UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark one)

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2016 Or
[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from___ to ___
Commission file number 1-31993
STERLING CONSTRUCTION COMPANY, INC. (Exact name of registrant as specified in its charter)
DELAWARE	25-1655321
State or other jurisdiction of incorporation or organization	(I.R.S. Employer Identification No.)
1800 Hughes Landing Blvd. The Woodlands, Texas	77380
(Address of principal executive office)	(Zip Code)
Registrant’s telephone number, including area code  (281) 214-0800
(Former name, former address and former fiscal year, if changed from last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. [√] Yes [ ] No   Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). [√] Yes [ ] No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ]                                Accelerated filer [√] Non-accelerated filer [ ]                                  Smaller reporting company [ ] (Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [√] No
At October 28, 2016, there were 25,002,964 shares outstanding of the issuer’s common stock, par value $0.01 per share.

 

STERLING CONSTRUCTION COMPANY, INC.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

 

 

 

PART I. FINANCIAL INFORMATION
Item 1.  Financial Statements	3
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.  Quantitative and Qualitative Disclosures about Market Risk	26
Item 4.  Controls and Procedures	26
PART II. OTHER INFORMATION
Item 1.  Legal Proceedings	27
Item 1A.  Risk Factors	27
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.  Defaults upon Senior Securities	27
Item 4.  Mine Safety Disclosures	27
Item 5.  Other Information	27
Item 6.  Exhibits	28
SIGNATURES	29

 

PART I

Item 1. Financial Statements

 

STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share and per share data)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except share and per share data)

(Unaudited)

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Amounts in thousands)

(Unaudited)

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2016

(Amounts in thousands)

(Unaudited)

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

 

 

 

 

 

 

 

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, 2015 (“2015 Form 10-K”) under “Part I, 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 Construction Company, Inc. (“Sterling” or “the Company”), is a leading heavy civil construction company that specializes in building and reconstruction of transportation and water infrastructure projects in Texas, Utah, Nevada, Colorado, Arizona, California, Hawaii and other states in which there are construction opportunities. Its transportation infrastructure projects include highways, roads, bridges, airfields, ports and light rail. Its water infrastructure projects include water, wastewater and storm drainage systems.

 

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 consist of one reportable segment, one operating segment and one reporting unit component: heavy civil construction. In making this determination, the Company considered the discrete financial information used by our Chief Operating Decision Maker (“CODM”). Based on this approach, the Company noted that the CODM organizes, evaluates and manages the financial information around each heavy civil construction project when making operating decisions and assessing the Company’s overall performance. Furthermore, we considered that each heavy civil construction project has similar characteristics, includes similar services, has similar types of customers and is subject to similar economic and regulatory environments. 

 

Market Outlook and Trends

 

Market outlook: Our core business is primarily driven by Federal and state funding. The late 2015 passage of the federally funded five-year $305 billion surface transportation bill will increase the annual federal highway investment by 15.1% over the five-year period from 2016 to 2020. In addition to the Federal program, several of the states in our key markets have instituted actions to further increase annual spending. In Texas, two constitutional amendments were passed, which will increase the annual funds allocated to transportation projects by $4.0 billion to $4.5 billion per year. In Utah, a 20% gas tax increase was put into effect January 1, 2016, which is the first state gas tax increase in 18 years. In addition, California is currently trying to pass a $3.6 billion per year transportation bill. See “Item 1. Business—Our Markets, Competition and Customers” in our 2015 Form 10-K for a more detailed discussion of our markets and their funding sources.

 

Bid discipline and project execution: To ensure that we take full advantage of the improved market conditions and maximize profitability we have completed an extensive evaluation of our projects’ historical success based on project size, end customer, product delivered and geography. The knowledge gained has now been incorporated into a more formal and rigorous bid evaluation and approval process, which along with the institution of common processes, we believe will enable us to focus our resources on the most beneficial projects and significantly reduce our risk. In addition, in order to strengthen these processes and capitalize further on the improved market conditions, we appointed a Chief Operating Officer late in the first quarter of 2016.

