Sterling Construction Company, Inc. — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three months ended March 31, 2016, filed May 2, 2016. The company is a heavy civil construction contractor focused on transportation and water infrastructure projects, primarily in Texas, Utah, Nevada, Colorado, Arizona, California and Hawaii. The filing identifies the registrant as Sterling Construction Company, Inc.
Results are unaudited and may be seasonally affected, particularly by winter weather and lower first-quarter equipment and labor utilization.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $126.6 million | $117.7 million | 7.6% increase |
| Gross profit (loss) | $3.8 million | $(6.8) million | Improved $10.7 million |
| Gross margin | 3.0% | (5.8)% | Improved 8.8 points |
| Operating loss | $(6.5) million | $(16.7) million | Loss reduced 61.2% |
| Net loss attributable to common stockholders | $(7.3) million | $(17.0) million | Loss reduced 56.9% |
| Basic and diluted loss per share | $(0.37) | $(0.90) | Improved |
| Net cash from operating activities | $0.8 million | $(2.9) million | Improved $3.8 million |
- Cash and cash equivalents were $14.9 million at March 31, 2016, compared with $4.4 million at December 31, 2015. Approximately $0.6 million was held by a majority-owned joint venture and was generally unavailable for other purposes.
- Working capital was $32.4 million, compared with $30.6 million at year-end 2015.
- Total debt was approximately $32.1 million, including $30.0 million under the equipment-based facility and $3.2 million of equipment and other notes, partially offset by deferred loan costs. Debt increased from approximately $20.2 million at December 31, 2015.
- The equipment-based facility comprised a $13.1 million revolving-loan draw and a $16.9 million term loan. The borrowing base was approximately $30.0 million, based on 65% of appraised collateral value.
- Interest expense increased to $0.9 million from $0.4 million, primarily because of the higher interest rate on the equipment-based facility.
- Capital expenditures were $2.8 million, partially offset by $0.7 million of proceeds from asset sales.
Material changes versus the prior comparable period
- Revenue growth was driven mainly by increased activity in Utah and Colorado, higher backlog and project timing. The comparison also benefited from significant downward project revisions and a $2.8 million out-of-period revenue reduction recorded in Q1 2015.
- Gross profit improved substantially, although Q1 2016 included an approximately $1.0 million additional loss on a California project, largely related to a subcontractor claim. Excluding that claim, gross margin would have been approximately 3.8%.
- General and administrative expense declined to $10.5 million from $11.6 million. Q1 2015 included approximately $2.4 million of non-recurring employee severance costs.
- Operating performance remained loss-making despite the improvement. The company recorded a $1.2 million net charge from changes in estimated contract revenues and gross margins in Q1 2016, compared with a $12.0 million charge in Q1 2015.
- Financing activities provided $11.8 million in Q1 2016, primarily from a $13.1 million net revolving-loan draw. Financing activities used $4.4 million in Q1 2015, primarily because of repayments under the prior credit facility.
- Backlog increased to $854 million from $761 million at December 31, 2015 and $745 million at March 31, 2015. Backlog gross margin increased to 7.7% from 7.0% at year-end 2015 and 6.0% one year earlier.
Guidance, outlook, commentary and risks
- Management expects improved federal and state infrastructure funding to support demand. The company cited the five-year $305 billion federal surface transportation bill, increased Texas transportation funding and a Utah gas-tax increase.
- Management reported approximately $390 million of project wins during the prior two quarters at an average margin above 8.5%. It expects backlog margins to reach approximately 8.5% to 9.0% by December 31, 2016 after completing approximately $70 million of legacy projects with small or zero margins.
- The company formalized its bid evaluation and approval process and appointed a chief operating officer late in the first quarter to improve project selection and execution.
- Management believes available liquidity and financing resources are sufficient for the next twelve months, including bonding requirements, but acknowledged that continued losses, substantial cash constraints or an inability to obtain financing could materially harm liquidity.
- Potential capital alternatives include asset or business sales, equity issuance, resolution of contract claims and refinancing the equipment-based facility. No specific transaction or proceeds were assured.
- Key risks include project cost overruns, inaccurate estimates under percentage-of-completion accounting, weather, funding reductions, subcontractor or joint-venture partner failures, material and fuel inflation, competition, regulatory and environmental matters, and dependence on government customers.
- The company recorded a $0.8 million legal reserve for a subcontractor dispute in arbitration and offered that amount to settle. Other ordinary-course claims were not expected by management to be material.
- Unconsolidated joint ventures had approximately $124 million of remaining work, including $54 million representing Sterling’s proportionate share. Joint venture agreements generally impose joint and several liability, although management was not aware of an issue requiring it to fund a partner’s obligations.
- The equipment-based facility carries an initial fixed annual interest rate of 12%, subject to a possible two-percentage-point increase or decrease based on fixed-charge coverage ratios. It is secured by substantially all company personal property and specified affiliate equipment.
Most important facts for an investor to verify
- Whether improved backlog volume and stated 8.5% to 9.0% target margins convert into sustained positive gross and operating profits.
- The status, final cost and cash impact of the California subcontractor claim and other contract disputes.
- Liquidity headroom under the equipment-based facility, including the $30.0 million borrowing base, $13.1 million revolver draw and 12% interest rate.
- Cash conversion and collection risk given contracts receivable of $94.8 million and continued reliance on contract billings and working capital.
- Whether seasonal first-quarter under-absorption reverses in later quarters as management expects.
- Potential obligations arising from joint and several liability for unconsolidated joint ventures and the $46.2 million liability for mandatorily redeemable members’ interests.
- The effect of percentage-of-completion estimates, project revisions, weather, subcontractor performance and government infrastructure funding on reported margins and backlog.