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STRL > SEC Filings for STRL > Form 10-Q on 11-Aug-2014All Recent SEC Filings

Show all filings for STERLING CONSTRUCTION CO INC

Form 10-Q for STERLING CONSTRUCTION CO INC


11-Aug-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Comment Regarding Forward-Looking Statements

This Report includes statements that are, or may be considered to be, "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These forward-looking statements are included throughout this Report, including in this section, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and relate to matters such as our industry, business strategy, goals and expectations concerning our market position, future operations, margins, profitability, capital expenditures, liquidity and capital resources and other financial and operating information. We have used the words "anticipate," "assume," "believe," "budget," "continue," "could," "estimate," "expect," "forecast," "future," "intend," "may," "plan," "potential," "predict," "project," "should," "will," "would" and similar terms and phrases to identify forward-looking statements in this Report.

Forward-looking statements reflect our current expectations as of the date of this Report regarding future events, results or outcomes. These expectations may or may not be realized. Some of these expectations may be based upon assumptions or judgments that prove to be incorrect. In addition, our business and operations involve numerous risks and uncertainties, many of which are beyond our control, that could result in our expectations not being realized or otherwise could materially affect our financial condition, results of operations and cash flows.

Actual events, results and outcomes may differ materially from our expectations due to a variety of factors. Although it is not possible to identify all of these factors, they include, among others, the following:

changes in general economic conditions, including recessions, reductions in federal, state and local government funding for infrastructure services and changes in those governments' budgets, practices, laws and regulations;

delays or difficulties related to the completion of our projects, including additional costs, reductions in revenues or the payment of liquidated damages, or delays or difficulties related to obtaining required governmental permits and approvals;

actions of suppliers, subcontractors, design engineers, joint venture partners, customers, competitors, banks, surety companies and others which are beyond our control, including suppliers', subcontractors', and joint venture partners' failure to perform;

factors that affect the accuracy of estimates inherent in our bidding for contracts, estimates of backlog, percentage-of-completion accounting policies, including onsite conditions that differ materially from those assumed in our original bid, contract modifications, mechanical problems with our machinery or equipment and effects of other risks discussed in this document;

design/build contracts which subject us to the risk of design errors and omissions;

cost escalations associated with our contracts, including changes in availability, proximity and cost of materials such as steel, cement, concrete, aggregates, oil, fuel and other construction materials, and cost escalations associated with subcontractors and labor;

our dependence on a limited number of significant customers;

adverse weather conditions; although we prepare our budgets and bid contracts based on historical rain and snowfall patterns, the incidence of rain, snow, hurricanes, etc., may differ materially from these expectations;

the presence of competitors with greater financial resources or lower margin requirements than ours, and the impact of competitive bidders on our ability to obtain new backlog at reasonable margins acceptable to us;

our ability to successfully identify, finance, complete and integrate acquisitions;

citations issued by any governmental authority, including the Occupational Safety and Health Administration;

federal, state and local environmental laws and regulations where non-compliance can result in penalties and/or termination of contracts as well as civil and criminal liability;

adverse economic conditions in our markets; and

the other factors discussed in more detail in our Annual Report on Form 10-K for the year ended December 31, 2013 ("2013 Form 10-K") under "Item 1A. - Risk Factors."

In reading this Report, you should consider these factors carefully in evaluating any forward-looking statements and you are cautioned not to place undue reliance on any forward-looking statements. Although we believe that our plans, intentions and expectations reflected in, or suggested by, the forward-looking statements that we make in this Report are reasonable, we can provide no assurance that they will be achieved.


The forward-looking statements included in this Report are made only as of the date of this Report, and we undertake no obligation to update any information contained in this Report or to publicly release the results of any revisions to any forward-looking statements to reflect events or circumstances that occur, or that we become aware of after the date of this Report, except as may be required by applicable securities laws.

Overview

Sterling is a leading heavy civil construction company that specializes in the building and reconstruction of transportation and water infrastructure projects in Texas, Utah, Nevada, Arizona, California, Hawaii and other states where there are construction opportunities. Its transportation infrastructure projects include highways, roads, bridges and light rail and its water infrastructure projects include water, wastewater and storm drainage systems. Sterling performs the majority of the work required by its contracts with its own crews and equipment.

