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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number: 0-19450
STERLING CONSTRUCTION COMPANY, INC.
(Exact name of registrant as specified in its charter)
Delaware 25-1655321
State or other jurisdiction of I.R.S. Employer
incorporation or organization Identification Number
2751 Centerville Road Suite 3131
Wilmington, Delaware 19803
Address of principal executive offices Zip Code
Registrant's telephone number, including area code: (817) 416-0717
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
-------------------
Common Stock, $0.01 par value per share
Preferred Shares Purchase Rights
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Second 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. Yes |X| No | |
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Exchange Act Rule 12b-2). | | Yes |X| No
Aggregate market value at March 1, 2003 of the voting stock held by
non-affiliates of the registrant: $4,239,777.
At March 1, 2003 the registrant had 5,069,016 shares of common stock outstanding
DOCUMENTS INCORPORATED BY REFERENCE
None
1
PART I
ITEM 1. BUSINESS
CAUTIONARY STATEMENT
This Report on Form 10-K contains certain forward-looking statements
that involve risks and uncertainties. The cautionary statements contained in
this Report should be read as being applicable to all related forward-looking
statements wherever they appear in this Report. The Company's actual results in
the future could differ materially from those discussed here. Important factors
that could cause or contribute to such differences include those discussed in
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS and elsewhere in this Report.
FORMATION AND HISTORY OF STERLING CONSTRUCTION COMPANY, INC.
Oakhurst Company, Inc. ("Oakhurst"), renamed Sterling Construction
Company, Inc. in November 2001 and hereinafter referred to as "Sterling" or "the
Company", was formed as part of a merger transaction in 1991, in which Steel
City Products, Inc. ("SCPI") became a majority-owned subsidiary of the Company.
In accordance with the merger agreement, Sterling owns 10% of SCPI's outstanding
common stock and all of SCPI's Series A Preferred Stock, with the result that
Sterling owns 90% of the voting stock of SCPI.
Because Sterling's ownership of SCPI is primarily in the form of
preferred stock Sterling retains most of the value of SCPI, and Sterling's
income from SCPI is determined by the Series A Preferred stock dividend. This
form of ownership was designed to facilitate the preservation of SCPI's net
operating tax loss carry-forwards and capital losses, which amounted to
approximately $110 million at December 31, 2002.
In December 1998 Sterling formed a wholly-owned subsidiary, Oakhurst
Technology, Inc. ("OTI") to invest in New Heights Recovery and Power, LLC ("New
Heights") which was to become a fully integrated recycling and waste-to-energy
facility in Ford Heights, Illinois. In conjunction with OTI's funding commitment
to New Heights, Sterling entered into certain agreements with KTI, Inc. ("KTI")
(which subsequently merged into Casella Waste Systems, Inc., "Casella")
regarding the funding of capital improvements and start-up losses at New
Heights.
Due to significant and continuing losses incurred at New Heights, and
Casella's decision to exit certain non-core activities, of which New Heights was
deemed one, in April 2001 the Company, OTI, Casella and KTI entered into certain
agreements (the "Unwinding Agreements") pursuant to which (a) all of OTI's
equity interest in New Heights was transferred to KTI, (b) the Sterling common
stock held by KTI was transferred back to the Company, (c) all securities
pledged to KTI by the Company and/or OTI were released, (d) all but $1 million
of the KTI Loan, which included accrued interest and aggregated approximately
$16.1 million, was cancelled; the $1 million was converted into a four year
subordinated promissory note bearing interest at 12%, and (e) the Company issued
to KTI a ten-year warrant to purchase 494,302 shares of the Company's common
stock at $1.50 per share. The Unwinding Agreements were placed into escrow upon
signing in April 2001 and became effective upon their release from escrow on
July 3, 2001.
In January 1999, OTI made a minority investment in Sterling
Construction Company, Inc., which in connection with the renaming of the Company
was itself renamed Sterling Houston Holdings, Inc. (hereinafter referred to as
"SHH") in November 2001. SHH is a heavy civil construction company based in
Houston, Texas that specializes in municipal and state contracts for highway
paving, bridge, water and sewer, and light rail projects. In October 1999 SHH
achieved certain growth objectives that triggered the right of certain
shareholders of SHH to exercise their right to sell a second tranche of equity
to OTI. Cash for the second equity purchase was obtained
2
through the issuance by OTI of notes (secured by the second equity tranche), of
which a part was issued to two officers and directors of Sterling, and the
remainder was issued to certain directors and members of the management of SHH.
These notes were restructured as part of a transaction in July 2001 (the
"Sterling Transaction"), in which Sterling further increased its equity position
in SHH from 12% to 80.1%. The original investments were recorded as an
investment using the cost method. The subsequent acquisition in July 2001
resulted in step-acquisition treatment of the original investments.
In November 2001, the Company changed its fiscal year end from the last
day of February to December 31. Accordingly, this report covers the fiscal year
from January 1, 2002 through December 31, 2002, ("Fiscal 2002"). The transition
period from March 1, 2001 to December 31, 2001 is referred to as "Fiscal 2001".
Prior fiscal years are referred to as "Fiscal 2000" (the twelve months ended
February 28, 2001); "Fiscal 1999" (the twelve months ended February 29, 2000)
and "Fiscal 1998" (the twelve months ended February 28, 1999).
The name changes referred to above were effected in order to better
reflect the change of focus of the Company. The Company reports two operating
segments, "Construction", which consists of the operations of SHH, and
"Distribution" which consists of the operations of SCPI. After the transfer of
its assets and liabilities to the Company, OTI was dissolved in December 2001.
See Note 15 to the Consolidated Financial Statements for additional segment
information.
STERLING HOUSTON HOLDINGS, INC. ("SHH")
BACKGROUND
SHH was founded in Michigan in 1955 by two brothers, James and Richard
Manning. In 1978, SHH relocated its business to Houston, Texas to participate in
the rapid economic and population growth in that region. SHH is now one of the
largest regional contractors of its kind in the Houston market engaged in the
construction of underground sanitary sewers, water mains, storm sewers and
paving. Recently, SHH expanded its business to include construction of portions
of a light rail system in the City of Houston.
In addition to its established operations in Houston, SHH has operated
in the Dallas/Fort Worth market for several years, and in 1999 entered the San
Antonio market. SHH is primarily engaged in working for local and county
municipalities and agencies, and to a lesser extent, the State of Texas. SHH
also occasionally undertakes projects for private developers and corporate
customers.
In September 2002, a wholly-owned subsidiary of SHH, Texas Sterling
Construction, L.P. ("TSC") acquired the Kinsel Heavy Highway construction
business (the "Kinsel Business") from a subsidiary of Insituform Technologies,
Inc. ("ITI"). The acquisition included the purchase of construction equipment at
its appraised value of approximately $4.4 million, and the assumption by TSC of
equipment operating leases with a future obligation of approximately $1.4
million. Certain unstarted construction contracts with revenues estimated at $38
million, subject to post-closing adjustments, were assigned to TSC. TSC has been
engaged to manage the completion of certain other contracts in return for a
management fee, and has hired most of Kinsel's construction crews together with
project managers and other supervisory personnel. The consideration of $4.4
million for the Kinsel Business was financed by TSC through the issuance to ITI
of two unsecured two-year notes aggregating $1.5 million, with the balance
funded through additional borrowings under the SHH revolving line of credit.
The size of the acquisition and the amount of assets acquired were not
material in relation to the Company's overall business. No goodwill was
recognized in the Kinsel Business transaction.
OPERATIONS
Most of the revenues of SHH are generated through the Houston municipal
market, which includes the City of Houston, the Houston Metropolitan Transit
Authority and Harris County. In 1999, SHH entered the state highway business, a
market that is expected to benefit from growth in federal highway spending.
3
SEASONALITY
Operations of SHH can be materially affected by poor weather
conditions, so that generally less construction business is completed in the
winter months. In particular, significant rainfall can cause construction delays
affecting revenues and margins on contracts in progress.
CUSTOMER BASE
SHH principally bids for contracts offered by local, city and county
municipalities and agencies, including the City of Houston, the Houston
Metropolitan Transit Authority, Harris County and the State of Texas. Major
customers also include the cities of San Antonio, Fort Worth and Dallas, and
suburban communities in these regions. Except for a limited amount of private
work, most contracts are subject to a competitive public tender process.
There are no foreign sales.
The following table shows contract revenues generated from SHH's
largest customers which accounted for more than 10% of consolidated revenues in
fiscal 2002:
Fiscal year ended Fiscal year ended
December 31, 2002 December 31, 2001
----------------------- -----------------------
Contract % of Contract % of
Revenues Revenues Revenues Revenues
City of Houston $26,044 23.3% $18,252 27.6%
Houston Metropolitan
Transit Authority $51,821 46.4% $15,593 23.6%
The above amounts reflect a large number of separate contracts for each
customer, each contract being obtained through a competitive bidding process.
BACKLOG
At December 31, 2002, the backlog at SHH totaled approximately $138
million. Of this amount, approximately $95 million is forecast to be completed
within fiscal 2003, and approximately $43 million is to be completed in fiscal
2004 and beyond. SHH expects to add further contracts during 2003 for
construction during that year.
COMPETITION
The typical public contract selection process is by sealed bid with the
lowest bidder winning in a public selection process. SHH undertakes a
significant due diligence process in preparing each bid. Participants must post
bid bonds for up to 10% of the amount bid, and on successful bids must post
performance bonds for 100% of the contract amount. Contracts are priced for
labor, sub-contracting and materials against detailed specifications provided by
the customer.
SHH's competitors include large national and regional construction
companies as well as smaller contractors. Management is unable to determine the
relative size of most competitors, which are privately-owned, but believes that
SHH is one of the larger participants in its marketplace, and the largest non
state-highway contractor in Houston that is engaged in municipal civil
construction work.
4
SHH's size relative to its many smaller competitors in the municipal
construction market gives it several advantages, including greater flexibility
to manage its backlog to maximize its manpower and equipment resources, and the
cost effective purchasing of materials, insurance and bonds. Since SHH owns most
of the equipment required for such contracts and has the experienced manpower to
handle all types of municipal civil construction, it is able to bid
competitively on many categories of contracts, especially complex multi-task
projects. In state highway work, SHH has encountered some difficulty in
penetrating the market, where most competitors are large, regional contractors,
due to the larger size of individual contracts and the different range of
specialized skills required as compared with its traditional municipal
contracts.
With the completion of the acquisition of the Kinsel Business in
September 2002, SHH added over 100 employees, including several key personnel
with specialized skills and over 150 pieces of construction equipment which will
enable SHH to compete on a more equal footing in the State Highway market.
REGULATION
Management does not anticipate that existing or known pending
environmental legislation or other regulations will require major capital
expenditures or will adversely affect its operations. However, in the last two
years environmental issues have adversely impacted the rate at which certain
highway contracts have been let in the Houston market.
EMPLOYEES
SHH employs approximately 750 persons, of whom 29 are employed in the
headquarters in Houston. Most of the others are field personnel. No SHH
employees are represented by a labor union. Senior executives, including Patrick
Manning (also Chief Executive Officer of Sterling) and Joseph Harper (also
President of Sterling) have many years of service with SHH and are employed
under long-term contracts.
STEEL CITY PRODUCTS, INC. ("SCPI")
BACKGROUND
SCPI was incorporated in West Virginia in 1959 and in 1963 became known
as Heck's, Inc. Prior to 1990, Heck's Inc. operated a Retail Division consisting
of a chain of discount department stores. In September 1990, all of the assets
of the Retail Division were sold to Retail Acquisition Corp. ("RAC").
SCPI was reincorporated in Delaware under the name Hallwood Industries
Incorporated in fiscal 1991. The name was changed to Steel City Products, Inc.
in fiscal 1993.
The Steel City Products automotive accessories distribution business
was founded in 1947 and was acquired by SCPI in 1969. In fiscal 1996, SCPI
expanded its business to include the distribution of non-food pet supplies and
in fiscal 2000 SCPI broadened its distribution business further to include lawn
and garden supplies.
OPERATIONS
For many years SCPI distributed only automotive accessories, including
functional and decorative car and truck accessories, car care products,
chemicals and car repair and maintenance items. In fiscal 1996, SCPI expanded
its merchandise selection to include non-food pet supplies and in fiscal 2000
added lawn and garden products. Although these products were not typical of
SCPI's historical merchandise mix, management determined that the availability
of existing customers which sell pet supplies and lawn and garden products in
addition to automotive accessories, combined with SCPI's distribution expertise
and infrastructure, offered opportunities to increase sales. Sales in fiscal
2002 of pet supplies and lawn and garden products represented approximately 21%
and 11%, respectively, of SCPI's total sales. SCPI's automotive and pet
distribution operations are conducted in leased facilities in McKeesport,
Pennsylvania and its lawn and garden operations are conducted in leased
facilities in Glassport, Pennsylvania.
5
Historically, much of SCPI's business has been performed on a service
basis, which involves visits by its sales personnel to customers' stores to
count and re-order merchandise. Generally, these re-orders are transmitted
electronically to SCPI's central offices. In recent years a growing proportion
of its customers electronically transmit their own orders to SCPI's
headquarters. Since many orders are generated electronically and are shipped
within a few days of receipt, the size of SCPI's order backlog is not relevant
to an understanding of the business. Shipments are either made directly to each
of the customers' stores or are packed for onward shipment to stores via the
retailers' own distribution centers. SCPI also provides price ticketing and
associated services to those of its customers who request such services.
SOURCES OF SUPPLY
SCPI acquires its merchandise from a large number of suppliers, the
largest of which accounted for 13.5% of its purchases for the fiscal year ended
December 31, 2002. Many of the products sold by SCPI carry nationally-advertised
brand names, but because of the diversity and number of suppliers and products
carried, the business is not generally dependent on the continued availability
of individual products or continued dealings with existing supply sources. From
time to time, market or seasonal conditions may affect the availability of
certain merchandise, but not to the extent that the Company believes would
materially impact its business.
Steel City Products generally carries in inventory only those products
that its customers have identified as necessary for their own merchandising
needs and does not acquire significant quantities of other merchandise.
SEASONALITY
SCPI's automotive and lawn and garden businesses are seasonal, being
slowest in the early winter months than at other times of the year. In
anticipation of higher sales volume in the spring and summer, SCPI carries
higher inventories of these products beginning in the winter months. As is
customary in the automotive aftermarket and in the lawn and garden business,
some suppliers allow extended payment terms to SCPI for such inventory
build-ups.
SCPI's pet supply business experiences different seasonal trends from
the automotive and lawn and garden businesses, but the effect of this is not
material to the overall business.
SCPI's needs for working capital are affected by these seasonal
fluctuations and other factors (see Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources").
CUSTOMER BASE
SCPI's customers include supermarket chains, drug stores, general
merchandise retail chains, automotive specialty stores, hardware stores, variety
stores and other automotive accessory distributors. Most customers are based in
the northeastern United States, although stores operated by some customers are
located outside of that area, and in February 2000 SCPI began selling to the
west coast distribution facility of one of its major customers. There are no
foreign sales.
SCPI's customers are continually affected by changes in the retail
environment, including the competitive pressures facing regional mass
merchandisers and the growing influence of national automotive specialty chains.
These have led to fluctuations in the level of business that SCPI enjoys with
individual customers. Some customers have changed their buying practices to
acquire certain merchandise direct from manufacturers rather than through
distributors such as SCPI.
In its efforts to offset these trends, SCPI has in recent years added
new customers, especially in the supermarket and drug store sectors, has
expanded its product offerings to certain customers, has enlarged the territory
that it serves and has introduced new categories of products. Management
believes that these efforts have
6
resulted in a more diverse and financially
secure customer base. However, in August 2001 SCPI's largest remaining discount
chain customer, Ames Department Stores ("Ames"), filed for Chapter 11 bankruptcy
protection and in July 2002, liquidated its remaining business.
SCPI's sales in fiscal 2002 represented 17% of the Company's
consolidated sales. Reflecting the acquisition of SHH in July 2001, no single
customer of SCPI accounted for more than 10% of Sterling's consolidated revenues
in fiscal 2002. However, prior to the completion of the Sterling Transaction in
July 2001, sales at SCPI represented 100% of consolidated revenues. The
following table shows sales to SCPI's customers that individually accounted for
more than 10% of SCPI's sales during the last three fiscal years (dollars in
thousands):
Fiscal Year 2002 Ended Fiscal Year 2001 Ended Fiscal Year 2000 Ended
December 31, 2002 December 31, 2001 February 28, 2001
------------------------ ------------------------ ----------------------
(ten months)
Sales % of Sales Sales % of Sales Sales % of Sales
Warehouse Sales $3,711 16% $2,193 13% * *
Kroger $3,591 16% $2,758 16% $2,057 10%
Ames $2,918 13% $3,217 18% $3,746 18%
Giant Eagle $2,959 13% $2,313 13% $2,055 10%
American Sales * * $1,863 11% * *
*represents less than 10% of sales
In August 2001, Ames filed for Chapter 11 protection. SCPI continued to
ship to Ames as a debtor-in-possession under strict payment terms. Pre-petition
sales to Ames during fiscal 2001 (mostly of automotive products) totaled $1.5
million, of which approximately $680,000 was unpaid at the time of Ames
bankruptcy filing. Sales to Ames in fiscal 2002 prior to its liquidation in
July, aggregated $2.9 million, with the increase primarily attributable to sales
of pet supplies.
SCPI's five largest customers accounted for approximately two-thirds of
its total revenues in fiscal 2002. Management has no reason to believe that its
business with any of these customers will be terminated in the foreseeable
future, as evidenced by the continuing increases in sales to each of them,
except Ames. In the event that one of its largest customers ceased doing
business with SCPI, the resulting reduction in revenues could significantly
reduce profitability, unless a replacement customer is obtained.
None of SCPI's business is based on government contracts and there are
no long-term sales contracts with any customers.
COMPETITION
The distribution business for automotive parts and accessories,
non-food pet supplies and lawn and garden products is highly competitive, with
several similar companies operating in SCPI's market place, and many of SCPI's
suppliers also offer their products directly to retailers. Management is unable
to quantify SCPI's relative size in relation to its competitors but believes it
is one of the larger independent distributors of automotive accessories in the
Northeastern United States. In recent years, a number of significant competitors
of SCPI have gone out of business and some of SCPI's customers have chosen to
purchase some products directly from manufacturers. SCPI competes on the basis
of its management's merchandise expertise, the breadth of merchandise offered,
price, levels of service, order fill rates and order turnaround times.
Management believes that SCPI's long history, good reputation, experienced
management, product selection, pricing, service levels and traditionally high
order fill rates enable it to compete favorably with other distributors.
REGULATION
SCPI's management does not anticipate that existing or known pending
environmental legislation or other regulations will require major capital
expenditures or will affect its operations.
7
EMPLOYEES
SCPI employs approximately 50 persons, of which about 40 are employed
in the headquarters office and distribution facility in McKeesport and the
Glasport distribution facility. The others are field personnel. Senior
executives, including the Chairman of the Board of Directors, Bernard H. Frank
(a founder of Steel City Products), the President and Chief Executive Officer,
Terrance W. Allan and the Vice President of Sales, Patrick Nicholson, have many
years of service with SCPI. Mr. Allan is employed under a long-term contract.
Warehouse and certain office employees of SCPI are represented by Local
636 of the International Brotherhood of Teamsters. SCPI has experienced
generally good labor relations and no significant labor disputes have affected
its business for many years. The union contract was renewed in November 1999 for
a three-year term through November 2002, and has been extended since November
2002 while renewal negotiations continued.
DISCONTINUED OPERATIONS - DOWLING'S FLEET SERVICE CO., INC.
Dowling's Fleet Service Co., Inc. was acquired by the Company in fiscal
1994 and was historically one of the largest regional distributors of
aftermarket automotive radiators in the northeastern United States. In
subsequent years, the radiator replacement market underwent significant changes,
including aggressive competition, industry consolidation and direct selling by
manufacturers to installers, and operating results at Dowling's declined. In
fiscal 1998, Dowling's reported a loss of approximately $400,000 and the
Company's Board of Directors decided to dispose of the business. In June 2000,
the Company entered into an agreement to dispose of Dowling's through its merger
with an importer of radiators for consideration equivalent to the amount owed at
the merger closing by Dowling's under its revolving credit agreement. The
closing took place on November 29, 2000.
ITEM 2. PROPERTIES
In June 2001, SHH relocated its headquarters in Houston from leased
facilities to a purpose-built, owned 15,000 square-foot building located on a
seven-acre parcel on which its equipment repair center is also located. It also
leases small offices in Grand Prairie, Texas and San Antonio.
Since December 1997, SCPI has operated its automotive and pet supply
businesses from a leased, 67,000 square-foot building located in an industrial
park in McKeesport, Pennsylvania. With the addition of the lawn and garden
distribution business, SCPI leased an additional 43,000 sq. ft. of warehouse
space located in an industrial park in nearby Glassport, Pennsylvania,
commencing in December 2000.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings pending against the Company or
to which the Company is a party or to which any of its property is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Meeting of Shareholders on October 17,
2002. Shareholders re-elected each of the two Class I directors to serve for a
term of three years. The following table lists the number of votes cast for,
against or withheld for each matter and nominee, as well as the number of
abstentions and broker non-votes relating thereto:
8
Matter For Against Withheld Abstentions Broker
non-votes
Election of directors:
Joseph P. Harper 2,977,630 690 -- -- --
Patrick T. Manning 2,977,630 690 -- -- --
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock was listed and traded on the Nasdaq
Small-Cap Market under the symbol OAKC until February 10, 1998, when the Common
Stock was delisted from trading. The delisting was a result of the fall in the
Company's stock to below the Nasdaq minimum closing bid price of $1.00 per share
and the fall in the Company's net tangible assets to below Nasdaq's minimum
maintenance requirements. Commencing February 11, 1998, the Company's Common
Stock began trading on the OTC Bulletin Board, under the symbol OAKC.OB. As a
result of the Company's change of name in November 2001, the stock symbol on the
OTC Bulletin Board was changed to STCS.OB.
The following table sets forth the high and low bid prices by fiscal
quarter for the Company's common stock for fiscal years 2002 and 2001.
Fiscal 2002 Fiscal 2001
Quarterly High Quarterly Low Quarterly High Quarterly Low
Quarter 1 $1.85 $1.48 $0.78 $0.75
Quarter 2 $2.05 $1.50 $1.50 $0.75
Quarter 3 $2.08 $1.60 $1.64 $1.25
Quarter 4 $1.95 $1.58 $1.70 $1.63
* Due to the Company's change of fiscal year end from the last day of February
to December 31, the fourth quarter of fiscal 2001 consisted of one month.
Such quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.
There were approximately 3,600 holders of record of the Company's
common stock on March 1, 2003.
No cash dividends were declared or paid in fiscal 2002, 2001 or 2000.
The Company does not anticipate the declaration of cash dividends in the
foreseeable future. The ability of the Company's operating subsidiaries, SHH and
SCPI, to upstream funds to Sterling for payment of dividends is limited by their
respective bank credit agreements.
9
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial and other data of
Sterling Construction Company, Inc. (formerly Oakhurst Company, Inc.) and
subsidiaries and should be read in conjunction with Management's Discussion and
Analysis of Financial Condition and Results of Operations, which follows, and
the Consolidated Financial Statements and related Notes.
Fiscal 2001 December Fiscal 1999 Fiscal 1998
Fiscal 2002 December 31, 2000 Fiscal 2000 February February
December 31, 2001 (ten February 28, 29, 28,
31, 2002 (c) (d) months) 2001(a)(d) 2000(a)(d) 1999(a)(d)
----------- (ten months) (unaudited) ------------ ----------- -----------
------------ -----------
Dollar and share amounts in thousands, except per share data
Operating results:
Revenues ............................... $ 134,317 $ 66,121 $ 17,256 $ 20,694 $ 20,142 $ 18,092
========= ======== ======== ======== ======== ========
Income (loss) from continuing
operations before income ............... $ 4,345 $ (1,965) $ (4,774) $ (7,044) $ (2,517) $ (804)
taxes
Minority interest (e) .................. (873) (647) -- -- -- --
--------- -------- -------- -------- -------- --------
Current income tax expense ............. (14) (14) (5) (27) (10) (8)
Deferred income tax benefit (b) ........ 1,264 -- -- -- -- --
--------- -------- -------- -------- -------- --------
Income (loss) from continuing
operations ............................. 4,722 (2,626) (4,779) (7,071) (2,527) (812)
Income (loss) from discontinued
operations(a) .......................... -- -- 399 399 (2,456) (185)
--------- -------- -------- -------- -------- --------
Net income (loss) ...................... $ 4,722 $ (2,626) $ (4,380) $ (6,672) $ (4,983) $ (997)
========= ======== ======== ======== ======== ========
BASIC AND DILUTED PER SHARE AMOUNTS:
Basic earnings (loss) per share
from continuing operations ............. $ 0.93 $ (0.52) $ (0.97) $ (1.43) $ (0.51) $ (0.16)
Basic earnings (loss) per share
from discontinued operations ........... $ -- $ -- $ 0.08 $ 0.09 $ (0.49) $ (0.05)
--------- -------- -------- -------- -------- --------
Basic earnings (loss) per share ........ $ 0.93 $ (0.52) $ (0.89) $ (1.34) $ (1.00) $ (0.21)
========= ======== ======== ======== ======== ========
Basic weighted average shares .......... 5,062 5,056 4,943 4,943 4,943 4,943
========= ======== ======== ======== ======== ========
outstanding
Diluted earnings (loss) per share
from continuing operations ............. $ 0.78 $ (0.52) $ (0.97) $ (1.43) $ (0.51) $ (0.16)
Diluted earnings (loss) per share
from discontinued operations ........... $ -- $ -- $ 0.08 $ 0.09 $ (0.49) $ (0.05)
--------- -------- -------- -------- -------- --------
Diluted earnings (loss) per share ...... $ 0.78 $ (0.52) $ (0.89) $ (1.34) $ (1.00) $ (0.21)
========= ======== ======== ======== ======== ========
Diluted weighted average shares
outstanding ............................ 6,102 5,056 4,943 4,943 4,943 4,943
========= ======== ======== ======== ======== ========
Cash dividends declared ................ $ (0.00) $ (0.00) $ (0.00) $ (0.00) $ (0.00) $ (0.00)
========= ======== ======== ======== ======== ========
BALANCE SHEET STATISTICS:
Total assets ........................... $ 72,757 $ 59,138 $ 17,103 $ 16,507 $ 21,952 $ 16,925
Long-term obligations .................. $ 34,323 $ 30,241 $ 17,965 $ 4,633 $ 13,428 $ 8,254
Book value per share of common stock ... $ 2.14 $ 1.21 $ (1.50) $ (2.01) $ (0.66) $ 0.34
(a) In fiscal 1999, the decision was made to dispose of Dowling's. Results
of operations for fiscal 1999 reflect a loss on the disposal of $2.0
million, relating primarily to the write-off of goodwill, together with
an operating loss of $428,000. Results for Dowling's have been
presented as discontinued operations for all periods shown. Upon
completion of the sale of Dowling's in fiscal 2000, the Company
recorded income of $399,000.
