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Sterling Construction Company Inc. (NASDAQ:STRL)

Q4 2008 Earnings Call

March 16, 2009; 11:00 am ET

Executives

Patrick. Manning - Chairman, Chief Executive Officer

Joseph Harper Sr. - President, Chief Operating Officer

James Allen Jr. - Chief Financial Officer, Senior Vice President

Analysts

Rich Wesolowski - Sidoti & company

John Rogers - D.A. Davidson

Craig Bell - SMH Capital

Eric Glover - Canaccord Adams

Operator

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

Jim Allen

Thank you, Regina. I want to say good morning ladies and gentlemen, who are all on the conference call. I would like to welcome you to this conference call to discuss the results of the fourth quarter and the year ended December 31, 2008, which we released this morning. I’m joined today by Pat Manning, our Chairman and Chief Executive Officer and Joe Harper, our President and Chief Operating Officer.

First, I must remind you that this call may include certain statements that fall within the definition of forward-looking statements under the Private Securities Litigation Reform Act of 1995. Any such statements including our 2009 guidance are subject to risk and uncertainties, including overall economic and market conditions, competitors, customers and suppliers’ actions and weather conditions, as well as 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. Although we may give guidance about future results, this is only a statement of managements’ beliefs at the time the statement is made. Predictions that we may make may not continue to reflect management’s beliefs and we do not undertake to publicly update guidance. It is the company’s current policy to provide guidance only on our annual results, and we do not issue guidance about quarterly results.

Now, turning to the financial results, I am pleased to report that the company achieved another record year in 2008 in terms of revenues, profits, working capital and stockholder’s equity as follows. Revenues for the year of 2008 were up 36% to $415 million. A majority of the increase in revenues was due to the revenues earned by our Nevada operations, which we acquired on October 31, 2007 and included in the results of 2008 for a full year, but only two months in 2007. Year-over-year growth in revenues earned by our Texas operations also contribute to the increase in revenues, primarily because weather in Texas was good throughout 2008, whereas the first three quarters of 2007 suffered from some of the wettest weather we’ve seen in many years.

Gross profits were up $8 million or 25% to $42 million in 2008 due to gross profits earned by our Nevada operations and better weather conditions in Texas during most of 2008 than during 2007, which allowed our crews and equipment to be more productive.

Gross margins decreased to 10.1% for 2008 from 11% for 2007 because of operating inefficiencies on certain contracts in Texas, higher fuel costs and lower profit margins on certain contracts started in a nice pace for 2008. Operating income was up 34% in 2008 to $28 million. The percentage increase in operating profits was higher than the percentage increase in gross profit, in large part, because of our general and administrative expenses, which increased to $0.5 million in 2008, but were only 3.3% of our 2008 revenues versus 4.1% of our 2007 revenues.

The percentage of G&A to revenues decreased because our Nevada operations G&A is not as large a percent of revenues as the rest of Sterling’s G&A, which includes corporate overhead and expenses associated with being a public company and also because of lower stock compensation expense in 2008 as a result of lower stock options awarded in 2007 and 2008.

Net income was up 25% to $18 million for the reasons I have discussed. Net income per diluted share was up 8% to $1.32 per share on an increase and weighted average diluted shares outstanding of 16% to 13.7 million shares in 2008 from 11.8 million shares in 2007. These record results were achieved even though fourth quarter 2008 gross profit decreased $2.5 million or 21% from 2007.

Gross profit was 13.7% of revenues in 2007 versus 8.7% in the fourth quarter of 2008. As a result of some unusually profitable municipal projects being performed primarily in the fourth quarter of 2007, without those projects, the gross profit percentage for the fourth quarter 2007 would have been more in line with our normal profit margins, although still somewhat better than the fourth quarter of 2008.

We expect the trend of lower profit margins on contract awards to continue at least in the first half of 2009. With respect to other results for the fourth quarter of 2008 versus 2007, revenues in the fourth quarter of 2008 were a record $109 million up 24% over the fourth quarter of 2007 for the same reasons as previously discussed for the full year’s revenues.

Operating income of $6 million in the fourth quarter was down 19% versus 2007 for the same reasons as discussed for the decrease in the fourth quarter gross profit. Net income of $3.8 million in the fourth quarter of 2008 was down $900,000 or 19% from 2007. The percentage decrease of net income was less than the percentage decrease in operating income as a result of interest income on higher investable funds and a lower tax rate in the fourth quarter of 2008 versus 2007.

Diluted income per share was $0.28 or down 28% in the fourth quarter of 2008 versus $0.39 per share in 2007. In part, due to the decrease in gross profit previously discussed and in part, due to the increased number of shares outstanding as a result of the 1.8 million shares stock offering we closed on December 24, 2007.

