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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 2003
--------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number: 0-19450
STERLING CONSTRUCTION COMPANY, INC.
-----------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 25-1655321
- ------------------------ ------------------------------------
(State of Incorporation) (I.R.S. Employer Identification No.)
2751 CENTERVILLE ROAD, SUITE 3131, WILMINGTON, DELAWARE
19808
(Address of principal executive offices)
(Zip Code)
(817) 416-0717
--------------
(Registrant's telephone number, including area code)
-------------------------------------------------------------------
(Former name, former address, and former fiscal year,
if changed from last report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such report(s), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the Registrant is an accelerated filer
(as described in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
As of May 1, 2003, 5,069,016 shares of the Registrant's Common Stock,
$0.01 par value per share were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
STERLING CONSTRUCTION COMPANY, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets at March 31, 2003
and December 31, 2002....................................................... 3
Condensed Consolidated Statements of Operations for the three
months ended March 31, 2003 and March 31, 2002.............................. 4
Condensed Consolidated Statements of Cash Flows for the three
months ended March 31, 2003 and March 31, 2002.............................. 5
Notes to Condensed Consolidated Financial Statements........................ 6
2
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
March 31, December 31,
2003 2002
----------- ------------
(Unaudited)
ASSETS
Current assets:
Cash ............................................................ $ 855 $ 2,406
Contracts receivable ............................................ 28,940 22,218
Costs and estimated earnings in excess of billings on
uncompleted contracts ........................................... 4,371 2,793
Trade accounts receivable, less allowance of $829 and $796,
respectively .................................................... 4,375 3,095
Inventories ..................................................... 4,824 3,378
Deferred tax asset............................................... 1,132 1,659
Other ........................................................... 1,322 160
-------- --------
Total current assets .................................. 45,819 35,709
-------- --------
Property and equipment, at cost ...................................... 29,461 28,585
Less accumulated depreciation ................................... (6,870) (5,791)
-------- --------
22,591 22,794
-------- --------
Goodwill, ............................................................ 7,809 7,809
Deferred tax asset (long-term) ....................................... 5,798 5,952
Other assets ......................................................... 350 493
-------- --------
13,957 14,254
-------- --------
$ 82,367 $ 72,757
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................ $ 23,023 $ 14,634
Accrued interest ................................................ 471 396
Billings in excess of costs and estimated earnings on uncompleted
contracts ....................................................... 6,565 3,541
Current maturities of long-term obligations ..................... 1,020 1,038
Current maturities of long-term obligations, related parties .... 2,250 2,000
Other accrued expenses .......................................... 2,676 2,353
-------- --------
Total current liabilities .................................. 36,005 23,962
-------- --------
Long-term obligations:
Long-term debt .................................................. 14,559 17,783
Long-term debt, related parties ................................. 9,690 10,023
Put liability ................................................... 4,577 4,577
Other long-term obligations ..................................... 1,538 1,940
-------- --------
30,364 34,323
-------- --------
Minority interest .................................................... 3,971 3,646
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, 5,069,516 shares issued and outstanding ................. 50 50
Additional paid-in capital ...................................... 65,876 65,871
Deficit ......................................................... (53,898) (55,094)
Treasury stock, at cost, 207 common shares ...................... (1) (1)
-------- --------
Total stockholders' equity ................................. 12,027 10,826
-------- --------
$ 82,367 $ 72,757
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements
3
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, 2003 MARCH 31, 2002
-------------- --------------
Contract revenues .......................................... $ 35,679 $ 23,134
Sales ...................................................... 6,019 6,548
---------- ----------
41,698 29,682
---------- ----------
Cost of contract revenues earned ........................... 31,822 20,874
Cost of goods sold, including occupancy, buying and
warehouse expenses ......................................... 5,160 5,501
Selling and administrative expenses ........................ 1,995 1,920
Interest expense, net of interest income ................... 600 591
---------- ----------
39,577 28,886
---------- ----------
Income before minority interest and income
taxes....................................................... 2,121 796
Minority interest in net earnings of subsidiary ............ 324 156
---------- ----------
Income before taxes ........................................ 1,797 640
Income tax expense ......................................... 601 270
Deferred taxes ............................................. -- --
Netincometax(benefit)expense ........................ 601 270
Net income ................................................. $ 1,196 $ 370
========== ==========
