Sterling Infrastructure, Inc. (STRL) Q4 2012 Earnings Report, Transcript and Summary

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

Thank you, Rob. Good morning, ladies and gentlemen, and welcome to Sterling Construction Company's Fourth Quarter 2012 Conference Call. I'm joined by Peter MacKenna, our Chief Executive Officer. 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; 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 make at any time may not continue to reflect management's beliefs, and we do not undertake to publicly update them. We are pleased with the results for the fourth quarter, which showed improvements in gross margins, revenues and operating income over the 2011 fourth quarter. The $44 million increase in revenues for the December 2012 quarter was inline with our expectations of an overall 25% increase for the full year of 2012 over 2011. Most of the increase was attributable to our new California and Arizona operations, which contributed $48.4 million in revenues in the quarter as compared to $11.6 million in the 2011 fourth quarter. In addition, projects in Texas were another major contributor to the increase in revenues. We also saw higher revenues in Utah and Nevada. The gross margin of 10.3% in the fourth quarter of 2012 was an improvement over the 3.4% for the 2011 fourth quarter, as well as the 6.9% for the third quarter 2012. As you will recall, the 2011 fourth quarter was impacted by downward revisions in profitability on projects in Texas. Margins for the 2012 fourth quarter were favorably impacted by upward revisions on certain projects in Utah, including a project that is substantially complete. Diluted earnings per share was $0.01 for the quarter as compared to a loss of $2.72 for the 2011 fourth quarter. Basic and diluted EPS for the 2012 fourth quarter includes a $0.17 charge related to the increase in certain noncontrolling interest liabilities. In accordance with GAAP, revisions to the estimated liability are recorded directly to retained earnings and do not impact net income, but these are taken into consideration in computing EPS. You will have seen similar charges in previous quarters, so this is not a new item that I wanted to highlight it. You will recall that earnings for the 2011 fourth quarter included a goodwill impairment of $67 million pretax or $2.55 per share after tax. General and administrative expenses for the 2012 fourth quarter increased $3.3 million as compared to the 2011 fourth quarter. As a percent of revenues, G&A was 5.9% versus 5.3% in the prior year quarter. The increase as a percent of revenues reflects higher professional fees as well as increased salaries. Earnings attributable to noncontrolling interest were $2.9 million for the 2012 fourth quarter and were impacted by the higher results from projects in Utah. As a result of the acquisition of the noncontrolling interest in Ralph L. Wadsworth in December 2012, you will recall this is a 20% interest. Earnings of noncontrolling interest owners in future periods, so beginning with the 2013 first quarter, will be entirely attributable to the 50% interest held by Myers, which has operations in California; and RHB, which has our operations in Nevada and Hawaii. Capital expenditures were $37.4 million for the 2012 year. For 2013, we expect capital expenditures will be lower as certain expenditures for buildings as well as piling and shoring equipment should be less significant. Proceeds from disposals of property and equipment were $12.5 million for 2012 versus $1.3 million for 2011. As mentioned previously, increased sales in purchases of equipment in 2013 are results of the efforts and Texas and other markets to ensure that we have a right-sized and efficient fleet. Our overall effective tax rate for the quarter is impacted by the $2.9 million of earnings attributable to noncontrolling interest owners. After adjusting for this impact, the overall effective rate was 34.9% for the fourth quarter, which is very close to the statutory rate. Backlog at December 31, 2013, was $656 million and compares to $660 million at December 31, 2011. Both of these numbers exclude any awards that where we're the apparent low bidder but for which we don't have a signed contract. Estimated gross margins in our backlog are lower than the margins reported for our 2012 results of 7.5%. This reflects the impact of jobs bid prior to 2012 and on which we have made downward revisions either late in 2011 or during 2012. Sterling continues to be in very sound financial condition. Net working capital at quarter end totaled $87.5 million. As previously announced, we purchased the remaining 20% interest in RLW on December 31, 2012. A payment of $23.1 million was made using funds from our $50 million credit facility, so you see the $24 million outstanding on that credit facility in our year end financials. But since year end, we sold short-term investments to repay the borrowings under the credit facility. Subject to certain conditions, we have the ability to increase the facility by an additional $50 million. I'll now turn the call over to our CEO, Peter MacKenna.

