STERLING INFRASTRUCTURE, INC. quarterly report, Q2 FY2011

Sterling Construction Company, Inc. Form 10-Q Summary

Reporting period: Three and six months ended June 30, 2011; filed August 8, 2011. The filing identifies the registrant as Sterling Construction Company, Inc. The company is a heavy civil construction contractor focused on transportation and water infrastructure, primarily in Texas, Utah and Nevada, with substantial public-sector customers and construction joint ventures.

Financial Performance and Position

Metric	Three Months 2011	Three Months 2010	Six Months 2011	Six Months 2010
Revenue	$128.5 million	$116.9 million	$227.7 million	$203.0 million
Gross profit	$13.6 million	$12.7 million	$21.2 million	$21.0 million
Gross margin	10.6%	10.9%	9.3%	10.3%
Operating income	$7.3 million	$7.4 million	$9.0 million	$10.2 million
Operating margin	5.7%	6.3%	3.9%	5.0%
Net income attributable to Sterling stockholders	$4.2 million	$4.7 million	$4.3 million	$6.2 million
Diluted EPS	$0.25	$0.28	$0.26	$0.38

Revenue increased 10.0% in the second quarter and 12.2% year to date, driven mainly by higher Texas activity and increased joint-venture activity, particularly in Utah.
Operating income declined 1.2% in the quarter and 12.0% year to date as general and administrative expenses rose faster than gross profit.
Net income attributable to Sterling stockholders declined 9.8% in the quarter and 31.6% year to date. Increased earnings attributable to noncontrolling interests reduced the portion available to Sterling stockholders.
Cash flow from operating activities was $6.6 million for the six months, compared with $23.7 million in the prior-year period.
Capital expenditures were $15.2 million, versus $3.6 million in the prior-year period, reflecting equipment replacement, project requirements and facility expansion.
At June 30, 2011, cash and cash equivalents were $10.3 million and short-term investments were $60.5 million. Working capital was $106.0 million.
Total debt was approximately $0.4 million, consisting primarily of a $0.4 million mortgage. There were no borrowings under the $75.0 million credit facility; $1.8 million of letters of credit reduced availability to $73.2 million.
Total assets were $375.9 million and Sterling common stockholders’ equity was $253.4 million at June 30, 2011.

Material Changes Versus Prior Period

Gross margin declined 30 basis points in the quarter and 100 basis points year to date because of competitive bidding pressure, lower-than-expected activity and under-absorption of indirect costs.
General and administrative expenses increased 20.2% in the quarter and 15.4% year to date, primarily due to higher salaries, wages and related benefits.
The prior-year period benefited from gains on investment securities; 2011 included a $41,000 quarterly loss and a $245,000 year-to-date loss on securities and other items.
The effective tax rate decreased to 14.4% from 27.7%, partly because of a $0.5 million reduction in estimated 2010 state tax expense and the tax treatment of earnings attributable to noncontrolling owners.
Backlog was $720 million at June 30, 2011, down from $740 million at March 31, 2011 but up from $557 million at June 30, 2010. Approximately $185 million had not yet been officially awarded.
Cash declined by $39.2 million during the first six months, primarily because of net purchases of short-term securities, capital expenditures and financing distributions.

Guidance, Outlook, Risks and Unusual Items

Management expects 2011 net income and diluted EPS attributable to Sterling stockholders to be significantly below 2010 levels because of competitive bidding, lower anticipated margins and infrastructure-funding uncertainty.
Management expects the markets eventually to recover and margins, earnings and revenue to return toward historical levels, but provides no timing for that recovery.
Key market risks include reductions or delays in federal, state and local infrastructure funding, particularly uncertainty regarding federal highway legislation; lower Utah and Nevada transportation spending; and municipal budget constraints.
Operational risks include project delays, weather, contract-estimate changes, liquidated damages, customer or subcontractor performance, labor and material cost escalation, competition and dependence on government customers.
The company began using diesel-fuel cash-flow hedges. At June 30, 2011, hedged volume totaled 1.79 million gallons at prices ranging from $2.99 to $3.24 per gallon, with an unrealized loss of $194,000. The hedges reduce downside fuel-price exposure but also limit benefits from falling prices.
Unconsolidated joint ventures had approximately $763 million of remaining work, of which Sterling’s proportionate share was $163 million. Joint venture arrangements generally involve joint and several liability.
A subsidiary is appealing a $1.0 million subcontractor judgment and has posted a $1.3 million bond. Management does not expect ordinary-course litigation to have a material adverse effect.
The IRS is examining the company’s 2007 through 2009 federal tax returns; management expects no material adjustments, interest or penalties.
On August 1, 2011, the company acquired J. Banicki Construction, Inc. for an initial $8.0 million, with potential earn-out payments of up to $5.0 million, and acquired a 50% interest in a California construction partnership for $1.3 million.
Management stated that disclosure controls were effective at June 30, 2011 and that there were no material changes in internal control over financial reporting.

Important Facts for Investors to Verify

Confirm the final awarded portion of the $720 million backlog and the timing and margin profile of backlog conversion.
Monitor gross-margin trends, project cost estimates and the effect of competitive bidding and under-absorbed indirect costs.
Assess operating cash conversion, especially growth in contracts receivable and costs in excess of billings.
Verify liquidity after the August 2011 acquisitions, capital expenditures, investment purchases and distributions to noncontrolling owners.
Review the terms, valuation and potential 2013 purchase obligation for the RLW noncontrolling interest and the extended RHB put/call obligation, increased to $8.2 million.
Evaluate exposure to government funding reductions, joint and several joint-venture obligations, fuel prices, weather and construction-contract estimates.
Track the subcontractor litigation appeal, IRS examination and potential earn-out payments related to J. Banicki Construction.