(b) In December 2001, the Company again recorded a deferred tax asset that
exceeded its valuation allowance (see Note 7 to the Consolidated
Financial Statements). The asset was reassessed in fiscal 2002
resulting in a tax benefit of $1.2 million.
(c) In November 2001, the Board of Directors of the Company voted to change
its fiscal year end from the last day of February to December 31.
Accordingly, results for Fiscal 2001 are for the ten month period March
1 to December 31, 2001.
10
(d) In July 2001, the Company increased its percentage ownership in SHH
from 12% to 80.1%. The original investments were recorded using the
cost method. The subsequent acquisition in July 2001 resulted in
step-acquisition treatment of the original investments. Fiscal 2000,
1999 and 1998 have been restated to reflect this treatment.
(e) Minority interest represents the 19.9% of SHH not owned by the Company.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The corporate structure resulting from the 1991 merger, whereby Steel
City Products, Inc. ("SCPI") became a special, limited purpose, majority-owned
subsidiary of Oakhurst Company, Inc. ("Oakhurst"), since renamed Sterling
Construction Company, Inc. (hereinafter referred to as "Sterling") was designed
to facilitate capital formation by Sterling while permitting Sterling and SCPI
to file consolidated tax returns so that both may utilize existing tax benefits,
including approximately $110 million of net operating loss carry-forwards.
Through Sterling's ownership of SCPI, primarily in the form of preferred stock,
Sterling retains the value of SCPI and receives substantially all of the benefit
of SCPI's operations through dividends on such preferred stock.
Sterling's principal business historically has been the distribution of
products to the automotive aftermarket, described herein as the "Distribution
Segment". The one remaining automotive distribution business (following the
disposal of Dowling's Fleet Service Company, Inc. in fiscal 2000, see below) is
conducted by SCPI under the trade name "Steel City Products" and involves the
distribution of automotive parts and accessories, non-food pet supplies and lawn
and garden products from facilities in McKeesport and Glassport, Pennsylvania.
SCPI is believed to be one of the largest independent wholesale distributors of
automotive accessories in the Northeastern United States.
Dowling's, a New York-headquartered distributor of automotive radiators
and related products, was acquired by Sterling in August 1994 for an aggregate
purchase price of $4.7 million. Due to operating losses at Dowling's of
approximately $400,000 in fiscal 1999, the Company's Board of Directors decided
to dispose of the business. In June 2000, the Company disposed of Dowling's
through a merger with an importer of radiators. The merger closed on November
29, 2000. The statement of operations for fiscal 2000 reflects a gain of
$399,000 from discontinued operations as a result of the completion of the
disposal of Dowling's.
Representing a significant change from its historical operating
business, in December 1998, Sterling formed a wholly-owned subsidiary, Oakhurst
Technology, Inc. ("OTI") to invest in New Heights Recovery and Power, LLC ("New
Heights") which was to become a fully integrated recycling and waste-to-energy
facility in Ford Heights, Illinois. In conjunction with OTI's funding commitment
to New Heights, Sterling entered into certain agreements with KTI, Inc. ("KTI")
(which subsequently merged into Casella Waste Systems, Inc., "Casella")
regarding the funding of capital improvements and start-up losses at New
Heights.
Due to significant and continuing losses incurred at New Heights, and
Casella's decision to exit certain non-core activities, of which New Heights was
deemed one, in April 2001 certain agreements (the "Unwinding Agreements") were
signed among the Company, OTI, Casella and KTI pursuant to which (a) all of
OTI's equity interest in New Heights was transferred to KTI, (b) the Sterling
common stock held by KTI was transferred to the Company, (c) all securities
pledged to KTI by the Company and/or OTI were released, (d) the KTI Loan,
including accrued interest thereon, aggregating approximately $16.1 million was
cancelled, with the exception of $1 million, which sum was converted into a four
year subordinated promissory note bearing interest at 12%, and (e) the Company
issued to KTI a ten-year warrant to purchase 494,302 shares of the Company's
common stock at $1.50 per share. The Unwinding Agreements were placed into
escrow upon signing in April 2001 and became effective upon their release from
escrow on July 3, 2001.
In January 1999 OTI made a minority investment in Sterling Construction
Company, Inc., since renamed Sterling Houston Holdings, Inc. ("SHH"). SHH is a
heavy civil construction company based in Houston that specializes in municipal
and state contracts for highway paving, bridge, water and sewer, and light rail,
herein described as the "Construction Segment". Upon reaching certain
performance objectives, in October 1999 certain Sterling shareholders exercised
their right to sell a second tranche of equity to OTI. Cash for the second
equity purchase was obtained through the issuance of notes (secured by such
equity) of which $559,000 was due to Robert Davies, then the Company's Chairman
and CEO. Under a Participation Agreement, Maarten Hemsley, then the Company's
President and CFO, funded $116,000 of the amount advanced by Mr. Davies pursuant
to such
12
Promissory Note. These notes were restructured as part of the Sterling
Transaction in July 2001 whereby the Company increased its equity percentage in
SHH from 12% to 80.1%.
As the prior investment in SHH of $2.7 million accounted for less than
20% of SHH, the Company accounted for the investment under the cost method. The
acquisition in July 2001 resulted in step-acquisition treatment of the prior
balance. Accordingly, the results of operations of the Company have been
restated to reflect its ownership of SHH as if it had been reported as an equity
investment for fiscal 2001 and fiscal 2000. Equity investment income generated
by SHH for fiscal 2001 and 2000 was $63,000 and $260,000, respectively. In
addition, goodwill expense of $25,000 and $51,000 was recorded as part of the
step acquisition in fiscal 2001 and 2000, respectively.
Pursuant to the terms of the Sterling Transaction, in July 2001 Patrick
T. Manning, President and Chief Executive Officer of SHH was appointed a
director and Chairman and Chief Executive Officer of the Company and Joseph P.
Harper, Chief Financial Officer and Treasurer of SHH was appointed a director
and President of the Company. Robert W. Frickel and Christopher H.B. Mills were
also appointed to the Board at that time. Robert M. Davies, former Chairman and
Chief Executive Officer, remained a director of the Company, Maarten D. Hemsley
continues as Chief Financial Officer and a director of the Company and John D.
Abernathy remains a director of the Company. All incumbent directors were
re-elected to the Board at the Annual Stockholders' Meeting held in October
2001. Also at that meeting stockholders approved the Company's name change to
more accurately reflect its current business. Messrs. Mark Auerbach, Bernard H.
Frank and Joel S. Lever resigned from the Company's Board upon completion of the
Sterling Transaction.
In September 2002, a wholly-owned subsidiary of SHH, Texas Sterling
Construction, L.P. ("TSC") acquired the Kinsel Heavy Highway construction
business (the "Kinsel Business") from a subsidiary of Insituform Technologies,
Inc. ("ITI"). The acquisition included the purchase of construction equipment at
its appraised value of approximately $4.4 million, and the assumption by TSC of
equipment leases with a future obligation of approximately $1.4 million. Certain
unstarted construction contracts with revenues estimated at $38 million, subject
to post-closing adjustments, were assigned to TSC. TSC has been engaged to
manage the completion of certain other contracts in return for a management fee,
and hired most of Kinsel's construction crews together with project managers and
other supervisory personnel. The consideration of $4.4 million for the Kinsel
Business was financed by TSC through the issuance to ITI of two unsecured
two-year notes aggregating $1.5 million, with the balance funded through
additional borrowings under the SHH revolving line of credit.
Each of the Distribution Segment and the Construction Segment is
managed by its own decision makers and is comprised of different customers,
suppliers and employees. Terry Allan, President of SCPI and Maarten Hemsley, the
Chief Financial Officer of the Company, review the operating profitability of
the Distribution Segment and its working capital needs to allocate financial
resources. The operating profitability and capital expenditure requirements of
the Construction Segment are reviewed by Joseph Harper, the Company's President
and the Chief Financial Officer of SHH, to determine its financial needs.
Allocation of resources among the Company's operating segments is determined by
Messrs. Harper and Hemsley, subject to the terms of each of the Construction
Segment and the Distribution Segment's bank covenants which affect upstreaming
of funds to the Company.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and 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. Management's estimates,
judgments and assumptions are continually evaluated based on available
information and experience, however actual amounts could differ from those
estimates. The Company's significant accounting policies are described in Note 1
of the Notes to Consolidated Financial Statements.
13
Certain of the Company's accounting policies require higher degrees
of judgment than others in their application. These include the recognition of
revenue and earnings from construction contracts and the valuation of long-term
assets. Management evaluates all of its estimates and judgments on an on-going
basis.
Revenue Recognition: The Company uses the percentage of completion
accounting method for construction contracts in accordance with the American
Institute of Certified Public Accountants Statement of Position 81-1,
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts." Revenue and earnings on construction contracts are recognized on the
percentage of completion method in the ratio of costs incurred to estimated
final costs. Provisions are recognized in the statement of income for the full
amount of estimated losses on uncompleted contracts whenever evidence indicates
that the estimated total cost of a contract exceeds its estimated total revenue.
Factors that can contribute to changes in estimates of contract
profitability include, without limitation, site conditions that differ from
those assumed in the original bid to the extent that contract remedies are
unavailable, the availability and skill level of workers in the geographic
location of the project, the availability and proximity of materials, the
accuracy of the original bid, inclement weather and timing and coordination
issues inherent in all projects, including design/build. Contract cost consists
of direct costs on contracts; including labor and materials, amounts payable to
subcontractors, direct overhead costs and equipment expense (primarily
depreciation, fuel, maintenance and repairs). Depreciation is provided using
straight-line methods for construction equipment. Contract cost is recorded as
incurred and revisions in contract revenue and cost estimates are reflected in
the accounting period when known. If the Company projects a loss on a project
the estimated loss is immediately recognized. Claims for additional contract
revenue are recognized if it is probable that the claim will result in
additional revenue and the amount can be reliably estimated. The foregoing as
well as weather, stage of completion and mix of contracts at different margins
may cause fluctuations in reported gross profit between periods and these
fluctuations may be significant.
A significant portion of the Construction Segment's revenues is
derived from contracts that are "fixed unit price" under which the Company is
committed to provide materials or services required by a project at fixed unit
prices (for example, dollars per cubic yard of concrete or cubic yards of earth
excavated). Other contracts, including most design-build contracts, are priced
on a lump-sum basis under which the Company bears the risk that it may not be
able to perform all the work for the specified amount. All government contracts
and many of the Company's other contracts provide for termination of the
contract for the convenience of the party contracting with the Company, with
provisions to pay the Company for work performed through the date of
termination.
The construction industry is highly competitive and lacks firms with
dominant market power. A substantial portion of the Company's business involves
construction contracts obtained through competitive bidding. The volume and
profitability of the Company's construction work depends to a significant extent
upon the general state of the economies of Texas and especially the Houston area
and the volume of work available to contractors. The Company's construction
operations could be adversely affected by labor stoppages or shortages, adverse
weather conditions, shortages of supplies or other governmental action.
Valuation of Long-Term Assets: Long-lived assets, which include
property, equipment and acquired identifiable intangibles, are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Impairment evaluations
involve management estimates of useful asset lives and future cash flows. Actual
useful lives and cash flows could be different from those estimated by
management and this could have a material effect on operating results and
financial position. Additionally, the Company had approximately $7.8 million in
goodwill at December 31, 2002, which must be reviewed for impairment at least
annually in accordance with Statement of Financial Accounting Standards No. 142
("SFAS 142"). The Company completed its initial impairment review for its
goodwill in the first half of 2002 which did not result in an impairment charge.
The impairment testing required by SFAS 142 requires considerable judgment and
there can be no assurance that an impairment charge will not be required in the
future. The Company completed its annual impairment review for goodwill
effective October 2002. The results of the review did not reveal impairment of
goodwill.
14
Deferred Taxes: Deferred tax assets and liabilities are recognized
based on the differences between the financial statement carrying amounts and
tax bases of assets and liabilities. The Company regularly reviews its deferred
tax assets for recoverability and establishes a valuation allowance based upon
historical losses, projected future taxable income and the expected timing of
the reversals of existing temporary differences. As a result of this review and
the related SHH acquisition, the Company reduced the valuation allowance against
the deferred tax asset related to the estimated utilization of the net operating
losses.
LIQUIDITY AND CAPITAL RESOURCES
At SHH, the level of working capital varies principally as a result of
changes in the levels of cost and estimated earnings in excess of billings, and
in billings in excess of cost and estimated earnings. SHH's cash requirements
are also impacted by its needs for capital equipment, which have generally been
financed from cash flow or from borrowings under its lines of credit.
At SCPI, the level of working capital needs varies primarily with the
amounts of inventory carried, which can change seasonally, the size and
timeliness of payment of receivables from customers and the amount of credit
extended by suppliers. SCPI's working capital needs not financed by suppliers
have been financed from cash flow and borrowings under its line of credit.
FINANCING
At December 31, 2002, the Company's debt consisted of (in thousands):
Related party notes:
Subordinated debt $3,500
Subordinated zero coupon notes 5,917
Convertible subordinated note 560
Management/director notes 2,046
-------
12,023
SHH revolver 14,010
SCPI revolver 2,616
Insituform Notes 1,400
Mortgage payable 1,265
KTI loan 1,156
Equipment notes and capital leases 108
Other 28
-------
$32,606
Related Party Notes
Subordinated Debt
As part of the Sterling Transaction, certain shareholders of SHH were
issued subordinated promissory notes by SHH in the aggregate amount of $6
million in payment for certain of their SHH shares. These notes are repayable
over three years in equal quarterly installments and carry interest at 12% per
annum.
Subordinated Zero Coupon Notes
The Sterling Transaction was funded in part through the sale of zero
coupon notes combined with the issuance of zero coupon notes to certain selling
shareholders of SHH. Warrants for Sterling common stock were issued in
connection with the zero coupon notes. The zero coupon notes are shown at their
present value, discounted at a rate of 12% and mature four years from the date
of closing of the Sterling Transaction. Warrants issued in connection with the
notes are exercisable for ten years from closing and become exercisable four
years
15
after issuance at $1.50 per share. Mr. Manning and Mr. Harper received zero
coupon notes in the face amount of $799,000 and $1.0 million, respectively and
warrants for 63,498 shares and 81,301 shares, respectively.
Management/Director Notes
Notes with an aggregate face amount of $1.3 million issued in
connection with the October 1999 purchase of the second equity tranche of shares
of SHH were restructured as part of the Sterling Transaction. Of the total,
notes for $800,000 were issued to several members of Sterling's management,
including Joseph P. Harper, since appointed the Company's President. Notes
totaling approximately $559,000 were due to Robert Davies, the Company's former
Chairman and Chief Executive Officer, and, through a participation agreement,
Maarten Hemsley, formerly the Company's President and now its Chief Financial
Officer. In consideration for the extension of the maturity dates of these
notes, the face amounts were increased by an aggregate of approximately
$342,000. Furthermore, certain amounts owed by the Company to Messrs. Davies and
Hemsley aggregating approximately $355,000 were converted into notes. All such
notes mature over four years and carry interest at 12% per year. Principal and
interest may be paid only from defined cash flow of Sterling and SCPI, or from
proceeds of any sale of SCPI's business.
SHH Revolver and SCPI Revolver
In conjunction with the Sterling Transaction, SHH entered into a
three-year agreement providing for a bank revolving line of credit with a
maximum line of $13.0 million, subject to a borrowing base (the "SHH Revolver").
The line of credit carries interest at prime, subject to achievement of certain
financial targets and is secured by the equipment of SHH. In September 2002,
upon the acquisition of the Kinsel heavy highway business, the SHH Revolver was
amended to provide for a maximum line of $17 million. At December 31, 2002, the
balance on the SHH Revolver was $14.0 million. In March 2003 SHH agreed with its
bank on a two-year extension of its bank revolving line of credit, until March
31, 2006. Reflecting recent strong cash flow and expected lower borrowing
requirements, the maximum amount available under the line is to be reduced, at
the request of SHH, to $14 million from $17 million.
Management believes that the SHH Revolver will provide adequate funding
for SHH's working capital, debt service and capital expenditure requirements,
including seasonal fluctuations for at least the next twelve months.
Due to concerns stemming from the filing for bankruptcy by SCPI's
institutional lender, and as a condition of the completion of the Sterling
Transaction, SCPI changed institutional lenders in July 2001 and entered into an
agreement for a two-year bank revolving line of credit in the amount of $5.0
million, subject to a borrowing base (the "SCPI Revolver"). The new revolver
originally carried an interest rate equal to prime plus 1%. Following the
bankruptcy filing in August 2001 of Ames Department Stores, a significant
customer of SCPI, which created a technical default under the terms of the
Revolver, it was amended in September 2001 to reduce the maximum borrowing level
to $3.75 million, increase the interest rate to prime plus 1.5%, and to
accelerate the maturity to April 30, 2002. Upon demonstrating SCPI's ability to
generate new business and maintain its relationships with customers and vendors,
in December 2001 the SCPI Revolver was again amended to restore the maximum
borrowing level of $5.0 million and to extend the term to May 2003. In fiscal
2002, the line of credit was further amended to extend the term to May 2004 and
to remove certain limitations on borrowing. At December 31, 2002, the
outstanding balance on the Revolver was $2.6 million and the effective rate of
interest was 5.75%. The SCPI Revolver is secured by the assets of SCPI and is
subject to the maintenance of certain financial covenants.
Convertible Subordinated Notes
In December 2001, in conjunction with the December 2001 amendment to
the SCPI Revolver and in order to strengthen SCPI's working capital position
through the purchase of additional inventory, Sterling obtained funding
principally from members of management and directors (including Messrs. Frickel,
Harper and Hemsley, who loaned $155,000, $100,000 and $25,000, respectively)
aggregating $500,000 (the "Convertible Subordinated
16
Notes"). In January 2002, two other members of management, including Bernard
Frank funded a further $60,000, which was used for general corporate purposes.
The notes evidencing these advances are convertible at any time prior to the
maturity date into the Company's common stock at a price of $2.50 per share and
mature and are payable in full in December 2004. Interest at an annual rate of
12% is payable monthly. The notes are senior to debt issued in connection with
the Sterling Transaction.
In January 2003, members of management of the Company and of SHH
(including Messrs. Harper and Hemsley) further funded SCPI with a short-term
loan to reduce SCPI's vendor payables in the aggregate amount of $250,000. The
notes, which are subordinate to the SCPI Revolver, mature in July 2003. Interest
at the annual rate of 10% is payable monthly. The notes may be prepaid without
penalty.
Management believes that the SCPI Revolver, proceeds from the
Convertible Subordinated Notes and the short-term loan of $250,000 made in
January 2003 by members of management of the Company will provide adequate
funding for SCPI's working capital, debt service and capital expenditure
requirements, including seasonal fluctuations for at least the next twelve
months, assuming no material deterioration in current sales or profit margins.
KTI Loan
In December 1998, Sterling entered into a loan agreement with KTI, Inc.
(the "KTI Loan") pursuant to which KTI committed to lend Sterling a minimum of
$11.5 million for capital expenditures and start-up losses incurred by New
Heights. The KTI Loan carried interest at a fixed rate of 14%, payable quarterly
and was due, by its original terms, in April 2001. The KTI Loan was secured by a
pledge of all the capital stock of OTI and all of OTI's equity interest in New
Heights.
Also in December 1998 the Company's subsidiary, OTI, entered into an
Investment Agreement with New Heights pursuant to which OTI agreed to fund
defined capital expenditures, costs of obtaining permits, start-up losses and
working capital of the New Heights waste-to-energy facility in Ford Heights,
Illinois, and to receive in return an initial 50% equity interest in New
Heights.
Pursuant to the Investment Agreement, KTI agreed to provide, directly
or through OTI as its affiliate, the funding required to satisfy the New Heights
Business Plan. Accordingly, KTI and Sterling entered into the KTI Loan. Funds
drawn by Sterling under the KTI Loan were invested in OTI, principally to
facilitate the financing of the New Heights Business Plan.
In July 2001, all except $1,000,000 of the KTI Loan and accrued
interest thereon was cancelled pursuant to the Unwinding Agreements, with the
balance converted to a four year subordinated loan, with interest of 12% due at
maturity. The face value of the KTI Loan has been accounted for to reflect a
reduction for the fair value of the approximately 494,000 warrants for the
Company's common stock issued to KTI, to be amortized over the life of the loan.
SHH Mortgage
In June 2001, SHH completed the construction of a new headquarters
building on land adjacent to its existing equipment repair facility in Houston.
The building was financed principally through an additional mortgage of $1.1
million on the land and facilities, at an interest rate of 7.75% per annum,
repayable over 15 years. The new mortgage is cross-collateralized with an
existing mortgage on the land and facilities which was obtained in 1998 in the
amount of $500,000, repayable over 15 years with an interest rate of 9.3% per
annum.
Insituform Note
In September 2002, a wholly-owned subsidiary of SHH acquired the Kinsel
Heavy Highway construction business from a subsidiary of Insituform
Technologies. The transaction was financed through the issuance of two unsecured
two-year notes aggregating $1.5 million to Insituform, with the balance funded
through additional
17
borrowings under the SHH Revolver. The Insituform Notes bear interest at 9% and
are payable in quarterly installments plus accrued interest thereon. The first
installment was due 90 days after the completion of the transaction and was paid
in December 2002.
Other Debt
In October 1998, SCPI obtained from the Redevelopment Authority of the
City of McKeesport a loan (the "Subordinated Loan"), subordinated to the SCPI
Revolver, in the amount of $98,000 and carrying interest at 5% per annum. The
loan, which funded leasehold improvements at SCPI, is being repaid in monthly
installments through October 2003.
CAPITAL EXPENDITURES
Capital expenditures made by Sterling and its subsidiaries during
fiscal 2002 totaled $4.3 million, consisting primarily of heavy construction
equipment and the equipment acquired through the Kinsel transaction at SHH.
TAX LOSS CARRY-FORWARDS
At December 31, 2002, SCPI and Sterling had net operating tax loss
carry-forwards (the "Tax Benefits") of approximately $110 million, which expire
in the years 2003 through 2021 and which shelter most income of SCPI, Sterling
or its subsidiaries from federal income taxes. A change in control of SCPI or
Sterling exceeding 50% in any three-year period may lead to the loss of the
majority of the Tax Benefits. In order to reduce the likelihood of such a change
of control occurring, SCPI's and Sterling's Certificates of Incorporation
include restrictions on the registration of transfers of stock resulting in, or
increasing, individual holdings exceeding 4.5% of each company's common stock.
Shareholdings over 5% resulting from the Sterling Transaction were approved by
the Company's Board following receipt of required opinions that these would not
adversely affect the availability of the Tax Benefits. The shareholdings
exceeding 5% held by Messrs. Davies and Hemsley include options, the exercise of
which is subject to a standstill agreement that provides that they may not be
exercised except with Board approval following an opinion that such exercise
will not adversely affect the availability of the Tax Benefits.
Since the regulations governing the Tax Benefits are highly complex and
may be changed from time to time, and since SCPI's and Sterling's attempts to
reduce the likelihood of a change of control occurring may not be successful,
management is unable to determine the likelihood of the continued availability
of the Tax Benefits. However, management believes that the Tax Benefits are
currently available in full and intends to take all appropriate steps to help
ensure that they remain available. Should the Tax Benefits become unavailable to
SCPI or Sterling, most of their future income and that of any consolidated
affiliate would not be shielded from federal taxation, thus reducing funds
otherwise available for corporate purposes (see Note 10 to the Consolidated
Financial Statements).
CASH FLOWS
Net cash provided by operations for the fiscal year ended December 31,
2002 was $5.1 million, an increase of $2.5 million compared with prior year. The
increase was due primarily to substantially improved cash flow from operations,
combined with higher levels of vendor payables and other accrued expenses,
offset by increases in accounts receivable and contracts receivable, due to
slower payment by customers.