Thanks, Liz. This is my second quarterly call as President and CEO of Sterling. On my first call, I had to tell you that Pat Manning, our Chairman and recently retired CEO is in the hospital. I'm happy to tell you that he's fully recovered. And in fact, I spent the last few days with Pat and he's doing just fine. In these, my prepared remarks, I hope to be able to add a little color to the numbers that Liz just reported. Further, I hope to be able to address any unanswered questions you may have during the Q&A session. It's been 6 months now since I joined the company and I can say that I continue to be impressed with what I see. In the fourth quarter, the 1,700 men and women of Sterling put in place more than $158 million dollars worth of construction in 10 states. Most impressively, they performed that work safely and profitably. We worked more than 3 million man hours in 2012. And I'm pleased to say that our loss time incident rate, which is a measure of serious accidents, was less than 0.21 accidents per 200,000 man hours worked, and that's a best-in-class statistic. In fact, Ralph L. Wadsworth, our Utah subsidiary, worked more than 1.2 million man hours without a single loss time accident. That's something we're very proud. Our fourth quarter also saw greatly improved gross margins, especially when compared year-on-year. We've made many changes in the Texas Sterling subsidiary, specifically in policy, process, procedures and personnel. The rigorous review of ongoing projects is having its desired effect. We believe that the surprise of losing projects are a thing of the past, and we further believe we're entering a period of more normal project reassessments. While in the fourth quarter, we had some downward project adjustments, we also had a significant number of upward adjustments. We're a single large design-build joint venture project where we are the minority partner. We're currently taking measure to bring the project back on track. The results of these efforts should be completed in the early part of the second quarter of 2013. Another thing that has impressed me is the breadth of construction accomplishments within the Sterling portfolio. This past year, we've constructed a post-tensioned segmental bridge in Montana; major new highway and interchange work in Dallas, Austin, San Antonio, Houston, Phoenix, Salt Lake City, Los Angeles, Sacramento and numerous rural areas throughout the West. We've established our place in the alternative delivery marketplace and entered the private sector building parking structures in Utah and Colorado. We regularly perform foundation construction in several states and are a significant constructor of water distribution systems, specifically here in Texas. We also now had 8 active projects in Hawaii with a healthy backlog. Lastly, we've been chosen to complete several projects in Texas for a failed construction company by the surety. Functionally, Sterling is evolving from a constellation of operating units into a more integrated group. Deployment of IT shared services will provide the underpinnings for many of the integration projects we have before us. HR shared services and the alignment of benefit programs are already having a positive effect. Further, in 2 weeks we'll be launching a major project to investigate the feasibility of deploying a financial shared service across the entire enterprise. All of our integration initiatives are driven by our desire to have the most efficient, effective and scalable functions in support of our construction operations. Naturally, the pursuit of new work continues to be a major focus of the company. We secured more than 100 new projects in 2012, not including the projects where we were the apparent low bidder but had not yet secured the contract at year end. The amount of new work secured during the fourth quarter was somewhat below expectations, but the anticipated gross margin in the new work continues to compare favorably to what is currently in the backlog. At year end, we were pleased to see that all of our operating units had very strong pipelines of new opportunities in 2013. Normally at this point in the call, I'd ask Brian Manning, our Exec VP and Chief Development Officer, to speak to the opportunities in the marketplace, but Brian is on a well-deserved vacation with his family. So I'll take a few moments to share what we see in the construction space. Fortunately, the recent political theater in Washington has not yet had a direct impact on heavy highway construction. The Highway Trust Fund is exempt from the sequester; and the MAP-21 legislation, which is the extension of the transportation bill, is expected to remain in full effect through 2014. With that said, structural funding problems continue to play at the trust fund. A recent testimony before Congress, the U.S. Department of Transportation Undersecretary for Policy stated that the -- at the conclusion of MAP-21, Congress will have transferred $54 billion from the general fund into the trust fund just to live up to the commitments to keep surface transportation afloat. This crisis of funding must be addressed. Some good new term news is right here in Texas. The state legislature is currently in session and is struggling on how to spend nearly an $8 billion surplus. Several proposed pieces of legislation call for significant increases in the TXDOT budget. Some even call for tapping into the state's significant rainy day fund to add to the TXDOT kitty. I guess we'll see how that turns out in the near future. The other states in which we operate do not have the surplus problem that Texas does and have reduced or static transportation programs. Overall, state departments of transportation lettings in the past 3 months are down about 10% year-on-year. With all that said, Sterling is tracking more than 25% more opportunities than at this time last year, not to mention more than $4 billion in alternative delivery pursuits. In the first few weeks of this year, Sterling has been successful on more than a dozen exciting new projects, including a short duration $22 million design-build project in Utah, a $19 million project for the Port of Houston and several projects with for the San Jacinto River Authority, where we are still waiting award. In spite of all the financial turmoil and political noise, I'm confident that Sterling will get its share of the pie. With the new control we've put in place, projects should come with sustainable margins and improve upon our backlog. As a final comment, we'll continue to look at the heavy highway space and those spaces adjacent to seek out accretive acquisition opportunities where we can diversify our portfolio. And now we'd be happy to entertain any questions you may have.

