Smith-Midland Corporation — Q2 2018 Form 10-Q
Business and period: The company manufactures, sells, rents, licenses and installs precast concrete products, principally for construction, highway, utility and farming markets. This unaudited report covers the quarter and six months ended June 30, 2018. Financial amounts below are in thousands of dollars, except per-share data and where noted.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $9,833 | $10,728 | $18,958 | $20,225 |
| Gross profit | $2,976 | $2,877 | $4,567 | $6,194 |
| Operating income | $911 | $1,093 | $358 | $2,450 |
| Net income | $691 | $711 | $270 | $1,569 |
| Diluted EPS | $0.14 | $0.14 | $0.05 | $0.31 |
| Gross margin | 30.3% | 26.8% | 24.1% | 30.6% |
| Operating margin | 9.3% | 10.2% | 1.9% | 12.1% |
Margins are calculated from reported revenue and income. Q2 revenue declined 8%, while gross profit rose; higher gross margin was attributed mainly to lower direct labor costs. Six-month revenue declined 6%, and operating income and net income fell sharply year over year. The company reported a $421 net loss in Q1 and $691 net income in Q2.
Revenue mix: Q2 product sales fell 9% to $6,943; barrier sales declined 59% to $1,590, while soundwall sales rose 77% to $2,525 and SlenderWall sales were $1,422 versus none a year earlier. Six-month product sales rose 15% to $14,396, but service revenue fell 40% to $4,562, largely reflecting lower barrier rental revenue versus a prior-year special project and the buy-back arrangement. Royalty income was $727 for the six months, down 20%.
Cash flow and liquidity: Operating cash flow was negative $1,339 for the first six months, versus positive $1,270 a year earlier. Investing cash outflow was $1,006, including $1,057 of capital expenditures; financing cash outflow was $206. Cash declined to $839 from $3,390 at year-end 2017; available-for-sale investments were $1,097. Receivables increased, including billed receivables of $11,262 and unbilled receivables of $1,272. Management attributed cash reduction mainly to increased production and billings late in Q2, retainage, capital purchases and debt payments. Days sales outstanding, excluding unbilled revenue, was 78 days versus 75 days at year-end.
At June 30, current assets were $19,328 and current liabilities $7,459. Total debt obligations were $3,571, including $693 due within 12 months; the company also recorded a $3,733 deferred buy-back lease obligation and a $2,986 related lease asset. No balance was outstanding on its $2,000 revolving line or $1,500 equipment line. The company was in compliance with loan covenants. It reported $35.3 million of backlog as of August 1, 2018, versus $30.2 million a year earlier.
Material changes and notable items
- The guaranteed buy-back barrier contract is accounted for as an operating lease rather than an ordinary product sale. Proceeds tied to the obligation are deferred, and revenue is recognized over the project period. The company said this arrangement significantly reduced reported barrier sales; deliveries began in Q2 and were expected to finish by year-end 2018.
- Six-month cost of goods sold as a share of revenue excluding royalties increased to 79% from 73%. Management cited the absence of a high-margin special project in Q1 2017 and Columbia plant soundwall design issues that required more steel and labor than estimated. Change orders for affected contracts remained under negotiation.
- General and administrative expense rose 18% year to date to $2,919, attributed mainly to salaries, use tax associated with SlenderWall sales and higher bad-debt expense. Management also expects raw-material prices to continue rising, with steel pricing affected by tariffs and demand.
- The company adopted ASC 606 on January 1, 2018 using the modified retrospective method; it reported no material effect on revenue timing or amount and no opening retained-earnings adjustment.
Outlook, risks and contingencies
Management anticipated continued profit for the remainder of 2018, while cautioning that there is no assurance. It expected full-year soundwall sales to exceed 2017, SlenderWall production to continue into 2019, and barrier sales to be lower than 2017 because of the buy-back contract. It also cited potential improvement in rentals, buildings, utility products, royalties, and shipping and installation. The company said backlog supported revenue into 2019.
A North Carolina plant expansion is planned: a 15,000-square-foot facility estimated to cost $3.3 million, funded through bank financing. Construction was expected to begin in Q3 2018, with completion by the end of Q1 2019 and production beginning in Q2 2019; cost, financing, timing and completion are not assured. The company planned approximately $1,500 of additional capital purchases during the rest of 2018, excluding expansions, and was seeking to increase its annual capital-expenditure limit under its bank agreement.
Key risks include construction-industry cyclicality and seasonality, adverse weather, rising input costs, project execution and specification risks, customer payment delays and retainage, availability and terms of financing, interest-rate exposure, and uncertainty in achieving profitable operations. Management said anticipated operating cash flow and unused credit availability should fund operations for at least 12 months, but gave no assurance. The company reported no material litigation; disclosure controls were assessed as effective, with no material internal-control changes reported.
Investor verification checklist
- Track collections, retainage, receivables and operating cash flow, given the six-month operating cash outflow and lower cash balance.
- Verify the buy-back contract’s revenue recognition, lease asset and obligation balances, and subsequent rental revenue and product disposition.
- Monitor Columbia soundwall project change orders and whether added steel and labor costs are recovered.
- Assess backlog conversion, project margins, and whether the expected 2018 profit and sales trends materialize.
- Confirm financing, capital-spending covenant capacity, cost and schedule for the North Carolina expansion, and the effect of continued raw-material inflation.