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Sterling Construction Company Inc (NASDAQ:STRL)

Q4 2007 Earnings Call

March 14, 2008 10:00 am ET

Executives

Jim Allen - CFO

Pat Manning - Chairman and CEO

Joe Harper - President and COO

Analysts

Rich Wesolowski - Sidoti & Company

Craig Bell - SMH Capital

John Rogers - D.A. Davidson

Presentation

Operator

Good day, everyone, and welcome to the Sterling Construction Fourth Quarter 2007 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 Mr. Jim Allen. Please go ahead, sir.

Jim Allen

Thank you. Good morning, ladies and gentlemen. This is Jim Allen, the Chief Financial Officer, and I would like to welcome you to the Sterling Construction Company conference call to discuss the results for the fourth quarter and year ended December the 31st, 2007, which we released this morning.

I am joined today by Pat Manning, our Chairman and Chief Executive Officer, and Joe Harper, our President and Chief Operating Officer.

Now the really exciting part of this conference call: 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 2008 guidance, are subject to risks and uncertainties, including overall economic and market conditions, competitors, customers, and suppliers’ actions, and 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. 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 management’s beliefs at the time the statement is made. Predictions that we 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 an annual basis. We do not issue guidance about quarterly results.

Turning to the financial results, I am very pleased to report the company achieved another record year in 2007, in terms of revenues, profits, working capital and stockholders’ equity. Revenues were up 23% to $306 million, and pre-tax income from continuing operations increased 16% over the $22 million of the prior year.

Net income from continuing operations was up 14% to $14.5 million. Diluted earnings per share from continuing operations were $1.22 in 2007. Last year we earned $1.08 per diluted share. The results were achieved on a record fourth quarter, which was much drier than the first three quarters of 2007. The first three quarters were much wetter than normal, and primarily was the reason the gross margin for 2007 of 11.1% was 4% lower than in 2006.

Speaking of the fourth quarter of 2007, it was a record quarter. We had revenues of 88 million in the fourth quarter versus 77 million in our third quarter of 2007 and 64 million in the comparable fourth quarter of 2006. Our pre-tax income from continuing operations for the fourth quarter of 2007 was 4.7 million, or up 62% over the 2.9 million for the comparable period of 2006. Diluted earnings per share from continuing operations were $0.39 in the fourth quarter of 2007, or up in excess of 60% over the fourth quarter of 2006.

As noted above, the weather in the fourth quarter was drier than the first three quarters, and we did not have any hurricanes in this past season. So we got a lot of work done and better utilized our crews and equipment than in the first three quarters of 2007. The fourth quarter was indeed a strong quarter for our company.

Now back to the full year – excuse me – 2007. Our effective tax rate was 35.3% for 2007, versus 34.2% for last year, due – the increase was due to the new margins tax, Texas Margins Tax, and higher statutory rate resulting from the higher level of pre-tax income. As many of you may have estimated, our tax loss carry-forwards continue to offset most of our federal income tax liability in 2007, as they did in 2006. With the benefit of these tax loss carry-forwards and depreciation of 9.5 million, cash flow from consolidated operating activities was 31 million in 2007 as compared to 27 million in 2006.

Following our [1,840,000] share stock offering in December 2007, with strong operating results, stockholders’ equity at the year-end 2007 rose to $139 million, and we had total cash and cash equivalents of $81 million. At the end of 2007, we entered into a new $75 million credit facility to replace the then existing $35 million line of credit that we had. At December 31, 2007, there was 8.5 million in undrawn balance on the credit facility.

Year-end 2007 working capital was 82 million, and the current ratio was 2.3 to 1. Our strong working capital and ratio were achieved even though we had record level of capital expenditures in 2007 of $36 million, including approximately 10 million of plant, property and equipment required with Road and Highway Builders, LLC, which we refer to as RHB.

A note about RHB: while it was accretive to our revenues and net incomes in – and net income in 2007, its effects on our results of operation were nominal, due to its results being included in our financial statements for only the last two months of the year, or since the date of acquisition, and the seasonality of the Nevada construction business.

