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, 2002
--------------
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
------ -----
As of May 1, 2002, 5,055,516 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
<Table>
Condensed Consolidated Balance Sheets at March 31, 2002
and December 31, 2001........................................................ 3
Condensed Consolidated Statements of Operations for the three month
periods ended March 31, 2002 and March 31, 2001.............................. 4
Condensed Consolidated Statements of Cash Flows for the three month
periods ended March 31, 2002 and March 31, 2001............................... 5
Notes to Condensed Consolidated Financial Statements........................... 6
</Table>
2
STERLING CONSTRUCTION COMPANY, INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<Table>
<Caption>
March 31,
ASSETS 2002 December 31,
(Unaudited) 2001
----------- ------------
Current assets:
Cash ................................................................................ $ 976 $ 2,884
Contracts receivable ................................................................ 19,014 15,195
Costs and estimated earnings in excess of billings on uncompleted contracts ......... 1,835 1,732
Trade accounts receivable, less allowance of $615 and $588, respectively ............ 3,858 1,963
Inventories ......................................................................... 6,055 4,126
Deferred tax asset .................................................................. 1,545 1,545
Other ............................................................................... 284 800
-------- --------
Total current assets ...................................................... 33,567 28,245
-------- --------
Property and equipment, at cost .......................................................... 21,493 20,540
Less accumulated depreciation ....................................................... (3,331) (2,539)
-------- --------
18,162 18,001
-------- --------
Goodwill, net ............................................................................ 7,740 7,740
Deferred tax asset (long-term) ........................................................... 4,499 4,769
Other assets ............................................................................. 363 383
-------- --------
12,602 12,892
-------- --------
$ 64,331 $ 59,138
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .................................................................... $ 17,255 $ 12,270
Billings in excess of costs and estimated earnings on uncompleted contracts ......... 5,274 4,013
Current maturities of long-term obligations ......................................... 243 259
Current maturities of long-term obligations, related parties ........................ 2,500 2,500
Other accrued expenses .............................................................. 1,529 949
-------- --------
Total current liabilities ...................................................... 26,801 19,991
-------- --------
Long-term obligations:
Long-term debt ...................................................................... 11,622 13,551
Long-term debt, related parties ..................................................... 10,980 11,268
Put liability ....................................................................... 4,178 4,056
Other long term obligations ......................................................... 1,318 1,366
-------- --------
28,098 30,241
-------- --------
Minority interest ........................................................................ 2,929 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,
5,055,516 shares issued ......................................................... 50 50
Additional paid-in capital .......................................................... 65,900 65,900
Deficit ............................................................................. (59,446) (59,816)
Treasury stock, at cost, 207 common shares .......................................... (1) (1)
-------- --------
Total stockholders' equity ..................................................... 6,503 6,133
-------- --------
$ 64,331 $ 59,138
======== ========
</Table>
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)
<Table>
<Caption>
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, 2002 MARCH 31, 2001
-------------- --------------
Contract revenues ............................................... $ 23,134 $ --
Sales ........................................................... 6,548 5,371
----------- -----------
29,682 5,371
----------- -----------
Cost of contract revenues earned ................................ 20,874 --
Cost of goods sold, including occupancy and buying expenses ..... 5,258 4,470
Operating, selling and administrative expenses .................. 2,163 1,006
Interest expense, net of interest income ........................ 591 765
----------- -----------
28,886 6,241
----------- -----------
Income (loss) before loss from equity investment, minority
interest and income taxes ....................................... 796 (870)
Loss from equity investments .................................... -- (1,981)
Minority interest in net earnings of subsidiary ................. (156) --
----------- -----------
Income (loss) before taxes ...................................... 640 (2,851)
Income tax expense .............................................. 270 22
----------- -----------
Net income (loss) ............................................... $ 370 $ (2,873)
=========== ===========
Basic and diluted net income (loss) per share:
Basic ...................................................... $ 0.07 $ (0.58)
Diluted .................................................... $ 0.06 $ (0.58)
Weighted average number of shares outstanding used in
computing basic and diluted per share amounts:
Basic ...................................................... 5,055,516 4,943,018
Diluted .................................................... 5,801,816 4,943,018
</Table>
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)
<Table>
<Caption>
Three months Three months
Ended Ended
March 31, 2002 March 31, 2001
-------------- --------------
Cash flows from operating activities:
Net income (loss) .................................... $ 370 $ (2,873)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization ..................... 882 35
Loss from equity investment ....................... -- 1,980