 

Backlog, backlog gross margin and gross margin trends:

 

	Backlog	Gross Margin in Backlog
	(Dollar amounts in thousands)
Third quarter of 2016	$820,000	8.0%
Second quarter of 2016	$810,000	7.8%
First quarter of 2016	$854,000	7.7%
Fourth quarter of 2015	$761,000	7.0%
Third quarter of 2015	$718,000	6.5%

 

Our total margin in backlog has increased approximately 150 basis points, from 6.5% at September 30, 2015 to 8.0% at September 30, 2016. During the nine months ended September 30, 2016, we have won approximately $455 million worth of new projects at an average margin of more than 8.5%. In addition, once we complete approximately $21 million worth of legacy projects with small or zero margins, we expect that our overall backlog margins to continue to increase and will be in the 8.0% to 8.5% range by December 31, 2016. The increases noted above are primarily the result of the improving market conditions and actions that we have taken to improve bid discipline.

 

Our gross margin has increased 1.2%, 66.7% and 8.8% from the third quarter of 2015 to the third quarter of 2016, from the second quarter of 2015 to the second quarter of 2016 and from the first quarter of 2015 to the first quarter of 2016, respectively. These increases are a result of the improving market conditions, our bid discipline and our improving project execution.

 

For purposes of the discussions which follow, “Current Quarter” refers to the three-month period ended September 30, 2016, “Prior Quarter” refers to the three-month period ended September 30, 2015, Current Period” refers to the nine-month period ended September 30, 2016 and “Prior Period” refers to the nine-month period ended September 30, 2015.

 

Summary of Financial Results for the Current Quarter and Current Period

 

In the Current Quarter and Current Period, we had operating income of $3.7 million and $0.6 million, respectively, income before income taxes and earnings attributable to noncontrolling interest owners of $3.2 million and a loss of $1.6 million, respectively, net income attributable to Sterling common stockholders of $2.4 million and a loss attributable to Sterling common stockholders of $2.9 million, respectively, and net income per diluted share attributable to Sterling common stockholders of $0.10 and a net loss per diluted share attributable to Sterling common stockholders of $0.12, respectively.

 

Results of Operations

 

Backlog

 

At September 30, 2016, our backlog of construction projects was $820 million, as compared to $761 million at December 31, 2015. Our contracts are typically completed in 12 to 36 months. At September 30, 2016 and December 31, 2015, approximately $94 million and $197 million, respectively, was excluded from our consolidated backlog for projects in which we were the apparent low bidder, but had not yet been formally awarded the contract or the contract price had not been finalized (“Unsigned Low-bid Awards”). Total backlog, including Unsigned Low-bid Awards, at September 30, 2016 and December 31, 2015, was $914 million and $958 million, respectively. Backlog at September 30, 2016 includes $61 million attributable to our share of estimated revenues related to joint ventures where we are a noncontrolling joint venture partner.

 

