Sterling Construction Company, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2015; filed August 10, 2015. The filing identifies the registrant as Sterling Construction Company, Inc. (the request metadata refers to Sterling Infrastructure, Inc.). The company is a heavy civil construction contractor focused on transportation and water infrastructure projects, principally in the southwestern United States. Interim results are unaudited and subject to seasonal variation.
Financial Performance and Position
| Metric | Three months ended June 30, 2015 | Three months ended June 30, 2014 | Six months ended June 30, 2015 | Six months ended June 30, 2014 |
|---|---|---|---|---|
| Revenue | $177.4 million | $194.8 million | $295.1 million | $329.3 million |
| Gross profit | $9.1 million | $12.5 million | $2.3 million | $20.4 million |
| Gross margin | 5.1% | 6.4% | 0.8% | 6.2% |
| Operating income (loss) | $(0.2) million | $2.5 million | $(16.8) million | $3.0 million |
| Net income (loss) attributable to common stockholders | $(2.5) million | $1.2 million | $(19.5) million | $1.4 million |
| Diluted earnings (loss) per share | $(0.13) | $0.07 | $(1.03) | $0.08 |
- Cash and cash equivalents were $14.3 million at June 30, 2015, down from $22.8 million at December 31, 2014.
- Working capital was $31.1 million, compared with $52.3 million at year-end 2014. Total assets were $307.3 million and total equity was $121.4 million.
- Operating activities used $3.6 million of cash in the first six months, compared with $8.5 million used in the prior-year financial statements; the MD&A cash-flow table presents prior-year operating cash use as $7.5 million.
- Investing activities used $2.9 million, including $3.3 million of capital expenditures and $3.3 million of proceeds from equipment sales.
- Net cash decreased by $8.5 million during the first six months.
- Debt at June 30, 2015 included $14.6 million drawn on a revolving loan and a $20.0 million term loan. Total balance-sheet debt, including other debt, was approximately $38.3 million, consisting of $5.0 million of current maturities and $33.3 million of long-term debt.
- The new equipment-based facility has an initial fixed interest rate of 12%, matures in May 2019, and had approximately $1.3 million of additional borrowing availability at quarter-end. The facility is secured primarily by construction equipment and other personal property.
- Backlog was $743 million at June 30, 2015, compared with $764 million at December 31, 2014. Approximately $57 million of apparent low-bid work was excluded pending formal award or price finalization.
Material Changes Versus the Prior Comparable Period
- Second-quarter revenue declined 8.9%, while six-month revenue declined 10.4%, primarily because large Texas projects were completed and certain project estimates were revised downward.
- Six-month gross profit fell 88.8%, and gross margin declined to 0.8% from 6.2%. Management attributed the deterioration to downward percentage-of-completion revisions, higher Texas labor rates, defective materials and related rework, uncollectible change orders, and unusually heavy Texas rainfall.
- Second-quarter gross margin also declined, primarily because of record rainfall affecting Texas operations.
- General and administrative expense increased 17.8% for the six-month period, principally because of $2.4 million of nonrecurring employee severance costs recorded in the first quarter.
- The company recorded a $2.8 million out-of-period revenue decrease in the first quarter after reviewing projects. Management concluded the adjustment was immaterial to current and prior financial statements.
- On May 29, 2015, the company replaced its prior Comerica credit facility with a $40.0 million equipment-based facility. It recorded a $0.2 million loss on extinguishment of the prior debt and $1.3 million of deferred debt issuance costs.
- Goodwill impairment testing was triggered by the stock-price decline and first-quarter loss, but no impairment was recorded.
Outlook, Risks, Contingencies, and Unusual Items
- Management stated that available cash, operating cash flow, and borrowing capacity were expected to fund operations and bonding requirements for the next twelve months. Management also cautioned that continued losses, cash constraints, or inability to obtain financing could materially affect liquidity.
- Capital expenditures for the second half of 2015 were expected to be below the comparable prior-year period, with continued efforts to sell underutilized equipment.
- The company planned to sell its sole long-term contract receivable for approximately $7.3 million on a non-recourse basis and a Harris County, Texas land parcel for approximately $2.4 million, both anticipated to close in the third quarter of 2015.
- Fuel hedging was being discontinued. At June 30, 2015, contracts covered 20,000 gallons at $2.75 per gallon, with the final swaps expected to settle in August 2015.
- Unconsolidated joint ventures had approximately $41 million of remaining construction work, including $13 million attributable to Sterling. Joint venture agreements may create joint and several liability if a partner cannot perform or fund its share.
- The company disclosed a material weakness in internal control over financial reporting related to review of Texas construction-project costs and revenues. Disclosure controls were therefore deemed ineffective at June 30, 2015. Remediation included personnel changes, increased senior oversight, and enhanced work-in-progress procedures.
- Effective July 3, 2015, the chief financial officer and chief accounting officer resigned. Kevan M. Blair became interim CFO and chief accounting officer, and the company began an internal and external search for a permanent CFO. The company recorded $0.5 million of severance expense in July.
- Key operating risks include project-cost estimation, weather, labor and material cost escalation, defective materials, change-order collectability, government infrastructure funding, competitive bidding, subcontractor and joint-venture performance, and potential delays or liquidated damages.
- Normal-course litigation was disclosed, but management stated that no pending or threatened matters were expected to have a material adverse effect.
Investor Verification Checklist
- Verify the sustainability of project margins and whether Texas project estimates, rework costs, labor rates, and change-order collectability have stabilized.
- Review the remediation and subsequent testing of the material weakness in project accounting and internal controls.
- Monitor liquidity, operating cash flow, borrowing-base availability, and the 12% cost of the equipment-based facility.
- Confirm completion and cash proceeds from the planned receivable and land sales.
- Assess backlog conversion, award timing, margins on new work, and the effect of government infrastructure funding.
- Evaluate potential exposure from joint and several obligations, mandatory redemption of a member’s interest, and the equipment collateral supporting the debt facility.
- Follow the CFO transition and any additional severance or restructuring costs.