Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part Ii-Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 6. Exhibits
Exhibits
EX-31.1
a2019093010-qexhibit311.htm
EX-31.2
a2019093010-qexhibit312.htm
EX-32.1
a2019093010-qexhibit321.htm
EX-32.2
a2019093010-qexhibit322.htm
Sterling Construction Earnings 2019-09-30
STRL 10Q Quarterly Report
Balance Sheet
Income Statement
Cash Flow
10-Q 1 a20190930form10-q.htm FORM 10-Q Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___ to ___
Commission File Number 1-31993
STERLING CONSTRUCTION COMPANY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
25-1655321
(State or other jurisdiction of incorporation
or organization)
(I.R.S. Employer
Identification No.)
1800 Hughes Landing Blvd.
The Woodlands, Texas
77380
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (281) 214-0800
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $0.01 par value per share
STRL
The NASDAQ Stock Market LLC
(Title of each class)
(Trading Symbol)
(Name of each exchange on which registered)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. þ Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). þ Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
Accelerated filer
þ
Non-accelerated filer
¨
Smaller reporting company
¨
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes þ No
The number of shares outstanding of the registrant’s common stock as of November 1, 2019 – 27,719,238
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Three Months Ended September 30,
Nine Months Ended September 30,
2019
2018
2019
2018
Revenues
$
291,699
$
291,266
$
779,734
$
782,492
Cost of revenues
(262,483
)
(259,987
)
(705,519
)
(700,333
)
Gross profit
29,216
31,279
74,215
82,159
General and administrative expense
(10,839
)
(11,455
)
(34,102
)
(36,998
)
Acquisition related costs
(1,896
)
—
(2,158
)
—
Other operating expense, net
(4,366
)
(5,451
)
(9,936
)
(11,960
)
Operating income
12,115
14,373
28,019
33,201
Interest income
331
274
986
604
Interest expense
(3,024
)
(3,066
)
(8,988
)
(9,265
)
Income before income taxes
9,422
11,581
20,017
24,540
Income tax expense
(913
)
(1,413
)
(1,782
)
(1,551
)
Net income
8,509
10,168
18,235
22,989
Less: Net income attributable to noncontrolling interests
(552
)
(1,251
)
(635
)
(3,409
)
Net income attributable to Sterling common stockholders
$
7,957
$
8,917
$
17,600
$
19,580
Net income per share attributable to Sterling common stockholders:
Basic
$
0.30
$
0.33
$
0.67
$
0.73
Diluted
$
0.30
$
0.33
$
0.66
$
0.72
Weighted average common shares outstanding:
Basic
26,365
26,908
26,359
26,893
Diluted
26,637
27,295
26,661
27,174
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.
3
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
(Unaudited)
September 30, 2019
December 31, 2018
Assets
Current assets:
Cash and cash equivalents
$
76,530
$
94,095
Accounts receivable, including retainage
160,512
145,026
Costs and estimated earnings in excess of billings
67,602
41,542
Inventory
2,386
3,159
Receivables from and equity in construction joint ventures
14,651
10,720
Other current assets
11,065
8,074
Total current assets
332,746
302,616
Property and equipment, net
48,584
51,999
Operating lease right-of-use assets
14,589
—
Goodwill
85,231
85,231
Other intangibles, net
40,617
42,418
Other non-current assets, net
202
309
Total assets
$
521,969
$
482,573
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable
$
110,624
$
99,426
Billings in excess of costs and estimated earnings
61,533
62,407
Current maturities of long-term debt
12,238
2,899
Current portion of long-term lease obligations
7,492
—
Income taxes payable
214
318
Accrued compensation
14,576
9,448
Other current liabilities
6,982
4,676
Total current liabilities
213,659
179,174
Long-term debt
62,489
79,117
Long-term lease obligations
7,191
—
Members’ interest subject to mandatory redemption and undistributed earnings
51,272
49,343
Deferred taxes
3,011
1,450
Other long-term liabilities
1,088
1,229
Total liabilities
338,710
310,313
Commitments and contingencies
Stockholders’ equity:
Preferred stock, par value $0.01 per share; 1,000 shares authorized, none issued
—
—
Common stock, par value $0.01 per share; 38,000 shares authorized, 27,049 and 27,064 shares issued, 26,476 and 26,597 shares outstanding
271
271
Additional paid in capital
234,309
233,795
Treasury Stock, at cost: 573 and 467 shares
(6,581
)
(4,731
)
Retained deficit
(47,334
)
(64,934
)
Total Sterling stockholders’ equity
180,665
164,401
Noncontrolling interests
2,594
7,859
Total stockholders’ equity
183,259
172,260
Total liabilities and stockholders’ equity
$
521,969
$
482,573
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.
4
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30,
2019
2018
Cash flows from operating activities:
Net income
$
18,235
$
22,989
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
12,288
12,511
Amortization of deferred debt costs
2,375
2,427
Gain on disposal of property and equipment
(466
)
(466
)
Deferred tax expense
1,561
1,299
Stock-based compensation expense
2,489
2,181
Changes in operating assets and liabilities (Note 15)
(28,005
)
(14,695
)
Net cash provided by operating activities
8,477
26,246
Cash flows from investing activities:
Capital expenditures
(7,871
)
(9,533
)
Proceeds from sale of property and equipment
1,265
1,499
Net cash used in investing activities
(6,606
)
(8,034
)
Cash flows from financing activities:
Repayments of long-term debt
(10,435
)
(11,298
)
Distributions to noncontrolling interest owners
(5,900
)
(1,350
)
Purchase of treasury stock
(3,201
)
—
Other
100
(181
)
Net cash used in financing activities
(19,436
)
(12,829
)
Net change in cash and cash equivalents
(17,565
)
5,383
Cash and cash equivalents at beginning of period
94,095
83,953
Cash and cash equivalents at end of period
$
76,530
$
89,336
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.
5
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In thousands)
(Unaudited)
Nine Months Ended September 30, 2019
Common Stock
Additional Paid in Capital
Retained Deficit
Treasury Stock
Total Sterling Stockholders’ Equity
Non-controlling Interests
Total Stockholders’ Equity
Shares
Amount
Shares
Amount
Balance at December 31, 2018
26,597
$
271
$
233,795
$
(64,934
)
467
$
(4,731
)
$
164,401
$
7,859
$
172,260
Net income
—
—
—
1,815
—
—
1,815
46
1,861
Stock-based compensation
(1
)
—
1,021
—
—
—
1,021
—
1,021
Distributions to owners
—
—
—
—
—
—
—
(5,100
)
(5,100
)
Purchase of treasury stock
(250
)
—
—
—
250
(3,201
)
(3,201
)
—
(3,201
)
Issuance of stock
130
—
(1,314
)
—
(130
)
1,314
—
—
—
Shares withheld for taxes
(52
)
—
—
—
45
(564
)
(564
)
—
(564
)
Balance at March 31, 2019
26,424
$
271
$
233,502
$
(63,119
)
632
$
(7,182
)
$
163,472
$
2,805
$
166,277
Net income
—
—
—
7,828
—
—
7,828
37
7,865
Stock-based compensation
—
—
649
—
—
—
649
—
649
Issuance of stock
49
—
(494
)
—
(49
)
494
—
—
—
Shares withheld for taxes
(7
)
(98
)
—
—
—
(98
)
—
(98
)
Balance at June 30, 2019
26,466
$
271
$
233,559
$
(55,291
)
583
$
(6,688
)
$
171,851
$
2,842
$
174,693
Net income
—
—
—
7,957
—
—
7,957
552
8,509
Stock-based compensation
—
—
819
—
—
—
819
—
819
Distributions to owners
—
—
—
—
—
—
—
(800
)
(800
)
Issuance of stock
13
—
(69
)
—
(13
)
139
70
—
70
Shares withheld for taxes
(3
)
—
—
—
3
(32
)
(32
)
—
(32
)
Balance at September 30, 2019
26,476
$
271
$
234,309
$
(47,334
)
573
$
(6,581
)
$
180,665
$
2,594
$
183,259
6
Nine Months Ended September 30, 2018
Common Stock
Additional Paid in Capital
Retained Deficit
Treasury Stock
Total Sterling Stockholders’ Equity
Non-controlling Interests
Total Stockholders’ Equity
Shares
Amount
Shares
Amount
Balance at December 31, 2017
27,051
$
271
$
231,183
$
(90,121
)
—
$
—
$
141,333
$
4,856
$
146,189
Net income
—
—
—
2,489
—
—
2,489
1,191
3,680
Stock-based compensation
(3
)
—
617
—
—
—
617
—
617
Shares withheld for taxes
(13
)
(1
)
(193
)
—
—
—
(194
)
—
(194
)
Balance at March 31, 2018
27,035
$
270
$
231,607
$
(87,632
)
—
$
—
$
144,245
$
6,047
$
150,292
Net income
—
—
—
8,174
—
—
8,174
967
9,141
Stock-based compensation
39
—
766
—
—
—
766
—
766
Shares withheld for taxes
(10
)
1
(108
)
—
—
—
(107
)
—
(107
)
Balance at June 30, 2018
27,064
$
271
$
232,265
$
(79,458
)
—
$
—
$
153,078
$
7,014
$
160,092
Net income
—
—
—
8,917
—
—
8,917
1,251
10,168
Stock-based compensation
4
—
798
—
—
798
—
798
Distributions to owners
—
—
—
—
—
—
(1,350
)
(1,350
)
Shares withheld for taxes
—
—
(7
)
—
—
—
(7
)
—
(7
)
Balance at September 30, 2018
27,068
$
271
$
233,056
$
(70,541
)
—
$
—
$
162,786
$
6,915
$
169,701
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.
