Sterling Construction Company, Inc. — Q1 2018 Form 10-Q Summary
Business Context and Reporting Period
The filing covers the unaudited three months ended March 31, 2018. The registrant identified in the filing is Sterling Construction Company, Inc. The company provides heavy civil construction services, including highways, bridges, aviation, water and wastewater infrastructure, and residential and commercial concrete construction, primarily in western and southern U.S. markets.
The company operated through two reportable segments: Heavy Civil Construction and Residential Construction. The Residential Construction segment reflects the Tealstone acquisition completed on April 3, 2017.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $222.5 million | $153.4 million | Up 45.0% |
| Gross profit | $20.6 million | $9.3 million | Up 121.8% |
| Gross margin | 9.3% | 6.1% | Up 320 basis points |
| Operating income (loss) | $6.7 million | $(1.8) million | Improved by $8.5 million |
| Operating margin | 3.0% | (1.2)% | Improved by 420 basis points |
| Net income (loss) attributable to Sterling stockholders | $2.5 million | $(2.3) million | Returned to profitability |
| Diluted earnings (loss) per share | $0.09 | $(0.09) | Improved |
| Net cash used in operating activities | $(23.3) million | $(3.1) million | Greater use of cash |
Heavy Civil Construction generated $187.2 million of revenue and $1.9 million of operating income. Residential Construction generated $35.3 million of revenue and $4.7 million of operating income.
Cash and cash equivalents were $55.5 million at March 31, 2018, compared with $84.0 million at December 31, 2017. Working capital was $98.7 million, compared with $96.2 million at year-end. Cash used in investing activities was $1.0 million, including $1.9 million of capital expenditures, while financing activities used $4.2 million, including $4.7 million of Oaktree Facility repayments.
Total debt was $94.5 million, consisting principally of $80.3 million outstanding under the Oaktree Facility and $12.7 million of Tealstone-related notes and deferred seller payments. Long-term debt, net of current maturities and deferred loan costs, was $85.1 million. The Oaktree Facility bears interest at LIBOR plus 8.75% and matures in April 2022. Management stated that the company was in compliance with its debt covenants at March 31, 2018.
Material Changes Versus the Prior Comparable Period
- Revenue increased primarily because Tealstone contributed approximately $53.0 million, with additional growth from Rocky Mountain joint venture projects and aviation work.
- Gross margin improved due to the higher-margin Tealstone business and approximately 1 percentage point of improvement in Heavy Civil Construction gross margin.
- Heavy Civil Construction operating income improved from a $1.8 million loss to $1.9 million of income, reflecting better bid discipline, project management and project execution, partly offset by lower fixed-cost absorption.
- Interest expense increased to $3.1 million from $0.1 million because the Oaktree Facility replaced the prior equipment-based facility and funded the cash portion of the Tealstone acquisition.
- General and administrative expense increased to $13.1 million from $10.6 million, primarily due to the Tealstone acquisition, but declined as a percentage of revenue to 5.9%.
- Operating cash flow deteriorated to a $23.3 million use, primarily due to a $28.2 million adverse change in contract capital, including lower accounts payable, contract liabilities and receivables from contracts and joint ventures.
- Backlog increased to $885 million at March 31, 2018, from $744 million at December 31, 2017. Unsigned low-bid awards were $151 million, resulting in combined backlog of $1.035 billion.
Guidance, Outlook, Risks and Unusual Items
Management expects approximately 61% of the $885 million heavy civil backlog to be recognized as revenue during the remainder of 2018. Backlog margin declined to 8.1% from 8.4% at year-end, while combined backlog margin increased to 8.4% from 8.3%. The company added approximately $305 million of new backlog during the quarter at an average margin of 8.1%.
Management cited increased infrastructure funding in Texas, Utah and California as supportive of the Heavy Civil Construction market. The company expects continued growth in its Dallas-Fort Worth residential market and plans to expand into Houston and surrounding areas in 2018. Management stated that it expects sufficient liquidity to fund operations and bonding requirements for the next twelve months, while acknowledging that substantial cash constraints, losses or inability to obtain financing could materially affect liquidity.
The company adopted ASC 606, Revenue from Contracts with Customers, effective January 1, 2018, using the modified retrospective method. Management reported no material impact on the financial statements.
Unapproved change orders of $5.0 million and claims of $6.0 million were included in contract assets at March 31, 2018. Management expects resolution without a material adverse effect, but noted that negotiations could produce materially different results. The company also has approximately $40.0 million of mandatory redemption obligations related to interests in two 50%-owned subsidiaries, plus $3.9 million of accumulated earnings.
Construction joint ventures involve joint and several liability. Approximately $94.6 million of work remained on unconsolidated joint venture contracts, including $47.0 million representing Sterling’s proportionate share. Management was not aware of any current situation requiring it to fund a partner’s obligations.
Principal risks include project execution and cost overruns, inaccurate contract estimates, claims and change orders, labor and subcontractor availability, material and fuel inflation, adverse weather, government infrastructure funding, customer concentration, competition, acquisition integration, joint venture obligations, bonding capacity and floating-rate debt. A 1 percentage point increase in the Oaktree interest rate would increase annual interest expense by approximately $0.8 million.
Management reported no material changes to previously disclosed risk factors, no material pending legal matters, and effective disclosure controls as of March 31, 2018.
Important Facts for Investors to Verify
- Confirm the registrant name and ticker identity, because the provided metadata references Sterling Infrastructure, Inc., while the filing identifies Sterling Construction Company, Inc.
- Assess whether improved profitability is sustainable after separating Tealstone’s contribution from organic Heavy Civil Construction performance.
- Monitor operating cash flow, receivables, contract assets and liabilities, and accounts payable given the $23.3 million quarterly operating cash use.
- Review the high-cost, floating-rate Oaktree Facility, required excess-cash-flow prepayments and covenant thresholds.
- Track resolution and collectability of the $5.0 million of unapproved change orders and $6.0 million of claims.
- Evaluate backlog conversion, backlog margin, unsigned low-bid awards and the risk that estimated contract profitability changes as projects progress.
- Review mandatory redemption obligations, joint venture guarantees and the availability of cash held by consolidated subsidiaries and joint ventures.
- Consider seasonality: management stated that interim results may vary significantly and are not necessarily indicative of full-year results.