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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q/A (Amendment No. 1)
(Mark one) | |
| [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
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For the quarterly period ended: September 30, 2015 Or | |
| [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
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For the transition period from___ to ___
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Commission file number 1-31993
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STERLING CONSTRUCTION COMPANY, INC. (Exact name of registrant as specified in its charter)
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| DELAWARE | 25-1655321 |
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State or other jurisdiction of incorporation or organization |
(I.R.S. Employer Identification No.) |
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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) | |
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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
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| 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 31, 2015, there were 19,588,170 shares outstanding of the issuer’s common stock, par value $0.01 per share.
1
EXPLANATORY NOTE
This Amendment No. 1 on Form 10-Q/A amends the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2015, which was filed with the Securities and Exchange Commission on November 9, 2015 (“the Original Filing”). The Company is filing this Amendment solely for the purpose of correcting typographical errors in Item 1. Financial Statements, in Note 10 to the condensed consolidated financial statements. The corrections eliminated the parenthesis around $1,108 and $2,941 for the three and nine months ended September 30, 2015, respectively, in the caption “Net (loss) income attributable to Sterling common stockholders,” and also removed the word “(loss)” in the caption.
This Amendment is presented as of the filing date of the Original Filing. Other than as set forth above, this Amendment does not modify or update disclosures in the Original Filing and does not reflect events that may have occurred after that date.
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STERLING CONSTRUCTION COMPANY, INC.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
| Item 1. Financial Statements | 4 |
| PART II. OTHER INFORMATION | |
| Item 6. Exhibits | 22 |
| SIGNATURES | 23 |
3
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
| September 30, 2015 | December 31, 2014 | |||||||
| (Unaudited) | ||||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 11,488 | $ | 22,843 | ||||
| Contracts receivable, including retainage | 99,666 | 78,896 | ||||||
| Costs and estimated earnings in excess of billings on uncompleted contracts | 23,287 | 33,403 | ||||||
| Inventories | 2,580 | 7,401 | ||||||
| Receivables from and equity in construction joint ventures | 11,089 | 9,153 | ||||||
| Other current assets | 9,044 | 5,278 | ||||||
| Total current assets | 157,154 | 156,974 | ||||||
| Property and equipment, net | 74,550 | 87,098 | ||||||
| Goodwill | 54,820 | 54,820 | ||||||
| Other assets, net | 4,150 | 7,559 | ||||||
| Total assets | $ | 290,674 | $ | 306,451 | ||||
| LIABILITIES AND EQUITY | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | 59,502 | $ | 66,792 | ||||
| Billings in excess of costs and estimated earnings on uncompleted contracts | 33,049 | 25,649 | ||||||
| Current maturities of long-term debt | 5,171 | 965 | ||||||
| Income taxes payable | 48 | 1,868 | ||||||
| Accrued compensation | 12,600 | 5,169 | ||||||
| Other current liabilities | 5,222 | 4,207 | ||||||
| Total current liabilities | 115,592 | 104,650 | ||||||
| Long-term liabilities: | ||||||||
| Long-term debt, net of current maturities | 30,509 | 37,021 | ||||||
| Member’s interest subject to mandatory redemption and undistributed earnings | 21,778 | 22,879 | ||||||
| Other long-term liabilities | 328 | 753 | ||||||
| Total long-term liabilities | 52,615 | 60,653 | ||||||
| Commitments and contingencies (Note 7) | ||||||||
| Equity: | ||||||||
| Sterling stockholders’ equity: | ||||||||
| Preferred stock, par value $0.01 per share; 1,000,000 shares authorized, none issued | – | – | ||||||
| Common stock, par value $0.01 per share; 28,000,000 shares authorized, 19,627,487 and 18,802,679 shares issued | 196 | 188 | ||||||
| Additional paid in capital | 206,639 | 205,697 | ||||||
| Retained deficit | (91,376 | ) | (72,098 | ) | ||||
| Accumulated other comprehensive loss | – | (101 | ) | |||||
| Total Sterling common stockholders’ equity | 115,459 | 133,686 | ||||||
| Noncontrolling interests | 7,008 | 7,462 | ||||||
| Total equity | 122,467 | 141,148 | ||||||
| Total liabilities and equity | $ | 290,674 | $ | 306,451 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except share and per share data)
(Unaudited)
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2015 | 2014 | 2015 | 2014 | |||||||||||||
| Revenues | $ | 176,000 | $ | 189,275 | $ | 471,107 | $ | 518,618 | ||||||||
| Cost of revenues | (161,542 | ) | (180,919 | ) | (454,374 | ) | (489,894 | ) | ||||||||
| Gross profit | 14,458 | 8,356 | 16,733 | 28,724 | ||||||||||||
| General and administrative expenses | (11,119 | ) | (9,326 | ) | (32,320 | ) | (27,316 | ) | ||||||||
| Other operating (expense) income, net | (958 | ) | (603 | ) | 1,128 | (4 | ) | |||||||||
| Operating income (loss) | 2,381 | (1,573 | ) | (14,459 | ) | 1,404 | ||||||||||
| Interest income | 32 | 113 | 464 | 644 | ||||||||||||
| Interest expense | (1,087 | ) | (211 | ) | (2,103 | ) | (766 | ) | ||||||||
| Loss on extinguishment of debt | – | – | (240 | ) | – | |||||||||||
| Income (loss) before income taxes and earnings attributable to noncontrolling interests | 1,326 | (1,671 | ) | (16,338 | ) | 1,282 | ||||||||||
| Income tax benefit (expense) | 39 | (546 | ) | 8 | (573 | ) | ||||||||||
| Net income (loss) | 1,365 | (2,217 | ) | (16,330 | ) | 709 | ||||||||||
| Noncontrolling owners’ interests in earnings of subsidiaries | (1,109 | ) | (1,718 | ) | (2,948 | ) | (3,238 | ) | ||||||||
| Net income (loss) attributable to Sterling common stockholders | $ | 256 | $ | (3,935 | ) | $ | (19,278 | ) | (2,529 | ) | ||||||
| Net income (loss) per share attributable to Sterling common stockholders: | ||||||||||||||||
| Basic | $ | 0.01 | $ | (0.21 | ) | $ | (1.00 | ) | (0.14 | ) | ||||||
| Diluted | $ | 0.01 | $ | (0.21 | ) | $ | (1.00 | ) | (0.14 | ) | ||||||
| Weighted average number of common shares outstanding used in computing per share amounts: | ||||||||||||||||
| Basic | 19,627,674 | 18,809,401 | 19,269,123 | 17,814,332 | ||||||||||||