Working capital was $95 million at December 31, 2008, which was up $13 million from the 2007 year-end. While stockholder’s equity was $159 million, which was up $21 million over 2007, both of these amounts are important quantitative measurements used by our surety in setting up bonding capacity.

Additional financial and business information may be found in our 2008 form 10-K, which we filed this morning with the SEC. I would now like to turn the call over to Joe Harper to talk about the operating results in more detail.

Joseph Harper

Thanks, Jim and good morning, everyone. 2008 was a record year for Sterling by every financial measure. We’re very proud to be part of the team responsible for our substantial increases in revenue, gross profit and EPS. It would have been much better were it not for the impact of Hurricane Ike, issues with a steel supplier in Houston and the sudden bankruptcy in Nevada.

In addition to excellent financial results, it was a good year when viewed from the perspective of operations and strategic positioning. We continue to make substantial investments in the resources, which allow us to produce these results, equipment and experienced leaders in the field. Across all operating divisions, our project managers and superintendents continued to perform at levels at or above our expectations. They are continuing execution on contracts, which allows us to produce results like those achieved this year.

While we had a few growing pains at our Dallas operation, the rapid growth deserves increased oversight. We’re all pleased with our current organization in all the markets. Looking at the last quarter and current operating results, Dallas is adding nicely to our gross profit line. Results in San Antonio and Houston exceeded our budget with lower costs and exceptional realization of incentive possibilities on contracts.

In Nevada, our management team expanded operations to include two substantial contracts in the southern region of the state and are continuing to exceed our expectations with excellent execution. With the first full year results in for road and highway builders, I can tell you our first acquisition of size has been a resounding success. We’re very pleased to have their organization as part of our team.

Looking ahead, our resources are fully deployed as we speak with some availability showing up in the 3rd quarter in virtually all of our markets. Pat will discuss the competitive landscape in a few minutes, but we’re hopeful that with the increase in the TXDOT budget plus the stimulus expenditures and projects expected in our municipal markets, we will keep most resources in full production.

We have no reason for concerns about margin and profitability for the first two quarters, and with the strong backlog in January, one plus the addition so far in 2009, we’re in pretty good shape currently given the difficulties in today’s economy. There’s more uncertainty at this time than we have experienced for many years, however, we are not changing guidance, because we believe there are some good opportunities coming this year, which would allow for achievement and then some.

Before I turn this over to Pat, I want everyone to understand that we feel we are extremely well positioned to take advantage of any and all opportunities, with our strong balance sheet, banking and bonding capabilities, bench strength in our management team; we are ready for continued organic growth, expansion of our geographic reach or the right acquisition. The uncertainties across the country are most likely going to provide some exceptional possibilities and we are ready to take advantage of them. Pat?

Patrick Manning

Thanks, Joe. We are pleased with last year’s financial results as well as the progress we made in finding new areas in which to compete. But as we move into 2009, we face new challenges with this economy. We’ve seen additional competition in the marketplace, not so much with new companies, but with more bidders on individual projects. This is especially true on the smaller jobs under $20 million, but to a lesser extent, even on the larger jobs. We were, though, able to pick up a number of smaller jobs this quarter, both here in Houston and in Nevada, which we typically do not announce.

With additional bidders, we have pressure on margins, and these economic conditions, that’s to be expected. On the other hand, as Joe mentioned, we have signed contracts which will be completed in 2009 of $380 million and backlog that extends into 2010. TXDOT spending is scheduled to be $2.9 billion this fiscal year up 38% from last year. You can you add to that another $1.2 billion in stimulus funding, which is expected to be committed by June 30, 2009 and $1.2 billion more a year from that date.

The Texas economy is the strongest in the country with an $11 billion budget surplus. And this is where we recognize a majority of our revenue. We are also expecting increased bidding activity on our municipal markets as they approach their fiscal year ends after a rather slow winter. While we were not successful in the March TXDOT lending, we were competitive. We prefer to hold the line on margins expecting that with the stimulus program, our markets will return to normal.

This is a balancing act which we are intimately familiar with, margin achievement versus the adding of new backlog. We have made good in-roads into new areas of our markets, we are pleased to report that we bid on our first joint venture on a $500 million public private partnership this year. While not successful, we have gained invaluable experience on this method of delivery, and are working together on large joint ventures. We were successful on our first design build in San Antonio with a new client the core of engineers; we participated in our first unsolicited proposal in El Paso to the Camino Real RMA, a potential new client. The results are still pending.