Although we describe our business in this report in terms of the services we provide, our base of customers and the geographic areas in which we operate, we have concluded that our operations comprise one reportable segment and one reporting unit component: heavy civil infrastructure construction. In making this determination, we considered that each project has similar characteristics, includes similar services and similar types of customers and is subject to similar regulatory and economic environments. We organize, evaluate and manage our financial information around each project when making operating decisions and assessing our overall performance.

Sterling has grown its service profile and geographic reach both organically and through acquisitions. Expansions into Utah, Arizona and California were achieved with the 2009 acquisition of RLW and the 2011 acquisitions of JBC and Myers. These acquisitions also extended Sterling's service profiles. For a more detailed discussion of the Company's business, readers of this report are advised to review "Item 1, Business," of the 2013 Form 10-K.

For purposes of the discussions which follow, "Current Quarter" refers to the three-month period ended June 30, 2014 and "Prior Quarter" refers to the three-month period ended June 30, 2013, "Current Period" refers to the six-month period ended June 30, 2014 and "Prior Period" refers to the six-month period ended June 30, 2013.

Financial Results for the Current Quarter and Current Period, Operational Issues and Outlook for 2014 Financial Results

In the Current Quarter and Current Period, we had operating income of $2.5 million and $3.0 million, respectively, income before income taxes and earnings attributable to noncontrolling interest owners of $2.5 million and $3.0 million, respectively, net income attributable to Sterling common stockholders of $1.2 million and $1.4 million, respectively, and net income per diluted share attributable to Sterling common stockholders of $0.07 and $0.08, respectively.

Revenues for the Current Quarter and the Current Period increased 46.1% and 34.8% from the Prior Quarter and Prior Period, respectively. This increase is primarily due to an increase in the number of projects in progress with increased productivity, largely in our Texas and California markets. Our overall margins increased to 6.4% and 6.2% for the Current Quarter and Current Period, respectively, as compared to 12.5% and 6.2% gross margin deficits in the Prior Quarter and Prior Period, respectively. The increases in gross margin during both periods are primarily attributed to the impact of downward revisions of gross profits related to three problem jobs in the Prior Quarter and Period. These projects have reached substantial completion during the Current Quarter and are no longer weighing down our margins as margins on these projects were at or near zero. This increase also reflects our continuous efforts to improve profitability on ongoing projects.

In the 2013 Form 10-K, we discussed various factors which impact the profitability on individual projects as well as the competitive pressures that have adversely affected our ability to secure construction projects at favorable margins. Our highway and related bridge work is generally funded through federal and state authorizations. Federal and state legislation related to infrastructure spending has been slow to pass due to the partisan standoffs in Congress. However, with the passage of MAP-21 and the expanded federal Transportation Infrastructure Finance and Innovation Act (TIFIA) loan program, the transportation market has some degree of certainty for its near term funding. This funding has marginally helped, and as a result, the heavy highway construction sector is expected to grow modestly for 2014.

For the first half of 2014, we have seen a steady turnaround in our gross margins and we are cautiously optimistic that the modest expected highway construction growth, along with our efforts to continuously improve our processes with a focus on increasing profitability, will result in gross margins in the mid-single digit range for the year. See "Item 1. Business - Our Markets, Competition and Customers" in the 2013 Form 10-K for a more detailed discussion of our markets and their funding sources.


Results of Operations

Backlog at June 30, 2014

At June 30, 2014, our backlog of construction projects was $727 million, as compared to $687 million at December 31, 2013. Our contracts are typically completed in 12 to 36 months. At June 30, 2014, there was approximately $116 million excluded from our consolidated backlog for which we were the apparent low bidder, but had not yet been formally awarded the contract or the contract price had not been finalized. Backlog includes $20 million attributable to our share of estimated revenues related to joint ventures for which we are a noncontrolling joint venture partner. Our backlog reflects, in part, our recently implemented strategy to target smaller, shorter duration projects with a particular focus on gross margins.

