Sterling Construction Company, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2016. The filing identifies the registrant as Sterling Construction Company, Inc., a heavy civil construction company serving transportation and water infrastructure markets in Texas, Utah, Nevada, Colorado, Arizona, California, Hawaii and other states. The interim financial statements are unaudited.
Financial results and position
| Metric | Three months ended June 30, 2016 | Three months ended June 30, 2015 | Six months ended June 30, 2016 | Six months ended June 30, 2015 |
|---|---|---|---|---|
| Revenue | $189.6 million | $177.4 million | $316.1 million | $295.1 million |
| Gross profit | $16.1 million | $9.1 million | $19.9 million | $2.3 million |
| Gross margin | 8.5% | 5.1% | 6.3% | 0.8% |
| Operating income (loss) | $3.4 million | $(0.2) million | $(3.1) million | $(16.8) million |
| Net income (loss) attributable to Sterling stockholders | $2.0 million | $(2.5) million | $(5.3) million | $(19.5) million |
| Diluted earnings (loss) per share | $0.09 | $(0.13) | $(0.25) | $(1.03) |
- Liquidity: Cash and cash equivalents were $42.6 million at June 30, 2016, versus $4.4 million at December 31, 2015. Working capital increased to $43.8 million from $30.6 million.
- Cash included $14.9 million held by a majority-owned joint venture and $8.7 million held by the consolidated variable interest entity, which generally may not be available for corporate purposes. Restricted cash totaled approximately $5.0 million.
- Cash flow: Six-month operating cash flow was $26.7 million, compared with $(3.6) million in the prior-year period. Investing cash flow was $(4.7) million, including $6.1 million of capital expenditures. Financing cash flow was $16.2 million, principally reflecting $19.1 million of net equity-offering proceeds.
- Debt: Total debt was $17.9 million at June 30, 2016, including $15.6 million under the equipment-based term facility and $3.3 million of equipment-related notes. The revolving loan had no outstanding balance; the borrowing base was approximately $27.0 million.
- Interest expense increased to $0.8 million for the quarter and $1.7 million for the six months, primarily because of the higher interest rate on the equipment-based facility. The facility carries an initial fixed annual rate of 12%, subject to potential adjustment.
- General and administrative expense declined 5.1% for the quarter and 7.3% for the six months. Income tax expense was minimal because of net operating loss carryforwards and a full valuation allowance on net deferred tax assets.
Material changes versus the prior comparable periods
- Second-quarter revenue increased 6.9%; six-month revenue increased 7.1%, driven primarily by greater activity in Nevada, Hawaii and Utah. Texas activity was affected by heavy rainfall and flooding, while a large California project was winding down.
- Gross margin improved substantially because the company had fewer zero- or near-zero-margin projects and was executing more profitable backlog. The six-month comparison also benefited from significant downward project-margin revisions recorded in 2015, including a $2.8 million out-of-period revenue reduction.
- The six-month 2016 gross margin included an approximately $1.0 million additional loss on a substantially completed California project related to a subcontractor claim. Excluding that item, management estimated six-month gross margin would have been approximately 6.6%.
- Other operating expense increased primarily because of $3.9 million of members’ interest expense in both the quarter and six-month period, compared with $0.7 million in the prior-year periods.
- On May 9, 2016, the company issued 5.175 million common shares at $4.00 per share, generating $19.1 million of net proceeds. Shares outstanding increased to approximately 25.0 million at July 29, 2016, creating dilution for existing shareholders.
- Backlog was $810 million at June 30, 2016, compared with $761 million at December 31, 2015 and $743 million at June 30, 2015. Backlog gross margin was 7.8%, versus 7.0% and 6.3%, respectively.
Outlook, commentary, risks and unusual items
- Management cited improved infrastructure funding, including a federally funded five-year $305 billion surface transportation program and increased transportation funding initiatives in Texas and Utah. No formal revenue or earnings guidance was provided.
- Management expects backlog gross margins to reach approximately 8.5% to 9.0% by December 31, 2016 after completing approximately $40 million of legacy projects with small or zero margins. This is a management expectation, not a reported commitment.
- The company implemented a more rigorous bid evaluation and approval process and appointed a chief operating officer late in the first quarter of 2016 to improve project selection and execution.
- Management stated that available cash, operating cash flow and borrowing capacity should be sufficient for the next twelve months, including bonding requirements. It also warned that continued losses, a substantial cash constraint or inability to obtain adequate debt financing could materially affect liquidity.
- A Texas project claim related primarily to customer-caused delays remains under negotiation; the company may pursue legal remedies if negotiations fail. Management believes the matter will be resolved without a material adverse effect, but recorded amounts could differ materially from the ultimate resolution.
- A subcontractor dispute resulted in a $1.0 million legal reserve, which was settled during the second quarter and is now fully resolved. Other ordinary-course claims and lawsuits were not considered material by management.
- Unconsolidated joint ventures had approximately $100 million of remaining construction work, including $46 million representing Sterling’s proportionate share. Joint venture agreements generally impose joint and several liability, creating potential exposure if a partner cannot perform or fund its share.
- Key operating risks include project cost overruns, inaccurate percentage-of-completion estimates, delays, weather, subcontractor and supplier performance, fuel and material-price inflation, government funding changes, competition, environmental and safety requirements, and customer or joint-venture concentration.
Investor verification items
- Verify the sustainability of the improved gross margins and whether the projected 8.5% to 9.0% backlog margin is achieved as legacy projects are completed.
- Review project-level estimates, claims and contingencies, particularly the unresolved Texas claim and the California subcontractor-related loss.
- Assess cash availability after considering restricted cash and amounts held by joint ventures or the consolidated variable interest entity.
- Monitor debt-service requirements, the 12% equipment-based facility, borrowing-base availability and potential interest-rate adjustments.
- Evaluate dilution from the May 2016 equity offering and the company’s continuing accumulated retained deficit.
- Reconcile reported backlog with signed awards, noting that $109 million of additional work was attributable to unsigned low-bid awards and that approximately $46 million of backlog related to joint ventures.