Net cash provided by operations in fiscal 2001 increased from the prior
year by $2.8 million. The improvement was due to decreases in contracts and
accounts receivable and by increases in trade payables.
In fiscal 2002, cash used in investing activities was $6.9 million, a
decrease of $3.6 million from the prior year, which included $9.4 million
related to the acquisition of SHH in July 2001. In fiscal 2002, $2.7 million was
used by a subsidiary of SHH to purchase the Kinsel Business and the Company also
spent $4.3 million in capital
18
expenditures, compared with $1.2 million in the prior year. The capital
expenditures related mostly to purchase of heavy construction equipment at SHH.
Cash used in investing activities for the ten-month period ended
December 31, 2001 totaled $10.5 million, compared with $3.7 million for fiscal
2000. The increase primarily related to the acquisition of SHH.
Financing activities provided approximately $1.3 million in cash during
fiscal 2002, compared with approximately $10.7 million in fiscal 2001, which
included the acquisition of SHH and increases in the SHH Revolver. During fiscal
2002, Company repayments of the Subordinated Debt were $2.5 million.
For fiscal 2001 and fiscal 2000, the Company's financing activities
provided cash of $10.7 million and $3.9 million, respectively, principally
related to the SHH acquisition in fiscal 2001 and from the issuance of long-term
debt of $3.7 million principally to fund the Company's investment in New Heights
in fiscal 2000.
Management does not believe that inflation has had a material negative
impact on the Company's operations or financial results during recent years
however, increases in oil prices may have an adverse effect on the Construction
Segment.
CERTIFICATION
This Annual Report on Form 10-K has been certified by Patrick T.
Manning, Chief Executive Officer of the Company, and by Maarten D. Hemsley,
Chief Financial Officer of the Company, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of section 1350, chapter 63
of title 18, United States Code) and the certification is attached as Exhibit
99.1.
RESULTS OF OPERATIONS
Operations include the consolidated results for SCPI, which through its
operating division, Steel City Products, headquartered in McKeesport,
Pennsylvania, distributes automotive accessories, non-food pet supplies and lawn
and garden products (the "Distribution Segment"). In July 2001, pursuant to the
Sterling Transaction, the Company increased its investment in SHH from 12% to
80.1%. SHH is a heavy civil construction company based in Houston that
specializes in municipal and state contracts for highway paving, bridge, water
and sewer and light rail. Operations of SHH make up one segment (the
"Construction Segment"). Until July 2001, OTI held equity investments in the
construction industry and the waste-to-energy industry. OTI was dissolved in
December 2001.
FISCAL YEAR ENDED DECEMBER 31, 2002 (FISCAL 2002) COMPARED WITH FISCAL YEAR
ENDED DECEMBER 31, 2001 (FISCAL 2001) (TEN MONTHS)
- ---------------------------------------------------------------------------
CONSTRUCTION
Revenues provided by the Construction segment totaled approximately
$112 million in fiscal 2002, compared with $49 million in fiscal 2001, which
included the six months since its acquisition by the Company in July 2001. In
September 2002, the Construction segment acquired the Kinsel Heavy Highway
Construction business. During fiscal 2002, Construction revenues increased due
to higher revenues on city and county contracts, however, state highway business
was lower than in the prior year.
Gross profit in fiscal 2002 was $12.8 million, or 11.5% of contract
revenues, compared with 8% of contract revenues in the six-month ownership
period of fiscal 2001. The improvement was due to the mix of contracts combined
with better weather affecting the Company in fiscal 2002 compared with fiscal
2001.
Operating income in fiscal 2002 was $7.1 million, compared with $2.3
million for the six-month ownership period in fiscal 2001.
19
Contract backlog at SHH at December 31, 2002 was approximately $138
million, of which approximately 31% is not expected to be constructed until
fiscal 2004 and beyond. Contract backlog at December 31, 2001 was $103 million.
DISTRIBUTION
Total revenues for the Distribution segment in fiscal 2002 were $22.6
million, an increase of $5.1 million compared with the ten months of fiscal
2001. The increase was due in part to the longer reporting period and to higher
sales of pet supplies and lawn and garden products. Sales of automotive
accessories totaled $15.3 million, compared with $13.6 million for the ten
months ended December 31, 2001, largely attributable to the longer reporting
period. Sales of pet supplies totaled $4.8 million, an increase of $1.8 million
from the prior fiscal year, due principally to sales to Ames as
debtor-in-possession until it liquidated its business in July 2002. In fiscal
2002, sales of lawn and garden products totaled $2.5 million, an increase of
$1.6 million compared with the prior period, which reflected the first full year
of operations for the lawn and garden business.
Gross profit for the Distribution segment was $3.7 million or 16.2% of
sales, compared with $2.6 million, or 14.8% of sales for the ten months ended
December 31, 2001. The increase was due to the longer reporting period, which
produced higher sales, and to better margins on certain product lines.
The Distribution segment reported an operating profit of $1.0 million,
compared with $481,000 in the prior year, which included ten months and had been
adversely affected by a bad debt provision for the Ames bankruptcy.
OTHER
Corporate overheads increased by $682,000, due primarily to a $520,000
expense related to the change in the value of the "put" for the purchase of the
remaining 19.9% of SHH. In fiscal 2002, expenses related to the corporate office
decreased by approximately $152,000; these reductions were offset in the prior
year by expenses related to OTI, which was dissolved in December 2001. Interest
expense increased by approximately $450,000 due to a full year of interest
related to the notes incurred in the Sterling transaction.
FISCAL YEAR ENDED DECEMBER 31, 2001 (FISCAL 2001) COMPARED WITH FISCAL YEAR
ENDED FEBRUARY 28, 2001 (FISCAL 2000)
- ---------------------------------------------------------------------------
CONSTRUCTION
Revenues provided by the Construction Segment totaled approximately $49
million for the six months since its acquisition in July 2001.
Gross margin for the period was approximately 8% of revenues.
The segment reported an operating profit of $2.3 million for the
six-month ownership period.
DISTRIBUTION
Total revenues for the Distribution segment for the ten months ended
December 31, 2001 were $17.5 million, a decrease of approximately $2.9 million,
due in part to the shorter fiscal year and to lower sales of automotive
accessories, primarily related to the bankruptcy filing of Ames in August 2001.
Sales of pet supplies totaled $2.9 million, an increase of $344,000 compared
with fiscal 2000, which included twelve months. Most of the increase resulted
from sales to new customers, which included shipments to Ames after its
bankruptcy filing. Sales of lawn and garden products totaled $836,000 for its
first full year of operation.
Gross profit totaled $3.3 million, a decrease of approximately $700,000
compared with fiscal 2000, due to the lower sales resulting from the shorter
reporting period.
20
Operating profits decreased by approximately $487,000 due principally
to a significant charge to bad debt expense resulting from the Ames bankruptcy.
OTHER
The Company recorded a loss on its equity investment at New Heights,
through the date of its disposition in July 2001, of $1.3 million. Interest
expense was lower than the prior year by $495,000 due to lower interest rates
affecting the SCPI Revolver, and the elimination of the debt owed to KTI for the
New Heights investment.
RESULTS FOR THE TEN MONTHS ENDED DECEMBER 31, 2001 COMPARED WITH THE TEN MONTHS
ENDED DECEMBER 31, 2000 (UNAUDITED)
- -------------------------------------------------------------------------------
As Fiscal 2001 includes ten months compared with twelve months in Fiscal
2000, a separate discussion below compares results of Fiscal 2001 with the
comparable ten-month period (unaudited) in Fiscal 2000.
(in thousands) December 31, December 31,
2001 2000
Sales $66,121 $17,256
Gross profit $ 7,299 $ 3,550
Operating profit $ 1,445 $ 294
CONSTRUCTION
Revenues provided by the Construction Segment totaled approximately $49
million for the six months since its acquisition in July 2001.
Gross margin for the period was approximately 8% of revenues.
The segment reported an operating profit of $2.3 million for the
six-month ownership period.
DISTRIBUTION
Comparing results for the ten months ended December 31, 2001 with the
ten months ended December 31, 2000, total sales increased by approximately
$212,000. Sales of automotive products decreased by $1.4 million, due primarily
to the bankruptcy filing of Ames Department Stores in August 2001. Sales of pet
products increased by $822,000 due to sales to new customers, which included
Ames after its bankruptcy filing. Sales of lawn and garden products were
$836,000. Sales of this product line began in November 2000.
Gross profits decreased by approximately $212,000, due to the sales
decrease of automotive products and to pressure placed on the Company to reduce
margins by certain larger customers.
Although savings were realized in operating and selling expenses due to
a reduction in personnel, these were offset by an increase of approximately
$469,000 in bad debt expense due to the bankruptcy filing of Ames.
CORPORATE
For the ten months ended December 31, 2001, there was a loss from
equity investment of $1.2 million, compared with a loss in the prior unaudited
ten-month period of $3.1 million, primarily related to New Heights. New Heights
was disposed of in July 2001. Interest expense decreased in the fiscal 2001
period by approximately $193,000, due to the disposition of New Heights.
21
ITEM 7(A). QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The Company and its subsidiaries are exposed to certain market risks
from transactions that are entered into during the normal course of business.
Sterling's primary market risk exposure is related to interest rate risk. The
Company manages its interest rate risk by attempting to balance its exposure
between fixed and variable rates while attempting to minimize its interest
costs. An increase of 1% in the market rate of interest would have increased the
Company's interest expense in fiscal 2002 by approximately $56,000......
Financial derivatives are used as part of the overall risk management
strategy. These instruments are used to manage risk related to changes in
interest rates. The portfolio of derivative financial instruments consists of
interest rate swap agreements. Interest rate swap agreements are used to modify
variable rate obligations to fixed rate obligations, thereby reducing the
exposure to higher interest rates. Amounts paid or received under interest rate
swap agreements are accrued as interest rates change with the offset recorded in
interest expense.
The Company applies Statement of Financial Standards (SFAS) No. 133,
Accounting for Derivative Instruments and Hedging Activities. Under SFAS No.
133, the Company's interest rate swaps have not been designated as hedging
instruments; therefore changes in fair value are recognized in current earnings.
Because the Company derives no revenues from foreign countries or
otherwise has no obligations in foreign currency, the Company experiences no
foreign currency exchange rate risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Certified Public Accountants................................. 42
Consolidated Balance Sheets: December 31, 2002 and December 31, 2001............... 44
Consolidated Statements of Operations for the fiscal periods ended
December 31, 2002, December 31, 2001 and February 28, 2001....................... 45
Consolidated Statement of Stockholders' Equity (Deficiency) for the fiscal periods
ended December 31, 2002, December 31, 2001 and February 28, 2001................. 46
Consolidated Statements of Cash Flows for the fiscal periods ended
December 31, 2002, December 31, 2001 and February 28, 2001....................... 47
Notes to Consolidated Financial Statements......................................... 49
Schedule II - Valuation and Qualifying Accounts.................................... 77
22
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On September 25, 2001, the Company's Board of Directors, acting on the
recommendation of its Audit Committee decided to no longer engage Deloitte &
Touche LLP ("Deloitte & Touche" or "DT") as the Company's independent public
accountants. This determination followed the Company's decision to seek
proposals from other independent accountants to audit the Company's consolidated
financial statements for the Transition Period ending December 31, 2001.
Deloitte & Touche's report on the Company's consolidated financial
statements for the fiscal year ended February 28, 2001 did not contain an
adverse opinion or disclaimer of opinion, nor was it qualified or modified as to
uncertainty, audit scope or accounting principles.
During the fiscal year ended February 28, 2001 and through the date
hereof, there were no disagreements with Deloitte & Touche on any matter of
accounting principle or practice, financial statement disclosure, or auditing
scope or procedure which, if not resolved to DT's satisfaction, would have
caused them to make reference to the subject matter in connection with their
report on the Company's consolidated financial statements for such year; and
there were no reportable events as defined in Item 304(a)(1)(v) of Regulation
S-K.
The Company provided Deloitte & Touche with a copy of the foregoing
disclosures.
Effective September 26, 2001, the Board of Directors, based on upon a
recommendation of its Audit Committee, retained Grant Thornton LLP as its
independent auditors to audit the Company's consolidated financial statements
for the Transition Period ending December 31, 2001 and the fiscal year ended
December 31, 2002.
During the fiscal year ended February 28, 2001 and through the date
hereof, except as disclosed in the following paragraph, the Company did not
consult Grant Thornton LLP with respect to the application of accounting
principles to a specified transaction, either completed or proposed, or the type
of audit opinion that might be rendered on the Company's consolidated financial
statements, or any other matters or reportable events as set forth in Items
304(a)(2)(i) and (ii) of Regulation S-K.
During the week preceding September 26, 2001, the Company had
discussions with Grant Thornton regarding proforma presentation regarding the
Sterling Transaction.
23
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS.
The by-laws of Sterling Construction Company, Inc. ("Sterling" or the
"Company") provide for such number of directors as is determined from time to
time by the Board of Directors and the Certificate of Incorporation of the
Company provides for the organization of directors into three classes, with
directors elected for three-year staggered terms. There are currently seven
directors.
Age at March 1, Current term Director
Name 2003 expires* since Class
John D. Abernathy 65 2003 1994 II
Robert M. Davies 52 2004 1996 III
Robert W. Frickel 60 2003 2001 II
Joseph P. Harper, Sr. 57 2005 2001 I
Maarten D. Hemsley 53 2004 1998 III
Patrick T. Manning 55 2005 2001 I
Christopher H.B. Mills 50 2004 2001 III
* the director also serves until a successor is elected
John D. Abernathy. Mr. Abernathy has been Chief Operating Officer of Patton
Boggs LLP, a Washington DC law firm, since January 1995. From March 1991 to
February 1994 he was the Managing Director of Summit, Solomon & Feldesman, a New
York City law firm and from July 1983 until June 1990, Mr. Abernathy was
Chairman and Chief Executive Partner of BDO Seidman, a public accounting firm.
He is a director of Pharmaceutical Resources, Inc., a generic drug manufacturer
and of the Company's majority owned subsidiary, Steel City Products, Inc.
("SCPI"). Mr. Abernathy is a certified public accountant.
Robert M. Davies. Mr. Davies was the Company's Chairman and Chief Executive
Officer from May 1997 to July 2001 and was its President from May 1997 to
January 1999. Mr. Davies had previously been a member of the Company's Board
from 1991 until 1994. Mr. Davies was a Vice President of Wexford Capital
Corporation, which acts as the investment manager to several private investment
funds, from 1994 to March 1997. From November 1995 to March 1997 Mr. Davies also
served as Executive Vice President of Wexford Management LLC, a private
investment management company. From September 1993 to May 1994 he was a Managing
Director of Steinhardt Enterprises, Inc., an investment banking company and from
1987 to August 1993, he was Executive Vice President of The Hallwood Group
Incorporated, a merchant banking firm. Mr. Davies is a director of SCPI. Mr.
Davies is a managing director of Menai Capital, L.L.C., a private equity
advisory company, and Managing Director of Greenwich Power, LLC.
Robert W. Frickel. Mr. Frickel is the founder and President of R.W. Frickel
Company, P.C., a certified public accounting firm that provides audit, tax and
consulting services primarily to the construction industry. Prior to the
founding of the R.W. Frickel Company in 1974, Mr. Frickel was employed by Ernst
& Ernst. He attained his CPA license in 1968 and holds a Bachelor of Business
Administration degree from the University of Michigan.
Joseph P. Harper, Sr.. President. Mr. Harper serves as CFO, Treasurer and
Secretary of Sterling Houston Holdings ("SHH") and has been with that company
since 1972. He has performed both estimating and project manager functions as
well as his primary role as CFO. Prior to joining SHH, Mr. Harper worked for
Price Waterhouse and attained his CPA license in 1970. He holds a Bachelor's
degree from St. Joseph College. Mr. Harper was elected the Company's President
in July 2001.
24
Maarten D. Hemsley. Mr. Hemsley was re-elected to the Board of Directors of the
Company and of SCPI in December 1998, having been an employee and director of
the Company or SCPI for many years prior to 1995. In December 1995, he had
resigned his positions with the Company and SCPI but continued to provide
consulting services to both companies through his wholly-owned business,
Bryanston Management, Ltd. Mr. Hemsley served as President, Chief Operating
Officer and Chief Financial Officer of the Company until July 2001, and
currently serves as Chief Financial Officer of both Sterling and SCPI. Mr.
Hemsley has been President of Bryanston Management, Ltd., a financial
consultancy firm, since 1993.
Patrick T. Manning. Chairman and Chief Executive Officer. Mr. Manning joined SHH
in 1971 and led that company's move into the Houston market in 1978. He
currently serves as President and CEO of SHH. Before 1971, Mr. Manning was
President of Oakland Construction Company, a custom home builder in suburban
Detroit. Mr. Manning has served on a variety of construction industry
committees, including the Gulf Coast Trenchless Association and the Houston
Contractors' Association, where he served as a member of the Board of Directors
and as President from 1987 to 1993. He attended Michigan State University from
1969 to 1972. Mr. Manning is the brother of James Manning, a founder of SHH. Mr.
Manning was elected the Company's Chairman and Chief Executive Officer in July
2001.
Christopher H.B. Mills. Mr. Mills is Chief Investment Officer of J.O. Hambro
Capital Management, an investment management company based in the United
Kingdom. Prior to his founding of J.O. Hambro Capital Management in 1993, Mr.
Mills was employed by Montagu Investment Management and its successor company
Invesco MIM as an investment manager and director from 1975 to 1993. He is Chief
Executive of North Atlantic Smaller Companies Investment Trust plc, ("NASCIT"),
a 12% shareholder in the Company and of American Opportunity Trust plc. Mr.
Mills serves as a director and is a shareholder of J.O. Hambro Capital
Management and a director of Lesco, Inc., a company based in the United States
that manufactures and sells fertilizer and lawn products.
EXECUTIVE OFFICERS.
The following are the names, ages, positions and a brief description of
the business experience during the last five years of the executive officers of
the Company and its subsidiaries who are not also directors of the Company, all
of whom serve until they resign or are removed by the Board of Directors. The
business histories of executive officers who are also directors (Messrs. Harper,
Hemsley and Manning) are set forth above under the heading "Directors."
Roger M. Barzun (61): Vice President, Secretary and General Counsel. Mr. Barzun
has been a Vice President, Secretary and General Counsel of the Company since
August 1991 and was a Senior Vice President from May 1994 until July 2001. He is
also Secretary and General Counsel of SCPI. Mr. Barzun has been a lawyer since
1968 and is a member of the New York and Massachusetts bars.
Terrance W. Allan (51): President, Steel City Products, Inc. Mr. Allan has been
an officer of SCPI for more than the last five years. He was appointed President
of SCPI in May 2000 and Chief Executive Officer in May 2002.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's officers and directors, and persons who own more than 10% of a
registered class of the Company's equity securities ("Insiders") to file reports
of beneficial ownership and certain changes in ownership with the Securities and
Exchange Commission and to furnish the Company with copies of those reports.
Based solely on a review of those reports and amendments thereto
furnished to the Company during the Transition Period or written representations
by Insiders that no reports were required to be filed, the Company believes that
during the fiscal year ended December 31, 2002 all Section 16(a) filing
requirements applicable to the Company's Insiders were satisfied, except as
noted in the following paragraphs.
25
NASCIT, a beneficial owner of greater than 10% of the Company's common
stock, did not timely report beneficial ownership of 605,520 shares of common
stock beneficially owned by it. Beneficial ownership of these shares was
reported on a Form 3 Report filed in February 2002.
Mr. Christopher Mills, a director of the Company, did not timely report
beneficial ownership of 605,520 shares of common stock beneficially owned by him
as an executive director and co-investment adviser of NASCIT and 12,000 options
granted to him on July 23, 2001. Beneficial ownership of these shares was
reported on a Form 3 Report filed in February 2002.
Mr. Joseph P. Harper, Sr., President and a director of the Company, did
not timely report beneficial ownership of 3,773 shares of common stock, a
warrant granted on July 19, 2001 for the right to acquire 46,236 shares of
common stock, and a warrant granted on October 31, 2001 for the right to acquire
1,019 shares of common stock. Beneficial ownership of these shares was reported
on a Form 4 Report filed in February 2002.
REPORT OF THE AUDIT COMMITTEE FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002.
The Audit Committee reviews the Company's financial reporting process
on behalf of the Board of Directors. Three independent directors, Mr. Abernathy,
Mr. Frickel, and Mr. Mills are members of the Audit Committee. The Committee
operates under a written Charter adopted by the Board in June 2000. Management
has the primary responsibility for the financial statements and the reporting
process. The Company's independent auditors are responsible for expressing an
opinion on the conformity of the Company's financial statements with generally
accepted accounting principles and whether the Company's financial statements
present fairly, in all material respects, the financial position and results of
operations of the Company.
In this context, the Audit Committee has reviewed and discussed with
management and the independent auditors the audited financial statements. The
Audit Committee has discussed with the independent auditors the matters required
to be discussed by Statement on Accounting Standards No. 61 ("Communication with
Audit Committees"). In addition, the Audit Committee has received from the
independent auditors the written disclosures required by Independence Standards
Board No. 1 ("Independence Discussions with Audit Committees") and discussed
with them their independence from the Company and its management.
In September 2001, the Company elected to change its independent
auditors.
The following table sets forth the aggregate fees billed to the Company
for the year ended December 31, 2002 by its current independent auditors, Grant
Thornton LLP:
Audit fees $171,000
Financial information systems design and implementation --
All other fees $ 5,000
Audit fees include the fees for the separate audits of SCPI and SHH as
well as the consolidated audit of the Company and resolution of issues that
arose during the audit process.
Items included in the "all other" category include services related to
acquisition issues and other matters. The Audit Committee determined that
services provided in the "all other" category did not impair the independence of
Grant Thornton, LLP.
In reliance on the reviews and discussions referred to above, the Audit
Committee recommended to the Board of Directors, and the Board has approved that
the audited financial statements be included in the Company's Annual Report on
Form 10-K for the year ended December 31, 2002 for filing with the Securities
and Exchange Commission.
26
ITEM 11. EXECUTIVE COMPENSATION.
This item contains information about compensation, stock options and
awards, employment arrangements and other information concerning the executive
officers of the Company and of its subsidiaries, SHH and SCPI.
SUMMARY COMPENSATION TABLE.
The following table sets forth all compensation for the 2002, 2001 and
2000 fiscal years paid on or before December 31, 2002 to those who served as the
Company's Chief Executive Officer during fiscal 2002 and to the other executive
officers of the Company who were serving at the end of the 2002 fiscal year for
services rendered in all capacities to the Company and its subsidiaries and
whose total annual salary and bonus exceeded $100,000 in fiscal 2002. Also
included is the compensation paid to an executive officer of SCPI who is not,
however, an executive officer of the Company.
Annual Compensation Long-term compensation
Other Securities
Fiscal Annual Underlying All Other
Name and Principal Position Year Salary Bonus** Compensation* Options/SARs Compensation
--------------------------- ------ ------ ------- ------------- ------------ ------------
Robert M. Davies(1) 2002 -- -- -- -- --
Former Chairman & Chief 2001 $ 22,395 -- -- -- --
Executive Officer
2000 $124,028 -- -- -- --
Patrick T. Manning(2) 2002 $225,000 -- -- 3,500 --
Chairman & Chief Executive 2001 $ 98,077 -- -- 3,700 --
Officer
Joseph P. Harper, Sr.(2) 2002 $225,000 -- -- 3,500 --
President 2001 $ 98,077 -- -- 3,700 --
Maarten D. Hemsley(3) 2002 $ 80,396 -- -- -- --
Chief Financial Officer 2001 $ 65,146 -- -- -- --
2000 $129,392 -- -- -- --
Terrance W. Allan(4) 2002 $177,424 $25,118 -- 5,000 --
President - SCPI 2001 $124,385 $40,771 -- -- --
2000 $132,072 $60,515 -- -- --
* Excludes perquisites and other personal benefits if the aggregate
amount of such items of compensation was less than the lesser of either $50,000
or 10% of the total annual salary and bonus of the named executive officer.
** Does not include bonuses earned and accrued during Fiscal 2002 that are
to be paid during Fiscal 2003.
1. Mr. Davies was elected Chairman, Chief Executive Officer and President
in May 1997 and resigned those positions in July 2001. Mr. Davies
remains a director of the Company.
2. In July 2001, Mr. Manning was elected Chairman and Chief Executive
Officer of the Company and Mr. Harper was elected President of the
Company. Both Mr. Manning and Mr. Harper are compensated by
Texas-Sterling Construction, LP, a subsidiary of SHH, under a long-term
employment agreements, except with respect to stock options and other
stock awards. Compensation is included only for the period of ownership
of SHH by the Company since July 2001.
27
3. In December 1998, Mr. Hemsley was elected President, Chief Operating
Officer and Chief Financial Officer of the Company. Following the
Sterling Transaction in July 2001, he remains Chief Financial Officer
of the Company.
4. Mr. Allan is compensated only by SCPI, except with respect to stock
options and stock awards.
OPTION GRANTS IN THE LAST FISCAL YEAR.
