SMITH MIDLAND CORP quarterly report, Q3 FY2019

Smith-Midland Corporation — Q3 2019 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2019. Unaudited; financial statement amounts below are in millions of dollars unless noted. The company manufactures, sells, rents, licenses, ships and installs precast concrete products, primarily for construction, highway, utility and farming markets.

Financial performance

Metric	Q3 2019	Q3 2018	Nine months 2019	Nine months 2018
Revenue	$13.209	$9.544	$34.249	$28.502
Gross profit	$2.593	$2.593	$6.971	$6.994
Operating income	$0.753	$0.664	$1.573	$1.022
Net income	$0.574	$0.520	$1.178	$0.790
Diluted EPS	$0.11	$0.10	$0.23	$0.15
Operating cash flow	Not stated by quarter	Not stated by quarter	$2.990	$5.718

Revenue increased 38% in Q3 and 20% year to date. Product sales rose 26% in Q3 and 10% year to date; service revenue, including shipping and installation, rose 70% and 49%, respectively.
Gross margin was approximately 19.6% in Q3 2019 versus 27.2% in Q3 2018, and 20.4% year to date versus 24.5%. Management attributes margin pressure mainly to a larger mix of lower-margin shipping and installation, higher shipping and labor costs, and competitive pricing.
Operating expenses fell year to date, primarily due to lower administrative staffing costs. Operating income increased despite essentially flat gross profit.
Operating cash flow declined by $2.728 million year to date. The comparison includes a $5.389 million cash-flow benefit from the deferred buy-back lease obligation in 2018; 2019 operating cash flow also benefited from lower receivables, inventories and refundable taxes.

Balance sheet, liquidity and debt

At September 30, cash was $1.019 million and available-for-sale investment securities were $1.170 million, compared with cash of $1.946 million and securities of $1.107 million at December 31, 2018. The company attributed the cash decrease primarily to capital spending.
Current assets were $18.035 million and current liabilities $10.066 million, implying a current ratio of approximately 1.8. Total assets were $40.403 million; total liabilities $20.126 million; stockholders’ equity $20.277 million.
Notes payable were $2.997 million, including $0.733 million due within 12 months. A separate $1.500 million construction line-of-credit draw was outstanding at quarter end. The company reported compliance with loan covenants.
On October 11, 2019, the North Carolina expansion financing closed with a $2.228 million, 10-year note at a fixed 3.64% rate; the company said the construction line draw was paid in full and converted to long-term debt. The bank also issued a commitment for a renewed $4.000 million line of credit, with renewal expected by year end.
Year-to-date capital expenditures were $3.392 million, mainly for the North Carolina plant expansion, rental barriers and equipment. Management planned approximately $1.000 million of additional spending during the rest of 2019. The company said expected operating cash flow and credit availability should fund operations for at least 12 months, but gave no assurance.

Material changes, outlook and risks

Revenue gains were led by Easi-Set/Easi-Span building sales, up 211% year to date, and shipping and installation revenue, up 61%. Soundwall sales declined 21% and SlenderWall sales declined 16% year to date. Barrier rentals rose 50%, partly due to accounting for a customer buy-back arrangement.
Management expected 2019 sales to exceed 2018 annual sales. It anticipated Q4 soundwall sales near the first three quarters’ level, lower building sales than in Q3, and utility sales around current levels. Management expected 2019 royalty revenue to be similar to 2018. These are estimates, not guarantees.
As of November 1, 2019, backlog was approximately $28.5 million versus $31.0 million a year earlier. Management attributed the decrease to large orders booked in early 2018 and competitive pressure; most backlog was expected to be produced within 12 months.
A customer buy-back guarantee is accounted for as an operating lease: product deliveries were expected to finish by mid-2020, while rental revenue and related net profits could continue until the customer’s project ends or the option expires, expected in 2022. Actual timing and outcome depend on the customer’s project and option decision.
The North Carolina plant expansion cost approximately $3.3 million; initial production began in Q3 2019, with full manufacturing operations expected to move from the existing facility in mid-2020. Management cautioned that timing and success are not assured.
Management cited competitive pricing, rising labor and shipping costs, possible raw-material increases, construction seasonality and weather, project execution, backlog conversion, customer payment delays and retainage, financing availability, and the need for expansion revenues to justify investment as risks. DSO, excluding unbilled revenue, was 90 days versus 76 days at year-end 2018, mainly because of retainage on large projects.
No material litigation was reported. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.

Important facts for investors to verify

Whether the North Carolina expansion completes its transition as planned and generates enough production and revenue to support its cost and new debt.
Whether backlog converts to sales on schedule, and how the lower year-over-year backlog affects future revenue.
Whether revenue growth can translate into improved margins despite lower-margin installation work, pricing pressure and rising labor and freight costs.
Cash conversion, customer collections and retainage exposure, given lower operating cash flow and higher DSO.
The customer’s progress toward completing the buy-back project and the timing and accounting effects of the buy-back option, expected to expire in 2022.
Completion of the committed $4.000 million credit-line renewal and continued compliance with lending covenants and capital-spending limits.