Deferred tax expense .............................. 270 --
Increase in put liability ......................... 122 --
Minority interest in net earnings of subsidiary ... 156 --
Changes in operating assets and liabilities, :
(Increase) in accounts receivable-trade ........... (1,895) (1,046)
(Increase) in contracts receivable ................ (3,819) --
(Increase) in inventories ......................... (1,929) (1,654)
(Increase) in costs and estimated earnings in
excess of billings on uncompleted contracts ....... (103) --
Decrease in prepaid expenses and other assets ..... 505 --
Increase in trade payables ........................ 4,985 2,333
Increase in billings in excess of costs and
estimated earnings on uncompleted contracts ....... 1,261 --
Increase in accrued compensation and other
liabilities ....................................... 825 748
-------- --------
Net cash provided by (used in) operating activities ........ 1,630 (477)
-------- --------
Cash flows from investing activities:
Additions to property and equipment .................. (1,012) (71)
-------- --------
Net cash used in investing activities ...................... (1,012) (71)
-------- --------
Cash flows from financing activities:
Borrowings under long term obligations ............... 763 551
Proceeds from issuance of long term debt ............. -- 46
Principal payments on long-term obligations .......... (3,289) (43)
-------- --------
Net cash (used in) provided by financing activities ........ (2,526) 554
-------- --------
Net (decrease) increase in cash ............................ (1,908) 6
Cash at beginning of period ................................ 2,884 61
-------- --------
Cash at end of period ...................................... $ 976 $ 67
======== ========
</Table>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
STERLING CONSTRUCTION COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2002
1. INTERIM FINANCIAL STATEMENTS
Oakhurst Company, Inc. ("Oakhurst") was renamed Sterling Construction
Company, Inc., in November 2001 and is hereinafter referred to as "Sterling" or
the "Company". 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 December 1998 the Company 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, the Company 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 back 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 at
May 31, 2001, 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, 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 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 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. Accordingly, the results of operations of
the Company for the three months ended March 31, 2001 have been restated to
reflect its ownership of SHH as if it had been reported as an equity investment.
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. In November 2001, the
Company changed its fiscal year end from the last day of February to December
31.
6
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.
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 be read in
conjunction with the audited consolidated financial statements for the
transition period ended December 31, 2001 ("fiscal 2001") as filed in the
Company's Transition Report on Form 10-K.
Operating results for the three months ended March 31, 2002 are not
necessarily indicative of the results that may be expected for the full fiscal
year.
2. NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 141 requires that the purchase method of accounting
be used for all business combinations initiated after June 30, 2001 as well as
all purchase method business combinations completed after June 30, 2001. SFAS
No. 141 also specifies criteria intangible assets acquired in a purchase method
business combination must meet to be recognized and reported apart from
goodwill, noting that any purchase price allocable to an assembled workforce may
not be accounted for separately.
SFAS No. 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of SFAS No. 142.
SFAS No. 142 will also require that intangible assets with definite useful lives
be amortized over their respective estimated useful lives to their estimated
residual values, and reviewed for impairment.
The Company adopted the provisions of SFAS No. 141 and SFAS No. 142 on
January 1, 2002. Since the Sterling Transaction was consummated after June 30,
2001, the adoption of the remaining provisions of SFAS No. 141 did not have an
impact on the consolidated financial statements of the Company.
In accordance with the provisions of SFAS No. 142, the Company is
required to test its goodwill for impairment. To accomplish this the Company
must identify its reporting units and determine the carrying value of each
reporting unit by assigning the assets and liabilities, including the existing
goodwill and intangible assets, to those reporting units as of the date of
adoption. The Company has up to six months from the date of adoption to
determine the fair value of each reporting unit and compare it to the reporting
unit's carrying amount. To the extent a reporting unit's carrying amount exceeds
its fair value, an indication exists that the reporting unit's goodwill may be
impaired and the Company must perform the second step of the transitional
impairment test. In the second step, the Company must compare the implied fair
value of the reporting unit's goodwill, determined by allocating the reporting
unit's fair value to all of its assets (recognized and unrecognized) and
liabilities in a manner similar to a purchase price allocation in accordance
with SFAS No. 141, to its carrying amount, both of which would be measured as of
the date of adoption. This second step is required to be completed as soon as
possible, but no later than the end of the year of adoption. Any transitional
impairment loss will be recognized as the cumulative effect of a change in
accounting principle in the Company's statement of earnings. The Company will
perform the required tests under SFAS No. 142 during the second quarter of 2002.
Management does not expect the analysis will indicate impairment of the
Company's recorded goodwill.
In August 2001, the FASB issued Statement of Financial Accounting
Standard 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
7
Assets to be Disposed Of". This standard was adopted January 1, 2002 and did not
have an impact on consolidated financial statements.