Options were granted to individuals named in the Summary Compensation
Table, above, during the fiscal year ended December 31, 2002, as summarized in
the table below:
Option Grants in Fiscal Year Period
Potential Realized
value at Assumed
Annual Rates of
Stock Price
Individual Grants Appreciation for
Option Term
Number of % of Total
Securities Options Granted Exercise
Name Underlying Options to Employees in Price Expiration 5%($) 10%($)
Granted (#) Fiscal 2002 ($/Share) Date
Patrick T. Manning 3,500 5.3% $1.73 July 24, 2012 $3,797 $ 9,622
Joseph P. Harper, Sr. 3,500 5.3% $1.73 July 24, 2012 $3,797 $ 9,622
Terrance W. Allan 5,000 7.6% $1.50 April 5, 2012 $4,717 $11,953
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES.
The following table sets forth certain information based upon the fair
market value per share of the Common Stock at December 31, 2002 ($1.75) or the
day closest to the Company's December 31, 2002 fiscal year end on which trades
were made, with respect to stock options held at that date by each of the
individuals named in the Summary Compensation Table, above. The "value" of
unexercised in-the-money options is the difference between the market value of
the Common Stock subject to the options at December 31, 2002 and the exercise
price of the option shares. During fiscal 2002, there were no option exercises
by any of these individuals.
Number of Securities Underlying Value of Unexercised In-the-Money
Unexercised Options at Fiscal Year End Options at Fiscal Year End
-------------------------------------- ---------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- --------------------- ----------- ------------- ----------- -------------
Robert M. Davies 538,992 6,000 $ 534,093 $1,500
Patrick T. Manning 1,234 5,966 $ 309 $ 687
Joseph P. Harper, Sr. 1,234 5,966 $ 309 $ 687
Maarten D. Hemsley 436,424 -- $ 305,625 --
Terrance W. Allan 32,000 3,750 $ 15,125 $ 938
COMPENSATION OF DIRECTORS.
Until 2001, all non-employee directors received annual stock option
grants on May 1 each year under the Non-Employee Director Stock Option Plan
covering 3,000 shares of Common Stock, which were immediately exercisable at an
option price equal to the market value on the date of grant. The maximum number
of shares issuable under the Plan was reached with the grants of options for an
aggregate of 7,000 shares to the five non-employee directors on May 1, 2001. In
July 2001, the three non-employee directors were issued options for 12,000
shares each under the 2001 Stock Incentive Plan. During fiscal 2002, each
non-employee director who did not otherwise receive compensation from the
Company was entitled an annual director's fee of $12,500. All fees are
28
payable quarterly in arrears. All directors are entitled to reimbursement for
out-of-pocket expenses incurred in attending meetings.
See also "Employment Contracts and Termination of Employment and
Change-in-Control Arrangements,".
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS.
Mr. Davies. Mr. Davies was elected Chairman, President and Chief Executive
Officer of the Company in May 1997. He had previously been a director of the
Company from 1991 until 1994. He was compensated at the rate of $5,000 per month
under a one-year consulting agreement until June 1998, when he entered into an
employment agreement at the same rate. Mr. Davies also received reimbursement of
expenses incurred by him in carrying out his duties and responsibilities. In
October 1998, Mr. Davies voluntarily took a 10% salary reduction, which amount
was added to a subordinated note issued to him at the time of the Sterling
Transaction. In December 1998, Mr. Davies also entered into a two-year
employment agreement with OTI that provided for a base salary of $60,000, plus a
car allowance. Both the Sterling and OTI employment agreements expired on
February 28, 2001. The Sterling employment agreement continued on a
month-to-month basis until July 2001 when Mr. Davies resigned as an executive of
the Company.
Mr. Manning. Mr. Manning is Chief Executive Officer of the Company.
Texas-Sterling Construction, LP, a subsidiary of SHH has a three-year employment
agreement with Mr. Manning dated July 18, 2001. The agreement provides for a
base annual salary of $200,000 per year and Mr. Manning is entitled to receive
an annual bonus of $100,000 in respect of any fiscal year during which SHH
achieves 75% or greater of approved budgeted EBITDA for such fiscal year, so
long as budgeted EBITDA is at least equal to actual EBITDA achieved in the prior
year. An additional incentive bonus is payable if actual performance exceeds
budget. The agreement provides that Mr. Manning shall be subject to a
non-compete provision for two years after employment with SHH ceases; payment
for which shall be $1,000 per month for the twenty-four month period.
Mr. Harper. Mr. Harper is President of the Company. Texas-Sterling Construction,
LP, a subsidiary of SHH has a three-year employment agreement with Mr. Harper
dated July 18, 2001. The agreement provides for a base annual salary of $200,000
per year for the first two years and $170,000 for the third year. Mr. Harper is
entitled to receive an annual bonus of $100,000 in respect of any fiscal year
during which SHH achieves 75% or greater of approved budgeted EBITDA for such
fiscal year, so long as budgeted EBITDA is at least equal to actual EBITDA
achieved in the prior year. An additional incentive bonus is payable if actual
performance exceeds budget. The agreement provides that Mr. Harper shall be
subject to a non-compete provision for two years after employment with SHH
ceases; payment for which shall be $1,000 per month for the twenty-four month
period.
Mr. Hemsley. Mr. Hemsley was employed by and was a director of the Company or
SCPI for several years prior to 1995. In 1995, he resigned his positions with
the Company and entered into a consulting agreement with the Company through his
wholly-owned company, Bryanston Management, Ltd. In December 1998, Mr. Hemsley
was elected to the Board of Directors and was appointed President, Chief
Operating Officer and Chief Financial Officer of the Company subject to an
employment agreement at the same rate of compensation as the Bryanston
consulting agreement of $85,000 per annum (of which 10% was later deferred under
a voluntary salary reduction, which deferral amount was converted into a
subordinated note in July 2001). In December 1998, Mr. Hemsley also entered into
a two-year employment agreement with OTI which provided for a base salary of
$40,000 annually, plus a car allowance. Both the Sterling and OTI employment
agreements expired on February 28, 2001. The Sterling employment agreement
continued on a month-to-month basis until July 2001, when the agreement was
amended to extend the employment period for one year at an annual rate of
$76,500. In July 2002, Mr. Hemsley's salary was increased to $85,000 per year
and his employment agreement was extended for three years.
Mr. Allan. SCPI has an employment agreement with Mr. Allan that commenced May 1,
2000 that provides for a base salary of $133,000 with annual salary increases.
Payment of the increase due September 2001 and part of his regular salary was
voluntarily deferred by Mr. Allan in light of the Chapter 11 filing of Ames
Department Stores,
29
one of SCPI's largest customers. The deferral was reflected as an accrued
liability of the Company. In January 2002, Mr. Allan began receiving his entire
regular salary. In January 2002, the bonus provisions of Mr. Allan's employment
agreement were modified to reflect his participation in a new bonus plan for all
members of SCPI's management. Pursuant to the new bonus program, Mr. Allan is
entitled to a profit-based bonus reflecting achievement of budgeted EBITDA,
ranging from 8% of his base salary if 75% of the budgeted level is achieved, to
51% of base salary if EBITDA equals twice the budgeted level. In addition, Mr.
Allan is entitled to a discretionary bonus of up to one-third of the
profit-based bonus paid. The initial term of Mr. Allan's agreement expires on
September 30, 2003, and may be extended thereafter on a year-to-year basis.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION.
In the fiscal year ended December 31, 2001, Mr. Davies, Mr. Abernathy,
Mr. Ross Pirasteh and Mr. Lever were members of the Compensation Committees of
both the Company and of SCPI. In July 2001, all members except Mr. Abernathy
resigned from the Compensation Committee and Mr. Frickel and Mr. Mills became
members. Mr. Frank and Mr. Harper serve on the Compensation Committee of SCPI.
Prior to July 2001, Mr. Davies was an executive officer of the Company, but none
of the Company's executive officers served as a director or member of the
Compensation Committee (or any other committee serving an equivalent function)
of any other entity, whose executive officers serve as a director or member of
the Company's Compensation Committee.
The Board of Directors intends that any transactions with officers,
directors and affiliates will be entered into on terms no less favorable to the
Company than could be obtained from unrelated third parties and that they will
be approved by a majority of the directors of the Company who are independent
and disinterested with respect to the proposed transaction.
In December 1998, KTI purchased approximately 1.7 million shares of the
Company's common stock, representing 35% of the common stock outstanding after
the purchase, at the market price of $0.50 per share. In conjunction with the
private placement of stock, KTI committed under a loan agreement to lend the
Company up to $11.5 million (see Notes 1 and 5 to the Consolidated Financial
Statements). Funding under the KTI Loan was used principally to enable OTI to
finance the Business Plan for New Heights, pursuant to an Investment Agreement
between New Heights, OTI and KTI (see Note 13 to the Consolidated Financial
Statements). In December 1998, New Heights appointed KTI to manage its facility,
pursuant to an Operating and Maintenance Agreement and OTI entered into a
non-exclusive License Agreement for the use of waste rubber recycling technology
owned by KTI's subsidiary, KTI Recycling.
Pursuant to these transactions, in January 1999, KTI nominated two
directors, Ross Pirasteh and Martin Sergi, to each of the Boards of Directors of
Sterling and OTI. In March 2000, Mr. Jack Polak was elected to the Company's
Board of Directors as KTI's third nominee under the Investment Agreement between
KTI and the Company. Pursuant to the Unwinding Agreements, the resignations of
Messrs Pirasteh, Sergi and Polak from the Boards of the Company and OTI became
effective on July 3, 2001.
In October 1999, certain shareholders of SHH exercised their right to
sell a second tranche of equity to OTI, thus increasing OTI's equity ownership
from 7% to 12%. The equity purchase was financed through the issuance of notes,
of which $559,000 was due to be repaid to Mr. Davies and Mr. Hemsley in October
2000. The notes which provided for interest payments at the rate of 14% per
annum, were extended by agreement until July 2001 when they were restructured
pursuant to the Sterling Transaction.
See also "Compensation of Directors", "Employment Contracts and
Termination of Employment and Change-in-Control Arrangements" and "Item 13.
Certain Relationships and Related Transactions."
30
REPORT ON EXECUTIVE COMPENSATION IN THE 2002 FISCAL YEAR.
This report has been prepared by the Compensation Committee of the
Board of Directors and addresses the Company's compensation policies with
respect to the Chief Executive Officer and executive officers of the Company in
general for the fiscal year ended December 31, 2002. The Company has no
operating business of its own, but is a holding company of operating businesses.
The Company has elected to include in the Summary Compensation Table certain
information concerning an executive officer of SCPI, who is not, however, an
executive officer of the Company and accordingly, a discussion of his
compensation is included here. Reference is made generally to the information
under the heading "Employment Contracts and Termination of Employment and
Change-in-Control Arrangements".
Compensation Policy. The overall intent in respect of executive
officers is to establish levels of compensation that provide appropriate
incentives in order to command high levels of individual performance and thereby
increase the value of the Company to its stockholders and that are sufficiently
competitive to attract and retain the skills required for the success and
profitability of the Company. The principal components of executive compensation
are salary, bonus and stock options.
Chief Executive Officer's Compensation. The compensation for Mr. Davies
prior to July 2001 and Mr. Manning after July 2001 was determined to be
appropriate by the members of the Committees serving at the time based on the
nature of the position; the expertise and responsibility that the position
requires; the Chief Executive Officer's prior experience in former employment;
and the subjective judgement of the members of the Committee of a reasonable
level of compensation.
Other Executive Officers. Mr. Allan is included in the Company's
disclosures relating to compensation because of his importance to the success of
the Company on a consolidated basis. Mr. Allan's employment agreement was
reviewed and approved by the Company's Compensation Committee and by the SCPI
Compensation Committee.
Salary. Since all of the executive officers named in the Summary
Compensation Table are long-term employees of the Company and/or SCPI and SHH,
their salaries in fiscal 2002 were based on the level of their prior salaries
and the subjective judgement of the members of the Company's and SCPI's
Compensation Committees as to the value of the executive's past contribution and
potential future contribution to the business.
Bonuses. Until January 2002, the bonus payable to Mr. Allan under his
employment agreement consisted of an Annual Management Bonus and an additional
Annual Executive Bonus. The Annual Management Bonus was paid from a pool of
funds equal to 8% of SCPI's consolidated net income before interest, taxes,
depreciation and amortization, prepared in accordance with generally accepted
accounting principles consistently applied. The Annual Executive Bonus was based
on achievement of certain defined profit levels, which were not met in fiscal
2001 or 2000. In 2002, Mr. Allan's employment agreement was amended to provide
for Mr. Allan's participation in a new bonus plan for all members of SCPI's
management. Pursuant to the new bonus program, Mr. Allan is entitled to a
profit-based bonus reflecting achievement of budgeted EBITDA, ranging from 8% of
his base salary if 75% of the budgeted level is achieved, to 51% of base salary
if EBITDA equals twice the budgeted level. In addition, Mr. Allan is entitled to
a discretionary bonus of up to one-third of the profit-based bonus paid.
Mr. Manning and Mr. Harper are entitled to receive an incentive bonus
of $100,000 in respect of any fiscal year during which SHH achieves 75% or
greater of its approved budgeted EBITDA for such fiscal year, provided that
budgeted EBITDA is equal to 100% of actual EBITDA for the preceding fiscal year.
In addition, additional incentive bonuses may be earned up to 100% of base
salary if EBITDA exceeds budgeted EBITDA by 10% to more than 30%. In fiscal
2002, those objectives were met, and accordingly, the maximum bonus payable was
accrued, subject to approval by the Company's Compensation Committee.
Stock Options. The Committee believes that stock ownership by executive
officers is important in aligning management's and stockholders' interests in
the enhancement of stockholder value over the long term. The exercise price of
all outstanding stock option grants is equal to the market price of the Common
Stock on the date of grant. In Fiscal 2002 options were granted to certain
executives in recognition of their performance.
31
Compliance with Internal Revenue Code Section 162(m). Section 162(m) of
the Internal Revenue Code, enacted in 1993, generally disallows a tax deduction
to public companies for compensation over $1 million paid to its chief executive
officer and its four other most highly compensated executives. The Company's
compensation payable to any one executive officer (including potential income
from outstanding stock options) is currently and for the foreseeable future
unlikely to reach that threshold. In addition, because of the Company's
significant net operating loss carryforwards, the deductibility of compensation
payments is not currently an issue. However, should circumstances change, the
Compensation Committee will study the matter and make recommendations to the
Board.
The Compensation Committee
John D. Abernathy
Robert W. Frickel
Christopher H.B. Mills
------------------------------
The following Performance Graph and the foregoing Report of the Compensation
Committee on Executive Compensation in this Item 11 are not and shall not be
deemed incorporated by reference into any filings of the Company with the
Securities and Exchange Commission by implication or by any reference in any
such filings to this Annual Report on Form 10-K.
PERFORMANCE GRAPH.
The following graph compares the percentage change in the Company's
cumulative total stockholder return on Common Stock for the last five years with
(i) the Dow Jones Total Return Index (a broad market index) and (ii) the Dow
Jones Heavy Construction Index, a group of companies whose marketing strategy is
focused on a limited product line, such as civil construction, over the same
period. Both indices are published in the Wall Street Journal.
The returns are calculated assuming the value of an investment in the
Company's stock and each index of $100 on the Company's February 28, 1997 fiscal
year end and that all dividends were reinvested; however, the Company paid no
dividends during the periods shown. The graph lines merely connect the beginning
and end of the measuring periods and do not reflect fluctuations between those
dates. The historical stock performance shown on the graph is not intended to,
and may not be indicative of, future stock performance.
[FIVE YEAR PERFORMANCE CHART]
1997 1998 1999 2000 2001 2002
---- ---- ---- ---- ---- ----
Dow Jones - Heavy Construction ........... 100 120 128 150 158 132
Dow Jones - Total Return ................. 100 125 153 139 122 95
Sterling Construction Company, Inc. ...... 100 100 139 67 149 156
32
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL HOLDERS AND MANAGEMENT.
This item sets forth certain information regarding ownership of the
Company's common stock at March 1, 2002. Except as otherwise indicated in the
footnotes, the Company believes that the beneficial owners of the Common Stock
listed in the tables, based on information furnished by such owners, have sole
investment and voting power with respect to the shares of common stock shown as
beneficially owned by them. The numbers and percentages assume for each person
or group listed the exercise of all stock options held by such person or group
that are exercisable within 60 days of March 1, 2003, in accordance with Rule
13d-3(d)(1) of the Securities Exchange Act of 1934, but not the exercise of such
stock options owned by any other person.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS.
This table sets forth each person, other than management, known by the
Company to own beneficially more than 5% of the outstanding common stock of the
Company.
NAME AND ADDRESS NUMBER OF SHARES PERCENTAGE OF
OF BENEFICIAL OWNER OF COMMON STOCK CLASS
Anthony N. Puma (1)
214 Loma Metisse
Malibu, CA 90265 266,667 5.2%
North American Smaller Companies Investment Trust plc
c/o JO Hambro Capital Management Limited
14 Ryder Street
Ryder Court SW1Y 6QB
London, England 605,520(2) 12.3%
JO Hambro Capital Management Group Limited
14 Ryder Street
Ryder Court SW1Y 6QB
London, England
605,520(2) 12.3%
JO Hambro Capital Management Limited
c/o JO Hambro Capital Management Limited
14 Ryder Street
Ryder Court SW1Y 6QB
London, England 605,520(2) 12.3%
Christopher Harwood Bernard Mills
c/o JO Hambro Capital Management Limited
14 Ryder Street
Ryder Court SW1Y 6QB
London, England 611,520(3) 12.3%
Growth Financial Services Limited
c/o JO Hambro Capital Management Limited
14 Ryder Street
Ryder Court SW1Y 6QB
London, England 605,520(2) 12.3%
(1) These shares were issued as part of the purchase by the Company of Puma
Products, Inc. from Mr. Puma in fiscal 1995. In fiscal 1997, the
Company sold Puma Products, Inc. back to Mr. Puma.
33
(2) These shares were purchased at $1.50 per share in July 2001 as part of
the Sterling Transaction. JO Hambro Capital Management Group Limited,
JO Hambro Capital Management Limited, Christopher Harwood Bernard
Mills, Growth Financial Services Limited and North American Smaller
Companies Investment Trust plc claim shared voting power of these
shares pursuant to a Schedule 13G filing dated February 14, 2002.
(3) This number includes 6,000 shares issuable under outstanding stock
options that are exercisable at $1.50 per share. The remaining 605,520
shares were purchased at $1.50 per share in July 2001 as part of the
Sterling Transaction. JO Hambro Capital Management Group Limited, JO
Hambro Capital Management Limited, Christopher Harwood Bernard Mills,
Growth Financial Services Limited and North American Smaller Companies
Investment Trust plc claim shared voting power of these shares pursuant
to a Schedule 13G filing dated February 14, 2002.
SECURITY OWNERSHIP OF MANAGEMENT.
The following table sets forth information regarding beneficial
ownership of the Common Stock by each director, each individual named in the
Summary Compensation Table in Item 11 and by all directors, all such named
individuals and all executive officers of the Company as a group
Name of Beneficial Owner Shares of Common Stock Percentage of Class
John D. Abernathy 123,162(1) 2.4%
Roger M. Barzun, Esq 42,161(2) *
Robert M. Davies 736,492(3) 13.1%
Robert W. Frickel 6,000(4) *
Joseph P. Harper, Sr 298,265(5) 5.9%
Maarten D. Hemsley 527,812(6) 9.6%
Patrick T. Manning 236,122(5) 4.7%
Christopher H.B. Mills 611,520(4) 12.0%
Terrance W. Allan 33,750(6) *
All directors and executive
officers as a group (9 persons) 2,615,284(8) 41.9%
--------------
* Less than 1%
1. Includes 108,162 shares issuable under outstanding stock options that
are presently exercisable at prices ranging from $0.75 to $3.375 per
share.
2. Includes 36,000 shares issuable under outstanding stock options that
are presently exercisable at prices ranging from $0.88 to $2.00 per
share.
34
3. This number includes 538,992 shares are issuable under outstanding
stock options that are presently exercisable at prices ranging from
$0.50 to $2.75 per share. The options are subject to a standstill
agreement effective July 2001 which provides that the options may not
be exercised if the effect of such exercise would be to jeopardize the
Company's Tax Benefits.
4. This number includes 6,000 shares issuable under outstanding stock
options that are exercisable at $1.50 per share.
5. This number includes 1,234 shares issuable under outstanding stock
options that are exercisable at $1.50 per share.
6. This number includes 436,424 shares issuable under outstanding stock
options that are presently exercisable at prices ranging from $0.50 to
$2.75 per share. The options are subject to a standstill agreement
effective July 2001 which provides that the options may not be
exercised if the effect of such exercise would be to jeopardize the
Company's Tax Benefits.
7. This number includes 33,750 shares issuable under outstanding stock
options that are exercisable at prices ranging from $1.00 to $2.00 per
share. Mr. Allan is an executive officer of the Company's subsidiary,
Steel City Products, Inc.
8. This number includes 1,131,296 shares issuable under outstanding stock
options that are exercisable within 60 days of March 1, 2003 at prices
ranging from $0.50 to $3.375 per share.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS.
Pursuant to the agreements entered into between KTI, Inc. and the
Company in December 1998, KTI received the right to appoint directors to the
Boards of the Company and its subsidiary, Oakhurst Technology, Inc. ("OTI").
Three representatives from KTI were appointed to the Board of Directors of the
Company; Messrs. Pirasteh and Sergi in January 1999, and Mr. Polak in March
2000, and two KTI representatives, Messrs. Pirasteh and Sergi, were appointed to
the Board of OTI. Pursuant to the Unwinding Agreements, the resignations of
Messrs Pirasteh, Sergi and Polak from the Boards of the Company and OTI became
effective on July 3, 2001.
In October 1999, certain shareholders of SHH exercised their right to
sell a second tranche of equity securities to OTI thereby increasing the
Company's consolidated equity ownership of SHH from 7% to 12%. The equity
purchase was financed through the issuance of two notes. One of these notes in
the amount of $559,000 was issued to Mr. Davies (the "First Note") in which Mr.
Hemsley had a participation of $116,000. The second note in the amount of
$800,000 (the "Manning Note") was issued to James D. Manning, the brother of
Patrick T. Manning and one of the SHH shareholders who sold SHH equity
securities to OTI. The First Note provided for interest payable quarterly and
was due in October 2000, but in fact, no interest payments were made and the
First Note was not repaid in October 2000. In connection with the Sterling
Transaction, accrued unpaid interest on the First Note of $134,000 was added to
the principal of the First Note, the maturity date of the First Note was
extended to July 2005, and the interest rate was reduced to 12%. In connection
with the Sterling Transaction, the Company also issued an additional four-year
12% promissory note to each of Messrs. Hemsley ($136,421) and Davies ($250,623)
(the "Second Notes") to repay certain amounts due to them by the Company or OTI,
including deferred compensation, the fee (and related interest) owed to them in
connection with the acquisition of the second tranche of SHH equity in October
1999, the fee due in July 2001 to them in connection with the Sterling
Transaction and a fee for the extension of the First Note.
In connection with the Sterling Transaction, the maturity date of the
Manning Note also was extended to July 2005 and the interest rate was reduced to
12%. In consideration for the extension of the maturity date and interest rate
reduction, Mr. James D. Manning received a promissory note in the amount of
$187,000 payable July 2005 with interest payable at maturity.
Interest and principal on the First Note, the Second Notes and the
Manning Note are payable prior to maturity only to the extent of cash available
to Sterling for these payments and as permitted by lenders to Sterling or its
subsidiaries.
35
After the Sterling Transaction, Mr. Harper purchased $300,000 of the
Manning Note from Mr. James D. Manning. As a result, Mr. Harper now holds a
separate note in the principal amount of $300,000 and Mr. James D. Manning holds
a note in the principal amount of $400,000, in each case, on the same terms and
conditions as the Manning Note.
Mr. James D. Manning is employed by an operating subsidiary of SHH
under a three-year employment agreement commencing January 1999 pursuant to
which he receives an annual salary of $75,000 plus $75.00 per hour for each hour
worked in excess of 1,000 hours during any calendar year. In addition, Mr.
Manning is entitled to receive incentive compensation in the amount of $50,000
if certain financial goals are met. The employment agreement limits the ability
of Mr. Manning to compete for a period of two years after he ceases to be an
employee if he terminated his employment without good cause or the company
terminated his employment for good cause, and for a period of one year after he
ceases to be an employee if he terminated his employment for good reason or the
company terminated his employment without good cause.
In 1996, Mr. Patrick Manning, Mr. Harper and Mr. James D. Manning
loaned $864,000 to SHH pursuant to notes bearing interest at the prime rate plus
2%. The final principal installments on these loans were paid in October 2001
(i) to Mr. James D. Manning in the amount of $240,000 plus accrued interest and
(ii) to each of Mr. Patrick Manning and Mr. Harper in the amount of $24,000 plus
accrued interest.
NASCIT lent $1,500,000 to SHH in connection with the Sterling
Transaction pursuant to a short-term promissory note bearing interest at 12%.
The note was paid in full on December 31, 2001. Mr. Mills is Chief Executive of
NASCIT and was elected a director of SHH in January 1999, representing funds
managed by J. O. Hambro Capital Management Limited.
From March 2001 until March 2002 Mr. Hemsley provided consulting
services to, and since April 2002 has been employed by, J. O. Hambro Capital
Management Limited as the fund manager of Leisure and Media Venture Capital
Trust plc, a fund that was not an investor in the Sterling Transaction.
