Sterling Construction Company, Inc. — Form 10-Q Summary
Reporting period: Three months ended March 31, 2013; filed May 10, 2013. The filing identifies the issuer as Sterling Construction Company, Inc., a heavy civil infrastructure contractor operating primarily in transportation and water infrastructure markets.
Business Context and Financial Position
Sterling performs highway, road, bridge, light rail, water, wastewater and storm-drainage construction, principally in Texas, Utah, Nevada, Arizona and California. The company reports one operating segment: heavy civil infrastructure construction. Construction contracts generally run 12 to 36 months and revenue is recognized using the percentage-of-completion method.
| Metric | March 31, 2013 | Prior comparable period or date |
|---|---|---|
| Revenue | $111.0 million | $98.4 million in Q1 2012 |
| Gross profit | $1.4 million | $1.9 million in Q1 2012 |
| Gross margin | 1.2% | 1.9% in Q1 2012 |
| Operating loss | $8.0 million | $4.6 million in Q1 2012 |
| Net loss attributable to Sterling stockholders | $4.6 million | $7.5 million in Q1 2012 |
| Diluted loss per share | $0.39 | $0.44 in Q1 2012 |
| Cash flow from operations | $(10.2) million | $1.4 million provided in Q1 2012 |
| Cash and cash equivalents | $4.2 million | $3.1 million at December 31, 2012 |
| Short-term investments | $21.6 million | $49.2 million at December 31, 2012 |
| Working capital | $71.1 million | $87.5 million at December 31, 2012 |
| Total debt shown on balance sheet | $12.1 million | $24.3 million at December 31, 2012 |
| Construction backlog | $693 million | $656 million at December 31, 2012 |
Material Changes Versus Q1 2012 and Year-End 2012
- Revenue increased 12.8%, primarily from projects in Texas, California and Nevada, but gross profit declined 26.1% and gross margin fell to 1.2%.
- Management recorded a net $4.3 million pre-tax downward revision to estimated contract revenues and gross profit, including $3.3 million related to two Texas projects. The filing states this reduced after-tax earnings attributable to Sterling by approximately $2.8 million, or $0.17 per diluted share.
- General and administrative expense increased 25.4% to $9.6 million, partly because of an expanded information systems team and higher employee benefit costs.
- Operating loss widened to $8.0 million from $4.6 million, despite the lower net loss attributable to Sterling. The prior-year results included an unusual $6.7 million increase in earnings allocated to RLW noncontrolling interests, together with a related $2.4 million tax benefit.
- Operating cash flow declined to an outflow of $10.2 million, driven in part by a $13.7 million increase in costs and estimated earnings in excess of billings and a $2.7 million increase in income tax receivable.
- Short-term investments declined by $27.6 million, primarily because securities were sold to repay borrowings under the Credit Facility. Net Credit Facility repayments were $12.3 million during the quarter.
- Backlog increased $37 million from year-end. New contract awards were $148 million, compared with $340 million in Q1 2012, which included five large awards totaling approximately $260 million.
Debt, Liquidity and Cash Flow
- The company had $11.7 million outstanding under its $50.0 million Comerica Credit Facility at March 31, 2013, plus a $1.8 million letter of credit; reported availability was $36.5 million. The facility matures September 30, 2016.
- Sterling was in compliance with its leverage, tangible-net-worth and asset-coverage covenants at quarter-end. Management stated that available liquidity should fund the next twelve months, including bonding requirements.
- Capital expenditures were $4.9 million, versus $5.9 million in Q1 2012. Management expected 2013 capital expenditures to be lower than the $37.4 million invested in 2012.
- Cash increased by $1.0 million during the quarter, primarily because sales of short-term investments more than offset operating and financing cash outflows.
Guidance, Outlook, Risks and Unusual Items
- Management did not expect significant improvement in 2013 gross margins compared with the 7.5% margin achieved in 2012. It reported improving margins on projects awarded in 2013 and expected those projects to contribute to improved results in 2014.
- Current backlog was estimated to carry a lower gross margin than the 2012 realized margin because of operational issues, competitive pressure and reduced federal and state infrastructure spending.
- The company hedged 965,000 gallons of forecast diesel purchases through December 2014 at fixed prices ranging from $2.79 to $3.24 per gallon. In April 2013, it added hedges for 1.2 million gallons through August 2015 at an average price of $2.75 per gallon.
- RHB’s noncontrolling interest obligation was revalued upward by $3.0 million pre-tax during the quarter, reducing retained earnings by $1.9 million after tax. The company also made a final $509,000 payment related to the purchase of the remaining 20% RLW interest in April 2013.
- The JBC acquisition earn-out liability had an estimated fair value of $2.2 million and could increase by up to $2.7 million depending on future EBITDA.
- Unconsolidated joint ventures had approximately $190.6 million of remaining work, including $68.9 million representing Sterling’s proportionate share. Joint venture agreements may impose joint and several liability if a partner cannot perform or fund its share.
- Key risks include construction cost overruns, inaccurate percentage-of-completion estimates, project delays, adverse weather, fuel and materials inflation, dependence on government infrastructure funding, competition, subcontractor or joint venture partner failures, and covenant or liquidity pressure.
- Management stated that ordinary-course litigation was not expected to have a material effect and that there were no material changes to previously disclosed risk factors.
Investor Verification Items
- Verify the status and final profitability of the two Texas projects responsible for most of the $4.3 million contract-estimate charge.
- Reconcile backlog growth with the much lower pace of new awards and confirm the margin profile of the $693 million backlog.
- Monitor operating cash flow, costs and estimated earnings in excess of billings, receivables and working capital.
- Confirm continued compliance with Credit Facility covenants and available borrowing capacity after letters of credit and other restrictions.
- Assess exposure to joint and several obligations, noncontrolling-interest payments, the JBC earn-out and the RHB redemption obligation.
- Evaluate whether the planned 2013 margin stabilization and expected 2014 improvement are supported by project execution and newly awarded work.