Sterling Construction Company, Inc. — FY2014 Form 10-K Summary
Business context and reporting period
The filing is for the fiscal year ended December 31, 2014, with quarterly information for the fourth quarter. The registrant is Sterling Construction Company, Inc. and its subsidiaries, a U.S. heavy civil construction company focused on transportation and water infrastructure, including highways, bridges, light rail, water, wastewater and storm-drainage projects. Operations are concentrated in Texas, Utah, Nevada, Arizona, California and Hawaii, with additional projects in other states. The company reports one operating and reportable segment: heavy civil construction.
Revenue is recognized primarily under the percentage-of-completion method. Most contracts are fixed-unit-price or lump-sum arrangements, exposing results to cost overruns, productivity, labor, material, weather, subcontractor and change-order risks.
Key financial metrics
| Metric | FY2014 | FY2013 | Change or comment |
|---|---|---|---|
| Revenue | $672.2 million | $556.2 million | Increased 20.9% |
| Gross profit (loss) | $32.4 million | $(29.9) million | Gross margin improved to 4.8% from (5.4)% |
| Operating loss | $(4.2) million | $(69.2) million | Material improvement |
| Loss before taxes and noncontrolling interests | $(4.6) million | $(68.8) million | Material improvement |
| Net loss attributable to Sterling stockholders | $(9.8) million | $(73.9) million | Loss per share improved to $(0.54) from $(4.91) |
| Operating margin | (0.6)% | (12.5)% | Improved |
| Operating cash flow | $(10.5) million | $(22.1) million | Still negative |
| Capital expenditures | $13.5 million cash additions; $16.7 million total equipment expenditures | $14.4 million cash additions | Management expects lower 2015 spending |
| Cash and equivalents | $22.8 million | $1.9 million | Improved primarily through financing activities |
| Working capital | $52.3 million | $8.7 million | Increased $43.6 million |
| Long-term debt | $37.0 million | $8.3 million | Debt increased substantially |
| Backlog | $764 million | $687 million | Increased 11.2% |
Fourth-quarter 2014 revenue was $153.6 million, gross profit was $3.7 million, and net loss attributable to Sterling stockholders was $7.3 million, or $(0.39) per share. The fourth quarter included a $9.5 million net charge from changes in estimated contract revenues and margins.
At December 31, 2014, total assets were $306.5 million, Sterling stockholders’ equity was $133.7 million, total equity was $141.1 million and goodwill was $54.8 million. Contracts receivable, including retainage, totaled $78.9 million, including $16.4 million of retainage.
Material changes versus the prior comparable period
- Revenue increased $116.0 million, primarily from more projects in progress in Texas and California, although performance was weaker than expected in California, Utah and Hawaii.
- Gross margin recovered from a 2013 deficit, but remained below the 7.5% achieved in 2012. Project profitability continued to be reduced by bid and site-condition issues, construction delays, subcontractor and vendor problems, commodity shortages and skilled-labor shortages, particularly in Texas.
- Net downward revisions to estimated contract revenue and gross margin produced a $9.1 million operating charge in 2014, compared with a $57.6 million charge in 2013. The filing states that the 2014 charge reduced diluted earnings by approximately $0.50 per share.
- General and administrative expense declined to $36.9 million from $41.0 million, and declined to 5.5% of revenue from 7.4%.
- Operating cash flow remained negative, although the use of cash improved from 2013. Cash and working capital increased largely because of a $14.0 million common-stock offering and a $26.8 million net draw on the credit facility.
- Backlog increased by $77 million to $764 million. Approximately $24 million of apparent low bids was excluded because awards were not final, and approximately $16 million of backlog represented Sterling’s share of joint-venture work.
Debt, liquidity and financing
At December 31, 2014, the company had $34.6 million outstanding under its Comerica revolving credit facility, $3.0 million of letters of credit and only $2.4 million of stated availability under the $40.0 million facility. Total long-term debt, including equipment notes and a mortgage, was $37.0 million net of current maturities.
The company was not in compliance with the credit facility’s tangible-net-worth covenant at December 31, 2014. On March 12, 2015, the lender granted a waiver and amendment that reduced total availability to $35 million immediately, $25 million on June 1, 2015 and $15 million on September 1, 2015; increased the stated annual borrowing rate from 4.75% to 6.75%; modified the tangible-net-worth covenant; and imposed a $0.4 million fee. Management stated that it expected to remain compliant for at least the next twelve months, but also warned that continued losses could create working-capital constraints and require asset sales or other actions.
Guidance, outlook, risks and unusual items
- Management expects 2015 capital expenditures to be below 2014 levels and is reviewing underutilized equipment for possible liquidation.
- Management is targeting smaller, shorter-duration projects with improved gross-margin opportunities and continues to pursue geographic diversification, operational controls, estimating improvements and selective acquisitions.
- Management expects long-term population growth and infrastructure needs to support future opportunities, but near-term funding remains uncertain and competition has pressured bid prices and margins.
- The former president and chief executive officer, Peter MacKenna, left effective January 31, 2015. Paul J. Varello became acting chief executive officer effective February 1, 2015. The company recorded $1.8 million of severance expense in February 2015.
- Goodwill was not impaired at December 31, 2014 after a triggering-event assessment, but the company warned that a continued depressed stock price or lower forecast cash flows could result in a future impairment of the $54.8 million goodwill balance.
- The company recorded a $36.6 million valuation allowance against net deferred tax assets, including federal and state net operating losses, because management concluded that realization was not likely based principally on cumulative losses.
- Key risks include fixed-price contract losses, inaccurate cost estimates, project delays, claims and change-order disputes, labor shortages, subcontractor and supplier failures, weather, governmental infrastructure funding, customer concentration, bonding capacity, covenant compliance, joint-and-several joint-venture liability, environmental and safety regulation, and access to working capital.
- Caltrans represented 14.5% of 2014 revenue. At year-end, TxDOT and Caltrans represented 30.6% and 23.2% of backlog, respectively, increasing exposure to individual customers and public funding decisions.
- The company had approximately $55 million of work remaining on unconsolidated joint ventures, of which $16 million represented Sterling’s proportionate share. Joint-venture agreements generally create potential joint and several liability if a partner cannot perform.
Grant Thornton LLP issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management likewise concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2014.
Most important facts for investors to verify
- Whether the company can restore sustained profitability, particularly on Texas projects, after the 2014 contract-estimate charges.
- Compliance with the amended credit-facility covenants and the effect of declining availability and higher interest costs on liquidity.
- Actual operating cash flow, collections of contract receivables, retainage and costs recognized in excess of billings.
- Whether the $764 million backlog converts to revenue at acceptable margins and how much is concentrated among TxDOT, Caltrans and other public customers.
- Potential goodwill impairment following the post-year-end share-price decline and the company’s reduced cash-flow assumptions.
- Exposure to unresolved claims, change orders, project losses, joint-venture obligations, bonding requirements and mandatory redemption of the $20 million RHB member interest.
- Execution of the CEO transition and the effect of severance, management changes and operational-control initiatives on 2015 results.