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 Ended September 30,												Nine Months Ended September 30,
		2016				2015				% Change				2016				2015				% Change
		(Dollar amounts in thousands)
Revenues		$	205,629			$	176,000				16.8	%		$	521,778			$	471,107				10.8	%
Gross profit		$	17,032			$	14,458				17.8			$	36,951			$	16,733				NM
General and administrative expenses			(9,575	)			(11,119	)			(13.9	)			(29,221	)			(32,320	)			(9.6	)
Other operating income (expense), net			(3,785	)			(958	)			NM				(7,143	)			1,128				NM
Operating income (loss)			3,672				2,381				54.2				587				(14,459	)			NM
Interest income			15				32				(53.1	)			19				464				(95.9	)
Interest expense			(491	)			(1,087	)			(54.8	)			(2,176	)			(2,103	)			3.5
Loss on extinguishment of debt			-				-				NM				-				(240	)			NM
Income (loss) before taxes and earnings attributable to noncontrolling interests a			3,196				1,326				NM				(1,570	)			(16,338	)			(90.4	)
Income tax (expense) benefit			(41	)			39				NM				(68	)			8				NM
Net income (loss)			3,155				1,365				NM				(1,638	)			(16,330	)			(90.0	)
Noncontrolling owners’ interests in earnings of subsidiaries and joint ventures			(740	)			(1,109	)			(33.3	)			(1,252	)			(2,948	)			(57.5	)
Net income (loss) attributable to Sterling common stockholders		$	2,415			$	256				NM			$	(2,890	)		$	(19,278	)			(85.0	)
Gross margin			8.3	%			8.2	%			1.2				7.1	%			3.6	%			97.2
Operating margin (deficit)			1.8	%			1.4	%			28.6				0.1	%			(3.1	)%			NM

 

NM – Not meaningful.

 

Revenues

 

Revenues increased $29.6 million, or 16.8%, in the Current Quarter compared with the Prior Quarter and increased $50.7 million, or 10.8%, in the Current Period compared with the Prior Period. As our markets continue to improve, so has the trend of increasing backlog which increased $102 million from September 30, 2015 to September 30, 2016. This trend has contributed to the increased execution of projects and has favorably affected revenues in both the Current Quarter and Current Period. Specifically, the increase in revenues during the Current Quarter as compared to the Prior Quarter is primarily the result of increased project activity in nearly all of our markets which resulted in a $35.0 million increase, offset by a $5.4 million decrease in Texas. The Texas decrease is primarily due to the slower ramp up of new work driven by owner delays. The majority of the increase was due to the ramp up of two large Utah projects constructed by our majority-owned construction joint venture that were not ongoing in the Prior Quarter or the Prior Period. The increase in the Current Period as compared to the Prior Period is primarily the result of the ramp up of these two large projects along with the lower revenue projects constructed in the Prior Period and the downward percent-complete revisions made to certain projects in the Prior Period. Current Period revenues increased largely in Utah, Nevada and Hawaii by $75.4 million which was offset by $24.7 million due to lower project activity in Texas as a result of heavy rainfall which caused flooding in the Houston and surrounding areas, slower ramp up of new work driven by owner delays and the winding down of a large project in California which was ongoing in the Prior Period.

 

Gross profit

 

Gross profit increased $2.6 million for the Current Quarter compared with the Prior Quarter and $20.2 million for the Current Period compared with the Prior Period. Our gross margins increased to 8.3% and 7.1% in the Current Quarter and Current Period, respectively, as compared to 8.2% and 3.6% in the Prior Quarter and Prior Period, respectively. The increase in gross margin during the Current Quarter as compared to the Prior Quarter was primarily related to the overall increasing margin in backlog driven by the Company’s improving markets and the change in the project margin mix as we have less revenue in the current quarter from zero or near zero margin projects. Favorable project mix has improved gross margin in backlog by 1.5% to 8.0% at September 30, 2016, from 6.5% at September 30, 2015. The increase in the gross margin during the Current Period as compared to the Prior Period is primarily a result of downward revision of gross profits related to construction projects in Texas in the Prior Period as well as improved project margin mix as noted above. Current Period gross margin was adversely affected by a completed California project which recorded an additional loss of approximately $1.6 million. This loss was primarily attributable to unfavorable developments relating to a subcontractor claim.

 

At September 30, 2016 and 2015, we had 121 and 133 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 we are able to refine our estimate of total revenues (including incentives, delay penalties, change orders and claims), costs and gross profit. Thus, gross profit as a percent of revenues can increase or decrease from comparable and subsequent quarters due to variations among contracts and depending upon the stage of completion of contracts.

