Sterling Construction Company, Inc. — FY2013 Form 10-K Summary
Business context and reporting period
Filed March 17, 2014 for the fiscal year ended December 31, 2013. The filing identifies the registrant as Sterling Construction Company, Inc. (the request metadata references Sterling Infrastructure, Inc.). Sterling operates as one reportable segment focused on heavy civil construction, including highways, roads, bridges, light rail, water, wastewater and storm-drainage infrastructure. Its principal markets are Texas, Utah, Nevada, Arizona, California and Hawaii, with additional projects in other states.
Most work is performed for public-sector customers under fixed-unit-price or lump-sum contracts and accounted for using the percentage-of-completion method. Backlog was $687 million at year-end, compared with $656 million in 2012; approximately $123 million of apparent low bids was excluded because contracts had not been formally awarded or priced.
Financial results and liquidity
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Revenue | $556.2 million | $630.5 million | Down 11.8% |
| Gross profit (loss) | $(29.9) million | $47.5 million | Down $77.4 million |
| Gross margin | (5.4)% | 7.5% | Down 12.9 percentage points |
| Operating income (loss) | $(69.6) million | $15.0 million | Turned to loss |
| Net income (loss) | $(70.0) million | $17.7 million | Turned to loss |
| Net loss attributable to common stockholders | $(73.9) million | $(0.3) million | Worsened materially |
| Basic and diluted loss per share | $(4.91) | $(0.26) | Worsened |
| Operating cash flow | $(21.6) million | $24.8 million | Declined $46.4 million |
| Capital expenditures | $14.9 million | $37.4 million | Down $22.5 million |
| Cash and cash equivalents | $1.9 million | $3.1 million | Down $1.3 million |
| Working capital | $8.7 million | $87.5 million | Down $78.8 million |
Results were driven primarily by net downward revisions of estimated revenues and gross margins on Texas and Arizona projects, particularly three large Texas projects awarded before 2012. Changes in contract estimates produced a net operating charge of approximately $57.6 million, or $3.46 per diluted share attributable to Sterling common stockholders.
At December 31, 2013, total assets were $273.0 million and equity attributable to Sterling common stockholders was $128.9 million, down from $210.1 million in 2012. Goodwill remained $54.8 million. The fourth-quarter goodwill impairment review found no impairment, but management stated that fair value was only approximately 12% above carrying value, leaving sensitivity to changes in forecast cash flows and market conditions.
Debt totaled $8.5 million, including $7.8 million outstanding under the Comerica credit facility, $0.2 million of mortgage debt and $0.5 million of equipment notes. Credit-facility availability was $30.2 million after outstanding borrowings and a $2.0 million letter of credit. The company sold all short-term investments during 2013, generating approximately $48.2 million of net proceeds that were used primarily to repay credit-facility borrowings and support operations.
Material changes versus the prior comparable period
- Revenue declined 11.8%, primarily because large Utah projects and certain Arizona projects were completed.
- Gross margin fell from 7.5% to negative 5.4%, reflecting major project estimate revisions, lower productivity, differing site or contract conditions and delays in addressing project issues.
- General and administrative expense increased 16.4% to $41.0 million and rose to 7.4% of revenue from 5.7%, partly because of expanded information-technology and process-improvement activities.
- Operating results moved from $15.0 million of income to a $69.6 million loss. The 2013 loss did not include a goodwill impairment charge; the comparable 2011 period included a $67.0 million impairment.
- Operating cash flow changed from a $24.8 million inflow to a $21.6 million outflow. Contracts receivable increased $6.4 million, while accounts payable increased $13.8 million.
- Working capital contracted substantially, and the company recorded a $28.2 million valuation allowance against net deferred tax assets because of cumulative losses and reduced confidence in future realization.
- The company purchased the remaining 20% interest in RLW at the end of 2012; therefore, 2013 results had lower noncontrolling-interest allocations than 2012.
- The company was not in compliance with leverage and tangible-net-worth covenants at December 31, 2013. A post-year-end waiver and fourth amendment waived the defaults but reduced total credit availability, increased borrowing costs and imposed 2014 liquidity thresholds.
Guidance, outlook, commentary and risks
Management was cautiously optimistic that operational improvements and the completion of significant write-downs on older projects would support gross margins in the mid-to-high single-digit percentage range in 2014. It expected 2014 capital expenditures to be similar to 2013 levels, approximately $14.9 million, subject to project awards and equipment needs. Management also expected longer-term recovery in backlog, revenue, margins, net income and earnings per share, but could not predict the timing.
Operational initiatives included stronger estimating and project-risk controls, improved overhead and equipment-cost allocation, better project reporting and clearer management responsibilities. The company also planned to diversify its project mix and pursue selected geographic expansion, alternative delivery methods and acquisitions.
- Fixed-price and percentage-of-completion contracts expose results to inaccurate bids, cost overruns, productivity problems, site conditions, change orders, claims, delays, penalties and subcontractor or supplier failures.
- Infrastructure demand depends heavily on federal, state and local funding, appropriations and governmental budgets. Public customers generally may terminate contracts for convenience and pay only for completed work and eligible termination costs.
- Customer concentration is significant: Caltrans represented 16.6% of 2013 revenue and UDOT 9.1%. At year-end, Caltrans, TxDOT, NTTA, the City of Honolulu and the San Jacinto River Authority represented 30.6%, 11.8%, 8.8%, 5.7% and 4.7% of backlog, respectively.
- Joint-venture arrangements generally impose joint and several liability. The company reported approximately $101 million of remaining work on unconsolidated joint ventures, including a $31 million proportionate share.
- Bonding capacity is essential and depends on capitalization, working capital, performance and surety-market conditions. Construction-contract proceeds and rights were pledged to the bond surety, while substantially all other assets secured the credit facility.
- Interest-rate, fuel, materials, labor, weather, environmental, safety, immigration, union, litigation, cyber and regulatory risks could materially affect profitability and cash flow.
- The company hedged approximately 1.1 million gallons of diesel purchases through August 2015, at fixed prices ranging from $2.75 to $2.93 per gallon.
- The company had approximately $49.1 million of federal and $28.7 million of state tax-loss carryforwards, but recorded a substantial valuation allowance against related deferred tax assets.
Grant Thornton issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal control over financial reporting were effective at December 31, 2013.
Most important facts for investors to verify
- Whether the 2014 margin recovery target was achieved and whether project estimate revisions normalized.
- The status of the Comerica credit facility, covenant compliance, liquidity thresholds, borrowing costs and available borrowing capacity.
- Cash conversion, working-capital requirements, contract receivables, retainage and billings in excess of costs and estimated earnings.
- Backlog quality, formal awards, project concentration and the profitability of the $687 million reported backlog.
- Potential additional losses, claims, penalties or change-order disputes on the three large Texas projects and other underperforming contracts.
- Whether the $54.8 million goodwill balance remains recoverable given the narrow valuation cushion reported at year-end.
- Potential obligations related to joint-and-several joint-venture liabilities, surety bonds, the $24.0 million mandatory redemption liability related to RHB, and the JBC earn-out.
- Progress in realizing operational-control improvements, cost reductions and the planned geographic and project-mix diversification.