[Operator Instructions] Our first question is from the line of Nick Coppola of Thompson Research.

I wanted to kind of talk a little bit about -- more about your perception of end-market growth. And I saw the comment about limited organic growth as kind of your outlook for '13. But reconciling that with kind of the comments you're making about the requested Texas budget being up significantly year-over-year and the idea that PPPs and TIFIA funding are positives for heavy civil construction, kind of why not a little more bullish on your expectations for revenue growth?

I think the issue is more in 2013. The alternative delivery projects, the PPPs and the work the legislature is looking at now probably won't -- they will come to market this year but we probably won't be putting shovels in the ground this year, especially on design-build projects where there's a significant amount of design work that goes prior to putting shovels in the ground. We don't really get a lot of revenue recognition from design work. So I think this is going to be a year of adding to the backlog, but I'm not sure about the revenue, which is why we kind of couched our comment.

Okay. That certainly makes sense in terms of the lag. And then, I guess, also talking about the margin outlook, and I can appreciate that you've got some projects that are still earning no margin. But how should we think about those projects burning off throughout the year? Should we kind of think about it -- is it kind of an even clip? Or do you think about second half '13 being better than first half '13 as the projects burn off?

I would say probably the second half of '13 is going to be better. I mean, we're going to continue to have a little choppiness in our margins just because we've got some larger projects. And if there is a big enough change, that ends up impacting us. I mean, you saw that with our Utah project this quarter. So it can go up and down. And it's hard -- I mean, it's just going to be hard to predict.

And Nick, I'd add to that. Most of our work is 2-year duration, some of the larger projects go 3 years. But I would say most of them are in the 2-year range. So you can kind of extrapolate from that where we should stop burning off this sort of 0 margin work or substandard margin work.

That makes sense. And then I guess, just last question if you can provide any comments on what the competitive environment is looking like to date, if you're kind of seeing better implied margins and newly-won work and if you're seeing bid lists get shorter, anything kind of by that nature.

I think it depends on the segment we're looking at. I think in general, the bid gross margins I'm fairly satisfied with. But the commodity work, the repaving, resurfacing work, we're still seeing a lot of competitors showing up. The numbers still seem rather depressed. With that said, I saw some statistic recently that said that these last 3 months at Texas, the low bids were about 6% under the engineer's estimate. I think what might be a more telling number is to look at the average or the median bids from all the competitors on a particular project, and then you start to see that there is some upward pressure. As we get away from that commodity work, which is really -- it's just not something that really floats my boat and look at some of the water work, look at some of the alternative delivery work that we're doing in Utah and in California, the margins are much healthier. And I think as we start to sort of migrate to more of that and try to exploit that market as best we can, we should see some recovery.

Our next question comes from the line of Saagar Parikh of Keybanc Capital Markets.

First question on your Texas market and just general conditions that you guys are seeing in terms of labor. Some larger E&C companies, not technically in the transportation field but really based in the Texas market have been talking a lot about how labor is tightening and how they're starting to face issues on their fixed price projects. What are you guys seeing in terms of labor for your market? Any concerns there going forward?

Well, there's always a concern there. And if we look at craft labor, we're starting to track our turnover -- employee turnover much more carefully now that they charge shared services in place. And the more skilled craft labors, something we really worked very hard to keep our arms around and then keep them close to us. And in an open-shop environment, you don't have the sort of common playing field that everyone is paying the same amount and it's easy to lure someone away by offering them a couple of cents more an hour. It's something we're really focused on. I don't think it's impacted us negatively yet, but it is certainly something we're very cautious about. In terms of white collar turnover, I'm pretty comfortable with our voluntary turnover rates there. They're very good, and we work very hard to keep our arms around our folks. At the end of the day, all a company is, is money and people. And we've really got to focus on keeping our people close and happy and engaged.

Okay. And then in terms of what's in backlog right now, what percentage of your backlog was booked in 2010 and 2011? And if that market does end up tightening, could we see issues with further downward revisions? Or is that something that you guys have already kind of scrubbed through backlog?

