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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number: 0-19450
STERLING CONSTRUCTION COMPANY, INC.
(Exact name of registrant as specified in its charter)
Delaware 25-1655321
State or other jurisdiction of I.R.S. Employer
incorporation or organization Identification Number
2751 Centerville Road Suite 3131
Wilmington, Delaware 19803
Address of principal executive offices Zip Code
Registrant's telephone number, including area code: (817) 416-0717
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
-------------------
Common Stock, $0.01 par value per share
Preferred Shares Purchase Rights
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Second 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No | |
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Exchange Act Rule 12b-2). | | Yes |X| No
Aggregate market value at March 1, 2003 of the voting stock held by
non-affiliates of the registrant: $4,239,777.
At March 1, 2003 the registrant had 5,069,016 shares of common stock outstanding
DOCUMENTS INCORPORATED BY REFERENCE
None
1
PART I
ITEM 1. BUSINESS
CAUTIONARY STATEMENT
This Report on Form 10-K contains certain forward-looking statements
that involve risks and uncertainties. The cautionary statements contained in
this Report should be read as being applicable to all related forward-looking
statements wherever they appear in this Report. The Company's actual results in
the future could differ materially from those discussed here. Important factors
that could cause or contribute to such differences include those discussed in
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS and elsewhere in this Report.
FORMATION AND HISTORY OF STERLING CONSTRUCTION COMPANY, INC.
Oakhurst Company, Inc. ("Oakhurst"), renamed Sterling Construction
Company, Inc. in November 2001 and hereinafter referred to as "Sterling" or "the
Company", was formed as part of a merger transaction in 1991, in which Steel
City Products, Inc. ("SCPI") became a majority-owned subsidiary of the Company.
In accordance with the merger agreement, Sterling owns 10% of SCPI's outstanding
common stock and all of SCPI's Series A Preferred Stock, with the result that
Sterling owns 90% of the voting stock of SCPI.
Because Sterling's ownership of SCPI is primarily in the form of
preferred stock Sterling retains most of the value of SCPI, and Sterling's
income from SCPI is determined by the Series A Preferred stock dividend. This
form of ownership was designed to facilitate the preservation of SCPI's net
operating tax loss carry-forwards and capital losses, which amounted to
approximately $110 million at December 31, 2002.
In December 1998 Sterling formed a wholly-owned subsidiary, Oakhurst
Technology, Inc. ("OTI") to invest in New Heights Recovery and Power, LLC ("New
Heights") which was to become a fully integrated recycling and waste-to-energy
facility in Ford Heights, Illinois. In conjunction with OTI's funding commitment
to New Heights, Sterling entered into certain agreements with KTI, Inc. ("KTI")
(which subsequently merged into Casella Waste Systems, Inc., "Casella")
regarding the funding of capital improvements and start-up losses at New
Heights.
Due to significant and continuing losses incurred at New Heights, and
Casella's decision to exit certain non-core activities, of which New Heights was
deemed one, in April 2001 the Company, OTI, Casella and KTI entered into certain
agreements (the "Unwinding Agreements") pursuant to which (a) all of OTI's
equity interest in New Heights was transferred to KTI, (b) the Sterling common
stock held by KTI was transferred back to the Company, (c) all securities
pledged to KTI by the Company and/or OTI were released, (d) all but $1 million
of the KTI Loan, which included accrued interest and aggregated approximately
$16.1 million, was cancelled; the $1 million was converted into a four year
subordinated promissory note bearing interest at 12%, and (e) the Company issued
to KTI a ten-year warrant to purchase 494,302 shares of the Company's common
stock at $1.50 per share. The Unwinding Agreements were placed into escrow upon
signing in April 2001 and became effective upon their release from escrow on
July 3, 2001.
In January 1999, OTI made a minority investment in Sterling
Construction Company, Inc., which in connection with the renaming of the Company
was itself renamed Sterling Houston Holdings, Inc. (hereinafter referred to as
"SHH") in November 2001. SHH is a heavy civil construction company based in
Houston, Texas that specializes in municipal and state contracts for highway
paving, bridge, water and sewer, and light rail projects. In October 1999 SHH
achieved certain growth objectives that triggered the right of certain
shareholders of SHH to exercise their right to sell a second tranche of equity
to OTI. Cash for the second equity purchase was obtained
2
through the issuance by OTI of notes (secured by the second equity tranche), of
which a part was issued to two officers and directors of Sterling, and the
remainder was issued to certain directors and members of the management of SHH.
These notes were restructured as part of a transaction in July 2001 (the
"Sterling Transaction"), in which Sterling further increased its equity position
in SHH from 12% to 80.1%. The original investments were recorded as an
investment using the cost method. The subsequent acquisition in July 2001
resulted in step-acquisition treatment of the original investments.
In November 2001, the Company changed its fiscal year end from the last
day of February to December 31. Accordingly, this report covers the fiscal year
from January 1, 2002 through December 31, 2002, ("Fiscal 2002"). The transition
period from March 1, 2001 to December 31, 2001 is referred to as "Fiscal 2001".
Prior fiscal years are referred to as "Fiscal 2000" (the twelve months ended
February 28, 2001); "Fiscal 1999" (the twelve months ended February 29, 2000)
and "Fiscal 1998" (the twelve months ended February 28, 1999).
The name changes referred to above were effected in order to better
reflect the change of focus of the Company. The Company reports two operating
segments, "Construction", which consists of the operations of SHH, and
"Distribution" which consists of the operations of SCPI. After the transfer of
its assets and liabilities to the Company, OTI was dissolved in December 2001.
See Note 15 to the Consolidated Financial Statements for additional segment
information.
STERLING HOUSTON HOLDINGS, INC. ("SHH")
BACKGROUND
SHH was founded in Michigan in 1955 by two brothers, James and Richard
Manning. In 1978, SHH relocated its business to Houston, Texas to participate in
the rapid economic and population growth in that region. SHH is now one of the
largest regional contractors of its kind in the Houston market engaged in the
construction of underground sanitary sewers, water mains, storm sewers and
paving. Recently, SHH expanded its business to include construction of portions
of a light rail system in the City of Houston.
In addition to its established operations in Houston, SHH has operated
in the Dallas/Fort Worth market for several years, and in 1999 entered the San
Antonio market. SHH is primarily engaged in working for local and county
municipalities and agencies, and to a lesser extent, the State of Texas. SHH
also occasionally undertakes projects for private developers and corporate
customers.
In September 2002, a wholly-owned subsidiary of SHH, Texas Sterling
Construction, L.P. ("TSC") acquired the Kinsel Heavy Highway construction
business (the "Kinsel Business") from a subsidiary of Insituform Technologies,
Inc. ("ITI"). The acquisition included the purchase of construction equipment at
its appraised value of approximately $4.4 million, and the assumption by TSC of
equipment operating leases with a future obligation of approximately $1.4
million. Certain unstarted construction contracts with revenues estimated at $38
million, subject to post-closing adjustments, were assigned to TSC. TSC has been
engaged to manage the completion of certain other contracts in return for a
management fee, and has hired most of Kinsel's construction crews together with
project managers and other supervisory personnel. The consideration of $4.4
million for the Kinsel Business was financed by TSC through the issuance to ITI
of two unsecured two-year notes aggregating $1.5 million, with the balance
funded through additional borrowings under the SHH revolving line of credit.
The size of the acquisition and the amount of assets acquired were not
material in relation to the Company's overall business. No goodwill was
recognized in the Kinsel Business transaction.
OPERATIONS
Most of the revenues of SHH are generated through the Houston municipal
market, which includes the City of Houston, the Houston Metropolitan Transit
Authority and Harris County. In 1999, SHH entered the state highway business, a
market that is expected to benefit from growth in federal highway spending.
3
SEASONALITY
Operations of SHH can be materially affected by poor weather
conditions, so that generally less construction business is completed in the
winter months. In particular, significant rainfall can cause construction delays
affecting revenues and margins on contracts in progress.