3. GOODWILL
The amounts recorded by the Company for goodwill are as follows
(dollars in thousands):
<Table>
<Caption>
Construction Distribution
Segment Segment Total
Balance, January 1, 2002 $ 7,612 $ 128 $ 7,740
Goodwill acquired -- -- --
Impairment losses -- -- --
------- ------ -------
Balance, March 31, 2002 $ 7,612 $ 128 $ 7,740
======= ====== =======
</Table>
The Company expects to perform impairment testing on both segments
during the second quarter of fiscal 2002. Management does not expect that the
analysis will indicate impairment of the Company's recorded goodwill for either
segment.
The following table adjusts net income for the add back of goodwill
amortization as of the three months ended March 31, 2002 and 2001 (dollar
amounts in thousands, except per share amounts):
<Table>
<Caption>
Three months ended
March 31, 2002 March 31, 2001
-------------- --------------
Reported net income (loss) $ 370 $ (2,873)
Add back goodwill amortization: -- 14
--------- ---------
Adjusted net income (loss): $ 370 $ (2,859)
========= =========
Basic earnings (loss) per share:
Reported net income (loss) $ 0.07 $ (0.58)
Goodwill amortization -- --
--------- ---------
Adjusted net income (loss) $ 0.07 $ (0.58)
========= =========
Diluted earnings per share:
Reported net income (loss) $ 0.06 $ (0.58)
Goodwill amortization -- --
--------- ---------
Adjusted net income (loss) $ 0.06 $ (0.58)
========= =========
</Table>
4. SEGMENT INFORMATION
Until July 2001, the Company 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.
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, 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
8
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 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):
<Table>
<Caption>
Three months ended 3/31/2002 Consolidated
SEGMENTS Construction Distribution Other Total
------------ ------------ ----- ------------
Revenues $ 23,134 $ 6,548 -- $ 29,682
Operating profit (loss) 1,174 474 (261) $ 1,387
Interest expense, net of interest
income $ (591)
Minority interest (156) $ (156)
--------
Pre-tax income $ 640
========
Segment assets 38,858 10,704 14,769 $ 64,331
</Table>
<Table>
<Caption>
Three months ended 3/31/2001 Consolidated
SEGMENTS Distribution OTI Corporate Total
------------ ------- --------- ------------
Net sales 5,371 -- -- $ 5,371
Operating profit (loss) 101 (49) (157) $ (105)
Interest expense $ (765)
Loss from equity investments (1,981) $ (1,981)
--------
Pre-tax loss $ (2,851)
========
Segment assets 8,901 8,730 (127) $ 17,504
</Table>
5. INVESTMENT IN AFFILIATED COMPANY ("STERLING TRANSACTION")
Following completion of the Unwinding Agreements 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 SHH. 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 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.
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of the Sterling Transaction, (in
thousands):
9
At July 18, 2001
<Table>
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
=========
</Table>
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.
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):
<Table>
SHH Revolver $ 4,900
Subordinated notes 2,580
Short-term subordinated note payable 1,500
Sale of Sterling common stock 908
-------
$ 9,888
=======
</Table>
The following summary unaudited pro forma financial information for the
period ended March 31, 2001 is presented as if the Unwinding Agreements and the
Sterling Transaction had been completed as of the beginning of fiscal 2001 (in
thousands, except per share data).
<Table>
<Caption>
Three months ended
--------------------------------
March 31, 2002 March 31, 2001
-------------- ---------------
(as reported) (proforma)
Total revenues $ 29,682 $ 24,350
Net income (loss) $ 370 $ (70)
Net income (loss) per share (basic) $ 0.07 $ (0.01)
Net income (loss) per share (diluted) $ 0.06 $ (0.01)
</Table>
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 2001, nor may
it be indicative of the future financial position or results of operations.
10
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 $161 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
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 December 1998, the Company formed a wholly-owned subsidiary,
Oakhurst Technology, Inc. ("OTI") to invest in New Heights Recovery and Power,
LLC ("New Heights"). In connection with the formation of OTI, the Company and
OTI completed certain agreements with KTI, Inc. ("KTI") a waste-to-energy and
recycling company that subsequently merged into Casella Waste Systems, Inc.
("Casella") in December 1999.
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 back 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 at
May 31, 2001, 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, 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 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.
As the prior investment in SHH of $2.7 million accounted for less than
20% of SHH, the Company originally 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
11
Company have been restated to reflect its ownership of SHH as if it had been
reported as an equity investment for the three months ended March 31, 2001.
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, 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, 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, and
in billings in excess of cost and estimated earnings. 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 and borrowings under its line of credit.
