Sterling Construction Company, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Unaudited quarterly report for the three and nine months ended September 30, 2020. Sterling operates in three U.S. segments: Heavy Civil, Specialty Services and Residential. The filing reflects the October 2, 2019 acquisition of Plateau, which significantly expanded Specialty Services and increased debt, amortization and related costs.
Financial Performance and Position
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $383.5 million | $291.7 million | $1,080.2 million | $779.7 million |
| Gross profit | $49.9 million | $29.2 million | $144.8 million | $74.2 million |
| Gross margin | 13.0% | 10.0% | 13.4% | 9.5% |
| Operating income | $28.8 million | $12.1 million | $74.0 million | $28.0 million |
| Net income attributable to Sterling | $15.2 million | $8.0 million | $36.5 million | $17.6 million |
| Diluted EPS | $0.54 | $0.30 | $1.30 | $0.66 |
- Q3 revenue increased 31%; nine-month revenue increased 39%. Specialty Services contributed $140.0 million in Q3 and $380.4 million for nine months, primarily from Plateau.
- Q3 operating margin was approximately 7.5%, versus 4.2% in the prior-year quarter; nine-month operating margin was approximately 6.8%, versus 3.6%.
- Heavy Civil revenue declined 8.1% in Q3 to $201.1 million, and segment operating income declined to $2.4 million from $7.4 million. Residential revenue increased 6.2% to $42.4 million, while its operating margin declined to 12.6% from 13.1%.
- Net cash provided by operating activities was $90.9 million for the nine months, compared with $8.5 million in 2019. Capital expenditures were $22.1 million, and net cash used in financing was $43.6 million.
- Cash and cash equivalents were $72.6 million at September 30, 2020, including approximately $6.1 million of restricted cash. Generally available cash was $35.1 million; additional cash was held by consolidated subsidiaries and construction joint ventures.
- Total debt was $400.4 million, including $380.0 million outstanding under the term loan, $10.0 million owed to a Plateau seller and approximately $9.8 million of PPP loans. The revolving facility had no borrowings and $75.0 million of available capacity.
- The company was in compliance with its debt covenants. The credit facility matures October 2, 2024, and the term loan requires scheduled principal payments, including $30.0 million in 2020 and $50.0 million annually in 2021 through 2023.
Material Changes Versus the Prior Comparable Period
- The Plateau acquisition added substantial Specialty Services revenue and profit but also increased interest expense to $7.2 million in Q3 and $22.5 million for nine months, versus $3.0 million and $9.0 million, respectively.
- Intangible amortization increased to $2.9 million in Q3 and $8.6 million for nine months, compared with $0.6 million and $1.8 million in the prior-year periods.
- Backlog increased to $1.24 billion at September 30, 2020 from $1.07 billion at December 31, 2019. Including unsigned low-bid awards, combined backlog was $1.51 billion versus $1.34 billion. Approximately 66% of backlog was expected to convert to revenue within twelve months.
- Heavy Civil profitability was adversely affected by higher estimated costs to complete three Texas bridge projects, lower aviation volume, a shift toward lower-margin heavy highway work and COVID-19-related costs. Management expects the mix to improve in 2021 as larger backlog projects ramp up.
- Operating cash flow improved substantially, while debt repayments totaled $52.7 million, including $20.0 million of term-loan repayments, $20.0 million of revolving-facility repayments and $12.5 million related to Tealstone acquisition obligations.
Outlook, Risks, Contingencies and Unusual Items
- The filing provides no formal quantitative earnings or revenue guidance. Management cited infrastructure funding, specialty-services development activity and continued residential expansion as potential drivers, while noting uncertainty from COVID-19.
- COVID-19 had not caused significant project shutdowns or operational interruptions through the filing date, but the company continued to face risks from renewed outbreaks, government restrictions, labor and subcontractor availability, supply-chain disruption and weaker customer demand.
- Unapproved change orders and claims included in contract prices totaled approximately $7.9 million at September 30, 2020, compared with $3.0 million at December 31, 2019. Negotiations remained ongoing, and legal action could be pursued if acceptable resolutions were not reached.
- Changes in contract estimates increased operating income by approximately $2.7 million in Q3 and $5.0 million for nine months. Construction-contract profitability remains sensitive to cost-to-complete estimates, productivity, materials, subcontractors, delays and claims.
- The interest-rate swap hedged $350.0 million of term-loan exposure and had a net fair-value liability of $8.4 million. The company reported a $6.1 million after-tax reduction in other comprehensive income for the nine months.
- Two 50%-owned subsidiaries have mandatory redemption obligations totaling $40.0 million, plus $10.8 million of accumulated earnings. The company maintains insurance intended to mitigate the related cash requirement.
- Construction joint ventures involve joint and several liability. Approximately $573.7 million of work remained on unconsolidated joint-venture contracts, including $255.9 million representing Sterling’s proportionate share. Management was not aware of any partner default requiring Sterling to assume additional obligations.
- The company reported no pending legal matters expected to have a material adverse effect and no indicators of material impairment of goodwill or long-lived assets.
Important Facts for Investors to Verify
- Assess whether the strong growth and margin expansion are sustainable after separating Plateau acquisition effects from underlying organic performance.
- Monitor Heavy Civil project execution, especially the Texas bridge cost increases and the expected 2021 margin recovery.
- Verify debt repayment requirements, leverage covenant compliance and the company’s ability to reduce approximately $400 million of debt while funding capital expenditures and growth.
- Track COVID-19 effects on project schedules, labor, subcontractors, residential demand and infrastructure funding.
- Review the collectability and ultimate resolution of the $7.9 million of unapproved change orders and claims.
- Evaluate the conversion, margin and timing of the $1.24 billion backlog and the $270 million of unsigned low-bid awards.
- Confirm the treatment and potential forgiveness of the approximately $9.8 million of PPP loans by the SBA.