CUSTOMER BASE
SHH principally bids for contracts offered by local, city and county
municipalities and agencies, including the City of Houston, the Houston
Metropolitan Transit Authority, Harris County and the State of Texas. Major
customers also include the cities of San Antonio, Fort Worth and Dallas, and
suburban communities in these regions. Except for a limited amount of private
work, most contracts are subject to a competitive public tender process.
There are no foreign sales.
The following table shows contract revenues generated from SHH's
largest customers which accounted for more than 10% of consolidated revenues in
fiscal 2002:
Fiscal year ended Fiscal year ended
December 31, 2002 December 31, 2001
----------------------- -----------------------
Contract % of Contract % of
Revenues Revenues Revenues Revenues
City of Houston $26,044 23.3% $18,252 27.6%
Houston Metropolitan
Transit Authority $51,821 46.4% $15,593 23.6%
The above amounts reflect a large number of separate contracts for each
customer, each contract being obtained through a competitive bidding process.
BACKLOG
At December 31, 2002, the backlog at SHH totaled approximately $138
million. Of this amount, approximately $95 million is forecast to be completed
within fiscal 2003, and approximately $43 million is to be completed in fiscal
2004 and beyond. SHH expects to add further contracts during 2003 for
construction during that year.
COMPETITION
The typical public contract selection process is by sealed bid with the
lowest bidder winning in a public selection process. SHH undertakes a
significant due diligence process in preparing each bid. Participants must post
bid bonds for up to 10% of the amount bid, and on successful bids must post
performance bonds for 100% of the contract amount. Contracts are priced for
labor, sub-contracting and materials against detailed specifications provided by
the customer.
SHH's competitors include large national and regional construction
companies as well as smaller contractors. Management is unable to determine the
relative size of most competitors, which are privately-owned, but believes that
SHH is one of the larger participants in its marketplace, and the largest non
state-highway contractor in Houston that is engaged in municipal civil
construction work.
4
SHH's size relative to its many smaller competitors in the municipal
construction market gives it several advantages, including greater flexibility
to manage its backlog to maximize its manpower and equipment resources, and the
cost effective purchasing of materials, insurance and bonds. Since SHH owns most
of the equipment required for such contracts and has the experienced manpower to
handle all types of municipal civil construction, it is able to bid
competitively on many categories of contracts, especially complex multi-task
projects. In state highway work, SHH has encountered some difficulty in
penetrating the market, where most competitors are large, regional contractors,
due to the larger size of individual contracts and the different range of
specialized skills required as compared with its traditional municipal
contracts.
With the completion of the acquisition of the Kinsel Business in
September 2002, SHH added over 100 employees, including several key personnel
with specialized skills and over 150 pieces of construction equipment which will
enable SHH to compete on a more equal footing in the State Highway market.
REGULATION
Management does not anticipate that existing or known pending
environmental legislation or other regulations will require major capital
expenditures or will adversely affect its operations. However, in the last two
years environmental issues have adversely impacted the rate at which certain
highway contracts have been let in the Houston market.
EMPLOYEES
SHH employs approximately 750 persons, of whom 29 are employed in the
headquarters in Houston. Most of the others are field personnel. No SHH
employees are represented by a labor union. Senior executives, including Patrick
Manning (also Chief Executive Officer of Sterling) and Joseph Harper (also
President of Sterling) have many years of service with SHH and are employed
under long-term contracts.
STEEL CITY PRODUCTS, INC. ("SCPI")
BACKGROUND
SCPI was incorporated in West Virginia in 1959 and in 1963 became known
as Heck's, Inc. Prior to 1990, Heck's Inc. operated a Retail Division consisting
of a chain of discount department stores. In September 1990, all of the assets
of the Retail Division were sold to Retail Acquisition Corp. ("RAC").
SCPI was reincorporated in Delaware under the name Hallwood Industries
Incorporated in fiscal 1991. The name was changed to Steel City Products, Inc.
in fiscal 1993.
The Steel City Products automotive accessories distribution business
was founded in 1947 and was acquired by SCPI in 1969. In fiscal 1996, SCPI
expanded its business to include the distribution of non-food pet supplies and
in fiscal 2000 SCPI broadened its distribution business further to include lawn
and garden supplies.
OPERATIONS
For many years SCPI distributed only automotive accessories, including
functional and decorative car and truck accessories, car care products,
chemicals and car repair and maintenance items. In fiscal 1996, SCPI expanded
its merchandise selection to include non-food pet supplies and in fiscal 2000
added lawn and garden products. Although these products were not typical of
SCPI's historical merchandise mix, management determined that the availability
of existing customers which sell pet supplies and lawn and garden products in
addition to automotive accessories, combined with SCPI's distribution expertise
and infrastructure, offered opportunities to increase sales. Sales in fiscal
2002 of pet supplies and lawn and garden products represented approximately 21%
and 11%, respectively, of SCPI's total sales. SCPI's automotive and pet
distribution operations are conducted in leased facilities in McKeesport,
Pennsylvania and its lawn and garden operations are conducted in leased
facilities in Glassport, Pennsylvania.
5
Historically, much of SCPI's business has been performed on a service
basis, which involves visits by its sales personnel to customers' stores to
count and re-order merchandise. Generally, these re-orders are transmitted
electronically to SCPI's central offices. In recent years a growing proportion
of its customers electronically transmit their own orders to SCPI's
headquarters. Since many orders are generated electronically and are shipped
within a few days of receipt, the size of SCPI's order backlog is not relevant
to an understanding of the business. Shipments are either made directly to each
of the customers' stores or are packed for onward shipment to stores via the
retailers' own distribution centers. SCPI also provides price ticketing and
associated services to those of its customers who request such services.
SOURCES OF SUPPLY
SCPI acquires its merchandise from a large number of suppliers, the
largest of which accounted for 13.5% of its purchases for the fiscal year ended
December 31, 2002. Many of the products sold by SCPI carry nationally-advertised
brand names, but because of the diversity and number of suppliers and products
carried, the business is not generally dependent on the continued availability
of individual products or continued dealings with existing supply sources. From
time to time, market or seasonal conditions may affect the availability of
certain merchandise, but not to the extent that the Company believes would
materially impact its business.
Steel City Products generally carries in inventory only those products
that its customers have identified as necessary for their own merchandising
needs and does not acquire significant quantities of other merchandise.
SEASONALITY
SCPI's automotive and lawn and garden businesses are seasonal, being
slowest in the early winter months than at other times of the year. In
anticipation of higher sales volume in the spring and summer, SCPI carries
higher inventories of these products beginning in the winter months. As is
customary in the automotive aftermarket and in the lawn and garden business,
some suppliers allow extended payment terms to SCPI for such inventory
build-ups.
SCPI's pet supply business experiences different seasonal trends from
the automotive and lawn and garden businesses, but the effect of this is not
material to the overall business.
SCPI's needs for working capital are affected by these seasonal
fluctuations and other factors (see Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources").
CUSTOMER BASE
SCPI's customers include supermarket chains, drug stores, general
merchandise retail chains, automotive specialty stores, hardware stores, variety
stores and other automotive accessory distributors. Most customers are based in
the northeastern United States, although stores operated by some customers are
located outside of that area, and in February 2000 SCPI began selling to the
west coast distribution facility of one of its major customers. There are no
foreign sales.
SCPI's customers are continually affected by changes in the retail
environment, including the competitive pressures facing regional mass
merchandisers and the growing influence of national automotive specialty chains.
These have led to fluctuations in the level of business that SCPI enjoys with
individual customers. Some customers have changed their buying practices to
acquire certain merchandise direct from manufacturers rather than through
distributors such as SCPI.
In its efforts to offset these trends, SCPI has in recent years added
new customers, especially in the supermarket and drug store sectors, has
expanded its product offerings to certain customers, has enlarged the territory
that it serves and has introduced new categories of products. Management
believes that these efforts have
6
resulted in a more diverse and financially
secure customer base. However, in August 2001 SCPI's largest remaining discount
chain customer, Ames Department Stores ("Ames"), filed for Chapter 11 bankruptcy
protection and in July 2002, liquidated its remaining business.