We bid on a $60 million asphalt project in West Texas, handled entirely by our Reno office, and finished a respectable third. The Metropolitan Transit Authority awarded the light rail project after a 2-year design and negotiation to Parsons Group for $1.4 billion, including a notice to proceed on the first section for $390 million, and we are hopeful that we will be able to participate in the actual construction, which is scheduled to begin by August.

As we move into 2009, we are in an extremely strong financial position with positive net cash and a bonding line in excess of $1 billion. We are positioned to take advantage of opportunities as they present themselves both organically and the area of expositions and they have the mindset to make this yet another successful year.

Before moving on to your questions, I should mention that on March 24, we will be presenting at the Sidoti 12th Annual Emergen Growth Institutional Investment Forum on April 2, and we will be presenting at the BB& T Manufacturers & Material Conference both in New York City. We hope to see some of you at these conferences. Now we would be happy to answer any of your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Rich Wesolowski - Sidoti & company.

Rich Wesolowski - Sidoti & company

Your 4Q gross margin, it sounds like that didn’t reflect any odd projects and that represents the best estimate of the project pricing in the market today. Is that true?

Joseph Harper Sr.

The fourth quarter had work in it that was bid a long time ago as well as more recent pickups, saw sort of a blend in that.

Rich Wesolowski - Sidoti & company

The margin on new work today, if you are holding the line on margin and not getting the some of the work say as you mentioned in the March quarter, it might even be lower than that?

Joseph Harper Sr.

We have bid as low as 6% to 8% range on specific projects where we thought the risks were low enough that that’s what we needed to be doing, but in general, we’re trying to hold the line very well.

Rich Wesolowski - Sidoti & company

Typically you guys get about $50 million or so in the book and burn revenue. The guidance implies a good deal more than that. Does that imply some kick from the stimulus work later in the year?

Joseph Harper Sr.

I guess that is one way of looking at it. I think we made the point on several of these calls that we pay a lot of attention to our resource schedules and when those resources are available and we had an unusual amount of availability this year showing up in the third quarter. With the stimulus plan and the increase in the TDOT budget, as well as the rail program, we’re pretty hopeful that the year turns out the way we got it pegged.

Rich Wesolowski - Sidoti & company

Can you give us a little historical perspective or refresher on the TXDOT budget? What was the peak number in ‘05 and ‘06?

Joseph Harper Sr.

Pat or Jim you want to take that?

James Allen

As I remember, ‘06 is somewhere around $2.7 billion. ‘05 I don’t remember.

Rich Wesolowski - Sidoti & company

Okay, so this 2.9 approximates as high as they’ve ever been?

James Allen

No, I think there were some periods of time where it was up over $3 billion, wasn’t it, Pat?

Patrick Manning

Yeah, I think we hit close to $3.9 billion in 2007.

Rich Wesolowski - Sidoti & company

And then finally, the last call we had talked about proposition 14 bonds, it was about $1.8 billion that they were looking to sell and spend. Is that included in the 2.9?

James Allen

I think those were proposition 12 bonds and $1.8 billion is included in the 2009 and 2010 budgets of TXDOR.

Operator

Our next question comes from John Rogers - D.A. Davidson.

John Rogers - D.A. Davidson

In terms of the 12-month backlog that you reported $379 million, a year ago and I can go back and look, but that was what something under $300 million?

James Allen

I don’t have that number in my mind, John, I’m sorry, I can get that, but I don’t have it right now.

John Rogers - D.A. Davidson

I guess my question, though really relates to in terms of the scheduling you mentioned some open capacity in the third quarter. Are you pretty well booked out then in the first half of the year adjusting for sort of normal seasonality especially in Nevada?

James Allen

I would say in the first half yes, we are pretty well booked out.

John Rogers - D.A. Davidson

And when I think about margins, for your business, I’m looking at more in terms of an annualized basis; I know they were lower in the fourth quarter, but that 10% margin, that seems to be about the mid point of your estimates, is that right?

James Allen

I think 10% is right around where we hope to achieve. And I’m again hopeful that we’ll be in that range certainly for the first two quarters. And then we’ll have to see what we pick up and how the stimulus program affects the bidding moving on forward to the rest of the year.

John Rogers - D.A. Davidson

And then the last thing, in terms of acquisitions, it sounded as if you’re hopeful you’ll see something out there, but it doesn’t sound like you’re seeing anything immediately, is that right?

James Allen

We always have three or four kind of in the pipeline that we’re working on in any one given time. We’re being very conservative and very cautious to make sure we’re doing the right thing especially in these times.

John Rogers - D.A. Davidson

Are you seeing anything Pat in terms of bonding business, working for bonding companies?

