Sterling Construction Company, Inc. — FY2012 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2012. The filing identifies the registrant as Sterling Construction Company, Inc., a Delaware corporation headquartered in Houston, Texas. The company operates as a single heavy civil construction segment, building transportation and water infrastructure primarily in Texas, Utah, Nevada, Arizona and California.
Business Context and Key Metrics
Sterling primarily serves public-sector customers under fixed-unit-price and lump-sum contracts, using its own crews and equipment. Transportation infrastructure represented 61% of 2012 revenue. UDOT and Caltrans contributed 16.0% and 15.0% of consolidated revenue, respectively.
| Metric | FY2012 | FY2011 | Change |
|---|---|---|---|
| Revenue | $630.5 million | $501.2 million | +25.8% |
| Gross profit | $47.5 million | $39.8 million | +19.2% |
| Gross margin | 7.5% | 8.0% | Down 0.5 points |
| Operating income (loss) | $15.0 million | $(52.2) million | Improved |
| Net income (loss) | $17.7 million | $(34.7) million | Improved |
| Net income (loss) attributable to Sterling stockholders | $(0.3) million | $(35.9) million | Improved |
| Basic and diluted EPS | $(0.26) | $(2.24) | Improved |
| Operating cash flow | $24.8 million | $21.0 million | +18.1% |
| Backlog | $656 million | $616 million | +6.5% |
Results are affected by noncontrolling interests. Net loss attributable to common stockholders included $6.7 million of additional earnings allocated to RLW noncontrolling owners, or approximately $4.3 million net of tax, following an amendment to the RLW operating agreement.
Cash Flow, Liquidity and Debt
- Cash and cash equivalents declined to $3.1 million from $16.4 million; short-term investments were $49.2 million.
- Working capital was $87.5 million, down from $94.7 million.
- Capital expenditures were $37.4 million, partly offset by $12.5 million of property and equipment sale proceeds.
- The company paid $23.1 million to acquire the remaining 20% of RLW and made $10.2 million of distributions to noncontrolling owners.
- Debt totaled $24.3 million, consisting primarily of $24.0 million drawn under the Comerica credit facility and a $0.3 million mortgage.
- The credit facility provides up to $50 million of borrowings and letters of credit, matures September 30, 2016, and had $24.2 million of availability at year-end after borrowings and a $1.8 million letter of credit.
- The company was in compliance with all credit-facility covenants at December 31, 2012. In January 2013, it sold approximately $27.7 million of short-term investments to repay the $24.0 million credit-facility balance.
- Management stated that available liquidity, operating cash flow and unused credit capacity were sufficient for the next twelve months, including bonding requirements.
Material Changes Versus Prior Period
- Revenue increased primarily because of a full year of activity from the 2011 JBC and Myers acquisitions; Arizona and California revenue rose to $168.9 million from $19.5 million.
- Gross margin declined because of downward revisions to estimated profitability on several projects, primarily in Texas. The 2012 net charge from changes in contract estimates was $4.9 million in operating income and $5.3 million after tax attributable to Sterling stockholders.
- Operating results improved substantially because 2012 had no goodwill impairment charge, compared with a $67.0 million charge in 2011.
- General and administrative expense increased 42.6% to $35.2 million, reflecting full-year acquisition-related costs, higher compensation and professional fees. It included a $250,000 signing bonus for the new CEO and $670,000 of compensation for the retiring CEO.
- The company acquired the remaining 20% of RLW for $23.1 million on December 31, 2012; an additional $568,000 payment was expected in 2013.
- New contract awards totaled $643 million, compared with $595 million in 2011. Backlog increased to $656 million, although management estimated that backlog margins were below the 7.5% realized in 2012.
- Management identified and remediated the 2011 material weakness related to estimating construction-project revenues and costs. Management and the independent auditor concluded that internal control over financial reporting was effective as of December 31, 2012.
Outlook, Risks and Unusual Items
Management did not expect a significant improvement in gross margins during 2013 and expected continued pressure on margins for new awards. It expected 2013 capital expenditures to be lower than 2012, absent a project requiring significant equipment purchases. The company expects long-term infrastructure demand to benefit from population growth and infrastructure needs, but could not predict when market conditions would return to historical profitability levels.
- Key risks include inaccurate cost estimates, fixed-price contract overruns, project delays, adverse weather, change-order disputes, design errors, liquidated damages and subcontractor or supplier failures.
- Government funding and authorization levels remain uncertain despite the 2012 MAP-21 transportation legislation. Reduced federal, state or local spending could limit new awards and compress margins.
- Customer concentration is significant: Caltrans represented 31.0% of year-end backlog, while NTTA, Central Texas Regional Mobility Authority, TxDOT and ADOT represented 16.2%, 7.4%, 6.8% and 5.7%, respectively.
- Unconsolidated joint ventures had approximately $214 million of remaining work, including $77 million attributable to Sterling. Joint venture agreements generally impose joint and several liability.
- Goodwill was $54.8 million at year-end. The 2012 impairment test indicated fair value was only approximately 3% above carrying value, so a modest deterioration in forecast cash flows could trigger impairment.
- The company had $6.0 million of operating lease commitments, a $2.4 million JBC earn-out liability and $0.6 million of RLW-related obligations in its contractual-obligations table.
- Diesel fuel hedges covered approximately 1.2 million gallons through 2014, with a year-end fair value asset of approximately $8,000.
- A previously disclosed subcontractor lawsuit was resolved in October 2012 after payment of the judgment, court costs and attorney fees. Management did not believe other pending ordinary-course claims would materially affect results.
- The company has never paid cash dividends and does not anticipate paying dividends in the foreseeable future.
Investor Verification Checklist
- Verify the sustainability and quality of the $656 million backlog, including its below-current margin profile and the $63 million of apparent low bids excluded from backlog.
- Reconcile consolidated earnings with the substantial $18.0 million allocation to noncontrolling interests and the RLW operating-agreement amendment.
- Monitor project-estimate revisions, Texas project performance and whether the new estimating controls prevent further margin deterioration.
- Confirm the January 2013 repayment of the credit facility and assess remaining liquidity after the use of short-term investments.
- Evaluate goodwill impairment sensitivity, given the approximately 3% excess of estimated equity fair value over carrying value.
- Assess exposure to UDOT, Caltrans and other concentrated public customers, government funding changes, contract cancellations and joint-and-several venture liabilities.
- Review the audited financial statements and notes for detailed contract claims, retainage, related-party transactions, bonding obligations and self-insurance reserves.