Business Valuations for Construction ContractorsConstruction Contractors

October 18, 2012

Brian Muncy, CPA, CFE

Paul Wonch, MBA, CPA/ABV, CVA,CFFA

OverviewOverview

Why Contractors Need Valuations Why Contractors Need Valuations Valuation Approaches & Methods Key Factors Key Factors Example I – Light Example II – Heavy Example II Heavy Rules of Thumb

Why Contractors Need ValuationsWhy Contractors Need Valuations

Estate or Exit Planning Estate or Exit Planning Shareholder Buyout Buy-Sell Agreement Buy-Sell Agreement Purchase a Contractor Divorce Divorce Death ESOP

Valuation Approaches & MethodsValuation Approaches & Methods Income Approach Discounted Cash Flows Discounted Cash Flows Capitalization of Earnings

Asset Approachpp Adjusted Net Asset Excess Earnings

Market Approach Direct Market Comparison Guideline Public Company Guideline Public Company

Key FactorsKey Factors Accounting Information Quality of information Basis of accounting Accuracy of Schedule of Construction in Progress

Estimated Costs to Completep

Type of Contractor General Contractors – Engaged by owners to coordinate and

oversee constructions projectsoversee constructions projects. Self-performing Design/build services

Subcontractors – Perform specialized tasks related to all types of Subcontractors Perform specialized tasks related to all types of construction.

Key FactorsKey Factors

Contract Risks Contract Risks Type of Contracts

Fixed price (Lump-sum) Cost plus Guaranteed Maximum Price (GMP) Time and Material

Previously Performed Work with Owner/Contractor Poor performing jobs – underbilling can be an indicator Collection of Receivables and Retention

Key FactorsKey Factors

Backlogg Realization of the Contract Expected Profitability 50% of Annual Revenue – CFMA Best of Class 50% of Annual Revenue CFMA Best of Class

Concentration of Customers and Projects Large Concentration with Few Customers

C Key Employee Relationship with Customer Service Agreements

Union versus non-union Age of Equipment

Example I - LightExample I Light

Suntower Inc Suntower, Inc.- Serves Telecommunications and Renewable Energy Industries

- Tower erection, antenna/line installation, engineering, testing, etc., , g g, g,

- Wind turbine installation, engineering, maintenance, etc.

- Demand for broadband coverage via smartphones, etc. increasing

D d f l i i i i i h i l i i h- Demand for electricity, rising energy prices, technical innovation = growth

- Highly trained workforce

- Customers include, AT & T, Verizon, American Tower, Alternative Wind, Co.

- Company poised for growth

Example I - LightExample I Light

Suntower Balance Sheet2006

ASSETSCurrent assets

Cash and cash equivalents 250,000$ Accounts receivable 950,000 C t d ti t d i i f billiCost and estimated earnings in excess of billings on uncompleted contracts 205,000

Total current assets 1,405,000

Property and equipmentVehicles and equipment 2 000 000Vehicles and equipment 2,000,000

2,000,000 Less accumulated depreciation 1,500,000

Total property and equipment 500,000

1,905,000$ 1,905,000$

Example I - LightExample I LightSuntower Balance Sheet

2006LIABILITIES AND STOCKHOLDER'S EQUITYCurrent liabilities

Accounts payable 135,000$ Line-of-credit payable 210,000Accrued liabilities 25,000Other current liabilities 5,500

Total current liabilities 375,500

Notes payable 150,000

Total liabilities 525 500Total liabilities 525,500

Stockholders' equity (deficit)Common stock 100,000 Retained earnings (deficit) 1,279,500

Total stockholders' equity (deficit) 1 379 500Total stockholders equity (deficit) 1,379,500

1,905,000$

Example I - LightExample I LightSuntower Historical Income Statements

2006 2005 2004Revenue 8,652,174$ 7,865,613$ 7,491,060$Revenue 8,652,174$ 7,865,613$ 7,491,060$ Cost of revenue 6,471,826 5,914,941 5,633,277

Gross profit 2,180,348 1,950,672 1,857,783

General and administrative expensesOfficer salary 181 696 165 178 157 312Officer salary 181,696 165,178 157,312 Office wages 95,174 94,387 82,402 Repairs and maintenance 34,609 31,462 37,455 Rent 147,087 133,715 127,348 Property and other taxes 25,957 15,731 22,473 Interest 8 652 15 731 37 455Interest 8,652 15,731 37,455 Depreciation 268,217 157,312 194,768 Employee benefits 173,043 157,312 149,821 Other 441,261 401,146 404,517

