Sterling Construction's (STRL) CEO Peter MacKenna on Q2 2014 Results - Earnings Call Transcript

Aug.11.14 | About: Sterling Construction (STRL)

Sterling Construction Company Inc (NASDAQ:STRL)

Q2 2014 Results Earnings Conference Call

August 11, 2014, 11:00 AM ET

Executives

Brian Manning - Chief Development Officer

Peter MacKenna - President and CEO

Tom Wright - CFO

Analysts

Tahira Afzal - KeyBanc Capital Markets

John Rogers - D.A. Davidson

Jack Kasprzak - BB&T

Operator

Greetings, and welcome to the Sterling Construction's Second Quarter 2014 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Brian Manning, Chief Development Officer of Sterling Construction. Thank you, sir. You may begin.

Brian Manning

Thank you, Kevin. Good morning, and welcome to Sterling Construction's second quarter 2014 earnings conference call. I am here today with our President and CEO, Peter MacKenna, and our Chief Financial Officer, Tom Wright.

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.

The second quarter was characterized by continued improved project performance and an equity raise that strengthened our balance sheet.

And now, I will turn over the call to Tom Wright, our Chief Financial Officer to discuss the quarter's financial results.

Tom Wright

Thank you, Brian. I would like to discuss our 2014 second quarter financial performance. Revenues for the 2014 second quarter were $194.8 million, which were 46.1% higher than the second quarter of 2013. The increase in revenues compared to the second quarter 2013, was due an increase in the number of projects and process particularly in our Texas, and California markets.

Gross margin for the 2014 second quarter increased to 6.4% of revenue compared to a gross deficit of 12.5% in the second quarter of 2013 due to improved overall profitability of projects.

Projects in the second quarter of 2013 were impacted by downward revisions and several large projects particularly in the Texas market.

General and administrative expenses in the 2014 second quarter were flat with the prior year period at $9.5 million despite the 46.1% increase in revenue. As a percent of revenue G&A declined 4.9% compared to 7.1% in the second quarter of 2013.

These decreases primarily needs careful cost controls and also requires the company's ability for leverage overhead due to previous investments and information systems which were designed to improve operational performance and create an infrastructure which is scalable.

Operating income for the 2014 second quarter was $2.5 million, compared to an operating loss of $26 million in the second quarter of 2013. Operating income in the second quarter of 2013 included charges of $18 million primarily due to site-specific conditions affecting jobs in Texas and Arizona.

Net income attributable to Sterling common shareholders for the 2014 second quarter was $1.2 million, compared to a net loss of $17 million in the second quarter of 2013. Net earnings per diluted share attributable to Sterling common shareholders for the 2014 second quarter was $0.07, compared to a loss of $0.93 in the second quarter of 2013.

Capital expenditures for the 2014 second quarter was $5.4 million compared to $1.8 million in the second quarter of 2013. The company continues to carefully manage capital expenditures and expects full year 2014 expenditures to be consistent with 2013 levels of approximately $15 million.

Bookings for the 2014 second quarter were $167 million, representing a book-to-bill ratio of 0.86:1.

Total backlog as of June 30, 2014 was $727 million, up from $687 million at December 31, 2013 and $714 million at June 30, 2013 and down from $799 million at March 31, 2014.

Total backlog at June 30, 2014, excluded $116 million of projects where the company was the apparent low bidder, but had not yet been awarded the contract. This is up from $71 million at March 31, 2014.

With the estimate of the current average gross margin of our projects and backlog is comparable to the gross margin reported in the second quarter of 2014.

Our 2014 second quarter working capital totaled $41.2 million. The company had borrowings of $18.6 million and tangible network of $94.3 million. The company was in compliance with all bank covenants at the end of 2014 second quarter.

Earlier in the 2014 second quarter, the company successfully completed an equity offering of approximately $14 million in net proceeds which was used to strengthen the company's balance sheet.

I will now turn the call over to our CEO, Peter MacKenna.