SCPI's sales in fiscal 2002 represented 17% of the Company's
consolidated sales. Reflecting the acquisition of SHH in July 2001, no single
customer of SCPI accounted for more than 10% of Sterling's consolidated revenues
in fiscal 2002. However, prior to the completion of the Sterling Transaction in
July 2001, sales at SCPI represented 100% of consolidated revenues. The
following table shows sales to SCPI's customers that individually accounted for
more than 10% of SCPI's sales during the last three fiscal years (dollars in
thousands):
Fiscal Year 2002 Ended Fiscal Year 2001 Ended Fiscal Year 2000 Ended
December 31, 2002 December 31, 2001 February 28, 2001
------------------------ ------------------------ ----------------------
(ten months)
Sales % of Sales Sales % of Sales Sales % of Sales
Warehouse Sales $3,711 16% $2,193 13% * *
Kroger $3,591 16% $2,758 16% $2,057 10%
Ames $2,918 13% $3,217 18% $3,746 18%
Giant Eagle $2,959 13% $2,313 13% $2,055 10%
American Sales * * $1,863 11% * *
*represents less than 10% of sales
In August 2001, Ames filed for Chapter 11 protection. SCPI continued to
ship to Ames as a debtor-in-possession under strict payment terms. Pre-petition
sales to Ames during fiscal 2001 (mostly of automotive products) totaled $1.5
million, of which approximately $680,000 was unpaid at the time of Ames
bankruptcy filing. Sales to Ames in fiscal 2002 prior to its liquidation in
July, aggregated $2.9 million, with the increase primarily attributable to sales
of pet supplies.
SCPI's five largest customers accounted for approximately two-thirds of
its total revenues in fiscal 2002. Management has no reason to believe that its
business with any of these customers will be terminated in the foreseeable
future, as evidenced by the continuing increases in sales to each of them,
except Ames. In the event that one of its largest customers ceased doing
business with SCPI, the resulting reduction in revenues could significantly
reduce profitability, unless a replacement customer is obtained.
None of SCPI's business is based on government contracts and there are
no long-term sales contracts with any customers.
COMPETITION
The distribution business for automotive parts and accessories,
non-food pet supplies and lawn and garden products is highly competitive, with
several similar companies operating in SCPI's market place, and many of SCPI's
suppliers also offer their products directly to retailers. Management is unable
to quantify SCPI's relative size in relation to its competitors but believes it
is one of the larger independent distributors of automotive accessories in the
Northeastern United States. In recent years, a number of significant competitors
of SCPI have gone out of business and some of SCPI's customers have chosen to
purchase some products directly from manufacturers. SCPI competes on the basis
of its management's merchandise expertise, the breadth of merchandise offered,
price, levels of service, order fill rates and order turnaround times.
Management believes that SCPI's long history, good reputation, experienced
management, product selection, pricing, service levels and traditionally high
order fill rates enable it to compete favorably with other distributors.
REGULATION
SCPI's management does not anticipate that existing or known pending
environmental legislation or other regulations will require major capital
expenditures or will affect its operations.
7
EMPLOYEES
SCPI employs approximately 50 persons, of which about 40 are employed
in the headquarters office and distribution facility in McKeesport and the
Glasport distribution facility. The others are field personnel. Senior
executives, including the Chairman of the Board of Directors, Bernard H. Frank
(a founder of Steel City Products), the President and Chief Executive Officer,
Terrance W. Allan and the Vice President of Sales, Patrick Nicholson, have many
years of service with SCPI. Mr. Allan is employed under a long-term contract.
Warehouse and certain office employees of SCPI are represented by Local
636 of the International Brotherhood of Teamsters. SCPI has experienced
generally good labor relations and no significant labor disputes have affected
its business for many years. The union contract was renewed in November 1999 for
a three-year term through November 2002, and has been extended since November
2002 while renewal negotiations continued.
DISCONTINUED OPERATIONS - DOWLING'S FLEET SERVICE CO., INC.
Dowling's Fleet Service Co., Inc. was acquired by the Company in fiscal
1994 and was historically one of the largest regional distributors of
aftermarket automotive radiators in the northeastern United States. In
subsequent years, the radiator replacement market underwent significant changes,
including aggressive competition, industry consolidation and direct selling by
manufacturers to installers, and operating results at Dowling's declined. In
fiscal 1998, Dowling's reported a loss of approximately $400,000 and the
Company's Board of Directors decided to dispose of the business. In June 2000,
the Company entered into an agreement to dispose of Dowling's through its merger
with an importer of radiators for consideration equivalent to the amount owed at
the merger closing by Dowling's under its revolving credit agreement. The
closing took place on November 29, 2000.
ITEM 2. PROPERTIES
In June 2001, SHH relocated its headquarters in Houston from leased
facilities to a purpose-built, owned 15,000 square-foot building located on a
seven-acre parcel on which its equipment repair center is also located. It also
leases small offices in Grand Prairie, Texas and San Antonio.
Since December 1997, SCPI has operated its automotive and pet supply
businesses from a leased, 67,000 square-foot building located in an industrial
park in McKeesport, Pennsylvania. With the addition of the lawn and garden
distribution business, SCPI leased an additional 43,000 sq. ft. of warehouse
space located in an industrial park in nearby Glassport, Pennsylvania,
commencing in December 2000.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings pending against the Company or
to which the Company is a party or to which any of its property is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Meeting of Shareholders on October 17,
2002. Shareholders re-elected each of the two Class I directors to serve for a
term of three years. The following table lists the number of votes cast for,
against or withheld for each matter and nominee, as well as the number of
abstentions and broker non-votes relating thereto:
8
Matter For Against Withheld Abstentions Broker
non-votes
Election of directors:
Joseph P. Harper 2,977,630 690 -- -- --
Patrick T. Manning 2,977,630 690 -- -- --
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock was listed and traded on the Nasdaq
Small-Cap Market under the symbol OAKC until February 10, 1998, when the Common
Stock was delisted from trading. The delisting was a result of the fall in the
Company's stock to below the Nasdaq minimum closing bid price of $1.00 per share
and the fall in the Company's net tangible assets to below Nasdaq's minimum
maintenance requirements. Commencing February 11, 1998, the Company's Common
Stock began trading on the OTC Bulletin Board, under the symbol OAKC.OB. As a
result of the Company's change of name in November 2001, the stock symbol on the
OTC Bulletin Board was changed to STCS.OB.
The following table sets forth the high and low bid prices by fiscal
quarter for the Company's common stock for fiscal years 2002 and 2001.
Fiscal 2002 Fiscal 2001
Quarterly High Quarterly Low Quarterly High Quarterly Low
Quarter 1 $1.85 $1.48 $0.78 $0.75
Quarter 2 $2.05 $1.50 $1.50 $0.75
Quarter 3 $2.08 $1.60 $1.64 $1.25
Quarter 4 $1.95 $1.58 $1.70 $1.63
* Due to the Company's change of fiscal year end from the last day of February
to December 31, the fourth quarter of fiscal 2001 consisted of one month.
Such quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.
There were approximately 3,600 holders of record of the Company's
common stock on March 1, 2003.
No cash dividends were declared or paid in fiscal 2002, 2001 or 2000.
The Company does not anticipate the declaration of cash dividends in the
foreseeable future. The ability of the Company's operating subsidiaries, SHH and
SCPI, to upstream funds to Sterling for payment of dividends is limited by their
respective bank credit agreements.
9
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial and other data of
Sterling Construction Company, Inc. (formerly Oakhurst Company, Inc.) and
subsidiaries and should be read in conjunction with Management's Discussion and
Analysis of Financial Condition and Results of Operations, which follows, and
the Consolidated Financial Statements and related Notes.
