Sterling Construction Company, Inc. — Fiscal 2011 Form 10-K Summary
Business context and reporting period
The filing covers the fiscal year ended December 31, 2011. The registrant is Sterling Construction Company, Inc. (not “Sterling Infrastructure, Inc.” as stated in the request metadata), a heavy civil infrastructure contractor operating primarily in Texas, Utah, Nevada, Arizona and California, with additional projects in Hawaii, Montana and Louisiana. Its single reportable segment provides transportation and water infrastructure construction, principally for public-sector customers.
Revenue is recognized using percentage-of-completion accounting, making reported results highly dependent on estimates of contract costs, revenues, change orders, claims and expected profitability.
Financial performance and key metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Revenue | $501.2 million | $459.9 million | +9.0% |
| Gross profit | $39.8 million | $62.7 million | -36.5% |
| Gross margin | 8.0% | 13.6% | -560 basis points |
| Operating income (loss) | $(52.2) million | $35.9 million | Unfavorable |
| Income (loss) before taxes | $(51.7) million | $36.5 million | Unfavorable |
| Net income (loss) attributable to Sterling stockholders | $(35.9) million | $19.1 million | Unfavorable |
| Diluted EPS | $(2.24) | $1.13 | Unfavorable |
| Cash flow from operating activities | $21.0 million | $47.1 million | Down $26.1 million |
| Capital expenditures | $24.0 million | $13.4 million | Up $10.6 million |
| Year-end backlog | $741 million | $660 million | +12.3% |
The 2011 loss included a $67.0 million goodwill impairment charge recorded in the fourth quarter. Excluding the impairment, management reported operating income of $14.8 million, income before taxes of $15.3 million, net income attributable to Sterling stockholders of $5.9 million and diluted EPS of $0.31. The filing also identifies an $11.8 million pretax net charge from revisions to estimated contract revenues and gross profits, including a $5.9 million fourth-quarter charge.
Year-end cash and cash equivalents were $16.4 million, compared with $49.4 million in 2010. Short-term investments were $44.9 million, and working capital was $94.7 million, down from $107.3 million. Total assets were $303.8 million, compared with $367.1 million. Equity attributable to Sterling stockholders was $213.3 million, compared with $250.4 million.
Debt, liquidity and cash flow
- No borrowings were outstanding under the $50.0 million Comerica credit facility at December 31, 2011; a $1.8 million letter of credit reduced availability to $48.2 million.
- The credit facility was amended in November 2011 to extend maturity to September 30, 2016. Sterling reported compliance with its financial covenants at year-end.
- Long-term debt was limited to approximately $0.8 million, consisting primarily of a $0.5 million related-party note and a $0.3 million mortgage.
- Operating cash flow of $21.0 million was more than offset by $42.7 million of investing cash use and $11.4 million of financing cash use, resulting in a $33.1 million decrease in cash.
- Investing uses included $24.0 million of capital expenditures, $3.9 million for acquired companies and $8.2 million to acquire the remaining RHB noncontrolling interest.
- Contractual obligations totaled approximately $9.6 million, excluding variable interest obligations. Noncontrolling owners of RLW could require Sterling to purchase their interest in 2013; the estimated put liability was approximately $18.9 million at year-end.
Material changes versus the prior comparable period
- Revenue increased because of higher production in Texas, increased joint-venture activity and the inclusion of JBC and Myers after their August 2011 acquisitions. JBC and Myers contributed $19.5 million of 2011 revenue after acquisition.
- Profitability deteriorated sharply because of production issues, weather and owner delays, differing site conditions, unapproved change-order costs, supplier and subcontractor issues, labor shortages and delayed identification of project problems.
- The company recorded a $67.0 million goodwill impairment, reducing goodwill from $114.7 million to $54.1 million.
- Backlog increased to $741 million, including approximately $125 million of projects not yet formally awarded. Approximately $592 million was expected to be constructed during 2012.