Patrick Manning

We are and have been working for travelers in St. Paul’s over the last year. We have not seen any new projects coming up for bid or in other words any contractors going down, while in conversation with travelers, they expect to have some losses this year.

Joseph Harper Sr.

It’s a little early in the cycle for that, John.

John Rogers - D.A. Davidson

Typically, is that something then that you would expect to see later, I don’t know how the cycle plays out, further out into ‘09 or is that a 2010 type event?

Joseph Harper Sr.

I think most of it will be 2010.

Operator

Our next question comes from Craig Bell - SMH Capital.

Craig Bell - SMH Capital

Pat you had mentioned the light rail project in Houston, and you hoped to get some construction work on that starting in August. When do you think you might find out if you’re going to participate in that?

Patrick Manning

I would say May to June if we’re going to start building in August and Metro has committed that they would have actual construction on the ground in August?

Craig Bell - SMH Capital

And also you started the bidding on some asphalt work in West Texas. Is that something you think has a lot more opportunities for you on?

Patrick Manning

Well, we had said that we hoped for some reverse synergies from RHB with that acquisition. And I just wanted to point out that that was the first one that we actually bid here in Texas out of the Nevada office.

Craig Bell - SMH Capital

And then lastly, obviously we saw a big upward revision in the March letting schedule for TXDOR, so far what I’ve seen, the April one hasn’t had that same effect. Are you expecting to see that revised upward or do you think that will show up more in May?

Patrick Manning

I think it will show up more in May. They’ve come out with their first three letting proposals so to speak, and they have one more that’s due out today, but I would expect that they’re going to not see a substantial increase.

Operator

(Operator Instructions) Your next question comes from Eric Glover - Canaccord Adams.

Eric Glover - Canaccord Adams

First question is; is your current level of business or anticipated business high enough to require the company to make new equipment purchases at this point?

Joseph Harper Sr.

Our cap spend was off a little bit in ‘08 from the previous couple of years and budgets for ‘09 are pretty much replacement numbers. Should be maybe 50% to 60% on last year’s spend.

Eric Glover - Canaccord Adams

And second question is; what are you guys hearing in terms of the potential size and timing of the new federal highway trust budget?

James Allen

I heard there was quite an increase in the administration’s proposed budget, but as of yet, we don’t know what the number is. But the last few years’, they’ve averaged around $40 billion a year, so we’re hoping and also they’re discussing the next five years, whatever they call it. I guess it won’t be safety [loop], but whatever they call it. And the talk is that there is a substantial amount of infrastructure work that needs to be done. And that they need to find a different way of funding it from the ways they have in the past. That’s about the extent I can tell you right now.

Operator

Your next question comes from Rich Wesolowski - Sidoti & company.

Rich Wesolowski - Sidoti & company

A while back we had spoken on a big utility program in Nevada. Has that been put on the shelf or do you have a status update for that?

Patrick Manning

The lasts thing I’ve seen on it Rich is that there were environmental issues; they scheduled a big meeting for late 2009. So, I believe that optimistically it would be mid-year 2010 before that program kicks off.

Rich Wesolowski - Sidoti & company

Okay. But it’s still generally on the board?

Patrick Manning

Yeah, there’s no reason to think that they don’t need that program to be built.

Rich Wesolowski - Sidoti & company

When they have the money, they’ll do it?

Patrick Manning

That’s right. I think they have the money, I really think it’s environmental issues. They were saying that it’s absolutely necessary by somewhere around 2013 or 2014 to be in service. They can’t push it much further than that, I don’t believe.

Rich Wesolowski - Sidoti & company

And the Houston Metro project, how much work do you think there will be in total for sub-contractors that you or your competitors on that?

Patrick Manning

That first section that they gave the notice to proceed on which is going down Harrisburg to the East, was $390 million and I believe that the majority of that will be construction opportunities. The whole program that was awarded to Parsons was $1.46 billion.

Rich Wesolowski - Sidoti & company

But, am I incorrect in thinking that the much of the construction has already been awarded to someone else?

Patrick Manning

No, none of the construction or very little I think they have awarded two $20 million contracts to do some utility relocations, and that’s the only construction that’s been awarded?

Operator

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

James Allen

We want to thank you for joining us today. And look forward to visiting with you in the future on our conference calls for the first quarter, its here in Houston, let us know and come by and see us. And if not, we don’t see you here; maybe we’ll see you at the Sidoti or BB& T Conferences’. Thank you very much.

Operator

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

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Source: Sterling Construction Company Inc. Q4 2008 Earnings Call Transcript
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