Results of Operations for the Current Quarter as Compared to the Prior Quarter and for the Current Period as compared to the Prior Period

                                               Three Months                              Six Months
                                                  Ended                                     Ended
                                                 June 30,                                 June 30,
                                                                   %                                        %
                                     2014          2013         Change        2014          2013          Change

Revenues                           $ 194,806     $ 133,350         46.1 %   $ 329,343     $ 244,385          34.8 %
Gross profit (loss)                $  12,499     $ (16,635 )         NM     $  20,369     $ (15,247 )          NM
General and administrative
expenses                              (9,507 )      (9,486 )        0.2       (17,991 )     (19,097 )        (5.8 )
Other operating income
(expense), net                          (457 )         108           NM           599           450            NM
Operating income (loss)                2,535       (26,013 )         NM         2,977       (33,894 )          NM
Gains on the sale of securities            -             -           NM             -           483            NM
Interest income                          189           255        (25.9 )         531           536          (0.9 )
Interest expense                        (251 )        (209 )       20.1          (554 )        (308 )        79.9
Income (loss) before taxes and
earnings attributable to
noncontrolling interests               2,473       (25,967 )         NM         2,954       (33,183 )          NM
Income tax (expense) benefit             (28 )       9,747           NM           (28 )      12,547            NM
Net income (loss)                      2,445       (16,220 )         NM         2,926       (20,636 )          NM
Noncontrolling owners' interests
in earnings of subsidiaries and
joint ventures                        (1,245 )        (805 )       54.7        (1,520 )        (966 )        57.3
Net income (loss) attributable
to Sterling common stockholders    $   1,200     $ (17,025 )         NM     $   1,406     $ (21,602 )          NM
Gross margin (deficit)                   6.4 %       (12.5 )%        NM           6.2 %        (6.2 )%         NM
Operating margin (deficit)               1.3 %       (19.6 )%        NM           0.9 %       (13.9 )%         NM



NM - Not meaningful.

                                                 Amount as of
                                  June 30,      March 31,       December 31,
                                    2014           2014             2013
Contract Backlog, end of period   $ 727,000     $  799,000     $      687,000

Revenues

Revenues increased $61.5 million, or 46.1%, in the Current Quarter compared with the Prior Quarter and increased $85.0 million, or 34.8%, for the Current Period compared with the Prior Period. The increase in both periods is primarily attributable to an increase in the number of projects in progress along with increased productivity, largely in our Texas and California markets.

Gross Profit

Gross profit increased $29.1 million for the Current Quarter compared with the Prior Quarter and $35.6 million for the Current Period compared with the Prior Period. Gross margins increased to 6.4% in the Current Quarter from a deficit of 12.5% in the Prior Quarter and to 6.2% in the Current Period from a deficit of 6.2% in the Prior Period. The increase in gross margin during both periods is primarily attributed to the impact of downward revisions of gross profits related to three problem jobs in the Prior Quarter and Prior Period. These projects have reached substantial completion during the Current Quarter and are no longer weighing down our margins as margins on these projects were at or near zero. This increase also reflects our continuous efforts to improve profitability on ongoing projects.


At June 30, 2014 and 2013, we had approximately 119 and 114 contracts-in-progress, respectively, which were less than 90% complete. These contracts are of various sizes, of different expected profitability and in various stages of completion. The nearer a contract progresses toward completion, the more visibility we have in refining our estimate of total revenues (including incentives, delay penalties and change orders), costs and gross profit. Thus, gross profit as a percent of revenues can increase or decrease from comparable and sequential quarters due to differences among contracts and depending upon the stage of completion of contracts.

General and administrative expenses

General and administrative expenses remained flat during the Current Quarter and Prior Quarter at $9.5 million and decreased $1.1 million to $18.0 million in the Current Period from $19.1 million in the Prior Period. The decrease during the Current Period as compared to the Prior Period is primarily the result of a decrease in employee benefit costs and non-recurring costs related to operational and financial process improvements which were expensed in the Prior Period.