- Sterling acquired JBC in Arizona for approximately $7.6 million in cash, subject to up to $5.0 million of earn-out consideration, and acquired a 50% interest in Myers in California for approximately $1.2 million. Myers was consolidated because Sterling determined it was the primary beneficiary of the variable-interest entity.
- Sterling paid $8.2 million to acquire the remaining 8.33% interest in RHB, making RHB wholly owned.
- The company repurchased 286,000 shares during 2011 for approximately $3.6 million; no cash dividends were declared.
Guidance, outlook, management commentary and risks
Management expected 2012 revenue to increase by more than 25%, supported by higher year-end backlog, a full year of JBC and Myers operations, and $144 million of contract awards from January 1 through March 12, 2012. However, management expected 2012 gross margin to be below the 8.0% achieved in 2011 and expected net income and diluted EPS to be below the 2011 results excluding the goodwill impairment, namely $5.9 million and $0.31 per share.
Management did not expect the planned operational and control improvements to have a substantial effect on 2012 results. Planned actions included improved estimating oversight, project-risk assessment, cost allocation, management reporting and clarification of responsibilities.
- Material weakness: Management identified a material weakness in internal control over financial reporting related to the timeliness and adequacy of estimating construction-project revenues and costs. Disclosure controls were therefore deemed ineffective, and Grant Thornton issued an adverse opinion on internal control over financial reporting while issuing an unqualified opinion on the consolidated financial statements.
- Funding risk: Continued uncertainty over federal highway funding and the absence of a long-term replacement for SAFETEA-LU were expected to constrain infrastructure spending and intensify competition.
- Contract risk: Fixed-unit-price and lump-sum contracts expose Sterling to cost overruns, unfavorable site conditions, delays, productivity shortfalls, change-order disputes, liquidated damages and inaccurate estimates.
- Customer concentration: UDOT represented 28.8% of 2011 revenue and TxDOT represented 15.1%. At year-end, several customers represented significant portions of backlog, including NTTA, Caltrans, the Central Texas Regional Mobility Authority, UDOT and TxDOT.
- Backlog quality: Customers generally may cancel contracts, and approximately $125 million of reported backlog had not yet been formally awarded. Backlog margins were expected to be lower than 2011 margins.
- Joint ventures and bonding: Sterling may be jointly and severally liable for joint-venture obligations and relies on surety bonding capacity to bid and perform projects. Unconsolidated joint ventures had approximately $539 million of remaining work, of which $127 million represented Sterling’s share.
- Fuel and commodity exposure: Sterling hedged approximately 790,000 gallons of diesel purchases through 2013. The derivatives had a combined negative fair value of approximately $223,000 at December 31, 2011.
- Litigation and contingencies: Sterling appealed a $1.0 million subcontractor judgment and had posted a $1.3 million bond pending the Nevada Supreme Court’s decision. Management did not expect other pending matters to have a material adverse effect.
- Management succession: The board began searching for a new CEO and planned to separate the chairman and CEO roles. The president and COO was expected to retire at the end of 2012.
Most important facts for investors to verify
- Whether the material weakness in project-estimate controls was remediated and whether subsequent filings identify additional restatements or material estimate revisions.
- Actual 2012 and later gross margins compared with the lower-margin backlog disclosed at year-end 2011.
- Conversion of the $741 million backlog into awarded, executable and profitable work, particularly the $125 million not formally awarded.
- Cash generation after capital expenditures, acquisitions, noncontrolling-interest payments and potential RLW put obligations.
- Exposure to UDOT, TxDOT and other concentrated customers, including receivable collections and contract claims.
- The outcome of the Nevada subcontractor litigation and the 2013 RLW noncontrolling-interest put.
- Future goodwill impairment risk, given the $54.1 million of goodwill remaining after the 2011 charge.
- Progress on CEO and COO succession and the operational changes intended to improve project profitability.