1,375,696 1,171,976 1,213,552

Net Income 804,652$ 778,696$ 644,231$

Example I - LightExample I LightSuntower Projected Operating Income

2007 2008 2009 2010 2011Revenue 10,382,609$ 12,978,261$ 15,573,913$ 16,664,087$ 17,413,971$ Cost of Revenue 7,766,191 9,707,739 11,649,287 12,464,737 13,025,650

Gross profit 2,616,417 3,270,522 3,924,626 4,199,350 4,388,321 Operating expenses

Officer salary 187,873 194,261 200,866 207,695 214,757 Office wages 98,410 101,756 105,215 108,793 112,492 Repairs and maintenance 35,785 36,644 37,524 38,424 39,346 Rent 152,088 155,738 159,476 163,303 167,222 Property and other taxes 26,839 27,483 28,143 43,227 44,265 Interest 8,946 9,161 9,381 9,606 9,837 Depreciation 277,337 283,993 290,809 297,788 304,935 Employee benefits 178,927 185,010 191,301 197,805 204,530 Other 456,264 467,214 478,427 489,909 501,667

1,422,469 1,461,261 1,501,141 1,556,552 1,599,052

Pre-tax operating income 1,193,948 1,809,261 2,423,485 2,642,798 2,789,269Pre tax operating income , 93,9 8 ,809, 6 , 3, 85 ,6 ,798 ,789, 69

After-tax operating income 850,810$ 1,256,505$ 1,683,074$ 1,835,384$ 1,937,105$

Example I - LightExample I LightSuntower Discount Rate Build-up

20 Year Treasury Note Rate (1) 4.00%

Equity Risk Premium (2) 6.00%

Industry Risk Premium (2) 6.00%

Size Premium (2) 5 80%Size Premium (2) 5.80%

Specific Company Premium (3) 3.00%

Discount Rate 24.80%

(1) – Economic Research & Data section of Federal Reserve Website.

(2) – Ibbotson SBBI Valuation Yearbooks published by Morningstar, Inc. or Duff & Phelps Risk Premium report published by Duff & Phelps, LLCp p y p

(3) – Based on judgment on a number of factors – See Next Slide.

Example I - LightExample I Light Specific Company Risk Factors Abnormal Present or Pending Competition Abnormal Present or Pending Competition Availability of Labor Customer Concentration Customer Pricing Leverage Ease of Market Entry Fi i l S h Financial Strength Key Person Dependence Pending or Threatened Lawsuits Pending or Threatened Lawsuits Profitability and Stability of Earnings

Example I - LightExample I Light

Suntower Discounted Cash Flows

Discount Rate 24.8%Growth Rate 4.5% (after year 5)

Discounted Cash Flow Value Calculation

Projected Plus Less CapitalLess cash needed for

Projected Annual Cash

Present Value

YearProjected

After-tax OIPlus

DepreciationLess Capital

Outlaysneeded for

growth in WCAnnual Cash

FlowsValue

Factors Present Value Sales Growth1 850,810 277,337 150,000 52,570 925,577 0.89514 828,524$ 20.0%2 1,256,505 283,993 187,500 65,713 1,287,285 0.71726 923,321 25.0%3 1,683,074 290,809 225,000 78,855 1,670,028 0.57473 959,814 20.0%4 1,835,384 297,788 240,750 84,375 1,808,047 0.46052 832,643 7.0%, , , , 7.0%5 1,937,105 304,935 251,584 88,172 1,902,285 0.36901 701,956 4.5%

Terminal Value (cash flows after year 5) - 3,613,518

Total Present Value 7,859,776

Indicated Value (rounded) 7,860,000$

Example II - HeavyExample II Heavy

Heavier Construction, Inc.,- Engaged in construction of sewers, water treatment plants, and roads, and provides excavation and bridge repair services- Most work is performed under fixed-price contracts with general Most work is performed under fixed price contracts with general contractors, developers and municipalities- Length of contracts vary and many extend beyond one year- Prone to fluctuations in the economyy- Business is currently down primarily due to recession- Capital intensive with heavy equipment also owning land and building- Significant cash reserves on hand to weather downturnsg- Company stabilized at historically depressed level

Example II - HeavyExample II Heavy

Heavier Historical Income StatementsHeavier Historical Income Statements 2010 2009 2008 2007 2006