 

The Company has projects where we are in the process of negotiating, or awaiting final approval of, unapproved change orders and claims with our customers. The Company is proceeding with its contractual rights to recoup additional costs incurred from its customers based on completing work associated with change orders with pending change order pricing or claims related to significant changes in scope which resulted in substantial delays and additional costs in completing the work. Unapproved change order and claim information has been provided to our customers and negotiations with the customers are ongoing. If additional progress with an acceptable resolution is not reached, legal action will be taken.

 

Based upon our review of the provisions of our contracts, specific costs incurred and other related evidence supporting the unapproved change orders, claims and our entitled unpaid project price, together with the views of the Company’s outside claim consultants, we concluded that including the unapproved change order, claim and entitled unpaid project price amounts of $2.4 million, $9.1 million and $3.9 million, respectively, at September 30, 2016, and $1.6 million, $5.2 million and $3.9 million, respectively, at December 31, 2015, in “Costs and estimated earnings in excess of billings on uncompleted contracts” on our condensed consolidated balance sheets was in accordance with GAAP. We expect these matters will be resolved without a material adverse effect on our financial statements. However, unapproved change order and claim amounts are subject to negotiations which may cause actual results to differ materially from estimated and recorded amounts.

 

General and administrative expenses

 

General and administrative expenses decreased $1.5 million to $9.6 million during the Current Quarter from $11.1 million in the Prior Quarter and decreased $3.1 million to $29.2 million during the Current Period from $32.3 million in the Prior Period. The decrease in the Current Quarter compared to the Prior Quarter is primarily the result of certain non-recurring costs related to consulting and employee severance payments of $1.1 million and $0.5 million, respectively, in the Prior Quarter. The decrease in the Current Period as compared to the Prior Period is primarily the result of certain non-recurring costs related to consulting and employee severance payments of $1.2 million and $2.9 million, respectively, in the Prior Period offset by an increase in certain employee and employee benefit costs in the Current Period.

 

As a percent of revenues, general and administrative expenses decreased 1.6% to 4.7% and 1.3% to 5.6% in the Current Quarter and Current Period, respectively, compared with 6.3% and 6.9% in the Prior Quarter and Prior Period, respectively. The decrease in general and administrative expenses, as a percentage of revenue, for the Current Quarter and Current Period is primarily the result of the decrease in the non-recurring employee severance costs and consulting costs paid in the Prior Period as mentioned above, along with the leverage generated from generally fixed costs and increases in revenue in both current periods.

 

Other operating income (expense), net

 

Other operating income (expense), net, includes 50% of earnings and losses related to members’ interests, gains and losses from sales of property, plant and equipment and other miscellaneous operating income or expense. Members’ interest earnings are treated as an expense and result in an increase to our liability account “Members’ interest subject to mandatory redemption and undistributed earnings.” The change in other operating income (expense), net was primarily due to increased Members’ interest earnings and an earn-out expense of $3.4 million and $0.4 million, respectively, for the Current Quarter and Members’ interest earnings of $7.3 million for the Current Period.

 

Income taxes

 

Our effective income tax rates for the Current and Prior Quarters were minimal. The Company is not expecting a current federal tax liability. We may incur current state tax liabilities in states in which we do not have sufficient net operating loss carry forwards. A minimal tax expense was recorded for the Current and Prior Quarters. The effective income tax rate varied from the statutory rate primarily as a result of the change in the valuation allowance, net income attributable to noncontrolling interest owners which is taxable to those owners rather than to the Company, state income taxes and other permanent differences.

 

Liquidity and Sources of Capital

 

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

 

		Nine Months Ended September 30,
		2016				2015
Net cash (used in) provided by:
Operating activities		$	35,710			$	3,492
Investing activities			(6,665	)			(6,172	)
Financing activities			9,550				(8,675	)
Total increase (decrease) in cash and cash equivalents		$	38,595			$	(11,355	)

 

		September 30, 2016				December 31, 2015
Cash and cash equivalents		$	43,021			$	4,426
Working capital		$	40,634			$	30,610

 

Operating Activities.

