Sterling Infrastructure, Inc. (STRL) Q1 2012 Earnings Report, Transcript and Summary

Greetings, and welcome to the Sterling Construction Company First Quarter 2012 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Elizabeth Brumley, Chief Financial Officer for Sterling Construction Company. Thank you. Ms. Brumley, you may begin.

Thank you. Good morning, ladies and gentlemen. I want to welcome you to the first quarter conference call. I'm joined here with Pat Manning, our Chairman and CEO; Brian Manning, Executive VP of Business Development; and Maarten Hemsley, our Lead Director. I would like to 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; the 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. 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 beliefs, and we do not undertake to publicly update them. And now going to the heart of the call. The results for the 2012 first quarter were impacted by 2 significant items: our projects continue to be impacted by a number of the issues identified in the fourth quarter of 2011, and changes in estimated revenues and gross margins on certain construction projects resulted in a net charge of $3.9 million included in operating results; and a $2.4 million after-tax charge or $0.15 per share attributable to Sterling common stockholders. Results for the first quarter of 2012 were also impacted by an increase in net income attributable to noncontrolling interest owners, which I will be discussing further. Revenues for the first quarter declined slightly from the 2011 first quarter. As discussed further in our press release, revenues declined for construction projects in Texas and, to a lesser extent, in Utah and Arizona. This decline was partially offset by $11.9 million in revenues, which are attributable to our newly acquired Arizona and California operations. As you may recall, those were acquired -- those 2 acquisitions were made August 1 of last year, so the comparable results do not include any revenues for our results from those operations and won't for the second quarter either. Gross profit and gross margins for the first quarter of 2012 declined substantially from the first quarter of 2011 levels and were under gross profit and gross margins for the fourth quarter of 2011 as well. As was the case in the 2011 fourth quarter, revisions to construction projects in Texas was the primary driver. Over 75% of the change is attributable to large revisions on 4 projects in Texas. With respect to the increase in income attributable to noncontrolling interest owners, subsequent to the issuance of the financial statements for 2011, the members of 80%-owned Ralph L. Wadsworth Construction Company agreed to amend the operating agreement effective January 1, 2012, and this agreement was to provide that goodwill impairments are not to be allocated to RLW for the purpose of calculating distributable net income. This included the 2011 fourth quarter goodwill impairment. We made this agreement because the write-down of goodwill attributable to RLW was not on the basis of RLW's relative financial performance to the company as a whole, but because the write-down -- and because the write-down did not have an impact on cash provided from operations. As a result, the amendment increased net income attributable to RLW's noncontrolling interest holders by $6.7 million for the 3 months ended March 31, 2012. Debt of the related tax impact, the $6.7 million increase, reduced net income to Sterling's common shareholders by $4.4 million or $0.27 per share. Without this item, we would have had a loss of $0.17 per share. Turning to our outlook for 2012. As was the case when we had our fourth quarter 2011 earnings call, we continue to expect that 2012 earnings will be more than 25% higher -- revenues will be more than 25% higher than in 2011. Backlog at March 31, 2012 remained strong at $868 million. It includes $194 million in new contract awards since year end. We currently estimate that $565 million of the March 31 backlog will be constructed during the remaining 9 months of 2012. However, based on estimated gross margins at our backlog, we expect our gross margins for 2012 to be lower than the 8% reported for 2011. We also anticipate that net income and diluted earnings per share for the remaining 9 months of 2012 will be comparable to the $5.9 million or $0.31 per share recorded for the last 9 months of 2011, after excluding the 2011 fourth quarter goodwill impairment. Although we've implemented changes to our internal controls to improve the processes for estimating revenues and gross margins on our construction projects, there hasn't been adequate time to evaluate the effectiveness of these changes, and we're continuing to evaluate what, if any, additional changes should be made to address the material weakness. With respect to general and administrative expenses, the first quarter increased as a result, in part, because of the acquisition of Banicki and Myers. In addition, the professional fees were slightly higher as well. Our overall effective tax rate was impacted by the $2.7 million of earnings allocable to noncontrolling interest holders. That's the tax impact. Excluding that tax impact, the overall effective rate would have been 34%. Despite these challenges, Sterling is in sound financial condition. Working capital at year end at March 31 totaled $92 million and includes $60 million of cash and short-term investments. We had no outstanding borrowings under our credit facility at March 31, and our bonding facility is based principally on the balance sheet strength and is available to support continued revenue growth. I will now turn it over to our CEO, Pat Manning.

