Sterling Construction Company, Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2013. The filing identifies the registrant as Sterling Construction Company, Inc. The company is a heavy civil infrastructure contractor focused on transportation and water projects, primarily in Texas, Utah, Nevada, Arizona, California, Hawaii and other markets.
Financial performance and position
| Metric | Three months ended Sept. 30, 2013 | Three months ended Sept. 30, 2012 | Nine months ended Sept. 30, 2013 | Nine months ended Sept. 30, 2012 |
|---|---|---|---|---|
| Revenue | $185.9 million | $205.3 million | $430.3 million | $472.4 million |
| Gross profit (loss) | $8.4 million | $14.2 million | $(6.9) million | $31.2 million |
| Gross margin | 4.5% | 6.9% | (1.6)% | 6.6% |
| Operating income (loss) | $1.5 million | $4.2 million | $(32.6) million | $7.9 million |
| Net income (loss) attributable to Sterling stockholders | $(0.2) million | $1.0 million | $(21.8) million | $(3.2) million |
| Diluted loss per share | $(0.06) | $0.01 | $(1.38) | $(0.27) |
- Cash flow: Operating activities used $11.8 million in the first nine months of 2013 versus $5.0 million provided in the prior-year period. Investing activities provided $20.5 million, primarily from net sales of short-term investments. Financing activities used $6.8 million, including net Credit Facility repayments and distributions to noncontrolling interest owners.
- Liquidity: Cash and cash equivalents were $5.0 million at September 30, 2013, compared with $3.1 million at December 31, 2012. Short-term investments were $21.0 million, down from $49.2 million. Working capital was $54.0 million, down from $87.5 million.
- Debt: Total reported debt was approximately $20.8 million, consisting of $20.4 million outstanding under the Credit Facility and a mortgage of approximately $0.2 million. The $50.0 million Credit Facility had $27.6 million of stated availability after outstanding borrowings and a $2.0 million letter of credit.
- Balance sheet: Total assets were $354.1 million and total equity was $190.8 million at September 30, 2013. Contracts receivable increased to $90.7 million from $70.8 million at year-end, while accounts payable increased to $79.1 million from $47.8 million.
Material changes versus the prior comparable period
- Revenue declined 9.4% in the quarter and 8.9% year to date, primarily because large Utah projects were completed during 2012.
- Profitability deteriorated substantially year to date. Management reported a net $23.3 million charge from revisions to estimated revenues and margins on construction projects, producing a $15.6 million after-tax impact, or $0.94 per diluted share attributable to Sterling stockholders.
- Production and project-estimate issues, particularly in Arizona and Texas and on legacy projects booked before 2012, reduced gross margin to a 1.6% deficit year to date. Quarterly gross margin improved from a 12.5% deficit in the second quarter of 2013 to 4.5% in the third quarter.
- General and administrative expenses increased 3.4% year to date and represented 6.3% of revenue, reflecting expanded information-systems staffing, employee benefit costs and operational and financial process-improvement costs.
- The effective tax rate was a 41.1% benefit year to date, mainly due to a $10.2 million deferred tax benefit associated with project-loss revisions and resulting net operating losses. Management expects the deferred tax benefit to be deductible in future years.
- Noncontrolling-interest earnings declined substantially, partly because the company purchased the remaining 20% interest in RLW on December 31, 2012. The company also recorded a $1.9 million pretax charge during the first nine months to revalue the RHB noncontrolling interest obligation.
Backlog, outlook and management commentary
- Construction backlog was $694 million at September 30, 2013, up from $656 million at December 31, 2012 and down from $714 million at June 30, 2013. New third-quarter awards were $165 million.
- Approximately $120 million of potential work was excluded from backlog because the company was apparent low bidder but contracts had not been formally awarded or prices had not been finalized. Backlog included approximately $38 million attributable to the company’s share of unconsolidated joint-venture revenues.
- Management stated that backlog margins were below the 7.5% margin realized in 2012 because of legacy-project production issues. It expected margins on projects awarded in 2013 to improve 2014 results.
- The company obtained an August 8, 2013 waiver and amendment after failing its leverage covenant at June 30, 2013. The amendment relaxed the leverage requirement through March 31, 2014 and increased borrowing rates by 100 basis points. The company reported compliance with all financial covenants in the third quarter and expected compliance through at least September 30, 2014.
- Management believed available cash, investments and unused Credit Facility capacity were sufficient to fund the next twelve months, including bonding requirements, while noting that higher equipment purchases or acquisitions could affect liquidity and tangible net worth.
Risks, contingencies and unusual items
- Construction revenue is recognized using the percentage-of-completion method, requiring estimates of contract revenue, costs, change orders, penalties and profitability. Revisions to those estimates can materially affect earnings.
- Key risks include project delays, cost overruns, design errors, adverse weather, labor and subcontractor performance, government infrastructure funding, competitive bidding, fuel and materials inflation, environmental and regulatory matters, and dependence on significant customers.
- Unconsolidated joint-venture contracts had approximately $124.7 million of remaining work, including $38.2 million representing Sterling’s proportionate share. Joint-venture arrangements generally provide for joint and several liability if a partner cannot perform or fund its share.
- The company had diesel-fuel swaps covering approximately 1.4 million gallons through August 2015, with fixed prices ranging from $2.75 to $3.21 per gallon. These contracts reduce fuel-price volatility but also limit benefits from lower fuel prices.
- The JBC earn-out liability had an estimated fair value of $2.0 million and an undiscounted amount of $2.2 million at September 30, 2013. The amount could vary materially with forecast EBITDA.
- Management stated that ordinary-course litigation was not expected to have a material effect on financial position, results or cash flows. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether project-estimate revisions and legacy-project losses have stabilized and whether reported quarterly margin improvement continues.
- The quality and collectability of the $90.7 million of contracts receivable and the effect of contract assets and billings on operating cash flow.
- Compliance with the amended Credit Facility covenants after the temporary leverage waiver expires and the effect of higher borrowing rates.
- Whether the $694 million backlog converts to revenue at anticipated margins, particularly the portion dependent on unresolved awards or joint ventures.
- The recoverability of deferred tax assets and the timing of future taxable income supporting the $10.2 million deferred tax benefit.
- Potential obligations from joint-and-several joint-venture liabilities, the RHB noncontrolling-interest obligation and the JBC earn-out.