7
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2019
($ and share values in thousands, except per share data)
(Unaudited)
1.
NATURE OF OPERATIONS
Nature of Operations—Sterling Construction Company, Inc. (“Sterling” or “the Company”), a Delaware corporation, is a construction company that specializes in heavy civil infrastructure construction and infrastructure rehabilitation as well as residential construction projects. The Company operates primarily in Arizona, California, Colorado, Hawaii, Nevada, Texas and Utah, as well as other states in which there are feasible construction opportunities. Heavy civil construction projects include highways, roads, bridges, airfields, ports, light rail, water, wastewater and storm drainage systems, foundations for multi-family homes, commercial concrete projects and parking structures. Residential construction projects include concrete foundations for single-family homes.
2.
BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation—The Condensed Consolidated Financial Statements included herein have been prepared by the Company, without audit, in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been either condensed or omitted pursuant to SEC rules and regulations. The Condensed Consolidated Financial Statements reflect, in the opinion of management, all normal recurring adjustments necessary to present fairly the Company’s financial position at September 30, 2019 and the results of operations and cash flows for the periods presented. The December 31, 2018 Condensed Consolidated Balance Sheet data herein was derived from audited financial statements, but as discussed above, does not include all disclosures required by GAAP. Interim results may be subject to significant seasonal variations and the results of operations for the quarters presented are not necessarily indicative of the results expected for the full year or subsequent quarters. Values presented within tables, excluding per share data, are in thousands.
Principles of Consolidation—The accompanying Condensed Consolidated Financial Statements reflect all wholly owned subsidiaries and those entities the Company is required to consolidate. See the “Consolidated 50% Owned Subsidiaries” and “Construction Joint Ventures” section of this Note for further discussion of the Company’s consolidation policy for those entities that are not wholly owned. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation have been included. All significant intercompany accounts and transactions have been eliminated in consolidation.
Consolidated 50% Owned Subsidiaries—The accompanying Condensed Consolidated Financial Statements include the accounts of two subsidiaries in which the Company has 50% ownership interest and exercises control over such entities. Therefore, the Company has consolidated these two entities. Both subsidiaries have individual provisions which, under circumstances that are certain to occur, obligate the Company to purchase each partner’s 50% interests. The Company has classified these obligations as mandatorily redeemable and has recorded a liability in “Members’ interest subject to mandatory redemption and undistributed earnings” on the Condensed Consolidated Balance Sheets. Each partner’s portion of net income (loss) is reflected in the Condensed Consolidated Statements of Operations line item “Other operating expense, net”.
Construction Joint Ventures—In the ordinary course of business, the Company executes specific projects and conducts certain operations through joint venture arrangements (referred to as “joint ventures”). The Company has various ownership interests in these joint ventures, with such ownership typically proportionate to the Company’s decision making and distribution rights.
Each joint venture is assessed at inception and on an ongoing basis as to whether it qualifies as a Variable Interest Entity (“VIE”) under the consolidations guidance in ASC Topic 810. If at any time a joint venture qualifies as a VIE, the Company performs a qualitative assessment to determine whether the Company is the primary beneficiary of the VIE and therefore needs to consolidate the VIE.
If the Company determines it is not the primary beneficiary of the VIE or only has the ability to significantly influence, rather than control the joint venture, it is not consolidated. The Company accounts for unconsolidated joint ventures using a pro-rata basis in the Condensed Consolidated Statements of Operations and as a single line item (“Receivables from and equity in construction joint ventures”) in the Condensed Consolidated Balance Sheets. This method is a permissible modification of the equity method of accounting which is a common practice in the construction industry.
8
Use of Estimates—The preparation of the accompanying Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Certain of the Company’s accounting policies require higher degrees of judgment than others in their application. These include the recognition of revenue from construction contracts over time and the valuation of goodwill, other intangibles and income taxes. Management continually evaluates all of its estimates and judgments based on available information and experience; however, actual results could differ from these estimates.
Reclassification—Reclassifications have been made to historical financial data on the Company’s Condensed Consolidated Financial Statements to conform to the Company’s current year presentation.
Heavy Civil Construction Revenue Recognition—The Company engages in various types of heavy civil construction projects principally for public (government) owners. Revenues are recognized as performance obligations are satisfied over time (formerly known as percentage-of-completion method), using the ratio of costs incurred to estimated total costs for each contract. This cost to cost measure is used because management considers it to be the best available measure of progress on these contracts. Contract costs include all direct material, labor, subcontract and other costs and those indirect costs determined to relate to contract performance, such as indirect salaries and wages, equipment repairs and depreciation, insurance and payroll taxes. Administrative and general expenses are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, estimated profitability and associated change orders and claims, including those changes arising from contract penalty provisions and final contract settlements, may result in revisions to costs and income and are recognized in the period in which the revisions are determined.
Change orders, claims and incentives are generally not distinct from the existing contract due to the significant integration service provided in the context of the contract and are accounted for as a modification of the existing contract and performance obligation. Change orders may include changes in specifications or designs, manner of performance, facilities, equipment, materials, sites and period of completion of the work. Either the Company or its customers may initiate change orders. Change orders that are unapproved as to both price and scope are evaluated as claims. The Company estimates variable consideration for a performance obligation at the most likely amount to which the Company expects to be entitled (or the most likely amount the Company expects to incur in the case of liquidated damages), utilizing estimation methods that best predict the amount of consideration to which the Company will be entitled (or will be incurred in the case of liquidated damages). The Company includes variable consideration in the estimated transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur or when the uncertainty associated with the variable consideration is resolved. The Company’s estimates of variable consideration and determination of whether to include estimated amounts in transaction price are based largely on an assessment of its anticipated performance and all information (historical, current and forecasted) that is reasonably available to the Company.
The Company considers claims to be amounts in excess of approved contract prices that the Company seeks to collect from its customers or others for customer-caused delays, errors in specifications and designs, contract terminations, change orders that are either in dispute or are unapproved as to both scope and price, or other causes of unanticipated additional contract costs. The effect of variable consideration on the transaction price of a performance obligation is recognized as an adjustment to revenue on a cumulative catch-up basis. To the extent unapproved change orders and claims reflected in transaction price (or excluded from transaction price in the case of liquidated damages) are not resolved in the Company’s favor, or to the extent incentives reflected in transaction price are not earned, there could be reductions in, or reversals of, previously recognized revenue.