| Diluted | 19,627,674 | 18,809,401 | 19,269,123 | 17,814,332 | ||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Amounts in thousands)
(Unaudited)
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2015 | 2014 | 2015 | 2014 | |||||||||||||
| Net income (loss) attributable to Sterling common stockholders | $ | 256 | $ | (3,935 | ) | $ | (19,278 | ) | $ | (2,529 | ) | |||||
| Net income attributable to noncontrolling interests included in equity | 1,109 | 1,718 | 2,948 | 3,238 | ||||||||||||
| Add / (deduct) other comprehensive income, net of tax: | ||||||||||||||||
| Realized loss (gain) from settlement of derivatives | 24 | 15 | 107 | (15 | ) | |||||||||||
| Change in the effective portion of unrealized loss in fair market value of derivatives | (6 | ) | (146 | ) | (6 | ) | (175 | ) | ||||||||
| Comprehensive income (loss) | $ | 1,383 | $ | (2,348 | ) | $ | (16,229 | ) | $ | 519 | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2015
(Amounts in thousands)
(Unaudited)
| STERLING CONSTRUCTION COMPANY, INC. STOCKHOLDERS | ||||||||||||||||||||||||||||
| Common Stock | Addi- tional Paid in | Retained | Accu- mulated Other Compre- hensive (Loss) | Noncon- trolling | ||||||||||||||||||||||||
| Shares | Amount | Capital | Deficit | Income | Interests | Total | ||||||||||||||||||||||
| Balance at January 1, 2015 | 18,803 | $ | 188 | $ | 205,697 | $ | (72,098 | ) | $ | (101 | ) | $ | 7,462 | $ | 141,148 | |||||||||||||
| Net (loss) income | – | – | – | (19,278 | ) | – | 2,948 | (16,330 | ) | |||||||||||||||||||
| Other comprehensive income | – | – | – | – | 101 | – | 101 | |||||||||||||||||||||
| Stock-based compensation | 921 | 9 | 1,310 | – | – | – | 1,319 | |||||||||||||||||||||
| Distributions to owners | – | – | – | – | – | (3,402 | ) | (3,402 | ) | |||||||||||||||||||
| Other | (96 | ) | (1 | ) | (368 | ) | – | – | – | (369 | ) | |||||||||||||||||
| Balance at September 30, 2015 | 19,628 | $ | 196 | $ | 206,639 | $ | (91,376 | ) | $ | – | $ | 7,008 | $ | 122,467 | ||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
Nine Months Ended September 30, | ||||||||
| 2015 | 2014 | |||||||
| Cash flows from operating activities: | ||||||||
| Net loss attributable to Sterling common stockholders | $ | (19,278 | ) | $ | (2,529 | ) | ||
| Plus: Noncontrolling owners’ interests in earnings of subsidiaries | 2,948 | 3,238 | ||||||
| Net (loss) income | (16,330 | ) | 709 | |||||
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: | ||||||||
| Depreciation and amortization | 12,479 | 13,809 | ||||||
| Gain on disposal of property and equipment | (1,205 | ) | (905 | ) | ||||
| Stock-based compensation expense | 1,319 | 592 | ||||||
| Loss on extinguishment of debt | 240 | – | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Contracts receivable | (20,770 | ) | (28,057 | ) | ||||
| Costs and estimated earnings in excess of billings on uncompleted contracts | 10,116 | (20,061 | ) | |||||
| Receivables from and equity in construction joint ventures | (1,936 | ) | (4,503 | ) | ||||
| Income tax receivable | 1,359 | 650 | ||||||
| Other assets | 12,780 | 1,759 | ||||||
| Accounts payable | (7,291 | ) | 19,497 | |||||
| Billings in excess of costs and estimated earnings on uncompleted contracts | 7,400 | (3,055 | ) | |||||
| Accrued compensation and other liabilities | 4,230 | 3,419 | ||||||
| Member’s interest subject to mandatory redemption and undistributed earnings | 1,101 | (1,152 | ) | |||||
| Net cash provided by (used in) operating activities | 3,492 | (17,298 | ) | |||||
| Cash flows from investing activities: | ||||||||
| Additions to property and equipment | (7,086 | ) | (11,224 | ) | ||||
| Proceeds from sale of property and equipment | 5,859 | 4,874 | ||||||
| Restricted cash | (4,945 | ) | – | |||||
| Net cash used in investing activities | (6,172 | ) | (6,350 | ) | ||||
| Cash flows from financing activities: | ||||||||
| Cumulative daily drawdowns – Credit Facility | 112,848 | 237,577 | ||||||
| Cumulative daily repayments – Credit Facility | (147,450 | ) | (211,242 | ) | ||||
| Cash received from equipment-based term loan | 18,980 | – | ||||||
| Cumulative drawdowns – equipment-based revolver | 13,100 | – | ||||||
| Distributions to noncontrolling interest owners | (3,402 | ) | (1,190 | ) | ||||
| Net proceeds from stock issued | – | 14,078 | ||||||
| Deferred loan costs | (1,309 | ) | – | |||||
| Other | (1,442 | ) | (447 | ) | ||||
| Net cash (used in) provided by financing activities | (8,675 | ) | 38,776 | |||||
| Net (decrease) increase in cash and cash equivalents | (11,355 | ) | 15,128 | |||||
| Cash and cash equivalents at beginning of period | 22,843 | 1,872 | ||||||
| Cash and cash equivalents at end of period | $ | 11,488 | $ | 17,000 | ||||
| Supplemental disclosures of cash flow information: | ||||||||
| Cash paid during the period for interest | $ | 1,893 | $ | 760 | ||||
| Cash paid during the period for income taxes | $ | 547 | $ | 28 | ||||
| Non-cash items: | ||||||||
| Transportation and construction equipment acquired through financing arrangements | $ | 1,161 | $ | 3,180 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| 1. | Business Summary and Significant Accounting Policies |
Business Summary
Sterling Construction Company, Inc. (“Sterling” or “the Company”), a Delaware corporation, 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 in which there are profitable construction opportunities. Its transportation infrastructure projects include highways, roads, bridges, airfields and light rail. Its water infrastructure projects include water, wastewater and storm drainage systems.
Presentation
The condensed consolidated financial statements included herein have been prepared by Sterling, without audit, in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) and should be read in conjunction with the 2014 Form 10-K. Certain information and note disclosures prepared in accordance with generally accepted accounting principles (“GAAP”) have been either condensed or omitted pursuant to SEC rules and regulations. The condensed consolidated financial statements reflect, in the opinion of management, all normal recurring adjustments necessary to present fairly the Company’s financial position at September 30, 2015 and the results of operations and cash flows for the periods presented. The December 31, 2014 condensed consolidated balance sheet data herein was derived from audited financial statements, but as discussed above, does not include all disclosures required by GAAP. Interim results may be subject to significant seasonal variations, and the results of operations for the three and nine months ended September 30, 2015 are not necessarily indicative of the results to be expected for the full year or subsequent quarters.