In December 2001, in order to strengthen SCPI's working capital
position, Sterling obtained funding in the amount of $500,000 from members of
management and directors, including Messrs. Frickel, Harper and Hemsley, who
contributed $155,000, $100,000 and $25,000, respectively. These notes are
convertible into common shares of the Company at a conversion price of $2.50 per
share at any time prior to the maturity date of December 2004. The notes, which
rank senior to debt incurred in the Sterling Transaction, bear interest at 12%
which is payable monthly.
In July 2001, Mr. Robert Frickel was elected to the Board of Directors.
Mr. Frickel serves as President of R.W. Frickel Company, P.C., an accounting
firm based in Michigan. R.W. Frickel Company has performed certain accounting
and tax services for SHH, and in fiscal 2002, for Sterling. Fees paid or accrued
to R.W. Frickel Company for fiscal 2002 were approximately $92,000.
Reference is made to information contained under the headings "Compensation of
Directors," "Employment Contracts and Termination of Employment and
Change-in-Control Arrangements," and "Compensation Committee Interlocks and
Insider Participation," in Item 11.
- ----------------------
36
PART IV
ITEM 14. CONTROLS AND PROCEDURES
The Company's management, including the Chief Executive Officer and
Chief Financial Officer, have conducted an evaluation of the effectiveness of
disclosure controls and procedures (as defined in Securities Exchange Act of
1934 Rules 13a-14 (c) and 15d-14 (c)) as of a date within 90 days before the
filing date of this Report. Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the disclosure controls and
procedures are effective in ensuring that all material information required to
be filed in this Annual Report on Form 10-K has been made known to them in a
timely fashion. There have been no significant changes in internal controls
subsequent to the date the Chief Executive Officer and Chief Financial Officer
completed their evaluation.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as a part of this report.
1. Financial Statements:
Report of Independent Certified Public Accountants
Consolidated Balance Sheets: December 31, 2002 and
December 31, 2001
Consolidated Statements of Operations for the fiscal periods
ended December 31, 2002, December 31, 2001, and
February 28, 2001
Consolidated Statements of Stockholders' Equity (Deficiency)
for the fiscal periods ended December 31, 2002,
December 31, 2001 and February 28, 2001
Consolidated Statements of Cash Flows for the fiscal periods
ended December 31, 2002, December 31, 2001, and
February 28, 2001
Notes to Consolidated Financial Statements
2. The following Financial Statement Schedules for the fiscal
periods ended December 31, 2002, December 31, 2001 and
February 28, 2001 are submitted herewith:
Schedule II - Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable or the
required information is shown in the consolidated financial statements or the
notes thereto.
3. Exhibits
Exhibit No. Description
2.1 Agreement and Plan of Merger dated as of May 20, 1991 (filed as
Appendix A to the Proxy Statement/Prospectus dated April 16, 1991 of
the Company and Steel City Products, Inc. [SEC Commission file number
0-2572).
2.2 Transaction Agreement, dated as of July 18, 2001, by and among Oakhurst
Company, Inc., Sterling Construction Company and Certain Stockholders
of Sterling Construction Company (filed as Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the fiscal quarter ended
May 31, 2001).
37
3.1 Restated and Amended Certificate of Incorporation (filed as Exhibit 3
to the Company's Quarterly Report on Form 10-Q for the fiscal quarter
ended August 31, 1996).
3.2 By-laws, as amended through January 13, 1998 (filed as Exhibit 3.2 to
the Company's Annual Report on Form 10-K for the fiscal year ended
February 28, 1998).
4.1 Certificate of Designations of Series A Junior Participating Preferred
Stock dated as of February 10, 1998 (filed as Exhibit 4.2 to the
Company's Annual Report on Form 10-K for the fiscal year ended February
28, 1998).
4.2 Warrant to Purchase Common Stock of Oakhurst Company, Inc. issued to
KTI, Inc., dated July 3, 2001 (filed as Exhibit B to Exhibit 10.26 to
the Company's Annual Report on Form 10-K405 for the fiscal year ended
February 21, 2001).
4.3*# Form of Warrant to Purchase Common Stock of Oakhurst Company, Inc.,
dated July 18, 2001.
10.1# Form of Option Agreement dated August 29, 1991 with directors and
executive officers (filed as Exhibit 10(b) to the Company's Annual
report on Form 10-K for the fiscal year ended February 29, 1992 [SEC
Commission file number 33-39954).
10.2 The 1994 Omnibus Stock Plan with form of option agreement (filed as
Exhibit 10.13 to the Company's Annual Report on Form 10-K for the
fiscal year ended February 28, 1995 [SEC Commission file number
0-19450).
10.3# The 1994 Non-Employee director Stock Option Plan with form of option
agreement (filed as Exhibit 10.13 to the Company's Annual Report on
Form 10-K for the fiscal year ended February 28, 1995 [SEC Commission
file number 0-19450).
10.4 Lease agreement between Regional Industrial Development Corporation of
Southwestern Pennsylvania and Steel City Products, Inc. dated as of
November 11, 1997 (filed as Exhibit 10.19 to the Company's Annual
Report on Form 10-K for the fiscal year ended February 28, 1998).
10.5 Rights Agreement, dated as of December 29, 1998 between Oakhurst
Company, Inc. and American Stock Transfer and Trust Company, including
the form of Certificate of Designation, the form of Rights Certificate
and the Summary of Rights attached thereto as Exhibits A, B and C,
respectively filed as Exhibit 99.1 to the Company's Registration
Statement on Form 8-A filed on January 5, 1999.
10.6# Amendment to the 1994 Omnibus Stock Plan, amended as of December 18,
1998 (filed as Exhibit 10.21 to the Company's Annual Report on Form
10-K for the fiscal year ended February 28, 1999).
10.7 Merger Agreement dated June 30, 2000 between Oakhurst Company, A.C.F.
Imports, Inc., A.C.F. Acquisition, Inc. and Dowling's Fleet Service
Co., Inc. (filed as Exhibit 10.33 to the Company's Quarterly Report on
Form 10-Q for the quarter ended August 31, 2000).
10.8 Lease Agreement by and between SPEDD, Inc. and Steel City Products,
Inc., dated November 21, 2000 (filed as Exhibit 10.24 to the Company's
Annual Report on Form 10-K405 for the fiscal year ended February 28,
2001).
10.9 Wind-Up Agreement, dated as of April 19, 2001 by and between KTI, Inc.,
Casella Waste Systems, Inc., Oakhurst Company, Inc. and Oakhurst
Technology, Inc. (filed as Exhibit 10.26 to the Company's Annual Report
on Form 10-K405 for the fiscal year ended February 28, 2001).
10.10# Subordinated Promissory Note, dated July 18, 2001, by Sterling
Construction Company to Patrick T. Manning.
38
10.11# Subordinated Promissory Note, dated July 18, 2001, by Sterling
Construction Company to Joseph P. Harper, Sr.
10.12# Subordinated Promissory Note, dated July 18, 2001, by Oakhurst Company,
Inc. to Patrick T. Manning.
10.13# Subordinated Promissory Note, dated July 18, 2001, by Oakhurst Company,
Inc. to Joseph P. Harper, Sr.
10.14# Secured Promissory Note, dated July 19, 2001, by Oakhurst Technology,
Inc. to Joseph P. Harper, Sr.
10.15# Subordinated Promissory Note, dated July 19, 2001, by Oakhurst Company,
Inc. to Joseph P. Harper, Sr.
10.16# Secured Promissory Note, dated October 18, 1999, by Oakhurst
Technology, Inc. to Robert M. Davies,
10.17# Amendment to Secured Promissory Note dated October 18, 1999, dated July
13, 2001, by and between Oakhurst Technology, Inc. and Robert M.
Davies.
10.18# Subordinated Promissory Note, dated July 13, 2001, by Oakhurst Company,
Inc. to Robert M. Davies.
10.19# Amendment No. 1 to Subordinated Promissory Note dated July 13, 2001,
dated July 19, 2001, by and between Oakhurst Company, Inc. and Robert
M. Davies.
10.20# Subordinated Promissory Note, dated July 13, 2001, by Oakhurst Company
Inc. to Maarten D. Hemsley.
10.21# Amendment No. 1 to Subordinated Promissory Note dated July 13, 2001,
dated July 19, 2001, by and between Oakhurst Company, Inc. and Maarten
D. Hemsley.
10.22# Amended and Restated Executive Employment Agreement, dated July 18,
2001, by and between Sterling Construction Company and Patrick T.
Manning.
10.23# Amended and Restated Executive Employment Agreement, dated July 18,
2001, by and between Sterling Construction Company and Joseph P.
Harper, Sr.
10.24# Executive Employment Agreement, dated July 18, 2001, by and between
Oakhurst Company, Inc. and Patrick T. Manning.
10.25# Executive Employment Agreement, dated July 18, 2001, by and between
Oakhurst Company, Inc. and Joseph P. Harper, Sr.
10.26# Employment Agreement, dated May 1, 2000, by and between Sterling
Construction Company and Terrance W. Allan (filed as Exhibit 10.25 to
the Company's Annual Report on Form 10-K405 for the fiscal year ended
February 28, 2001).
10.27 Subordinated Promissory Note, dated July 18, 2001, by Oakhurst Company,
Inc. to North Atlantic Smaller Companies Investment Trust Plc.
10.28 Oakhurst Group Tax Sharing Agreement, dated July 18, 2001, by and among
Oakhurst Company, Inc., Sterling Construction Company, Steel City
Products, Inc., and such other companies set forth therein.
10.29 Securities Purchase Agreement, dated as of July 18, 2001, by and among
JO Capital Management Ltd A/C A, JO Capital Management Ltd A/C B, JO
Capital Management Ltd A/C C, Orynx International Growth Fund Limited,
Invesco English & International Trust Plc, North Atlantic Small
Companies Investment Trust Plc, Oakhurst Company, Inc. and Sterling
Construction Company (filed as Exhibit 10.2 to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended May 31, 2001).
39
10.30# Stock Pledge Agreement, dated July 19, 2001, by and between Oakhurst
Company, Inc. and Joseph P. Harper, Sr. (filed as Exhibit 10.30 to the
Company's Transition Report on Form 10-K for the ten months ended
December 31, 2002).
10.31 Amended and Restated Revolving Credit Loan Agreement, dated July 18,
2001, between Comerica Bank-Texas and Sterling Construction Company
(filed as Exhibit 10.31 to the Company's Transition Report on Form 10-K
for the ten months ended December 31, 2002)
10.32 Amendment to Amended and Restated Revolving Credit Loan Agreement,
effective July 18, 2001, between Comerica Bank-Texas and Sterling
Construction Company (filed as Exhibit 10.32 to the Company's
Transition Report on Form 10-K for the ten months ended December 31,
2002)
10.33 Credit Agreement, dated as of July 13, 2001, by and between National
City Bank of Pennsylvania and Steel City Products, Inc. (filed as
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
fiscal quarter ended May 31, 2001).
10.34 Amendment to Revolving Credit Agreement, dated September 12, 2001
between National City Bank of Pennsylvania and Steel City Products,
Inc. (filed as Exhibit 10.3 to the Company's Quarterly Report on Form
10-Q for the fiscal quarter ended May 31, 2001).
10.35 Amendment No. 2 to Revolving Credit Agreement, effective December 13,
2001 between National City Bank of Pennsylvania and Steel City
Products, Inc. (filed as Exhibit 10.35 to the Company's Transition
Report on Form 10-K for the ten months ended December 31, 2002)
10.36# Convertible Subordinated Note, dated December 31, 2001, by Sterling
Construction Company, Inc. to Robert W. Frickel. (filed as Exhibit
10.36 to the Company's Transition Report on Form 10-K for the ten
months ended December 31, 2002)
10.37# Convertible Subordinated Note, dated December 31, 2001, by Sterling
Construction Company, Inc. to Joseph P. Harper, Sr. (filed as Exhibit
10.37 to the Company's Transition Report on Form 10-K for the ten
months ended December 31, 2002)
10.38# Convertible Subordinated Note, dated December 31, 2001, by Sterling
Construction Company, Inc. to Maarten D. Hemsley. (filed as Exhibit
10.38 to the Company's Transition Report on Form 10-K for the ten
months ended December 31, 2002)
10.39# Convertible Subordinated Note, dated January 2, 2002, by Sterling
Construction Company, Inc. to Bernard Frank. (filed as Exhibit 10.39 to
the Company's Transition Report on Form 10-K for the ten months ended
December 31, 2002)
10.40 Purchase Agreement between Insituform Technologies, Inc. and Texas
Sterling Construction, L.P. dated September 23, 2002 (filed as Exhibit
10.40 to the Company's Quarterly Report on Form 10-Q for the fiscal
quarter ended September 30, 2002).
16 Deloitte & Touche LLP letter to Securities and Exchange Commission
dated October 1, 2001 (filed as Exhibit 16 to Form 8-K/A, filed October
5, 2001.)
21 Subsidiaries at December 31, 2002:
Steel City Products, Inc. - Delaware
Oakhurst Management Corporation - Texas
Sterling Houston Holdings, Inc. - Delaware
23.1* Consent of Grant Thornton LLP to the incorporation by reference of the
filings on Form S-8 dated May 14, 2002.
40
23.2* Consent of Deloitte & Touche LLP to the incorporation by reference of
the filings on Form S-8 dated May 14, 2002.
99.1* Certification of Patrick T. Manning, Chief Executive Officer, and
Maarten D. Hemsley, Chief Financial Officer.
# Management contract or compensatory plan or arrangement.
* Filed herewith
(b) Reports on Form 8-K filed during the last quarter of the period covered
by this report: Form 8-K dated September 23, 2002.
41
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Sterling Construction Company, Inc.
We have audited the accompanying consolidated balance sheets of Sterling
Construction Company, Inc. and its subsidiaries as of December 31, 2002 and
2001, and the related consolidated statements of operations, stockholders'
equity, and cash flows for the year ended December 31, 2002 and the ten months
ended December 31, 2001. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Sterling
Construction Company, Inc. and its subsidiaries as of December 31, 2002 and
December 31, 2001 and the results of their operations and their cash flows for
year ended December 31, 2002 and the ten months ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States of
America.
The consolidated financial statements of Sterling Construction Company, Inc. and
its subsidiaries as of February 28, 2001, and for the year then ended, have been
restated to give effect to accounting for the investment in Sterling Houston
Holdings, Inc. under the equity method of accounting in accordance with the
step-acquisition method of accounting for the acquisition of a subsidiary. The
consolidated financial statements as of February 28, 2001 and for the year then
ended prior to such restatement were audited by other auditors whose report
thereon expressed an unqualified opinion on those statements. We audited the
change in the accumulated deficit at February 29, 2000, the changes in the
Company's investment in Sterling Houston Holdings and its accumulated deficit as
of February 28, 2001, and the changes in its income from equity investment in
Sterling Houston Holdings and the related amortization of goodwill for the year
ended February 28, 2001, which adjustments were necessary to restate the
investment in Sterling Houston Holdings from the cost method to the equity
method of accounting in accordance with the step-acquisition method of
accounting for the acquisition of a subsidiary, and in our opinion, such
adjustments have been properly reflected in the restated consolidated financial
statements.
We also audited Schedule II for the year ended December 31, 2002 and the ten
months ended December 31, 2001. In our opinion, this schedule, when considered
in relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information therein.
As discussed in Note 1 to the Consolidated Financial Statements, the Company
adopted Statement of Financial Standards No. 142 "Goodwill and Other Intangible
Assets" on January 1, 2002.
/S/ Grant Thornton LLP
Houston, Texas
March 20, 2003
42
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Sterling Construction Company, Inc.
We have audited the consolidated statements of operations, stockholders' equity
(deficiency) and cash flows of Sterling Construction Company, Inc. (formerly
Oakhurst Company, Inc.) and subsidiaries for the year ended February 28, 2001
(none of which are presented herein). Our audit also included the consolidated
financial statement schedule listed at Item 15(a)(2) for the year ended February
28, 2001. These consolidated financial statements and consolidated financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on the consolidated financial statements
and consolidated financial statement schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the results of operations and cash flows of Sterling
Construction Company, Inc. and subsidiaries for the year ended February 28, 2001
in conformity with accounting principles generally accepted in the United States
of America. Also, in our opinion, the consolidated financial statement schedule,
for the year ended February 28, 2001 when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/S/ Deloitte & Touche LLP
Pittsburgh, Pennsylvania
July 6, 2001
43
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
(FORMERLY OAKHURST COMPANY, INC.)
CONSOLIDATED BALANCE SHEETS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
December 31, December 31,
2002 2001
------------ ------------
Current assets:
Cash ....................................................................... $ 2,406 $ 2,884
Contracts receivable ....................................................... 22,218 15,195
Costs and estimated earnings in excess of billings ......................... 2,793 1,732
Trade accounts receivable, less allowance of $841 and $588, respectively ... 3,095 1,963
Inventories ......................................................... 3,378 4,126
Deferred tax asset ......................................................... 1,659 1,545
Other ...................................................................... 160 800
-------- --------
Total current assets ............................................. 35,709 28,245
-------- --------
Property and equipment, at cost ................................................... 28,585 20,540
Less accumulated depreciation .............................................. (5,791) (2,539)
-------- --------
22,794 18,001
-------- --------
Goodwill .......................................................................... 7,809 7,740
Deferred tax asset (long-term) .................................................... 5,952 4,769
Other assets ...................................................................... 493 383
-------- --------
14,254 12,892
-------- --------
$ 72,757 $ 59,138
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................................... $ 14,634 $ 12,270
Accrued interest ........................................................... 396 120
Billings in excess of cost and estimated earnings .......................... 3,541 4,013
Current maturities of long-term obligations ................................ 1,038 259
Current maturities of long-term obligations, related parties ............... 2,000 2,500
Other accrued expenses ..................................................... 2,353 829
-------- --------
Total current liabilities ............................................. 23,962 19,991
-------- --------
Long-term obligations:
Long-term debt ............................................................. 17,783 13,551
Long-term debt, related parties ............................................ 10,023 11,268
Put liability .............................................................. 4,577 4,056
Other long term obligations ................................................ 1,940 1,366
-------- --------
34,323 30,241
-------- --------
Minority interest ................................................................. 3,646 2,773
Commitments and contingencies ..................................................... -- --
Stockholders' equity:
Preferred stock, par value $0.01 per share; authorized 1,000,000
shares, none issued ........................................................ -- --
Common stock, par value $0.01 per share; authorized 14,000,000 shares,
5,069,016 and 5,055,516 shares issued ................................. 50 50
Additional paid-in capital ................................................. 65,871 65,900
Accumulated deficit ........................................................ (55,094) (59,816)
Treasury stock, at cost, 207 common shares ................................. (1) (1)
-------- --------
Total stockholders' equity ............................................ 10,826 6,133
-------- --------
$ 72,757 $ 59,138
======== ========
The accompanying notes are an integral part of these
consolidated financial statements
44
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
(FORMERLY OAKHURST COMPANY, INC.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollar amounts in thousands, except per share data)
FISCAL YEAR FISCAL YEAR FISCAL YEAR
ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, FEBRUARY 28,
2002 2001 2001
(TEN MONTHS)
------------- ------------- -------------
Contract revenues ........................................... $ 111,747 $ 48,654 $ --
Distribution revenues ....................................... 22,570 17,467 20,694
Other income ................................................ 319 157 565
----------- ----------- -----------
134,636 66,278 21,259
----------- ----------- -----------
Cost of contract revenues earned ............................ 98,935 44,694 --
Cost of goods sold, including occupancy, buying and
warehousing expenses ........................................ 18,917 14,865 17,436
Operating, selling and administrative expenses .............. 9,537 4,791 3,592
Provision for doubtful accounts ............................. 259 483 30
Interest expense ............................................ 2,643 2,193 2,688
----------- ----------- -----------
130,291 67,026 23,746
----------- ----------- -----------
Income (loss) from continuing operations before loss from
equity investment and income taxes .......................... 4,345 (748) (2,487)
Income (loss) from equity investment:
Investment in Sterling Houston Holdings ................ -- 63 260
Investment in New Heights .............................. -- (1,280) (4,817)
----------- ----------- -----------
Loss from equity investments ................................ -- (1,217) (4,557)
Minority interest ........................................... (873) (647) --
----------- ----------- -----------
Income (loss) before income taxes ........................... 3,472 (2,612) (7,044)
Income taxes:
Current income tax expense ........................... (14) (14) (27)
Deferred tax benefit ................................ 1,264 -- --
----------- ----------- -----------
Total income tax benefit (expense) .......................... 1,250 (14) (27)
----------- ----------- -----------
Income (loss) from continuing operations .................... 4,722 (2,626) (7,071)
----------- ----------- -----------
Discontinued operations
Income on disposal .................................. -- -- 399
----------- ----------- -----------
Net income (loss) ........................................... $ 4,722 $ (2,626) $ (6,672)
=========== =========== ===========
Basic net income (loss) per share:
Continuing operations ............................... $ 0.93 $ (0.52) $ (1.43)
Discontinued operations ............................. -- -- 0.09
----------- ----------- -----------
Net income (loss) per share ......................... $ 0.93 $ (0.52) $ (1.34)
=========== =========== ===========
Weighted average number of shares outstanding used in
computing basic per share amounts ...................... 5,061,598 5,055,516 4,943,018
=========== =========== ===========
Diluted net income (loss) per share:
Continuing operations ............................... $ 0.78 $ (0.52) $ (1.43)
Discontinued operations ............................. -- -- 0.09
----------- ----------- -----------
Net income (loss) per share ......................... $ 0.78 $ (0.52) $ (1.34)
=========== =========== ===========
Weighted average number of shares outstanding used in
computing diluted per share amounts ......................... 6,101,515 5,055,516 4,943,018
=========== =========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
45
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
(FORMERLY OAKHURST COMPANY, INC.)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY)
(DOLLARS IN THOUSANDS)
Additional
Common paid-in Accumulated Treasury
stock capital Deficit stock Totals
-------- ---------- ----------- -------- --------
Balance at February 29, 2000 ................ $ 49 $ 47,204 $(50,518) $ (1) $ (3,266)
Net loss .................................... -- -- (6,672) -- (6,672)
-------- -------- -------- -------- --------
Balance at February 28, 2001 ................ 49 47,204 (57,190) (1) (9,938)
Cancellation of debt and return of equity
investment .................................. 14,520 (1,297) 13,223
Stock issued for acquisition of Sterling
Houston Holdings ............................ (81) 843 762
Sale of treasury stock ...................... 454 454 908
Stock issued upon option exercise ........... 1 62 63
Deferred tax benefit resulting from a
reduction in the valuation allowance of
the deferred tax asset ...................... 3,741 3,741
Net loss .................................... -- -- (2,626) -- (2,626)
-------- -------- -------- -------- --------
Balance at December 31, 2001 ................ 50 65,900 (59,816) (1) 6,133
Stock issued upon option exercise ........... * 9 9
Deferred tax charge resulting from a
reduction in the valuation allowance of
the deferred tax asset ...................... (38) (38)
Net income .................................. -- -- 4,722 -- 4,722
-------- -------- -------- -------- --------
Balance at December 31, 2002 ................ $ 50 $ 65,871 $(55,094) $ (1) $ 10,826
======== ======== ======== ======== ========
* rounds to less than one thousand
The accompanying notes are an integral part of this
consolidated financial statement
46
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
(FORMERLY OAKHURST COMPANY, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLAR AMOUNTS IN THOUSANDS)
Fiscal year
Fiscal year Ended Fiscal year
Ended December 31, Ended
December 31, 2001 February 28,
2002 (ten months) 2001
------------ ------------ ------------
Cash flows from operating activities:
Income (loss) from continuing operations ..................... $ 4,722 $ (2,626) $ (7,071)
Adjustments to reconcile income (loss) from
continuing operations to net cash provided by
(used in) operating activities:
Depreciation and amortization ............................. 3,855 1,706 201
Bad debt expense .......................................... 259 483 --
Loss from equity investments .............................. -- 1,217 4,557
(Gain) loss on disposal of property and equipment ......... (47) 163 --
Deferred tax benefit ...................................... (1,264) -- --
Minority interest in net earnings of subsidiary ........... 873 647 --
Change in put liability ................................... 521 -- --
Other changes in operating assets and liabilities,
net of effect from acquisitions:
(Increase) decrease in accounts receivable ................ (1,391) 146 (98)
(Increase) decrease in contracts receivable ............... (7,023) 3,020 --
Decrease in inventories ................................... 748 25 645
(Increase) decrease in costs and estimated earnings
in excess of billings on uncompleted contracts ............ (1,061) 1,181 --
Decrease (increase) in prepaid expense and other assets ... 331 (343) --
Increase (decrease) in trade payables ..................... 2,364 (2,473) (477)
(Decrease) in billings in excess of costs and
estimated earnings on uncompleted contracts ............... (472) (553) --
Increase (decrease) in accrued compensation
and other liabilities ..................................... 2,691 (22) 2,140
-------- -------- --------
Net cash provided by (used in) operating activities of:
Continuing operations ....................................... 5,106 2,571 (103)
Discontinued operations ..................................... -- -- (111)
-------- -------- --------
Net cash provided by (used in) operating activities ................ 5,106 2,571 (214)
-------- -------- --------
Cash flows from investing activities:
Net cash paid upon acquisition of Kinsel
Heavy Highway Construction business ......................... (2,662) -- --
Net cash paid upon acquisition of Sterling
Houston Holdings ............................................ -- 9,354) --
Additions to property and equipment ......................... (4,346) (1,204) (59)
Proceeds from sale of property and equipment ................ 106 65 --
Increase in investment in New Heights ....................... -- -- (3,651)
-------- -------- --------
Net cash used in investing activities .............................. (6,902) (10,493) (3,710)
-------- -------- --------
Cash flows from financing activities:
Borrowings under long term obligations ...................... 4,074 10,349 292
Proceeds from issuance of long term debt .................... 60 500 3,742
Issuance of common stock, net of expenses ................... 9 63 --
Principal payments on long-term obligations ................. (2,825) (1,100) (156)
Sale of treasury stock ...................................... -- 908 --
Deferred loan costs ......................................... -- -- (20)
-------- -------- --------
Net cash provided by financing activities .......................... 1,318 10,720 3,858
-------- -------- --------
Net (decrease) increase in cash .................................... (478) 2,798 (66)
47
Fiscal year
Fiscal year Ended Fiscal year
Ended December 31, Ended
December 31, 2001 February 28,
2002 (ten months) 2001
------------ ------------ ------------
Cash at beginning of period ........................................ 2,884 86 152
-------- -------- --------
Cash at end of period .............................................. $ 2,406 $ 2,884 $ 86
======== ======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period for operating activities
from continuing operations:
Interest .................................................... $ 2,316 $ 1,384 $ 470
======== ======== ========
Income taxes, net of refunds received ....................... $ -- $ -- $ 1
======== ======== ========
Supplemental disclosure of non-cash financing activities:
Capital lease obligations for new
equipment ................................................... $ 32 $ -- $ 71
======== ======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
48
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
(FORMERLY OAKHURST COMPANY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation:
The accompanying consolidated financial statements include the accounts
of subsidiaries in which the Company has a greater than 50% ownership interest
and all significant intercompany accounts and transactions have been eliminated
in consolidation.