Basic and diluted net income per share:
Basic .................................................... $ 0.24 $ 0.07
Diluted .................................................. $ 0.20 $ 0.06
Weighted average number of shares outstanding
used in computing basic and
diluted per share amounts:
Basic .................................................... 5,069,016 5,055,516
Diluted .................................................. 5,993,090 5,801,816
The accompanying notes are an integral part of these condensed
consolidated financial statements
4
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLAR AMOUNTS IN THOUSANDS)
(UNAUDITED)
Three months Three months
Ended Ended
March 31, 2003 March 31, 2002
-------------- --------------
Cash flows from operating activities:
Net income .............................................. $ 1,196 $ 370
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization......................... 1,080 882
Gain on sale of property and equipment ............... -- --
Deferred tax benefit ................................. 601 270
Increase in put liability ............................ -- 122
Minority interest in net earnings of ................. 324 156
subsidiary
Changes in operating assets and liabilities:
(Increase) in trade accounts receivable .............. (1,280) (1,895)
(Increase) in contracts receivable ................... (6,722) (3,819)
(Increase) in inventories ............................ (1,446) (1,929)
(Increase) in costs and estimated earnings in excess
of billings on uncompleted contracts ................. (1,578) (103)
(Increase) decrease in prepaid expenses and other
assets ............................................... (937) 505
Increase in accounts payable ......................... 8,389 4,985
Increase in billings in excess of costs and estimated
earnings on uncompleted contracts .................... 3,024 1,261
Increase in accrued compensation and other liabilities 844 825
------- -------
Net cash provided by operating activities ..................... 3,495 1,630
------- -------
Cash flows from investing activities:
Additions to property and equipment ..................... (877) (1,012)
------- -------
Net cash used in investing activities ......................... (877) (1,012)
------- -------
Cash flows from financing activities:
Borrowings under long term obligations .................. -- 763
Proceeds from issuance of long term debt ................ -- --
Principal payments on long-term obligations ............. (4,174) (3,289)
Cash paid for options exercised in fiscal 2002 .......... 5 --
------- -------
Net cash used in financing activities ......................... (4,169) (2,526)
------- -------
Net decrease in cash .......................................... (1,551) (1,908)
Cash at beginning of period ................................... 2,406 2,884
------- -------
Cash at end of period ......................................... $ 855 $ 976
======= =======
The accompanying notes are an integral part of this condensed consolidated
financial statement.
5
STERLING CONSTRUCTION COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2003
1. INTERIM FINANCIAL STATEMENTS
Sterling Construction Company, Inc. (hereinafter referred to as
"Sterling" or the "Company") was until November 2001 known as Oakhurst Company,
Inc.. The Company was formed as a result 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 the
outstanding common stock of SCPI and all of SCPI's Series A Preferred Stock, and
as a result, it owns 90% of the voting stock of SCPI.
Until July 2001, the Company's principal historical business had been
the distribution of products to the automotive after-market, conducted by SCPI
under the trade name "Steel City Products". Although the primary business of
Steel City Products continues to be its automotive aftermarket distribution
business, in recent years it has expanded its distribution business to include
non-food pet supplies and, in the third quarter of fiscal 2000, lawn and garden
supplies. Steel City Products operates from two facilities, in McKeesport,
Pennsylvania and Glassport, Pennsylvania.
In January 1999 the Company made a minority investment in Sterling
Construction Company, which in connection with the renaming of the Company in
November 2001 was itself renamed Sterling Houston Holdings, Inc. ("SHH"). SHH is
a heavy civil construction company based in Houston, Texas that specializes in
municipal and state highway contracts for paving, bridge, water and sewer, and
light rail projects. In October 1999 certain shareholders of SHH exercised their
right to sell a second tranche of equity to Sterling. 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 the Company,
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 investments were recorded as an investment using
the cost method. The subsequent acquisition in July 2001 resulted in
step-acquisition treatment of the original investment.
In September 2002, an affiliate 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
two-year notes in the aggregate amount of $1.5 million, with the balance funded
through additional borrowings under the SHH revolving line of credit.
The Company reports two operating segments, the "Construction" segment,
which consists of the operations of SHH, and the "Distribution" segment, which
consists of the operations of SCPI.
The accompanying condensed consolidated financial statements include
the accounts of subsidiaries in which the Company has a greater than 50%
ownership interest and all intercompany accounts and transactions have been
eliminated in consolidation.
6
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments necessary to present
fairly the financial position, results of operations and cash flows for the
interim periods presented. All adjustments made are of a normal, recurring
nature.
These unaudited condensed consolidated financial statements should be
read in conjunction with the audited consolidated financial statements for the
fiscal year ended December 31, 2002 ("fiscal 2002") as filed in the Company's
Annual Report on Form 10-K.
