UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

þ       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: March 31, 2005

OR

o      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.

2751 CENTERVILLE ROAD SUITE 3131 WILMINGTON, DELAWARE
19803
(Address of principal executive offices)
(Zip Code)

(281) 821-9091

     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 þ No o

     Indicate by check mark whether the Registrant is an accelerated filer (as described in Rule 12b-2 of the Exchange Act). Yes o No þ

     As of May 1, 2005, 7,717,342 shares of the Registrant’s Common Stock, $0.01 par value per share were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
None

PART I. FINANCIAL INFORMATION

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STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES

The accompanying notes are an integral part of these condensed consolidated financial statements

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STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES

The accompanying notes are an integral part of these condensed consolidated financial statements

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STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES

The accompanying notes are an integral part of these condensed consolidated financial statements.

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STERLING CONSTRUCTION COMPANY, INC. AND SUBSIDIARIES

1. Basis of Presentation

     The condensed consolidated financial statements included herein have been prepared by Sterling Construction Company, Inc. (“Sterling” or “the Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission and should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. The condensed consolidated financial statements reflect, in the opinion of management, all normal recurring adjustments necessary to present fairly the Company’s financial position at March 31, 2005 and the results of operations and cash flows for the periods presented.

     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.

     Interim results may be subject to significant seasonal variations and the results of operations for the three months ended March 31, 2005 are not necessarily indicative of the results to be expected for the full year.

     The Company reports two operating segments, the “Construction” segment, which consists of the operations of Sterling Houston Holdings (“SHH”), a heavy civil construction company based in Houston, Texas, and the “Distribution” segment, which consists of the operations of Steel City Products, Inc. (“SCPI”), a wholesale distributor of automotive accessories, non-food pet supplies and lawn and garden products, based in Pittsburgh, Pennsylvania.

2. Recent Accounting Pronouncement

     In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, “Inventory Costs – an amendment of ARB No. 43 (“SFAS No. 151”), which is the result of its efforts to converge United States accounting standards for inventories with International Accounting Standards. SFAS No. 151 required idle facility expenses, freight, handling costs and wasted material (spoilage) costs to be recognized as current-period charges. It also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not believe adoption of SFAS No. 151 will have an impact on its consolidated financial statements.

     In December 2004, the FASB issued FASB Statement No. 123(R), “Share-Based Payment”, (“SFAS 123(R)”), which is a revision of FASB Statement No. 123 “Accounting for Stock-Based Compensation”. SFAS No. 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”) and amends FASB Statement No. 95, “Statement of Cash Flows”. The Company is required to adopt SFAS No. 123(R) beginning January 1, 2006. Pro forma disclosure, as was allowed under APB 25 and SFAS No. 123, will no longer be an alternative. Additionally, SFAS No. 123(R) requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS No. 123(R) and for all subsequent stock options granted thereafter. Because the Company utilizes a fair value based method of accounting for stock-based compensation costs for all employee stock compensation awards granted, modified or settled since January 1, 2003 and will not have significant unvested awards from periods prior to January 1, 2003 outstanding at January 1, 2006, adoption of SFAS No. 123(R) is not expected to have a material impact on its financial statements.

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     In March 2005, the FASB issued FASB Interpretation No. 47 “Accounting for Conditional Asset Retirement Obligations” (FIN 47). Fin 47 clarifies that an entity must record a liability for “conditional” asset retirement obligation if the fair value of the obligation can be reasonably estimated. The provision must be adopted no later than the end of the fiscal year ending December 31, 2005. The Company does not expect adoption of FIN 47 to have a material impact on its financial position, results of operations or cash flows.

3. 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 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.

4 Property and Equipment

5. Goodwill

     The amounts recorded by the Company for goodwill are as follows (dollars in thousands):

     The Company performed impairment testing under the terms of SFAS No. 142 “Goodwill and Other Intangible Assets” for its two reporting segments in the fourth quarter of fiscal 2004. The analysis did not indicate impairment of the Company’s recorded goodwill for either segment.

6. Earnings Per Share

     Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per common share is computed giving effect to all potential dilutive common stock and warrants using the treasury stock method. The following table reconciles the numerators and denominators of the basic and

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diluted per common share computations for net income for the three months ended March 31, 2005 and March 31, 2004 (in thousands, except share and per share data):

7. Stock-Based Compensation

     The Company accounts for its stock based compensation under the provisions of SFAS No. 148 “Accounting for Stock-Based Compensation – Transition and Disclosure”, which amended SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method. The Company adopted SFAS No. 148 effective January 1, 2003 utilizing the prospective method for options granted after that date and uses a Black-Scholes option pricing model for calculations of the fair value of options granted after January 1, 2003.

     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 prior to January 1, 2003 (dollars in thousands, except per share data).