Significant Accounting Policies
The Company’s significant accounting policies are more fully described in Note 1 of the Notes to Consolidated Financial Statements in the 2014 Form 10-K. These accounting policies include, but are not limited to, those related to:
| • | contracts receivable, including retainage |
| • | revenue recognition |
| • | valuation of property and equipment, goodwill and other long-lived assets |
| • | construction joint ventures |
| • | income taxes |
| • | segment reporting |
There have been no material changes to significant accounting policies since December 31, 2014.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of subsidiaries and construction joint ventures in which the Company has a greater than 50% ownership interest or otherwise controls such entities. For investments in subsidiaries and construction joint ventures that are not wholly-owned, but where the Company exercises control, the equity held by the remaining owners and their portions of net income (loss) are reflected in the balance sheet line item “Noncontrolling interests” in “Equity” and the statement of operations line item “Noncontrolling owners’ interests in earnings of subsidiaries,” respectively. All significant intercompany accounts and transactions have been eliminated in consolidation. For all years presented, the Company had no subsidiaries where its ownership interests were less than 50%.
Where the Company is a noncontrolling joint venture partner, and otherwise not required to consolidate the joint venture entity, its share of the operations of such construction joint venture is accounted for on a pro rata basis in the condensed consolidated statements of operations and as a single line item (“Receivables from and equity in construction joint ventures”) in the condensed consolidated balance sheets. This method is an acceptable modification of the equity method of accounting which is a common practice in the construction industry. Refer to Note 3 for further information regarding the Company’s construction joint ventures.
Under U.S. GAAP, the Company must determine whether each entity, including joint ventures in which it participates, is a variable interest entity (“VIE”). This determination focuses on identifying which owner or joint venture partner, if any, has the power to direct the activities of the entity and the obligation to absorb losses of the entity or the right to receive benefits from the entity disproportionate to its interest in the entity, which could have the effect of requiring us to consolidate the entity in which we have a noncontrolling variable interest. Refer to Note 10 for further information regarding the Company’s consolidated VIE.
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Use of Estimates
The preparation of the accompanying condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Certain of the Company’s accounting policies require higher degrees of judgment than others in their application. These include the recognition of revenue and earnings from construction contracts under the percentage-of-completion method, the valuation of long-term assets (including goodwill), and income taxes. Management continually evaluates all of its estimates and judgments based on available information and experience; however, actual results could differ from these estimates.
Reclassification
A reclassification has been made to historical financial data on our condensed consolidated statement of cash flows to conform to our current year presentation.
Revenue Recognition
The Company is a general contractor which engages in various types of heavy civil construction projects principally for public (government) owners. Credit risk is minimal with public owners since the Company ascertains that funds have been appropriated by the governmental project owner prior to commencing work on such projects. While most public contracts are subject to termination at the election of the government entity, in the event of termination the Company is entitled to receive the contract price for completed work and reimbursement of termination-related costs. Credit risk with private owners is minimized because of statutory mechanic’s liens, which give the Company high priority in the event of lien foreclosures following financial difficulties of private owners.
Revenues are recognized on the percentage-of-completion method, measured by the ratio of costs incurred up to a given date to estimated total costs for each contract. This cost to cost measure is used because management considers it to be the best available measure of progress on these contracts. Contract costs include all direct material, labor, subcontract and other costs and those indirect costs related to contract performance, such as indirect salaries and wages, equipment repairs and depreciation, insurance and payroll taxes. Administrative and general expenses are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability, including those changes arising from contract penalty provisions and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined.
Changes in estimated revenues and gross margin resulted in a net charge of $1.1 million and $12.3 million during the three months and nine months ended September 30, 2015, respectively, included in Operating income (loss), or $(0.06) and $(0.64) per diluted share attributable to Sterling common stockholders, respectively, included in Net income (loss) attributable to Sterling common stockholders. Changes in estimated revenues and gross margin resulted in a net loss of $4.5 million and a net gain of $0.4 million during the three months and nine months ended September 30, 2014, respectively, included in Operating income (loss), or $(0.24) and $0.02 per diluted share attributable to Sterling common stockholders, respectively, included in Net income (loss) attributable to Sterling common stockholders.
Our contracts generally take 12 to 36 months to complete. The Company generally provides a one to two-year warranty for workmanship under its contracts when completed. Warranty claims historically have been insignificant.
Financial Instruments and Fair Value
The fair value of financial instruments is the amount at which the instrument could be exchanged in a current transaction between willing parties. The Company’s financial instruments are cash and cash equivalents, restricted cash used as collateral for a letter of credit and restricted cash maintained in an escrow account, short-term and long-term contracts receivable, derivatives, accounts payable, mortgage and notes payable, a revolving loan (the “Revolving Loan”) with Nations Fund I, LLC and Nations Equipment Finance, LLC, as administrative agent and collateral agent for the lender (“Nations”), a term loan (the “Term Loan”) with Nations, and an earn-out liability related to the acquisition of J. Banicki Construction, Inc. (“JBC”).
The recorded values of cash and cash equivalents, and restricted cash, short-term contracts receivable and accounts payable approximate their fair values based on their liquidity and/or short-term nature. The recorded value of long-term contracts receivable was based on the amount of future cash flows discounted using the creditor’s borrowing rate and such recorded value approximated fair value.
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The Company provides credit in the normal course of business, principally to public (government) owners, and performs ongoing credit evaluations, as deemed necessary, but generally does not require collateral to support such receivables. In an effort to reduce its credit exposure, as well as accelerate its cash flows, in August 2015, the Company completed the sale, on a non-recourse basis, of its only long-term contract receivable pursuant to a factoring agreement with a related party. The Company received approximately $7.1 million upon the closing of this transaction and recorded a loss of approximately $1.4 million in “Other operating (expense) income, net.” As such, we did not have a long-term contract receivable at September 30, 2015. The long-term contract receivable was historically discounted at 4.25% and recorded at fair value. Interest earned related to the long-term contract receivable was less than $0.1 million and $0.2 million for the three and nine months ended September 30, 2015, respectively, and $0.1 million and $0.3 million for the three and nine months ended September 30, 2014, respectively.
Refer to Note 5 regarding the fair value of derivatives, Note 8 regarding the fair value of an earn-out liability along with the most current amendments, and Note 12 regarding the fair value of the Revolving Loan and the Term Loan. The Company had one mortgage outstanding at December 31, 2014 with a remaining balance of $0.1 million and was fully paid in June 2015. At December 31, 2014, the fair value of the mortgage approximated book value. The Company also has long-term notes payable of $2.5 million related to machinery and equipment purchased which have payment terms ranging from 3 to 5 years and associated interest rates ranging from 3.12% to 6.29%. The fair value of the notes payable approximates their book value. The Company does not have any off-balance sheet financial instruments other than operating leases (refer to Note 14 of the Notes to Consolidated Financial Statements in the 2014 Form 10-K).
In order to assess the fair value of the Company’s financial instruments, the Company uses the fair value hierarchy established by GAAP which prioritizes the inputs used in valuation techniques into the following three levels:
Level 1 Inputs – Based upon quoted prices for identical assets in active markets that the Company has the ability to access at the measurement date.
Level 2 Inputs – Based upon quoted prices (other than Level 1) in active markets for similar assets, quoted prices for identical or similar assets in markets that are not active, inputs other than quoted prices that are observable for the asset such as interest rates, yield curves, volatilities and default rates and inputs that are derived principally from or corroborated by observable market data.