As a percent of revenues, general and administrative expenses decreased 2.2% to 4.9% and 2.3% to 5.5% in the Current Quarter and Current Period, respectively, compared with 7.1% and 7.8% in the Prior Quarter and Prior Period, respectively. The decreases in general and administrative expenses, as a percentage of revenue, for both periods is the result of the investments made in our information systems infrastructure, and operational and financial process improvements which allowed us to increase our productivity without a significant increase in general and administrative expenses.

Income taxes

Our effective income tax rates for the Current Quarter and Prior Quarter were 1.1% and 37.5%, respectively, and for the Current Period and Prior Period were 0.9% and 37.8%, respectively. The Company is not expecting a current federal tax liability for 2014 due to sufficient net operating loss carry forwards that will offset projected taxable income. The Company does expect a state tax liability for 2014 in states without sufficient net operating loss carry forwards. Therefore, a current tax expense has been recorded for those states for the six months ended June 30, 2014. In the Prior Quarter and Prior Period, the effective income tax rate varied from the statutory rate primarily as a result of net income attributable to noncontrolling interest owners which is taxable to those owners rather than to us, state income taxes, and other permanent differences.

In order to determine that a valuation allowance was necessary, management assessed the available positive and negative evidence to estimate whether sufficient future taxable income would be generated to use the existing deferred tax assets. A significant piece of objective negative evidence evaluated was the cumulative loss incurred over the three-year period ended June 30, 2014. Such objective evidence limits the ability to consider other subjective evidence such as our projections for future growth. The ability to realize deferred tax assets and the need for a valuation allowance is evaluated and assessed quarterly. The amount of the deferred tax asset considered realizable could be adjusted if objective negative evidence or cumulative losses are no longer present, and additional weight may be given to subjective evidence such as our projections for growth. For the quarter ended June 30, 2014, there was no change in management's assessment of the amount of deferred tax asset considered realizable from the assessment made at December 31, 2013 and March 31, 2014.


Historical Cash Flows

The following table sets forth information about our cash flows and liquidity
(amounts in thousands):

                                                                Six Months Ended
                                                                    June 30,
                                                               2014         2013
Net cash used in:
Operating activities                                         $ (7,477 )   $ (26,946 )
Capital expenditures                                           (7,667 )      (6,689 )
Proceeds from sales of property and equipment, net of gain      4,250         2,086
Net sales of short-term securities                                  -        27,448
Net drawdown on the Credit Facility                            10,781         5,259
Distributions to noncontrolling interest owners                (1,190 )      (3,244 )
Net proceeds from stock issued                                 14,050             -
Other                                                            (338 )         (27 )
   Total                                                     $ 12,409     $  (2,113 )



                                   Amount as of
                            June 30,      December 31,
                              2014            2013
Cash and cash equivalents   $  14,281     $       1,872
Working capital             $  41,172     $       8,686

Operating Activities

Significant non-cash items included in operating activities include depreciation and amortization expense which was $9.2 million and $9.5 million in the Current Period and Prior Period, respectively. The depreciation expense has remained consistent from Prior Period to Current Period as a result of our efforts to maintain our current fleet of equipment and supplement it as necessary with leased equipment.

Besides the net income and net loss in the Current Period and Prior Period, respectively, and the non-cash items discussed above, other significant components of cash flows from operations were:

contracts receivable increased by $27.4 million in the Current Period and increased $16.9 million in the Prior Period while the net cash effect of billings in excess of costs and estimated earnings and costs and estimated earnings in excess of billings decreased cash by $21.6 million in the Current Period and increased cash by $2.8 million in the Prior Period;

accounts payable increased by $28.6 million in the Current Period and $8.0 million in the Prior Period; and

accrued compensation and other liabilities increased by $2.7 million in the Current Period and increased by $2.8 million in the Prior Period.

Investing Activities

Capital equipment is acquired as needed to support increased levels of production activities and to replace retiring equipment. Expenditures for the replacement of certain equipment and to expand our construction fleet of equipment for the Current Period and Prior Period totaled $7.7 million and $6.7 million, respectively. Proceeds from the sale of property and equipment for the Current Period and Prior Period totaled $4.3 million and $2.1 million, respectively, with an associated net gain for the Current Period and Prior Period of $0.9 million and less than $0.1 million, respectively. The level of expenditures in the Current Period only increased by $1.0 million from the Prior Period as a result of management's efforts to optimize utilization of our existing fleet of equipment based on current and projected workloads while supplementing our fleet with leased assets where appropriate.