At this point, I would say there's probably just a few significant jobs that could impact the 2013 results, and of course those are in Texas. So most of the -- I think most of it is going to burn off -- well, it should burn off by the end of 2013. But we had a significant burn in 2012. But there's still a handful of projects that are -- that we did not anticipate would have some challenges and started identifying some challenges, really, in the fourth quarter this year.

Yes. But Saagar, I think the important thing here is that the systems are in place now to identify these issues early and be able to redeploy assets and resources to try to mitigate these issues as soon as they pop up, not give you all a surprise in terms of our earnings but also don't give us a surprise that we can't move in quickly to try to fix these issues at least from an operational perspective.

Okay, great. And last question on my part. Peter, I know you went through the different end markets and where you see opportunities. But if I was to ask you maybe the top area for 2013 where you see -- where you -- where there's potential for an upside surprise to be in the middle of March, what would you say?

Well, that's a good question. I think we're going to see some great up opportunities in the water distribution area. We have some great opportunities there. We have some great opportunities in California, which really could deliver some interesting things, especially with some of the specialty work that we're doing where we're doing polyester overlays, which is something only a few companies in the country do. I think you're going to see some great things coming out of Hawaii, which is -- it's a tough market to break in to. And once you're in, you have some great opportunities before you. RHB has paid the tuition and gotten themselves in there, and there's some wonderful opportunities. I think the heavy highway sector, the commodity work, which is the overlaying work, is going to be sort of the dark cloud. It's relatively easy work. It's a relatively low barrier to entry. There's a lot of people that are still struggling in it. Hopefully, if Texas comes through with the increased budget and we start to use up capacity in the marketplace, we'll see some good recovery. I can tell you, I'm pretty optimistic about what's out there and coming to market and it's an exciting time to be here.

Our next question is from the line of Greg Cole of Sidoti & Company. Greg Cole - Sidoti & Company, LLC: A quick question on the project chart -- or the project charges in Utah. What was the net for this quarter?

We talked about -- I think we put $11.8 million for the 1 project that came. Again, that was the impact on the gross margin for the quarter. And then for the revisions overall, we were seeing for the quarter a net of $0.3 million. So very tiny. And then you had on an EPS basis, a negative $0.04 a share net. So you kind of got to take that $11.8 million and say, okay, that was the positive versus what the overall negatives were to get it -- to get at what's driving -- what is attributable primarily to Texas. Greg Cole - Sidoti & Company, LLC: Okay, all right. And so the 10.3% gross margin was mainly driven by projects ending and being able to book a lot of the profits?

Yes. I mean, so you had $11.8 million of the $16 million in gross margin was attributable to that 1 job. Greg Cole - Sidoti & Company, LLC: Okay. That was $11.8 million of the -- that was the total gross margin for that 1 project? Or was that the revision?

For the quarter. Yes, for the quarter. No, that's -- sorry, I think that's for the full year.

That's the full year.

Yes, that's the full year. Greg Cole - Sidoti & Company, LLC: Okay. And so there was only -- was that $0.3 million the net for the quarter or for the whole year?

$0.3 million is for the quarter. Greg Cole - Sidoti & Company, LLC: Okay, all right. And then can you talk a little bit -- Houston is having a lot of projects coming up to bid on the next month or so. Can you talk a little bit about, I guess, how confident you are with those?

How confident, we were recently selected for a project that we were the high bidder on. We were 6 out of 6 but we were still awarded the project because we offer, I think, some certainty to some of the clients that the job will get done and get done successfully. And I can tell you, the guys next door are bidding literally $100 million a week. And you're right, there's some great opportunities here. They're not just in the highway sector. They're in the highway sector, the water sector. It's interesting being a New Yorker coming down to Houston seeing the amount of work that's going on here. Houston is the strongest of our divisions in Texas, and they will more than get their share. There are great opportunities here. The biggest city in Texas, it's one of the biggest in the country. This is the place to be. I'm feeling pretty good about Houston. Greg Cole - Sidoti & Company, LLC: Okay. And when we see the results come out for these, you mentioned doing JVs in -- on these large highway projects. Is that what we should be expecting? Or should we be looking for you to be the low bidder if you're going to be winning these?

I think for the most part we're on our own. We joint venture when the projects are very large or very complex. And if you look at the TXDOT lettings, the very large complex jobs are not the lion's share of the projects being let. Most of the jobs are in the, gee, $8 million to $30 million range, where we're quite capable of standing on our own. Our reporting threshold is, I guess, $25 million and we don't report everything we get. So most of these jobs are less than that.