Even with a $34.5 million of net proceeds of our 2007 stock offering, we achieved the return on average equity in 2007 of over 13%. Additional financial and business information may be found in our 2007 10-K, which we expect to file with the SEC on Monday.

I want to welcome Jerry Pinchot of Monness, Crespi & Hardt, and Craig Bell of Sanders Morris Harris. Their firms recently began analyst coverage of our company. A big Sterling welcome to both of you.

I would now like to turn the call over to Joe Harper to talk about the operating results in more detail.

Joe Harper

Thanks, Jim, and good morning, everyone. In my opinion 2007 was a very good year for our company. We tested our management team and challenged our entire workforce with the poorest weather conditions since we began operations in Texas. You have all heard the statistics before, but 41% over normal rainfall for the year was way beyond reasonable expectations. Well, our managers passed the test, and laborers through superintendents met the challenges with flying colors. Our crews under direction of experienced superintendents and project managers managed to keep projects on schedule and were successful in achieving more contract incentives than we had anticipated.

Working with site conditions that were less than ideal, they found ways to contain costs, complete contracts on time, and earn the vast majority of available incentive payments. In addition, we continued our record of successfully making changes to projects, redesign traffic control and phase sequencing, embankment or backhoe materials, et cetera, which substantially enhanced our margin on several contracts. As a result of their hard work, our financial performance was beyond our expectations. Revenue and net income were very close to the midpoint of our guidance for 2007 issued in January.

During 2007, we continued to build our construction resources, adding 230 employees and spending over 26 million on capital expenditures to increase concrete plant capacity and provide equipment to our new crews. With the expansion of resources, we are ready to capitalize on the opportunities Pat will discuss in a few minutes.

Aside from operations, we had several successes during the year. Our first sizable acquisition, Road and Highway Builders, LLC, closed on October 31, brings us new construction expertise in new geography. This transaction positions us to participate in highway and water infrastructure build in a growing market with great demographics, and a substantial water program expected to begin in late 2008 or early ‘09. Our bonding company confirmed at a recent meeting that we have in place bonding capacity more than sufficient to meet our program needs.

We more than doubled the size of our credit facility with Comerica Bank and want to thank them for their confidence in our management team. Coupling that with the successful share offering in December, we have positioned the balance sheet to allow us to take advantage of new opportunities. Whether these are design-build programs, participation in larger projects in our traditional markets, or potential acquisitions, we are ready.

We have put in place a lot of assets over the past couple of years, the use of which have been constricted by poor weather. Looking ahead to 2008, our resource schedules indicate that all crews are fully deployed through the third quarter of the year, with a vast majority busy into 2009.

We just completed a record quarter for revenue and operating income, a quarter inhibited by two weeks of low productivity due to holidays and fewer hours of daylight than other times of the year. This year we should see the fruits of these investments. We are continuing our efforts to look for good acquisitions in new regions of the country.

We are pleased with the number and the quality of heavy civil construction companies, which we have the opportunity to consider. Of course, in some markets the competitive landscape is changing. But you can rest assured that we will be taking that into consideration. Overall, we are optimistic about our chances of finding the right company meeting our criteria in the foreseeable future.

Now I will turn this over to Pat to expand on our markets and potential opportunities.

Pat Manning

Thanks, Joe. Good morning, everyone. First, I would like to congratulate the management, as well as all of the men and women working in our Texas region. With one of the wettest years on record with no hurricane activity, they were able to produce record revenues and record profits. The effort necessary to do that, to work day in and day out in the rain and the mud was truly amazing.

Second, since it is important to our overall success, I would like to comment on Texas and our local economy. That economy overall remains strong. For the fiscal year ending August 2007, Texas had an $8.5 billion surplus in the general funds. Texas added more jobs in 2007 than any other state. In fact, Texas added more jobs than second place Florida and third place California combined. With oil at historically high levels and the housing downturn not near as severe as in the rest of the country, the outlook for our industry is bright.

Texas, as we have previously mentioned has cut back on their proposed spending for the fiscal year especially in the Houston district, but there are still 10 projects for Texas valued in excess of 95 million that we have identified to bid on or before December 1st. There are another four pass-through toll projects valued in excess of 130 million bidding in the same area and the same timeframe.

