Sterling Construction Company, Inc. — Form 10-Q Summary
Business context and reporting period
Sterling Construction Company, Inc. and subsidiaries filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2012. The company is a heavy civil contractor focused on transportation and water infrastructure, including highways, bridges, rail, water, wastewater and storm-drainage projects. Its principal markets include Texas, Utah, Nevada, Arizona and California, with additional projects in Hawaii, Montana and Louisiana.
The filing reports 16,393,716 common shares outstanding as of July 31, 2012. Results include the acquisitions of J. Banicki Construction and Myers & Sons for periods following their August 2011 acquisitions, and Nevada operations acquired or assumed during 2012.
Financial performance and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $168.7 million, up 31.3% | $267.1 million, up 17.3% |
| Gross profit | $15.2 million | $17.0 million |
| Gross margin | 9.0%, versus 10.6% | 6.4%, versus 9.3% |
| Operating income | $8.2 million | $3.7 million |
| Operating margin | 4.9%, versus 5.7% | 1.4%, versus 3.9% |
| Net income | $7.7 million | $7.9 million |
| Net income attributable to Sterling stockholders | $3.3 million, or $0.15 diluted EPS | $(4.2) million, or $(0.29) diluted EPS |
- Six-month operating cash flow was $23.1 million, compared with $6.6 million in the prior-year period.
- Capital expenditures were $17.9 million; proceeds from equipment sales were $6.8 million, including a $2.7 million gain.
- Net cash increased $2.7 million to $19.1 million at June 30, 2012. Short-term investments totaled $49.7 million.
- Working capital was $69.0 million, down from $94.7 million at December 31, 2011, primarily because $21.8 million of the RLW noncontrolling-interest obligation was classified as current.
- Total debt was approximately $0.8 million, consisting primarily of mortgage and other long-term obligations. No borrowings were outstanding under the $50 million credit facility at quarter-end; a $1.8 million letter of credit reduced availability to $48.2 million.
- The company was in compliance with credit-facility covenants and stated that available liquidity was sufficient for the next twelve months.
- Backlog was $782 million at June 30, 2012, compared with $741 million at December 31, 2011 and $868 million at March 31, 2012. Approximately $28 million represented expected awards not yet officially awarded.
Material changes versus the prior comparable period
- Revenue increased substantially, principally from the Arizona and California operations acquired in 2011 and increased Nevada activity following the assumption of contracts from Aggregate Industries.
- Gross profit increased in the second quarter but declined by $4.2 million for the six-month period. Margins contracted because of lower productivity, differing site or contract conditions, project delays and downward revisions to estimated profitability, primarily on Texas projects.
- Six-month operating income declined 59.0% despite higher revenue. General and administrative expense increased 30.4%, reflecting acquired operations and higher professional fees.
- Six-month earnings attributable to Sterling stockholders declined from $4.3 million of income to a $4.2 million loss. The filing attributes $6.7 million of additional earnings allocated to RLW noncontrolling owners to an amendment concerning the treatment of goodwill impairment; the related tax benefit was approximately $2.4 million.
- Operating cash flow improved, while investing cash use declined materially because net purchases of short-term securities were lower than in the prior-year period.
Guidance, outlook, risks and unusual items
- Management expected 2012 revenue to increase by more than 25% from 2011, supported by higher beginning backlog, a full year of JBC and Myers operations, and $263 million of contract awards during the first six months.
- Management expected 2012 gross margin to be below the 8.0% reported for 2011. About half of the June 30 backlog was expected to be constructed during the remainder of 2012, with estimated backlog margins below the 2011 level.
- The filing disclosed a continuing material weakness in internal control over financial reporting related to the timely identification, review and recording of changes in construction-contract estimates. Management had begun remedial actions, but had not established an adequate period to evaluate their effectiveness.
- The company’s construction contracts are primarily fixed-unit-price or lump-sum arrangements, exposing results to cost overruns, productivity issues, contract changes, weather, delays and inaccurate estimates under percentage-of-completion accounting.
- Public-sector funding and authorizations, competitive bidding, reduced infrastructure spending and lower bid margins remained significant risks. MAP-21, enacted in July 2012, reduced some federal transportation-funding uncertainty but did not eliminate market pressure.
- The company had hedged 620,000 gallons of diesel purchases through December 2014 at fixed prices ranging from $2.80 to $3.33 per gallon. The derivatives had a net fair-value liability of $198,000 at June 30, 2012.
- Unconsolidated joint ventures had approximately $435 million of remaining work, including $122 million representing Sterling’s proportionate share. Joint and several liability could require Sterling to fund a partner’s obligations if that partner failed to perform.
- A Nevada subcontractor dispute remained on appeal. Sterling had posted a $1.3 million bond against a $1.0 million jury verdict, excluding interest, costs and attorney fees.
- The IRS was examining the company’s 2007–2009 federal tax returns; management expected no material adjustments, interest or penalties.
- The RHB acquisition and related transactions were recorded using preliminary valuations. The JBC earn-out liability was estimated at $2.2 million at June 30, 2012 and could vary materially with future EBITDA.
Most important facts for investors to verify
- Whether the continuing material weakness in project-estimate controls is remediated and whether future estimate revisions produce additional charges.
- The sustainability of the 9.0% quarterly gross margin and the effect of lower-margin backlog on second-half and full-year results.
- The timing and amount of potential settlement of the $21.8 million current RLW put/call and related noncontrolling-interest obligations.
- Conversion of the $782 million backlog into revenue and cash flow, including the $28 million of projects not yet officially awarded.
- Liquidity after capital expenditures, equipment purchases, noncontrolling-owner distributions and possible acquisitions.
- Exposure to public infrastructure funding, competitive bidding, fuel and materials inflation, project delays and joint-venture obligations.
- The final valuation and accounting consequences of the 2012 Nevada transactions and other acquisition-related earn-outs.