Sterling Construction Company, Inc. — Form 10-Q Summary
Business context and reporting period
Filing for the three months ended March 31, 2015, filed May 11, 2015. The filing identifies the registrant as Sterling Construction Company, Inc. (the request metadata refers to Sterling Infrastructure, Inc.). The Company is a heavy civil construction contractor focused on transportation and water infrastructure projects, primarily in the western and southern United States. Interim results are subject to seasonality and are not necessarily indicative of full-year results.
Financial results and liquidity
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Revenue | $117.7 million | $134.5 million |
| Gross profit (loss) | $(6.8) million | $7.9 million |
| Gross margin | (5.8%) | 5.8% |
| Operating income (loss) | $(16.7) million | $0.4 million |
| Net income (loss) | $(16.7) million | $0.5 million |
| Net income (loss) attributable to common stockholders | $(17.0) million | $0.2 million |
| Diluted EPS | $(0.90) | $0.01 |
| Cash flow from operating activities | $(2.9) million | $(12.2) million |
- Cash and cash equivalents declined to $17.2 million from $22.8 million at December 31, 2014.
- Working capital was $37.1 million, down from $52.3 million at year-end 2014.
- Debt included $30.8 million outstanding under the Credit Facility, $3.5 million of current and long-term debt shown on the balance sheet, and a $3.0 million letter of credit that reduced Credit Facility availability to approximately $1.2 million at March 31, 2015.
- Capital expenditures were $1.2 million, while proceeds from property and equipment sales were $2.9 million. The Company also financed $0.6 million of equipment purchases.
- Backlog was $745 million at March 31, 2015, compared with $764 million at December 31, 2014. Approximately $24 million represented the Company’s share of unconsolidated joint venture backlog.
Material changes versus the prior comparable period
- Revenue fell 12.5%, primarily because of downward percentage-of-completion revisions on Texas projects, completion of large Texas projects, and a $2.8 million out-of-period revenue adjustment. Increased California activity partially offset the decline.
- Gross margin deteriorated from 5.8% to negative 5.8%. Management cited higher labor rates, defective materials requiring rework, uncollectable unapproved change orders, and unusually heavy Texas rainfall that reduced productivity and caused delays.
- General and administrative expense increased 36.8% to $11.6 million, including $2.4 million of non-recurring employee severance costs.
- Changes in estimated contract revenue and gross margin produced a $12.0 million net charge in Q1 2015, compared with a $2.7 million net gain in Q1 2014.
- Operating cash use improved year over year, but the Company still used $2.9 million in operating cash and repaid $3.8 million under the Credit Facility.
- The Company identified a material weakness in internal control over financial reporting related to work-in-progress reviews of job costs and revenues at its Texas subsidiary. Disclosure controls and procedures were considered ineffective at March 31, 2015.
Guidance, outlook, risks, contingencies and unusual items
- Management planned to replace the existing Credit Facility with longer-term financing by the end of May 2015. The Company stated that, absent refinancing or another waiver, it anticipated failing the tangible net worth covenant tested as of April 30, 2015, which could result in a default.
- The March 2015 Credit Facility amendment waived the prior covenant breach, reduced the credit line to $35 million, with scheduled reductions to $25 million on June 1, 2015 and $15 million on September 1, 2015, increased pricing to Prime plus 350 basis points, and reset the tangible net worth covenant to $75 million. A $400,000 amendment fee was required.
- Management believed available liquidity was sufficient for the next twelve months, including bonding requirements, but warned that continued losses or inability to secure debt financing could materially adversely affect working capital and liquidity.
- Management expects 2015 capital expenditures to be below the prior year and is evaluating underutilized equipment for sale.
- A $2.8 million out-of-period decrease in revenue was recorded in Q1 2015 and deemed immaterial to current and prior financial statements under SAB 99 and SAB 108.
- A goodwill impairment triggering event occurred following the stock price decline and first-quarter loss. Updated testing found no impairment, with estimated equity fair value approximately 8% above carrying value.
- The Company hedged 55,000 gallons of diesel purchases through August 2015 at fixed prices of $2.75 to $2.78 per gallon and intends to retire the hedging program after the final swap settles in August 2015.
- Joint venture arrangements generally involve joint and several liability. Approximately $67 million of work remained on unconsolidated joint venture contracts, including $24 million attributable to Sterling. Management was not aware of any current partner default requiring Sterling to assume additional responsibilities.
- In March 2015, the Company entered into a three-year CEO employment agreement providing for a $1 annual salary and 600,000 shares vesting over three years, subject to stockholder approval.
- Management reported no material adverse legal proceedings and no material changes to the risk factors disclosed in the 2014 Form 10-K.
Important facts for investors to verify
- Refinancing and covenant compliance: Confirm whether the Credit Facility was replaced or amended after the filing date and whether the April 30, 2015 tangible net worth test was satisfied.
- Project estimates: Review subsequent quarters for additional percentage-of-completion revisions, Texas project losses, change-order recoveries, and the effectiveness of the remediation plan.
- Liquidity: Monitor Credit Facility availability, scheduled borrowing-base reductions, debt maturities, bonding capacity, and operating cash flow.
- Internal controls: Determine whether the material weakness over Texas work-in-progress accounting was remediated and whether further restatements or adjustments occurred.
- Backlog quality: Assess backlog conversion, expected margins, project concentration, unawarded apparent-low-bid work, and joint venture obligations.
- Goodwill and valuation: Reassess impairment risk if losses continue or the stock price and projected gross margins decline further.