Sterling Construction Company, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2018; filed August 2, 2018. The unaudited interim statements cover Sterling Construction Company, Inc. and subsidiaries. The company operates in heavy civil construction and residential construction, primarily across the western and southern United States.
Business context
- Heavy civil projects include highways, roads, bridges, aviation, ports, rail, water and wastewater infrastructure, and commercial concrete work.
- Residential construction primarily consists of concrete foundations for single-family homes and related work for homebuilders and developers.
- The company reports two segments: Heavy Civil Construction and Residential Construction. The residential segment reflects the full-year contribution of the April 2017 Tealstone acquisition.
- Backlog was $885 million at June 30, 2018, compared with $745 million at December 31, 2017. Approximately 70% of backlog was expected to be recognized as revenue within the next twelve months. Unsigned low-bid awards were $156 million, producing combined backlog of approximately $1.04 billion.
Key financial metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|
| Revenue | $268.7 million | $491.2 million |
| Gross profit | $31.5 million | $52.0 million |
| Gross margin | 11.7% | 10.6% |
| Operating income | $12.2 million | $18.8 million |
| Operating margin | 4.5% | 3.8% |
| Net income attributable to Sterling stockholders | $8.2 million | $10.7 million |
| Diluted earnings per share | $0.30 | $0.39 |
- Six-month interest expense was $6.2 million, compared with $3.1 million in the prior-year period, largely because the Oaktree Facility was outstanding for six months in 2018 versus three months in 2017.
- Cash and cash equivalents were $66.6 million at June 30, 2018, down from $84.0 million at December 31, 2017. Working capital increased to $114.1 million from $96.2 million.
- Cash used in operating activities was $9.5 million for the first six months, compared with $12.3 million used in the prior-year period. Contract capital reduced liquidity by $32.3 million, primarily because of increases in receivables and changes in contract billings.
- Cash used in investing activities was $4.0 million, including $5.3 million of capital expenditures. Cash used in financing activities was $3.9 million, including $4.7 million of Oaktree Facility repayments.
- Total debt was $94.4 million, including $80.3 million outstanding under the Oaktree Facility and $13.0 million of Tealstone-related notes and deferred seller payments.
Material changes versus the prior comparable period
| Measure | Q2 2018 versus Q2 2017 | Six months 2018 versus six months 2017 |
|---|
| Revenue | Increased 9.1% to $268.7 million | Increased 22.9% to $491.2 million |
| Gross margin | Increased to 11.7% from 10.2% | Increased to 10.6% from 8.6% |
| Operating income | Increased to $12.2 million from $8.4 million | Increased to $18.8 million from $6.6 million |
| Net income attributable to Sterling | Increased to $8.2 million from $3.7 million | Increased to $10.7 million from $1.4 million |
- Second-quarter heavy civil revenue increased 6.7% to $223.3 million, driven by commercial and aviation work, while lower Texas volume and substantial completion of certain projects partially offset growth.
- Residential revenue increased 22.1% to $45.5 million in the quarter, reflecting Dallas-Fort Worth growth and expansion into adjacent markets, including Houston.
- Heavy civil operating income increased to $6.4 million from $3.1 million in the quarter; residential operating income increased to $5.8 million from $5.2 million.
- Six-month results benefited materially from the Tealstone acquisition, which contributed approximately $53.0 million of incremental revenue and $9.5 million of incremental gross profit compared with the prior-year period.
- Net contract-estimate revisions produced gains of $0.3 million in the quarter and $1.7 million year to date, compared with charges in the corresponding 2017 periods.
Guidance, outlook, risks and unusual items
- Management stated that available cash, operating cash flow and borrowing capacity were sufficient to fund the next twelve months of operations, including bonding requirements. No formal revenue or earnings guidance was provided.
- Management cited infrastructure funding in Texas, Utah and California as supportive of heavy civil demand. California’s incremental transportation funding was subject to a repeal referendum scheduled for fall 2018.
- The Oaktree Facility matures in April 2022, bears interest at LIBOR plus 8.75%, and requires quarterly offers to prepay 75% of excess cash flow. The company reported compliance with all facility covenants at June 30, 2018.
- A 1% increase in the Oaktree interest rate would increase annual interest expense by approximately $0.8 million based on the period-end balance.
- Unapproved change orders and claims of $8.7 million were included in contract assets at June 30, 2018, compared with $10.0 million at December 31, 2017. Management expected resolution without a material adverse effect, but acknowledged that negotiations could produce materially different results.
- Construction contracts involve estimation risk relating to labor, materials, subcontractors, productivity, change orders, claims, penalties and project completion costs. Joint ventures generally involve joint and several liability; approximately $56 million of work remained on unconsolidated joint venture contracts, including $28 million representing Sterling’s share.
- Cash included $17.6 million held by consolidated 50%-owned subsidiaries and $12.3 million held by construction joint ventures, which may not be freely available for general corporate purposes. Approximately $3.6 million was restricted cash.
- The company disclosed ordinary-course claims and lawsuits but stated that none were expected to have a material adverse effect. No material changes to previously disclosed risk factors were reported.
- The company adopted the new revenue recognition standard on January 1, 2018; management reported no material impact on the financial statements. New lease accounting guidance was expected to apply beginning January 1, 2019, with the impact still under assessment.
Important facts for investors to verify
- Reconcile backlog growth with the reported decline in backlog margin to 8.2% and assess expected conversion timing and profitability.
- Monitor collection of the $164.5 million receivables balance and the effect of contract capital on operating cash flow.
- Evaluate exposure to LIBOR-based debt, the 8.75% spread, required excess-cash-flow prepayments and facility covenant thresholds.
- Follow the resolution of $8.7 million of unapproved change orders and claims and assess the risk of revenue reversals or margin reductions.
- Assess the sustainability of residential growth, including Houston expansion, Tealstone earn-out obligations and dependence on homebuilder activity.
- Review joint and several liability exposure, restricted cash, mandatory redemption obligations of $47.8 million and the availability of subsidiary and joint-venture cash.
- Confirm the effect of California transportation-funding developments, government infrastructure budgets, material and labor inflation, weather, subcontractor performance and project execution on future results.