Operating results for the three months ended March 31, 2003 are not
necessarily indicative of the results that may be expected for the full fiscal
year.
Certain prior years' balances have been reclassified to conform to
current year presentation.
2. NEW ACCOUNTING PRONOUNCEMENTS
In April 2003, the FASB issued Statement of Financial Accounting
Standards No. 149 ("SFAS No. 149"), "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities", which amends and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts. SFAS No. 149 will be
effective for contracts entered into or modified after June 30, 2003 and for
hedging relationships designated after June 30, 2003. The provisions of SFAS No.
149 are to be applied prospectively. The Company is evaluating the impact, if
any, SFAS No. 149 will have on its financial statements.
3. GOODWILL
The amounts recorded by the Company for goodwill are as follows
(dollars in thousands):
Construction Distribution
Segment Segment Total
------------ ------------ -------
Balance, January 1, 2003... $7,681 $ 128 $7,809
Goodwill additions ........ -- -- --
Impairment losses ......... -- -- --
------ ------ ------
Balance, March 31, 2003.... $7,681 $ 128 $7,809
====== ====== ======
The Company performed impairment testing on both segments in the fourth
quarter of fiscal 2002. The analysis did not indicate impairment of the
Company's recorded goodwill for either segment.
4. STOCK-BASED COMPENSATION:
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.
Prior to January 1, 2003, the Company accounted 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.
7
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).
Three months ended Thee months ended
March 31, 2003 March 31, 2002
------------------ -----------------
Net income, as reported .......................................... $ 1,196 $ 370
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects............................ (13) (13)
-------- ------
Proforma net income .............................................. $ 1,183 $ 357
Basic and diluted net income per share:
Basic, as reported ............................................... $ 0.24 $ 0.07
Diluted, as reported ............................................. $ 0.20 $ 0.06
Proforma, basic .................................................. $ 0.23 $ 0.07
Proforma, diluted ................................................ $ 0.20 $ 0.06
5. 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 for the three
months ended March 31, 2003 and March 31, 2002 (in thousands, except per share
data):
Three months ended Three months ended
March 31, 2003 March 31, 2002
------------------ ------------------
Numerator:
Net income ........................................... $1,196 $ 370
Interest on convertible debt, net of tax ............. 11 11
------ ------
Net income before interest on convertible debt ....... $1,207 $ 381
====== ======
Denominator:
Weighted average common shares outstanding - basic ... 5,069 5,056
Shares for convertible debt .......................... 224 224
Shares for dilutive stock options and warrants ....... 700 522
------ ------
Weighted average common shares outstanding and assumed
conversions - diluted ................................ 5,993 5,802
====== ======
Basic earnings per common share: $ 0.24 $ 0.07
Diluted earnings per common share: $ 0.20 $ 0.06
6. SEGMENT INFORMATION
8
Until July 2001, the Company 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 business 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.
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 highway contracts for paving, bridge, water
and sewer, and light rail projects (the "Construction Segment").
Each of the Construction Segment and the Distribution Segment is
managed by its own decision makers and is comprised of unique customers,
suppliers and employees. Terry Allan, Chief Executive Officer 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.
The Company's operations are therefore 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):
Three months ended 3/31/2003 Consolidated
Segments Construction Distribution Corporate Total
------------ ------------ --------- ------------
Revenues .................. $ 35,679 $ 6,019 -- $ 41,698
Operating profit (loss).... 2,521 269 (69) $ 2,721
Interest expense, net ..... (254) (23) (323) $ (600)
Minority interest ......... (324) $ (324)
--------
Pre-tax income ............ $ 1,797
========
Segment assets ............ $ 54,750 $ 10,962 $ 16,655 $ 82,367
Three months ended 3/31/2002 Consolidated
Segments Construction Distribution Corporate Total
------------ ------------ --------- ------------
Revenues ................. $ 23,134 $ 6,548 -- $ 29,682
Operating profit (loss)... 1,174 474 (261) $ 1,387
Interest expense, net .... (106) (21) (464) $ (591)
Minority interest ........ (156) $ (156)
--------
Pre-tax income ........... $ 640
========
Segment assets ........... $ 38,858 $ 10,704 $ 14,769 $ 64,331
7. SUBSEQUENT EVENT
9
In April 2003 the Company repaid its obligation under the KTI Loan in
the amount of $1,000,000 plus accrued interest of approximately $220,000. In
consideration for the prepayment, 394,000 warrants for common shares of the
Company's stock that were issued in connection with the KTI loan were cancelled.