During the Current Period, we had no sales of short-term securities as compared to net sales of short-term securities of $27.4 million in the Prior Period. The net sales in the Prior Period were primarily used to repay borrowings under on our Credit Facility that were used to purchase the remaining 20% interest in RLW in December 2012.

Financing Activities

Financing activities in the Current Period consisted of net proceeds from our common stock offering of approximately $14 million which was used to strengthen our balance sheet. In addition, the net drawdown on our Credit Facility of $10.8 million was used to fund our operating activities. In the Prior Period, there was a net drawdown of $5.3 million on our Credit Facility which was used to fund our operating activities. During the Current Period, we distributed $1.2 million to the noncontrolling interest owners. During the Prior Period, $3.2 million was distributed to the noncontrolling interest owners. Of this amount, $2.3 million was distributed to the former RLW owners as their final distribution for RLW's earnings in 2012.


Liquidity and Sources of Capital

The level of working capital for our construction business varies due to fluctuations in:

contract receivables and contract retentions;

costs and estimated earnings in excess of billings;

billings in excess of costs and estimated earnings;

investments in our unconsolidated construction joint ventures;

the size and status of contract mobilization payments and progress billings; and

the amounts owed to suppliers and subcontractors.

Some of these fluctuations can be significant. At June 30, 2014, we had working capital of $41.2 million, an increase of $32.5 million over December 31, 2013. The increase in working capital was the result of the following (amounts in thousands):

Net income                                                   $  2,926
Depreciation and amortization                                   9,201
Capital expenditures                                           (7,667 )
Proceeds from sales of property and equipment, net of gain      3,334
Distributions to noncontrolling interest owners                (1,190 )
Net drawdown on the Credit Facility                            10,781
Net proceeds from stock issued                                 14,050
Other                                                           1,051
Total increase in working capital                            $ 32,486

In addition to our available cash and cash equivalents and cash provided by operations, from time to time we use borrowings under our Credit Facility with Comerica Bank to finance our capital expenditures and working capital needs. Subject to the terms of the Credit Facility, including the financial covenants and further amendments discussed below, up to $40 million in borrowings and letters of credit are available under the Credit Facility, which matures on September 30, 2016. Borrowings under the Credit Facility are secured by all assets of the Company, other than proceeds from and other rights under our construction contracts which are pledged to our bond surety. At June 30, 2014, there were $18.6 million of borrowings outstanding under the Credit Facility; in addition, there was an outstanding letter of credit of $3.0 million which reduced availability under the Credit Facility to $18.4 million.

The Credit Facility is subject to our compliance with certain covenants, including financial covenants relating to leverage, tangible net worth, asset coverage and total loss for a quarterly period. The Credit Facility contains restrictions on our ability to:

Make distributions or pay dividends;

Incur liens and encumbrances;

Incur further indebtedness;

Guarantee obligations;

Dispose of a material portion of assets or merge with a third party;

Make acquisitions; and

Make investments in securities.

At the end of the fourth quarter of 2013, we were not in compliance with the minimum tangible net worth and the leverage ratio financial covenants. As a result, subsequent to year end, we obtained a Waiver and Fourth Amendment to Credit Agreement (the "Fourth Amendment") with our bank which waived the noncompliance with the financial covenants as of December 31, 2013 and provided less restrictive covenant requirements. The Fourth Amendment also imposed liquidity thresholds that we are required to meet in 2014. We believe that we will be able to maintain compliance with all covenants required under the Fourth Amendment through at least the next twelve months. Refer to the discussion below of our revised amendment which eased our required liquidity thresholds.


Among other things, the Fourth Amendment reduced the borrowings available to $40 million from the previously available $50 million and has eliminated the option to increase the Credit Facility by an additional $50 million. The Fourth Amendment also modified the existing borrowing interest fee schedule and . . .

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