Sterling Construction Company, Inc. — FY2018 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2018; filed March 5, 2019. The source filing identifies the registrant as Sterling Construction Company, Inc. and covers the heavy civil construction and residential construction segments. The request metadata refers to Sterling Infrastructure, Inc.; investors should verify the intended issuer and filing.
Business Context
Sterling performs heavy civil infrastructure construction and rehabilitation, including highways, bridges, aviation, water and wastewater, transit, commercial concrete and related projects. Its residential construction business provides concrete foundations and other concrete work, primarily in Texas. Principal markets include Arizona, California, Colorado, Hawaii, Nevada, Texas and Utah.
Heavy civil revenue is generally recognized over time using a cost-to-cost measure, while residential revenue is generally recognized when foundation units are completed. Approximately 85% of 2018 revenue was recognized over time and 15% at a point in time.
Key Financial Metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Revenue | $1,037.7 million | $958.0 million | 8.3% increase |
| Gross profit | $110.3 million | $89.1 million | 23.8% increase |
| Gross margin | 10.6% | 9.3% | Up 130 basis points |
| Operating income | $42.6 million | $26.2 million | 62.8% increase |
| Operating margin | 4.1% | 2.7% | Up 140 basis points |
| Net income attributable to Sterling stockholders | $25.2 million | $11.6 million | 116.8% increase |
| Diluted EPS | $0.93 | $0.43 | Increase |
| Cash flow from operations | $39.5 million | $24.8 million | Increase |
| Capital expenditures | $13.2 million | $9.4 million | Increase |
| Total debt | $88.8 million | $99.0 million | Decrease |
Fourth quarter 2018: Revenue was $255.2 million, gross profit was $26.7 million, income before taxes and noncontrolling interests was $6.7 million, and net income attributable to Sterling stockholders was $5.6 million, or $0.21 diluted EPS. Fourth-quarter figures were unaudited quarterly information included in the 10-K.
Liquidity: Cash and cash equivalents were $94.1 million at year-end, including $42.6 million generally available to Sterling, $31.0 million held by consolidated 50%-owned subsidiaries and $20.5 million held by construction joint ventures. Working capital was $123.4 million, compared with $96.2 million in 2017. Some subsidiary and joint-venture cash was restricted to those activities and was not freely available without approval.
Segment Performance and Material Changes
- Heavy civil construction: Revenue increased to $886.0 million from $850.0 million; operating income increased to $21.5 million from $10.8 million. Growth reflected higher-margin commercial and aviation work, improved bid discipline, project execution and completion of projects in Hawaii and the Rocky Mountain region. Heavy highway revenue declined by approximately $65 million.
- Residential construction: Revenue increased to $151.7 million from $108.0 million and operating income increased to $21.1 million from $15.4 million. The increase primarily reflected a full year of Tealstone results in 2018 versus nine months in 2017, as well as organic growth and expansion into the Houston market.
- Tealstone acquisition: The 2017 acquisition expanded Sterling into residential foundations and commercial concrete. The transaction was funded with cash, stock, seller notes and deferred payments, and was financed in part through the Oaktree Facility.
- Backlog: Heavy civil backlog increased to $850.7 million from $744.4 million, while combined backlog including unsigned low-bid awards increased to approximately $1.1 billion from $1.0 billion. Management expected approximately 75% of backlog to convert to revenue during 2019. Backlog gross margin was approximately 8.5% at year-end.
- Debt reduction: Sterling repaid $10.4 million under the Oaktree Facility during 2018. Total debt declined by $10.2 million year over year, although interest expense increased to $12.4 million from $9.8 million because of higher rates and a full year of Oaktree financing.
- Share repurchases: Sterling repurchased 466,519 shares for $4.7 million during 2018. The November 2018 authorization permits repurchases of up to 2.0 million shares through June 30, 2020; 1,533,481 shares remained available under the program at year-end.
Outlook, Risks and Unusual Items
Management cited improving infrastructure funding in key states, including transportation measures in California, Texas, Arizona, Colorado and Utah, and continued federal surface transportation and aviation funding. Management expected 2019 capital expenditures to be similar to the $13.2 million incurred in 2018, subject to project awards and equipment needs. It stated that available liquidity was expected to fund the next year of operations and bonding requirements.
- The Oaktree term loan had $74.6 million outstanding at December 31, 2018, matures April 2022 and bears interest at LIBOR plus 8.75%. A 1% increase in the interest rate would increase annual interest expense by approximately $0.7 million based on year-end borrowings.
- The facility is secured by substantially all company and subsidiary assets and imposes restrictions on additional debt, liens, acquisitions, capital expenditures, investments and dividends. Sterling was in compliance with its financial covenants at year-end.
- Approximately $14.0 million to $16.0 million of operating lease right-of-use assets and corresponding liabilities were expected to be recorded upon adoption of the new lease standard in the first quarter of 2019; no material income-statement impact was expected.
- Revenue and profit depend on estimates of costs, productivity, project conditions, change orders, claims, subcontractor performance and completion penalties. A net $7.1 million increase in estimated contract revenue and gross margin was recognized in 2018.
- Unapproved change orders and claims totaling $9.3 million were included in contract assets at year-end, down from $10.0 million in 2017. Resolution remained subject to negotiations and could cause future adjustments.
- Major risks include fixed-price and fixed-unit-price contract exposure, material and labor cost inflation, fuel and steel prices, weather, government funding and shutdowns, customer concentration, bonding capacity, joint-and-several liability in joint ventures, residential housing cyclicality, labor availability, union matters, environmental compliance and information-technology disruption.
- Utah’s Department of Transportation represented 14.8% of consolidated revenue. Four major residential customers represented approximately 72% of residential segment revenue in 2018.
- Goodwill of $85.2 million and intangible assets of $42.4 million were recorded at year-end. No goodwill impairment was identified. The company maintained a $31.7 million valuation allowance against deferred tax assets and reported $1.7 million of income tax expense.
- Management reported no legal proceedings expected to have a material adverse impact, and Grant Thornton issued unqualified opinions on the financial statements and internal control over financial reporting.
Most Important Facts for Investors to Verify
- Confirm the issuer’s legal name and ticker because the supplied metadata says Sterling Infrastructure, Inc., while the filing identifies Sterling Construction Company, Inc.
- Reconcile unrestricted cash with cash held by subsidiaries and joint ventures, and assess liquidity after required debt prepayments, working-capital needs and bonding requirements.
- Review the Oaktree Facility’s LIBOR-based pricing, 2022 maturity, collateral package, covenant thresholds and restrictions on acquisitions, capital expenditures and dividends.
- Assess whether the $850.7 million heavy civil backlog and approximately 75% 2019 conversion expectation are supported by executed contracts, achievable margins and customer funding.
- Evaluate the recoverability of the $9.3 million of unapproved change orders and claims and the sensitivity of over-time revenue recognition to cost-to-complete revisions.
- Monitor customer concentration, especially UDOT and the residential customer base, as well as joint-venture completion obligations and potential partner liabilities.
- Consider the effect of interest-rate increases, material and labor cost inflation, weather, government infrastructure spending and housing-market conditions on margins and cash flow.