Level 3 Inputs – Based on unobservable inputs reflecting the Company’s own assumptions about the assumptions that market participants would use in pricing the asset based on the best information available.
For each financial instrument, the Company uses the highest priority level input that is available in order to appropriately value that particular instrument. In certain instances, Level 1 inputs are not available and the Company must use Level 2 or Level 3 inputs. In these cases, the Company provides a description of the valuation techniques used and the inputs used in the fair value measurement.
Out-of-Period Adjustment
During the first quarter of 2015, the Company recorded a $2.8 million out-of-period decrease in revenue that affected our results of operations for the nine months ended September 30, 2015. The adjustment was identified during our first quarter review of projects. Management evaluated the effect of the adjustment on the Company’s financial statements based on SEC Staff Accounting Bulletin (“SAB”) No. 99 and SAB 108 and concluded that it was immaterial to the current and prior year’s consolidated financial statements.
Recent Accounting Pronouncements
In August 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-15, “Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements.” The guidance, which incorporates the SEC Staff Announcement at the June 18, 2015 EITF meeting and is effective upon announcement, provides clarification related to the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements. The guidance states that the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The Company is currently accounting for its debt issuance costs for its Term Loan and line-of-credit Revolver Loan in this manner and would only expect a change in presentation of the deferred amounts related to the Term Loan upon adoption as required by ASU 2015-03. See below for the discussion related to ASU 2015-03.
11
In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory.” The guidance, which is effective for annual reporting periods beginning after December 15, 2016 and interim periods within those fiscal years, requires an entity to measure in scope inventory at the lower of cost and net realizable value. Early adoption is permitted as of the beginning of an interim or annual reporting period. Although early adoption is permitted, the Company expects to adopt this guidance as required and does not expect a material impact to the Company’s consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03, “Interest - Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs.” The guidance, which is effective for annual reporting periods beginning after December 15, 2015 and interim periods within annual periods beginning after December 15, 2015, requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The adoption of this ASU requires retrospective application to all periods presented. Although early adoption is permitted, the Company expects to adopt this guidance as required and expects a change in the presentation of our consolidated balance sheets and related disclosures. The Company does not expect a material impact to the consolidated statements of operations.
In February 2015, the FASB issued ASU 2015-02, “Consolidation: Amendments to the Consolidation Analysis.” The guidance, which is effective for annual reporting periods beginning after December 15, 2015 and interim periods within annual periods beginning after December 15, 2015, modifies the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. Early adoption is permitted. The Company does not expect a material impact to the Company’s consolidated financial statements and related disclosures.
In August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statement – Going Concern.” The guidance, which is effective for annual reporting periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016, requires management to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern and to provide related footnote disclosures. Early adoption is permitted. Although early adoption is permitted, the Company expects to adopt this guidance as required and does not expect a material impact to the Company’s consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers.” The guidance defines the steps to recognize revenue for entities that have contracts with customers. In August 2015, the FASB issued ASU 2015-14 which deferred the effective date of ASU 2014-09 by one year. As a result, the amendments in ASU 2014-09 are effective for public companies for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Entities would be permitted to adopt this ASU as early as the original public entity effective date, which was annual reporting periods beginning after December 15, 2016 and interim periods therein. Early adoption prior to that date would not be permitted. The Company is currently evaluating the impact of the adoption of this ASU to the Company’s consolidated financial statements and related disclosures.
| 2. | Cash and Cash Equivalents and Restricted Cash |
The Company considers all highly liquid investments with original or remaining maturities of three months or less at the time of purchase to be cash equivalents. Cash and cash equivalents include cash balances held by our wholly-owned and less than wholly-owned subsidiaries as well as the Company’s VIE. Refer to Note 10 for more information regarding the Company’s consolidated VIE.
Restricted cash of approximately $3.0 million is included in “other assets, net” on the condensed consolidated balance sheet as of September 30, 2015, and represents cash deposited by the Company into a separate account and designated as collateral for a standby letter of credit in the same amount in accordance with contractual agreements. Refer to Note 7 for more information about our standby letter of credit. In addition, restricted cash of approximately $2.0 million is included in “other current assets” on the condensed consolidated balance sheet as of September 30, 2015, and represents cash deposited by a customer, for the benefit of the Company, in an escrow account which is restricted until the customer releases the restriction upon the completion of the job.
The Company holds cash on deposit in U.S. banks, at times, in excess of federally insured limits. Management does not believe that the risk associated with keeping cash deposits in excess of federal deposit insurance limits represents a material risk.
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| 3. | Construction Joint Ventures |
The Company participates in various construction joint venture partnerships. Generally, each construction joint venture is formed to construct a specific project and is jointly controlled by the joint venture partners. Refer to Note 6 of the Notes to Consolidated Financial Statements in the 2014 Form 10-K for further information about our joint ventures. Condensed combined financial amounts of joint ventures in which the Company has a noncontrolling interest and the Company’s share of such amounts which are included in the Company’s condensed consolidated financial statements are shown below (amounts in thousands):
September 30, 2015 | December 31, 2014 | |||||||
| Total combined: | ||||||||
| Current assets | $ | 18,042 | $ | 18,132 | ||||
| Less current liabilities | (50,817 | ) | (49,035 | ) | ||||
| Net assets | $ | (32,775 | ) | $ | (30,903 | ) | ||
| Backlog | $ | 35,202 | $ | 55,063 | ||||
| Sterling’s noncontrolling interest in backlog | $ | 10,894 | $ | 15,889 | ||||
| Sterling’s receivables from and equity in construction joint ventures | $ | 11,089 | $ | 9,153 | ||||
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2015 | 2014 | 2015 | 2014 | |||||||||||||
| Total combined: | ||||||||||||||||
| Revenues | $ | 9,458 | $ | 7,734 | $ | 50,450 | $ | 44,959 | ||||||||
| Income before tax | 808 | 922 | 5,886 | 3,047 | ||||||||||||
| Sterling’s noncontrolling interest: | ||||||||||||||||
| Revenues | $ | 3,437 | $ | 2,747 | $ | 19,986 | $ | 18,371 | ||||||||
| Income before tax | 357 | 453 | 2,021 | 1,885 | ||||||||||||
Approximately $11 million of the Company’s backlog at September 30, 2015 was attributable to projects performed by joint ventures. The majority of this amount is attributable to the Company’s joint venture with Shimmick Construction Company, where the Company has a 30% interest.