The Company has projects that it is in the process of negotiating, or awaiting final approval of, unapproved change orders and claims with its customers. The Company is proceeding with its contractual rights to recoup additional costs incurred from its customers based on completing work associated with change orders, including change orders with pending change order pricing, or claims related to significant changes in scope which resulted in substantial delays and additional costs in completing the work. Unapproved change order and claim information has been provided to the Company’s customers and negotiations with the customers are ongoing. If additional progress with an acceptable resolution is not reached, legal action will be taken.
Contract modifications are routine in the performance of the Company’s contracts. Contracts are often modified to account for changes in the contract specifications or requirements. In most instances, contract modifications are for goods or services that are not distinct, and, therefore, are accounted for as part of the existing contract.
Assurance-type warranties are the only warranties provided by the Company and, as such, the Company does not recognize revenue on warranty-related work. The Company generally provides a one to two year warranty for workmanship under its contracts when completed. Warranty claims historically have been insignificant.
Pre-contract costs are generally charged to expense as incurred, but in certain cases their recognition may be deferred if specific probability criteria are met. The Company did not have significant deferred pre-contract costs at September 30, 2019.
9
Residential Construction Revenue Recognition—Residential construction revenue and related profit are recognized when construction on the concrete foundation unit is completed (i.e., at a point in time). The time from starting construction to finishing is typically less than one month.
Leases—Effective January 1, 2019, the Company determines if an arrangement is a lease at inception. The operating lease right-of-use (“ROU”) assets are included within the Company’s non-current assets and lease liabilities are included in current or non-current liabilities on the Company’s Condensed Consolidated Balance Sheets. Finance leases are included in property and equipment, current maturities of long-term debt, and long-term debt on the Company’s Condensed Consolidated Balance Sheets.
ROU assets represent the Company’s right to use, or control the use of, a specified asset for the lease term. Lease liabilities are the Company’s obligation to make lease payments arising from a lease, and are measured on a discounted basis. Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term on the commencement date. As most of the Company’s leases do not provide an implicit rate, the Company’s incremental borrowing rate was used based on the information available on the commencement date in determining the present value of lease payments. For future leases, the implied rate in the lease will be used to determine the present value. The operating lease ROU asset includes any lease payments made and initial direct costs incurred and excludes lease incentives. The lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for minimum lease payments continues to be recognized on a straight-line basis over the lease term.
Restricted cash—Restricted cash of approximately $4,200 and $3,900 is included in “Other current assets” on the Condensed Consolidated Balance Sheets at September 30, 2019 and December 31, 2018. This represents cash deposited by the Company into separate accounts and designated as collateral for standby letters of credit in the same amount in accordance with contractual agreements.
Recently Adopted Accounting Guidance
Leases—In February 2016, the Financial Accounting Standards Board (“FASB”) issued its new lease accounting guidance in ASU 2016-2, “Leases” (ASC 842). Under the new guidance, lessees are required to recognize all leases (with the exception of short-term leases) on the balance sheet. The Company adopted ASC 842 effective January 1, 2019 using the modified retrospective method. The new guidance has been applied to leases that exist or were entered into on or after January 1, 2019 without adjusting comparative periods in the financial statements. As an accounting policy, the Company has elected not to apply the recognition requirements to short-term leases (leases with terms of 12 months or less). Instead, the Company recognizes the lease payments in the Condensed Consolidated Statement of Operations on a straight-line basis over the lease term and variable lease payments in the period in which the obligation for those payments is incurred. The Company has elected to utilize the package of practical expedients that allows entities to not reassess 1) the classification of leases existing at the date of adoption 2) the initial direct costs for any existing leases and 3) whether any expired or existing contracts are or contain leases.
At January 1, 2019, the Company recorded an operating lease ROU asset, current maturity of operating lease liability and long-term operating lease liability of $13,600, $6,200 and $7,400, respectively on its Condensed Consolidated Balance Sheet, related to its existing operating leases. The adoption of this standard did not have a material impact on the Company’s Condensed Consolidated Statements of Operations. As of September 30, 2019, the weighted average remaining lease terms for the Company’s various operating leases extends out over the next 2.6 years. The weighted average discount rate used to determine the present value of the Company’s operating leases’ future payments was approximately 6.3%.
3.
REVENUE FROM CONTRACTS WITH CUSTOMERS
Performance Obligations Satisfied Over Time—Revenue for the heavy civil construction segment contracts that satisfy the criteria for over time recognition is recognized as the work progresses. The majority of the revenue is derived from long-term, heavy civil construction contracts and projects that typically span between 12 months to 36 months. Revenue from products and services transferred to customers over time accounted for 86% and 85% of revenue for the three and nine months ended September 30, 2019, respectively. Revenue from products and services transferred to customers over time accounted for 87% and 85% of revenue for the three and nine months ended September 30, 2018, respectively.
Performance Obligations Satisfied at a Point in Time—Revenue for the residential construction segment contracts that do not satisfy the criteria for over time recognition is recognized at a point in time and utilizes an output measure for performance based on the completion of a unit of work (e.g., residential foundation). The typical time frame for completion of a residential foundation is less than one month. Revenue from products and services transferred to customers at a point in time accounted for 14% and 15% of revenue for the three and nine months ended September 30, 2019, respectively. Revenue from products and services transferred to customers at a point in time accounted for 13% and 15% of revenue for the three and nine months ended September 30, 2018, respectively.
10
Backlog—On September 30, 2019, the Company had approximately $881,400 of remaining performance obligations (which is also referred to as “backlog”) in its heavy civil construction segment. The Company expects to recognize approximately 70% of its backlog as revenue during the next twelve months, and the balance thereafter.
Contract Estimates—Contract estimates are based on various assumptions to project the outcome of future events that often span several years. These assumptions include labor productivity and availability, the complexity of the work to be performed, the cost and availability of materials and the performance of subcontractors. Changes in job performance, job conditions and estimated profitability, including those changes arising from contract penalty provisions and final contract settlements, may result in revisions to costs and income and are recognized in the period in which the revisions are determined. Changes in estimated revenues and gross margin resulted in a net increase of approximately $500 and $3,700 for the three and nine months ended September 30, 2019, respectively, and a net increase of approximately $2,400 and $4,100 for the three and nine months ended September 30, 2018, respectively, to “Operating income” on the Condensed Consolidated Statements of Operations. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined.
Variable Consideration—The transaction price for contracts may include variable consideration, which includes increases to transaction price for approved and unapproved change orders, claims and incentives, and reductions to transaction price for liquidated damages. Based upon the Company’s review of the provisions of its contracts, specific costs incurred, and other related evidence supporting the unapproved change orders and claims, the Company concluded that it was appropriate to include amounts of approximately $15,400 and $9,300 at September 30, 2019 and December 31, 2018, respectively, in project price. These amounts, reflected in “Costs and estimated earnings in excess of billings on uncompleted contracts” on the Condensed Consolidated Balance Sheets, primarily relate to extended delays on a bridge project in Texas due to design errors in the original owner provided project plan. However, unapproved change order and claim amounts are subject to negotiations which may cause actual results to differ materially from estimated and recorded amounts.
Revenue by Heavy Civil Construction Category—The Company’s heavy civil construction segment’s portfolio of products and services consists of approximately 150 active contracts. The following series of tables presents the Company’s heavy civil construction revenue disaggregated by several categories:
Revenue by major end market
Three Months Ended September 30,
Nine Months Ended September 30,
2019
2018
2019
2018
Heavy Highway
$
142,118
$
151,882
$
365,692
$
385,844
Commercial
34,875
32,261
94,300
89,889
Aviation
39,105
30,587
106,103
81,671
Water Containment and Treatment
15,960
18,457
46,709
48,973
Other
19,699
21,357
48,267
58,691
Total Heavy Civil Construction Revenue
$
251,757
$
254,544
$
661,071
$
665,068
Revenue by contract type
Three Months Ended September 30,
Nine Months Ended September 30,
2019
2018
2019
2018
Fixed Unit Price
$
207,807
$
208,070
$
534,323
$
562,791
Lump Sum and Other
43,950
46,474
126,748
102,277
Total Heavy Civil Construction Revenue
$
251,757
$
254,544
$
661,071
$
665,068
Each of these two contract types present advantages and disadvantages. Typically, the Company assumes more risk with lump-sum contracts. However, these types of contracts offer additional profits if the work is completed for less than originally estimated. Under fixed-unit price contracts, the Company’s profit may vary if actual labor-hour costs vary significantly from the negotiated rates. Also, because some contracts can provide little or no fee for managing material costs, the components of contract cost can impact profitability.
