Sterling Construction Company, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2018. The filing identifies the registrant as Sterling Construction Company, Inc., a heavy civil infrastructure and residential construction company operating primarily in the western and southern United States. Results are unaudited and may be affected by seasonality.
Financial performance
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Revenue | $291.3 million | $304.2 million | $782.5 million | $704.0 million |
| Gross profit | $31.5 million | $30.6 million | $83.5 million | $65.1 million |
| Gross margin | 10.8% | 10.1% | 10.7% | 9.2% |
| Operating income | $14.4 million | $12.6 million | $33.2 million | $19.2 million |
| Operating margin | 4.9% | 4.2% | 4.2% | 2.7% |
| Net income attributable to Sterling | $8.9 million | $7.1 million | $19.6 million | $8.5 million |
| Diluted EPS | $0.33 | $0.26 | $0.72 | $0.33 |
Q3 revenue declined 4.3%, while gross profit increased 2.9% and operating income increased 13.7%. For the first nine months, revenue increased 11.1%, gross profit increased 28.3%, and operating income increased 72.9%. The nine-month comparison benefited from a full nine months of Tealstone acquisition contributions versus six months in 2017.
- Heavy civil revenue was $254.5 million in Q3 and $665.1 million for nine months; heavy civil operating income was $9.2 million and $17.5 million, respectively.
- Residential construction revenue was $36.7 million in Q3 and $117.4 million for nine months; residential operating income was $5.2 million and $15.7 million, respectively.
- Q3 residential revenue and operating income declined because heavy rainfall in Texas, including a record-wet September, reduced foundations poured by 19%.
- Net contract-estimate revisions produced gains of $2.4 million in Q3 and $4.1 million for the nine-month period.
Cash flow, liquidity and capital structure
| Metric | September 30, 2018 | December 31, 2017 |
|---|---|---|
| Cash and cash equivalents | $89.3 million | $84.0 million |
| Working capital | $118.7 million | $96.2 million |
| Total debt | $88.7 million | $99.0 million |
| Long-term debt, net of current maturities and loan costs | $78.4 million | $86.2 million |
| Total assets | $494.2 million | $463.3 million |
- Net cash provided by operating activities was $23.8 million for the first nine months, compared with $5.8 million in the prior-year period.
- Capital expenditures were $9.5 million. Investing cash usage was $8.0 million, compared with $57.3 million in 2017, when the Tealstone acquisition required approximately $55.0 million of cash.
- Financing activities used $10.4 million, including $10.4 million of Oaktree Facility repayments.
- Of total cash, $51.2 million was generally available, while $25.3 million was held by consolidated 50%-owned subsidiaries and $12.9 million by construction joint ventures. These amounts may be restricted from general corporate use.
- The Oaktree term loan had $74.6 million outstanding at September 30, 2018, matures April 4, 2022, and bears interest at LIBOR plus 8.75%; the reported rate was 10.88%. A 1% rate increase would increase annual interest expense by approximately $0.7 million.
- Management stated that available liquidity, operating cash flow and borrowing capacity were sufficient for the next twelve months, including bonding requirements. The company reported compliance with all Oaktree financial covenants.
Material changes and outlook
- Backlog increased to $833 million from $744 million at December 31, 2017. Approximately 70% was expected to be recognized as revenue over the following twelve months.
- Unsigned low-bid awards were $342 million, producing combined backlog of $1.175 billion. Combined backlog margin was 9.0%, compared with 8.3% at year-end 2017; reported backlog margin was 8.7%, compared with 8.4%.
- Management cited improving infrastructure funding in key markets, including Texas, Utah, California and aviation infrastructure, as a favorable market factor. The company also expanded its residential business into the Houston market.
- The company adopted ASC 606 revenue guidance on January 1, 2018, using the modified retrospective method. Management reported no material impact on the financial statements.
- The company expects to adopt new lease accounting guidance on January 1, 2019 using an optional transition method. It expects a material increase in reported assets and liabilities, but no material impact on income or cash flow.
Risks, contingencies and unusual items
- Unapproved change orders and claims included in contract assets totaled $9.3 million at September 30, 2018. Management expects resolution without a material adverse effect, but unfavorable outcomes could reduce or reverse previously recognized revenue.
- Construction results depend on estimates of total contract revenue and costs. Changes in productivity, labor, materials, subcontractor performance, project conditions, claims, incentives and liquidated damages can materially affect earnings.
- Construction joint ventures generally involve joint and several liability. Unconsolidated joint ventures had approximately $75.6 million of remaining work, including $37.8 million representing Sterling's proportionate share. Management was not aware of circumstances requiring it to fund a partner's obligations.
- The company has mandatory redemption obligations of $40.0 million related to interests in two 50%-owned subsidiaries, plus $8.8 million of accumulated earnings, for a total liability of $48.8 million.
- Normal-course legal claims and lawsuits were not expected by management to have a material adverse effect. No material changes to previously disclosed risk factors were reported.
- Key risks include government infrastructure funding, project delays, adverse weather, cost inflation, subcontractor and joint-venture performance, competition, customer concentration, bonding capacity, environmental compliance and interest-rate increases.
Investor verification checklist
- Verify the sustainability of the improved gross and operating margins, particularly the contribution from commercial and aviation projects.
- Reconcile backlog conversion, margin assumptions and the $342 million of unsigned low-bid awards.
- Monitor collections, contract assets, claims and change orders, including the $9.3 million of unapproved amounts.
- Assess liquidity available for general corporate purposes after excluding joint-venture and subsidiary-restricted cash.
- Track Oaktree covenant compliance, mandatory redemption obligations and exposure to LIBOR-based interest-rate increases.
- Evaluate weather effects and housing-market activity on residential construction volumes.
- Assess the balance-sheet effect of ASC 842 lease adoption beginning January 1, 2019.