[Operator Instructions] Our next question is from the line of John Rogers of D.A. Davidson. John B. Rogers - D.A. Davidson & Co., Research Division: Just one point of clarification. In the press release, you talked about $98 million added to backlog in 2013. That's the net work out. That's not -- or is your backlog $98 million higher than it was at the end of...

No, that's the net added. So it doesn't -- I mean, obviously, you're going to have some burn. John B. Rogers - D.A. Davidson & Co., Research Division: Right. Okay, that's -- I just wanted to confirm. And then on the minority interest adjustments with the -- with your purchase of the remainder of Wadsworth, are there any more significant adjustment potential going over the next couple of years?

Yes. The -- for Road and Highway Builders in which we own a 50% interest, the accounting treatment requires us to mark that to kind of a fair value based on a formula that's in an agreement that we have with Mr. Buenting. I won't get -- I'm getting a little more detailed than I normally would. But the bottom line is that you will see quarter-to-quarter adjustments as a result of that, and they could be up or down. John B. Rogers - D.A. Davidson & Co., Research Division: Okay. And I mean, and I know you don't want give specifics, but I mean, same orders of magnitude that we've seen over the last couple of years, given it's a smaller business, I mean I think?

It's going to be hard to say. I mean, candidly, it's kind of a good news, bad news story. So part of the way it's calculated is based on a trailing 12-month EBITDA number. So when those operations perform really well, we're going to have a charge that goes directly through retained earnings because of that. But the good news is we'll be making more money. So there you have it. John B. Rogers - D.A. Davidson & Co., Research Division: Okay. And then lastly, just in terms of the water business, there's some very large projects being proposed in Texas. And I was just wondering, Peter, when do those come up for bid? And also, how much water work is in your backlog right now or pipeline work?

Yes. I'm going to punt to Liz. She knows that number. I'm not sure I know that number off the top of my head. But in terms of the projects, we're in the middle of one of these programs right now, the San Jacinto River Authority work, which is bringing water down from north of Houston in through the northern suburbs and then eventually down to the city. And that's a several hundred million dollar program, but let in $8 million, $10 million and $15 million blocks. And we've been successful on a couple of those. And that tends to be the way these things in Texas work. There are very few very large stand-alone water projects, most of them are broken into relatively digestible small pieces, which is something we prefer at this point.

Yes. We did have some disclosures in the 10-K on the portion of our revenues in '12 that were highway related. And I think -- if I'm recalling, I think it was about 61%. So the remainder is going to be other stuff and will include water, but it won't be exclusively water.

I should mention in general the margins, the gross margins on the water work are better than the ones in the highway work. John B. Rogers - D.A. Davidson & Co., Research Division: Yes, okay. And I guess just lastly, I mean, given where the business is now and the strength of your balance sheet, would you look at additional acquisitions at this point?

I would say yes. The thing here is diversity, and not the diversity you might think, but diversity in our portfolio. We need to diversify geography a little bit more. We need to diversify our platform to the point that we're looking at more adjacent spaces where the cyclicality of heavy highway work can be compensated a little bit. And lastly and perhaps more importantly, diversity of funding sources. We have a real problem in the transportation sector and I'm not sure that Washington is going to get their act together and fix this anytime soon and the states are going to struggle. So we need to be prepared to take advantage of what's out there, but in addition, look for other sources of revenue and other kinds of work. So we're looking for accretive acquisitions that help us diversify that platform. And I think the timing is right. As you know, as we start to integrate, what I'd call the constellation of businesses, it's the perfect time to make an acquisition and integrate it as we integrate the rest of the business. So our eyes are open. John B. Rogers - D.A. Davidson & Co., Research Division: So are you implying more private sector-type work or geographically broader?

No, not private so much. Geographically, a little bit broader. We've gotten most of the West covered. There are some holes in the footprint. But also in, what I'm calling, adjacent space, which could be water or wastewater, it could be underground work, it could be foundation work. My background is foundation work and almost everything you build has a foundation component to it. So if you want to talk about diversity, whatever gets built has a foundation. So that's the kind of thing, as an example, that I'm kicking around.

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

Well, it's been an exciting quarter for us. It's definitely been a quarter to turnaround. In spite of the adjustments for the noncontrolling interest, it was a profitable quarter. And it's much nicer to have a profitable quarter than what we had in the prior. So with that, we are very optimistic about moving forward with our business. We're excited. We're engaged. We've got a lot of great initiatives in front of us, and we're looking forward to telling you more about it in the months and quarters to come. So with that, we thank you for your time and look forward to the next call.

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