Fiscal 2001 December Fiscal 1999 Fiscal 1998
Fiscal 2002 December 31, 2000 Fiscal 2000 February February
December 31, 2001 (ten February 28, 29, 28,
31, 2002 (c) (d) months) 2001(a)(d) 2000(a)(d) 1999(a)(d)
----------- (ten months) (unaudited) ------------ ----------- -----------
------------ -----------
Dollar and share amounts in thousands, except per share data
Operating results:
Revenues ............................... $ 134,317 $ 66,121 $ 17,256 $ 20,694 $ 20,142 $ 18,092
========= ======== ======== ======== ======== ========
Income (loss) from continuing
operations before income ............... $ 4,345 $ (1,965) $ (4,774) $ (7,044) $ (2,517) $ (804)
taxes
Minority interest (e) .................. (873) (647) -- -- -- --
--------- -------- -------- -------- -------- --------
Current income tax expense ............. (14) (14) (5) (27) (10) (8)
Deferred income tax benefit (b) ........ 1,264 -- -- -- -- --
--------- -------- -------- -------- -------- --------
Income (loss) from continuing
operations ............................. 4,722 (2,626) (4,779) (7,071) (2,527) (812)
Income (loss) from discontinued
operations(a) .......................... -- -- 399 399 (2,456) (185)
--------- -------- -------- -------- -------- --------
Net income (loss) ...................... $ 4,722 $ (2,626) $ (4,380) $ (6,672) $ (4,983) $ (997)
========= ======== ======== ======== ======== ========
BASIC AND DILUTED PER SHARE AMOUNTS:
Basic earnings (loss) per share
from continuing operations ............. $ 0.93 $ (0.52) $ (0.97) $ (1.43) $ (0.51) $ (0.16)
Basic earnings (loss) per share
from discontinued operations ........... $ -- $ -- $ 0.08 $ 0.09 $ (0.49) $ (0.05)
--------- -------- -------- -------- -------- --------
Basic earnings (loss) per share ........ $ 0.93 $ (0.52) $ (0.89) $ (1.34) $ (1.00) $ (0.21)
========= ======== ======== ======== ======== ========
Basic weighted average shares .......... 5,062 5,056 4,943 4,943 4,943 4,943
========= ======== ======== ======== ======== ========
outstanding
Diluted earnings (loss) per share
from continuing operations ............. $ 0.78 $ (0.52) $ (0.97) $ (1.43) $ (0.51) $ (0.16)
Diluted earnings (loss) per share
from discontinued operations ........... $ -- $ -- $ 0.08 $ 0.09 $ (0.49) $ (0.05)
--------- -------- -------- -------- -------- --------
Diluted earnings (loss) per share ...... $ 0.78 $ (0.52) $ (0.89) $ (1.34) $ (1.00) $ (0.21)
========= ======== ======== ======== ======== ========
Diluted weighted average shares
outstanding ............................ 6,102 5,056 4,943 4,943 4,943 4,943
========= ======== ======== ======== ======== ========
Cash dividends declared ................ $ (0.00) $ (0.00) $ (0.00) $ (0.00) $ (0.00) $ (0.00)
========= ======== ======== ======== ======== ========
BALANCE SHEET STATISTICS:
Total assets ........................... $ 72,757 $ 59,138 $ 17,103 $ 16,507 $ 21,952 $ 16,925
Long-term obligations .................. $ 34,323 $ 30,241 $ 17,965 $ 4,633 $ 13,428 $ 8,254
Book value per share of common stock ... $ 2.14 $ 1.21 $ (1.50) $ (2.01) $ (0.66) $ 0.34
(a) In fiscal 1999, the decision was made to dispose of Dowling's. Results
of operations for fiscal 1999 reflect a loss on the disposal of $2.0
million, relating primarily to the write-off of goodwill, together with
an operating loss of $428,000. Results for Dowling's have been
presented as discontinued operations for all periods shown. Upon
completion of the sale of Dowling's in fiscal 2000, the Company
recorded income of $399,000.
(b) In December 2001, the Company again recorded a deferred tax asset that
exceeded its valuation allowance (see Note 7 to the Consolidated
Financial Statements). The asset was reassessed in fiscal 2002
resulting in a tax benefit of $1.2 million.
(c) In November 2001, the Board of Directors of the Company voted to change
its fiscal year end from the last day of February to December 31.
Accordingly, results for Fiscal 2001 are for the ten month period March
1 to December 31, 2001.
10
(d) In July 2001, the Company increased its percentage ownership in SHH
from 12% to 80.1%. The original investments were recorded using the
cost method. The subsequent acquisition in July 2001 resulted in
step-acquisition treatment of the original investments. Fiscal 2000,
1999 and 1998 have been restated to reflect this treatment.
(e) Minority interest represents the 19.9% of SHH not owned by the Company.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The corporate structure resulting from the 1991 merger, whereby Steel
City Products, Inc. ("SCPI") became a special, limited purpose, majority-owned
subsidiary of Oakhurst Company, Inc. ("Oakhurst"), since renamed Sterling
Construction Company, Inc. (hereinafter referred to as "Sterling") was designed
to facilitate capital formation by Sterling while permitting Sterling and SCPI
to file consolidated tax returns so that both may utilize existing tax benefits,
including approximately $110 million of net operating loss carry-forwards.
Through Sterling's ownership of SCPI, primarily in the form of preferred stock,
Sterling retains the value of SCPI and receives substantially all of the benefit
of SCPI's operations through dividends on such preferred stock.
Sterling's principal business historically has been the distribution of
products to the automotive aftermarket, described herein as the "Distribution
Segment". The one remaining automotive distribution business (following the
disposal of Dowling's Fleet Service Company, Inc. in fiscal 2000, see below) is
conducted by SCPI under the trade name "Steel City Products" and involves the
distribution of automotive parts and accessories, non-food pet supplies and lawn
and garden products from facilities in McKeesport and Glassport, Pennsylvania.
SCPI is believed to be one of the largest independent wholesale distributors of
automotive accessories in the Northeastern United States.
Dowling's, a New York-headquartered distributor of automotive radiators
and related products, was acquired by Sterling in August 1994 for an aggregate
purchase price of $4.7 million. Due to operating losses at Dowling's of
approximately $400,000 in fiscal 1999, the Company's Board of Directors decided
to dispose of the business. In June 2000, the Company disposed of Dowling's
through a merger with an importer of radiators. The merger closed on November
29, 2000. The statement of operations for fiscal 2000 reflects a gain of
$399,000 from discontinued operations as a result of the completion of the
disposal of Dowling's.
Representing a significant change from its historical operating
business, in December 1998, Sterling formed a wholly-owned subsidiary, Oakhurst
Technology, Inc. ("OTI") to invest in New Heights Recovery and Power, LLC ("New
Heights") which was to become a fully integrated recycling and waste-to-energy
facility in Ford Heights, Illinois. In conjunction with OTI's funding commitment
to New Heights, Sterling entered into certain agreements with KTI, Inc. ("KTI")
(which subsequently merged into Casella Waste Systems, Inc., "Casella")
regarding the funding of capital improvements and start-up losses at New
Heights.
Due to significant and continuing losses incurred at New Heights, and
Casella's decision to exit certain non-core activities, of which New Heights was
deemed one, in April 2001 certain agreements (the "Unwinding Agreements") were
signed among the Company, OTI, Casella and KTI pursuant to which (a) all of
OTI's equity interest in New Heights was transferred to KTI, (b) the Sterling
common stock held by KTI was transferred to the Company, (c) all securities
pledged to KTI by the Company and/or OTI were released, (d) the KTI Loan,
including accrued interest thereon, aggregating approximately $16.1 million was
cancelled, with the exception of $1 million, which sum was converted into a four
year subordinated promissory note bearing interest at 12%, and (e) the Company
issued to KTI a ten-year warrant to purchase 494,302 shares of the Company's
common stock at $1.50 per share. The Unwinding Agreements were placed into
escrow upon signing in April 2001 and became effective upon their release from
escrow on July 3, 2001.
