll be the standard, kind of, process? Or do you think it will be some more, kind of, expediting allocating jobs to folks like yourselves that have assets in the area, maybe a little bit more expeditiously and at better price?

Well, we're -- yes, I think, for the short-term emergency work, I -- your latter example is exactly what's happened in -- what they do is, they need to get stuff done quickly, not a lot of time to put a lot of scope and design and bidding. So those are what Ron talked about. They start out saying, come out and here's $250,000 to get started and they grow from there. We currently have about $4 million to $5 million of jobs in that sort of, I'll call, category.

The larger jobs, if they were going to resize the storm water system through a part of Houston, that's going to take a little longer because they'll have to go back and do the design of that and those will come out as a more standard bid and more standard bid process.

Our next question today is coming from Sean Eastman from KeyBanc Capital Markets.

You guys gave some color on '18 in the press release. So I just wanted to maybe get a little bit more color on that. Just to start on your comments about the mid- to high single digit growth being achievable for '18. I'm just wondering, is that an organic outlook? And if you could provide a little more color on the moving parts in there between how Tealstone's going to grow versus the legacy business, that would be helpful.

Yes, sure, Sean. I'll let Ron talk in more detail but let me give you some overall color of what we see for 2018. On the heavy civil side, we're seeing the continuation of the FAST Act. If you, kind of, blend that across the country, it's 3% to 5%. We're seeing a little bit better market growth in some of our core markets than that. The Dallas market continues to be extremely strong. We're just receiving all of the 2018 forecast for our key customers up in that market. And that certainly looks like that will continue to grow in what I'll call that low to mid-double digit growth rates into 2018, and we'll get a little bit of a pickup from the expansion into the Houston market, into '18 as well.

Ron, you want to give some more detail on the elements of it and the numbers?

Sure. I think the one thing to be cautious of, one of the key reasons that Tealstone is so successful is the way they serve customers. So that's the most important opportunity, and risk, I think, as we move into a new territory. So we'll be very deliberate on growing Houston and giving our large customers the same service that they demand that we give them in the Dallas market. So we'll give you some more data once we start getting a better feel for how that business is going to ramp up because right now, we are still really in the planning with the customer mode pretty much and hopefully, we'll be pouring some slabs shortly.

The rest of the -- so if you go around the geographies, certainly, we talked about the opportunities in the Rocky Mountains. Those are nice projects, multi-year projects, we will have a partner on several of them but that should drive some growth in that -- continue to drive some growth in that market. We'll be finishing one of the -- one of our large projects here by the end of the year are pretty much wrapped up, the other one will -- could continue on through next year. So we've got a pretty base load growth to work off of.

Moving around a little bit. We talked about Texas already. California is coming back at a regular pace. I don't think we've seen anything crazy or extraordinary there but the work is good and we do a pretty good job of getting markets outside -- getting projects outside to heavy civil side of the distance. The one area that continues to be a little slower is Nevada, and we continue to believe that with the influence of new companies and people moving into particularly Reno, and that area that we will see some pickup at some point in time, but right now, the bidding activity in that part of the world -- sorry, the United States, is pretty slow. So all that probably equates to the kind of percentages that Joe was talking about.

Okay, that's helpful. I think one interesting part of the revenue outlook is just how the Rocky Mountains region is going to play a role and it sounds like a lot of the bigger stuff you guys are hoping to book next quarter will be JVs, partnership type of arrangements. So if that contribution is bigger for next year, I mean, what should we be thinking about in terms of those other income lines and noncontrolling interest lines, which can have a pretty meaningful, kind of, impact depending on that mix in the top line?

Sure. The -- so in 2017, we talked about our noncontrolling expense, if you will, second bottom line of the income statement, totaling somewhere between $4 million and $5 million. It is our goal to make that number as big as we can get it. Because if that number is big, the number [up above, it says if] you do the math, a lot larger.

So we don't really have -- I wouldn't -- until we get awarded some of these projects, I'm not going to try to guess yet at 2018 numbers. But without them, it still should be $3 million to $5 million, it's a pretty broad range, but we still got some work to do on those projects. And I -- and they're all a little bit different. So it's hard to answer them in total. What we know is that, that is a great market. It fits our entity, it takes care of that part of the world, our RLW entity, very well. They're very capable of doing this, and they get very strong partners that join up in these large projects. So it's really [double slot].

