Sterling Construction Company, Inc. — Q2 2019 Form 10-Q Summary
Business context and reporting period
The filing is for Sterling Construction Company, Inc. (NASDAQ: STRL), a heavy civil infrastructure and residential concrete construction company operating primarily in the western and southern United States. The unaudited interim period ended June 30, 2019, with comparisons to June 30, 2018. Results may be seasonally variable, particularly because of weather and construction-cycle timing.
Key financial metrics
| Metric | Three months ended June 30, 2019 | Three months ended June 30, 2018 | Six months ended June 30, 2019 | Six months ended June 30, 2018 |
|---|---|---|---|---|
| Revenue | $264.1 million | $268.7 million | $488.0 million | $491.2 million |
| Gross profit | $25.5 million | $31.0 million | $45.0 million | $50.9 million |
| Gross margin | 9.7% | 11.6% | 9.2% | 10.4% |
| Operating income | $11.2 million | $12.1 million | $15.9 million | $18.8 million |
| Operating margin | 4.2% | 4.5% | 3.3% | 3.8% |
| Net income attributable to Sterling stockholders | $7.8 million | $8.2 million | $9.6 million | $10.7 million |
| Diluted EPS | $0.29 | $0.30 | $0.36 | $0.39 |
- Six-month operating cash flow was negative $4.3 million, compared with negative $7.9 million in the prior-year period.
- Capital expenditures were $4.9 million; net investing cash use was $4.1 million.
- Net financing cash use was $14.0 million, including $5.8 million of debt repayments, $5.1 million of distributions to noncontrolling interest owners and $3.2 million of treasury-stock repurchases.
- Cash and cash equivalents were $71.7 million at June 30, 2019, down from $94.1 million at December 31, 2018. Working capital was $110.5 million, compared with $123.4 million at year-end.
- Total debt was $84.3 million, including $71.6 million outstanding under the Oaktree Facility. Total lease obligations were approximately $15.9 million.
- The Oaktree Facility matures in April 2022 and bears interest at LIBOR plus 8.75%. The Company stated that it was in compliance with all facility covenants at June 30, 2019.
Material changes versus the prior comparable period
- Second-quarter revenue declined 2%, while six-month revenue declined 1%. Severe weather affected both operating segments, particularly residential construction.
- Gross profit fell $5.6 million in the second quarter and $5.9 million year to date. Margin compression reflected lower residential volume and a less favorable heavy civil project mix.
- Heavy civil revenue increased 2.2% in the second quarter to $228.1 million but declined 0.3% year to date to $409.3 million. Heavy civil operating income declined to $6.1 million in the quarter and $5.3 million year to date.
- Residential revenue declined 20.9% in the second quarter to $36.0 million and 2.5% year to date to $78.7 million. Management attributed the quarterly decline to approximately 30 unworkable weather days in Texas and a 22.5% reduction in completed slabs.
- General and administrative expense decreased $2.4 million in the quarter and $2.2 million year to date, partly offsetting gross-profit pressure.
- Interest expense declined modestly because of lower debt balances, although higher interest rates partially offset the benefit.
- Average borrowings under the Oaktree Facility declined to $72.8 million from $81.6 million in the comparable six-month period.
Guidance, outlook, commentary, risks and unusual items
- Backlog was $909.0 million at June 30, 2019, up from $850.7 million at December 31, 2018. Management expects approximately 70% of backlog to be recognized as revenue over the following twelve months. Unsigned low-bid awards were $314.9 million, producing combined backlog of approximately $1.2 billion.
- Backlog margin increased to 8.8% from 8.5% at year-end; combined-backlog margin increased to 9.1% from 8.9%.
- Management expects full-year cash flow from operations to approximate operating income and believes available liquidity is sufficient for the next twelve months, including bonding requirements.
- Management cited increased state and local infrastructure funding, federal aviation funding and the FAST Act as positive market factors, while noting that any new federal infrastructure legislation would likely have limited impact before 2020 or 2021.
- The Company included approximately $15.7 million in unapproved change orders and claims in project pricing at June 30, 2019, primarily relating to delays on a Texas bridge project caused by design errors in the owner-provided plans. These amounts remain subject to negotiation and could be reduced or reversed.
- Unconsolidated joint ventures generally carry joint and several liability. Approximately $71.8 million of work remained on those contracts, including $34.3 million representing Sterling’s proportionate share. Management was not aware of a partner-performance situation requiring Sterling to assume a partner’s obligations.
- The Company maintained a $31.7 million valuation allowance against deferred tax assets but indicated that continued positive results could support removing the allowance in the fourth quarter of 2019. The timing and amount of any release were not certain.
- Key risks include weather, project delays, cost escalation, labor and subcontractor availability, design errors, government funding, contract-estimate revisions, claims and change-order outcomes, joint-venture obligations, customer concentration, competition and variable-rate debt.
- The Company adopted lease accounting guidance effective January 1, 2019, recording approximately $13.6 million of operating lease right-of-use assets and related liabilities at adoption. The adoption did not materially affect reported earnings.
- Management reported no material pending legal matters, no material changes to previously disclosed risk factors, and effective disclosure controls as of June 30, 2019.
Most important facts for investors to verify
- Whether weather-related delays and residential-volume weakness reverse during the second half of 2019.
- Whether gross margins recover from the 9.2% year-to-date level and whether heavy civil project execution supports the stated backlog margins.
- The collectability and final resolution of the $15.7 million of unapproved claims and change orders.
- Compliance with the Oaktree Facility’s tightening secured-debt-to-EBITDA covenant and the Company’s ability to meet the April 2020 Tealstone payments.
- Whether seasonal operating cash inflows materialize as expected, given negative year-to-date operating cash flow and the $28.8 million reduction from contract capital.
- Whether the deferred-tax valuation allowance can be removed in the fourth quarter and the resulting effect on earnings and equity.
- Potential exposure from joint and several liabilities, mandatory redemption obligations of $48.8 million related to 50%-owned subsidiaries, and other construction contingencies.