Contract Balances—The timing of revenue recognition, billings and cash collections results in billed accounts receivable and costs and estimated earnings in excess of billings on uncompleted contracts (contract assets) on the Condensed Consolidated Balance Sheet. In the Company’s heavy civil construction segment, amounts are billed as work progresses in accordance with agreed-upon contractual terms, either at periodic intervals (e.g., biweekly or monthly) or upon achievement of contractual milestones. Generally, billing occurs subsequent to revenue recognition, resulting in contract assets. However, the Company occasionally receives advances or deposits from its customers, before revenue is recognized, resulting in billings in excess of costs and estimated earnings on uncompleted contracts (contract liabilities). These assets and liabilities are reported on the Condensed Consolidated Balance Sheet on a contract-by-contract basis at the end of each reporting period. Changes in the contract asset and liability balances during the nine month period ended September 30, 2019 were not materially impacted by any other factors.
11
4.
CONSOLIDATED 50% OWNED SUBSIDIARIES
The Company has a 50% interest in two subsidiaries (“Myers” and “RHB”). Both subsidiaries have provisions obligating the Company to purchase each partner’s 50% interests for $20,000 ($40,000 in the aggregate), due to circumstances outlined in the partner agreements that are certain to occur. Therefore, the Company has consolidated these two entities and classified these obligations as mandatorily redeemable and has recorded a liability in “Members’ interest subject to mandatory redemption and undistributed earnings” on the Condensed Consolidated Balance Sheets. All undistributed earnings at the time of the noncontrolling owners’ death or permanent disability for both of these subsidiaries are also mandatorily payable. The Company has purchased two separate $20,000 death and permanent total disability insurance policies to mitigate the Company’s cash draw if such events were to occur.
The liability consists of the following:
September 30, 2019
December 31, 2018
Members’ interest subject to mandatory redemption
$
40,000
$
40,000
Net accumulated earnings
11,272
9,343
Total liability
$
51,272
$
49,343
Fifty percent of the earnings of these consolidated 50% owned subsidiaries for the three and nine months ended September 30, 2019 were approximately $5,500 and $8,200, respectively and for the three and nine months ended September 30, 2018 were $5,100 and $10,400, respectively. These amounts were included in “Other operating expense, net” on the Company’s Condensed Consolidated Statements of Operations.
The Company must determine whether any of its entities, including these two 50% owned subsidiaries, in which it participates, is a variable interest entity (“VIE”). The Company determined Myers is a VIE, as Sterling is the primary beneficiary, as pursuant to the terms of the Myers Operating Agreement the Company is exposed to the majority of potential losses of the partnership.
The following table presents the condensed financial information of Myers, which is reflected in the Company’s Condensed Consolidated Balance Sheets:
September 30, 2019
December 31, 2018
Assets
Current assets:
Cash and cash equivalents
$
11,202
$
8,745
Accounts receivable, including retainage
24,314
24,109
Other current assets
15,079
14,533
Total current assets
50,595
47,387
Property and equipment, net
6,008
7,219
Operating lease right-of-use assets
3,020
—
Goodwill
1,501
1,501
Total assets
$
61,124
$
56,107
Liabilities
Current liabilities:
Accounts payable
$
21,869
$
22,211
Other current liabilities
15,459
9,811
Total current liabilities
37,328
32,022
Other long-term liabilities
1,123
1,976
Total liabilities
$
38,451
$
33,998
12
5.
CONSTRUCTION JOINT VENTURES
The Company participates in joint ventures with other major construction companies and other partners, typically for large, technically complex projects, including design-build projects, when it is desirable to share risk and resources in order to seek a competitive advantage. Joint venture partners typically provide independently prepared estimates, furnish employees and equipment, enhance bonding capacity and often also bring local knowledge and expertise. These projects generally have joint and several liability. The Company selects its joint venture partners based on its analysis of their construction and financial capabilities, expertise in the type of work to be performed and past working relationships with the Company, among other criteria.
Joint ventures with a controlling interest—For these joint ventures, the equity held by the remaining owners and their portions of net income (loss) are reflected in the Condensed Consolidated Balance Sheets line item “Noncontrolling interests” in “Stockholders’ equity” and the Condensed Consolidated Statements of Operations line item “Net income attributable to noncontrolling interests”, respectively.
Joint ventures with a noncontrolling interest—Where the Company has a noncontrolling joint interest in a venture, the Company accounts for its share of the operations of such construction joint ventures on a pro-rata basis using proportionate consolidation on its Condensed Consolidated Statements of Operations and as a single line item (“Receivables from and equity in construction joint ventures”) in the Condensed Consolidated Balance Sheets. This method is an acceptable modification of the equity method of accounting which is a common practice in the construction industry. Condensed combined financial amounts of joint ventures in which the Company has a noncontrolling interest and the Company’s share of such amounts which are included in the Company’s Condensed Consolidated Financial Statements are shown below:
September 30, 2019
December 31, 2018
Total combined joint ventures:
Current assets
$
92,300
$
64,815
Less: current liabilities
(92,141
)
(74,543
)
Net liabilities
$
159
$
(9,728
)
Sterling’s receivables from and equity in noncontrolling construction joint ventures
$
14,651
$
10,720
Three Months Ended September 30,
Nine Months Ended September 30,
2019
2018
2019
2018
Total combined joint ventures:
Revenues
$
40,875
$
32,190
$
127,565
$
89,010
Operating income
3,588
1,728
14,401
7,324
Sterling’s noncontrolling interest:
Revenues
$
20,119
$
12,820
$
61,774
$
41,739
Operating income
1,769
858
5,869
3,716
The caption “Receivables from and equity in construction joint ventures” includes undistributed earnings and receivables owed to the Company. Undistributed earnings are typically released to the joint venture partners after the customer accepts the project as complete and the warranty period, if any, has passed.
13
6.
PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows:
September 30, 2019
December 31, 2018
Construction and transportation equipment
$
149,859
$
144,630
Buildings and improvements
11,206
11,072
Land
2,720
2,720
Office equipment
2,657
2,711
Total property and equipment
166,442
161,133
Less accumulated depreciation
(117,858
)
(109,134
)
Total property and equipment, net
$
48,584
$
51,999
7.
OTHER INTANGIBLE ASSETS
The following table presents the Company’s acquired finite-lived intangible assets at September 30, 2019 and December 31, 2018:
September 30, 2019
December 31, 2018
Weighted Average Life
Gross Carrying Amount
Accumulated Amortization
Gross Carrying Amount
Accumulated Amortization
Customer relationships
23 years
$
40,823
$
(4,513
)
$
40,823
$
(3,159
)
Trade name
13 years
5,307
(1,313
)
5,307
(919
)
Non-competition agreements
7 years
487
(174
)
487
(121
)
Total
22 years
$
46,617
$
(6,000
)
$
46,617
$
(4,199
)
The Company's intangible amortization expense was approximately $600 and $1,800 for the three and nine months ended September 30, 2019.
8.