 

During the Current Period, net cash provided by operating activities was $35.7 million compared to $3.5 million in the Prior Period. The drivers of operating activities cash flows were primarily the result of our lower net loss discussed above, non-cash items, the change in our accounts receivable, inventory, net contracts in progress and accounts payable balances (collectively, “Contract Capital”) and the change in other assets as discussed below.

 

The significant non-cash items included in operating activities include depreciation and amortization expense, which were $12.1 million in the Current Period and $12.5 million in the Prior Period. Depreciation expense has decreased from the Prior Period to the Current Period as a result of our efforts to maintain our current fleet of equipment and supplement it as necessary with more economical project specific leased equipment.

 

The need for working capital for our business varies due to fluctuations in operating activities and investments in our Contract Capital. The components of Contract Capital at September 30, 2016 and December 31, 2015 and changes during the Current Period were as follows (amounts in thousands):

 

		September 30, 2016				December 31, 2015				Change
Costs and estimated earnings in excess of billings on uncompleted contracts		$	31,989			$	26,905			$	(5,084	)
Billings in excess of costs and estimated earnings on uncompleted contracts			(61,896	)			(30,556	)			31,340
Contracts in progress, net			(29,907	)			(3,651	)			26,256
Contracts receivable, including retainage			105,415				82,112				(23,303	)
Receivables from and equity in construction joint ventures			9,469				12,930				3,461
Inventories			4,000				2,535				(1,465	)
Accounts payable			(76,861	)			(58,959	)			17,902
Contract Capital, net		$	12,116			$	34,967			$	22,851

 

The Current Period change in Contract Capital increased liquidity by $22.9 million. Fluctuations in our Contract Capital balance and its components are not unusual in our business and are impacted by the size of our projects and changing type and mix of projects in our backlog. Our Contract Capital is particularly impacted by the timing of new awards and related payments of performing work and the contract billings to the customer as we complete our projects. Contract Capital is also impacted at period-end by the timing of accounts receivable collections and accounts payable payments for our projects.

 

Other assets increased by $1.3 million in the Current Period compared to a decrease of $9.3 million in the Prior Period which was primarily due to the sale of our long-term contract receivable in the Prior Period.

 

Cash from operating activities continues to improve with the quality of our backlog margin. We expect this improvement in backlog margin, along with our focus on project cost containment and working capital management, to continue into 2017.

 

Investing Activities.

 

During the Current Period, net cash used in investing activities was $6.7 million compared to $6.2 million in the Prior Period. The primary driver of investing activities cash flows was cash used as collateral for our letter of credit requirements and for use in an escrow account where both amounts were designated as restricted cash and also investments in capital equipment as discussed below.

 

Capital equipment is acquired as needed to support changing levels of production activities and to replace retiring equipment. Expenditures for the replacement of certain equipment and to expand our construction fleet totaled $8.9 million for the Current Period. Proceeds from the sale of property and equipment totaled $2.2 million for the Current Period with an associated net gain of $0.3 million. For the Prior Period, expenditures totaled $7.1 million, while proceeds from the sale of property and equipment totaled $5.9 million with an associated net gain of $1.2 million. The decrease in proceeds in the Current Period was due to the completion of our Company wide initiative that focused on selling underutilized and non-core assets that was ongoing in the Prior Period. The level of expenditures in the Current Period increased by $1.8 million compared to the Prior Period. This increase was the result of the need to replace and expand our construction fleet in strategic areas of our markets in order to satisfy specific project needs.

 

Financing Activities.

 

During the Current Period, net cash provided by financing activities was $9.6 million compared to cash used of $8.7 million in the Prior Period. The increase in cash provided by financing activities was primarily a result of net proceeds of $19.1 million received from the issuance of common stock which was offset by the Revolving Loan payoff and Term Loan monthly payments along with a $5 million prepayment made in the Current Period. Financing activities in the Prior Period consisted of the net repayments on our Prior Credit Facility of $34.6 million and cumulative drawdowns on our equipment-based revolver of $13.1 million and cash received from our equipment-based term loan of $19.0 million, both of which were used to fund our operating activities and replace our Prior Credit Facility. In addition, during the Prior Period, distributions of $3.4 million were made to a noncontrolling interest member.

