Sterling Construction Company, Inc. — Q1 2012 Form 10-Q Summary
Business context and reporting period
The filing covers the three months ended March 31, 2012. The company is a heavy civil contractor focused on transportation and water infrastructure, primarily for public-sector customers, with operations in Texas, Utah, Nevada, Arizona, California and other states. Revenue is recognized using the percentage-of-completion method, and most contracts generally run 12 to 36 months.
The filing identifies the registrant as Sterling Construction Company, Inc. The company reported 16.3 million common shares outstanding at April 30, 2012. Results may be seasonally variable and are not necessarily indicative of full-year performance.
Key financial metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Revenue | $98.4 million | $99.2 million | Down 0.8% |
| Gross profit | $1.9 million | $7.6 million | Down 75.4% |
| Gross margin | 1.9% | 7.7% | Down 5.8 percentage points |
| Operating income (loss) | $(4.6) million | $1.7 million | Shifted to loss |
| Income (loss) before taxes | $(3.8) million | $1.6 million | Shifted to loss |
| Net income | $0.2 million | $1.5 million | Down 86.8% |
| Net income (loss) attributable to common stockholders | $(7.5) million | $0.04 million | Shifted to loss |
| Diluted EPS | $(0.44) | $0.00 | Lower |
| Net cash provided by operating activities | $1.4 million | $5.4 million | Down $4.1 million |
| Capital expenditures | $5.9 million | $8.4 million | Lower |
| Cash and cash equivalents | $16.6 million | $12.4 million | Compared with Q1 2011 ending cash |
At March 31, 2012, short-term investments were $43.6 million, total current assets were $166.2 million, working capital was $92.1 million, and total assets were $308.9 million. Total debt was approximately $0.8 million, consisting primarily of current maturities and a mortgage; there were no borrowings outstanding under the $50 million credit facility, although a $1.8 million letter of credit reduced available capacity to $48.2 million.
The company reported a $4.0 million income tax benefit despite a pretax loss. The benefit primarily reflected deferred tax effects related to the increased allocation of earnings to RLW noncontrolling interest owners. The reported effective tax rate was 105.2%, while management stated that the rate excluding noncontrolling-interest effects was 34.0%.
Material changes versus the prior comparable period
- Revenue was essentially flat, but gross profit declined by $5.7 million as gross margin fell from 7.7% to 1.9%.
- Management recorded a net $3.9 million pretax charge from revisions to estimated revenues and gross profit on construction projects, primarily in Texas. The estimated after-tax impact attributable to common stockholders was approximately $2.4 million, or $0.15 per diluted share.
- Production issues, lower productivity, higher equipment costs, differing site or contract conditions, labor shortages, and performance issues involving suppliers, subcontractors or customers contributed to contract estimate revisions.
- General and administrative expense increased 26.6% to $7.7 million, including costs related to JBC and Myers and higher professional fees.
- Net income attributable to noncontrolling interests increased to $7.7 million from $1.4 million. A January 1, 2012 amendment to the RLW operating agreement excluded goodwill impairment from the calculation of distributions to RLW noncontrolling owners, increasing their reported earnings by $6.7 million and increasing the related tax benefit by $2.4 million.
- Backlog increased to $868 million at March 31, 2012 from $741 million at December 31, 2011. Approximately $565 million was expected to be constructed during the remainder of 2012, and the company received or was the apparent low bidder on $194 million of contracts during the quarter.
Cash flow, liquidity and debt
- Operating cash flow was $1.4 million, compared with $5.4 million in Q1 2011. Working-capital movements included lower receivables and higher accounts payable, partially offset by increased contract costs, joint-venture receivables, taxes receivable, inventories and other current assets.
- Investing cash outflow was $1.1 million, including $5.9 million of capital expenditures, $11.3 million of short-term investment sales, $9.8 million of purchases and $3.3 million of proceeds from equipment sales. Equipment disposals generated a $1.2 million gain.
- Financing cash outflow was $0.1 million. The company drew and repaid $1.0 million under its credit facility during the quarter.
- Management stated that available cash, short-term investments, operating cash flow and unused credit capacity were sufficient to fund the next twelve months, including bonding requirements. The company was in compliance with its credit-facility covenants at March 31, 2012.
Guidance, outlook, risks and unusual items
Management expected 2012 revenue to increase more than 25% from 2011, driven by higher beginning backlog, a full year of JBC and Myers operations, and new awards. However, management expected 2012 gross margin to be below the 8.0% reported for 2011 because of lower-margin backlog and ongoing operational issues. Net income and diluted EPS attributable to common stockholders for April through December 2012 were expected to be comparable to $5.9 million and $0.31 per share for the comparable 2011 period, excluding the 2011 goodwill impairment.
The company stated that it did not expect the internal process improvements to have a substantial impact on 2012 results. A material weakness in internal control over financial reporting related to the estimation and review of construction-contract revenues and gross profits continued to exist at March 31, 2012. Management was implementing improved estimating, project-risk identification, cost-allocation and reporting processes.
- Infrastructure funding remained uncertain because the federal government had not enacted a long-term, adequately funded highway bill; competitive bidding was pressuring margins.
- Backlog contracts may generally be canceled at the customer’s election, although the company had not historically experienced material adverse effects from cancellations.
- The company had approximately $454.1 million of remaining work in unconsolidated construction joint ventures, including $112.4 million representing Sterling’s proportionate share. Joint venture arrangements may create joint and several liability if a partner cannot perform or fund its obligations.
- The company hedged diesel exposure on 660,000 gallons through December 2013 at fixed prices ranging from $2.99 to $3.33 per gallon. The hedges reduce adverse fuel-price exposure but also limit benefits from falling prices.
- A $1.0 million jury verdict against Road and Highway Builders remained on appeal, secured by a $1.3 million bond. Management expected a Nevada Supreme Court decision by mid-2012 and did not expect other litigation to be material.
- On April 27, 2012, RHB entered into a transaction granting its CEO a 50% interest in exchange for companies with approximately $12 million of machinery, equipment and quarry land. Sterling also agreed to provide RHB with a $5 million line of credit.
Most important facts for investors to verify
- Whether the continuing material weakness in contract-estimate controls is remediated and whether further contract losses or estimate revisions emerge.
- Whether the company achieves its expectation of more than 25% revenue growth while maintaining sufficient cash generation despite projected lower margins.
- The quality and profitability of the $868 million backlog, including the approximately $565 million expected to be executed during the remainder of 2012 and the $11 million not yet officially awarded.
- The effect of RLW noncontrolling-interest arrangements, including the $24.3 million obligation at March 31, 2012 and future put/call requirements.
- Federal, state and local infrastructure funding and competitive bidding conditions in the company’s principal markets.
- Potential obligations from joint and several liabilities, litigation, equipment purchases, the RHB transaction and the related $5 million credit commitment.