In January 1999 OTI made a minority investment in Sterling Construction
Company, Inc., since renamed Sterling Houston Holdings, Inc. ("SHH"). SHH is a
heavy civil construction company based in Houston that specializes in municipal
and state contracts for highway paving, bridge, water and sewer, and light rail,
herein described as the "Construction Segment". Upon reaching certain
performance objectives, in October 1999 certain Sterling shareholders exercised
their right to sell a second tranche of equity to OTI. Cash for the second
equity purchase was obtained through the issuance of notes (secured by such
equity) of which $559,000 was due to Robert Davies, then the Company's Chairman
and CEO. Under a Participation Agreement, Maarten Hemsley, then the Company's
President and CFO, funded $116,000 of the amount advanced by Mr. Davies pursuant
to such
12
Promissory Note. These notes were restructured as part of the Sterling
Transaction in July 2001 whereby the Company increased its equity percentage in
SHH from 12% to 80.1%.
As the prior investment in SHH of $2.7 million accounted for less than
20% of SHH, the Company accounted for the investment under the cost method. The
acquisition in July 2001 resulted in step-acquisition treatment of the prior
balance. Accordingly, the results of operations of the Company have been
restated to reflect its ownership of SHH as if it had been reported as an equity
investment for fiscal 2001 and fiscal 2000. Equity investment income generated
by SHH for fiscal 2001 and 2000 was $63,000 and $260,000, respectively. In
addition, goodwill expense of $25,000 and $51,000 was recorded as part of the
step acquisition in fiscal 2001 and 2000, respectively.
Pursuant to the terms of the Sterling Transaction, in July 2001 Patrick
T. Manning, President and Chief Executive Officer of SHH was appointed a
director and Chairman and Chief Executive Officer of the Company and Joseph P.
Harper, Chief Financial Officer and Treasurer of SHH was appointed a director
and President of the Company. Robert W. Frickel and Christopher H.B. Mills were
also appointed to the Board at that time. Robert M. Davies, former Chairman and
Chief Executive Officer, remained a director of the Company, Maarten D. Hemsley
continues as Chief Financial Officer and a director of the Company and John D.
Abernathy remains a director of the Company. All incumbent directors were
re-elected to the Board at the Annual Stockholders' Meeting held in October
2001. Also at that meeting stockholders approved the Company's name change to
more accurately reflect its current business. Messrs. Mark Auerbach, Bernard H.
Frank and Joel S. Lever resigned from the Company's Board upon completion of the
Sterling Transaction.
In September 2002, a wholly-owned subsidiary of SHH, Texas Sterling
Construction, L.P. ("TSC") acquired the Kinsel Heavy Highway construction
business (the "Kinsel Business") from a subsidiary of Insituform Technologies,
Inc. ("ITI"). The acquisition included the purchase of construction equipment at
its appraised value of approximately $4.4 million, and the assumption by TSC of
equipment leases with a future obligation of approximately $1.4 million. Certain
unstarted construction contracts with revenues estimated at $38 million, subject
to post-closing adjustments, were assigned to TSC. TSC has been engaged to
manage the completion of certain other contracts in return for a management fee,
and hired most of Kinsel's construction crews together with project managers and
other supervisory personnel. The consideration of $4.4 million for the Kinsel
Business was financed by TSC through the issuance to ITI of two unsecured
two-year notes aggregating $1.5 million, with the balance funded through
additional borrowings under the SHH revolving line of credit.
Each of the Distribution Segment and the Construction Segment is
managed by its own decision makers and is comprised of different customers,
suppliers and employees. Terry Allan, President of SCPI and Maarten Hemsley, the
Chief Financial Officer of the Company, review the operating profitability of
the Distribution Segment and its working capital needs to allocate financial
resources. The operating profitability and capital expenditure requirements of
the Construction Segment are reviewed by Joseph Harper, the Company's President
and the Chief Financial Officer of SHH, to determine its financial needs.
Allocation of resources among the Company's operating segments is determined by
Messrs. Harper and Hemsley, subject to the terms of each of the Construction
Segment and the Distribution Segment's bank covenants which affect upstreaming
of funds to the Company.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Management's estimates,
judgments and assumptions are continually evaluated based on available
information and experience, however actual amounts could differ from those
estimates. The Company's significant accounting policies are described in Note 1
of the Notes to Consolidated Financial Statements.
13
Certain of the Company's accounting policies require higher degrees
of judgment than others in their application. These include the recognition of
revenue and earnings from construction contracts and the valuation of long-term
assets. Management evaluates all of its estimates and judgments on an on-going
basis.
Revenue Recognition: The Company uses the percentage of completion
accounting method for construction contracts in accordance with the American
Institute of Certified Public Accountants Statement of Position 81-1,
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts." Revenue and earnings on construction contracts are recognized on the
percentage of completion method in the ratio of costs incurred to estimated
final costs. Provisions are recognized in the statement of income for the full
amount of estimated losses on uncompleted contracts whenever evidence indicates
that the estimated total cost of a contract exceeds its estimated total revenue.
Factors that can contribute to changes in estimates of contract
profitability include, without limitation, site conditions that differ from
those assumed in the original bid to the extent that contract remedies are
unavailable, the availability and skill level of workers in the geographic
location of the project, the availability and proximity of materials, the
accuracy of the original bid, inclement weather and timing and coordination
issues inherent in all projects, including design/build. Contract cost consists
of direct costs on contracts; including labor and materials, amounts payable to
subcontractors, direct overhead costs and equipment expense (primarily
depreciation, fuel, maintenance and repairs). Depreciation is provided using
straight-line methods for construction equipment. Contract cost is recorded as
incurred and revisions in contract revenue and cost estimates are reflected in
the accounting period when known. If the Company projects a loss on a project
the estimated loss is immediately recognized. Claims for additional contract
revenue are recognized if it is probable that the claim will result in
additional revenue and the amount can be reliably estimated. The foregoing as
well as weather, stage of completion and mix of contracts at different margins
may cause fluctuations in reported gross profit between periods and these
fluctuations may be significant.
A significant portion of the Construction Segment's revenues is
derived from contracts that are "fixed unit price" under which the Company is
committed to provide materials or services required by a project at fixed unit
prices (for example, dollars per cubic yard of concrete or cubic yards of earth
excavated). Other contracts, including most design-build contracts, are priced
on a lump-sum basis under which the Company bears the risk that it may not be
able to perform all the work for the specified amount. All government contracts
and many of the Company's other contracts provide for termination of the
contract for the convenience of the party contracting with the Company, with
provisions to pay the Company for work performed through the date of
termination.
The construction industry is highly competitive and lacks firms with
dominant market power. A substantial portion of the Company's business involves
construction contracts obtained through competitive bidding. The volume and
profitability of the Company's construction work depends to a significant extent
upon the general state of the economies of Texas and especially the Houston area
and the volume of work available to contractors. The Company's construction
operations could be adversely affected by labor stoppages or shortages, adverse
weather conditions, shortages of supplies or other governmental action.
Valuation of Long-Term Assets: Long-lived assets, which include
property, equipment and acquired identifiable intangibles, are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Impairment evaluations
involve management estimates of useful asset lives and future cash flows. Actual
useful lives and cash flows could be different from those estimated by
management and this could have a material effect on operating results and
financial position. Additionally, the Company had approximately $7.8 million in
goodwill at December 31, 2002, which must be reviewed for impairment at least
annually in accordance with Statement of Financial Accounting Standards No. 142
("SFAS 142"). The Company completed its initial impairment review for its
goodwill in the first half of 2002 which did not result in an impairment charge.
The impairment testing required by SFAS 142 requires considerable judgment and
there can be no assurance that an impairment charge will not be required in the
future. The Company completed its annual impairment review for goodwill
effective October 2002. The results of the review did not reveal impairment of
goodwill.
14
Deferred Taxes: Deferred tax assets and liabilities are recognized
based on the differences between the financial statement carrying amounts and
tax bases of assets and liabilities. The Company regularly reviews its deferred
tax assets for recoverability and establishes a valuation allowance based upon
historical losses, projected future taxable income and the expected timing of
the reversals of existing temporary differences. As a result of this review and
the related SHH acquisition, the Company reduced the valuation allowance against
the deferred tax asset related to the estimated utilization of the net operating
losses.