Thanks, Liz. As Liz mentioned, revenues were down in Texas, and there were additional write-downs mainly restricted to 4 projects, which have continued to present challenges to our estimated productivity. We have channeled additional resources, especially with regards to management oversight to these areas. Oftentimes, those problem jobs, it's difficult to turn them around, but we are focusing our full attention to these issues. Revenues and productivity were both affected by adverse weather conditions throughout Texas in the first quarter, as well as the stage of work we were performing, and therefore, the revenue recognition on various projects was delayed. We believe the changes in both management and systems that we have made will return us to profitability, but the results will not be achieved overnight. I hope to be able to report on our next quarterly call significant improvement in our operational efficiency. Now in regards to our operations for the second quarter and the balance of 2012. We have begun work on our $78 million project in Turlock, just south of Sacramento, with Myers & Sons, which is scheduled to be completed this year. And our $44 million project in Northern California with RHBCa, which has a 2-year completion time. We will start the $2 million JV with Shimmick in Los Angeles later this quarter and are working through other backlog with Myers & Sons. We have just begun work on our $72 million JV between RLW and Banicki Construction in Phoenix on SR 24, and we continue to pick up CMAR work, airport work in Arizona through our subsidiary, RLW -- through our subsidiary, Banicki. RLW is 73% done with the I-15 CORE project in Utah and still anticipating finishing on schedule, with the substantial completion late this year. We are scheduled to work -- start work next quarter with RHB in California around Lake Tahoe and are working on a number of smaller projects in [Audio Gap] Hawaii. Now that the weather permits, we are beginning work in Nevada on several asphalt-paving projects. Here in Texas, we are ramping up construction on a $92 million road project in Dallas, for the North Texas Toll Authority, while just beginning work on our other toll road projects -- value [ph] projects valued at $65 million. Our joint venture project with CTRMA is moving ahead with bridge and dirt work and will begin concrete-paving work this summer. This should all have a positive impact on the balance of the year and 2013. We are seeing some improvement in our market conditions as this downturn takes it toll on less well-capitalized businesses, and we are seeing opportunities for margin increases as our backlog continues to grow. As reported, backlog is up 17.1% to a record $868 million. And while margins remain compressed from our historical norms, the resources are in place to capitalize on our future markets. For the 2 acquisitions that we made in August of last year, we now have operations in 7 states, with individual projects in 2 additional states, spread all across the southwest and western United States, with anticipated revenues being up some 25% year-over-year. As we work through backlog this year, running in from last year, we are replacing it with higher-margin work. The opportunities for joint ventures and larger projects for the remainder of the year and 2013, especially here in Texas, are substantial and will be -- priced based on their size and difficulty. We have positioned ourselves over the last several years to take advantage of the opportunities that these large project joint ventures will present. So let me have Brian tell you about his efforts on business development.

Thank you, Pat. In Washington, the first meeting of the Surface Transportation Conference Committee was held on Tuesday. Senate and House conferees gave opening remarks on what is anticipated to be one of the final hurdles in passing a transportation bill. The Senate will go to conference with MAP-21, a 2-year, $109 billion bill, which includes a significant number of policy improvements and reforms. The House will go to the conference with a 90-day extension. The Senate is likely to have the upper hand in negotiations because it is entering the conference with a more substantive bill. As Pat mentioned, the current joint venture design-build projects are progressing well. The I-15 CORE project in Utah is approximately 75% complete and our 290 Manor Expressway project in Austin is approximately 25% complete. We have growth opportunity in California as it is a new market for Sterling. We see opportunity in Northern California to the magnitude of $2.6 billion through our partnership in Myers & Sons. Some of this increased activity in Texas is fueled by the Texas Transportation Commission recently allocating an additional $2 billion to communities across Texas. Approximately $500 million of this allocation will be let in 2012, bringing Texas budget for 2012 to approximately $5 billion. There are numerous opportunities, especially in design-build, on large transportation projects with joint venture partners. On the 6- to 9-month horizon, we should see details on large-scale projects in Houston, such as 290, 288, 249 and 2100. These are all major freeway reconstruction and expansion projects. Texas Sterling is currently on shortlisted teams for the Grand Parkway in Houston, I-35E in Dallas, and we are pursuing the MoPac project in Austin for the same client we are building the 290 design-build project for the Central Texas Regional Mobility Authority. These projects are design-build. The Grand Parkway and I-35E are each in excess of $1 billion, and the MoPac project is close to $200 million. These design-build projects typically demand higher-margin than traditional design-bid-build projects. In total, we are currently tracking over $5 billion in alternative delivery bid opportunities. Now, I will turn it over to Maarten Hemsley, our Lead Director.