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8. Segment Information

     Each of the Construction Segment and the Distribution Segment is managed by its own decision makers and comprises different customers, suppliers and employees. The operating profitability of the Construction Segment is reviewed by its Treasurer, Joseph P. Harper, who is also the Company’s President and Chief Operating Officer. To determine the financial needs of the Distribution Segment, Terry Allan, Chief Executive Officer of SCPI and Maarten Hemsley, the Company’s Chief Financial Officer, review the segment’s operating profitability and working capital needs to allocate financial resources. Allocation of resources among the Company’s operating segments is determined by Messrs. Harper and Hemsley. (dollars in thousands)

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The Company operates primarily as a heavy civil construction company through its subsidiary Sterling Houston Holdings in Houston, Texas under the trade name “Texas Sterling Construction” (“SHH” or the “Construction Segment”). The Company’s distribution business is conducted in Pittsburgh, Pennsylvania under the name “Steel City Products” (“SCPI” or the “Distribution Segment”).

Forward Looking Statements

     From time to time the information provided by the Company or statements made by its employees may fall within the definition of “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. In particular, statements contained in this Item 2 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which

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are not historical facts (including, but not limited to, statements concerning anticipated sales, contracts, EBITDA and profit levels, customers, backlog and cash flows) are forward-looking statements. Any such statements are subject to risks and uncertainties, including overall economic and market conditions, competitors’ and customers’ actions, weather conditions and other risks identified in the Company’s filings with the Securities and Exchange Commission, any of which could cause actual results to differ materially from those anticipated. Accordingly, such statements should be considered in light of these risks. The Company’s actual future results may differ significantly from those stated in any forward-looking statements due to the factors discussed above, as well as the accuracy of the Company’s internal estimates of revenue and expense levels. These factors and others are discussed from time to time in the Company’s Securities and Exchange Commission filings. Any prediction by the Company of future financial results or other events is only a statement of management’s belief at the time the prediction is made. There can be no assurance that any prediction once made will continue thereafter to reflect management’s belief, and the Company does not undertake to update predictions.

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, of billings in excess of cost and estimated earnings, of customer receivables and contract retentions and creditor liabilities, and of the use of the revolving line of credit to finance operations and capital expenditures

     At SCPI, the level of working capital needs varies primarily with the amounts of inventory carried, the size and timeliness of payment of receivables from customers and the amount of credit extended by suppliers, all of which can fluctuate seasonally. SCPI’s working capital needs not financed by supplier credit have been financed from cash flow and borrowings under its line of credit.

Financing

     The following is a summary of the Company’s long-term debt and lines of credit and should be read in conjunction with Footnote 5 to the Company’s Consolidated Financial Statements included in the Annual Report on Form 10-K:

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Cash Flows

     For the quarter ended March 31, 2005, the Company’s consolidated operations provided cash of $7.1 million, due to higher levels of trade payables and billings in excess of costs and estimated earnings on uncompleted contracts. This was offset by higher levels of contract receivables and accounts receivable and inventories. At the Construction Segment, higher revenues in the first quarter led to an increase in contract receivables. At Distribution, trade receivables were higher due to dating on orders placed at the annual trade show, and there were increases in inventories due to anticipated price increases. In the prior year period, operations used $834,000 in cash, principally reflecting increases in contracts and accounts receivable, inventories, and costs and estimated earnings in excess of billings on uncompleted contracts.

     In the quarter ended March 31, 2005, cash used in investing activities increased by $2.4 million compared with the prior year period, due to higher capital expenditures for construction equipment reflecting the Segment’s enlarged contract backlog.

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     Cash used in financing activities was approximately $6.8 million in the first quarter due principally to borrowings under SHH’s revolving line of credit being $6.7 million lower at quarter-end than at the beginning of the quarter. This reflected the timing of accounts payable, which were $8.8 million higher than at the start of the period.

     The decrease of $3.5 million in the level of working capital at the end of the first quarter, compared with such level at the end of the prior year period is primarily the result of the lower level of borrowings under SHH’s available line of credit at the end of the quarter.

Inflation

     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 and recent fluctuations in the price of steel have affected the prices at which the Construction Segment has bid certain contracts, and potential gross profits on contracts. Inflation may also affect prices of products purchased by the Distribution Segment and the prices which it can charge to its customers. In times of increasing inflation, SCPI may increase inventory levels of affected items to help protect its gross margin. This occurred to some degree in the first quarter of 2005.

Risk Factors

     SHH measures its performance within the construction industry through the bidding process and the number, size and expected profitability of contracts obtained throughout the year. The Company is subject to various risks and uncertainties. Many factors affect the bidding climate, including, but not limited to, fluctuations in the Texas economy, the amount of local, state and federal government funds available for infrastructure upgrade and new construction, as well as the number of bidders in the market and the prices at which they are prepared to bid, which are in turn affected by such bidders’ profitability and contract backlogs. Factors outside the bidding climate include: (a) weather conditions, such as precipitation and temperature, which can result in significant variability in quarterly revenues and earnings, particularly in the first and fourth quarters; (b) the availability of bonding, the absence of which would adversely affect the Company’s ability to obtain new contracts (although the level of SHH’s bonding capacity has not constrained its business in many years); (c) the price of oil products; (d) the price and availability of steel, cement and other construction materials (including, for example, recent market shortages of aggregates and cement), which can significantly fluctuate and impact operating expense; (e) the availability of heavy construction equipment, and (f) the availability of qualified field and supervisory personnel.