Casella Waste Systems, the parent company of KTI, retains 100,000 warrants,
which are exercisable for common shares of the Company's stock at $1.50 per
share. The warrants may be exercised after January 2006.
ITEM 2. 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" or "the
Company") 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 remaining at December 31, 2002. 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 was the distribution of
automotive aftermarket accessories, described herein as the "Distribution
Segment". The Distribution Segment is conducted by SCPI under the trade name
"Steel City Products" and involves the distribution of automotive parts and
accessories, together with 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.
In January 1999 OTI made a minority investment in Sterling Construction
Company, since renamed Sterling Houston Holdings, Inc. ("SHH"). SHH is a heavy
civil construction company based in Houston, Texas that specializes in municipal
and state highway contracts for paving, bridge, water and sewer, and light rail
projects, (the "Construction Segment"). Upon reaching certain performance
objectives, in October 1999 certain SHH 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 Chief Executive
Officer. Under a Participation Agreement, Maarten Hemsley, then the Company's
President and now its Chief Financial Officer, funded $116,000 of the amount
advanced by Mr. Davies pursuant to such Promissory Note. The balance of the
notes issued to acquire the second tranche is owed to certain directors and
management of SHH, a portion of which was reflected as adjustments to additional
paid-in capital. These notes were restructured as part of the Sterling
Transaction whereby the Company further increased its equity percentage in SHH
from 12% to 80.1%. The Sterling Transaction was closed in July 2001.
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
10
unsecured two-year notes in the aggregate amount of $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 comprises unique customers, suppliers and
employees. Terry Allan, Chief Executive Officer 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, the Company's President and SHH's Chief Financial Officer
to determine its financial needs. Allocation of resources among the Company's
operating segments is determined by Messrs. Harper and Hemsley.
LIQUIDITY AND CAPITAL RESOURCES
FINANCING
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, in
billings in excess of cost and estimated earnings, and in customer receivables
and contract retentions. SHH's cash requirements are also impacted by its needs
for capital equipment, which in the past have generally been financed from cash
flow or from borrowings under its line 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, borrowings under its line of credit and other loans.
At March 31, 2003, the Company's debt consisted of (in thousands):
Related party notes:
Subordinated debt .................... $ 3,000
Zero coupon notes .................... 6,084
Convertible subordinated notes ....... 560
Management/director notes ............ 2,296
-------
11,940
SHH revolver .............................. 8,919
SCPI revolver ............................. 4,448
Insituform notes .......................... 1,213
Mortgage payable .......................... 1,234
KTI Loan .................................. 1,192
Equipment notes & capital leases .......... 93
Other ..................................... 18
-------
$29,057
=======
Related Party Notes
Subordinated Debt
As part of the Sterling Transaction, certain shareholders of SHH were
issued subordinated promissory notes 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.
11
Subordinated Zero Coupon Notes
The Sterling Transaction was funded in part through the sale of zero
coupon notes and the issuance of zero coupon notes to certain selling
shareholders in 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 after issuance at $1.50 per common share. Patrick Manning, Chairman and
Chief Executive Officer of the Company, and Joseph P. 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, in the Sterling
Transaction.
Convertible Subordinated Notes
In December 2001, in conjunction with an amendment to the SCPI Revolver
and in order to strengthen SCPI's working capital position through an advance to
SCPI to fund the purchase of additional inventory, Sterling obtained funding
principally from members of management and directors (including Robert Frickel,
Joseph P. Harper and Maarten Hemsley, who contributed $155,000, $100,000 and
$25,000, respectively) aggregating $500,000 (the "Convertible Subordinated
Notes"). In January 2002, two other members of management, including Bernard
Frank, Chairman of SCPI, funded a further $60,000, which was used for general
corporate purposes. The notes evidencing these advances are convertible at any
time prior to their 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.
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 SHH's management, including Joseph P.
Harper, since appointed President of the Company. 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 accrued amounts due 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 Sterling and SCPI, or from proceeds of any sale of
SCPI's business.
In January 2003, in order to further improve SCPI's working capital
position, certain members of the Company's management loaned SCPI an aggregate
of $250,000 under short-term promissory notes that mature in July 2003. The
notes bear interest at 10% per annum, payable monthly. The notes may be repaid
after March 31, 2003 but prior to maturity as long as SCPI is in compliance with
financial covenants under the SCPI Revolver and excess availability of at least
$100,000 remains under the line of credit after repayment of the notes.