Continuing operations
Oakhurst Company, Inc. ("Oakhurst"), renamed Sterling Construction
Company, Inc. in October 2001, (hereinafter referred to as "Sterling" or "the
Company") was formed as part of a merger transaction in 1991, in which Steel
City Products, Inc. ("SCPI") became a majority-owned subsidiary of the Company.
In accordance with the merger agreement, Sterling owns 10% of SCPI's outstanding
common stock and all of the SCPI Series A Preferred Stock, and as a result, it
owns 90% of the voting stock of SCPI.
Because Sterling's ownership of SCPI is primarily in the form of
preferred stock, Sterling retains most of the value of SCPI, and Sterling's
income from SCPI is determined by the Series A Preferred stock dividend. This
form of ownership was designed to facilitate the preservation of SCPI's net
operating tax loss carry-forwards and capital losses, which amounted to
approximately $110 million at December 31, 2002.
In December 1998 Sterling formed a wholly-owned subsidiary, Oakhurst
Technology, Inc. ("OTI") to invest in New Heights Recovery and Power, LLC ("New
Heights") which was to become a fully integrated recycling and waste-to-energy
facility in Ford Heights, Illinois. In conjunction with OTI's funding commitment
to New Heights, Sterling entered into certain agreements with KTI, Inc. ("KTI")
(which subsequently merged into Casella Waste Systems, Inc., "Casella")
regarding the funding of capital improvements and start-up losses at New
Heights.
Due to significant and continuing losses incurred at New Heights, and
Casella's decision to exit certain non-core activities, of which New Heights was
deemed one, in April 2001 certain agreements (the "Unwinding Agreements") were
signed among the Company, OTI, Casella and KTI pursuant to which (a) all of
OTI's equity interest in New Heights was transferred to KTI, (b) the Sterling
common stock held by KTI was transferred to the Company, (c) all securities
pledged to KTI by the Company and/or OTI were released, (d) the KTI Loan,
including accrued interest thereon, aggregating approximately $16.1 million, was
cancelled, with the exception of $1 million, which sum was converted into a four
year subordinated promissory note bearing interest at 12%, and (e) the Company
issued to KTI a ten-year warrant to purchase 494,302 shares of the Company's
common stock at $1.50 per share. The Unwinding Agreements were placed into
escrow upon signing in April 2001 and became effective upon their release from
escrow on July 3, 2001.
In January 1999, OTI made a minority investment in Sterling
Construction Company, Inc., renamed Sterling Houston Holdings, Inc. in October
2001 (hereinafter referred to as "SHH"). SHH is a heavy civil construction
company based in Houston that specializes in municipal and state contracts for
highway paving, bridge, water and sewer, and light rail. In October 1999 SHH
achieved certain growth objectives that triggered the right of certain
shareholders of SHH to exercise their right to sell a second tranche of equity
to OTI. Cash for the second equity purchase was obtained through the issuance of
notes secured by the second equity tranche, of which a part was due to two
officers and directors of Sterling, and the remainder was due to certain
directors and management of SHH. These notes were restructured as part of a
transaction in July 2001 (the "Sterling Transaction"), in which Sterling further
increased its equity position in SHH from 12% to 80.1%. The original
49
investments were recorded using the cost method. The subsequent acquisition in
July 2001 resulted in step-acquisition treatment of the original investment.
Accordingly, the results of operations of the Company have been restated to
reflect its ownership of SHH as if it had been reported as an equity investment
for fiscal 2001, fiscal 2000 and fiscal 1999. Equity investment income generated
by SHH for fiscal 2001, 2000 and 1999 was $63,000, $260,000 and $506,000,
respectively. In addition, goodwill expense of $25,000, $51,000 and $36,000 was
recorded as part of the step-acquisition in fiscal 2001, 2000 and 1999,
respectively. In fiscal 1999, beginning accumulated deficit was restated for the
equity earnings of SHH and related goodwill amortization in the aggregate amount
of $49,000.
In September 2002, a wholly-owned subsidiary of SHH, Texas Sterling
Construction, L.P. ("TSC") acquired the Kinsel Heavy Highway construction
business (the "Kinsel Business") from a subsidiary of Insituform Technologies,
Inc. ("ITI"). The acquisition included the purchase of construction equipment at
its appraised value of approximately $4.4 million, and the assumption by TSC of
equipment operating leases with a future obligation of approximately $1.4
million. Certain new construction contracts with revenues estimated at $38
million, subject to post-closing adjustments, were assigned to TSC. TSC has been
engaged to manage the completion of certain other contracts in return for a
management fee, and hired most of Kinsel's construction crews together with
project managers and other supervisory personnel. The consideration of $4.4
million for the Kinsel Business was financed by TSC through the issuance to ITI
of two unsecured two-year notes aggregating $1.5 million, with the balance
funded through additional borrowings under the SHH revolving line of credit.
To better reflect the change of focus of the Company, in October 2001
the shareholders of Oakhurst approved a name change to Sterling Construction
Company, Inc and at the same time the subsidiary formerly carrying that name was
renamed Sterling Houston Holdings, Inc. The Company reports two operating
segments, "Construction", which consists of the operations of SHH, and
"Distribution" which consists of the operations of SCPI. OTI was dissolved in
December 2001.
Discontinued operations
During fiscal 1999, the Board of Directors decided to sell Dowling's
Fleet Service Co., Inc. ("Dowling's"). In June 2000, Oakhurst entered into an
agreement to dispose of Dowling's through its merger with an importer of
radiators. The merger closed on November 29, 2000. Accordingly, the income
related to the disposal of Dowling's has been presented as discontinued
operations in the statement of operations and the statement of cash flows.
Use of Estimates:
The consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of America,
which require management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, and disclosure of contingent assets
and liabilities at the date of the financial statements, and the reported amount
of revenues and expenses during the reporting period. Significant estimates
included in the Company's financial statements include the allowance for
doubtful accounts and estimates for the use of the Company's net operating loss
carryforwards. Actual results could differ from those estimates.
Business Activities:
The Company's continuing operations at December 31, 2002 consisted of
two businesses, Construction and Distribution. Construction comprises SHH, a
heavy civil construction company based in Houston that specializes in municipal
and state contracts for highway paving, bridge, water and sewer, and light rail.
Distribution comprises SCPI, a wholesale distributor operating under the trade
name Steel City Products which principally sells automotive accessories,
primarily to drug and supermarket retailers, discount retail chains, hardware
and automotive stores, based mainly in the Northeastern United States. SCPI also
distributes non-food pet supplies primarily to supermarket retailers. In the
third quarter of fiscal 2000, SCPI began the distribution of lawn and garden
supplies.
50
Fiscal Year:
Historically, the Company's fiscal year ended on the last day of
February. In November 2001, the Board of Directors voted to change the Company's
fiscal year end to December 31. Accordingly, this report covers the fiscal year
from January 1, 2002 through December 31, 2002 ("Fiscal 2002"). The transition
period from March 1, 2001 to December 31, 2001 is referred to as "Fiscal 2001"
and the twelve months ended February 28, 2001 is referred to as "Fiscal 2000".
Revenue Recognition:
Construction
The Company's primary business since July 2001 has been as a general
contractor in the State of Texas where it engages in various types of heavy
civil construction projects for both public and private owners. Credit risk is
minimal with public (government) owners since the Company ascertains that funds
have been appropriated by the governmental project owner prior to commencing
work on public projects. However, most public contracts are subject to
termination at the election of the government but, in the event of termination,
the Company is entitled to receive the contract price on completed work and
reimbursement of termination-related costs. Credit risk with private owners is
minimized because of statutory mechanics liens, which give the Company high
priority in the event of lien foreclosures following financial difficulties of
private owners.
Revenues are recognized on the percentage-of-completion method,
measured by the percentage of costs incurred to date to estimated total costs
for each contract.
Contract costs include all direct material, labor, subcontract and
other costs and those indirect costs related 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 and estimated profitability, including those 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. An amount equal to costs attributable to contract claims is included
in revenues when realization is probable and the amount can be reliably
estimated.
The asset, "Costs and estimated earnings in excess of billings on
uncompleted contracts" represents revenues recognized in excess of amounts
billed. The liability "Billings in excess of costs and estimated earnings on
uncompleted contracts" represents billings in excess of revenues recognized.
Distribution
Revenue is recognized when all of the following criteria are met:
- Persuasive evidence of an arrangement exists
- Delivery has occurred or service has been rendered
- The seller's price to the buyer is fixed or determinable, and
- Collectibility is reasonably assured.
The Company provides appropriate provisions for uncollectible accounts
and credit for returns.
Inventories:
The Company's inventories are stated at the lower of cost as determined
by the first-in first-out (FIFO) method, or market.
51
Property and Equipment:
Property and equipment are stated at cost. Depreciation and
amortization are computed using the straight-line method. The estimated useful
lives used for computing depreciation and amortization are:
Building and improvements 15-39 years
Construction equipment 5-15 years
Leasehold improvements 3-10 years
Transportation equipment 5 years
Furniture and fixtures 5 years
Office furniture, warehouse
equipment and vehicles 3-10 years
Depreciation expense for continuing operations was approximately $3.8
million, $1.6 million and $123,000 in fiscal 2002, 2001 and 2000.
Deferred Loan Costs:
Deferred loan costs represent loan origination fees paid to the lender
and related professional fees. These fees are amortized over the term of the
loan. Amortization expense for fiscal years 2002, 2001 and 2000 was $151,000,
$65,000 and $91,000, respectively.
Investments:
Sterling accounts for investments of more than 20% in affiliated
companies and in which it exerts significant influence on the equity basis of
accounting and accordingly, consolidated results of operations include
Sterling's share of the loss from New Heights, from December 1998 to July 3,
2001, the date of disposition.
Sterling utilizes the cost method of accounting for investments in
which it has less than a 20% ownership interest, does not exert significant
influence, and where there is no readily determinable market value. Sterling
accounted for its investment in SHH prior to the Sterling Transaction utilizing
the cost method, but restated using the equity method at the transaction date in
July 2001. Accordingly, the Company's investment in SHH was restated as of
February 28, 2001 to reflect SHH as an equity investment.
Management performs a review of investments whenever events or changes
in circumstances occur which may indicate that there is other than a temporary
decline in the value of the investments. In performing this review, management
considers numerous factors including the financial condition and prospects of
the investee and the Company's intention and ability with respect to retaining
the investment.
Goodwill:
Goodwill represents the excess of the cost of companies acquired over
the fair value of their net assets at the dates of acquisition.
The Company accounts for goodwill in accordance with SFAS 142, which
was adopted on January 1, 2002. SFAS 142 supercedes APB Opinion No. 17,
Intangible Assets. SFAS 142 primarily addresses the accounting for goodwill and
intangible assets subsequent to their acquisition (i.e., the post-acquisition
accounting). The most significant changes made by SFAS 142 are: (1) goodwill and
indefinite lived intangible assets will no longer be amortized, (2) goodwill
will be tested for impairment at least annually at the reporting unit level, (3)
the amortization period of intangible assets with finite lives will no longer be
limited to forty years, and (4) intangible assets deemed to have an indefinite
life will be tested for impairment at least annually using a one step process.
52
The first step in the impairment test of goodwill is to identify a
potential impairment by comparing the fair value to the reported value of each
reporting unit. The second step of the goodwill impairment test measures the
amount of the impairment loss, if any, and is recorded in the consolidated
statements of operations during the period in which the test is performed.
Intangible assets that have finite lives continue to be subject to
amortization. In addition, the Company must evaluate the remaining useful life
each reporting period to determine whether events and circumstances warrant a
revision of the remaining period of amortization. If the estimate of an
intangible assets remaining life is changed, the remaining carrying amount of
the intangible asset is amortized prospectively over that revised remaining
useful life.
Resulting from the step acquisition of SHH in July 2001, whereby the
Company increased its investment in SHH from 12% to 80.1%, the Company restated
its investment in SHH to provide for goodwill prior to the July 2001 transaction
date. Results of operations for fiscal 2001 and 2000 have been restated to
amortize the Company's goodwill in SHH, reflecting expense of $25,000 and
$51,000, respectively.
The amounts recorded by the Company for goodwill are as follows
(dollars in thousands):
Construction Distribution
Segment Segment Total
Balance, January 1, 2002 $7,612 $128 $7,740
Goodwill adjustment* 69 -- 69
Impairment losses -- -- --
------ ---- ------
Balance, December 31, 2002 $7,681 $128 $7,809
====== ==== ======
* The adjustment to goodwill related to additional consideration pertaining to
the Sterling Transaction in July 2001.
The Company performed impairment testing on both reporting units as of
January 1, 2002 and again as of October 1, 2002. The analysis indicated no
impairment of the Company's recorded goodwill for either reporting unit.
Prior to the implementation of SFAS No. 142, the Company amortized
goodwill over the expected life of the asset. The following table adjusts net
income for the add back of goodwill amortization as of fiscal years 2002, 2001
and 2000 (dollar amounts in thousands, except per share amounts):
Fiscal 2002 Fiscal 2001 Fiscal 2000
December 31, December 31, February 28,
------------ ------------ ------------
2002 2001 2001
------------ ------------ ------------
Reported net income (loss) $ 4,722 $ (2,626) $ (6,672)
Add back goodwill amortization: -- 25 57
--------- ---------
Adjusted net income (loss): $ 4,722 $ (2,601) $ (6,615)
========= ========= =========
Basic earnings (loss) per share:
Reported net income (loss) $ 0.93 $ (0.52) $ (1.34)
Goodwill amortization -- $ -- $ 0.01
--------- --------- ---------
Adjusted net income (loss) $ 0.93 $ (0.52) $ (1.33)
========= ========= =========
Diluted earnings per share:
Reported net income (loss) $ 0.78 $ (0.52) $ (1.34)
Goodwill amortization -- $ -- $ 0.01
--------- --------- ---------
Adjusted net income (loss) $ 0.78 $ (0.52) $ (1.33)
========= ========= =========
53
Equipment Under Capital Leases:
The Company accounts for capital leases, which transfer substantially
all the benefits and risks incident to the ownership of the property to the
Company, as the acquisition of an asset and the incurrence of an obligation.
Under this method of accounting, the cost of the leased asset is amortized
principally using the straight-line method over its estimated useful life and
the obligation, including interest thereon, is liquidated over the life of the
lease. Depreciation expense on leased equipment and the related accumulated
depreciation is included with that of owned equipment.
Shipping and Handling Costs:
Shipping costs are recorded in cost of goods sold. Expenses incurred
for handling goods in preparation for shipment to customers totaled $875,000,
$737,000 and $898,000 during fiscal 2002, 2001 and 2000, respectively. These
expenses are primarily related to warehouse personnel and beginning in fiscal
2002 are presented in the financial statements as part of cost of goods sold.
Prior to fiscal 2002, handling expenses were reported as part of operating,
selling and administrative expenses. Years prior to fiscal 2002 have been
reclassified to reflect the new treatment.
Federal and State Income Taxes:
Sterling accounts for income taxes using an asset and liability
approach. Deferred tax liabilities and assets are recognized for the future tax
consequences of events that have already been recognized in the financial
statements or tax returns. Net deferred tax assets are recognized to the extent
that management believes that realization of such benefits is considered more
likely than not. Changes in enacted tax rates or laws may result in adjustments
to the recorded deferred tax assets or liabilities in the period that the tax
law is enacted (see Note 10).
Stock-Based Compensation:
The Company accounts for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
The following table illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition provisions of
FASB Statement No. 123, "Accounting for Stock-Based Compensation", to
stock-based employee compensation (dollars in thousands, except per share data).
Fiscal Ten months Fiscal
year ended ended year ended
December 31, December 31, February 28,
2002 2001 2001
Net income (loss), as reported $ 4,722 $ (2,626) $ (6,672)
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (50) (80) (112)
--------- --------- ---------
Proforma net income (loss) $ 4,672 $ (2,707) $ (6,784)
Basic and diluted net income (loss) per
share:
Basic, as reported $ 0.93 $ (0.52) $ (1.34)
Diluted, as reported $ 0.78 $ (0.52) $ (1.34)
Proforma, basic $ 0.92 $ (0.54) $ (1.37)
Proforma, diluted $ 0.77 $ (0.54) $ (1.37)
54
Effective January 1, 2003, the Company adopted FASB No. 148 "Accounting
for Stock-Based Compensation - Transition and Disclosure" which amends FASB
Statement No. 123 to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. The Company will transition utilizing the prospective method for
options granted after January 1, 2003. The Company does not believe the adoption
of SFAS No. 148 will have a material effect on its financial position or results
of operations.
Earnings Per Share:
Basic net income or loss per common share is computed by dividing net
income (or loss) by the weighted average number of common shares outstanding
during the period. Diluted net income per common share is the same as basic but
assumes the exercise of convertible subordinated debt securities and includes
dilutive stock options and warrants using the treasury stock method. Loss per
share amounts do not include common stock issuable upon the exercise of stock
options since that would have an antidilutive effect and reduce net loss per
share. The following table reconciles the numerators and denominators of the
basic and diluted per common share computations for net income (and loss) for
the fiscal 2002, 2001 and 2000, as follows (in thousands, except per share
data):
Fiscal 2002 Fiscal 2001 Fiscal 2000
Numerator:
Net income (loss) $4,722 $ (2,626) $ (7,071)
Interest on convertible debt, net of tax 44 -- --
------ --------- ---------
Net income (loss) before interest on convertible debt $4,766 $ (2,626) $ (7,071)
====== ========= =========
Denominator:
Weighted average common shares outstanding - basic 5,062 5,056 4,943
Shares for convertible debt 224 -- --
Shares for dilutive stock options and warrants 816 -- --
------ --------- ---------
Weighted average common shares outstanding and assumed
conversions - diluted 6,102 5,056 4,943
====== ========= =========
Basic earnings (loss) per common share:
Continuing operations $ 0.93 $ (0.52) $ (1.43)
Discontinued operations -- -- 0.09
------ --------- ---------
Net income (loss) per common share $ 0.93 $ (0.52) $ (1.34)
====== ========= =========
Diluted earnings (loss) per common share:
Continuing operations $ 0.78 $ (0.52) $ (1.43)
Discontinued operations -- -- 0.09
------ --------- ---------
Net income (loss) per common share $ 0.78 $ (0.52) $ (1.34)
====== ========= =========
Derivatives:
Financial derivatives are used as part of the overall risk management
strategy. These instruments are used to manage risk related to changes in
interest rates. The portfolio of derivative financial instruments consists of
interest rate swap agreements. Interest rate swap agreements are used to modify
variable rate obligations to fixed rate obligations, thereby reducing the
exposure to higher interest rates. Amounts paid or received under interest rate
swap agreements are accrued as interest rates change with the offset recorded in
interest expense.
55
The Company applies Statement of Financial Standards (SFAS) No. 133,
Accounting for Derivative Instruments and Hedging Activities. Under SFAS No.
133, the Company's interest rate swaps have not been designated as hedging
instruments; therefore changes in fair value are recognized in current earnings.
New Accounting Pronouncements:
In June 2001, the FASB issued SFAS No. 143, Accounting for
Asset Retirement Obligations. This statement requires entities to record a
liability for the estimated retirement and removal costs of assets used in their
business. The liability is recorded at its fair value, with a corresponding
asset which is depreciated over the remaining useful life of the long-lived
asset to which the liability relates. Period expenses will also be recognized
for changes in the original value of the liability as a result of the passage of
time and revisions in the undiscounted cash flows required to satisfy the
obligation. The provisions of SFAS 143 are effective for fiscal years beginning
after June 15, 2002. The Company anticipates that adoption of SFAS 143 will not
have a material effect on the financial statements of the Company.
In August 2001, the FASB issued SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets", which addresses implementation
issues related to SFAS No. 121 "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of". This standard was adopted
by the Company on January 1, 2002 and did not have an impact on its consolidated
financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FAS Statement No. 13, and Technical
Corrections ("SFAS 145"). This statement rescinds the requirement in SFAS No. 4,
Reporting Gains and Losses from Extinguishment of Debt, that material gains and
losses on the extinguishment of debt be treated as extraordinary items. The
statement also amends SFAS No. 13, Accounting for Leases, to eliminate an
inconsistency between the accounting for sale-leaseback transactions and the
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions. Finally the standard makes a number of
consequential and other technical corrections to other standards. The provisions
of the statement relating to the rescission of SFAS 4 are effective for fiscal
years beginning after May 15, 2002. Provisions of the statement relating to the
amendment of SFAS 13 are effective for transactions occurring after May 15, 2002
and the other provisions of the statement are effective for financial statements
issued on or after May 15, 2002. The Company has reviewed SFAS 145 and concluded
that its adoption will not have a material effect on its consolidated financial
statements.
In July 2002, the FASB issued SFAS No. 146, Accounting for Exit or
Disposal Activities ("SFAS 146"). SFAS 146 applies to costs associated with an
exit activity (including restructuring) or with a disposal of long-lived assets.
Those activities can include eliminating or reducing product lines, terminating
employees and contracts, and relocating plant facilities or personnel. SFAS 146
will require a Company to disclose information about its exit and disposal
activities, the related costs, and changes in those costs in the notes to the
interim and annual financial statements that include the period in which an exit
activity is initiated and in any subsequent period until the activity is
completed. SFAS 146 is effective prospectively for exit or disposal activities
initiated after December 31, 2002, with earlier adoption encouraged. SFAS 146
supersedes Emerging Issues Task Force Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring), and requires liabilities
associated with exit and disposal activities to be expensed as incurred and can
be measured at fair value. SFAS 146 is effective for exit or disposal activities
of the Company that are initiated after December 31, 2002. The adoption of SFAS
146 is not expected to have a material effect on the Company's consolidated
financial statements.
On October 1, 2002, the FASB issued FASB Statement No. 147,
"Acquisitions of Certain Financial Institutions". This statement, which provides
guidance on the accounting for the acquisition of a financial institution,
applies to all acquisitions except those between two or more mutual enterprises.
The adoption of Statement No. 147 is not expected to affect the Company.
In December, 2002, the FASB issued FASB Statement No. 148, "Accounting
for Stock-Based Compensation - Transition and Disclosure", which amends FASB
Statement No. 123 to provide alternative
56
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of Statement 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The transition guidance and annual disclosure
provisions for SFAS No. 148 are effective for fiscal years ending after December
15, 2002. The interim disclosure provisions are effective for financial
reporting containing financial statements for interim periods beginning after
December 15, 2002. The Company adopted Statement No. 148 in January 2003, and
will transition utilizing the prospective method for options granted after
January 1, 2003. The Company does not believe adoption of SFAS No. 148 will have
a material effect on its financial position or results of operations.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 requires a guarantor
entity, at the inception of a guarantee covered by the measurement provisions of
the interpretation, to record a liability for the fair value of the obligation
undertaken in issuing the guarantee. The Company previously did not record a
liability when guaranteeing obligations unless it became probable that the
Company would have to perform under the guarantee. Interpretation 45 applies
prospectively to guarantees the Company issues or modifies subsequent to
December 31, 2002, but has certain disclosure requirements effective for interim
and annual periods ending after December 15, 2002. The Company does not have any
guarantees that would be required to disclose in accordance with the provisions
of FIN 45. The Company does not believe adoption of FIN 45 will have a material
effect on its 2003 financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities. FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, Consolidated Financial Statements, for
certain entities which do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties or in which equity investors do not have the characteristics of a
controlling financial interest ("variable interest entities"). Variable interest
entities will be required to be consolidated by their primary beneficiary. The
primary beneficiary of a variable interest entity is determined to be the party
that absorbs a majority of the entity's expected losses, receives a majority of
its expected returns, or both, as a result of holding variable interests, which
are ownership, contractual, or other pecuniary interests in an entity. FIN 46
applies immediately to variable interest entities created after January 31,
2003, and to variable interest entities in which an enterprise obtains an
interest after that date. It applies in the first fiscal year or interim period
beginning after June 15, 2003, to variable interest entities in which an
enterprise holds a variable interest that it acquired before February 1, 2003.