The Harris County Toll Road Authority has $1 billion plus program expected to start bidding in the fourth quarter of this year and continue through 2009 and 2010. Further, the Metropolitan Transit Authority has the next phase of the light rail coming, as well as multiple city and county projects. And after speaking with the representative of the Associated General Contractors, he has information that the Lieutenant Governor of Texas and the Chairman of the House Appropriations Committee have signed a letter requesting the authorization of the sale of $1.5 billion in bonds to increase the 2009 TxDOT funding levels.

With current resources in both San Antonio and Austin at maximum utilization through the fall, we see good opportunities for expansion and increasing margins. Couple that with the robust bidding climate in Dallas, and the fact that for the most part the projects are in – are long in nature, typically two to three years, the prospects for 2009 and 2010 look very good. We were low bidder on the last two projects that we bid in Dallas with five bidders on one and only four on the other.

There was 100 – there’s also $150 million-plus job just advertised on the George Bush Toll Road, and there are many more projects yet to come. There are two projects advertised by DART for design-build of additional sections of the light rail system in Dallas, one for 165 million and one for 425 million.

I mentioned these opportunities more specifically, because there seems to be a perception in the marketplace that replacing backlog over the foreseeable future will be challenging. This is hardly the case. As a matter of fact, as we move into 2008, to date, we have more than replaced runoff in backlog company-wide with the two wins in Dallas, 26 million and 55 million, and the numerous smaller wins under 20 million that we don’t announce.

We continue to be excited about the opportunities that we see in Nevada. Recently the Southern Nevada Water Authority raised their rates in average of 30%. They have announced plans to bring water into Las Vegas area with over 300 miles of large diameter pipeline that they are anticipating to begin bidding towards the end of the year or the first part of next year. This is a program valued at approximately $2 billion. The NDOT bidding activity is strong, with many larger projects scheduled to bid in the next two quarters.

All of these opportunities in both Texas and Nevada are not based on housing starts or the national economy, but on demographics, the need for services and the local economies. On the national level, the House and Senate Committee have approved a budget blueprint proposing additional highway spending over and above the President’s request in November. We now have over 1,200 employees committed to achieving the best possible results. With good weather and attention to detail, we hope to deliver on our goals.

That concludes the formal part of our remarks. Before moving on to your questions, I should mention that on March 25th and 26th we will be presenting at the Sidoti 12th Annual Emerging Growth Institutional Investment Forum in New York, and on April 4th and 5th at the B. Riley & Company 9th Annual Investor Conference in Las Vegas. We hope to see some of you there.

Now I would be happy to answer any questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Rich Wesolowski with Sidoti & Company.

Rich Wesolowski - Sidoti & Company

The gross margin was a big surprise to us. It was higher than I even thought you could get to on a good quarter. How much was the volume of work versus the incentives versus the re-design of the projects, is there any way to quantify those?

Joe Harper

Those are pretty tough to quantify, Rich. But there certainly was an impact of all of them. The incentive recognition in the fourth quarter, if I remember correctly, was not terribly material, it was pretty typical; but re-design and changes in projects to enhance the profitability, we were – we had some good things happen for us.

Rich Wesolowski - Sidoti & Company

I just want to understand what that means. When that occurs, you lower the total expected cost of the project, which enables you to raise the profit recognition on the work already done?

Joe Harper

That’s correct. I mean, if we have a change in gross margin or gross profit on a job, and we are 50% done, we have $100,000 change, 50,000 of that flows to the income statement in the quarter that we recognize it.

Rich Wesolowski - Sidoti & Company

Is that mainly a 4Q phenomenon? I think, I remember that happening last year as well.

Pat Manning

No, it’s a random phenomenon.

Rich Wesolowski - Sidoti & Company

Okay. Just happens when it happens.

Pat Manning

Some of that, I guess, you would say.

Rich Wesolowski - Sidoti & Company

Okay. You – it seems you guys are obviously bullish on your bidding activity except for the Houston area, which seems like a hole in the middle of great Dallas and still strong for Nevada. Why would it be weak there and strong elsewhere?