DEBT
The Company’s outstanding debt at September 30, 2019 and December 31, 2018 was as follows:
September 30, 2019
December 31, 2018
Oaktree Facility
$
67,088
$
74,571
Notes and deferred payments to sellers (Tealstone Acquisition)
11,967
13,572
Notes payable for construction and transportation equipment
856
612
Total debt
79,911
88,755
Less - Current maturities of long-term debt
(12,238
)
(2,899
)
Less - Unamortized deferred debt costs
(5,184
)
(6,739
)
Total long-term debt, net of unamortized debt costs
$
62,489
$
79,117
14
Oaktree Facility—At September 30, 2019, the Company had $67,088 outstanding under an $85,000 term loan with Wilmington Trust, National Association, as agent, and the lenders party thereto (the “Oaktree Facility”). The five-year Oaktree Facility, which was set to mature in April 2022, was secured by substantially all of the assets of the Company and its subsidiaries. Interest on the Oaktree Facility was equal to the one-, two-, three- or six-month London Interbank Offered Rate, or LIBOR, plus 8.75% per annum on the unpaid principal amount of the Oaktree Facility, subject to adjustment under certain circumstances, and was generally payable monthly. There were no amortized principal payments due under the Oaktree Facility; however, the Company was required to prepay the Oaktree Facility, and in certain cases pay a prepayment premium thereon, with proceeds received from the issuances of debt or equity, transfers, events of loss and extraordinary receipts. The Company was required to make an offer quarterly to the lenders to prepay the Oaktree Facility in an amount equal to 75% of its excess cash flow, plus accrued and unpaid interest thereon and a prepayment premium. As described in Note 16, on October 2, 2019 the Company entered into a new Credit Agreement to obtain the Facilities which refinanced and extinguished the Oaktree Facility.
Notes and Deferred Payments to Sellers—At September 30, 2019, the Company had $11,967 outstanding, net of debt discounts, of the combined Promissory Notes and deferred cash payments issued as part of the Tealstone Acquisition. During the nine months ended September 30, 2019, the Company paid approximately $2,400 of the deferred cash payments. The remaining principal amounts of $5,000 of Promissory Notes and $7,500 of deferred cash payments are due on April 3, 2020. Based on a 12% discount rate, the Company recorded $11,600 as notes and deferred payments to sellers in long-term debt on its Condensed Consolidated Balance Sheet at the acquisition closing date. Accreted interest for the period was approximately $300 and $800 for the three and nine months ended September 30, 2019, respectively, and $300 and $900 for the three and nine months ended September 30, 2018, respectively, and was recorded as interest expense.
Notes Payable for Construction and Transportation Equipment—The Company has purchased and financed various construction and transportation equipment to enhance the Company’s fleet of equipment. The total long-term notes payable related to the purchase of financed equipment was approximately $900 and $600 at September 30, 2019 and December 31, 2018, respectively. The notes have payment terms ranging from 3 to 5 years and the associated interest rates range from 2.99% to 6.92%.
Compliance—The Oaktree Facility contained various covenants that limited, among other things, the Company’s ability and certain of its subsidiaries’ ability to incur certain indebtedness, grant certain liens, merge or consolidate, sell assets, make certain loans, enter into acquisitions, incur capital expenditures, make investments, and pay dividends. In addition, the Company was required to maintain the following principal financial covenants:
•
a ratio of secured indebtedness to EBITDA of not more than 1.8 to 1.00 for the trailing four consecutive fiscal quarters ending September 30, 2019 through maturity in 2022;
•
daily cash collateral of not less than $15,000;
•
gross margin in contract backlog of not less than $70,000 for the average of the trailing four consecutive fiscal quarters;
•
net capital expenditures during the trailing four consecutive fiscal quarters shall not exceed $15,000;
•
bonding capacity shall be maintained at all times in an amount not less than $1,000,000; and
•
the EBITDA of Tealstone Residential Concrete, Inc. shall not be less than $12,000 for each of the trailing four consecutive fiscal quarters.
The Company was in compliance with these covenants at September 30, 2019.
9.
LEASE OBLIGATIONS
The Company has operating and finance leases primarily for construction and transportation equipment, as well as office space. The Company’s leases have remaining lease terms of 1 month to 5 years, some of which include options to extend the leases for up to 10 years.
The components of lease expense were as follows:
Three Months Ended September 30, 2019
Nine Months Ended September 30, 2019
Operating lease cost
$
2,276
$
6,447
Short-term lease cost
$
5,363
$
13,375
Finance lease cost:
Amortization of right-of-use assets
$
69
$
140
Interest on lease liabilities
9
12
Total finance lease cost
$
78
$
152
15
Supplemental cash flow information related to leases was as follows:
Nine Months Ended September 30, 2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
$
6,277
Operating cash flows from finance leases
$
12
Financing cash flows from finance leases
$
140
Right-of-use assets obtained in exchange for lease obligations (noncash):
Operating leases
$
8,138
Finance leases
$
770
Supplemental balance sheet information related to leases was as follows:
September 30, 2019
Operating Leases
Operating lease right-of-use assets
$
14,589
Current portion of long-term lease obligations
$
7,492
Long-term lease obligations
7,191
Total operating lease liabilities
$
14,683
Finance Leases
Property and equipment, at cost
$
1,433
Accumulated depreciation
(429
)
Property and equipment, net
$
1,004
Current maturities of long-term debt
$
208
Long-term debt
582
Total finance lease liabilities
$
790
Weighted Average Remaining Lease Term
Operating leases
2.6
Finance leases
4.3
Weighted Average Discount Rate
Operating leases
6.3
%
Finance leases
4.2
%
Maturities of lease liabilities are as follows:
Operating
Leases
Finance
Leases
Year Ending December 31,
2019 (excluding the nine months ended September 30, 2019)
$
1,839
$
78
2020
6,459
209
2021
4,795
186
2022
2,565
161
2023
545
154
Thereafter
21
77
Total lease payments
$
16,224
$
865
Less imputed interest
(1,541
)
(75
)
Total
$
14,683
$
790
16
10.
COMMITMENT AND CONTINGENCIES
The Company is required by its insurance providers to obtain and hold a standby letter of credit. These letters of credit serve as a guarantee by the banking institution to pay the Company’s insurance providers the incurred claim costs attributable to its general liability, workers compensation and automobile liability claims, up to the amount stated in the standby letters of credit, in the event that these claims were not paid by the Company. These letters of credit are cash collateralized, resulting in the cash being designated as restricted.
The Company is the subject of certain other claims and lawsuits occurring in the normal course of business. Management, after consultation with legal counsel, does not believe that the outcome of these actions will have a material impact on the Condensed Consolidated Financial Statements of the Company.
11.
INCOME TAXES
The Company and its subsidiaries file U.S. federal and various U.S. state income tax returns. Current income tax expense (benefit) represents federal and state taxes based on tax paid or expected to be payable or receivable for the periods shown in the Condensed Consolidated Statements of Operations.
Due to net operating loss carryforwards, the Company does not expect a current federal liability. The Company may incur current state tax liabilities in states in which the Company does not have net operating loss carry forwards. Current income tax expense of $113 and $221 was recorded for the three and nine months ended September 30, 2019, respectively and for the three and nine months ended September 30, 2018 was $114 and $252, respectively.
The Company’s deferred tax expense reflects the change in deferred tax assets and liabilities. The Company performs an analysis at the end of each reporting period to determine whether it is more likely than not the deferred tax assets are expected to be realized in future years. Based upon this analysis, a valuation allowance of approximately $28,900 and $31,700 has been applied to the Company’s net deferred tax assets at September 30, 2019 and December 31, 2018, respectively. As part of this analysis, the Company monitors its quarterly results. Based on the Company’s continued positive income trend and current forecast for the full year of 2019, the Company believes that there could be enough positive evidence to remove the valuation allowance in the fourth quarter of 2019. Deferred tax liabilities are a consideration in the analysis of whether to apply a valuation allowance because taxable temporary differences may be used as a source of taxable income to support the realization of deferred tax assets. A deferred tax liability that relates to an asset with an indefinite life, such as goodwill, may not be considered a source of income and should not be netted against deferred tax assets for valuation allowance purposes. The Company expects to have a deferred tax liability for the excess of book over tax basis difference in its goodwill. An $800 and $1,561 deferred tax expense for the three and nine months ended September 30, 2019, respectively has been recorded to reflect this liability.