The caption “Receivables from and equity in construction joint ventures” includes undistributed earnings and receivables owed to the Company. Undistributed earnings are typically released to the joint venture partners after the customer accepts the project as complete and the warranty period, if any, has passed.
| 4. | Property and Equipment |
Property and equipment are summarized as follows (amounts in thousands):
| September 30, 2015 | December 31, 2014 | |||||||
| Construction equipment | $ | 116,221 | $ | 129,150 | ||||
| Transportation equipment | 17,864 | 18,205 | ||||||
| Buildings | 10,796 | 10,777 | ||||||
| Office equipment | 2,810 | 2,761 | ||||||
| Leasehold improvement | 894 | 878 | ||||||
| Construction in progress | 1,823 | 387 | ||||||
| Land | 4,257 | 5,530 | ||||||
| Water rights | 200 | 200 | ||||||
| 154,865 | 167,888 | |||||||
| Less accumulated depreciation | (80,315 | ) | (80,790 | ) | ||||
| $ | 74,550 | $ | 87,098 | |||||
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Asset Sold - Land
On August 24, 2015, the Company completed the sale of a parcel of land located in Harris County, Texas to Joseph P. Harper, Sr., a former President and Chief Operating Officer of the Company. Proceeds received were approximately $2.4 million. Upon completion of the sale, the Company recognized a gain of approximately $1.4 million included in “Other operating (expense) income, net” on the condensed consolidated statement of operations.
Assets Held for Sale – Construction and Transportation Equipment
The Company intends to sell certain construction and transportation equipment during the next twelve months. At September 30, 2015, the Company’s condensed consolidated balance sheet included assets held for sale with a carrying value of approximately $3.8 million, net of an immaterial impairment charge, which have been reclassified out of “Property and equipment, net,” and into “other current assets.”
| 5. | Derivative Financial Instruments |
From time to time, the Company historically entered into various fixed rate commodity swap contracts in an effort to manage its exposure to price volatility of diesel fuel. Refer to Note 9 of the Notes to Consolidated Financial Statements in the 2014 Form 10-K for further information about our derivative financial instruments.
At September 30, 2015, accumulated other comprehensive income consisted of unrecognized losses of zero, down from $101,000 at December 31, 2014, which represented the unrealized change in fair value of the effective portion of the Company’s commodity contracts, designated as cash flow hedges, as of the balance sheet date. For the nine months ended September 30, 2015 and 2014, the Company recognized a pre-tax net realized cash settlement loss on commodity contracts of $107,000 and gain of $15,000, respectively.
Due to the recent decline in oil and fuel prices, the Company has not entered into any new derivative instruments and we retired our hedging program when the last swap contract was settled in August 2015.
Fair Value
The Company’s swaps were historically valued based on a discounted future cash flow model. The primary input for the model was the forecasted prices for ULSD. The Company’s model was validated by the counterparty’s fair value statements. The swaps were designated as Level 2 within the valuation hierarchy. Refer to Note 1 for a description of the inputs used to value the information shown above.
At September 30, 2015 and December 31, 2014, the Company did not have any derivative assets or liabilities measured at fair value on a recurring basis that meet the definition of Level 1 or Level 3 fair value inputs.
| 6. | Income Taxes |
The Company and its subsidiaries file U.S. federal and various U.S. state income tax returns. Current income tax expense or (benefit) represents federal and state taxes based on tax paid or expected to be payable or receivable for the periods shown in the condensed consolidated statements of operations. The income tax (benefit) expense in the accompanying condensed consolidated financial statements consists of the following (amounts in thousands):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2015 | 2014 | 2015 | 2014 | |||||||||||||
| Current tax (benefit) expense | $ | (39 | ) | $ | 546 | $ | (8 | ) | $ | 573 | ||||||
| Deferred tax expense | – | – | – | – | ||||||||||||
| Total tax (benefit) expense | $ | (39 | ) | $ | 546 | $ | (8 | ) | $ | 573 | ||||||
The Company is not expecting a current federal tax liability for the year due to a projected taxable loss. The Company does expect a state tax liability for 2015 in states without sufficient net operating loss carry forwards. This state tax expense has been offset with a state tax benefit related to a prior year. Therefore, a net current tax benefit has been recorded for those states for the three and nine months ended September 30, 2015.
The Company’s deferred tax expense or (benefit) reflects the change in deferred tax assets or liabilities. The Company performs an analysis at the end of each reporting period to determine whether it is more likely than not the deferred tax assets are expected to be realized in future years. Based upon this analysis, a valuation allowance has been applied to our net deferred tax assets as of September 30, 2015 and December 31, 2014. Therefore, there has been no change in net deferred taxes for the three and nine months ended September 30, 2015.
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The income tax expense or (benefit) differs from the amounts using the statutory federal income tax rate of 35% for the following reasons (amounts in thousands, except for percentages):
| Nine Months Ended September 30, | ||||||||||||||||
| 2015 | 2014 | |||||||||||||||
| Amount | % | Amount | % | |||||||||||||
| Tax (benefit) expense at the U.S. federal statutory rate | $ | (5,718 | ) | 35.0 | % | $ | 449 | 35.0 | % | |||||||
| State tax based on income, net of refunds and federal benefits | (398 | ) | 2.4 | (53 | ) | (4.1 | ) | |||||||||
| Taxes on subsidiaries’ earnings allocated to noncontrolling interests owners | (1,326 | ) | 8.1 | (1,906 | ) | (148.8 | ) | |||||||||
| Valuation allowance | 7,438 | (45.5 | ) | 1,529 | 119.4 | |||||||||||
| Reduction of tax receivable | – | – | 524 | 40.9 | ||||||||||||
| Other permanent differences | (4 | ) | – | 30 | 2.4 | |||||||||||
| Income tax (benefit) expense | $ | (8 | ) | – | % | $ | 573 | 44.8 | % | |||||||
As a result of the Company’s analysis, management has determined that the Company does not have any material uncertain tax positions.
| 7. | Commitments and Contingencies |
The Company is required by our insurance provider to obtain and hold a standby letter of credit. This letter of credit serves as a guarantee by the banking institution to pay our insurance provider the incurred claim costs attributable to our general liability, workers compensation and automobile liability claims, up to the amount stated in the standby letter of credit, in the event that these claims were not paid by the Company. Due to our new Equipment-based Facility, as defined in Note 12, we have now cash collateralized the letter of credit, resulting in the cash being designated as restricted. Refer to Note 2 for more information on our restricted cash and Note 12 for more information on our new Equipment-based Facility.
The Company is the subject of certain claims and lawsuits occurring in the normal course of business. Management, after consultation with legal counsel, does not believe that the outcome of these actions will have a material impact on the condensed consolidated financial statements of the Company.
The Company typically indemnifies contract owners for claims arising during the construction process and carries insurance coverage for such claims, which in the past have not been material.