 

Cash and Working Capital.

 

Cash at September 30, 2016, was $43.0 million, which increased based on the items mentioned above. Cash includes $2.1 million that was held by our VIE, $14.1 million belonging to our majority owned joint venture and a $22.9 million increase in contract capital in the Current Period offset by our net loss attributable to Sterling common stockholders of $2.9 million in the Current Period.

 

Credit Facility and Other Sources of Capital

 

In addition to our available cash, cash equivalents and cash provided by operations, from time to time, we use borrowings under our Equipment-based Facility to finance our capital expenditures and working capital needs.

 

In May 2015, the Company and its wholly-owned subsidiaries entered into a $40.0 million loan and security agreement with Nations Fund I, LLC and Nations Equipment Finance, LLC, as the administrative agent and collateral agent for the lender (“Nations”), consisting of a $20.0 million term loan (the “Term Loan”) and a $20.0 million revolving loan (the “Revolving Loan” and combined with the Term Loan, the “Equipment-based Facility”), which replaced its prior credit facility. The amount of the Revolving Loan that may be borrowed from time to time is determined quarterly and may not exceed $20.0 million. In addition, the sum of the outstanding balance of the Equipment-based Facility may not exceed the lesser of $40.0 million or 65% of the appraised value of the collateral pledged for the loans. At September 30, 2016, the Company had a borrowing base of approximately $27.0 million, which was the result of calculating 65% of the appraised value (where appraised value equals net operating liquidated value) of the Company’s collateral. At September 30, 2016, we had $9.6 million outstanding on the Term Loan and no outstanding balance on the Revolving Loan.

 

The Equipment-based Facility bears interest at an initial fixed annual rate of 12%, which is subject to (i) a decrease of up to two percentage points based on the Company's fixed charge coverage ratio for each of the most recently ended four quarters beginning with the four quarters ended June 30, 2016; and (ii) an increase of two percentage points beginning December 31, 2015 based on the fixed charge coverage ratio at the end of the following two quarters. There have been no interest rate changes during the three and nine months ended September 30, 2016. Principal on the Term Loan is payable in 47 monthly installments (with accrued interest) with a final payment of the then outstanding principal amount on May 29, 2019. Up to $5.0 million of the Term Loan may be prepaid in any year, but subject to a pre-payment fee that declines as the Term Loan nears maturity. During the three and nine months ended September 30, 2016, we prepaid $5 million of the Term Loan and paid $0.2 million in pre-payment fees. The outstanding Revolving Loan is payable in full on May 29, 2019.

 

The Equipment-based Facility is secured by all of the Company's personal property, including all of its construction equipment, which forms the basis of availability under the Revolving Loan. The Equipment-based Facility is also secured by specified equipment of the Company's 50%-owned affiliates, Road and Highway Builders, LLC and Myers & Sons Construction, L.P. pursuant to a separate security agreement with those entities. If a default occurs, Nations may exercise the Company's rights in the collateral, with all of the rights of a secured party under the Uniform Commercial Code, including, among other things, the right to sell the collateral at public or private sale.

 

The Company’s Equipment-based Facility has no financial covenants; however, it contains restrictions on the Company’s ability to incur liens and encumbrances or dispose of a material portion of assets or merge with a third party.

 

Average borrowings under our Equipment-based Facility for the Current Quarter and Current Period were $11.0 million and $21.1 million, respectively, and the largest amount of borrowings was $31.6 million from January 5, 2016 to January 31, 2016. Average combined borrowings under the prior credit facility and the Equipment-based Facility during the year ended December 31, 2015, were $25.9 million and the largest amount of borrowings was under the Equipment-based Facility of $34.6 million from June 5, 2015 to June 30, 2015.

