STERLING INFRASTRUCTURE, INC. quarterly report, Q2 FY2022

Sterling Infrastructure, Inc. (10-Q) Summary

Reporting period: Quarter and six months ended June 30, 2022. The company changed its legal name from Sterling Construction Company, Inc. to Sterling Infrastructure, Inc. on June 1, 2022. Sterling operates in E-Infrastructure Solutions, Transportation Solutions and Building Solutions across the United States.

Financial performance and position

Metric	Q2 2022	Q2 2021	Six months 2022	Six months 2021
Revenue	$510.6 million	$401.7 million	$920.9 million	$717.0 million
Gross profit	$68.4 million	$56.2 million	$124.5 million	$101.3 million
Gross margin	13.4%	14.0%	13.5%	14.1%
Operating income	$41.1 million	$32.7 million	$69.4 million	$55.5 million
Net income attributable to Sterling	$26.0 million	$20.1 million	$45.2 million	$30.6 million
Diluted EPS	$0.86	$0.69	$1.50	$1.06

Q2 revenue increased 27.1%; six-month revenue increased 28.4%.
Operating margin was approximately 8.0% in Q2 and 7.5% for the six-month period, compared with 8.1% and 7.7%, respectively, in the prior-year periods.
Six-month operating cash flow was $34.6 million, down from $91.5 million, primarily because contract capital reduced liquidity by $56.6 million, including a $70.7 million increase in accounts receivable.
Capital expenditures were $28.9 million and acquisition spending was $3.0 million during the first six months. Investing cash outflow was $31.0 million.
Cash and cash equivalents were $72.9 million at June 30, 2022, compared with $81.8 million at December 31, 2021. Restricted cash was $7.6 million.
Total debt was $446.5 million, including $435.3 million under the term loan. The company had no revolver borrowings and $416.0 million of long-term debt, net of current maturities and issuance costs.
The term loan matures October 2, 2024. The company made $11.6 million of scheduled term-loan payments during the six months and was in compliance with its debt covenants.

Material changes versus the prior comparable period

The December 30, 2021 Petillo acquisition materially increased E-Infrastructure revenue by $76.0 million in Q2 and $123.4 million in the first six months. Petillo was acquired for aggregate consideration of $196.8 million.
E-Infrastructure revenue increased 88.7% in Q2 and 82.7% year to date; its operating margin declined to 14.1% in Q2 and 13.4% year to date, primarily because of inflation, supply-chain constraints, productivity pressures and the lower-margin mix from Petillo.
Transportation revenue declined 5.8% in Q2 but increased 0.5% year to date. Management continued shifting away from lower-margin low-bid heavy-highway work toward design-build and other work.
Building Solutions revenue increased 14.5% in Q2 and 13.7% year to date, with higher operating income and margin, although material and labor costs remained elevated.
Gross margin declined 60 basis points in Q2 and 60 basis points year to date. General and administrative expense increased to 4.6% of Q2 revenue and 5.0% year to date, partly due to Petillo, professional fees and inflation.
Interest expense declined despite higher borrowings, reflecting the amended credit agreement, although the benefit was partly offset by higher rates and acquisition-related debt.
First-half 2022 net income included a $2.4 million gain from forgiveness of a PPP loan. The prior-year periods included smaller debt-extinguishment gains.

Backlog, outlook, risks and unusual items

Backlog was $1.54 billion at June 30, 2022, up from $1.49 billion at December 31, 2021. Combined backlog, including unsigned low-bid awards, was $1.73 billion versus $1.52 billion. Approximately 65% of backlog was expected to convert to revenue within twelve months.
Backlog margin increased to 12.6% from 12.2%, driven by a greater E-Infrastructure mix. The six-month book-to-burn ratio was 1.1x for backlog and 1.3x for combined backlog.
Management expects full-year general and administrative expense of approximately 5% of revenue and an effective tax rate of approximately 28%. The filing does not provide a clear full-year revenue or earnings guidance figure.
Management cited favorable long-term infrastructure and e-infrastructure opportunities, including federal infrastructure funding, data-center and distribution-center development, and continued residential demand in Houston and Phoenix.
Key pressures include inflation, fuel and material costs, supply-chain delays, labor shortages, subcontractor costs, rising interest rates, potential housing-demand volatility, project delays, weather, competition and execution of acquisitions.
The company had included $14.0 million in project price for unapproved change orders and claims at June 30, 2022. Negotiations remained ongoing, and legal action could follow if acceptable resolutions were not reached.
Unconsolidated joint ventures had approximately $178.5 million of remaining construction work, including $75.8 million representing Sterling’s proportionate share. Joint and several liability could expose Sterling to partners’ obligations if they fail to perform.
The company hedged $200 million of term-loan exposure with an interest-rate swap. For the approximately $235 million of unhedged term debt, a 100-basis-point rate change would affect annual interest expense by approximately $2.4 million.
Management stated that legal proceedings were ordinary-course matters without an expected material adverse effect. No material changes to previously disclosed risk factors were reported.

Important facts for investors to verify

Whether Petillo integration, acquisition accounting and the preliminary purchase-price allocation produce additional adjustments.
Whether backlog converts at the disclosed margins, particularly given inflation, labor availability, material costs and project-estimate risks.
Whether operating cash flow improves as elevated receivables and contract assets are collected.
The company’s ability to refinance or repay the term loan before its October 2024 maturity while funding capital expenditures and acquisitions.
The resolution and collectability of the $14.0 million of unapproved change orders and claims.
Exposure to housing-market weakness, infrastructure-award timing, joint-venture obligations and interest-rate increases.
The scope limitation for disclosure controls: Petillo and Kimes acquired operations were excluded from the controls evaluation under applicable SEC guidance.