The Company’s Certificate of Incorporation provides for indemnification of its officers and directors. The Company has a directors and officers liability insurance policy that limits their exposure to litigation against them in their capacities as such.
| 8. | Acquisitions and Subsidiaries and Joint Ventures with Noncontrolling Owners’ Interests |
On December 30, 2013, the Company and Richard Buenting revised the Second Amended and Restated Operating Agreement entered into on April 27, 2012 and their Management Agreement entered into on February 1, 2012. The Third Amended and Restated Operating Agreement and the amended Management Agreement eliminated the buy/sell option and instead included the obligation for the Company to purchase Mr. Buenting’s interest upon his death or permanent disability for $20 million or $18 million, respectively. In the event of Mr. Buenting’s death or permanent disability, his estate representative, trustee or designee shall become the selling representative and sell his 50% interest to the Company. In order to fund the purchase of Mr. Buenting’s interest, the Company has purchased term life insurance with a payout of $20 million in the event of Mr. Buenting’s death. The Company will be the beneficiary and will also pay the premiums related to this life insurance contract. The life insurance proceeds of $20 million shall be used as full payment for Mr. Buenting’s interest in the occurrence of his death. On June 2, 2015, the Company purchased an insurance policy with a five-year term on Mr. Buenting that provides a lump sum disability benefit in the principal sum of $20 million. In the event of Mr. Buenting’s permanent total disability, the principal sum becomes payable to the Company, and in turn the Company is obligated to use the proceeds of the policy to purchase Mr. Buenting’s 50% member’s interest in RHB in accordance with the terms of the amended agreements. No other transfer of member’s interest is permitted other than to the selling representative in the event of Mr. Buenting’s death or permanent disability. In the event that Mr. Buenting resigns his 50% interest in RHB or is terminated without cause (i.e., termination other than through cause, permanent disability or death), RHB shall be dissolved unless both members agree otherwise. The amended agreements were entered into in order to eliminate the earnings-per-share volatility caused by the buy/sell option.
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The amended agreements resulted in an obligation to purchase Mr. Buenting’s 50% member’s interest that the Company is certain to incur, either because of Mr. Buenting’s permanent disability or death; therefore, the Company has classified the noncontrolling interest as mandatorily redeemable and has recorded a liability in “Member’s interest subject to mandatory redemption and undistributed earnings” on the condensed consolidated balance sheets. The liability consists of the following (amounts in thousands):
September 30, 2015 | December 31, 2014 | |||||||
| Member’s interest subject to mandatory redemption | $ | 20,000 | $ | 20,000 | ||||
| Accumulated undistributed earnings attributable to this interest | 6,892 | 6,079 | ||||||
| Earnings distributed | (5,114 | ) | (3,200 | ) | ||||
| Total liability | $ | 21,778 | $ | 22,879 | ||||
Due to the amended agreements and the accounting classification, Mr. Buenting’s 50% member’s interest, or undistributed earnings, is included in “Other operating (expense) income, net” on the Company’s condensed consolidated statements of operations. Undistributed earnings attributable to this interest increased $1.5 million and $0.8 million for the three and nine months ended September 30, 2015, respectively, and undistributed earnings increased by $0.5 million and $2.0 million for the three and nine months ended September 30, 2014, respectively.
Changes in Noncontrolling Interests
The following table summarizes the changes in the noncontrolling owners’ interests in subsidiaries (amounts in thousands):
| Nine Months Ended September 30, | ||||||||
| 2015 | 2014 | |||||||
| Balance, beginning of period | $ | 7,462 | $ | 4,097 | ||||
| Net income attributable to noncontrolling interest included in equity | 2,948 | 3,238 | ||||||
| Distributions to noncontrolling interest owners | (3,402 | ) | (1,190 | ) | ||||
| Balance, end of period | $ | 7,008 | $ | 6,145 | ||||
The “Noncontrolling owners’ interest in earnings of subsidiaries” for the three and nine months ended September 30, 2015 and 2014, shown in the accompanying condensed consolidated statements of operations, was $1.1 million and $2.9 million, respectively, and $1.7 million and $3.2 million, respectively, which the Company includes in “Equity”, “Noncontrolling interests” in the accompanying condensed consolidated balance sheets. There was a distribution of $1.0 million and $3.4 million to certain noncontrolling interest members during the three and nine months ended September 30, 2015 and there were no distributions and distributions of $1.2 million during the three and nine months ended September 30, 2014, respectively.
Noncontrolling Interests’ – Call Options
During the nine months ended September 30, 2015, the Company entered into two agreements, one with RHB and one with Myers, which gives the 50% owners of these entities the option to buy the Company’s 50% interest in these entities for $1.00 should the Company ever become subject to the repossession or disposition of its collateral as defined in the Company’s new debt agreement with Nations or if the Company dissolves or becomes insolvent. Based on these agreements, the Company does not believe that it is likely that the exercise of these options would ever transpire; therefore, there has been no value placed on these options which resulted in no impact to our condensed consolidated financial statements. Refer to Note 12 for more information about the debt agreement with Nations.
Earn-out Agreement
In connection with the August 1, 2011, acquisition of JBC by Ralph L. Wadsworth Construction Company, LLC (“RLW”), RLW agreed to additional purchase price payments of up to $5 million to be paid over a five-year period. The additional purchase price is in the form of an earn-out and is classified as a Level 3 fair value measurement. In making this valuation, the unobservable input consisted of forecasted EBITDA for the periods after the period being reported on through July 31, 2016. The additional purchase price is calculated generally as 50% of the amount by which EBITDA exceeds $2.0 million for each of the calendar years 2011 through 2015 and $1.2 million for the seven months ended July 31, 2016.
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On January 23, 2014, RLW, the former owner of JBC and the Company agreed to amend the above mentioned earn-out agreement in order to reduce the Company’s recorded liability at that time, while providing the former owner, who at the time was the chief executive officer of JBC, a greater incentive to meet earnings benchmarks. The amendment resulted in a reduction of $0.6 million in the Company’s earn-out liability, thereby reducing the total earn-out liability to $1.4 million on December 31, 2013. As part of the amendment, a payment of $0.8 million was made during the first quarter of 2014. The amendment increased the total available earn-out from $5.0 million to $10.0 million if certain EBITDA benchmarks are met. The amendment extended the earn-out period through December 31, 2017 and reduced the benchmark EBITDA for 2014 and 2015 to $1.5 million and increased it to $2.0 million in 2016 and 2017. This earn-out liability continues to be classified as a Level 3 fair value measurement and the unobservable inputs continue to be the forecasted EBITDA for the periods after the period being reported on through December 31, 2017. There was no yearly excess forecasted EBITDA in our calculation at September 30, 2015 of the minimum EBITDA benchmarks for the years 2015 through 2017. The discounted present value of the additional purchase price was estimated to be $0.3 million as of September 30, 2014 which included a revaluation benefit of $0.3 million recorded in interest income on the condensed consolidated statement of operations. The undiscounted earn-out liability as of September 30, 2015 is estimated at zero and could increase by $9.3 million if EBITDA during the earn-out period increases $18.5 million or more and could decrease by the full amount of the liability for the year if EBITDA does not exceed the minimum threshold for that year. Each year is considered a discrete earnings period and future losses by JBC, if any, would not reduce the Company’s liability in years in which JBC has exceeded its earnings benchmark. Any significant increase or decrease in actual EBITDA compared to the forecasted amounts would result in a significantly higher or lower fair value measurement of the additional purchase price. This liability is included in other long-term liabilities on the accompanying condensed consolidated balance sheets. As part of recording the present value of this liability, the Company incurs accreted interest expense for the passage of time until the time of settlement. The Company incurred accreted interest expense of zero and $0.3 million for the three months and nine months ended September 30, 2014, respectively. As part of the updated EBITDA forecast, the Company reduced its liability to zero and recorded interest income of $0.3 million in the first quarter of 2015. There has been no change in the value of this liability; therefore, the interest income was zero and $0.3 million for the three and nine months ended September 30, 2015, respectively.
| 9. | Stockholders’ Equity |
Stock-Based Compensation Plan
The Company has a stock-based incentive plan which is administered by the Compensation Committee of the Board of Directors. Refer to Note 16 of the Notes to Consolidated Financial Statements included in the 2014 Form 10-K for further information. The Company recorded stock-based compensation expense of $0.8 million and $1.3 million for the three and nine months ended September 30, 2015, respectively, and $0.2 million and $0.6 million for the three and nine months ended September 30, 2014, respectively.