Peter MacKenna

Thanks, Tom, good morning. In these short prepared remarks, I'd like take a few minutes to address some of the issues and trends that we're seeing in our business. Of course, we'll be able to answer your specific questions in a few minutes.

As it has become our custom, I'd like to spend a moment and let you know, what privilege it is to work with the men and women at Sterling.

Our hard work and dedication in implementing our turnaround strategy were improved as we continued to execute our projects with special focus on safety and optimal efficiency.

More than our 1,000 employees have received training under our Safe and Sound program, and I'm very pleased to tell you that in the second quarter, Sterling's outperformed nearly a million man-hours without a single lost-time accident.

I'm also pleased to tell you that our efforts on developing our employees. Our two management oriented programs is going on professionals program and Sterling women leadership initiatives, are off to a great start in comparing the company's next generation of leaders.

Our craft labor received similar focus on training and development. As an example, last quarter we invested more than 2,000 man-hours in training [indiscernible] employees in Texas alone. Our emphasis on developing our employees is a critical piece of strategy to prepare Sterling for the challenges ahead.

As Tom described, our second quarter financial performance was a significant improvement over our performance at this time last year, and over the first quarter of 2014. I often mentioned legacy projects as used to potential completion during the second quarter, and we expect final close at third and fourth quarters.

We continue to be encouraged by our level of order bookings and the risk and margin profile associated with our newer projects. As of the end of June, our year-to-date book-to-bill ratio was 1.08:1.

As Tom said, our backlog at the end of the quarter was $727 million, but I want to emphasize that it does not include $116 million hours worth of work pending contract execution.

We have been effectively implementing our strategy of pursuing smaller projects, alternative delivery projects and opportunities where we can collaborate between our business units.

Following my comments, Brian Manning, our Chief Development Officer will briefly discuss our marketplace and the opportunities we are tracking.

Looking forward to the second half of 2014, we expect revenues to be higher than in the comparable period last year. As Tom noted, gross margins for the second and third quarters of this year are anticipated to be comparable to the second quarter.

Further gross margin improvement is being somewhat constrained by what we believe are signs of an overheating marketplace, especially in our major Texas markets. As I noted in this mornings press release, we have observed spot shortages of construction materials and our experience in heavy competition for both craft and support labor.

The company has taken active steps to mitigate these conditions and we continue to monitor the situation closely. Also as commented earlier, in spite of a 46% increase in second quarter year-on-year revenue, G&A costs have remained flat with a resulting decrease of 4.9% of revenue for the quarter.

This is the result of not only careful cost control but of our building and overhead structure that is flexible and efficient.

At the end of the first half, budgets and performance on our 119 projects continues to track as we expect.

Our IT investments are paying dividends and we continue to roll-out controls for use at both the tendering stage for project and for enhanced project execution.

Our Texas subsidiary and all of Sterling has turned to corner from the last three very difficult years.

I want to finish up by saying that while we are pleased with our performance today, we are not satisfied. We will continue to look for ways to improve our efficiency, streamline our operations and seek out opportunities that are accretive to our business and our brand.

I’ll now turn the call over to Brian Manning.

Brian Manning

Thank you, Peter.

As we mentioned on the last call, the federal highway bill, MAP-21 expires at the end of September but we expect a series of continuing resolutions for the bill, with similar funding levels until the new bill is approved.

President Obama recently signed a bill extending spending authority up to $10.8 billion for the federal highway program through May, 2015, and as a result, Transportation Secretary, Anthony Foxx has wrote the safe transportation official note that there’ll be no customer highway projects.

Mr. Foxx is urging Congress to enact a multi-year legislation. There are significant state legislations created for the November ballot. Recent water pipeline burst in L.A brought the importance of aging infrastructure into focus, as more than 20 million gallons of water submerged 100s of cars and parking garages and damaged University of California facility.

Earlier in the month, California Governor, Jerry Brown called for lawmakers to place a $6 billion bond measure on the November ballot for water. More than 80% of California is experiencing extreme drought after three years of record low rainfall.

