Sterling Construction Company, Inc. — Form 10-Q Summary
Business context and reporting period
Unaudited quarterly results for the three months ended March 31, 2019, compared with the three months ended March 31, 2018. The filing identifies the registrant as Sterling Construction Company, Inc. (NASDAQ: STRL), a heavy civil infrastructure and residential construction company operating primarily in the southwestern United States and Texas.
Reportable segments are heavy civil construction, including highways, bridges, aviation, commercial, water and wastewater projects, and residential construction, principally concrete foundations for homebuilders.
Financial performance and liquidity
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $223.9 million | $222.5 million | 0.7% increase |
| Gross profit | $19.5 million | $19.8 million | 1.7% decrease |
| Gross margin | 8.7% | 8.9% | Down 20 basis points |
| Operating income | $4.7 million | $6.7 million | 29.3% decrease |
| Operating margin | 2.1% | 3.0% | Down 90 basis points |
| Net income attributable to Sterling stockholders | $1.8 million | $2.5 million | 27.1% decrease |
| Diluted earnings per share | $0.07 | $0.09 | Decrease |
| Net cash used in operating activities | $(19.2) million | $(22.5) million | Improved by $3.3 million |
Heavy civil revenue was $181.2 million, down 3.2%, and produced an operating loss of $0.8 million versus operating income of $1.9 million in the prior-year quarter. Residential revenue rose 21.3% to $42.8 million, while residential operating income increased to $5.6 million from $4.7 million.
At March 31, 2019, cash and cash equivalents were $56.8 million, including approximately $40.3 million generally available, $13.3 million held by consolidated 50%-owned subsidiaries and $3.1 million held by construction joint ventures. Working capital was $106.9 million, down from $123.4 million at December 31, 2018.
Total debt was $83.5 million, including $71.6 million outstanding under the secured Oaktree Facility. Total operating lease liabilities were $15.5 million following adoption of the new lease standard. The Company was in compliance with its debt covenants at March 31, 2019.
Cash used in investing activities was $3.7 million, primarily for $3.8 million of capital equipment purchases. Cash used in financing activities was $14.4 million, including $5.6 million of debt repayments, $5.1 million of distributions to noncontrolling interest owners and $3.2 million of treasury stock purchases.
Material changes versus the prior comparable period
- Revenue was broadly flat, as residential growth of $7.5 million largely offset a $6.1 million decline in heavy civil revenue.
- Heavy civil profitability deteriorated because of lower heavy highway volume and adverse weather. Two large joint venture projects substantially completed in 2018 reduced related heavy civil revenue by approximately $29.7 million year over year.
- Residential revenue benefited from weather-delayed slab starts and growth in the Dallas-Fort Worth and Houston markets; completed slabs increased approximately 25%.
- Other operating expense increased to $2.3 million from $0.8 million, primarily because earn-out expense increased by approximately $0.8 million and members’ interest earnings increased by approximately $0.7 million.
- Cash declined by $37.3 million during the quarter, compared with a $28.5 million decline in the prior-year quarter, mainly because of seasonal operating cash usage, debt repayment, distributions and share repurchases.
- The Company repurchased approximately 250,000 shares for $3.2 million under its repurchase program and had approximately 1.3 million shares remaining authorized for repurchase at March 31, 2019.
- The Company adopted ASC 842 lease accounting effective January 1, 2019, recording approximately $13.6 million of operating lease right-of-use assets and $13.6 million of related lease liabilities at adoption. The adoption did not materially affect operations.
Guidance, outlook, commentary and risks
Backlog was $808.7 million at March 31, 2019, down from $850.7 million at December 31, 2018. Approximately 78% of backlog was expected to be recognized as revenue over the following twelve months. Unsigned low-bid awards increased to $401.5 million from $292.7 million, resulting in combined backlog of approximately $1.2 billion. Backlog margin declined to 8.3% from 8.5%, primarily because of weather and project mix.
Management cited increased state and local infrastructure funding, the federal FAST Act and aviation infrastructure funding as favorable market factors. The Company is applying a more formal bid evaluation process intended to focus on projects with acceptable margins and reduce execution risk. Management also expects operating cash flow to improve with seasonality and believes available liquidity is sufficient to fund the next twelve months of operations, including bonding requirements.
The filing does not provide specific full-year revenue or earnings guidance. Management indicated that continued positive earnings trends and its 2019 forecast could support removal of the deferred tax valuation allowance in the fourth quarter of 2019.
Key risks include project delays, adverse weather, cost overruns, inaccurate estimates, unapproved change orders and claims, liquidated damages, labor and subcontractor availability, material and fuel cost inflation, government funding changes, competition, customer concentration and joint venture performance. Approximately $9.3 million of unapproved change orders and claims, primarily related to extended delays on a Texas bridge project, was included in contract assets; unfavorable resolution could reduce or reverse previously recognized revenue.
Unconsolidated joint venture contracts had approximately $82.7 million of remaining work, including $40.1 million representing Sterling’s proportionate share. These arrangements generally involve joint and several liability, although management was not aware of any partner default requiring Sterling to assume another partner’s obligations. The Company also reported ordinary-course claims and lawsuits that management does not expect to have a material impact.
Important facts for investors to verify
- Whether heavy civil margins recover from the Q1 weather and volume impacts and whether backlog margin remains above debt-covenant requirements.
- The collectability and ultimate resolution of the approximately $9.3 million of unapproved Texas bridge change orders and claims.
- Seasonal working-capital requirements, generally available cash of approximately $40.3 million and the impact of restricted or joint-venture cash balances.
- Compliance with the Oaktree Facility’s leverage, cash collateral, backlog margin, capital expenditure, bonding and Tealstone EBITDA covenants.
- The effect of the high-cost Oaktree Facility, which carried an interest rate of approximately 11.2%; a 1-percentage-point rate increase would increase annual interest expense by approximately $0.7 million.
- The sustainability of residential growth and the effect of completed joint venture projects on future heavy civil revenue.
- Whether the deferred tax valuation allowance is removed as contemplated in the fourth quarter of 2019.