LIQUIDITY AND CAPITAL RESOURCES
At SHH, the level of working capital varies principally as a result of
changes in the levels of cost and estimated earnings in excess of billings, and
in billings in excess of cost and estimated earnings. SHH's cash requirements
are also impacted by its needs for capital equipment, which have generally been
financed from cash flow or from borrowings under its lines of credit.
At SCPI, the level of working capital needs varies primarily with the
amounts of inventory carried, which can change seasonally, the size and
timeliness of payment of receivables from customers and the amount of credit
extended by suppliers. SCPI's working capital needs not financed by suppliers
have been financed from cash flow and borrowings under its line of credit.
FINANCING
At December 31, 2002, the Company's debt consisted of (in thousands):
Related party notes:
Subordinated debt $3,500
Subordinated zero coupon notes 5,917
Convertible subordinated note 560
Management/director notes 2,046
-------
12,023
SHH revolver 14,010
SCPI revolver 2,616
Insituform Notes 1,400
Mortgage payable 1,265
KTI loan 1,156
Equipment notes and capital leases 108
Other 28
-------
$32,606
Related Party Notes
Subordinated Debt
As part of the Sterling Transaction, certain shareholders of SHH were
issued subordinated promissory notes by SHH in the aggregate amount of $6
million in payment for certain of their SHH shares. These notes are repayable
over three years in equal quarterly installments and carry interest at 12% per
annum.
Subordinated Zero Coupon Notes
The Sterling Transaction was funded in part through the sale of zero
coupon notes combined with the issuance of zero coupon notes to certain selling
shareholders of SHH. Warrants for Sterling common stock were issued in
connection with the zero coupon notes. The zero coupon notes are shown at their
present value, discounted at a rate of 12% and mature four years from the date
of closing of the Sterling Transaction. Warrants issued in connection with the
notes are exercisable for ten years from closing and become exercisable four
years
15
after issuance at $1.50 per share. Mr. Manning and Mr. Harper received zero
coupon notes in the face amount of $799,000 and $1.0 million, respectively and
warrants for 63,498 shares and 81,301 shares, respectively.
Management/Director Notes
Notes with an aggregate face amount of $1.3 million issued in
connection with the October 1999 purchase of the second equity tranche of shares
of SHH were restructured as part of the Sterling Transaction. Of the total,
notes for $800,000 were issued to several members of Sterling's management,
including Joseph P. Harper, since appointed the Company's President. Notes
totaling approximately $559,000 were due to Robert Davies, the Company's former
Chairman and Chief Executive Officer, and, through a participation agreement,
Maarten Hemsley, formerly the Company's President and now its Chief Financial
Officer. In consideration for the extension of the maturity dates of these
notes, the face amounts were increased by an aggregate of approximately
$342,000. Furthermore, certain amounts owed by the Company to Messrs. Davies and
Hemsley aggregating approximately $355,000 were converted into notes. All such
notes mature over four years and carry interest at 12% per year. Principal and
interest may be paid only from defined cash flow of Sterling and SCPI, or from
proceeds of any sale of SCPI's business.
SHH Revolver and SCPI Revolver
In conjunction with the Sterling Transaction, SHH entered into a
three-year agreement providing for a bank revolving line of credit with a
maximum line of $13.0 million, subject to a borrowing base (the "SHH Revolver").
The line of credit carries interest at prime, subject to achievement of certain
financial targets and is secured by the equipment of SHH. In September 2002,
upon the acquisition of the Kinsel heavy highway business, the SHH Revolver was
amended to provide for a maximum line of $17 million. At December 31, 2002, the
balance on the SHH Revolver was $14.0 million. In March 2003 SHH agreed with its
bank on a two-year extension of its bank revolving line of credit, until March
31, 2006. Reflecting recent strong cash flow and expected lower borrowing
requirements, the maximum amount available under the line is to be reduced, at
the request of SHH, to $14 million from $17 million.
Management believes that the SHH Revolver will provide adequate funding
for SHH's working capital, debt service and capital expenditure requirements,
including seasonal fluctuations for at least the next twelve months.
Due to concerns stemming from the filing for bankruptcy by SCPI's
institutional lender, and as a condition of the completion of the Sterling
Transaction, SCPI changed institutional lenders in July 2001 and entered into an
agreement for a two-year bank revolving line of credit in the amount of $5.0
million, subject to a borrowing base (the "SCPI Revolver"). The new revolver
originally carried an interest rate equal to prime plus 1%. Following the
bankruptcy filing in August 2001 of Ames Department Stores, a significant
customer of SCPI, which created a technical default under the terms of the
Revolver, it was amended in September 2001 to reduce the maximum borrowing level
to $3.75 million, increase the interest rate to prime plus 1.5%, and to
accelerate the maturity to April 30, 2002. Upon demonstrating SCPI's ability to
generate new business and maintain its relationships with customers and vendors,
in December 2001 the SCPI Revolver was again amended to restore the maximum
borrowing level of $5.0 million and to extend the term to May 2003. In fiscal
2002, the line of credit was further amended to extend the term to May 2004 and
to remove certain limitations on borrowing. At December 31, 2002, the
outstanding balance on the Revolver was $2.6 million and the effective rate of
interest was 5.75%. The SCPI Revolver is secured by the assets of SCPI and is
subject to the maintenance of certain financial covenants.
Convertible Subordinated Notes
In December 2001, in conjunction with the December 2001 amendment to
the SCPI Revolver and in order to strengthen SCPI's working capital position
through the purchase of additional inventory, Sterling obtained funding
principally from members of management and directors (including Messrs. Frickel,
Harper and Hemsley, who loaned $155,000, $100,000 and $25,000, respectively)
aggregating $500,000 (the "Convertible Subordinated
16
Notes"). In January 2002, two other members of management, including Bernard
Frank funded a further $60,000, which was used for general corporate purposes.
The notes evidencing these advances are convertible at any time prior to the
maturity date into the Company's common stock at a price of $2.50 per share and
mature and are payable in full in December 2004. Interest at an annual rate of
12% is payable monthly. The notes are senior to debt issued in connection with
the Sterling Transaction.
In January 2003, members of management of the Company and of SHH
(including Messrs. Harper and Hemsley) further funded SCPI with a short-term
loan to reduce SCPI's vendor payables in the aggregate amount of $250,000. The
notes, which are subordinate to the SCPI Revolver, mature in July 2003. Interest
at the annual rate of 10% is payable monthly. The notes may be prepaid without
penalty.
Management believes that the SCPI Revolver, proceeds from the
Convertible Subordinated Notes and the short-term loan of $250,000 made in
January 2003 by members of management of the Company will provide adequate
funding for SCPI's working capital, debt service and capital expenditure
requirements, including seasonal fluctuations for at least the next twelve
months, assuming no material deterioration in current sales or profit margins.
KTI Loan
In December 1998, Sterling entered into a loan agreement with KTI, Inc.
(the "KTI Loan") pursuant to which KTI committed to lend Sterling a minimum of
$11.5 million for capital expenditures and start-up losses incurred by New
Heights. The KTI Loan carried interest at a fixed rate of 14%, payable quarterly
and was due, by its original terms, in April 2001. The KTI Loan was secured by a
pledge of all the capital stock of OTI and all of OTI's equity interest in New
Heights.
Also in December 1998 the Company's subsidiary, OTI, entered into an
Investment Agreement with New Heights pursuant to which OTI agreed to fund
defined capital expenditures, costs of obtaining permits, start-up losses and
working capital of the New Heights waste-to-energy facility in Ford Heights,
Illinois, and to receive in return an initial 50% equity interest in New
Heights.
Pursuant to the Investment Agreement, KTI agreed to provide, directly
or through OTI as its affiliate, the funding required to satisfy the New Heights
Business Plan. Accordingly, KTI and Sterling entered into the KTI Loan. Funds
drawn by Sterling under the KTI Loan were invested in OTI, principally to
facilitate the financing of the New Heights Business Plan.
In July 2001, all except $1,000,000 of the KTI Loan and accrued
interest thereon was cancelled pursuant to the Unwinding Agreements, with the
balance converted to a four year subordinated loan, with interest of 12% due at
maturity. The face value of the KTI Loan has been accounted for to reflect a
reduction for the fair value of the approximately 494,000 warrants for the
Company's common stock issued to KTI, to be amortized over the life of the loan.