Sterling Revolver and SCPI Revolver
In conjunction with the Sterling Transaction, SHH entered into a
three-year agreement providing for a 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, secured by the equipment of SHH and is subject to the
maintenance of certain financial covenants. In September 2002, in connection
with the acquisition of the Kinsel
12
Business, the line of credit was amended to increase the maximum line to $17.0
million. At March 31, 2003, the balance on the SHH Revolver was $8.9 million and
SHH was in compliance with covenant requirements. 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.
In July 2001, SCPI replaced its existing line of credit with financing
from an institutional lender (the "Revolver"). The Revolver originally was for a
term of two years in the amount of $4.5 million, subject to a borrowing base and
carried an interest rate equal to prime plus 1%. Due to concerns stemming from
the bankruptcy filing of Ames Department Stores, a significant customer of SCPI,
in August 2001, the Revolver was amended to shorten the term of the line and
increase the interest rate to prime plus 1.5%. Upon satisfaction to the lender
of SCPI's ability to maintain sales and profitability levels, the Revolver was
again amended in December 2001 to provide for a line of $5.0 million, subject to
a borrowing base, and to extend the term to May 31, 2003. In November 2002, the
Revolver was again amended to extend the term to May 31, 2004 and to remove
certain limitations on borrowing. At March 31, 2003, the outstanding balance on
the Revolver was $4.5 million and the effective rate of interest was 5.75%. The
Revolver is secured by the assets of SCPI and is subject to the maintenance of
certain financial covenants. SCPI was in compliance with its covenant
requirements at March 31, 2003.
Management believes that the SCPI Revolver and the proceeds from the
Convertible Subordinated Notes and short-term notes 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 levels or profit
margins.
KTI Loan
In December 1998, the Company entered into a loan agreement with KTI,
Inc., a subsidiary of Casella Waste Systems, Inc. (the "KTI Loan") pursuant to
which KTI committed to fund a minimum of $11.5 million for capital expenditures
and start-up losses incurred by New Heights, a waste-to-energy facility located
in Ford Heights, Illinois. 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 the Company entered into the KTI Loan. Funds
drawn by the Company 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 was
13
accounted for by 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.
In April 2003, the KTI loan of $1,000,000 plus accrued interest of
approximately $220,000 was prepaid. In consideration for the prepayment, 394,000
warrants for Sterling common stock were cancelled.
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.
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.
Other Debt
In October 1998, SCPI obtained from the Redevelopment Authority of the
City of McKeesport a low-interest 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.
CASH FLOWS
Net cash provided by operating activities in the three months ended
March 31, 2003 increased by approximately $1.9 million compared with the three
months ended March 31, 2002. The increase was principally due to substantially
improved cash flow from operations, combined with increases in levels of vendor
payables, offset in part by increases in accounts receivable, due to dating to
certain customers, and contracts receivable, due to expansion of the
construction business.
Compared with the prior year, net cash used in investing activities
decreased by approximately $135,000 reflecting fewer purchases of capital
equipment in the current year.
In the three months ended March 31, 2003 the Company reduced its debt
obligations by approximately $1.6 million, primarily due to a decrease in the
SHH Revolver.
FORWARD LOOKING STATEMENTS
From time to time the information provided by the Company or statements
made by its employees may contain so-called "forward-looking" information that
involves risks and uncertainties. In particular, statements contained in this
Item 2 - "Management's Discussion and Analysis of Financial Condition and
Results of Operations," which are not historical facts (including, but not
limited to statements concerning anticipated sales, profit levels, customers and
cash flows) are forward-looking statements. The Company's actual future results
may differ significantly from those stated in any forward-looking statements.
Factors that may cause such
14
differences include, but are not limited to the factors discussed above as well
as the accuracy of the Company's internal estimates of revenue and operating
expense levels. Each of these factors and others are discussed from time to time
in the Company's Securities and Exchange Commission filings.
CERTIFICATION
This Form 10-Q 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.
MATERIAL CHANGES IN FINANCIAL CONDITION
At March 31, 2003, there had been no material changes in the Company's
financial condition since December 31, 2002, as discussed in Item 7 of the
Company's Annual Report on Form 10-K for the period ended December 31, 2002.
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 highway contracts for paving, bridge, water
and sewer, and light rail. Operations of SHH consist of one segment (the
"Construction Segment").