FIN 46 applies to public enterprises as of the beginning of the applicable
interim or annual period. The Company currently does not have an ownership
interest in any entities that meet the definition of a variable interest entity
which are not consolidated in the accompanying financial statements, and
therefore does not expect the adoption of FIN 46 to have a material impact on
its 2003 financial statements.
In November 2002, the Emerging Issues Task Force reached a consensus
opinion on EITF 00-21, Revenue Arrangements with Multiple Deliverables. The
consensus provides that revenue arrangements with multiple deliverables should
be divided into separate units of accounting if certain criteria are met. The
consideration for the arrangement should be allocated to the separate units of
accounting based on their relative fair values, with different provisions if the
fair value of all deliverables are not known or if the fair value is contingent
on delivery of specified items or performance conditions. Applicable revenue
recognition criteria should be considered separately for each separate unit of
accounting. EITF 00-21 is effective for revenue arrangements entered into in
fiscal periods beginning after June 15, 2003. Entities may elect to report the
change as a cumulative effect adjustment in accordance with APB Opinion 20,
Accounting Changes. The Company has not determined the effect of adoption of
EITF on its financial statements.
Reclassifications
Certain prior years' balances have been reclassified to conform with
current year classifications.
57
2. SALE OF SUBSIDIARY
In fiscal 1999, Sterling's Board of Directors decided to dispose of
Dowling's. In June 2000, the Company entered into an agreement to merge
Dowling's with an importer of radiators for consideration equivalent to the
amount owed at the merger closing by Dowling's under its revolving credit
agreement. The merger closed on November 29, 2000.
The statement of operations for fiscal 2000 reflects a gain of $399,000
from discontinued operations as a result of the completion of the disposal of
Dowling's.
3. PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows (in thousands):
December 31, December 31,
2002 2001
Construction equipment ................................ $ 21,045 $ 14,922
Transportation equipment .............................. 4,083 2,213
Buildings ............................................. 1,493 1,549
Leasehold improvements ................................ 402 359
Office furniture, warehouse equipment and vehicles .... 1,380 1,315
Land .................................................. 182 182
-------- --------
...................................................... 28,585 20,540
Less accumulated depreciation ......................... (5,791) (2,539)
-------- --------
$ 22,794 $ 18,001
======== ========
Warehouse equipment financed under capital leases amounted to $320,750
and $284,750 at December 31, 2002 and December 31, 2001, respectively and
accumulated depreciation related to such leased assets was $202,330 and
$164,790.
4. DISPOSITION OF NEW HEIGHTS
In December 1998, OTI acquired an initial 50% interest in, and became
the managing member of, New Heights in exchange for its commitment to fund
through equity investment up to a minimum of $11.5 million. No accounting
recognition was afforded this initial commitment. Based upon the carrying value
of the net assets of New Heights accounted for under fresh start accounting, a
50% interest in New Heights would have been valued at approximately $11.2
million at the date of acquisition.
Due to significant and continuing losses at New Heights, in April 2001,
the Company entered into the Unwinding Agreements with Casella Waste Systems,
Inc. and KTI, which provided for the transfer to KTI of the equity interest
owned by OTI in New Heights in return for (a) the Company's common stock held by
KTI, (b) cancellation of the KTI Loan and accrued interest thereon, except for
$1 million and (c) the issuance to KTI of 494,302 warrants to acquire the
Company's stock. These agreements were finalized in July 2001. The net effect of
the Unwinding Agreements is as follows (in thousands):
Cancellation of debt and accrued interest $ 17,064
Purchase of common stock into treasury 1,297
Transfer of equity interest in New Heights (2,891)
Issuance of new 4-year note at 12%, net of the
unamortized fair value of the warrants (950)
--------
Adjustment to paid-in capital $ 14,520
========
58
5. INVESTMENT IN AFFILIATED COMPANY ("STERLING TRANSACTION")
Following completion of the Unwinding Agreements (see Note 4 -
"Disposition of New Heights"), which returned to the Company shares that had
been owned by KTI and eliminated the losses and most of the loans attributable
to New Heights, on July 18, 2001, the Company completed the "Sterling
Transaction", in which it increased its equity ownership in Sterling
Construction Company (since renamed Sterling Houston Holdings, or "SHH") from
12% to 80.1%. SHH is a heavy civil construction company based in Houston that
specializes in municipal and state contracts for highway paving, bridge, water
and sewer, and light rail. The results of SHH have been included in the
Company's results since that date.
Total consideration for the increase in equity was $24.6 million,
including the Company's previous investment in SHH of $3.5 million, and
consisted of (a) cash payment of $9.9 million, (b) conversion of a $1.3 million
SHH subordinated note receivable into Sterling equity, (c) issuance of
subordinated notes and warrants, and (d) the sale and issuance of the Company's
common stock. For accounting purposes, the value of the 1,124,536 shares of
common stock sold was determined based on the average price of the Company's
common shares over the 5-day period before and after the closing date.
As part of the Sterling Transaction, the Company granted certain
selling shareholders a "Put" option for the remaining 19.9% of SHH stock owned
by them, pursuant to which they have the right to sell the remaining SHH shares
to the Company between July 2004 and July 2005 at a minimum price of $105 per
share. The Company recorded the fair value of the Put as a $4.1 million
liability at July 18, 2001. The fair value of the Put is to be reviewed
quarterly and any changes reflected as components of pre-tax earnings. In fiscal
2002, the Company recorded approximately $520,000 as expense related to the
change in the fair value of the Put and the liability increased to approximately
$4.6 million at December 31, 2002.
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of the Sterling Transaction, (in
thousands):
At July 18, 2001
Current assets $ 21,920
Property, plant and equipment 18,242
Goodwill 7,637
Deferred tax asset 4,757
--------
Total assets acquired 52,556
Current liabilities (16,017)
Long-term liabilities (9,756)
--------
Total liabilities assumed (25,773)
Minority interest (2,126)
--------
$ 24,657
At the time of the acquisition, management re-evaluated the need for a
valuation allowance on the Company's deferred tax asset. Based on the reversing
effects of deferred tax liabilities and projected future income of SHH and SCPI,
management reduced the valuation allowance by a total of $8.2 million, with $4.7
million recorded as a reduction to goodwill and $3.5 million as an adjustment to
paid in capital. (See note 8.)
Management has determined that the value of intangibles, such as
non-compete agreements and contracts in place are not significant.
Funding for the cash portion of the Sterling Transaction was provided
principally through borrowings by SHH under its bank revolving credit, and by
the Company through the issuance of notes and the sale of common stock, as
follows (in thousands):
SHH Revolver $4,900
Subordinated notes 2,580
Short-term subordinated note payable 1,500
Sale of Sterling common stock 908
------
$9,888
59
The following summary unaudited pro forma financial information for the
periods ended December 31, 2001 and February 28, 2001 is presented as if the
Unwinding Agreements described in Note 4 and the Sterling Transaction had been
completed as of the beginning of fiscal 2000 (in thousands, except per share
data). Fiscal 2002 reflects actual results.
Fiscal 2002 Fiscal 2001 Fiscal 2000
----------- ----------- -----------
Total revenues $134,317 $ 96,175 $ 92,185
Net income (loss) $ 4,722 $ (442) $ 798
Net income (loss) per share $ 0.93 $ (0.09) $ 0.16
The pro forma information is presented for informational purposes only
and is not necessarily indicative of the financial position and results of
operations that would have occurred had the Unwinding Agreements and the
Sterling Transaction been completed as of the beginning of fiscal 2000, nor may
it be indicative of the future financial position or results of operations.
6. ACQUISITION OF KINSEL HEAVY HIGHWAY CONSTRUCTION BUSINESS
In September 2002, a wholly-owned subsidiary of SHH, Texas Sterling
Construction, L.P. ("TSC") acquired the Kinsel Heavy Highway construction
business (the "Kinsel Business") from a subsidiary of Insituform Technologies,
Inc. ("ITI"). The acquisition included the purchase of construction equipment at
its appraised value of approximately $4.4 million, and the assumption by TSC of
operating equipment leases with a future obligation of approximately $1.4
million. Certain unstarted construction contracts with revenues estimated at $38
million, subject to post-closing adjustments, were assigned to TSC. TSC has been
engaged to manage the completion of certain other contracts in return for a
management fee and hired most of Kinsel's construction crews together with
project managers and other supervisory personnel. The consideration of $4.4
million for the Kinsel Business was financed by TSC through the issuance to ITI
of two unsecured two-year notes aggregating $1.5 million, with the balance
funded through additional borrowings under the SHH revolving line of credit.
The size of the acquisition and the amount of assets acquired were not
material in relation to the Company's overall business. No goodwill was
recognized in the Kinsel transaction.
7. LINE OF CREDIT AND LONG-TERM OBLIGATIONS
Long-term obligations consist of the following (in thousands):
December 31, December 31,
2002 2001
------------ ------------
SHH Revolving Credit Agreement, due March 2004 .............. $ 14,010 $ 10,000
Subordinated debt, due quarterly through September 2004 ..... 3,500 6,000
Subordinated zero coupon notes, due July 2005 ............... 5,917 5,283
SCPI Revolving Credit Agreement, due May 2004 ............... 2,616 2,535
Management/director notes due July 2005 ..................... 2,046 1,984
Mortgage payable, due monthly through June 2016 ............. 1,265 1,388
Insituform Notes due quarterly through September 2004 ....... 1,400 --
KTI Loan, due July 2005 ..................................... 1,156 1,016
Convertible subordinated notes, due December 2004 ........... 560 500
Other ....................................................... 136 238
-------- --------
32,606 28,944
Less current portion ........................................ (3,038) (2,759)
-------- --------
Net long-term portion ....................................... $ 29,568 $ 26,185
======== ========
60
Related Party Notes
Subordinated Debt
As part of the Sterling Transaction, certain shareholders of SHH were
issued subordinated promissory notes by SHH in the aggregate amount of $6
million in payment for certain of their SHH shares. These notes are repayable
over three years in equal quarterly installments and carry interest at 12% per
annum. The December 2001 installment on these notes was not made until February
2002.
Subordinated Zero Coupon Notes
The Sterling Transaction was funded in part through the sale of zero
coupon notes combined with the issuance of zero coupon notes to certain selling
shareholders of SHH. Warrants for the Company's common stock were issued in
connection with the zero coupon notes. The zero coupon notes are shown at their
present value, discounted at a rate of 12% and mature four years from the date
of closing of the Sterling Transaction. Warrants issued in connection with the
notes are exercisable for ten years from closing and become exercisable four
years after issuance at $1.50 per share. Mr. Manning and Mr. Harper received
notes for the face value of $799,000 and $1.0 million, respectively and warrants
for 63,486 shares and 80,282 shares, respectively.
Short-term Subordinated Note
In order to facilitate the Sterling Transaction, SHH borrowed $1.5
million from one of the Company's shareholders. The note was repaid in two equal
installments on September 30, 2001 and December 31, 2001. The note carried
interest at 12%.
Management/Director Notes
Notes with an aggregate face amount of $1.3 million issued in
connection with the October 1999 purchase of the second equity tranche of shares
of SHH were restructured as part of the Sterling Transaction. Of the total,
notes for $800,000 were due to members of Sterling's management, including
Joseph P. Harper Sr., since appointed the Company's President. Notes totaling
approximately $550,000 were due to Robert Davies, the Company's former Chairman
and Chief Executive Officer, and, through a participation agreement, Maarten
Hemsley, formerly the Company's President and now its Chief Financial Officer.
In consideration for the extension of the maturity dates of these notes, the
face amounts were increased by an aggregate of approximately $342,000.
Furthermore, certain amounts due by the Company to Messrs. Davies and Hemsley
aggregating approximately $355,000 were converted into notes. All such notes
mature over four years and carry interest at 12%. Principal and interest may be
paid only from defined cash flow of SHH and SCPI, or from proceeds of any sale
of SCPI's business.
Convertible Subordinated Notes
In December 2001, in order to strengthen SCPI's working capital
position, Sterling obtained funding in the amount of $500,000 principally from
members of management and directors (including Messrs. Frickel,
61
Harper and Hemsley, who contributed $155,000, $100,000 and $25,000,
respectively) (the "Convertible Subordinated Notes"). In January 2002, two other
members of management funded a further $60,000 that was used for general
corporate purposes. The notes, which are convertible at any time prior to the
maturity date into the Company's common stock at a price of $2.50 per share,
mature and are payable in full in December 2004. Interest at 12% is payable
monthly. The notes rank senior to debt issued in connection with the Sterling
Transaction.
In January 2003, members of management of the Company and of SHH
(including Messrs. Harper and Hemsley) further funded SCPI with a short-term
loan to reduce SCPI's vendor payables in the aggregate amount of $250,000. The
notes, which are subordinate to the SCPI Revolver, mature in July 2003. Interest
at the annual rate of 10% is payable monthly. The notes may be prepaid without
penalty.
SHH Revolver and SCPI Revolver
In conjunction with the Sterling Transaction, SHH entered into a
three-year bank agreement providing for a revolving line of credit with a
maximum line of $17.0 million, subject to a borrowing base. The line of credit
carries interest at the prime rate, subject to achievement of certain financial
targets and is secured by the equipment of SHH. The balance on the SHH Revolver
at December 31, 2002 was $14.0 million.
Due to concerns stemming from SCPI's institutional lender's filing for
bankruptcy, and as a condition of the completion of the Sterling Transaction,
SCPI changed institutional lenders in July 2001 and entered into an bank
agreement for a two-year revolving line of credit in the amount of $5.0 million,
subject to a borrowing base. The new revolver carried an interest rate equal to
the prime rate plus 1%. Following the bankruptcy filing in August 2001 of a
significant customer of SCPI, which created a default under its terms, the SCPI
Revolver was amended in September 2001 to reduce the maximum borrowing level to
$3.75 million, increase the interest rate to prime plus 1.5%, and accelerate the
term to April 30, 2002. Upon demonstrating SCPI's ability to generate new
business and maintain its relationships with customers and vendors, in December
2001 the SCPI Revolver was again amended to restore the maximum borrowing level
of $5.0 million and extend the term to May 2003. Further amendments in fiscal
2002 extended the term of the SCPI Revolver to May 2004 and removed a limitation
on borrowing. At December 31, 2002, the balance on the SCPI Revolver was $2.6
million and carried an effective rate of interest of 5.75%. The SCPI Revolver is
secured by the assets of SCPI and is subject to the maintenance of certain
financial covenants. At December 31, 2002, SCPI was in compliance with its
financial covenants.
KTI Loan
In December 1998, Sterling entered into a loan agreement with KTI, Inc.
(the "KTI Loan") pursuant to which KTI committed to lend Sterling a minimum of
$11.5 million for capital expenditures and start-up losses incurred by New
Heights. The KTI Loan carried interest at a fixed rate of 14%, payable quarterly
and was due, by its original terms, in April 2001. The KTI Loan was secured by a
pledge of all the capital stock of OTI and all of OTI's equity interest in New
Heights.
Also in December 1998 the Company's subsidiary, OTI, entered into an
Investment Agreement with New Heights pursuant to which OTI agreed to fund
defined capital expenditures, costs of obtaining permits, start-up losses and
working capital of the New Heights waste-to-energy facility in Ford Heights,
Illinois, and to receive in return an initial 50% equity interest in New
Heights.
Pursuant to the Investment Agreement, KTI agreed to provide, directly
or through OTI, the funding required to satisfy the New Heights Business Plan.
Accordingly, KTI and Sterling entered into the KTI Loan. Funds drawn by Sterling
under the KTI Loan were invested in OTI, principally to facilitate the financing
of the New Heights Business Plan.
Effective July 2001, all except $1,000,000 of the KTI Loan and accrued
interest thereon was cancelled pursuant to the Unwinding Agreements, with such
balance converted to a four year subordinated loan, with interest
62
of 12% due at maturity. The face value of the KTI Loan has been accounted for to
reflect a reduction for the fair value of the approximately 494,000 warrants for
Sterling common stock issued to KTI, to be amortized over the life of the loan.
Insituform Notes
In September 2002, a wholly-owned subsidiary of SHH acquired the Kinsel
Heavy Highway construction business from a subsidiary of Insituform
Technologies. The transaction was financed through the issuance of two unsecured
two-year notes aggregating $1.5 million to Insituform, with the balance funded
through additional borrowings under the SHH Revolver. The Insituform Notes bear
interest at 9% and are payable in quarterly installments plus accrued interest
thereon.. The first installment was paid in December 2002.
SHH Mortgage
In June 2001, SHH completed the construction of a new 15,000
square-foot headquarters on a seven acre parcel in Houston on which its existing
equipment repair facility is located. The building was financed principally
through an additional mortgage of $1.1 million on the land and facilities, at a
rate of 7.75% per annum, repayable over 15 years. The new mortgage is
cross-collateralized with an existing mortgage on the land and facilities which
was obtained in 1998 in the amount of $500,000, repayable over 15 years with an
interest rate of 9.3% per annum.
Other Debt
In October 1998, SCPI obtained from the Redevelopment Authority of the
City of McKeesport a loan (the "Subordinated Loan"), subordinated to the SCPI
Revolver, in the amount of $98,000 and carrying interest at 5% per annum. The
loan, which funded leasehold improvements at SCPI, is being repaid in monthly
installments through October 2003.
The Company acquired certain warehouse and computer equipment through
capital leases, usually with five-year lease terms, with expirations ranging
from September 2003 through October 2007. Equipment financed under capital
leases totaled $320,750 at December 31, 2002.
The Company's long-term obligations mature during each fiscal year as
follows (in thousands):
Fiscal Year
2003 $ 3,038
2004 19,496
2005 9,262
2006 130
2007 130
Thereafter 550
-------
$32,606
9. FINANCIAL INSTRUMENTS
The carrying value of the Company's financial instruments, which
include accounts receivable, accounts payable, the SHH and SCPI Revolver,
capital lease obligations, the Convertible Subordinated Note, the Subordinated
Loan and the interest rate swaps approximate their fair value at December 31,
2002 and December 31, 2001.
10. DERIVATIVE FINANCIAL INSTRUMENTS
During fiscal 2002, in connection with certain long-term debt, SHH
entered into two interest rate swap agreements to manage exposure to
fluctuations in interest rates on a portion of loan balances.
63
Under the interest rate swap agreements, the Company exchanged variable
rate interest on a portion of the loan balances, equal to a notional amount of
$3,000,000 each, with fixed rates of 5.87% and 6.57%.
During fiscal 2002, SHH recorded interest expense and accrued
liabilities of $177,796 as a result of adjusting the carrying amounts of
derivatives to reflect their fair values at December 31, 2002.
11. INCOME TAXES AND DEFERRED TAX ASSET
At December 31, 2002, SCPI and Sterling had net operating tax loss
carry-forwards (the "Tax Benefits") of approximately $110 million, which expire
in the years 2003 through 2021 and which shelter most income of SCPI, Sterling
or its subsidiaries from federal income taxes. A change in control of SCPI or
Sterling exceeding 50% in any three-year period may lead to the loss of the
majority of the Tax Benefits. In order to reduce the likelihood of such a change
of control occurring, SCPI's and Sterling's Certificates of Incorporation
include restrictions on the registration of transfers of stock resulting in, or
increasing, individual holdings exceeding 4.5% of each company's common stock.
Deferred tax assets and liabilities consist of the following:
(in thousands) December 31, 2002 December 31, 2001
Current Long Term Current Long Term
ASSETS
Net operating loss carryforwards $ 6,920 $ 28,195 $ 17,595 $ 37,310
Reserve for bad debts 269 -- 159 --
-------- -------- -------- --------
7,189 28,195 17,754 37,310
LIABILITIES
Depreciation of property and equipment -- 2,588 2,496 --
-------- -------- -------- --------
Net asset before valuation allowance 7,189 25,607 17,754 34,814
Less: valuation allowance (5,530) (19,655) (16,209) (30,045)
-------- -------- -------- --------
Net asset $ 1,659 $ 5,952 $ 1,545 $ 4,769
======== ======== ======== ========
During fiscal 2002, the valuation allowance decreased by $21.3 million
due to the following:
Expiration of net operating loss carryforwards $16,226
Reassessment of valuation allowance based on future
taxable income forecasts: 5,100
-------
$21,326
=======
As a result of the acquisition of SHH in fiscal 2001, the Company
evaluated and decreased the valuation allowance on its net deferred tax asset.
Management believes that more likely than not, the deferred assets will be
realized based on the future earnings of both SHH and SCPI.
Fluctuations in market conditions and trends and other changes in the
Company's earnings base, such as subsidiary acquisitions and disposals, warrant
periodic management reviews of the recorded tax asset to determine if an
increase or decrease in the recorded valuation allowance is necessary to change
the tax asset to an amount that management believes will more likely than not be
realized.
In fiscal 1990, SCPI underwent a quasi-reorganization. As a result of
this quasi-reorganization, any subsequent recognition of net operating loss
carryforwards generated before the quasi-reorganization resulted in an
adjustment to paid-in capital. At February 28, 2001, the Company had
approximately $147 million in net operating losses generated before the
quasi-reorganization. Of this amount, approximately $18 million had previously
been recognized and then subsequently re-reserved, resulting in a charge to
earnings of approximately $6.1 million in prior years. During fiscal 2001, most
of these net operating loss carryforwards were either utilized
64
to offset current taxable income or the valuation allowance was reduced based on
the evaluation of the deferred tax assets when accounting for the SHH
acquisition. At December 31, 2002, the Company has approximately $83 million of
net operating losses that are fully reserved that relate to the period prior to
the quasi-reorganization. Any subsequent reduction in the valuation allowance
related to the loss carryforwards would result in an adjustment to paid-in
capital.
If future profit levels exceed current expectations and economic or
business changes warrant upward revisions in the estimate of the realizable
value of net operating tax loss carry-forwards, the consequent reduction in the
valuation allowance would result in a corresponding deferred tax benefit in
future results of operations to the extent of the aggregate charges of
approximately $2 million to deferred tax expense in prior years, and any benefit
in excess of such charge would be reflected as an addition to paid-in capital.
The accounting treatment to increase paid-in capital results from SCPI's
quasi-reorganization accounting in fiscal 1990.
The deferred tax effects of temporary differences are not significant,
and current income taxes payable represent state income taxes.
Income tax expense from continuing operations consists of the following
(in thousands):
Fiscal Year Ended
December 31, December 31, February 28,
2002 2001 2001
------------ ------------ ------------
Current tax expense ................................ $ 14 $ 14 $ 27
(Decrease) increase in valuation allowance
for the deferred tax asset ......................... (1,516) (4,062) 2,475
Deferred tax expense (benefit) ..................... 252 4,062 (2,475)
------- ------- -------
Income tax (benefit) expense ....................... $(1,250) $ 14 $ 27
======= ======= =======
The income tax provision differs from the amount using the statutory
federal income tax rate of 34% applied to income or loss from continuing
operations for the following reasons (in thousands):
Fiscal Year Ended
December 31, December 31, February 28,
2002 2001 2001
------------ ------------ ------------
Tax (expense) benefit at the U.S. federal
statutory rate ..................................... $ 1,176 $ (893) $(2,475)
State income tax expense, net of refunds
and federal benefits ............................... 14 14 27
Utilization of net operating loss carryforwards
against current taxable income ..................... (1,426) 00 00
Gain on disposal of equity investment .............. -- 4,937 --
(Decrease) increase in deferred tax asset
valuation allowance ................................ (1,516) (4,062) 2,475
Non-deductible costs ............................... 502 18 --
------- ------- -------
Income tax (benefit) expense ....................... $(1,250) $ 14 $ 27
======= ======= =======
The availability of the net operating tax loss carry-forwards may be
adversely affected by future ownership changes of SCPI or Sterling; at this
time, such changes cannot be predicted. Sterling's estimated net operating tax
loss carry-forwards at December 31, 2002 expire as follows (in thousands):
Fiscal Year
-----------
2003 $ 22,000
2004 49,000
2005 13,000
2010 2,000
2011 2,000
2017 3,000
2018 1,000
Thereafter 18,000
--------
$110,000
========
65
12. COSTS AND BILLINGS ON UNCOMPLETED CONTRACTS
Costs and billings on uncompleted contracts at December 31, 2002 are as
follows (in thousands):
Costs incurred on uncompleted contracts $ 113,707
Billings on uncompleted contracts (114,455)
---------
$ (748)
=========
Included in accompanying balance sheets under the following captions:
Costs in excess of billings on uncompleted contracts $ 2,793
Billings in excess of costs on uncompleted contracts (3,541)
---------
$ (748)
=========
13. STOCK OPTIONS AND WARRANTS
OPTIONS
In fiscal 1991, the Board of Directors granted ten-year options to
purchase 194,388 shares of the Company's common stock to key employees and to
certain members of the Board of Directors. The exercise price of the options,
which was equal to the market value of the stock at the date of the grant, was
$2.75 and in fiscal 1996, the exercise price of 49,984 of such options was
reduced to $2.00 per share. These options, which were fully vested, expired in
January 2002, however, 84,420 of these options are subject to a standstill
agreement executed as part of the Sterling Transaction that extended the
expiration date beyond January 2002. Each employee's options expire upon such
employee's resignation.