SHH Mortgage
In June 2001, SHH completed the construction of a new headquarters
building on land adjacent to its existing equipment repair facility in Houston.
The building was financed principally through an additional mortgage of $1.1
million on the land and facilities, at an interest rate of 7.75% per annum,
repayable over 15 years. The new mortgage is cross-collateralized with an
existing mortgage on the land and facilities which was obtained in 1998 in the
amount of $500,000, repayable over 15 years with an interest rate of 9.3% per
annum.
Insituform Note
In September 2002, a wholly-owned subsidiary of SHH acquired the Kinsel
Heavy Highway construction business from a subsidiary of Insituform
Technologies. The transaction was financed through the issuance of two unsecured
two-year notes aggregating $1.5 million to Insituform, with the balance funded
through additional
17
borrowings under the SHH Revolver. The Insituform Notes bear interest at 9% and
are payable in quarterly installments plus accrued interest thereon. The first
installment was due 90 days after the completion of the transaction and was paid
in December 2002.
Other Debt
In October 1998, SCPI obtained from the Redevelopment Authority of the
City of McKeesport a loan (the "Subordinated Loan"), subordinated to the SCPI
Revolver, in the amount of $98,000 and carrying interest at 5% per annum. The
loan, which funded leasehold improvements at SCPI, is being repaid in monthly
installments through October 2003.
CAPITAL EXPENDITURES
Capital expenditures made by Sterling and its subsidiaries during
fiscal 2002 totaled $4.3 million, consisting primarily of heavy construction
equipment and the equipment acquired through the Kinsel transaction at SHH.
TAX LOSS CARRY-FORWARDS
At December 31, 2002, SCPI and Sterling had net operating tax loss
carry-forwards (the "Tax Benefits") of approximately $110 million, which expire
in the years 2003 through 2021 and which shelter most income of SCPI, Sterling
or its subsidiaries from federal income taxes. A change in control of SCPI or
Sterling exceeding 50% in any three-year period may lead to the loss of the
majority of the Tax Benefits. In order to reduce the likelihood of such a change
of control occurring, SCPI's and Sterling's Certificates of Incorporation
include restrictions on the registration of transfers of stock resulting in, or
increasing, individual holdings exceeding 4.5% of each company's common stock.
Shareholdings over 5% resulting from the Sterling Transaction were approved by
the Company's Board following receipt of required opinions that these would not
adversely affect the availability of the Tax Benefits. The shareholdings
exceeding 5% held by Messrs. Davies and Hemsley include options, the exercise of
which is subject to a standstill agreement that provides that they may not be
exercised except with Board approval following an opinion that such exercise
will not adversely affect the availability of the Tax Benefits.
Since the regulations governing the Tax Benefits are highly complex and
may be changed from time to time, and since SCPI's and Sterling's attempts to
reduce the likelihood of a change of control occurring may not be successful,
management is unable to determine the likelihood of the continued availability
of the Tax Benefits. However, management believes that the Tax Benefits are
currently available in full and intends to take all appropriate steps to help
ensure that they remain available. Should the Tax Benefits become unavailable to
SCPI or Sterling, most of their future income and that of any consolidated
affiliate would not be shielded from federal taxation, thus reducing funds
otherwise available for corporate purposes (see Note 10 to the Consolidated
Financial Statements).
CASH FLOWS
Net cash provided by operations for the fiscal year ended December 31,
2002 was $5.1 million, an increase of $2.5 million compared with prior year. The
increase was due primarily to substantially improved cash flow from operations,
combined with higher levels of vendor payables and other accrued expenses,
offset by increases in accounts receivable and contracts receivable, due to
slower payment by customers.
Net cash provided by operations in fiscal 2001 increased from the prior
year by $2.8 million. The improvement was due to decreases in contracts and
accounts receivable and by increases in trade payables.
In fiscal 2002, cash used in investing activities was $6.9 million, a
decrease of $3.6 million from the prior year, which included $9.4 million
related to the acquisition of SHH in July 2001. In fiscal 2002, $2.7 million was
used by a subsidiary of SHH to purchase the Kinsel Business and the Company also
spent $4.3 million in capital
18
expenditures, compared with $1.2 million in the prior year. The capital
expenditures related mostly to purchase of heavy construction equipment at SHH.
Cash used in investing activities for the ten-month period ended
December 31, 2001 totaled $10.5 million, compared with $3.7 million for fiscal
2000. The increase primarily related to the acquisition of SHH.
Financing activities provided approximately $1.3 million in cash during
fiscal 2002, compared with approximately $10.7 million in fiscal 2001, which
included the acquisition of SHH and increases in the SHH Revolver. During fiscal
2002, Company repayments of the Subordinated Debt were $2.5 million.
For fiscal 2001 and fiscal 2000, the Company's financing activities
provided cash of $10.7 million and $3.9 million, respectively, principally
related to the SHH acquisition in fiscal 2001 and from the issuance of long-term
debt of $3.7 million principally to fund the Company's investment in New Heights
in fiscal 2000.
Management does not believe that inflation has had a material negative
impact on the Company's operations or financial results during recent years
however, increases in oil prices may have an adverse effect on the Construction
Segment.
CERTIFICATION
This Annual Report on Form 10-K has been certified by Patrick T.
Manning, Chief Executive Officer of the Company, and by Maarten D. Hemsley,
Chief Financial Officer of the Company, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of section 1350, chapter 63
of title 18, United States Code) and the certification is attached as Exhibit
99.1.
RESULTS OF OPERATIONS
Operations include the consolidated results for SCPI, which through its
operating division, Steel City Products, headquartered in McKeesport,
Pennsylvania, distributes automotive accessories, non-food pet supplies and lawn
and garden products (the "Distribution Segment"). In July 2001, pursuant to the
Sterling Transaction, the Company increased its investment in SHH from 12% to
80.1%. SHH is a heavy civil construction company based in Houston that
specializes in municipal and state contracts for highway paving, bridge, water
and sewer and light rail. Operations of SHH make up one segment (the
"Construction Segment"). Until July 2001, OTI held equity investments in the
construction industry and the waste-to-energy industry. OTI was dissolved in
December 2001.
FISCAL YEAR ENDED DECEMBER 31, 2002 (FISCAL 2002) COMPARED WITH FISCAL YEAR
ENDED DECEMBER 31, 2001 (FISCAL 2001) (TEN MONTHS)
- ---------------------------------------------------------------------------
CONSTRUCTION
Revenues provided by the Construction segment totaled approximately
$112 million in fiscal 2002, compared with $49 million in fiscal 2001, which
included the six months since its acquisition by the Company in July 2001. In
September 2002, the Construction segment acquired the Kinsel Heavy Highway
Construction business. During fiscal 2002, Construction revenues increased due
to higher revenues on city and county contracts, however, state highway business
was lower than in the prior year.
Gross profit in fiscal 2002 was $12.8 million, or 11.5% of contract
revenues, compared with 8% of contract revenues in the six-month ownership
period of fiscal 2001. The improvement was due to the mix of contracts combined
with better weather affecting the Company in fiscal 2002 compared with fiscal
2001.
Operating income in fiscal 2002 was $7.1 million, compared with $2.3
million for the six-month ownership period in fiscal 2001.
19
Contract backlog at SHH at December 31, 2002 was approximately $138
million, of which approximately 31% is not expected to be constructed until
fiscal 2004 and beyond. Contract backlog at December 31, 2001 was $103 million.
DISTRIBUTION
Total revenues for the Distribution segment in fiscal 2002 were $22.6
million, an increase of $5.1 million compared with the ten months of fiscal
2001. The increase was due in part to the longer reporting period and to higher
sales of pet supplies and lawn and garden products. Sales of automotive
accessories totaled $15.3 million, compared with $13.6 million for the ten
months ended December 31, 2001, largely attributable to the longer reporting
period. Sales of pet supplies totaled $4.8 million, an increase of $1.8 million
from the prior fiscal year, due principally to sales to Ames as
debtor-in-possession until it liquidated its business in July 2002. In fiscal
2002, sales of lawn and garden products totaled $2.5 million, an increase of
$1.6 million compared with the prior period, which reflected the first full year
of operations for the lawn and garden business.
