Sterling Construction Company, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2014. The filing is unaudited and covers Sterling Construction Company, Inc. and subsidiaries, a heavy civil infrastructure contractor focused on transportation and water projects across multiple U.S. states.
Financial performance and position
| Metric | Three months ended June 30, 2014 | Three months ended June 30, 2013 | Six months ended June 30, 2014 | Six months ended June 30, 2013 |
|---|---|---|---|---|
| Revenue | $194.8 million | $133.4 million | $329.3 million | $244.4 million |
| Gross profit (loss) | $12.5 million | $(16.6) million | $20.4 million | $(15.2) million |
| Gross margin | 6.4% | (12.5)% | 6.2% | (6.2)% |
| Operating income (loss) | $2.5 million | $(26.0) million | $3.0 million | $(33.9) million |
| Net income (loss) attributable to common stockholders | $1.2 million | $(17.0) million | $1.4 million | $(21.6) million |
| Diluted EPS | $0.07 | $(0.93) | $0.08 | $(1.32) |
- Revenue increased 46.1% in the quarter and 34.8% year to date, primarily from more projects in progress and higher productivity, particularly in Texas and California.
- General and administrative expense was $9.5 million in the quarter and $18.0 million year to date, down 5.8% year to date. G&A declined as a percentage of revenue to 4.9% for the quarter and 5.5% year to date.
- Income tax expense was $28,000 for both the quarter and six-month period. Federal net operating loss carryforwards are expected to offset projected federal taxable income; state tax expense remains applicable in certain jurisdictions.
- Cash and cash equivalents were $14.3 million at June 30, 2014, compared with $1.9 million at December 31, 2013. Working capital increased to $41.2 million from $8.7 million.
- Operating cash flow was negative $7.5 million for the six months, an improvement from negative $26.9 million in the prior-year period. Working-capital uses included increases of $27.4 million in contract receivables and $20.3 million in costs and estimated earnings in excess of billings.
- Capital expenditures were $7.7 million, partially offset by $4.3 million of proceeds from equipment sales.
- Total debt was approximately $20.1 million, consisting primarily of $18.6 million outstanding under the revolving Credit Facility. The facility had $40 million of total borrowing capacity, with $18.4 million of availability after an outstanding $3.0 million letter of credit.
- On May 6, 2014, the company issued 2.1 million common shares at $6.90 per share and received approximately $14.0 million net proceeds, which were used to repay Credit Facility borrowings.
Material changes versus the prior comparable period
- The company returned to profitability after substantial losses in the prior-year quarter and six-month period. Management attributed the improvement primarily to the completion or substantial completion of three problem jobs that generated major downward margin revisions in 2013.
- Operating margin improved to 1.3% for the quarter and 0.9% year to date, compared with deficits of 19.6% and 13.9%, respectively.
- Management reported a net $5.0 million gain from changes in estimated revenues and gross margins on construction contracts during the six months, equal to approximately $0.27 per diluted share attributable to common stockholders.
- Backlog was $727 million at June 30, 2014, up from $687 million at December 31, 2013, but down from $799 million at March 31, 2014. Approximately $116 million of apparent low-bid work had not yet been formally awarded or finalized.
- The company consolidated Myers & Sons Construction, a 50%-owned variable interest entity, and reported $1.5 million of noncontrolling interest earnings for the six months.
- The company’s obligation related to the 50% membership interest in RHB subject to mandatory redemption was $24.3 million at June 30, 2014, including a $20.0 million redemption amount and $5.5 million of undistributed earnings, net of distributions.
Guidance, outlook, risks and unusual items
- Management was cautiously optimistic that improved execution, modest expected highway-construction growth and process improvements would produce full-year gross margins in the mid-single-digit range. The filing does not provide specific revenue or earnings guidance.
- Infrastructure funding remained subject to federal and state budget decisions. Management cited MAP-21 and the expanded TIFIA program as providing some near-term funding certainty.
- Construction results depend heavily on percentage-of-completion estimates. Changes in job performance, site conditions, costs, penalties, change orders and final settlements can materially affect reported revenue and profit.
- The Credit Facility includes leverage, tangible-net-worth, asset-coverage and loss covenants, as well as restrictions on dividends, additional debt, liens, guarantees, acquisitions and investments. The company had violated certain covenants at December 31, 2013, but obtained a waiver and amendments. Management stated that it expects to remain compliant for at least the next twelve months.
- The company faces liquidity risk because contract receivable collections and working-capital requirements are difficult to predict. Delayed or lower-than-expected collections could adversely affect liquidity.
- Unconsolidated joint ventures had approximately $68.7 million of remaining backlog, of which approximately $20.4 million represented Sterling’s noncontrolling share. Joint venture agreements generally provide for joint and several liability if a partner cannot fund or perform its obligations.
- Diesel fuel swaps covered approximately 0.6 million gallons through August 2015 at fixed prices ranging from $2.75 to $2.88 per gallon. The instruments reduce exposure to fuel-price increases but also limit benefits from declining prices.
- The J. Banicki earn-out liability was estimated at $0.3 million at June 30, 2014. The potential earn-out could increase materially if specified EBITDA benchmarks are exceeded.
- Management reported no material pending litigation and stated that disclosure controls were effective as of June 30, 2014. A valuation allowance remained against net deferred tax assets.
Investor verification checklist
- Verify whether improved gross margins are sustainable after the 2013 problem projects have been completed and whether new projects are being won at acceptable margins.
- Monitor contract receivables, costs in excess of billings, operating cash flow and the timing of customer collections.
- Review Credit Facility covenant compliance, borrowing availability, interest-rate step-ups and liquidity thresholds.
- Assess backlog conversion, including the $116 million of apparent low-bid work that had not been formally awarded.
- Evaluate potential obligations under joint and several joint-venture arrangements and the mandatory redemption obligation related to RHB.
- Reconcile cash generation with capital expenditures, equipment sales, debt drawdowns and equity financing.
- Consider the effect of construction-contract estimate revisions, weather, labor and material costs, fuel prices, government infrastructure funding and project delays.