Joe Harper

Well, when the DOT had to pull $1 billion from the budget, it seemed to us as though Houston bore the brunt of that pullback. And I don’t have exact statistics by all the districts where it came from, but the list of jobs pulled from Weddings for the Houston district were pretty numerous.

These are jobs now that are fully designed and sitting on the shelf, and if we get the kind of bounce that, Pat’s comment with the sale of bonds in the ‘09 fiscal year, it should improve an awful lot out there. But you are right, we are very comfortable every place but the Houston district, and we will have the challenge potentially of moving some labor and other resources from Houston to Dallas, potentially.

Rich Wesolowski - Sidoti & Company

Okay. Lastly, can you just flesh out the comments: I am not sure whether it was on competition for buying acquisitions or competition from other contractors in bidding. But either way, can you review the competition in both Nevada and Texas? Are you seeing more bidders because housing has collapsed? How widely can that affect the good margins?

Joe Harper

You are seeing – in the Nevada markets, we are seeing one or two bidders on projects, who would not have been bidding say a year or year and half ago. And that’s – that’s a big – on a percentage basis, that’s a big increase. In the past, there would be two to three bidders, and now there’s one or two new players there. So that could have an impact in the short run, Rich. In Texas, I don’t think we have seen – while in Houston we have – we have seen one or two contractors who primarily worked for developers in the past come into the municipal markets, but we are talking about one or two job capacity on an annual basis. So we haven’t seen a significant impact there.

Rich Wesolowski - Sidoti & Company

Right. So it’s much bigger in Nevada than in Texas?

Joe Harper

Yeah.

Rich Wesolowski - Sidoti & Company

Thank you.

Operator

Your next question comes from Craig Bell with SMH Capital.

Craig Bell - SMH Capital

Yes. Good morning. Just wondering can you give any of the metrics on RHB’s contribution, or are you going to do that in the K?

Pat Manning

Jim, can you answer that?

Jim Allen

Yes, we are going to – we are doing that to an extent in the K, but the RHB’s contribution was rather nominal. From the standpoint of revenues for the year, they had about 7 million out of the total 306 million. And from the standpoint of income, it was substantially smaller. Percentage-wise, it was for the whole year 2 to 3%. Then, as I said earlier that’s due to, one, they were only in our financial statements for two months since the date of acquisition and, two, that the seasonality out there in Nevada, and in Northern Nevada particularly, snow, cold weather and so forth like that, their fall season to the winter season is really slow.

Craig Bell - SMH Capital

Okay. And then...

Jim Allen

So, while we are still – we are still very – we are very positive on RHB, and we expect big things from it, the contribution in the last two months was – while we would have missed it, it still was nominal.

Craig Bell - SMH Capital

Right. And then looking at your balance sheet, has there been any significant change today versus at year-end? I guess in other words, have you taken the – any of the proceeds from that secondary and paid down the revolver at all or...?

Jim Allen

Well, the revolver – the credit facility goes up and down as the needs arise. And yes, the credit facility is probably substantially down. Right now, even the level of activity actually goes down a little bit over the Christmas holidays and coming into the New Year. So other than that, and the – but it’s still available to be drawn upon.

Craig Bell - SMH Capital

Okay. And then lastly, as we look at the – sort of the first two, two and half months here of this year, particularly looking just at, say, Houston and Dallas markets, are you seeing any significant difference in weather versus last year?

Joe Harper

Yeah, I...

Jim Allen

I wasn’t here for last year, but I was in Houston, and I know it’s drier this quarter than it was last year. Joe, Dallas and San Anton, what’s your observation?

Joe Harper

Well, it’s drier across the whole state this year than last year. I don’t have those statistics here, but there’s no question. The weather is much more like normal. I am knocking on wood as I say that.

Jim Allen

Okay.

Joe Harper

Yeah, it has been pretty normalized, Craig.

Craig Bell - SMH Capital

As we look at the weather for you going forward, I mean obviously if you get some days with quite a bit of rain in there, that’s a problem, but is it more a function of the quantity of rain or the quantity of days do you think?

Joe Harper

Quantity of days, no question about it. A half inch rain hurts us just as much as a 12-inch rain.

Craig Bell - SMH Capital

Okay. Great. Thank you.

Operator

(Operator Instructions). Your next question comes from John Rogers with D.A. Davidson.

