Sterling Construction Company, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2021, compared with the corresponding 2020 periods. The filing identifies the registrant as Sterling Construction Company, Inc. (NASDAQ: STRL), although the request metadata names Sterling Infrastructure, Inc.
Business Context
Sterling operates in three U.S. segments: Heavy Civil, Specialty Services and Residential. Its projects include highways, bridges, airports, water infrastructure, site development, commercial concrete and residential foundations, primarily across the southern United States, Rocky Mountain states, California and Hawaii.
Financial Performance
| Metric | Q3 2021 | Q3 2020 | 9M 2021 | 9M 2020 |
|---|---|---|---|---|
| Revenue | $463.4 million | $383.5 million | $1.180 billion | $1.080 billion |
| Gross profit | $57.8 million | $49.9 million | $159.1 million | $144.8 million |
| Gross margin | 12.5% | 13.0% | 13.5% | 13.4% |
| Operating income | $32.0 million | $28.8 million | $87.5 million | $74.0 million |
| Net income attributable to Sterling | $21.1 million | $15.2 million | $51.7 million | $36.5 million |
| Diluted EPS | $0.72 | $0.54 | $1.79 | $1.30 |
| Operating cash flow | Not separately provided | Not separately provided | $135.7 million | $92.3 million |
Third-quarter revenue increased 20.9%, while nine-month revenue increased 9.3%. Third-quarter operating income rose 11.1%, and nine-month operating income rose 18.3%. Net income attributable to Sterling increased 39.4% in the quarter and 41.8% year to date. The quarter’s gross margin declined because of inflation, labor constraints and material-supply issues; the nine-month margin improved modestly due to higher volume and a more favorable Heavy Civil project mix.
Segment Results
- Heavy Civil: Q3 revenue increased 24.3% to $249.9 million and operating income increased to $7.2 million from $2.4 million. Results benefited from large design-build joint ventures and reduced lower-margin low-bid highway work.
- Specialty Services: Q3 revenue increased 5.9% to $148.3 million, but operating income decreased to $17.9 million from $21.5 million because of supply-chain, productivity and project-mix pressures.
- Residential: Q3 revenue increased 54.0% to $65.3 million and operating income increased to $6.9 million. Higher slab volumes were partly offset by material inflation, labor shortages and higher subcontractor costs.
Cash Flow, Liquidity and Debt
- Cash and cash equivalents were $117.7 million at September 30, 2021, compared with $66.2 million at December 31, 2020. This includes cash held by consolidated subsidiaries and construction joint ventures.
- Nine-month operating cash flow was $135.7 million, compared with $92.3 million in 2020. The improvement included a $27.9 million favorable change in contract capital, largely reflecting higher accounts payable and contract-related balances.
- Capital expenditures were $39.3 million, compared with $22.1 million in the prior-year period. Investing cash outflow was $37.2 million.
- Financing cash outflow was $46.7 million, including $44.2 million of debt repayments and $2.0 million of distributions to noncontrolling interest owners.
- Total debt was $326.3 million at September 30, 2021, versus $375.4 million at year-end 2020. The $310.9 million term loan had no revolver borrowings outstanding.
- The credit facility provides up to $475 million, including a $75 million revolving facility, and matures October 2, 2024. The company was in compliance with its financial and restrictive covenants.
- An interest-rate swap hedges $275 million of term-loan exposure. Its fair-value liability was approximately $4.0 million, and the filing reports a net AOCI loss of $3.8 million.
Material Changes and Unusual Items
- The June 2021 credit agreement amendment reduced applicable interest margins, reduced required excess-cash-flow prepayments and lowered scheduled term-loan payments.
- Interest expense declined to $3.9 million in Q3 and $15.7 million for nine months, primarily due to debt reduction and lower contractual interest margins.
- PPP loan forgiveness generated a $968,000 gain on debt extinguishment in Q3 and a $2.0 million gain year to date. One remaining PPP loan was awaiting an SBA forgiveness determination.
- Backlog increased to $1.41 billion from $1.18 billion at December 31, 2020. Approximately 64% was expected to convert to revenue during the following twelve months. Combined backlog, including unsigned low-bid awards, was $1.53 billion.
- Management included $13.9 million in project price for unapproved change orders and claims, compared with $7.1 million at year-end 2020. Resolution remains subject to customer negotiations and potentially legal action.
Outlook, Commentary and Risks
Management expects general and administrative expense to remain approximately 4.8% of full-year 2021 revenue and expects a 2021 effective tax rate of 27.5% to 28%. The filing does not provide a specific revenue or earnings guidance range.
Management cited favorable infrastructure funding prospects, continued demand in site development and strong residential demand in Texas and Arizona. The Infrastructure Investment and Jobs Act and other potential federal funding measures could support Heavy Civil activity, but the timing and effect of such programs were uncertain as of the filing.
- COVID-19, potential workplace vaccination or testing requirements and labor availability could increase costs or disrupt operations.
- Inflation and shortages affecting fuel, steel, concrete, lumber, equipment and subcontractor labor may pressure margins and may not be fully recoverable from customers.
- Construction results depend on estimates of contract costs, productivity, change orders, claims, weather, project delays and customer or subcontractor performance.
- Unconsolidated joint ventures expose Sterling to joint and several liability. Approximately $354.1 million of work remained on such contracts, including $152.6 million representing Sterling’s proportionate share.
- Government funding, approvals or shutdowns could materially affect Heavy Civil revenue. The company also depends on bonding capacity, letters of credit and access to capital.
- Management stated that ordinary-course legal proceedings were not expected to have a material adverse effect on the company’s financial statements.
Key Facts Investors Should Verify
- Whether margin pressure from inflation, supply-chain constraints and labor shortages persists or improves.
- The collectability and ultimate resolution of the $13.9 million of unapproved change orders and claims included in project pricing.
- Backlog conversion, project profitability and the sustainability of the shift toward higher-margin design-build work.
- Debt repayment requirements, 2024 credit-facility maturity, interest-rate exposure and remaining PPP loan forgiveness.
- Cash availability by entity, including restrictions on cash held by joint ventures and consolidated subsidiaries.
- Potential joint-and-several obligations, bonding and letter-of-credit requirements, and any future material legal or project contingencies.