Revenue 75,000,000$ 70,000,000$ 85,000,000$ 100,000,000$ 150,000,000$ Cost of revenue 75,750,000 67,900,000 80,750,000 84,000,000 124,500,000

Gross profit (750,000) 2,100,000 4,250,000 16,000,000 25,500,000

General and administrative expensesOperating expenses 1,950,000 2,940,000 1,445,000 4,200,000 4,800,000 Other expenses 75,000 350,000 680,000 1,000,000 1,500,000 Interest expense 150,000 140,000 170,000 300,000 450,000

2 175 000 3 430 000 2 295 000 5 500 000 6 750 0002,175,000 3,430,000 2,295,000 5,500,000 6,750,000

Other income 500,000 450,000 2,500,000 850,000 400,000

Net Income (loss) (2,425,000)$ (880,000)$ 4,455,000$ 11,350,000$ 19,150,000$

Example II - HeavyExample II HeavyHeavier Balance Sheet

2010ASSETSCurrent assets

Cash and cash equivalents 12,350,000$ Accounts receivable 20,990,000 Prepaid expenses 300,000 Cost and estimated earnings in excess of billings

l d 2 800 000 on uncompleted contracts 2,800,000 Total current assets 36,440,000

Property and equipmentLand 10,000 B ildi 500 000Buildings 500,000 Construction equipment 45,000,000 Office equipment 350,000

45,860,000 Less accumulated depreciation 40,000,000

T l d i 5 860 000Total property and equipment 5,860,000

42,300,000$

Example II - HeavyExample II HeavyHeavier Balance Sheet

2010LIABILITIES AND STOCKHOLDER'S EQUITYCurrent liabilitiesCurrent liabilities

Accounts payable 11,000,000$ Accrued losses on uncompleted contracts 2,500,000Accrued liabilities 1,200,000Billings in excess of costs and estimated earnings on

uncompleted contracts 350 000 uncompleted contracts 350,000 Total current liabilities 15,050,000

Notes payable 150,000

Total liabilities 15,200,000

Stockholders' equity (deficit)Common stock 100,000 Retained earnings (deficit) 27,000,000

Total stockholders' equity (deficit) 27,100,000

42,300,000$

Example II - HeavyExample II HeavyHeavier Adjusted Net Asset Value December 31, Adjustments Estimated

2010. To Fair Fair MarketBook Value Market Value Value

ASSETSCurrent assets

Cash and cash equivalents 12,350,000$ -$ 12,350,000$ Accounts receivable 20,990,000 (1,049,500) 19,940,500 Prepaid expenses 300,000 - 300,000 Cost and estimated earnings in excess of billings on uncompleted contracts 2,800,000 2,800,000

Total current assets 36,440,000 (1,049,500) 35,390,500

Property and equipmentp y q pLand 10,000 190,000 200,000 Buildings 250,000 1,250,000 1,500,000 Construction equipment 5,500,000 9,500,000 15,000,000 Office equipment 100,000 (12,500) 87,500

5,860,000 10,927,500 16,787,500

Total assets 42,300,000 9,878,000 52,178,000

LIABILITIES AND STOCKHOLDER'S EQUITYCurrent liabilities

Accounts payable 11,000,000$ - 11,000,000$ Accrued losses on uncompleted contracts 2,500,000 400,000 2,900,000 Accrued liabilities 1,200,000 - 1,200,000 Billings in excess of costs and estimated earnings on uncompleted contracts 350,000 100,000 450,000

Total current liabilities 15,050,000 500,000 15,550,000

Notes payable 150,000 - 150,000

Total liabilities 15,200,000 500,000 15,700,000

Value of adjusted net assets (rounded) 27,100,000$ 9,378,000$ 36,478,000$

Rules of ThumbRules of Thumb

Book Value Book Value Adjusted BV plus Unrecognized GP on Jobs in Progress Book Value plus a Multiple of Backlog Book Value plus a Multiple of Backlog 20 to 25 percent of annual sales plus Inventory 1 to 2 times Sellers Discretionary Earnings plus Inventory 1 to 2 times Sellers Discretionary Earnings plus Inventory 2 to 3 times EBITDA These are provided as a general rule from which actual facts and circumstances should be considered to

determine the actual valuedetermine the actual value.

Questions?Questions?

Th k Yo !Thank You!Contact InformationCo tact o at o

Brian Muncy – bmuncy@kbparrish.comPaul Wonch – pwonch@kbparrish.com