The effective income tax rate varied from the statutory rate primarily as a result of the change in the valuation allowance, net income attributable to noncontrolling interest owners which is taxable to those owners rather than to the Company, state income taxes and other permanent differences. For interim periods, the Company estimates an annual effective tax rate and applies that rate to year-to-date operating results.
As a result of the Company’s analysis, management has determined that the Company does not have any material uncertain tax positions.
12.
STOCK INCENTIVE PLAN AND OTHER EQUITY ACTIVITY
General—The Company has a stock incentive plan (the “Stock Incentive Plan”) that is administered by the Compensation and Talent Development Committee of the Board of Directors. Under the Stock Incentive Plan, the Company can issue shares to employees and directors in the form of restricted stock awards (“RSAs”), restricted stock units (“RSUs”), and performance based shares (“PSUs”). Changes in common stock, additional paid in capital, and treasury stock during the nine months ended September 30, 2019 primarily relate to activity associated with the Stock Incentive Plan and share repurchases. During 2019, the Company implemented an Employee Stock Purchase Plan (“ESPP”). Under the ESPP, employees may make quarterly purchases of shares at a discount through regular payroll deductions for up to 15% of their compensation ($25 maximum per year). The shares are purchased at 85% of the closing price per share on the last trading day of the calendar quarter.
17
Share Grants—During the nine months ended September 30, 2019, the Company had the following share grants associated with the Stock Incentive Plan:
Shares
Weighted Average Grant-Date Fair Value per Share
RSAs
52
$
12.06
RSUs
138
$
10.96
PSUs
185
$
10.89
Total shares granted
375
Share Issuances—During the nine months ended September 30, 2019, the Company had the following share issuances associated with the Stock Incentive Plan:
Shares
RSA (issued upon grant)
52
RSUs (issued upon vesting)
80
PSUs (issued upon vesting)
54
ESPP (issued upon sale)
6
Total shares issued
192
Stock-Based Compensation Expense—During the three and nine months ended September 30, 2019 the Company recognized $819 and $2,489, respectively, of stock-based compensation expense, and during the three and nine months ended September 30, 2018 the Company recognized $798 and $2,181 of stock-based compensation expense, respectively, primarily within general and administrative expenses. The Company recognizes forfeitures as they occur, rather than estimating expected forfeitures. Included within total stock-based compensation expense for the three and nine months ended September 30, 2019 is $12 of expense related to the ESPP. ESPP expense, represents the difference between the fair value on the date of purchase and the price paid. At September 30, 2019, 794 authorized shares remained available for issuance under the ESPP.
Share Repurchases—During the nine months ended September 30, 2019, the Company repurchased 250 shares of the Company’s outstanding common stock for $3,201 under the stock repurchase plan, all of which were purchased in the first quarter of 2019. The Company also repurchased 3 and 62 shares for taxes withheld on stock-based compensation vestings for $32 and $694 during the three and nine months ended September 30, 2019, respectively.
13.
EARNINGS PER SHARE
The following table reconciles the numerators and denominators of the basic and diluted per common share computations for net income attributable to Sterling common stockholders:
Three Months Ended September 30,
Nine Months Ended September 30,
2019
2018
2019
2018
Numerator:
Net income attributable to Sterling common stockholders
$
7,957
$
8,917
$
17,600
$
19,580
Denominator:
Weighted average common shares outstanding — basic
26,365
26,908
26,359
26,893
Shares for dilutive unvested stock and warrants
272
387
302
281
Weighted average common shares outstanding — diluted
26,637
27,295
26,661
27,174
Basic net income per share attributable to Sterling common stockholders
$
0.30
$
0.33
$
0.67
$
0.73
Diluted net income per share attributable to Sterling common stockholders
$
0.30
$
0.33
$
0.66
$
0.72
18
14.
SEGMENT INFORMATION
Segment reporting is aligned based upon the services offered by the Company’s heavy civil construction and residential construction operating groups, which also represent the Company’s reportable segments. The Company’s Chief Operating Decision Maker (“CODM”) evaluates the performance of the aforementioned operating groups based upon revenue and income from operations. Each operating group’s income from operations reflects corporate costs, allocated based primarily upon revenue.
The following table presents total revenue and income from operations by reportable segment for the three and nine months ended September 30, 2019 and 2018:
Three Months Ended September 30,
Nine Months Ended September 30,
2019
2018
2019
2018
Revenues
Heavy Civil Construction
$
251,757
$
254,544
$
661,071
$
665,068
Residential Construction
39,942
36,722
118,663
117,424
Total Revenues
$
291,699
$
291,266
$
779,734
$
782,492
Operating Income
Heavy Civil Construction
$
8,692
$
9,148
$
14,253
$
17,488
Residential Construction
5,319
5,225
15,924
15,713
Subtotal
14,011
14,373
30,177
33,201
Acquisition related costs
(1,896
)
—
(2,158
)
—
Total Operating Income
$
12,115
$
14,373
$
28,019
$
33,201
15.
SUPPLEMENTAL CASH FLOW INFORMATION
Operating assets and liabilities—The following table summarizes the changes in the components of operating assets and liabilities:
Nine Months Ended September 30,
2019
2018
Accounts receivable, including retainage
$
(15,486
)
$
(26,316
)
Contracts in progress, net
(26,934
)
(1,573
)
Receivables from and equity in construction joint ventures
(3,931
)
(141
)
Other assets
(2,111
)
127
Accounts payable
11,198
8,814
Accrued compensation and other liabilities
7,330
2,936
Members' interest subject to mandatory redemption and undistributed earnings
1,929
1,458
Changes in operating assets and liabilities
$
(28,005
)
$
(14,695
)
19
16.
SUBSEQUENT EVENTS
As disclosed in the Company’s Form 8-K on October 2, 2019 and amended on October 21, 2019 (the “Plateau Acquisition Date”), pursuant to the Equity Purchase Agreement with Greg K. Rogers, Philip T. Travis, as trustee of the Lorin L. Rogers 2018 Trust, Kimberlin Rogers 2018 Trust, Gregory K. Rogers 2018 Trust and Mary A. Rogers 2018 Trust, LK Gregory Construction, Inc., Plateau Excavation, Inc. and DeWitt Excavation, LLC (collectively, “Plateau”), the Company consummated the acquisition (the “Plateau Acquisition”) of all of the issued and outstanding shares of capital stock of LK Gregory Construction, Inc. and Plateau Excavation, Inc., and all of the issued and outstanding equity interests in DeWitt Excavation, LLC, for aggregate consideration of $411,608, consisting of $375,000 in cash, 1,245 shares of the Company’s common stock (the “Shares”), a $10,000 subordinated promissory note with a preliminary fair value discount rate of 8%, and a preliminary target working capital adjustment of $10,413. Plateau is engaged in the business of surveying, clearing and grubbing, erosion control, grading, grassing, site excavation, storm drainage, sanitary sewer and water main installation, drilling and blasting, curb and gutter, paving, concrete work and landfill services, in each case to general contractors and developers engaged in construction services, and engineering services relating thereto.
The Company will record the assets acquired and liabilities assumed at their fair values as of the Plateau Acquisition Date. As disclosed in the Company’s Form 8-K amended on October 21, 2019, the preliminary purchase price was allocated with $98,771 of net tangible assets, $162,675 of identifiable intangible assets, and $150,162 of goodwill. Due to the limited amount of time since the closing of the Plateau Acquisition, the final purchase accounting for the Plateau Acquisition has yet to be completed. Additional disclosures will be provided in the Company’s Form 10-K for the fiscal year ending December 31, 2019.