In fiscal 1994, the Board of Directors and shareholders approved two
stock option plans, the 1994 Omnibus Stock Plan (the "1994 Omnibus Plan") and
the 1994 Non-Employee Director Stock Option Plan (the "Director Plan"). Under
both plans, the exercise price of options granted may not be less than the fair
market value of the common stock on the date of the grant and the term of the
grant may not exceed ten years.
The 1994 Omnibus Plan initially provided for the issuance of a maximum
of 350,000 shares of the Company's common stock pursuant to the grant of
incentive stock options to employees of Sterling and its subsidiaries and the
grant of non-qualified stock options, stock or restricted stock to employees,
consultants, directors and officers of Sterling and its subsidiaries.
Subsequently, the number of options available under the plan was increased to
1,150,000 shares. The options generally vest over a four year period and expire
ten years from the date of the grant. In fiscal 2002, 13,500 of these options
were exercised at a price of $1.07 per share.
The Director Plan (a "formula plan") provided for the issuance of up to
100,000 shares of common stock pursuant to options granted to directors who were
not employees of the Company. The plan provided that on every May 1, each
non-employee director holding office on such date would automatically receive a
fully-exercisable, fully vested, ten-year option to purchase 3,000 shares at the
market value on such date. Each director's options expire upon such director's
resignation. The final seven thousand options which remained under the plan were
issued in May 2001. Messrs. Pirasteh, Polak and Sergi, following their
resignations from the Board of Directors in July 2001, exercised their options
under the director plan aggregating 12,498 shares, at prices ranging from $0.75
to $1.06 per share, for net proceeds to the Company of $12,164.
In December 1998, the Board of Directors approved the 1998 Omnibus
Stock Plan (the "1998 Omnibus Plan"). Under the 1998 Omnibus Plan, the exercise
price of the options granted may not be less than the fair market value of the
common stock on the date of grant and the term of the grant may not exceed ten
years. The
66
1998 Omnibus Plan provides for the issuance of 700,000 shares. Stock options
granted under the plan generally vest over a three-year period. Messrs. Pirasteh
and Sergi exercised the options granted to them under the plan following their
resignation from the Board in July 2001, for an aggregate of 100,000 shares, for
net proceeds to the Company of $50,000.
In fiscal 2001, the shareholders ratified the 1998 Omnibus Stock Plan
and the Board of Directors approved the 2001 Stock Incentive Plan (the "2001
Stock Incentive Plan"). The 2001 Stock Incentive Plan provides for the issuance
of incentive stock awards for up to 500,000 shares of common stock, under which
stock options may be granted at an exercise price not less than the fair market
value of the common stock on the date of grant. The Company's and its
subsidiaries' officers, employees, directors, consultants and advisors are
eligible to be granted awards under the plan. Stock options generally vest over
time and can be exercised no more than 10 years after the date of the grant. In
July 2001, 97,400 options were granted to certain employees of SHH and to
non-employee directors. In July 2002, 55,900 options were granted to certain
employees of SHH. The plan also provides for stock grants, but none have been
made as of December 31, 2002.
The following tables summarize the activity under the five plans:
1991 Plan Director Plan 1994 Omnibus Plan
Shares Price range Shares Price range Shares Price range
------- ----------- ------ ----------- ------ -----------
Outstanding at 2/00: 128,573 $2.00-2.75 75,000 $0.84-3.38 893,684 $0.88-3.88
Granted 18,000 $ 1.06 13,500 $ 1.07
Expired/forfeited -- -- (16,300) $0.88-3.88
------- ------ -------
Outstanding at 2/01: 128,573 $2.00-2.75 93,000 $0.84-3.38 890,884 $0.88-3.88
Granted 7,000 $ 0.75
Exercised (12,498) $0.75-1.06
Expired/forfeited -- -- (24,600) $1.00-3.38
------- ------ -------
Outstanding at 12/01: 128,573 $2.00-2.75 87,502 $0.75-3.38 866,284 $0.88-3.88
Granted -- --
Exercised -- -- (13,500) $ 1.07
Expired/forfeited (29,157) $ 2.00 -- (30,000) $1.00-3.88
------- ------ -------
Outstanding at 12/02: 99,416 $ 2.75 87,502 $0.75-3.38 822,784 $0.88-3.38
======= ====== =======
1998 Omnibus Plan (a) 2001 Stock Incentive Plan
Shares Price range Shares Price range
Outstanding at 2/00: 641,000 $0.50-1.00
Granted
Expired/forfeited --
Outstanding at 2/01: 641,000 $0.50-1.00
-------
Granted 97,400 $ 1.50
Exercised (100,000) $ 0.50
Expired/forfeited (500) $ 1.00 --
------- -------
Outstanding at 12/01: 540,500 $0.50-1.00 97,400 $ 1.50
Granted 10,000 $ 1.50 55,900 $ 1.73
Exercised -- --
------- -------
Outstanding at 12/02: 550,500 $0.50-1.50 153,300 $1.50-1.73
======= =======
(a) Of the options to purchase 600,000 shares granted in fiscal 1999, one
third were immediately exercisable, one third vested in December 1999
and one third vested in December 2000. The option to purchase 41,000
shares gratned in fiscal 2000 vest over a four year period, with one
quarter of the total being immediately exercisable.
The following table summarizes information about stock options
outstanding and exercisable at December 31, 2002:
Options Options
outstanding exercisable
Weighted Weighted Weighted
Range of average average average
exercise Number remaining exercise Number exercise
price per of contractual price per of price per
share shares life (years) share shares share
$0.50 - $0.88 916,098 5.38 $0.67 916,098 $0.67
$1.00 - $1.50 329,900 5.83 $1.24 260,227 $1.17
$1.73 - $2.00 172,900 4.16 $1.91 117,000 $2.00
$2.75-$3.38 294,600 1.54 $2.79 294,600 $2.79
--------- ---------
1,713,498 $1.27 1,587,925 $1.21
========= =========
67
At December 31, 2001, options to purchase 1,624,734 shares were
exercisable at a weighted average exercise price of $1.25 per share.
The weighted average fair value per share of all options granted during
fiscal 2002, 2001 and 2000 was $1.45, $0.83 and $0.27, respectively.
The pro forma adjustments were calculated using the Black-Scholes
option pricing model using the following assumptions in each year:
Fiscal 2002 Fiscal 2001 Fiscal 2000
----------- ----------- -----------
Risk free interest rate 4.00% 4.50% 6.00%
Expected volatility 79.0% 35.1% 79.0%
Expected life of option 10.0 years 10.0 years 9.00 years
Expected dividends None None None
WARRANTS
As part of the Sterling Transaction in July 2001, warrants attached to
zero coupon notes were issued to certain members of SHH management, to NASCIT
and to KTI. These ten-year warrants to purchase shares of the Company's common
stock at $1.50 per share become exercisable 54 months from the issue date. At
December 31, 2002 and December 31, 2001, there were 1,244,302 warrants
outstanding.
14. EMPLOYEE BENEFIT PLAN
Sterling and its subsidiaries maintain defined contribution
profit-sharing plans covering substantially all persons employed by the Company
and its subsidiaries, whereby employees may contribute a percentage of
compensation, limited to maximum allowed amounts under the Internal Revenue
Code. The Plan provides for discretionary employer contributions, the level of
which, if any, may vary by subsidiary and is determined annually by each
company's Board of Directors. SHH matched $217,255 in contributions for the year
ended December 31, 2002. SCPI and Sterling did not provide matching
contributions.
Total plan related expense was approximately $26,000, $74,000 and
$19,000 in fiscal 2002, 2001 and 2000, respectively.
14. OPERATING LEASES
In December 1997, SCPI entered into an operating lease for its
warehouse with an initial term that expires January 1, 2003, with one additional
five-year renewal option. SCPI exercised its renewal option in late 2002. The
lease requires minimum rental payments of $247,000 through December 2005,
increasing to $259,000 per annum through December 2007, and payment by SCPI of
certain expenses such as liability insurance, maintenance and other operating
costs. With the addition of lawn and garden business in fiscal 2001, SCPI
entered into a lease agreement for additional warehouse and office space with an
initial term of seven years, expiring December 2007, with one three-year renewal
option. Rent escalates annually from $139,000 to $192,000.
Operations of SHH are conducted from an owned building in Houston,
Texas. SHH also leased incidental office space in Fort Worth, Texas for an
initial term of two years, commencing October, 2001. In January 2002, SHH
entered into a lease agreement for incidental office space in San Antonio, Texas
for a term of two years.
Through the acquisition of the Kinsel Business in September 2002, SHH
acquired several equipment operating leases, with balances on the lease terms
ranging from several months to approximately five years.
68
Minimum annual rentals for all operating leases having initial
non-cancelable lease terms in excess of one year are as follows (in thousands):
Fiscal Year
2003 ................................... $ 795
2004 ................................... 562
2005 ................................... 537
2006 ................................... 532
2007 ................................... 511
Thereafter ............................. 42
------
Total future minimum rental payments ... $2,979
======
Total rent expense for all operating leases amounted to approximately
$428,000, $313,000 and $268,000 in fiscal 2002, 2001 and 2000.
15. SEGMENT INFORMATION
The Company has historically operated as a wholesale distributor of
automotive aftermarket accessories (the "Distribution Segment"). Its subsidiary,
SCPI, is one of the larger independent wholesale distributors of automotive
accessories in the Northeastern United States. In fiscal 1996, SCPI began the
distribution of non-food pet supplies, and in the third quarter of fiscal 2000,
expanded its product offerings to include lawn and garden products. SCPI's
customer base of drug and supermarket retailers, discount retail chains,
hardware, and automotive chains is largely the same across its product lines
(the "Distribution Segment").
In July 2001, the Company increased its equity investment in SHH from
12% to 80.1%. SHH is a heavy civil construction company based in Houston that
specializes in municipal and state contracts for highway paving, bridge, water
and sewer, and light rail (the "Construction Segment").
Each of the Distribution Segment and the Construction Segment is
managed by its own decision makers and is comprised of unique customers,
suppliers and employees. Terry Allan, President of SCPI and Maarten Hemsley, the
Chief Financial Officer of the Company, review the operating profitability of
the Distribution Segment and its working capital needs to allocate financial
resources. The operating profitability of the Construction Segment is reviewed
by Joseph P. Harper, its Chief Financial Officer to determine its financial
needs. Allocation of resources among the Company's operating segments is
determined by Messrs. Harper and Hemsley, subject to the terms of each Segment's
bank covenants which affect upstreaming of funds to the Company.
The Company's operations are organized into the two operating segments
included in the following table. Prior year segment information has been
restated to conform to the current management of the business (in thousands):
Fiscal 2002 Consolidated
Segments Construction Distribution Corporate Total
------------ ------------ --------- -----
Revenues .......................... $ 111,747 $ 22,570 $ 134,317
========= ========= =========
Operating profit (loss) ........... 7,086 1,039 (1,137) 6,988
Interest expense .................. 2,643
---------
Income before minority interest and
income taxes ...................... 4,345
Minority interest expense ......... (873) (873)
Net income ........................ 4,722
=========
Depreciation and amortization ..... $ 3,703 $ 149 $ 3 $ 3,855
Segment assets .................... $ 49,442 $ 6,906 $ 16,409 $ 72,757
Capital expenditures .............. $ 8,603 $ 101 $ 3 $ 8,707
69
Fiscal 2001 - ten months Consolidated
Segments Construction Distribution Other Total
------------ ------------ --------- ------------
Revenues .......................... $ 48,654 $ 17,467 $ 66,121
========= ========= =========
Operating profit (loss) ........... 2,293 481 (1,329) 1,445
Interest expense .................. 2,193
---------
Loss before equity investment and
income taxes ...................... (748)
Net loss from equity affiliates ... (1,217) (1,217)
Minority interest expense ......... (647) (647)
Net loss .......................... (2,626)
=========
Depreciation and amortization ..... $ 1,553 $ 125 $ 28 $ 1,706
Segment assets .................... $ 37,241 $ 7,134 $ 14,763 $ 59,138
Capital expenditures .............. $ 1,175 $ 29 -- $ 1,204
Fiscal 2000 Consolidated
Segments Distribution Dowling's OTI Corporate Total
------------ --------- -------- --------- ------------
Net sales ....................... $ 20,694 $ 20,694
======== ========
Operating profit (loss) ......... $ 1,018 $ (313) $ (504) $ 201
Interest expense ................ $ 2,688
--------
Loss before equity investment and
income taxes .................... $ (2,487)
Net loss in equity affiliates ... $ (4,557) $ (4,557)
Loss from continuing operations . $ (7,071)
Income from disposal of
discontinued business segment ... $ 399 $ 399
--------
Net loss ........................ $ (6,672)
========
Depreciation and amortization ... $ 118 $ 53 $ 30 $ 201
Segment assets .................. $ 7,290 $ 9,030 $ 187 $ 16,507
Investment in SHH ............... $ 3,473 $ 3,473
Net investment in New Heights ... $ 4,170 $ 4,170
Capital expenditures ............ $ 126 $ 4 $ 130
The following table shows contract revenues generated from SHH's
largest customers which accounted for more than 10% of consolidated revenues in
the period since completion of the Sterling Transaction in July 2001:
Fiscal year ended Six months ended
December 31, 2002 December 31, 2001
------------------------ ------------------------
Contract % of Contract % of
Revenues Revenues Revenues Revenues
City of Houston $26,044 23.3% $18,252 27.6%
Houston Metropolitan Transit
Authority $51,821 46.4% $15,593 23.6%
70
Following the discontinuance of the Dowling's segment in fiscal 1999
and prior to the acquisition of SHH in July 2001, sales attributable to SCPI
represented 100% of Sterling's consolidated sales. The following table shows
sales to SCPI's customers that individually accounted for more than 10% of sales
during any of the latest three fiscal years (dollars in thousands):
Fiscal Year Ended Fiscal Year Ended Fiscal Year Ended
December 31, 2002 December 31, 2001 February 28, 2001
------------------------ ----------------------- ---------------------
(ten months)
Sales % of Sales Sales % of Sales Sales % of Sales
Warehouse Sales $3,711 16% $2,193 13% * *
Kroger $3,591 16% $2,758 16% $2,057 10%
Ames $2,918 13% $3,217 18% $3,746 18%
Giant Eagle $2,399 11% $2,313 13% $2,055 10%
American Sales * * $1,863 11% * *
* did not represent more than 10% of sales
In August 2001, Ames filed for Chapter 11 protection. SCPI continued to
ship to Ames as debtor-in-possession under strict payment terms. Pre-petition
sales to Ames during fiscal 2001 (mostly of automotive products) totaled $1.5
million, of which approximately $680,000 was unpaid at the time of Ames
bankruptcy filing. Sales to Ames in fiscal 2002 prior to its liquidation in
July, aggregated $3.5 million, with the increase primarily attributable to sales
of pet supplies.
16. COMMITMENTS AND CONTINGENCIES
EMPLOYMENT AGREEMENTS
SCPI has an employment agreement with Mr. Allan that provides
termination rights in the event of a defined change in control of SCPI. The
rights include payments of up to twenty-four months of Mr. Allan's base salary,
along with continuation of benefits and certain other payments. The agreement
also provides for substantially the same provisions in the event that Mr.
Allan's employment were terminated by SCPI without cause.
Messrs. Harper and Manning and certain other officers of SHH have
employment agreements with a subsidiary of SHH which provide for payments of
annual salary and benefits if the executive's employment is terminated without
cause.
SELF-INSURANCE
SHH is self-insured for employee health claims. Its policy is to
accrue the estimated liability for claims through December 31, 2002. The Company
has obtained reinsurance coverage for the policy period from June 1, 2002
through May 31, 2003 as follows:
- Specific excess reinsurance coverage for medical and
prescription drug claims in excess of $40,000 with a maximum
lifetime reimbursable of $960,000.
- Aggregate reinsurance coverage for medical, dental and
prescription drug claims with a plan year maximum of
$1,000,000 for claims in excess of approximately $468,000
which is estimated based on the number of employees.
71
For the twelve months ended December 31, 2002, SHH incurred
approximately $848,000 in expenses related to this plan, compared with $126,000
in the prior year, which included six months of ownership by the Company.
LITIGATION
The Company is involved in certain claims and lawsuits occurring in the
normal course of business. Management, after consultation with outside legal
counsel, does not believe that the outcome of these actions would have a
material impact on the financial statements of the Company.
17. MINORITY INTEREST
Under the fiscal 1992 merger (see Note 1) SCPI was required for a
period of five years following the merger to issue to the Company (or cancel)
such number of shares of Series A Preferred Stock and/or common stock as were
necessary, in accordance with periodic determinations, to maintain the Company's
aggregate stock ownership of SCPI at 90%.
During fiscal 1993, the cumulative dividends on SCPI's Series A
Preferred Stock exceeded SCPI's net income for that year, thus creating a loss
attributable to SCPI's common stockholders in excess of the minority interest,
and accordingly, the Company reduced to zero the minority interest related to
SCPI. At such time as SCPI's cumulative net income attributable to common
stockholders from the effective date of the merger exceeds the cumulative Series
A Preferred Stock dividends in arrears, the Company will again reflect the
appropriate minority interest liability.
In July 2001, the Company increased its investment in SHH from 12% to
80.1%. Accordingly, a minority interest liability of $3.6 million and $2.8
million is reflected in the consolidated balance sheet for fiscal 2002 and
fiscal 2001, respectively. Minority interest expense of approximately $873,000
and $647,000 is reflected in the consolidated results of operations for fiscal
2002 and 2001, respectively.
18. UNAUDITED SELECTED FINANCIAL DATA
In November 2001, the Company elected to change its fiscal year end to
December 31. The following tables present condensed consolidated financial
information for the fiscal year ended December 31, 2002, and for the 12 months
ended December 31, 2001 (unaudited) (in thousands):
December 31,
2001
December 31, (12 months)
Consolidated Statements of Operations 2002 (unaudited)
----------- -----------
Net revenues ..................................................... $ 134,317 $ 69,558
Expenses, including interest expense, net of other income ........ 129,972 71,183
----------- -----------
Income (loss) before loss on equity investment and income taxes .. 4,345 (1,625)
Income from investment in SHH .................................... -- 62
Loss from investment in New Heights .............................. -- (2,990)
----------- -----------
Loss on equity investment ........................................ -- (2,928)
Minority interest ................................................ (873) (647)
Current income tax expense ....................................... (14) (14)
Deferred income tax benefit ...................................... 1,264 --
----------- -----------
Net income (loss) ................................................ $ 4,722 $ (3,892)
=========== ===========
Basic and diluted per share amounts:
Basic net income (loss) ....................................... $ 0.93 $ (0.76)
Diluted net income (loss) ..................................... $ 0.78 $ (0.76)
Weighted average shares outstanding used in computation of basic
income (loss) per share .......................................... 5,061,598 5,055,516
Weighted average shares outstanding used in computation of
diluted income (loss) per share .................................. 6,101,515 5,055,516
72
19. RELATED PARTY TRANSACTIONS
The Sterling Transaction was funded in part through the issuance of
zero coupon notes and warrants to certain members of SHH's management, including
Messrs. Patrick Manning and Harper. The zero coupon notes carry an imputed rate
of interest of 12%, compounded annually, and mature in July 2005. Also as part
of the Sterling Transaction, additional notes were issued to Mr. Harper and
another member of SHH's management, which carry interest at 12% and mature in
July 2005. The notes are subordinated to the SHH Revolver and the SCPI Revolver.
Payments made on the additional notes are restricted to defined cash flows of
SHH and SCPI.
In October 1999, to fund the second tranche of SHH equity, notes were
issued to Messrs. Davies and Hemsley which were to mature in April 2001. These
notes were extended and restructured as part of the Sterling Transaction, now
carry interest at 12% and mature in July 2005. Payment on the notes is
restricted to defined cash flows of SHH and SCPI.
In December 2001, in conjunction with an amendment to the SCPI Revolver
and in order to strengthen SCPI's working capital position through the purchase
of additional inventory, Sterling obtained funding in the amount of $500,000
principally from members of management and directors (including Messrs. Frickel,
Harper and Hemsley, who contributed $155,000, $100,000 and $25,000,
respectively) (the "Convertible Subordinated Notes"). In January 2002, two other
members of management funded a further $60,000 that was used for general
corporate purposes. The notes, which are convertible at any time prior to the
maturity date into the Company's common stock at a price of $2.50 per share,
mature and are payable in full in December 2004. Interest at 12% is payable
monthly. The notes are senior to debt issued in connection with the Sterling
Transaction.
In January 2003, certain members of management and directors (including
Messrs. Harper and Hemsley) funded a further $250,000 through a short-term loan
to SCPI to reduce vendor payables. The loans, which are subordinate to the SCPI
Revolver, mature in July 2003. Interest at the annual rate of 10% is paid
monthly.
Mr. Robert Frickel elected a director of the Company in July 2001. Mr.
Frickel's company, the R.W. Frickel Company, P.C. has provided services to SHH
for many years and provided services to SHH and to the Company in fiscal 2002,
primarily related to accounting and tax issues. SHH and the Company incurred
fees for such services in the amount of $92,000, which SHH and the Company
believe were reasonable and competitive in the marketplace.
20. QUARTERLY FINANCIAL INFORMATION
(UNAUDITED) (Dollar amounts in thousands, except per share data)
Fiscal 2002 quarter ended March 31 June 30 September 30 December 31 Total
Revenues $ 29,682 $ 33,990 $ 32,520 $ 38,125 $134.317
Gross profit 3,308 4,275 4,035 4,847 16,465
Income before minority interest and taxes 796 1,418 1,125 1,006 4,345
Net income $ 370 $ 697 $ 1,241 $ 2,414 $ 4,722
Net income per share, basic: $ 0.07 $ 0.14 $ 0.25 $ 0.47 $ 0.93
Net income per share, diluted: $ 0.06 $ 0.12 $ 0.20 $ 0.40 $ 0.78
Fiscal 2001 quarter ended May 31 August 31 November 30* December 31* Total
Revenues $ 5,719 $ 23,664 $ 30,270 $ 6,468 $ 66,121
Gross profit 783 2,505 3,092 182 6,562
(Loss) income before minority interest
and taxes (1,665) (665) 721 356 (1,965)
Net (loss) income $ (1,668) $ (750) $ 63 $ (271) $ (2,626)
Net (loss) income per share: $ (0.34) $ (0.15) $ 0.02 $ (0.04) $ (0.52)
* In fiscal 2001, the Board of Directors voted to change the Company's fiscal
year end from the last day of February to December 31. There was no separately
reported third quarter. Results for December 31 include only one month.
73
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
STERLING CONSTRUCTION COMPANY, INC.
Dated: March 26, 2003 By: /s/ Patrick Manning
-------------------------------------
Patrick Manning, Chief Executive Officer
(duly authorized officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
SIGNATURES TITLES DATE
/s/ Patrick Manning Chairman of the Board March 26, 2003
- --------------------------------- Chief Executive Officer
Patrick Manning Director (principal
executive officer)
/s/ Maarten D. Hemsley Chief Financial Officer March 26, 2003
- --------------------------------- (principal financial and
Maarten D. Hemsley accounting officer)
Director
/s/ Joseph P. Harper President, March 26, 2003
- --------------------------------- Director
Joseph P. Harper
/s/ John D. Abernathy Director March 26, 2003
- ---------------------------------
John D. Abernathy
/s/ Robert M. Davies Director March 26, 2003
- ---------------------------------
Robert M. Davies
/s/ Robert W. Frickel Director March 26, 2003
- ---------------------------------
Robert W. Frickel
/s/ Christopher H.B. Mills Director March 26, 2003
- ---------------------------------
Christopher H.B. Mills
74
Section 302 Certifications for the Signatures
CERTIFICATION FOR ANNUAL REPORT ON FORM 10-K
I, Patrick T. Manning, certify that:
1. I have reviewed this Annual Report on Form 10-K of Sterling
Construction Company, Inc.
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for the periods presented in this annual report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a. Designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
b. Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
annual report (the "Evaluation Date"), and
c. Presented in this annual report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the
Evaluation date;
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of the
registrant's Board of Directors;
a. All significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b. Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated
in this annual report whether or not there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
Date: March 26, 2003
By: /S/ Patrick T. Manning
------------------------------------
Chairman and Chief Executive Officer
75
CERTIFICATION FOR ANNUAL REPORT ON FORM 10-K
I, Maarten D. Hemsley, certify that
1. I have reviewed this Annual Report on Form 10-K of Sterling
Construction Company, Inc.
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for the periods presented in this annual report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a. Designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
b. Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
annual report (the "Evaluation Date"), and
c. Presented in this annual report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the
Evaluation date
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of the
registrant's Board of Directors;
a. All significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b. Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated
in this annual report whether or not there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
Date: March 26, 2003
By: /S/ Maarten D. Hemsley
------------------------------------
Chief Financial Officer
76
SCHEDULE II
STERLING CONSTRUCTION COMPANY, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(DOLLARS IN THOUSANDS)
Column A Column B Column C Column D Column E
Charges to
Balance at Charged to other Balance
beginning costs and accounts - Deductions - at end of
Description of period expenses describe describe(A) period
Allowance for doubtful accounts deducted from trade accounts receivable:
Years ended:
December 31, 2002 $588 259(C) -- 6 $841
December 31, 2001 $191 483(C) -- 86 $588
February 28, 2001 $367 30 137(B) 69 $191
(A) Amounts were deemed uncollectible
(B) Relates to the disposal of Dowling's
(C) Relates to the bankruptcy of Ames, a significant customer of SCPI
77