At March 31, 2002, the Company's debt consisted of (in thousands):
<Table>
Related party notes:
Subordinated debt $ 5,500
Zero coupon notes 5,432
Convertible subordinated notes 560
Management/director notes 1,988
-------
13,480
SHH revolver 7,275
SCPI revolver 3,298
Mortgage payable 1,362
KTI Loan 1,049
Equipment notes & capital leases 146
Other 52
-------
$26,662
=======
</Table>
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. The
March installment was made on April 1, 2002.
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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 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 63,488 shares and 80,282 shares, respectively.
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,
and Messrs.Harper and 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.
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 and is secured by the equipment of SHH.
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 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 agreements for
a two-year revolving line of credit in the amount of $5.0 million, subject to a
borrowing base and maintenance of certain financial covenants (the "SCPI
Revolver"). The SCPI 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 default under its terms,
the SCPI Revolver was amended in September 2001 to reduce the maximum borrowing
level to
13
$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 suppliers, 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.
Management believes that the SCPI Revolver and the proceeds from the
Convertible Subordinated 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 or profit margins.
KTI Loan
In December 1998, the Company entered into a loan agreement with KTI,
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.
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 has been 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.
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 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 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, 2002 increased by approximately $1.7 million compared with the three
months ended March 31, 2001. The increase was principally due to higher levels
of vendor payables and other accrued expenses, combined with cash flow from
operations, offset in part by increases in accounts receivable, contracts
receivable and inventories.
14
Net cash used in investing activities increased by approximately $1.0
million reflecting equipment purchases at SHH.
In the three months ended March 31, 2002 the Company reduced its
obligations under the SHH Revolver by approximately $2.7 million, and reduced
its obligations under the Subordinated Note by $500,000. These reductions were
offset by increased borrowings on the SCPI Revolver of approximately $763,000.
For the three months ended March 31, 2001, the Company's financing activities
provided cash of $554,000 principally as a result of higher borrowing levels on
the SCPI Revolver.
MATERIAL CHANGES IN FINANCIAL CONDITION
At March 31, 2002, there had been no material changes in the Company's
financial condition since December 31, 2001, as discussed in Item 7 of the
Company's Transition Report on Form 10-K for the period ended December 31, 2001.
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"). Until July 2001, OTI held investments in the
construction industry and the waste-to-energy industry. OTI was dissolved in
December 2001.
THREE MONTHS ENDED MARCH 31, 2002 COMPARED WITH THREE MONTHS ENDED MARCH 31,
2001
CONSTRUCTION
SHH became a majority-owned subsidiary of the Company on July 18, 2001.
SHH provides pipe-laying and road construction services primarily to
municipalities in Texas and to the Texas Department of Transportation. Revenues
on construction contracts in progress totaled $23.0 million for the quarter
ended March 31, 2002.
Gross profit for the period was $2.3 million, or 9.8% of contract
revenues.
SHH reported an operating profit of $1.2 million.
Backlog at SHH at March 31, 2002 was approximately $112 million, of
which approximately 20% is not expected to become billable until fiscal 2003.
DISTRIBUTION
Sales at SCPI totaled $6.5 million, an increase of $1.1 million
compared with the first quarter of the prior year. The increase was principally
due to higher sales of pet supply products, which increased by approximately
$900,000 in the first quarter. This increase was due principally to sales to
Ames Department Stores, which began purchasing pet supplies from SCPI after its
bankruptcy filing in August 2001. Sales of lawn and garden products increased by
approximately $350,000 due to increased sales to existing customers. Sales of
automotive products decreased by approximately $95,000, principally as a result
of credit restrictions placed on shipments to Ames.
Gross profit for the segment was $1.3 million, or 19.7% of sales,
compared with $901,000 or 16.8% of sales in the first quarter of the prior year.
The increase was due principally to the higher sales level, and to better
margins earned on certain product lines.
15
The Distribution Segment reported operating profit of $474,000 in the
first quarter, compared with $101,000 in the first quarter last year, due
principally to the increase in sales, to the improved gross margins and to
reductions in operating expenses.
CORPORATE
Operating expenses at the corporate level decreased by approximately
$64,000 due primarily the dissolution of OTI in December 2001. These savings
were offset by expense related to the Put for the remaining SHH shares, which
totaled approximately $121,000 for the three months ended March 31, 2002.
Interest expense decreased by $174,000 due to the cancellation of the
KTI Loan in July 2001.
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. The Company's policies do
not permit active trading or speculation in derivative financial instruments.
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, 2002 by
approximately $12,000.
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
- ----------
*filed herewith
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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.
STERLING CONSTRUCTION COMPANY, INC.
Date: May 10, 2002 By: /s/ Joseph P. Harper, Sr.
-----------------------------------------
Joseph P. Harper, Sr.
President
Date: May 10, 2002 By: /s/ Maarten D. Hemsley
-----------------------------------------
Maarten D. Hemsley
Chief Financial Officer
17