Smith-Midland Corporation — Q1 2018 Form 10-Q
Business and period: The company manufactures, sells, rents, licenses and installs precast concrete products, primarily for construction, highway, utility and farming markets. This unaudited report covers the three months ended March 31, 2018; comparisons are with Q1 2017 unless noted. Dollar amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 / prior date |
|---|---|---|
| Revenue | $9.125 | $9.497 |
| Gross profit / gross margin | $1.591 / 17.4% | $3.316 / 34.9% |
| Operating income (loss) | $(0.553) | $1.356 |
| Net income (loss) | $(0.422) | $0.857 |
| Diluted EPS | $(0.08) | $0.17 |
| Operating cash flow | $(1.503) | $1.511 |
| Capital expenditures | $0.860 | $0.674 |
| Cash and cash equivalents | $1.006 | $3.390 at Dec. 31, 2017 |
| Available-for-sale investment securities | $1.087 | $1.098 at Dec. 31, 2017 |
| Total notes payable | $3.732 | $3.533 at Dec. 31, 2017 |
| Current assets / current liabilities | $17.329 / $6.734 | $19.032 / $7.834 at Dec. 31, 2017 |
Revenue declined 4%, but product sales rose 51% to $7.453 million. Barrier rentals fell 88% to $0.309 million, royalties fell 49% to $0.221 million, and shipping and installation revenue fell 28% to $1.142 million. Cost of goods sold rose 22% to $7.534 million. The company recorded an income tax benefit of $0.135 million, versus $0.486 million of tax expense a year earlier; management attributed the rate change to the federal tax rate reduction enacted in 2017.
Operating cash use, together with capital spending and debt repayments, reduced cash by $2.384 million during the quarter. Management cited higher receivables, including project retainage, as a factor. Days sales outstanding, excluding unbilled revenue, was 93 days, compared with 75 days for the year ended December 31, 2017. Debt included $0.693 million due within 12 months. The company had no balance on its $2.0 million revolver or $1.5 million equipment line commitment, and reported compliance with loan covenants. Working capital was approximately $10.595 million at quarter-end.
Material changes and unusual items
- Profitability deteriorated substantially: the company moved from operating and net income to losses, with gross margin falling to 17.4% from 34.9%.
- Management attributed lower margins partly to a high-margin special project in Q1 2017 that did not recur, and to soundwall design issues at the Columbia, South Carolina facility. Those issues increased steel usage and direct labor; the company said it corrected designs for future bids but was still negotiating change orders on current contracts.
- A customer buy-back guarantee affects accounting for part of a barrier contract: proceeds are deferred and recognized as lease revenue over the usage period. At March 31, the balance sheet included a $1.076 million deferred buy-back lease asset and a $1.344 million obligation.
- The company adopted ASC 606 on January 1, 2018 using the modified retrospective method; it reported no material effect on revenue recognition and no opening retained-earnings adjustment.
- On April 27, the board approved a planned $3.3 million, 15,000-square-foot North Carolina manufacturing plant, with completion expected by year-end 2018. The company owns the site; the existing facility will remain operating during construction.
Outlook, commentary and risks
Management expected sales to rise from Q1 levels, citing a sales backlog of approximately $38.4 million as of May 10, 2018, versus $27.4 million a year earlier. Most backlog projects were expected to be produced within 12 months, though some extend several years; management cautioned that results are not assured. A large soundwall contract awarded in April was expected to be produced and delivered over three years. Management also anticipated higher 2018 building sales and expected raw-material prices to continue rising. It planned approximately $1.5 million of additional capital purchases during the rest of 2018, excluding plant expansions.
Key risks include construction seasonality and adverse winter weather; rising material costs; customer payment delays and retainage; execution, design, cost and timing risks on large projects; dependence on construction and public infrastructure spending; and the need for financing to support operations and capital projects. Management said expected operating cash flow and available credit should fund operations for at least 12 months, but gave no assurance. The bank agreement limits annual capital expenditures to $1.5 million; the company said it was seeking an increase to accommodate planned spending. The filing reported no material litigation and effective disclosure controls as of March 31.
Important facts for investors to verify
- Whether change orders or other recoveries resolve the Columbia soundwall project cost overruns, and how margins develop on subsequent work.
- Whether the $38.4 million backlog converts to revenue and cash on schedule, including the large multi-year soundwall project.
- Receivables, retainage, days sales outstanding and operating cash flow, given the quarter’s cash decline and negative operating cash flow.
- Funding, bank approval and covenant capacity for the planned North Carolina expansion and other capital spending.
- Costs and revenue recognition associated with the customer buy-back guarantee, and exposure to rising raw-material prices.