Sterling Construction Company, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2011; filed November 8, 2011. The filing identifies the registrant as Sterling Construction Company, Inc. and its subsidiaries, a heavy civil construction company serving transportation and water infrastructure markets primarily in Texas, Utah, Nevada, Arizona and California.
Business Context and Reporting Period
- Operations include highways, roads, bridges, rail infrastructure, water and wastewater systems, paving, concrete, aggregates and related construction services, primarily for public-sector customers.
- The company operates in one reportable segment: heavy civil construction.
- On August 1, 2011, the company acquired J. Banicki Construction, Inc. for approximately $7.6 million in initial cash consideration and acquired a 50% interest in Myers & Sons Construction, L.P. for approximately $1.2 million. Myers was consolidated as a variable interest entity because Sterling controls its activities and bears more than 50% of potential losses.
Key Financial Metrics
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $159.4 million | $118.9 million | $387.2 million | $321.9 million |
| Gross profit | $14.8 million | $13.0 million | $35.9 million | $34.0 million |
| Gross margin | 9.3% | 10.9% | 9.3% | 10.5% |
| Operating income | $7.8 million | $6.2 million | $16.7 million | $16.4 million |
| Operating margin | 4.9% | 5.2% | 4.3% | 5.1% |
| Net income attributable to Sterling stockholders | $3.5 million | $3.5 million | $7.7 million | $9.7 million |
| Diluted EPS | $0.21 | $0.21 | $0.47 | $0.59 |
| Net cash provided by operating activities | Not separately provided | Not separately provided | $4.6 million | $37.4 million |
- Pre-tax income was $7.9 million in the quarter and $17.0 million year to date. The nine-month effective tax rate was 19.4%, compared with 27.8% in the prior-year period.
- At September 30, 2011, cash and cash equivalents were $16.7 million, short-term investments were $49.8 million and working capital was $106.2 million.
- Total debt was approximately $8.9 million, consisting primarily of $8.0 million outstanding under the credit facility and mortgage debt. The company reported $65.2 million of availability under its then-current $75.0 million facility, after $1.8 million of letters of credit.
- Total assets were $404.0 million and total equity was $256.7 million at September 30, 2011.
Material Changes Versus the Prior Comparable Period
- Revenue increased 34.1% in the quarter and 20.3% for the nine months, primarily from higher activity on Texas contracts, increased joint-venture activity and contributions from the Arizona and California acquisitions.
- Gross profit increased, but gross margins declined because of competitive bidding pressure, higher-than-anticipated Texas job costs, lower activity and under-absorption of indirect costs. Utah margins improved and partially offset these pressures.
- Quarterly operating income increased 25.6%, while nine-month operating income increased only 2.2% because of higher general and administrative, acquisition and legal expenses.
- Nine-month net income attributable to Sterling stockholders declined 20.6%, and diluted EPS declined from $0.59 to $0.47. The decline reflects greater earnings attributable to noncontrolling owners, lower margins and higher expenses.
- Operating cash flow fell to $4.6 million from $37.4 million. The principal working-capital uses were increases in contracts receivable and costs and estimated earnings in excess of billings.
- Capital expenditures rose to $19.6 million from $7.8 million, reflecting equipment replacement and expansion of shop and office facilities.
- Backlog was $672 million at September 30, 2011, down from $720 million at June 30, 2011 but up from $575 million at September 30, 2010. Third-quarter awards or apparent low bids totaled $55 million.
Guidance, Outlook, Risks and Unusual Items
- Management expected 2011 net income and diluted EPS attributable to Sterling stockholders to be significantly below 2010 levels because of competitive bidding, lower anticipated margins and uncertainty in infrastructure funding. Management expected markets to recover over time but could not predict the timing.
- Key market risks include reduced or delayed federal, state and local infrastructure funding, the unresolved renewal of federal highway funding legislation, competitive pricing, project delays, adverse weather, cost escalation for fuel and materials, customer concentration, acquisition integration and surety-bond availability.
- The company hedged 1.182 million gallons of diesel purchases through December 2013 at fixed prices ranging from $2.99 to $3.34 per gallon. Derivative liabilities totaled approximately $492,000 at September 30, 2011.
- The RHB noncontrolling owner exercised a put requiring an $8.2 million payment, expected to close in December 2011. The liability was recorded as a current liability.
- A Nevada subcontractor dispute involved a $1.0 million jury judgment, for which the company posted a $1.3 million bond and appealed. The Nevada Supreme Court heard the case on November 3, 2011, with a decision anticipated by mid-2012.
- In November 2011, the credit facility was amended to mature September 30, 2016. The amended facility provides for up to $50 million of borrowings, with an optional increase of up to $50 million. Management stated that liquidity was adequate for expected requirements through at least December 31, 2012.
- The company repurchased 147,000 shares during the third quarter at a weighted average price of $11.91 per share.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. No material changes to previously disclosed risk factors were reported.
Facts Investors Should Verify
- Reconcile the substantial revenue growth with declining gross and operating margins and the 20.6% year-to-date decline in attributable net income.
- Assess whether the sharp reduction in operating cash flow is temporary or reflects persistent contract receivable and unbilled-cost requirements.
- Review backlog quality, expected margins, customer cancellation rights and the decline in third-quarter awards, particularly in Texas and Utah.
- Evaluate the liquidity impact of the $8.2 million RHB put, acquisition earn-outs, capital expenditures, noncontrolling-owner distributions and joint-and-several obligations on unconsolidated joint ventures.
- Confirm the terms, covenants, borrowing capacity and post-quarter amendment of the credit facility, as well as surety-bond capacity.
- Monitor the diesel hedges, fuel-price exposure and the potential effects of competitive bidding, public infrastructure funding and construction cost escalation.
- Review the outcome of the Nevada litigation appeal and any final purchase-price allocation adjustments for JBC and Myers.