At September 30, 2015, total unrecognized compensation cost related to unvested common stock awards was $3.0 million. This cost is expected to be recognized over a weighted average period of 2.0 years. There was no unrecognized compensation expense related to stock options at September 30, 2015 and 2014. There were no proceeds received by the Company from the exercise of stock options for the three and nine months ended September 30, 2015 and such proceeds were immaterial for the three and nine months ended September 30, 2014. No stock options were granted in the three or nine months ended September 30, 2015 or 2014. At September 30, 2015, there were 0.8 million shares of common stock covered by outstanding unvested common stock.
On January 1, 2015, the Company launched a long- and short-term incentive program for certain employees. The short-term incentive plan is paid in cash if certain short-term achievements are met and the long-term incentive plan is paid with the Company’s stock if certain long-term achievements are met. The stock based awards are awarded based in two parts; 50% is based on completing a service period of three years and 50% is based on the level of achievement of the Company’s total shareholder return (“TSR”) compared to the TSR of a designated peer group over a three year period. The service based awards are recorded as usual; however, the awards based on TSR must be valued using a Monte Carlo simulation. Based on the valuation obtained using Monte Carlo simulation and valuation on the service based awards, the Company recorded an expense of $0.1 million and $0.3 million, which was included in the $0.8 million and $1.3 million expense mentioned above, for the three and nine months ended September 30, 2015, respectively.
On March 9, 2015, the Company entered into a three-year employment agreement with Paul J. Varello, the Company’s Chief Executive Officer (“CEO”). As part of the agreement, Mr. Varello will be paid an annual salary of $1 and received 600,000 shares of the Company’s common stock which vest in three equal installments on the first three anniversaries of the March 9, 2015 award date. The award is a special one-time plan for the CEO and was approved by the Company’s stockholders at its 2015 Annual Meeting in May 2015 and was valued at approximately $2.5 million.
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On July 3, 2015, the Company granted our former CFO a discretionary bonus consisting of 106,478 shares of the Company's common stock valued at $0.4 million which was included in the $0.8 million and $1.3 million expense mentioned above for the three and nine months ended September 30, 2015.
| 10. | Variable Interest Entities |
The Company owns a 50% interest in Myers, of which it is the primary beneficiary, and has consolidated Myers into the Company’s financial statements. Because the Company exercises primary control over activities of the partnership and it is exposed to the majority of potential losses of the partnership, the Company has consolidated Myers within the Company’s financial statements since August 1, 2011, the date of acquisition. Refer to Note 3 of the Notes to Consolidated Financial Statements included in the 2014 Form 10-K for additional information on the acquisition of this limited partnership.
The condensed financial information of Myers, which is reflected in the Company’s condensed consolidated balance sheets and statements of operations, is as follows (amounts in thousands):
September 30, 2015 | December 31, 2014 | |||||||
| Assets: | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 946 | $ | 148 | ||||
| Contracts receivable, including retainage | 28,758 | 21,327 | ||||||
| Other current assets | 8,777 | 7,656 | ||||||
| Total current assets | 38,481 | 29,131 | ||||||
| Property and equipment, net | 10,444 | 9,303 | ||||||
| Goodwill | 1,501 | 1,501 | ||||||
| Total assets | $ | 50,426 | $ | 39,935 | ||||
| Liabilities: | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | 24,179 | $ | 15,795 | ||||
| Other current liabilities | 11,644 | 9,000 | ||||||
| Total current liabilities | 35,823 | 24,795 | ||||||
| Long-term liabilities: | ||||||||
| Other long-term liabilities | 400 | 16 | ||||||
| Total liabilities | $ | 36,223 | $ | 24,811 | ||||
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2015 | 2014 | 2015 | 2014 | |||||||||||||
| Revenues | $ | 43,444 | $ | 40,159 | $ | 134,035 | $ | 101,953 | ||||||||
| Operating income | 2,216 | 3,461 | 5,885 | 6,760 | ||||||||||||
| Net income attributable to Sterling common stockholders | 1,108 | 1,728 | 2,941 | 3,376 | ||||||||||||
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| 11. | Net Income (Loss) per Share Attributable to Sterling Common Stockholders |
Basic net income (loss) per share attributable to Sterling common stockholders is computed by dividing net income (loss) attributable to Sterling common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share attributable to Sterling common stockholders is the same as basic net income (loss) per share attributable to Sterling common stockholders but includes dilutive unvested stock and stock options using the treasury stock method. The following table reconciles the numerators and denominators of the basic and diluted per common share computations for net income (loss) attributable to Sterling common stockholders (amounts in thousands, except per share data):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2015 | 2014 | 2015 | 2014 | |||||||||||||
| Numerator: | ||||||||||||||||
| Net income (loss) attributable to Sterling common stockholders | $ | 256 | $ | (3,935 | ) | $ | (19,278 | ) | $ | (2,529 | ) | |||||
| Denominator: | ||||||||||||||||
| Weighted average common shares outstanding — basic | 19,628 | 18,809 | 19,269 | 17,814 | ||||||||||||
| Shares for dilutive unvested stock and stock options | – | – | – | – | ||||||||||||
| Weighted average common shares outstanding and incremental shares assumed repurchased— diluted | 19,628 | 18,809 | 19,269 | 17,814 | ||||||||||||
| Basic and diluted income (loss) per share attributable to Sterling common stockholders | $ | 0.01 | $ | (0.21 | ) | $ | (1.00 | ) | $ | (0.14 | ) | |||||
In accordance with the treasury stock method, 0.2 million and 0.4 million shares of unvested common stock and stock options were excluded from the diluted weighted average common shares outstanding for the three and nine months ended September 30, 2015, as the assumed proceeds related to these shares would purchase more shares than the unvested shares outstanding resulting in anti-dilution.