Good morning, ladies and gentlemen. As Lead Director and Chairman of the company's CEO search committee, I thought I would say a few words about the search in response to questions that we've had from some investors. The qualities that we're seeking in our new CEO candidate includes solid construction experience, either in our historical, heavy civil sector, although we are considering other construction sectors, and we're also looking for a strategic thinker with the leadership skills to integrate all our businesses, in view of the very strong growth that Pat and Joe have achieved over recent years. I'm pleased to say that we've interviewed a number of very suitable, qualified candidates, and we're now in the process of making the final decision. So we hope to be in the position to make the announcement before the end of the second quarter about a new CEO who will continue to develop the company and its culture of superior performance. I'll now turn this over to the operator for any questions.

[Operator Instructions] Our first question is from Tahira Afzal with KeyBanc Capital Markets.

This is Saagar on for Tahira. Quick questions. Looking first at this being a presidential year, typically, historically, what we've seen in the past is as we get closer to November, sometimes our municipalities and state governments cut down spending a little bit as people get distract. Have you guys seen that, or are you expecting anything, building anything in for that going forward?

On the election, I think our biggest anticipation is the transportation bill and how politics will play into the passage of the bill. We are seeing more momentum nationally. Locally, I think it would have less of an effect as the local municipalities already have their budgets set. So I don't see much effect locally.

Okay. We've just seen and heard that people do get distracted by the back-and-forth that goes on. But -- and then second question related to cost estimation. What -- you guys have some additional estimation write-downs in the first quarter. What makes you confident that you won't get that going forward, and what risk is there really in the future?

There's always risk in the construction projects. I think we have done everything we can to make sure that these problems are solved. We're sending additional management to the areas in question. As I mentioned in my script, it's sometimes difficult to turn around bad projects, so we've got to get through them and make sure that they don't turn any worse. But we've got a 30-year history behind us of doing better than we expect. I think we'll return to that.

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

Couple of things. First of all, the ramp in revenue that you're talking about this year to get to that 25% growth, is it going to be, I mean, every quarter substantial increases? I mean, can you give us a little help there in terms of the -- how seasonality is going to play in that, and what you're thinking about?

Yes, it'll increase over the next 9 months and the next 3 quarters, and those are our best 3 quarters in a lot of areas. I mean, in Nevada, because of the weather, we're starting additional work in Utah. We've obviously brought on, and as I mentioned in my script, the California -- 2 operations in California, which are cranking up large projects, and the projects that we're beginning for the toll road here in Texas. So I think you'll see a significant ramp-up, and I think Liz mentioned in her release that we anticipate doing $565 million of the backlog through the next 9 months.

Yes. And most of that is going to be, because of seasonality, second and third quarter. So you'll see your typical drop off in the fourth quarter barring any revisions, estimates or things of that nature.

Okay. So we will see it, I mean, including the second quarter. I mean, I would think...

Yes. The second quarter should be pretty strong, given the -- where we are on some of these projects.

Okay. And then in terms of the 4 problem projects that you noted in Texas. Is there any commonality that you can point to between these projects? Or I mean, sort of what went wrong, and what would be different about -- in the future?

There are different issues, John. There's -- and it's always the case. It's based mostly around productivity. In one of the jobs, there's a lot of additional rock that we didn't anticipate that we're responsible for. So I mean, it's the typical production issues that we have that weren't handled really very well, so we're -- that's why we're sending more management there.

Okay. And then, Pat, I don't know -- were these projects outside of your -- what I think of as your core Houston, I guess, market?

Not really. I mean, that is stuff we do all the time, I mean, except for -- we're a little, I would say, unfamiliar with the rock excavations that we have in San Antonio. It's not our general line of work.

Okay. And then in terms of the big projects, Brian, that you referred to, the I35 and the Grand Parkway. Who are you partnering with on those, and what's your share of -- in those partnerships?