Yes, and I think the other thing to keep in mind, Sean, you know, these are -- these projects bid our RLW business very, very well. But not only are they a great opportunity for next year, some of these projects are 2 and 3 years long. So they can really solidify that business over the next several years for us.

Okay, that's great. And then maybe just shifting over to margins. You guys also indicated that it's likely you'll get some good margin expansion next year. Obviously folding in a full year of Tealstone and some strong growth for Tealstone next year, is going to be a tailwind there? But just wondering about some of the moving parts for the legacy business margin performance. It's been mentioned that it seems like the labor market's tightening.

How big of a risk is that to executing on that 8.5% margin and backlog right now? And maybe, what kind of cost leverage do you guys have left in the Texas business that you could potentially pull and squeeze a bit more margin there?

Well, a couple of things to help you feel a little bit better. All the bids that we are putting out today, we are factoring in our best estimate on what we think labor inflation rates could potentially be. Especially any of the jobs that could go a long period of time. So we're covering a fair amount of that. The bigger risk is if labor gets tight and you're trying to get them all together, but we have put in factors for both raw materials, we trend the raw materials, we draw the trend fuel, trend labor, and we are proactively factoring those into it. So we anticipate with the margin, we'll continue to pick up into 2018 as a result of the higher-bid margins and better execution we've had to date, and we will continue to see the benefits of that as we go forward.

We talked about before, it's interesting. We entered the year with about, what, with an average backlog gross margin of 8%. Our expectations this year, by the time we get to the end of it, we'll be right at that number, slightly better. So we'll be entering in if status quo remains. We have 8.5% in our total backlog right now. You would expect close to that average number, everything else being equal for the full year. Obviously, we'll continue to have seasonality, and we don't expect interesting -- what I'll tell you about 2018 is we don't expect the seasonality to change significantly as it relates to which quarters are the best or the slowest.

We continue to expect the busiest quarter to be the third quarter, followed by the second, followed by the fourth, followed by the first being the slowest, and I think, we have -- now have a mix of business and backlog. But hopefully, when we roll up our numbers, we'll be able to make some money in each of the quarters as opposed to starting out in a hole which you tend to do if you don't have alternatives to some of the snowbound states in slow months.

Yes. The other piece I would add, Sean, is we still believe we've got $1 million to $2 million of incremental leverage in cost we can get into Texas market as we continue to refine the cost structure in some of the asset base there. So we still have some room to go as well.

Our next question is a follow up from Brent Thielman from D.A. Davidson.

Maybe one more on the -- the gross margin and backlog, obviously, it continues to get better. I know this has been, kind of, an ongoing self-improvement process. But as you look at work you're winning today, any way you could talk about how much of that Sterling emphasis on the right jobs versus industry capacity absorption and, kind of, better market conditions?

Yes, it's a -- I'd like to tell you is, one, it's a combination of all of the above and each market's a little different. The Texas market is still a little tougher than some of the other markets, has not moved as quickly on the pricing. So I would tell you, in the Texas market, it's more around discipline and picking the right jobs.

As we go to some of the other markets, we are seeing the -- I'll call the baseline price, go up for those. And as we've talked many times in the past, every quarter we measure what we leave on the table when we're winning bids, and if we lose, how much we're losing by. And we continue to refine that every quarter point we can get out of that's free -- a free quarter point of money for us. So we'll continue to drive that. We're waiting patiently for the Texas market to respond like some of the other markets. We believe it will. Just seems to be lagging a little bit but we've seen some nice movements, well, I'll call it, West of Texas.

We have reached end of our question-and-answer session. I'd like to turn the floor back over to Joe for any further or closing comments.

Great. Thanks again, everyone, for joining our call today. If you wish to schedule a call, please feel free to contact our Director of Investor Relations, Jennifer Maxwell, or our partners at The Equity Group. Their contact information can be found at the bottom of the press release. Again, thanks, everyone, and have a great day.

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.