Sterling Construction Company, Inc. — Fiscal 2016 Form 10-K Summary
Business context and reporting period
The filing is Sterling Construction Company, Inc.’s Form 10-K for the year ended December 31, 2016, filed March 9, 2017. The company operates as a single heavy civil construction segment, building transportation and water infrastructure in Texas, Utah, Nevada, Colorado, Arizona, California, Hawaii and other U.S. markets.
Revenue is primarily generated under fixed-unit-price and lump-sum contracts for governmental and public-sector customers. The company recognizes contract revenue using the percentage-of-completion method based on cost-to-cost progress.
Key financial metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Revenue | $690.1 million | $623.6 million | Up 10.7% |
| Gross profit | $43.9 million | $29.0 million | Up 51.5% |
| Gross margin | 6.4% | 4.6% | Up 180 basis points |
| Operating loss | $4.7 million | $14.4 million | Improved by $9.7 million |
| Net loss attributable to common stockholders | $9.2 million | $39.2 million | Improved by $30.0 million |
| Basic and diluted loss per share | $0.40 loss | $2.02 loss | Improved |
| Cash flow from operating activities | $44.5 million | $9.0 million | Improved by $35.5 million |
| Cash and cash equivalents | $42.8 million | $4.4 million | Up $38.4 million |
| Working capital | $29.3 million | $30.6 million | Down $1.3 million |
| Total long-term debt | $1.5 million | $15.3 million | Down $13.8 million |
| Backlog | $823 million | $761 million | Up 8.1% |
Fourth-quarter 2016 revenue was $168.3 million, gross profit was $6.9 million, and the company recorded a $6.3 million net loss attributable to common stockholders, or $0.25 per diluted share. The fourth quarter included a $2.5 million charge related to a negotiated global settlement involving a Texas project, as well as other Texas project charges and under-recovered equipment costs.
Capital expenditures were approximately $11.6 million, including $0.7 million of financed equipment purchases. Net cash used in investing activities was $8.2 million. The company paid approximately $2.6 million of interest during the year.
Material changes versus the prior comparable period
- Revenue increased primarily because of the ramp-up of two large Utah projects, including a majority-owned joint venture, and activity in Nevada and Hawaii. This was partly offset by project wind-downs in California and owner delays and weather-related disruptions in Texas.
- Gross margin improved because of higher-margin projects, stronger bid discipline, improved project execution and fewer downward percentage-of-completion revisions.
- General and administrative expense declined to $38.6 million from $41.9 million, while G&A as a percentage of revenue declined to 5.6% from 6.7%.
- Other operating expense increased to $10.0 million from $1.5 million, primarily due to approximately $8.9 million of members’ interest earnings and a $1.2 million J. Banicki earn-out expense.
- Operating cash flow benefited from a $38.5 million favorable change in contract capital, including increased billings in excess of costs and higher accounts payable.
- The company completed a public offering of 5.175 million shares in May 2016, generating $19.1 million of net proceeds. Proceeds were used for working capital, debt repayment and general corporate purposes.
- The company prepaid $10.0 million of its equipment-based term loan during 2016. At year-end, $3.5 million was outstanding under the term loan and the revolving loan had no balance.
- The 2015 net loss included an $18.8 million revaluation of a noncontrolling interest; no comparable revaluation was recorded in 2016.
Guidance, outlook, commentary and unusual items
Management expected infrastructure markets to continue improving, supported by the federal FAST Act and transportation funding measures in Texas, Utah and California. Backlog gross margin increased from 7.0% at December 31, 2015 to 8.2% at December 31, 2016. The company won approximately $749 million of new projects during 2016 at an average margin of approximately 9%.
Unsigned low-bid awards were $226 million at year-end 2016, compared with $197 million a year earlier. Management expected substantially all of the 2016 amount to be formally signed and added to backlog during the first quarter of 2017. Capital expenditures for 2017 were expected to be similar to the $11.6 million incurred in 2016, subject to project requirements.
On March 8, 2017, the company agreed to acquire Tealstone Construction for $85 million, subject to adjustments and customary closing conditions. The proposed financing included $15 million of seller financing, 1,882,058 shares of Sterling common stock and $55 million of debt under a new $85 million credit facility. Closing was expected in the second quarter of 2017 and required new debt financing and regulatory approvals.
Management stated that available cash, operating cash flow and borrowing capacity were expected to fund the next twelve months of operations, including bonding requirements. However, the equipment-based facility bears interest at 12%, is secured by substantially all personal property and limits additional debt, acquisitions, investments and certain asset dispositions.
Risks and contingencies
- Profitability depends heavily on accurate cost estimates and control of costs under fixed-price contracts. Weather, site conditions, labor, subcontractor performance, material and fuel prices, productivity and schedule delays can materially reduce margins.
- Revenue and earnings are subject to significant estimates under percentage-of-completion accounting. The filing reports a $6.3 million net charge from changes in estimated contract revenue and gross margin in 2016.
- Unapproved change orders, claims and entitled unpaid project amounts recorded at December 31, 2016 totaled $2.2 million, $9.2 million and $3.9 million, respectively. Recoveries and timing remain subject to negotiation and could differ from recorded amounts.
- Three customers—Caltrans, TXDOT and UDOT—each contributed more than 10% of 2016 revenue. TXDOT owed the company $7.9 million at year-end, representing more than 10% of contracts receivable.
- Most contracts may be terminated for customer convenience, and contracts may contain liquidated damages, performance obligations and claims-related funding delays.
- Joint venture agreements generally impose joint and several liability. Approximately $107 million of work remained on unconsolidated joint venture contracts, including approximately $53 million attributable to Sterling’s share of backlog.
- The company had $45.2 million of members’ interests subject to mandatory redemption and undistributed earnings, as well as $11.3 million of future operating lease payments.
- Federal and state net operating loss carryforwards totaled approximately $169.0 million, but the company maintained a full $58.0 million valuation allowance on net deferred tax assets.
- Other risks include bonding capacity, liquidity and borrowing-base fluctuations, customer concentration, labor availability and union matters, environmental and safety regulation, litigation, equipment availability, cybersecurity and potential goodwill impairment.
Investor verification points
- Verify conversion of the $226 million of unsigned low-bid awards into executed backlog and assess the margins and timing of related projects.
- Review the aging, collectability and ultimate resolution of the $9.2 million of claims, $2.2 million of unapproved change orders and $3.9 million of entitled unpaid project amounts.
- Assess whether the improved 6.4% gross margin is sustainable after the 2016 weather effects, settlement charge and project-specific cost adjustments.
- Confirm the company’s post-acquisition financing, dilution, leverage and liquidity after the proposed $85 million Tealstone transaction.
- Evaluate exposure to the 12% equipment-based facility, borrowing-base restrictions, mandatory redemption obligations and surety bonding requirements.
- Monitor customer concentration, particularly Caltrans, TXDOT and UDOT, and the impact of government infrastructure funding.
- Review the assumptions supporting percentage-of-completion estimates, goodwill valuation and the full deferred-tax-asset valuation allowance.