In addition, in accordance with the treasury stock method, 0.1 million and 0.1 million shares of unvested common stock and stock options were excluded from the diluted weighted average common shares outstanding for the three and nine months ended September 30, 2014, respectively, as the Company incurred a loss during these periods and the impact of such shares would have been antidilutive.
| 12. | Debt |
On May 29, 2015, the Company and its wholly-owned subsidiaries entered into a $40.0 million loan and security agreement with Nations, consisting of a $20.0 million Term Loan and a $20.0 million Revolving Loan (combined, the “Equipment-based Facility”), which replaced its prior credit facility with Comerica (“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 balances 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, 2015, the Company had approximately $34.3 million of borrowing base which was the result of calculating 65% of the appraised value (where appraised value equals net operating liquidated value) of the Company’s collateral. The Revolving Loan may be utilized by the Company to provide ongoing working capital and for other general corporate purposes. At September 30, 2015, the Company had $13.1 million drawn on the Revolving Loan, $19.0 million Term Loan outstanding and $2.2 million of borrowings available.
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. 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. Outstanding Revolving Loans are payable in full thirty days before the maturity date of the Term Loan.
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The Equipment-based Facility is secured by all of the Company's personal property except accounts receivable, including all of its construction equipment, which forms the basis of availability under the Revolving Loan. The Equipment-based Facility is also secured by one-half of the 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 proceeds of the Term Loan of $20.0 million and our initial draw of $14.6 million under the Revolving Loan were utilized by the Company to repay the balance outstanding and terminate the Prior Credit Facility and for other general corporate purposes. In addition, in connection with incurring this debt, we recorded $1.3 million in deferred debt issuance costs which are included in “Other assets, net” in our condensed consolidated balance sheet, which is being amortized over the term of the Equipment-based Facility.
The Company’s Equipment-based Facility has no financial covenants; however, it contains restrictions on the Company’s ability to:
| · | Incur liens and encumbrances; |
| · | Incur further indebtedness; |
| · | Dispose of a material portion of assets or merge with a third party; |
| · | Make acquisitions; and |
| · | Make investments in securities. |
Due to this new Equipment-based Facility agreement, the Company’s Letter of Credit, which under our Prior Credit Facility reduced the Company’s borrowing availability, is now collateralized with cash. Refer to Note 2 for more information regarding the Company’s cash and cash equivalents including restricted cash used as collateral.
Interest expense was $1.1 million and $2.1 million for the three and nine months ended September 30, 2015, respectively, compared to $0.2 million and $0.8 million for the three and nine months ended September 30, 2014, respectively. This increase in interest expense was driven by the increased interest rate on the new Equipment-based Facility agreement, as described above.
Fair Value
The Company’s debt is recorded at the carrying amount in the condensed consolidated balance sheets. The Company uses an income approach to determine the fair value of its 12% Equipment-based Term Loan due May 29, 2019 using estimated cash flows, which is a Level 3 fair value measurement. As of September 30, 2015, the carrying values and fair values are as follows (amounts in thousands):
| September 30, 2015 | ||||||||
| Carrying Value | Fair Value | |||||||
| Equipment-based revolving loan | $ | 13,100 | $ | – | ||||
| Equipment-based term loan | 18,980 | 18,980 | ||||||
| Total Equipment-based Facility debt | $ | 32,080 | $ | 18,980 | ||||
The Equipment-based revolving loan’s fair value was not practicable to estimate as the timing of cash drawdowns and repayments cannot be determined. The effective interest rate of the Equipment-based revolving loan was 12.17% at September 30, 2015 with a maturity date of May 29, 2019.
As of December 31, 2014, the recorded value of the Company’s Prior Credit Facility approximated its fair value, as the amount outstanding at any given point in time was the principal amount due and interest was paid based on this amount considering the duration outstanding. In order to extinguish this Prior Credit Facility debt, the Company incurred costs of $0.2 million which is included in the Company’s condensed consolidated statement of operations.
| 13. | Goodwill |
During the first quarter of 2015, the Company made announcements regarding the Company’s earnings and noncompliance with one of our Prior Credit Facility covenants. On January 27, 2015, the Company announced its preliminary fourth quarter and full year 2014 results and that the Company was not in compliance with the Prior Credit Facility’s tangible net worth covenant. On March 16, 2015, the Company announced actual fourth quarter and full year 2014 results and that a waiver of the covenant breach had been obtained. As a result of these announcements, the Company’s stock price fluctuated greatly during the first quarter of 2015, dropping from a January 2nd price of $6.41 to a March 31st price of $4.52.
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Due to the decrease in the stock price that resulted and our first quarter loss, the Company noted that a goodwill impairment triggering event occurred during the first quarter of 2015. Therefore, we updated our fourth quarter goodwill impairment assessment using the two methods discussed in Note 8 of the Notes to Consolidated Financial Statements in the 2014 Form 10-K. The assessment used updated first quarter information which incorporated the Company’s stock price at March 31, 2015 and reduced gross margins used in our discounted cash flow model projections. Based on this revised testing, there was no goodwill impairment and we determined that the fair value of the Company’s equity was approximately 8% above the carrying value of the Company’s equity.
During the third quarter of 2015, the Company noted that the revenue projections used in our first quarter goodwill impairment assessment were higher than our actual results for the second and third quarters of 2015; therefore, the Company determined that a goodwill impairment triggering event occurred during the third quarter of 2015. As such, we updated our first quarter goodwill impairment assessment with third quarter 2015 information which incorporated the Company’s stock price at September 30, 2015 and reduced the projected revenue used in our discounted cash flow model. The forecasted cash flows took into consideration historical and recent results, backlog and near term projects, recent developments, strategic actions and management’s outlook for the future. The forecast and growth assumptions included, among other things, improved project performance, continuation of a strong base market, and margin improvements driven by incremental margin product opportunities and pursuing work in adjacent markets. Based on this revised testing, there was no goodwill impairment and we passed by an improved margin compared to that of our first quarter’s 2015 assessment margin.
Our third quarter goodwill impairment assessment’s concluded fair value could be negatively impacted if actual future performance falls short of the collective cash flow model assumptions or if our stock price is adversely affected. If based on future assessments, our goodwill is deemed to be impaired; the impairment would result in a charge to earnings which could be material.
| 14. | Subsequent event |
On October 19, 2015, the Company and Richard Buenting executed the Fourth Amended and Restated Operating Agreement (“Fourth Amendment”) which amends, restates and replaces the Third Amended and Restated Operating Agreement in its entirety which was entered into on December 30, 2013. This revised Fourth Amendment consolidates and clarifies certain conflicting provisions in earlier agreements. The Company is still evaluating the impact of the Fourth Amendment. Refer to Note 8 for further information on this member’s interest.
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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. | |
| 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. |
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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: | November 16, 2015 |
By: | /s/ Paul J. Varello | ||
| Paul J. Varello | |||||
| Chief Executive Officer | |||||
| Date: | November 16, 2015 | By: | /s/ Ronald A. Ballschmiede | ||
Ronald A. Ballschmiede |
|||||
| Chief Financial Officer | |||||
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STERLING CONSTRUCTION COMPANY, INC.
Quarterly Report on Form 10-Q for Period Ended September 30, 2015
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. | |
| 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. |
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