John, for competitive reasons right now, I probably won't reveal that. But just to say that they're significant partners, and we share 20% in -- approximately 20% in each of the JVs.

Okay. That's helpful. I just wanted to understand sort of the opportunity there. And given these projects, and I guess there's another big one in Houston as well, is that a lot of -- is that going to distort the market, especially in Texas, I mean, in terms of tightening it up this year over the next couple of years? Or is it going to bring in more capacity into the market, too? Just how do you think about that.

We're viewing it as a positive, because we're well positioned here and have great capability. So we are sought after as a partner. So for Sterling, we view it as a good thing. There are -- the projects are very large, so it does tend to draw large players in. But having that local advantage and being able to pick our teams is certainly a nice position to be in.

Okay. And lastly, in terms of the backlog ramp that you're already seeing. Can you give us any comment or confidence that the margins on that work -- what they look like relative to what we've seen recently? Obviously, you don't have the project revisions, but still, margins are below where they've been historically.

I do think taking out those revisions helps you get a better idea as to what the margins would have been if we hadn't had the write-downs, and I think that can be helpful, John.

Yes. We have write-downs which hurt us very badly, and I don't -- and hopefully, we won't see those going forward.

But is there -- I mean, given the mix of business that you have now, is there any possibility in the near term, or well, even in long term that we can get back up over the 10% margin -- project margin levels?

I would certainly hope so, especially on these large joint venture projects. The market is still compressed. You won't see 10% tomorrow morning, but obviously, we want to get back there.

John, following up on your question, and I'm looking at something that is published. On I-35, I can tell you that our partners are Ferrovial, Webber and Texas Sterling rounds out that team.

Our next question is from line of Avi Fisher with BMO Capital Markets.

Liz, on the minority interest with RLW, I guess I've been curious to what changed from the end of the year to now. Is this a function of fairness or trying to be fair with the subsidiary not charging them the sins of the parents, or what's going on there?

Yes. I think that's a pretty fair assessment, that it's looking at -- I mean, as you may recall, we got in -- we talked about how the goodwill impairment was driven based on an evaluation that's done on the company as a whole because we have one reporting unit. But for accounting purposes, you've got to allocate that write-down to your subsidiaries, and it was then simply pro rata. It was not a reflection of the performance of those subsidiaries at all. And so when we looked at how distributions of net income were going to be made, it just didn't seem appropriate to tag RLW with the $6.7 million of write-downs for purposes of making those distributions.

And is it cash distribution? I mean, does the balance sheet reflect that distribution already?

Actually, because we were talking about it subsequent to filing the 10-K, the distributions for the first quarter that normally would hit didn't hit until April. So you'll see those coming through in the second quarter Q. But yes, it's -- to the noncontrolling interest holders, it's a cash distribution.

It's reflected in our shared gross numbers.

The obligation is, yes.

The obligation is, but the cash out hasn't been.

The cash will go out the door in April. Normally, it would go out right after the filing of the 10-K.

Right. So you had this change?

We had this change, and it was something that we thought about long and hard.

Kind of what pushed you over the edge?

The fact is this -- the allocation was just simply because -- RLW's performance has been very good. I mean, we've been very pleased with the results from those operations. And they got tagged with some of the goodwill write-down, and it just didn't seem appropriate.

It's basically a fairness issue.

Okay. Regarding the CEO search, and, Maarten, I appreciate the update, I don't know if you would be able to say this, but have you put out offers that have been rejected?

I wouldn't normally comment on that, but no, we're still in the process of coming up with a short list. So we haven't made offers at this stage.

Okay. I appreciate the color there. On the backlog number, this may be a small thing, but if you just go and add in the -- I think the $194 million you disclosed in the press release, whatever the number you disclosed in the press release, take out the revenues, it doesn't fit.

The piece that you're missing is the backlog we picked up in connection with the Aggregate Industries transaction. So there's a subsequent footnote, an event footnote in the 10-Q that talks about that. It's on Page 18 of the 10-Q. And in January, we assume $25 million of revenues related to 7 contracts.

Got you. So it's acquired backlog?

It's acquired backlog as opposed to awarded backlog, which we -- I think the awarded is more of an indicator as to what is truly happening in the market. So that's why we focused on that number as opposed to the acquired backlog.

I appreciate that. Just need to make a calculation for -- to get the awards. A few other very quick questions, and -- John kind of touch on these. On the projects, the 4 projects, when do they complete? When are they expected to complete?