 

Based on our average borrowings for 2015 and our 2016 forecasted cash needs, we continue to believe that the Company has sufficient liquid financial resources to fund our requirements for the next twelve months of operations, including our bonding requirements. Furthermore, the Company is continually assessing ways to increase revenues and reduce costs to improve liquidity. However, in the event of a substantial cash constraint and if we were unable to secure adequate debt financing, or we continue to incur losses, our working capital could be materially and adversely affected. Refer to “Part I, Item 1A. Risk Factors” in the 2015 Form 10-K for further discussion of liquidity related risks.

 

On May 9, 2016, the Company completed an underwritten public offering of 5,175,000 shares of the Company’s common stock, which included the full exercise of the sole underwriter’s over-allotment option, at a price to the public of $4.00 per share ($3.77 per share net of underwriting discounts). The net proceeds from the offering of $19.1 million, after deducting underwriting discounts and other offering expenses, were used for working capital, repayment of our indebtedness under the revolving loan portion of our Equipment-based Facility and for general corporate purposes.

 

Due to the continuing improvement in our markets along with several large project wins during the Current Period, we will be exploring additional capital alternatives to further strengthen our financial position in order to take advantage of this improving transportation infrastructure market. This would include the potential sale of assets, businesses or equity, the favorable resolution of outstanding contract claims, refinancing our Equipment-based Facility, or a combination thereof. We expect to use proceeds from these initiatives to reduce a portion of our debt and for other working capital needs.

 

Inflation

 

Inflation generally has not had a material impact on our financial results; however, from time to time, increases in oil, fuel and steel prices have affected our cost of operations. Anticipated cost increases and reductions are considered in our bids to customers on proposed new construction projects.

 

Where we are the successful bidder on a project, we execute purchase orders with material suppliers and contracts with subcontractors covering the prices of most materials and services, other than oil and fuel products, thereby mitigating future price increases and supply disruptions. These purchase orders and contracts do not contain quantity guarantees and we have no obligation for materials and services beyond those required to complete the contracts with our customers. There can be no assurance that increases in prices of oil and fuel used in our business will be adequately covered by the estimated escalation we have included in our bids and there can be no assurance that all of our vendors will fulfill their pricing and supply commitments under their purchase orders and contracts with the Company. We adjust our total estimated costs on our projects when we believe it is probable that we will have cost increases which will not be recovered from customers, vendors or re-engineering.

 

Off-Balance Sheet Arrangements and Joint Ventures

 

We participate in various construction joint ventures in order to share expertise, risk and resources for certain highly complex projects. The venture’s contract with the project owner typically requires joint and several liability among the joint venture partners. Although our agreements with our joint venture partners provide that each party will assume and fund its share of any losses resulting from a project, if one of our partners is unable to pay its share, we would be fully liable for such share under our contract with the project owner. Circumstances that could lead to a loss under these guarantee arrangements include a partner’s inability to contribute additional funds to the venture in the event that the project incurs a loss or additional costs that we could incur should the partner fail to provide the services and resources toward project completion that had been committed to in the joint venture agreement.

 

At September 30, 2016, there was approximately $126 million of construction work to be completed on unconsolidated construction joint venture contracts, of which $61 million represented our proportionate share. Due to the joint and several liability under our joint venture arrangements, if one of our joint venture partners fails to perform, we and the remaining joint venture partners would be responsible for completion of the outstanding work. As of September 30, 2016, we are not aware of any situation that would require us to fulfill responsibilities of our joint venture partners pursuant to the joint and several liability provisions under our contracts.

 

Off-balance sheet arrangements related to operating leases are discussed in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations –Liquidity and Sources of Capital− Contractual Obligations” in our 2015 Form 10-K.