THREE MONTHS ENDED MARCH 31, 2003 COMPARED WITH THREE MONTHS ENDED MARCH 31,
2002
CONSTRUCTION
For the three months ended March 31, 2003, Construction reported
revenues of $35.7 million, an increase of $12.6 million, or 54% compared with
the three months ended March 31, 2002. The increase was due to higher revenues
on municipal contracts and the addition of the Kinsel business enhanced by
generally favorable weather during the quarter.
Gross profit for the period was $3.9 million, or 10.8% of contract
revenues, compared with gross profit in the first quarter last year of $2.3
million, or 9.8% of contract revenues. Improved margins resulted principally
from the mix of contracts compared with the prior year.
SHH reported an operating profit of $2.5 million for the quarter,
compared with a profit of $1.2 million last year. The improvement was due
primarily to the revenue increase and improved gross margins.
Contract backlog at SHH at March 31, 2003 was approximately $132
million, of which approximately 40% is not expected to be constructed until
fiscal 2004.
Distribution
Sales at SCPI totaled $6.0 million, a decrease of $529,000 compared
with the first quarter of the prior year. The decrease was principally due to
the liquidation of Ames Department Stores, a significant customer, in July 2002;
sales to Ames in the first quarter of fiscal 2002 totaled approximately $1.2
million. Sales of automotive products decreased by approximately $448,000 and
sales of pet products decreased by $866,000 principally due to the liquidation
of
15
Ames Department Stores, a significant customer, in July 2002. Offsetting the
decreases were sales of lawn and garden products which increased by 91% in the
first quarter or by $785,000.
Gross profit for the segment was $859,000, or 14.3% of sales, compared
with gross profit in the prior year of $1.0 million, or 16.0% of sales. The
decrease was due to the lower sales volumes, combined with lower margins on the
increased proportion of lawn and garden products shipped in the current year.
The Distribution Segment reported an operating profit of $269,000 in
the first quarter, compared with an operating profit of $474,000 in the first
quarter of the prior year. The decrease was due to the lower sales volume and
lower gross margins, offset in part by reduced operating expenses.
CORPORATE
Operating expenses at the corporate level decreased by approximately
$192,000 due primarily to lower legal, tax and shareholder expenses and to a
reduction in expense related to the put liability for the three months ended
March 31, 2003.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is 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 for the
three months ended March 31, 2003 by approximately $25,000.
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 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, the Company
carried out an evaluation under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Rule 13a-14 under the
Securities Exchange Act of 1934, as amended. Based on that evaluation, the
Company's Chief Executive Officer and Chief Financial Officer have concluded
that the Company's disclosure controls and procedures are adequate and effective
in timely alerting them to material information relating to the Company required
to be included in the Company's periodic filings with the SEC.
16
There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect internal controls
subsequent to the date the Company carried out its evaluation.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
There are no material legal proceedings outstanding against the
Company.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the
quarter for which this report is filed.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
*99.1 Certification of Patrick T. Manning, Chief Executive Officer, and
Maarten D. Hemsley, Chief Financial Officer
(b) No reports on Form 8-K were filed during the quarter for which this
report is filed.
- ----------
*filed herewith
17
SIGNATURES
Pursuant to the requirements of the Securities and 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.
Date: May 12, 2003 By: /s/ Patrick T. Manning.
--------------------------
Patrick T. Manning.
Chief Executive Officer
Date: May 12, 2003 By: /s/ Maarten D. Hemsley
-------------------------
Maarten D. Hemsley
Chief Financial Officer
18
Section 302 Certifications for the Signatures
CERTIFICATION FOR QUARTERLY REPORTS ON FORM 10-Q
I, Patrick T. Manning, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Sterling
Construction Company, Inc.
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly 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 quarterly
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 quarterly report (the "Evaluation Date"), and
c. Presented in this quarterly 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
quarterly 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: May 12, 2003
By: /s/ Patrick T. Manning
--------------------------------------
Chairman and Chief Executive Officer
19
CERTIFICATION FOR QUARTERLY REPORTS ON FORM 10-Q
I, Maarten D. Hemsley, certify that
1. I have reviewed this quarterly report on Form 10-Q of Sterling
Construction Company, Inc.
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly 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 quarterly
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 quarterly report (the "Evaluation Date"), and
c. Presented in this quarterly 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
quarterly 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: May 12, 2003
By: /s/ Maarten D. Hemsley
-----------------------------------------
Chief Financial Officer
20
INDEX TO EXHIBITS
No. Description
- ----- ------------------------------------------------------------------
*99.1 Certification of Patrick T. Manning, Chief Executive Officer, and
Maarten D. Hemsley, Chief Financial Officer
- ------------
* filed herewith