     The distribution industry has been adversely affected by suppliers that offer products directly to retailers, sidestepping the need for a distributor. SCPI has been able to maintain its presence in the distribution industry by offering new product lines and by competing through product selection, distribution services, order fill rates, short turnaround times and breadth of merchandise offered, but it may not be able to continue to do so.

Material Changes in Financial Condition

     At March 31, 2005, there had been no material changes in the Company’s financial condition since December 31, 2004, as discussed in Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

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Results of Operations

Three months ended March 31, 2005 compared with three months ended March 31, 2004

     The Company reported consolidated revenues of $45.9 million, a 42% increase compared with the first quarter of fiscal 2004. The Company measures its performance at the operating profit level and the levels of Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”), among other factors. EBITDA for the first quarter was $3.0 million, an increase of approximately $0.9 million from fiscal 2004. Results for the Construction Segment and the Distribution Segment are discussed below.

Construction

     Contract revenues in the first quarter of fiscal 2005 increased compared with the same period in fiscal 2004 by approximately 54%. In the current year, more projects were in progress. In addition, despite higher than average rainfall in January and February, the weather position improved significantly in March so that weather had less of an adverse impact than in the prior year.

     Construction Segment gross profit for the quarter was $3.4 million, or 8.5% of contract revenues, compared with gross profit in the first quarter last year of $2.7 million, or 10.5% of contract revenues. Certain contracts in progress during the current year period were bid at lower margins in 2003 and 2004 when there was an aggressive bidding climate, and there were losses in the first quarter this year on some small contracts in the Dallas/Fort Worth market.

     Operating profit at the Construction Segment increased by approximately $372,000 principally due to the higher revenues and related gross profits in the first quarter of the current year.

Distribution

     The sales decrease of $187,000 at the Distribution Segment was due primarily to lower sales of winter products such as antifreeze, ice melters and show shovels, as the winter in Distribution’s primary markets was unseasonably mild.

     Gross profit for Distribution was $973,000, or 14.9% of sales, compared with gross profit in the prior year of $947,000, or 14.1% of sales. The increase was due to a higher margin product mix, and to lower sales of lower margin winter products.

     The Distribution Segment reported an operating profit of $397,000 in the first quarter, compared with an operating profit of $340,000 in the first quarter of the prior year. The increase of $57,000 was primarily related to the higher gross margins.

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Corporate

     Operating expenses at the corporate level decreased by approximately $197,000 due primarily to an expense of $207,000 in the prior year related to variable option expense for option grants after June 2000 and before adoption of SFAS 123 in January 2003. In March 2004, the Company discontinued variable option plans.

Company Website

     The Company maintains a website at www.sterlingconstructionco.com. The Company makes available free of charge on or through its website, access to its latest Annual Report on Form 10-K, recent Quarterly Reports on Form 10-Q, any amendments to those filings, recent press releases, its Code of Ethics and Audit Committee Charter, together with other filings related to shareholdings.

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 changes in interest rates. The Company manages its interest rate risk by balancing in part its exposure to fixed and variable interest rates while attempting to minimize its interest costs.

     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 Company’s portfolio of derivative financial instruments consists of interest rate swap agreements, which are used to convert variable interest rate obligations to fixed interest rate obligations, thereby reducing the exposure to increases in interest rates. Amounts paid or received under interest rate swap agreements are accrued as interest rates fluctuate with the offset recorded in interest expense.

     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, 2005 by approximately $11,000.

     The Company applies SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities pursuant to which 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 and has no obligations in foreign currency, it experiences no direct foreign currency exchange rate risk. However, prices of certain raw materials and consumables, such as oil and steel, may be affected by currency fluctuations.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company maintains “disclosure controls and procedures”, as that phrase is defined in Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed in the Company’s reports, filed pursuant to the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer, its President and its Chief Financial Officer, as appropriate, to allow timely decisions regarding the required disclosures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management

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necessarily is required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures.

     The Company’s Chief Executive Officer and Chief Financial Officer (its principal executive officer and principal financial officer, respectively) have evaluated the effectiveness of the Company’s “disclosure controls and procedures” as of March 31, 2005. Based on their evaluation, except as noted below, the principal executive officer and principal financial officer concluded that the Company’s controls and procedures are effective.

Changes in Internal Controls

     Subsequent to the issuance of the Company’s financial statement for the quarter ended September 30, 2004, the Company’s management determined that borrowings under the SCPI Revolver should have been classified as short-term in the consolidated balance sheets. Management has implemented a formal loan review process and has established a control to ensure that debt is properly classified in the financial statements.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

     There are no material legal proceedings outstanding against the Company.

Item 2. Changes in Securities and Use of Proceeds

     None

Item 3. Defaults upon Senior Securities

     None

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 5. Other Information

     None

Item 6. Exhibits

(a) Exhibits

     *31.1 Certification of Patrick T. Manning, Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a)

     *31.2 Certification of Maarten D. Hemsley, Chief Financial Officer, pursuant to Exchange Act Rule 13a-14(a)

     *32.0 Certification of Patrick T. Manning, Chief Executive Officer and Maarten D. Hemsley, Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002)

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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.

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