To finance a portion of the purchase price of the Plateau Acquisition, and to refinance and extinguish all of the outstanding indebtedness of the Company under the Oaktree Facility, among other things, on the Plateau Acquisition Date the Company, as borrower, and certain of its subsidiaries, as guarantors, entered into a Credit Agreement (the “Credit Agreement”) with the financial institutions from time to time party thereto as lenders, BMO Harris Bank N.A., as administrative agent, Bank of America, N.A., as syndication agent, and BMO Capital Markets Corp. and BofA Securities, Inc., as joint lead arrangers and joint book runners. The Credit Agreement provides the Company with senior secured debt financing in an amount up to $475,000 in the aggregate, consisting of (i) a senior secured first lien revolving credit facility in an aggregate principal amount of $75,000 (with a $75,000 limit for the issuance of standby and documentary letters of credit and a $15,000 sublimit for swing line loans) and (ii) a senior secured first lien term loan facility in the amount of $400,000 (the “Facilities”). The Credit Agreement also includes an increase option that will allow the Company to increase the Facilities by an aggregate principal amount of up to $100,000 subject to certain conditions contained in the Credit Agreement. Borrowings under the Credit Agreement bear interest at either the Base Rate or Adjusted LIBOR, at the Company’s option, plus the Applicable Margin, as defined in the Credit Agreement. The Facilities will mature on October 2, 2024.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Report, including the documents incorporated herein by reference, contains statements that are, or may be considered to be, “forward-looking statements” regarding the Company which represent our expectations and beliefs concerning future events. These forward-looking statements are intended to be covered by the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995 as set forth in Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21 E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. The forward-looking statements included herein or incorporated herein by reference relate to matters that are predictive in nature, such as our industry, business strategy, goals and expectations concerning our market position, future operations, margins, profitability, capital expenditures, liquidity and capital resources and other financial and operating information, and may use or contain words such as “anticipated,” “assume,” “believe,” “budget,” “continue,” “could,” “estimate,” “expect,” “forecast,” “future,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “willt,” “would” and similar terms and phrases.
Forward-looking statements reflect our current expectations as of the date of this Report regarding future events, results or outcomes. These expectations may or may not be realized. Some of these expectations may be based upon assumptions or judgments that prove to be incorrect. In addition, our business and operations involve numerous risks and uncertainties, many of which are beyond our control, that could result in our expectations not being realized or otherwise could materially affect our financial condition, results of operations and cash flows.
Actual events, results and outcomes may differ materially from those anticipated, projected or assumed in the forward-looking statements due to a variety of factors. Although it is not possible to identify all of these factors, they include, among others, the following:
•
factors that affect the accuracy of estimates inherent in the bidding for contracts, estimates of backlog, over time recognition accounting policies, including onsite conditions that differ materially from those assumed in the original bid, contract modifications, mechanical problems with machinery or equipment and effects of other risks discussed in this document;
•
actions of suppliers, subcontractors, design engineers, joint venture partners, customers, competitors, banks, surety companies and others which are beyond our control, including suppliers’, subcontractors’ and joint venture partners’ failure to perform;
•
cost escalations associated with our contracts, including changes in availability, proximity and cost of materials such as steel, cement, concrete, aggregates, oil, fuel and other construction materials, including changes in U.S. trade policies and retaliatory responses from other countries, and cost escalations associated with subcontractors and labor;
•
change in cost to lease, acquire or maintain our equipment;
•
our dependence on a limited number of significant customers;
•
the presence of competitors with greater financial resources or lower margin requirements than ours, and the impact of competitive bidders on our ability to obtain new backlog at reasonable margins acceptable to us;
•
a shutdown of the federal government;
•
our ability to qualify as an eligible bidder under government contract criteria;
•
changes in general economic conditions, including recessions, reductions in federal, state and local government funding for infrastructure services, changes in those governments’ budgets, practices, laws and regulations and adverse economic conditions in our geographic markets;
•
delays or difficulties related to the completion of our projects, including additional costs, reductions in revenues or the payment of liquidated damages, or delays or difficulties related to obtaining required governmental permits and approvals;
•
design/build contracts which subject us to the risk of design errors and omissions;
•
our ability to obtain bonding or post letter of credit;
•
our ability to raise additional capital on favorable terms;
•
our ability to attract and retain key personnel;
•
increased unionization of our workforce or labor costs and any work stoppages or slowdowns;
•
adverse weather conditions;
•
our ability to successfully identify, finance, complete and integrate acquisitions, including the Plateau Acquisition;
•
citations issued by any governmental authority, including the Occupational Safety and Health Administration;
•
federal, state and local environmental laws and regulations where non-compliance can result in penalties and/or termination of contracts as well as civil and criminal liability; and
•
the factors discussed in more detail in the Company’s annual report on Form 10-K for the year ended December 31, 2018 (the “2018 Form 10-K”) under “Part I, Item 1A. Risk Factors.”
In reading this Report, you should consider these factors carefully in evaluating any forward-looking statements and you are cautioned not to place undue reliance on any forward-looking statements. Investors are cautioned that many of the assumptions upon which our forward-looking statements are based are likely to change after the forward-looking statements are made. Further, we may make changes to our business plans that could affect our results. Although we believe that our plans, intentions and expectations reflected in, or suggested by, the forward-looking statements that we make in this Report are reasonable, we can provide no assurance that they will be achieved.
The forward-looking statements included herein are made only as of the date hereof, and we undertake no obligation to update any information contained herein or to publicly release the results of any revisions to any forward-looking statements to reflect events or circumstances that occur, or that we become aware of after the date of this Report.
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OVERVIEW
General—Sterling Construction Company, Inc. (“Sterling” or “the Company”), is a construction company that specializes in heavy civil infrastructure construction and infrastructure rehabilitation as well as residential construction projects. The Company operates primarily in Arizona, California, Colorado, Hawaii, Nevada, Texas and Utah, as well as other states in which there are feasible construction opportunities. Heavy civil construction projects include highways, roads, bridges, airfields, ports, light rail, water, wastewater and storm drainage systems, foundations for multi-family homes, commercial concrete projects and parking structures. Residential construction projects include concrete foundations for single-family homes.
Recent Developments—On October 2, 2019, the Company consummated the acquisition of LK Gregory Construction, Inc., Plateau Excavation, Inc. and DeWitt Excavation, LLC (collectively, “Plateau”). Plateau is engaged in the business of surveying, clearing and grubbing, erosion control, grading, grassing, site excavation, storm drainage, sanitary sewer and water main installation, drilling and blasting, curb and gutter, paving, concrete work and landfill services, in each case to general contractors and developers engaged in construction services, and engineering services relating thereto. For additional information, refer to Note 16 to our Condensed Consolidated Financial Statements in this Report.
In addition, on October 2, 2019, the Company entered into a Credit Agreement (the “Credit Agreement”) for a revolving credit facility in the principal amount of $75 million and a term loan facility in the principal amount of $400 million (the “Facilities”) with the various lenders party thereto, BMO Harris Bank N.A., as administrative agent, Bank of America, N.A., as syndication agent, and BMO Capital Markets Corp. and BofA Securities, Inc., as joint lead arrangers and joint book runners. The Company entered into the Credit Agreement to finance a portion of the purchase price of the Plateau Acquisition, refinance and extinguish certain existing indebtedness of the Company, finance capital expenditures, working capital, acquisitions permitted under the Credit Agreement, and other general corporate purposes and fund certain fees and expenses associated with the closing of the Facilities and the Plateau Acquisition. For additional information, refer to Note 16 to our Condensed Consolidated Financial Statements in this Report.
MARKET OUTLOOK AND TRENDS
Heavy Civil Construction—Sterling’s heavy civil construction business is primarily driven by federal, state and municipal funding. Federal funds, on average, provide 50% of annual State Department of Transportation (DOT) capital outlays for highway and bridge projects. Several of the states in Sterling’s key markets have instituted actions to further increase annual spending. In November 2018, various state and local transportation measures were passed securing, and in some cases increasing, funding of $1.57 billion in California, $1.27 billion in Texas, $528.5 million in Arizona, $128.2 million in Colorado and $87 million in Utah. In October 2018, the Federal Aviation Administration reauthorized $3.35 billion annually for the next five years. This reauthorization also includes more than $1 billion a year for airport infrastructure grants and about $1.7 billion for disaster relief.
