Sterling Construction Company, Inc. — Fiscal 2020 Form 10-K Summary
Business context and reporting period
Sterling Construction Company, Inc. operates in three U.S. segments: Heavy Civil, Specialty Services and Residential. Heavy Civil provides infrastructure construction and rehabilitation; Specialty Services provides site development, excavation, drilling, foundations and commercial concrete; Residential provides single-family concrete foundations. The filing covers the fiscal year ended December 31, 2020, with comparisons to 2019 and 2018. The filing is an annual report, not a quarterly filing.
- Approximately 2,600 employees at year-end, with approximately 13% represented by unions.
- The Plateau acquisition, completed October 2, 2019 for approximately $427.5 million, materially affected 2020 results through a full year of Specialty Services operations.
- Backlog was $1.175 billion at December 31, 2020, compared with $1.068 billion at December 31, 2019. Including unsigned low-bid awards, combined backlog was approximately $1.5 billion.
Financial performance and key metrics
| Metric | 2020 | 2019 | Change |
|---|---|---|---|
| Revenue | $1.427 billion | $1.126 billion | +26.7% |
| Gross profit | $191.4 million | $107.8 million | +77.5% |
| Gross margin | 13.4% | 9.6% | +380 basis points |
| Operating income | $94.9 million | $37.8 million | +151.4% |
| Income before taxes | $65.4 million | $14.5 million | +351.6% |
| Net income attributable to Sterling | $42.3 million | $39.9 million | +6.0% |
| Diluted earnings per share | $1.50 | $1.47 | +2.0% |
| Operating cash flow | $119.3 million | $41.1 million | +190.3% |
| Capital expenditures | $32.9 million | $15.4 million | Increased |
Specialty Services revenue increased 139% to $508.9 million, primarily because 2020 included a full year of Plateau operations. Heavy Civil revenue decreased 1% to $753.8 million, while Residential revenue increased 8% to $164.7 million. Segment operating income was $70.6 million for Specialty Services, $20.8 million for Residential and $4.5 million for Heavy Civil.
Year-end cash and cash equivalents were $66.2 million, compared with $45.7 million in 2019. Current assets were $361.5 million and current liabilities were $321.9 million. Accounts receivable were $177.4 million, contract assets were $85.0 million and contract liabilities were $114.0 million.
Total debt was $375.4 million at December 31, 2020, consisting principally of $355.0 million under the Term Loan Facility and a $10.0 million seller note. Net long-term debt, after current maturities and unamortized issuance costs, was $291.2 million. The $75 million revolving facility had no outstanding borrowings, providing $75 million of stated availability.
The Company generated $20.5 million of net cash during 2020. Financing cash outflows included $77.7 million of debt repayments, including $45.0 million of term-loan repayments and $20.0 million of revolver repayments. The Company was in compliance with all debt covenants at year-end.
Material changes versus the prior comparable period
- Revenue growth and margin expansion were driven primarily by the full-year contribution from Plateau and a more favorable project mix.
- Gross margin increased from 9.6% to 13.4%; backlog gross margin increased from 11.5% to 12.0%.
- Interest expense increased to $29.4 million from $16.7 million because of acquisition-related borrowings.
- The 2019 income tax benefit of $26.2 million changed to 2020 tax expense of $22.5 million, producing a 34.4% effective tax rate. The Company reported no federal cash income-tax payments in 2020 or 2019 because of net operating loss carryforwards, although it made state tax payments.
- Debt declined from $443.0 million to $375.4 million. The Tealstone seller notes and deferred payments were fully repaid during 2020.
- The Company repurchased no shares under its repurchase program in 2020; the program expired June 30, 2020.
Guidance, outlook, risks and unusual items
- Management expects approximately 64% of year-end backlog to be recognized as revenue during 2021, with substantially all of the remainder recognized in the following twelve months.
- Management expects 2021 capital expenditures of approximately $35 million to $40 million, subject to project awards and equipment requirements.
- Management reported no significant COVID-19 shutdowns or operational interruptions through the filing date, but warned that future effects remain uncertain. The Company implemented social distancing, wellness checks, sanitation and personal protective equipment protocols.
- Heavy Civil demand is supported by state, local and federal infrastructure funding, including transportation and airport programs. Specialty Services benefits from data-center, e-commerce, distribution and warehouse investment, while the multifamily market remains under pressure. Residential performance depends on housing starts and demand in Texas markets.
- The Company’s long-term contracts are generally fixed-unit-price or lump-sum contracts. Revenue is recognized over time using a cost-to-cost method, requiring estimates of costs to complete, productivity, subcontractor performance, claims, change orders and other variable consideration. Changes in estimates could materially increase or reduce earnings.
- At December 31, 2020, the Company included $7.1 million of unapproved change orders and claims in project prices, compared with $3.0 million in 2019. Recovery remains subject to negotiation and, potentially, legal action.
- The Term Loan Facility matures October 2, 2024. A $32.7 million excess-cash-flow payment was required in the first quarter of 2021; $15.0 million had been prepaid in the fourth quarter of 2020 and $17.7 million remained payable.
- Approximately $9.8 million of PPP loans received by consolidated 50%-owned subsidiaries remained classified as short-term debt pending SBA forgiveness determinations.
- Key risks include project cost overruns, fixed-price contract exposure, customer concentration, subcontractor and supply-chain failures, labor availability and costs, bonding capacity, weather, government infrastructure funding, housing-market cyclicality, COVID-19 impacts, interest-rate and LIBOR transition risk, debt covenants, joint-venture obligations and potential impairment of approximately $192 million of goodwill and $244.9 million of intangible assets.
- Unconsolidated joint-venture contracts had approximately $522.6 million of remaining work, including $234.2 million representing Sterling’s proportionate share. Management was not aware of any situation requiring it to fulfill a joint-venture partner’s obligations.
- Grant Thornton LLP issued unqualified opinions on the financial statements and internal control over financial reporting. Revenue recognition was identified as a critical audit matter.
Most important facts for investors to verify
- Whether Specialty Services’ post-acquisition revenue and margins remain sustainable without continued acquisition-related distortion.
- The timing, profitability and cancellation risk of the $1.175 billion backlog and the $356.9 million of unsigned low-bid awards.
- Compliance with tightening leverage covenants and the Company’s ability to fund scheduled debt amortization and the 2021 excess-cash-flow payment.
- Collection and resolution of contract assets, retainage, unapproved claims and change orders.
- COVID-19, labor, materials, fuel, weather and supply-chain effects on fixed-price project costs.
- The status and potential forgiveness of the approximately $9.8 million PPP loans.
- Customer concentration, particularly in Residential, where four customers represented 83% of segment revenue in 2020.
- Potential changes in goodwill, intangible-asset valuations and the Company’s ability to use its federal and state net operating loss carryforwards.