The governor declared a state of emergency in January as reservoirs are 45% below normal levels. Well, drought has impacted some, the enacted proposition fix in last years ballot, we'll see projects approvals coming online in this September, and projects, - these projects help guard against future drought conditions that are inevitable.

Texas will address transportation on the November election. Proposition 1 will be on the ballot and if approved, will provide at least $1.4 billion for transportation projects.

We are experiencing increased competition for labor in our Texas market. Texas's seasonally adjusted unemployment rate fell to 5.1% in June, 2014 from 6.4% in June 2013 for the Nations rate decreased from 7.5% to 6.1%.

Texas's construction employment growth rate was one of the industries highest at 3.95% according to [XCNM] (ph) real estate center. Nationally, the number of American's applying for initial jobless benefits, declined last week to an adjusted 289,000, the enforcing indication of a strengthening job market.

The four week moving average obtained is to its lowest level in more than eight years according to the AGC of America.

Our private pipeline remained strong for diverse project opportunity for most our geography, and overall we are looking at $4.2 billion in potential project per seats for the remainder of 2014.

And now, we welcome your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is from Tahira of KeyBanc Capital Markets. Please proceed with your question.

Tahira Afzal - KeyBanc Capital Markets

Okay. Good morning and congratulations on the quarter.

Peter MacKenna

Good morning, Tahira.

Tahira Afzal - KeyBanc Capital Markets

I guess, first question is, you've been talking about the overheating in the Texas market, it's been great to see that you guys keeping on top of it and being cautious and watchful of it. Can you talk about, - when we talk about your clients, are they not really adjusting for, the cost increases that are coming about in Texas at this point. Do you think you could start to see that being more rarely adjusted in your pricing at some point?

Peter MacKenna

The pricing we put in the tenders, which I don't anticipate labor costs, reaching out for period of time, that's one focusing on smaller projects where we think we have better visibility both in to the availability and the quality of labor.

We haven't experienced real shortages, what we’re seeing though is people leaving for relatively small amounts of increases in pay. And that's the thing that I think we find concerning, the turnover and then the need to retrain and reorient.

So, I think that our pricing will reflect the shortages but it's the operational impact I think that has most of our attention.

Brian Manning

I think there has been a lot of different movement in the labor market and what we’re seeing is some of these larger projects are taking crews from our company and the crews are working exceptional hours and eventually that translates into them moving once again.

So we thought that with the oil field and now we’re seeing that with some of the more significant projects where that quality of life is not worth the increased pay. But as the end results, the overall market pay has increased and we're seeing a lot of movement with labor force.

Tahira Afzal - KeyBanc Capital Markets

Got it. And, if you look outside of Texas, it seems like the environment is little better. Can you talk about, as you continue to make inroads outside of Texas as well, could you talk about, whether the mix shift eventually will migrate for margins regardless of what's happening in Texas?

Peter MacKenna

Texas continues to be one of our most important markets. And you're right we're not seeing the labor issues in our other markets, particular intermountain nor in California.

Our goal here is really to diversify this platform and try not to be reliant on one particular geography or one particular segment for – to your question Tahira. So, unfortunately or fortunately if any time you look at it, Texas will always remain a very significant part of our portfolio.

Tahira Afzal - KeyBanc Capital Markets

Fair enough. Thank you very much.

Peter MacKenna

Thank you, Tahira.

Operator

Thank you. Our next question today is coming from John Rogers from D.A. Davidson. Please proceed with your question.

John Rogers - D.A. Davidson

Hi, good morning.

Peter MacKenna

Good morning, John.

John Rogers - D.A. Davidson

Couple of things. First of all, just in terms of the recorded numbers, the other income or expense in the quarter of $460,000, what was included in that?

Tom Wright

John, this is Tom. The way we treat the [indiscernible] in this year is that their income – their 50% of the income gets eliminated on the other expense line. This has to do with the change in agreement where we’re actually obligated to buy them out eventually in the event of - partner there still.

So, that's what you're seeing and in an underline.

John Rogers - D.A. Davidson

Okay. So Tom will it continue with that rate or is tied our HP's profitability?

Tom Wright

It tied to our HP's profit.

John Rogers - D.A. Davidson

Okay. And then the other question I had was, the adjustment in estimated revenues and gross margins in the quarter, looks like it was about $2.3 million. Were there specific projects there or just a group of them that caused that upper provision?

Tom Wright

How much, I apologize.

John Rogers - D.A. Davidson

In the Q you talked about changes in estimated revenues and gross margins during the six months added $5 million to operating results for the six months. And I think in the first quarter it was $2.7 million from the $2.3 million in the second quarter?

Tom Wright

On an ongoing basis if we look at our job estimates and revise them up or down based on the situation of role or jobs, I mean what you're looking at is, is the total of $120 that were changing estimates.

So there is cumulative affect of all of those. We'll have something in that line every quarter based on the information as we get it.

John Rogers - D.A. Davidson

And I guess I'm just wondering is that, was there one particular job or was it just cumulative?

Tom Wright

Just cumulative, it's some total of all the jobs.

John Rogers - D.A. Davidson

Okay. And then lastly I guess here in terms of the comments relative to revenue growth and activity in the back half of the year, I don't know if you can give us a little more thought there, specifically just in terms of your expected revenue growth. Should we see the same sort of seasonal patterns that we have seen in the past into the third and fourth quarters or how does your scheduling look?

Tom Wright

I don't think that seasonality has changed an awful lot. The project duration has changed and we're looking at, I think something like 12 to 18 month duration on most of these projects. So as we pick them up, we burn north about that rate. I'm not sure I want to get into much more than that.

John Rogers - D.A. Davidson

But there is nothing to expect the third quarter shouldn’t be a very strong revenue quarter just from your work schedule at this point?

Tom Wright

I think it's consistent with what you’ve seen in the past.

John Rogers - D.A. Davidson

And then just in terms of your actions relative to higher cost that you talked about. Is there anything you can do, I know in the past certainly you got forward on some gas, oil or some fuel and other things, is it just a matter of getting it into the pricing on your bit?

Tom Wright

Pricing is less troublesome than variability in potential truck shortages and rationing of trucks is a tremendous shortage of truckers and trucking in Texas right now. My border have 10 trucks and get three.

That's probably more concerning, more from an execution perspective from a pure incremental cost or unit cost. We have taken a lot of steps to secure supplies hedge fuel, we have hedge fuel in the past, we have some hedges going forward.

It’s really getting the stuff to deliver timely and accurately and within our schedules, the most important thing for us right now.

And there is some labor inflation but again the turnover in competition for labor that has us concerned its training these folks and getting oriented into our safety program. And there is always a learning curve I think people are more, and it's big churn that is constructive.

John Rogers - D.A. Davidson

Okay. And then last if I could, I mean how far away are we from getting back to the 8%, 10% sort of margins that, I guess you inspired to us - referenced in the past yield for?

Tom Wright

It's a good question, John. It's hard to say. Lot of uncertainty coming out of D.C. the strong market in Texas and weak markets in Midwest and Mountain states, it's hard to say. We need certainly our goal to get there but I don't want to forecast it.

John Rogers - D.A. Davidson

Okay. I appreciate the help. Thank you.

Tom Wright

Sure.

Operator

Thank you. (Operator Instructions) Our next question is coming from [Andrew Stock] (ph) of Private Investor. Please proceed with your question.

Unidentified Analyst

Thank you. My name is Andrew Stock, I'm a Private Investor, investing construction companies around the world. I have a couple of - three questions if I may.

First of all, its hardly six, seven years now, and you've done a great job joining this company, [indiscernible].

I’ll start the question on longer term, what is your vision for this company. You have now – you've included IT system, the [indiscernible] facilities et cetera and now profitability is beginning to come. You are almost a net cash by the debt, what is the two to three years plan going forward? Are you – if one or two years more of improving profitability and then add acquisitions or do you want to, is it all organic growth or, what is your long term plans?