  

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Changes in interest rates are one of our sources of market risks. Outstanding indebtedness under our Equipment-based Facility does not bear interest at floating rates, so our results from operations are not impacted from a change in interest rates. However, our interest rate could increase by 2% based on our fixed charge coverage ratio as noted above in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Sources of Capital.”

 

See “Inflation” above regarding risks associated with materials and fuel purchases required to complete our construction contracts.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Disclosure controls and procedures include, but are not limited to, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is accumulated and communicated to the issuer’s management, including the principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

The Company’s principal executive officer and principal financial officer reviewed and evaluated the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on that evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures were effective at September 30, 2016 to ensure that the information required to be disclosed by the Company in this Report is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to the Company's management including the principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Inherent Limitations on Effectiveness of Controls

 

Internal control over financial reporting may not prevent or detect all errors and all fraud. Also, projections of any evaluation of effectiveness of internal control to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

 

We are now and may in the future be involved as a party to various legal proceedings that are incidental to the ordinary course of business. We regularly analyze current information about these proceedings and, as necessary, provide accruals for probable liabilities on the eventual disposition of these matters.

In the opinion of management, after consultation with legal counsel, there are currently no threatened or pending legal matters that would reasonably be expected to have a material adverse impact on our condensed consolidated results of operations, financial position or cash flows.

 

Item 1A. Risk Factors

 

There have not been any material changes from the risk factors previously disclosed in “Part I, Item 1A. Risk Factors” of our 2015 Form 10-K. You should carefully consider such risk factors, which could materially affect our business, financial condition or future results.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3. Defaults upon Senior Securities

 

None.

 

Item 4. Mine Safety Disclosures

 

The information concerning mine safety violations and other regulatory matters required by section 1503(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act and Item 104 of Regulation S-K is included in Exhibit 95.1 of this Quarterly Report on Form 10-Q, which is incorporated by reference.

 

Item 5. Other Information

 

None.

 

Item 6. Exhibits

 

Exhibit No.

Description

31.1*

Certification of Paul J. Varello, Chief Executive Officer of Sterling Construction Company, Inc.

31.2*

Certification of Ronald A. Ballschmiede, Chief Financial Officer of Sterling Construction Company, Inc.

32*

Certification pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350) of Paul J. Varello, Chief Executive Officer, and Ronald A. Ballschmiede, Chief Financial Officer

95.1*

Mine Safety Disclosure

101.INS*

XBRL Instance Document

101.SCH*

XBRL Taxonomy Extension Schema Document

101.CAL*

XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF*

XBRL Taxonomy Extension Definition Linkbase Document

101.LAB*

XBRL Taxonomy Extension Label Linkbase Document

101.PRE*

XBRL Taxonomy Extension Presentation Linkbase Document

________________

* Filed herewith.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

 

 

	STERLING CONSTRUCTION COMPANY, INC.
Date: October 31, 2016	By: /s/ Paul J. Varello
	Paul J. Varello
	Chief Executive Officer
Date: October 31, 2016	By: /s/ Ronald A. Ballschmiede
	Ronald A. Ballschmiede
	Chief Financial Officer

 

 

 

 

 

 

 

STERLING CONSTRUCTION COMPANY, INC.

Quarterly Report on Form 10-Q for Period Ended September 30, 2016

Exhibit Index

 

 

Exhibit No.		Description
31.1*		Certification of Paul J. Varello, Chief Executive Officer of Sterling Construction Company, Inc.
31.2*		Certification of Ronald A. Ballschmiede, Chief Financial Officer of Sterling Construction Company, Inc.
32*		Certification pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350) of Paul J. Varello, Chief Executive Officer, and Ronald A. Ballschmiede, Chief Financial Officer.
95.1*		Mine Safety Disclosure
101.INS*		XBRL Instance Document
101.SCH*		XBRL Taxonomy Extension Schema Document
101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*		XBRL Taxonomy Extension Label Linkbase Document
101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document

 

________________

* Filed herewith.