John Rogers - D.A. Davidson

Good morning.

Pat Manning

Morning, John.

Jim Allen

Good morning, John.

John Rogers - D.A. Davidson

Jim, you touched on this in term of seasonality a little bit, but just so I understand thinking about 2008, will RHB be pretty quiet in the first quarter in terms of activity levels, and then most – 70% of the work in the second and third quarters?

Jim Allen

John, I believe that’s the case. But Joe has spent a quite a bit of time out at RHB. I am going to let him respond to that.

Joe Harper

Yeah, John. The primary revenue producer there is the asphalt installation piece...

John Rogers - D.A. Davidson

Right.

Joe Harper

-- work, and that’s when the revenues will get recognized. So in the Northern Nevada region, which is where the majority of our work is right now, that would point to May through October being by far the highest revenue months. And I think that’s what you should expect.

John Rogers - D.A. Davidson

Okay. When you mentioned, or Pat, I can’t remember, talked about visibility out through the first three quarters of this year given your current backlog. I mean at what point given you have seen these sequential declines, excluding RHB, I mean, how comfortable are you, or concerned are you as that backlog comes down, and at what point do you really have to rebuild it?

Joe Harper

We have been talking I think on at least two of the last three calls, maybe on all three of them about size of backlog versus the revenue stream.

John Rogers - D.A. Davidson

Right.

Joe Harper

And coming into 2008, we had about 370 million, I think, was the number of the 2008 guidance in backlog at the time. So we needed to book 80 million plus or minus and build it and we are very comfortable with the ability to do that. My expectation with the Houston district being soft for the next quarter or two is that backlog is going to pull down, but I don’t think it’s going to have any impact on our revenue stream, John.

John Rogers - D.A. Davidson

Okay. And in terms of the shorter-term projects, I mean, my impression has always been that if you can fill up with a lot of those they tend to be at least, if not more profitable than some of the larger projects.

Joe Harper

Well, we get a lot of enhancement of resource utilization on the longer jobs just because we can plan better where we want to have crews down to – all underground crews are not equals, and putting the right personnel on the right projects, and that kind of stuff. So we get better utilization with the longer time to be able to plan for the work on the one hand. On the other hand, typically our shorter duration projects are municipal work and margins continue to be stronger there than they are on highway work.

John Rogers - D.A. Davidson

Okay.

Jim Allen

I would add to that.

John Rogers - D.A. Davidson

Yeah.

Jim Allen

There is so much work coming out in Dallas that that may be different this year with the larger projects up there, just because of the inability of contractors to book and build them.

John Rogers - D.A. Davidson

Okay. And then last question. Just in terms of materials’ prices, and I am saying particularly aggregates in the Texas market, what’s happening there? I mean, is pricing coming down? And are you seeing any benefits from that or is it just very pass-through stuff?

Jim Allen

Primarily pass-through stuff. So, like we have said previously, we lock in all our materials’ prices as soon as we are found to be low bidder. So they stay fairly static. We neither get too many cuts for that particular project, nor do we get any add-ons.

John Rogers - D.A. Davidson

Okay.

Joe Harper

And now, I mean, John, just let me expand on that for a sec. The – because that’s the way we do operate, we do lock in prices, purchase orders and subcontract agreements work both ways, and we don’t try and renegotiate midstream.

John Rogers - D.A. Davidson

Okay. And is it a negative in Nevada at this point for you?

Joe Harper

I am sorry?

John Rogers - D.A. Davidson

I mean, because of – you own some of the aggregates there.

Joe Harper

No, we haven’t seen any pullback. I mean, I...

John Rogers - D.A. Davidson

Okay.

Joe Harper

I know that the housing portion of civil construction here in Nevada is basically at a standstill. So volumes coming out of quarries and asphalt plants and concrete plants must be down, but we haven’t seen any impact in pricing. Frankly, we don’t buy very much on the aggregate side, so I wouldn’t know it.

John Rogers - D.A. Davidson

Okay. Great. Thank you, and congratulations on the year.

Operator

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

Pat Manning

Thank you, everybody, for being with us today, and we hope to see you next quarter. Thanks a lot.

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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