Tom Wright

Andrew I think it's, for all of those, our goal is to, - in position with the company so we can take advantage of the marketplace. This business is highly fragmented and I think there's a lot of opportunities for a low position, low structured, well capitalized organization to really take advantage of the marketplace.

It's a matter becoming relevant and we are relevant to local markets but we have ambition beyond that.

So when the business is strong and acquisitions are certainly something that we should be considering as is organic growth but as we've mentioned in the past, our goal is to diversify this platform and our portfolio work so that we have diversity not just of working of geography but of funding sources, I don’t believe that politicians are going to figure out transportation funding anytime soon.

We have to bridge the gap between need and political will and I think that is true. Our long-term national problem.

Unidentified Analyst

Thank you. A follow up question then, your background, in the most senior management was, world's largest and most efficient company. I remember the [indiscernible] margin, their EBIT margin running, has been running on the 6%, 7%, 8%, 9%. Structurally wise, why do they have such high margins and why, - could you move towards that range or is that a lower range and what is the sort of high range.

Tom Wright

When you work some places 17 years, part of that becomes ingrained in you. They have the unique ability to, and a very strong balance sheet to pursue extremely large projects, which have a very different risk than margin profile.

They are also very good at executing alternative delivery projects, design build projects and public private partnerships where they have both participation on the equity side and on the construction side, extraordinary good developing people.

All these things I think led them bring whole much higher margins that certainly our ambition to get there, but this company is now in a position to execute a multi billion dollar single project. And I think that's one of the reasons they can command much higher margins.

We will at some point, start moving towards larger projects. Again, our focus is on smaller ones while we find [indiscernible] and get ourselves positioned. But ultimately I think we're going to be looking at larger projects, emphasize project, but certainly larger projects in our portfolio.

Unidentified Analyst

Fair enough. And could you please help me understand, when I compare the construction markets of Europe, they are very extremely consolidated and it comes from in that front, last three major components - three main components controlling everything.

In the U.S. feels like they have a solid - what do the market line looks like in Texas? Are you in number of 3, 4, 5 player or another hunt company out there or what’s the potential of that type of consolidation?

Peter MacKenna

When you look at us as far as ranking is concerned, you'll find us in the top 20 in transportation and heavy suitable construction. There is quite a few very large companies that compromise at the top of the ENR 400 list.

And they are, they’ve got building components to their vertical building components, but when you look at the heavy civil contractor and transportation contractors, we are in the top 20.

Unidentified Analyst

Thank you. Finally, just a couple of questions on the Q2 results. First question, is there any cost associated with these troublesome large projects in this quarter? Secondly, on the non-control interest at $1.2 million, how should I think about that line going forward? Given CapEx basic number of net profits in to that component, enter the pocket?? Why is such a lot amount and how should I think about that line in the future?

Tom Wright

For the second quarter, there was no loss effect on the trouble jobs but, there was still some work being done at low margins.

For the non-controlling interest line, that's going to be directly tied to the profitability of our California business, the joint venture partnership that they have in California with Myers & Sons and Ralph Wadsworth. So that will, it will fluctuate based on profitability of that business.

Unidentified Analyst

All right, thanks a lot. Thank you very, gentlemen.

Tom Wright

Thank you.

Operator

Thank you. (Operator Instructions) Our next question is coming from Jack Kasprzak with BB&T. Please proceed with your question.

Jack Kasprzak - BB&T

Thanks. Good morning, guys.

Tom Wright

Hey Jack.

Jack Kasprzak - BB&T

Good morning. Hi, G&A expense, you referenced it being below 6% of sales, obviously the performance in the quarter and the leverage you got was very good. But I’m just wondering on, in terms of dollars, $8.5 million in Q1, $9.5 million in Q2, is there any guidance you can give us in terms of - should step up a bit in the back half with some of these training or labor issues you're referencing, or will it be kept on a pretty tight range?