In addition to the state locally funded actions, Sterling is in year four of the 2015 federally funded five-year $305 billion Fixing America’s Surface Transportation (“FAST”) Act that increased the annual federal highway investment by 15.1% over the five-year period from 2016 to 2020. With the FAST Act set to expire next year, the federal government is currently working towards a bipartisan Federal Infrastructure Bill (America’s Transportation Infrastructure Act) that would both increase and solidify funding for the next five years. Should the federal government approve this incremental infrastructure investment, it would be an additional growth catalyst; however, it would be unlikely to create a significant business impact before late 2020 or 2021.
Bid Discipline and Project Execution—To ensure that the Company takes full advantage of the improved market conditions and maximizes profitability, the Company has completed an extensive evaluation of its historical success on heavy civil construction projects based on project size, end customer, product delivered and geography. The knowledge gained has now been incorporated into a more formal and rigorous bid evaluation and approval process which, along with the institution of common processes, will enable the Company to focus its resources on the most beneficial projects and significantly reduce its risk.
Backlog—At September 30, 2019, backlog of construction projects, which is made up solely of the heavy civil construction segment, was $881.4 million, as compared to $850.7 million at December 31, 2018. The contracts in this backlog are typically completed in 12 to 36 months. Contracts for which the Company is the apparent low bidder on the project (“Unsigned Low-bid Awards”) are excluded from backlog until the contract has been executed by its customer. Unsigned Low-bid Awards were $272.6 million at September 30, 2019 as compared to $292.7 million at December 31, 2018. The combination of backlog and Unsigned Low-bid Awards, which the Company refers to as “Combined Backlog,” totaled $1.2 billion and $1.1 billion, respectively at September 30, 2019 and December 31, 2018. Backlog includes $23.0 million and $33.6 million at September 30, 2019 and December 31, 2018, respectively, attributable to the Company’s share of estimated revenues related to joint ventures where the Company is a noncontrolling joint venture partner.
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The Company’s margin in backlog has increased from 8.5% at December 31, 2018 to 9.3% at September 30, 2019 and the Combined Backlog margin increased from 8.9% at December 31, 2018 to 9.3% at September 30, 2019, driven by a greater mix of heavy highway awards.
Residential Construction—Continuing revenue growth of the Company’s residential construction business is directly related to the growth of new home starts in its key markets. The Company’s core customer base is primarily made up of leading national home builders as well as regional and custom home builders. The Company’s customers’ expected average growth during 2019 was approximately 10% in the Dallas-Fort Worth Metroplex, however some of this growth may have been dampened by significant Texas weather impacts earlier in the year. The Company has continued its expansion of the residential business into the Houston market and surrounding areas.
RESULTS OF OPERATIONS
Consolidated Results
Summary—For the third quarter of 2019, the Company had operating income of $12.1 million, income before income taxes of $9.4 million, net income attributable to Sterling common stockholders of $8.0 million and net income per diluted share attributable to Sterling common stockholders of $0.30.
Consolidated financial highlights for the three and nine months ended September 30, 2019 as compared to the three and nine months ended September 30, 2018 are as follows:
Three Months Ended September 30,
Nine Months Ended September 30,
(In thousands)
2019
2018
2019
2018
Revenues
$
291,699
$
291,266
$
779,734
$
782,492
Gross profit
29,216
31,279
$
74,215
$
82,159
General and administrative expense
(10,839
)
(11,455
)
(34,102
)
(36,998
)
Acquisition related costs
(1,896
)
—
(2,158
)
—
Other operating expense, net
(4,366
)
(5,451
)
(9,936
)
(11,960
)
Operating income
12,115
14,373
28,019
33,201
Interest, net
(2,693
)
(2,792
)
(8,002
)
(8,661
)
Income tax expense
(913
)
(1,413
)
(1,782
)
(1,551
)
Less: Net income attributable to noncontrolling interests
(552
)
(1,251
)
(635
)
(3,409
)
Net income attributable to Sterling common stockholders
$
7,957
$
8,917
$
17,600
$
19,580
Gross margin
10.0
%
10.7
%
9.5
%
10.5
%
Revenues—Revenues increased $0.4 million, or 0.1% for the third quarter of 2019 compared with the third quarter of 2018. The increase in the third quarter of 2019 was driven by a $3.2 million increase in residential construction and by a $2.8 million decrease in heavy civil construction. Revenues decreased $2.8 million, or 0.4% in the nine months ended September 30, 2019 compared with the nine months ended September 30, 2018. The decrease in the nine months ended September 30, 2019 was driven by a $4.0 million decrease in heavy civil construction and a $1.2 million increase in residential construction.
Gross profit—Gross profit decreased $2.1 million for the third quarter of 2019 compared with the third quarter of 2018. The Company’s gross margin as a percent of revenue decreased to 10.0% in the third quarter of 2019, as compared to 10.7% in the third quarter of 2018. The decrease in gross margin during the third quarter of 2019 as compared to the third quarter of 2018 was driven by heavy civil construction’s lower margin mix, and to a lesser extent, lower margins from expansion into the Houston residential construction market. Gross profit decreased $8.0 million for the nine months ended September 30, 2019 compared with the nine months ended September 30, 2018. The Company’s gross margin as a percent of revenue decreased to 9.5% in the nine months ended September 30, 2019, as compared to 10.5% in the nine months ended September 30, 2018. The decrease in gross margin during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018 was driven by heavy civil construction’s lower margin mix of projects and lower volume from revenues.
At September 30, 2019 and 2018, the Company had approximately 183 and 173 heavy civil contracts-in-progress, respectively, that were less than 90% complete. These contracts are of various sizes, of different expected profitability and in various stages of completion. The nearer a contract progresses toward completion, the more the Company is able to refine its estimate of total revenues (including incentives, delay penalties, change orders and claims), costs and gross profit. Thus, gross profit as a percent
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of revenues can increase or decrease from comparable and subsequent quarters due to variations among contracts and depending upon the stage of completion of contracts.
General and administrative expenses—General and administrative expenses decreased $0.7 million to $10.8 million during the third quarter of 2019 from $11.5 million in the third quarter of 2018. As a percent of revenues, general and administrative expenses decreased approximately 22 basis points to 3.7% during the three months ended September 30, 2019, primarily due to higher business development costs in 2018. General and administrative expenses decreased $2.9 million to $34.1 million during the nine months ended September 30, 2019 from $37.0 million during the nine months ended September 30, 2018, primarily due to higher business development costs in 2018. As a percent of revenues, general and administrative expenses decreased approximately 35 basis points to 4.4% during the nine months ended September 30, 2019.
Acquisition related costs—The Company had acquisition related costs of $1.9 million and $2.2 million during three and nine months ended September 30, 2019, respectively, related to the Plateau Acquisition, as described in Note 16 to our Condensed Consolidated Financial Statements in this Report.
Other operating expense, net—Other operating expense, net, includes 50% of earnings and losses related to Members’ interest of consolidated 50% owned subsidiaries, earn-out expense, and other miscellaneous operating income or expense. Members’ interest earnings are treated as an expense and increase the liability account. The change in other operating expense, net, was $1.1 million during the third quarter of 2019 compared to the third quarter of 2018. Earn-out expense was $0.2 million for the third quarter of 2019, compared to $0.3 million in the third quarter of 2018. Members’ interest earnings decreased by $0.9 million during the third quarter of 2019 to $4.2 million from $5.1 million in the third quarter of 2018, reflecting decreased revenue and project mix.
The change in other operating expense, net, was $2.1 million during the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018. Earn-out expense was $1.7 million for nine months ended September 30, 2019, compared to $1.5 million in the nine months ended September 30, 2018. Members’ interest earnings decreased by $2.2 million during the nine months ended September 30, 2019 to $8.2 million from $10.4 million in the nine months ended September 30, 2018, reflecting decreased revenue and project mix.
Interest expense—Interest expense was $3.0 million in the third quarter of 2019 compared to $3.1 million in the third quarter of 2018 and interest expense was $9.0 million in the nine months ended September 30, 2019 compared to $9.3 million in the nine months ended September 30, 2018. The interest expense on lower comparative debt levels was partially offset by higher interest rates. The interest expense is primarily related to borrowings under the Oaktree Facility.
Operating Group Results
The Company’s revenue and income from operations by reportable segment are as follows: