Sterling Construction Company, Inc. — Q1 2020 Form 10-Q Summary
Reporting period: Three months ended March 31, 2020; filed May 5, 2020. The filing identifies the registrant as Sterling Construction Company, Inc. (NASDAQ: STRL), although the request metadata refers to Sterling Infrastructure, Inc.
Business Context
Sterling operates in heavy civil, specialty services and residential construction across the southern U.S., Rocky Mountain states, California, Hawaii and other strategic markets. Heavy civil work includes highways, bridges, aviation, ports, rail and water infrastructure. Specialty services include excavation, drilling, grading, drainage and commercial concrete. Residential operations primarily provide concrete foundations for homebuilders.
The October 2019 Plateau acquisition expanded the Specialty Services segment and materially increased revenue, debt, intangible assets and goodwill. The company continued operating during the COVID-19 pandemic as an “Essential Critical Infrastructure” provider and reported no significant project-site shutdowns or operational interruptions through March 31, 2020.
Financial Performance and Position
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Revenue | $296.7 million | $223.9 million | 32.5% increase |
| Gross profit | $35.2 million | $19.5 million | 80.7% increase |
| Gross margin | 11.9% | 8.7% | Up 320 basis points |
| Operating income | $12.1 million | $4.7 million | 156.4% increase |
| Net income attributable to Sterling stockholders | $3.1 million | $1.8 million | 71.6% increase |
| Diluted EPS | $0.11 | $0.07 | Increase |
| Interest expense | $7.8 million | $3.1 million | Increase from acquisition-related borrowings |
| Income tax expense | $1.2 million | $0.2 million | Increase |
Segment results: Heavy Civil revenue was $155.6 million, with a $3.6 million operating loss. Specialty Services revenue was $104.7 million and operating income was $11.1 million, primarily reflecting a full quarter of Plateau operations. Residential revenue was $36.4 million and operating income was $5.1 million.
Cash flow: Operating activities provided $10.8 million, compared with $19.2 million used in Q1 2019. Investing activities used $6.8 million, including $7.4 million of capital expenditures. Financing activities provided $24.2 million, primarily from a $30.0 million revolving-credit draw, partly offset by $5.1 million of debt repayments. Ending cash was $73.9 million, compared with $45.7 million at December 31, 2019.
Liquidity and debt: Total debt was $468.2 million at March 31, 2020, including $395.0 million under the term loan and $50.0 million under the revolving facility. The revolving facility had $25.0 million of remaining capacity. The company was in compliance with all financial and restrictive covenants. Working capital, excluding cash, declined to $10.9 million from $18.3 million at year-end 2019.
Other financial items: The interest-rate swap hedging $350.0 million of term debt had a $9.5 million fair-value loss, producing a $7.1 million after-tax reduction in other comprehensive income. Total assets were $976.4 million and stockholders’ equity was $218.9 million at March 31, 2020.
Material Changes Versus the Prior Period
- Revenue increased primarily because Q1 2020 included a full quarter of Plateau results, adding approximately $74.0 million of Specialty Services revenue.
- Gross margin improved to 11.9% from 8.7%, while operating margin increased to approximately 4.1% from 2.1%.
- General and administrative expense rose to $17.6 million from $11.9 million, including higher stock-based compensation and Plateau-related costs.
- Intangible amortization increased to $2.8 million from $0.6 million, and acquisition-related costs were $0.5 million in Q1 2020.
- Interest expense increased substantially because of debt incurred for the Plateau acquisition.
- Heavy Civil remained loss-making, primarily because of seasonal fixed-cost under-absorption and unfavorable productivity effects associated with COVID-19 procedures.
- Residential revenue declined 15.0%, reflecting heavy March rainfall, smaller average home sizes and an 11% decline in completed slabs.
- Backlog increased to $1.19 billion from $1.07 billion at December 31, 2019. Combined backlog, including unsigned low bids, increased to $1.43 billion from $1.34 billion.
Guidance, Outlook, Risks and Unusual Items
The company withdrew its full-year 2020 guidance because of COVID-19 uncertainty. Management expected a second-quarter slowdown in housing demand and noted potential adverse effects on multifamily development. Heavy Civil productivity was affected by customer and back-office disruptions and newly implemented field procedures.
Approximately 65% of backlog was expected to be recognized as revenue within the following twelve months. Backlog margin increased to 12.7% from 11.5% at December 31, 2019, driven largely by a greater mix of Specialty Services awards.
- COVID-19 may disrupt project operations, customer demand, subcontractor performance, labor availability, supply chains and economic conditions.
- Construction results depend on estimates of costs to complete, labor productivity, materials, subcontractors, weather, change orders, claims and project delays.
- The company included $7.1 million of unapproved change orders and claims in project prices at March 31, 2020, compared with $3.0 million at year-end 2019. Unresolved claims could result in revenue reductions or reversals.
- Unconsolidated joint ventures had approximately $431.2 million of remaining construction work, with Sterling’s proportionate share of approximately $208.4 million. Joint venture agreements generally impose joint and several liability.
- The company had $49.2 million of liabilities related to mandatory redemption obligations and undistributed earnings of two 50%-owned subsidiaries.
- The company had $83.3 million of federal and $44.9 million of state net operating loss carryforwards at December 31, 2019.
- Management reported no material pending legal matters, no indicators of material long-lived-asset or goodwill impairment, and effective disclosure controls; however, acquired Plateau operations were excluded from the control evaluation under SEC guidance.
Investor Verification Points
- Assess COVID-19’s effect on project execution, backlog conversion, residential demand, labor, subcontractors and margins after March 31, 2020.
- Verify the company’s ability to meet debt amortization and leverage covenants, particularly given $468.2 million of total debt and limited revolver availability.
- Monitor Heavy Civil turnaround prospects and whether Specialty Services performance remains elevated after Plateau integration.
- Review the collectibility and ultimate resolution of the $7.1 million of unapproved claims and change orders.
- Evaluate the sensitivity of earnings and cash flow to construction-cost estimates, weather, contract modifications and joint venture obligations.
- Confirm the final purchase-price allocation for Plateau and any resulting changes to goodwill, intangible assets or amortization.