Tom Wright

The $9.5 million is basically flat with last year. We feel that G&A and the structure we have is scalable. So, from a percentage standpoint I think the more we increase revenue, that will be on a percentage basis.

But from a guidance standpoint going forward, we only think that, we've said is, the 6% revenue range. And we're beating that.

Jack Kasprzak - BB&T

Right, okay. Thanks. And I guess, you talked about this already but, I feel compelled to ask in terms of the gross margin, you still have little bit of dilutive affect in Q2 from these three legacy jobs. You said the second half will be - gross margin will be similar to Q2.

I am just wondering why there won’t be at least a bit more of a step-up, little bit more of a positive outlook on gross margin in the back half with those jobs coming off in the hot market, the flip side maybe being the ability to reflect diluted price and get a little better margin.

Tom Wright

We’re still seeing the striping fairly competitive, although it’s a lot better than it was. As I noted in the press release and in my comments, our ability to improve the gross margin is somewhat constrained by our concerns about the overheating market.

Those concerns don't develop as bad a concern and you can draw some conclusions from that but we feel fairly comfortable in mentioning that. We think the margins will be consistent with second quarter going forward.

I know hitting market is something that proved very troublesome for the company, in the last couple of years and we are not going to let that repeat itself.

Jack Kasprzak - BB&T

Okay. Fair enough. Last question you referenced this as well, but anyway the spot shortages of the commodities you referenced trucking, truckers. Is there anything else may be on the material side that you’re seeing there, that’s worth mentioning.

Brian Manning

Yeah Jack, this is Brian. I think some difficulty in obtaining concrete to fiscal readymade concrete when you have something as an operation plan in either small amount of concrete. So that's been a challenge but it's primarily a schedule and challenge.

On our larger project, we control that by having our own badge plans. So, just concrete in general and then - in the trucking.

Tom Wright

Yeah, and we think some – not shortages of aggregates but certainly not getting the allocation we thought we’d be getting.

As I mentioned, the water at 10 trucks and the three will show up. And they're transporting aggregate to us and we saw that up in North Texas last quarter, I mentioned certainly seems to be continuing. And especially as we reaching these very large projects in Houston and Dallas, that consume a lot of the resources. The Grand Parkway here in Houston for example is consuming a lot of construction resources in the area, are competing with them, doing our job.

Jack Kasprzak - BB&T

Okay. Just on the aggregates topic, is that, so you're saying the major Texas – Dallas and Houston markets are you seeing that sort of affect on the aggregate side?

Tom Wright

It is more queued up in North Texas and - understand frankly, the same we're competing for, the same stand that goes out oil fields but that was the biggest issue that we have.

Jack Kasprzak - BB&T

Okay. Great. Thanks guys. Appreciate it.

Tom Wright

Sure, Jack.

Operator

(Operator Instructions) Our next question is a follow-up from John Rogers with D.A. Davidson. Please proceed with your question.

John Rogers - D.A. Davidson

Hi, just in terms of the problem project to pick early than then [3D] (ph), essentially closed off now. Can you update on recoveries there or what you're trying to do with open issues or could be pretty well settled amount?

Peter MacKenna

John, those matters are ongoing and we are negotiating with the different clients. So comment there wouldn't be appropriate at this time, but they are still open issues.

John Rogers - D.A. Davidson

Okay. So they are still open I guess.

Tom Wright

Yes. They are not closed yet.

John Rogers - D.A. Davidson

Okay. And any timing on – and they maybe close downs?

Tom Wright

We think it will be this year hoping to get resolution, in the third quarter but it might be early fourth quarter.

John Rogers - D.A. Davidson

Okay. Right, thank you.

Operator

Thank you. We've reached end of our question-and-answer session. I’d like to turn the floor back over to management for any further or closing comments.

Peter MacKenna

Thank you it's been a pleasure to participate in this conference call and relate to you our second quarter results. And we look forward to speaking with you all in November and giving you our third quarter results.

So with that, thank you from Houston.

Operator

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.

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