Those projects as well as the other projects that we had challenges on in the fourth quarter, most of that is going to roll off in the second and the third quarter of this year. There'll be some impact later on, but substantially all of it, I mean, as you would expect, because you've got such a large piece of our backlog rolling off this year.

Okay, that's great. When we back out the gross -- the charges, we end up with a gross margin about 6%. That's kind of -- obviously, below the 8%. Is some of that due to weather? Because you did call out bad weather in the quarter.

Yes. Certainly, due to weather. I don't know that -- Liz cautions me that it might not be worse weather than it was year-over-year, but we still have some significant rain. I was talking to our Vice President this morning in Dallas, and he said all of the lake levels in Dallas are back up to normal after being significantly low over the course of last year, so.

I mean, January was an extremely wet month. As you may recall, last year, with the Super Bowl, we had horrible freezes and snow in Dallas, and so first quarter last year was a challenge with weather.

Okay. Is the 6% margin outside of these -- excluding these projects. Is that, at the very least, in the normal rate of 8% at the bottom? I mean, would you be bidding below that?

No. We are -- I would rather, I guess, not go into exactly what we're bidding at, but we are trying to raise margins. And certainly, we're trying to get them back up into the 10% range. I mean, there could be a project that we might bid below 6%, depending on where it was and what the timing was and what the -- there's a lot of factors that go into it.

Potential upside.

Potential upside for change orders and things like that.

And speaking of upside, is there an award when the Utah project completes, with Fluor?

Is there what?

Are there any sort of contingency harvesting when the project completes?

There's is the potential for completing it ahead of the schedule that we gave them. There are certainly contingencies built into that work that we don't know if we have to use yet. So there may be a plus.

Just 2 other quick questions. The tax rate, you said it was 34% in the quarter. Is that what we should model in for the year?

I would model somewhere between 30% and 34%. The kind of the red herring is the relative amount of nontaxable interest income versus the rest of the earnings. And I think we break the nontaxable interest income out separately in the footnote, in the right -- in the rate reconciliation in the footnote. So just caution on that.

Okay. I will flip through that. And finally, I'm curious about what you're seeing with material costs. You mentioned an asphalt project. It seems like asphalt prices are growing fairly rapidly. Curious across-the-board asphalt, labor, concrete, diesel.

Obviously, the diesel and the gasoline prices have been up in the short run, but they're trending down right now. And what we're seeing for the futures market is they will continue to trend that way. Obviously, that's very volatile with what we have going on in the Mid East. Other products are becoming a little short supply in Texas, due to all the Eagle Ford Shale and the work we have on the -- in the oil patches in the different parts of the state. So aggregates are becoming a little bit short, not so much because of the price of the aggregates but because of the price of the trucking. Labor, so far has stayed relatively steady.

Our next question is from line of Nick Coppola with Thompson Research.

So I'll ask a little bit more about the competitive environment. Are there any signals you could talk to us about, in terms of any -- are bid lists getting any shorter? Are you seeing any less irrational bidders out there?

Yes, I would say bid lists are getting some shorter. So on any given project, you could still see the 10 to 12 bidders, but a lot of the projects are getting less bidders. The volume of work coming out of different spots seems to be a little bigger. We're spread across the country, so it's different for different markets. I'm most familiar with here in Houston because I live here. And for the first time in 3 years, I'm starting to see various building projects going on, strip centers, a couple of office buildings, FedEx building, things like that. So it seems to me the economy is picking up.

We are seeing pick up on the private side, which is relieving some of the pressure on the public projects that we did.

Okay. And for PPP in Texas, what kind of opportunities are you tracking? Is there an ability to move the needle with alternative funding mechanisms in lieu of, I guess, a long-term highway bill?

The way PPP has gone so far in Texas is they've run them as dual procurement. So they've had a public/private partnership option and a design-build option. And on recent short lists, they've been going design-build. So Texas has been able to find the funds to build the projects or enter into a cooperative agreement with counties in order to build projects. On a go forward basis for some of these projects, and we're talking about projects in excess of $1 billion, there will certainly be some more activity on PPP.

[Operator Instructions] We have no further questions in queue at this time.

Thank you, everybody. We all look forward to speaking to you in the next quarter call.

Ladies and gentlemen, this does concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.