Sterling Construction Company, Inc. — Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2019. The filing identifies the registrant as Sterling Construction Company, Inc. (NASDAQ: STRL), not “Sterling Infrastructure, Inc.” The filing was signed March 3, 2020.
Business Context
Sterling provides heavy civil construction, specialty services and residential concrete services across the United States, primarily in the southern U.S., Rocky Mountain states, California and Hawaii. Heavy Civil serves transportation, aviation, water and other infrastructure markets; Specialty Services provides site development, excavation, drilling, concrete and related services; Residential provides single-family foundation construction.
On October 2, 2019, Sterling acquired Plateau for total consideration of approximately $427.7 million, including $375.0 million of cash, 1.245 million shares, a $10.0 million seller note and other consideration. Plateau contributed $84.6 million of revenue and $10.9 million of operating income from acquisition through year-end. The acquisition resulted in the creation of the Specialty Services segment and materially increased debt, assets and goodwill.
Key Financial Metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Revenue | $1,126.3 million | $1,037.7 million | 8.5% increase |
| Gross profit | $107.8 million | $110.3 million | 2.3% decrease |
| Gross margin | 9.6% | 10.6% | Down 100 bps |
| Operating income | $37.8 million | $42.6 million | 11.4% decrease |
| Operating margin | 3.4% | 4.1% | Down 70 bps |
| Income before taxes | $14.5 million | $31.3 million | 53.7% decrease |
| Net income attributable to Sterling stockholders | $39.9 million | $25.2 million | 58.4% increase |
| Diluted EPS | $1.47 | $0.93 | 58.1% increase |
| Cash flow from operations | $41.1 million | $39.5 million | 4.1% increase |
The unusually large net income increase was primarily driven by a $29.4 million tax benefit from releasing the valuation allowance on deferred tax assets. This benefit more than offset lower operating income, higher interest expense and a $7.7 million loss on extinguishment of debt.
Segment Performance and Backlog
| Segment | 2019 Revenue | 2019 Operating Income | 2018 Revenue | 2018 Operating Income |
|---|---|---|---|---|
| Heavy Civil | $760.3 million | $3.3 million | $765.6 million | $17.0 million |
| Specialty Services | $212.8 million | $18.2 million | $120.3 million | $4.6 million |
| Residential | $153.1 million | $20.5 million | $151.7 million | $20.9 million |
Year-end backlog was $1.068 billion, up from $850.7 million in 2018. Approximately 70% of backlog was expected to be recognized as revenue during 2020. Unsigned low-bid awards totaled approximately $273.5 million. Backlog gross margin increased to 11.5% from 8.5%, primarily due to Plateau backlog, improved market conditions and greater bid discipline.
Cash Flow, Debt and Liquidity
- Cash and cash equivalents declined to $45.7 million from $94.1 million, largely because of the Plateau acquisition.
- Net cash used in investing activities was $410.4 million, including $396.3 million for Plateau and $15.4 million of capital expenditures.
- Net cash provided by financing activities was $320.9 million, including $430.0 million drawn under the new credit facility.
- Total debt was $443.0 million at year-end, compared with $88.8 million in 2018; long-term debt was $390.6 million.
- The new senior secured Credit Facility provides up to $475 million, consisting of a $400 million term loan and a $75 million revolving facility. Outstanding borrowings were $420 million, including $20 million revolver borrowings, leaving $55 million of revolver capacity.
- The Credit Facility matures October 2, 2024. Scheduled term-loan principal payments total $30 million in 2020, $50 million in each of 2021–2023 and $220 million in 2024.
- Sterling entered into a three-year interest-rate swap covering $350 million of the term loan. Management reported compliance with all financial and restrictive covenants at December 31, 2019.
- Working capital declined to $64.0 million from $123.4 million. Management stated that available liquidity and forecast cash resources were sufficient for the next year of operations, while noting that substantial cash constraints could materially affect liquidity.
Material Changes and Unusual Items
- The Plateau acquisition added substantial revenue, assets, goodwill and intangible assets, but also increased leverage and integration requirements. Goodwill rose to $191.9 million and other intangible assets to $256.3 million.
- A Texas bridge project affected by owner design flaws produced a $10.2 million fourth-quarter gross-profit reduction after Sterling agreed to accelerate completion by working on three bridges simultaneously. Sterling also recognized approximately $17 million of cost recovery under an interim agreement.
- Heavy Civil operating income fell sharply because of the bridge charge, adverse weather and the completion of two large design-build joint-venture projects in 2018.
- Interest expense increased to $16.7 million from $12.4 million due to acquisition-related borrowings. Debt extinguishment costs were $7.7 million from refinancing the Oaktree Facility.
- The Company adopted lease accounting under ASC 842 in 2019, recognizing operating lease right-of-use assets of $14.0 million and lease liabilities of approximately $14.1 million.
- The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management and the auditor excluded Plateau from the 2019 internal-control assessment; Plateau represented 51% of consolidated assets and 8% of consolidated revenue.
Outlook, Risks and Contingencies
Management cited continued infrastructure funding, private-sector development activity and housing-market expansion as growth drivers. It expected Heavy Civil joint-venture revenue and Residential margins to improve in 2020, and projected 2020 capital expenditures of approximately $22 million to $27 million due to the full-year impact of Plateau. No formal earnings guidance was provided.
- Contract profitability depends on estimates of costs, productivity, schedule, materials, subcontractor performance, claims and change orders. Revisions under over-time revenue recognition could materially reduce previously reported profit.
- Approximately 70% of backlog was fixed-unit-price or lump-sum work, exposing Sterling to cost overruns, labor and material inflation, fuel prices and design or site-condition risks.
- Customers may terminate most contracts for convenience after paying for work performed. Backlog may not be fully realized or profitable.
- Government infrastructure funding, procurement rules, shutdowns and competitive bidding materially affect Heavy Civil results. Utah DOT accounted for 12% of 2019 consolidated revenue.
- Residential revenue is concentrated among major homebuilders; four customers represented approximately 75% of Residential revenue in 2019.
- The Company faces substantial leverage, mandatory debt amortization, interest-rate and LIBOR-transition exposure, covenant requirements and refinancing risk.
- Joint-venture arrangements generally impose joint and several liability. Sterling reported approximately $392.0 million of remaining work on unconsolidated joint-venture contracts, including a $161.4 million proportionate share.
- Other risks include weather, labor availability and union activity, bonding capacity, environmental and safety compliance, customer and supplier performance, acquisition integration, goodwill impairment and collection of receivables, claims and retainage.
- No pending or threatened legal matter was identified by management as reasonably expected to have a material adverse effect on results, financial position or cash flows.
Investor Verification Points
- Verify the registrant’s legal name and filing identity, given the request metadata’s reference to “Sterling Infrastructure, Inc.”
- Assess operating performance excluding the $29.4 million deferred-tax valuation-allowance release and considering the $10.2 million bridge-project charge.
- Review Plateau’s full-year pro forma results, integration progress, purchase-price allocation and the sustainability of the acquired margins.
- Reconcile debt maturities, required amortization, covenant headroom and available revolver capacity against expected operating cash flow.
- Evaluate whether the $1.068 billion backlog, 11.5% backlog margin and $273.5 million of unsigned low bids convert to revenue and cash flow as expected.
- Monitor Heavy Civil project execution, claims and change orders, particularly the Texas bridge project and other contracts recognized using cost-to-cost estimates.
- Review customer concentration, joint-venture obligations, retainage collections and the risks associated with the Company’s increased leverage.