Sterling Construction Company, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2015; filed November 9, 2015. The filing identifies the issuer as Sterling Construction Company, Inc. The company is a heavy civil construction contractor focused on transportation and water infrastructure projects, primarily in Texas, Utah, Nevada, Arizona, California and Hawaii. Interim results are unaudited and may be seasonal.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Revenue | $176.0 million | $189.3 million | $471.1 million | $518.6 million |
| Gross profit | $14.5 million | $8.4 million | $16.7 million | $28.7 million |
| Gross margin | 8.2% | 4.4% | 3.6% | 5.5% |
| Operating income (loss) | $2.4 million | $(1.6) million | $(14.5) million | $1.4 million |
| Net income (loss) attributable to common stockholders | $0.3 million | $(3.9) million | $(19.3) million | $(2.5) million |
| Diluted EPS | $0.01 | $(0.21) | $(1.00) | $(0.14) |
| Operating cash flow | Not separately provided | Not separately provided | $3.5 million | $(17.3) million |
At September 30, 2015, cash and cash equivalents were $11.5 million, working capital was $41.6 million, total assets were $290.7 million and total equity was $122.5 million. Contracts receivable, including retainage, was $99.7 million. Backlog was $718 million, compared with $764 million at December 31, 2014; approximately $112 million of apparent-low-bid work was excluded because it had not been formally awarded or finalized.
Total debt consisted principally of $19.0 million outstanding under the equipment-based term loan and $13.1 million drawn on the equipment-based revolver. The company reported $2.2 million of additional borrowing availability at September 30, 2015, against an approximately $34.3 million borrowing base. The facility bears an initial fixed interest rate of 12% and matures in May 2019. Interest expense increased to $2.1 million for the first nine months from $0.8 million in the prior-year period.
Material changes versus the prior comparable period
- Third-quarter revenue declined 7.0%, primarily because large Texas projects were completed; increased Utah activity partly offset the decline.
- Nine-month revenue declined 9.2%, reflecting downward percentage-of-completion revisions on Texas projects, project completions and a $2.8 million out-of-period revenue reduction recorded in the first quarter.
- Third-quarter gross margin improved to 8.2% from 4.4%, largely because the prior-year quarter included downward revisions on three problem jobs. Nine-month gross margin declined to 3.6% from 5.5% because of project revisions, rainfall-related productivity declines and delays in Texas.
- General and administrative expense increased 19% for the quarter and 18% for the nine months. The company cited consulting costs and employee severance payments, including $1.1 million and $0.5 million in the quarter and $1.2 million and $2.9 million, respectively, for the nine-month period.
- Operating cash flow improved to $3.5 million from a use of $17.3 million, helped by working-capital changes and the sale of the company’s only long-term contract receivable.
- In May 2015, the company replaced its prior credit facility with a $40 million equipment-based facility. The transaction generated $32.1 million of new borrowings and included $1.3 million of deferred debt issuance costs.
- Property and equipment, net, declined to $74.6 million from $87.1 million at December 31, 2014, reflecting asset sales and reduced capital expenditures.
Outlook, commentary, risks and unusual items
- Management stated that available cash, operating cash flow and borrowing capacity were expected to provide sufficient liquidity for the next twelve months, including bonding requirements. Management also cautioned that continued losses or a substantial cash constraint could materially impair liquidity.
- Management identified $3.8 million of underutilized or non-core equipment held for sale and expected to use sale proceeds for debt reduction and working capital.
- The company expects to pursue higher-margin work, adjacent markets and margin improvement opportunities. Its goodwill impairment analysis assumed improved project performance, a strong base market and future margin improvement; no impairment was recorded, but a future shortfall in performance or stock price could result in a material charge.
- The company sold a Harris County, Texas land parcel for approximately $2.4 million and recognized a gain of approximately $1.4 million. It also sold its long-term contract receivable for approximately $7.1 million and recorded a loss of approximately $1.4 million.
- The company retired its diesel-fuel hedging program after the final swap was settled in August 2015. No derivative contracts were outstanding at September 30, 2015.
- Management reported material weaknesses in internal control over financial reporting. One related to reviewing construction-project work-in-progress estimates at the Texas subsidiary; another related to review and challenge of inputs used in the goodwill valuation model. Disclosure controls were therefore deemed ineffective at quarter-end.
- Construction contracts are accounted for using percentage-of-completion estimates, and revisions to projected revenue, costs, penalties, change orders and profitability can materially affect reported results.
- Unconsolidated joint ventures had approximately $35 million of remaining construction work, including $11 million attributable to Sterling. Because of joint and several liability provisions, Sterling could be responsible for a partner’s share if that partner fails to perform or fund its obligations.
- The company reported no pending legal matters expected by management to have a material adverse effect, but ordinary-course claims and litigation remain possible.
Investor verification points
- Verify the company identity and any subsequent corporate name changes, because the filing issuer is Sterling Construction Company, Inc., while the request metadata references Sterling Infrastructure, Inc.
- Assess the sustainability of the improved third-quarter gross margin against the nine-month decline and the company’s reliance on improved project execution assumptions.
- Review the Texas project revisions, the $2.8 million out-of-period adjustment and the status of remediation for the reported material weaknesses.
- Evaluate liquidity under the 12% equipment-based facility, the limited $2.2 million borrowing availability, asset-sale plans and potential interest-rate step-up provisions.
- Monitor backlog conversion, the $112 million of unawarded apparent-low-bid work and the decline in backlog from year-end.
- Consider potential goodwill impairment, joint-venture obligations, construction claims and contract-estimate revisions as downside risks.