Gross profit for the Distribution segment was $3.7 million or 16.2% of
sales, compared with $2.6 million, or 14.8% of sales for the ten months ended
December 31, 2001. The increase was due to the longer reporting period, which
produced higher sales, and to better margins on certain product lines.
The Distribution segment reported an operating profit of $1.0 million,
compared with $481,000 in the prior year, which included ten months and had been
adversely affected by a bad debt provision for the Ames bankruptcy.
OTHER
Corporate overheads increased by $682,000, due primarily to a $520,000
expense related to the change in the value of the "put" for the purchase of the
remaining 19.9% of SHH. In fiscal 2002, expenses related to the corporate office
decreased by approximately $152,000; these reductions were offset in the prior
year by expenses related to OTI, which was dissolved in December 2001. Interest
expense increased by approximately $450,000 due to a full year of interest
related to the notes incurred in the Sterling transaction.
FISCAL YEAR ENDED DECEMBER 31, 2001 (FISCAL 2001) COMPARED WITH FISCAL YEAR
ENDED FEBRUARY 28, 2001 (FISCAL 2000)
- ---------------------------------------------------------------------------
CONSTRUCTION
Revenues provided by the Construction Segment totaled approximately $49
million for the six months since its acquisition in July 2001.
Gross margin for the period was approximately 8% of revenues.
The segment reported an operating profit of $2.3 million for the
six-month ownership period.
DISTRIBUTION
Total revenues for the Distribution segment for the ten months ended
December 31, 2001 were $17.5 million, a decrease of approximately $2.9 million,
due in part to the shorter fiscal year and to lower sales of automotive
accessories, primarily related to the bankruptcy filing of Ames in August 2001.
Sales of pet supplies totaled $2.9 million, an increase of $344,000 compared
with fiscal 2000, which included twelve months. Most of the increase resulted
from sales to new customers, which included shipments to Ames after its
bankruptcy filing. Sales of lawn and garden products totaled $836,000 for its
first full year of operation.
Gross profit totaled $3.3 million, a decrease of approximately $700,000
compared with fiscal 2000, due to the lower sales resulting from the shorter
reporting period.
20
Operating profits decreased by approximately $487,000 due principally
to a significant charge to bad debt expense resulting from the Ames bankruptcy.
OTHER
The Company recorded a loss on its equity investment at New Heights,
through the date of its disposition in July 2001, of $1.3 million. Interest
expense was lower than the prior year by $495,000 due to lower interest rates
affecting the SCPI Revolver, and the elimination of the debt owed to KTI for the
New Heights investment.
RESULTS FOR THE TEN MONTHS ENDED DECEMBER 31, 2001 COMPARED WITH THE TEN MONTHS
ENDED DECEMBER 31, 2000 (UNAUDITED)
- -------------------------------------------------------------------------------
As Fiscal 2001 includes ten months compared with twelve months in Fiscal
2000, a separate discussion below compares results of Fiscal 2001 with the
comparable ten-month period (unaudited) in Fiscal 2000.
(in thousands) December 31, December 31,
2001 2000
Sales $66,121 $17,256
Gross profit $ 7,299 $ 3,550
Operating profit $ 1,445 $ 294
CONSTRUCTION
Revenues provided by the Construction Segment totaled approximately $49
million for the six months since its acquisition in July 2001.
Gross margin for the period was approximately 8% of revenues.
The segment reported an operating profit of $2.3 million for the
six-month ownership period.
DISTRIBUTION
Comparing results for the ten months ended December 31, 2001 with the
ten months ended December 31, 2000, total sales increased by approximately
$212,000. Sales of automotive products decreased by $1.4 million, due primarily
to the bankruptcy filing of Ames Department Stores in August 2001. Sales of pet
products increased by $822,000 due to sales to new customers, which included
Ames after its bankruptcy filing. Sales of lawn and garden products were
$836,000. Sales of this product line began in November 2000.
Gross profits decreased by approximately $212,000, due to the sales
decrease of automotive products and to pressure placed on the Company to reduce
margins by certain larger customers.
Although savings were realized in operating and selling expenses due to
a reduction in personnel, these were offset by an increase of approximately
$469,000 in bad debt expense due to the bankruptcy filing of Ames.
CORPORATE
For the ten months ended December 31, 2001, there was a loss from
equity investment of $1.2 million, compared with a loss in the prior unaudited
ten-month period of $3.1 million, primarily related to New Heights. New Heights
was disposed of in July 2001. Interest expense decreased in the fiscal 2001
period by approximately $193,000, due to the disposition of New Heights.
21
ITEM 7(A). QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The Company and its subsidiaries are exposed to certain market risks
from transactions that are entered into during the normal course of business.
Sterling's primary market risk exposure is related to interest rate risk. The
Company manages its interest rate risk by attempting to balance its exposure
between fixed and variable rates while attempting to minimize its interest
costs. An increase of 1% in the market rate of interest would have increased the
Company's interest expense in fiscal 2002 by approximately $56,000......
Financial derivatives are used as part of the overall risk management
strategy. These instruments are used to manage risk related to changes in
interest rates. The portfolio of derivative financial instruments consists of
interest rate swap agreements. Interest rate swap agreements are used to modify
variable rate obligations to fixed rate obligations, thereby reducing the
exposure to higher interest rates. Amounts paid or received under interest rate
swap agreements are accrued as interest rates change with the offset recorded in
interest expense.
The Company applies Statement of Financial Standards (SFAS) No. 133,
Accounting for Derivative Instruments and Hedging Activities. Under SFAS No.
133, the Company's interest rate swaps have not been designated as hedging
instruments; therefore changes in fair value are recognized in current earnings.
Because the Company derives no revenues from foreign countries or
otherwise has no obligations in foreign currency, the Company experiences no
foreign currency exchange rate risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Certified Public Accountants................................. 42
Consolidated Balance Sheets: December 31, 2002 and December 31, 2001............... 44
Consolidated Statements of Operations for the fiscal periods ended
December 31, 2002, December 31, 2001 and February 28, 2001....................... 45
Consolidated Statement of Stockholders' Equity (Deficiency) for the fiscal periods
ended December 31, 2002, December 31, 2001 and February 28, 2001................. 46
Consolidated Statements of Cash Flows for the fiscal periods ended
December 31, 2002, December 31, 2001 and February 28, 2001....................... 47
Notes to Consolidated Financial Statements......................................... 49
Schedule II - Valuation and Qualifying Accounts.................................... 77
22
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On September 25, 2001, the Company's Board of Directors, acting on the
recommendation of its Audit Committee decided to no longer engage Deloitte &
Touche LLP ("Deloitte & Touche" or "DT") as the Company's independent public
accountants. This determination followed the Company's decision to seek
proposals from other independent accountants to audit the Company's consolidated
financial statements for the Transition Period ending December 31, 2001.
Deloitte & Touche's report on the Company's consolidated financial
statements for the fiscal year ended February 28, 2001 did not contain an
adverse opinion or disclaimer of opinion, nor was it qualified or modified as to
uncertainty, audit scope or accounting principles.
During the fiscal year ended February 28, 2001 and through the date
hereof, there were no disagreements with Deloitte & Touche on any matter of
accounting principle or practice, financial statement disclosure, or auditing
scope or procedure which, if not resolved to DT's satisfaction, would have
caused them to make reference to the subject matter in connection with their
report on the Company's consolidated financial statements for such year; and
there were no reportable events as defined in Item 304(a)(1)(v) of Regulation
S-K.
The Company provided Deloitte & Touche with a copy of the foregoing
disclosures.
Effective September 26, 2001, the Board of Directors, based on upon a
recommendation of its Audit Committee, retained Grant Thornton LLP as its
independent auditors to audit the Company's consolidated financial statements
for the Transition Period ending December 31, 2001 and the fiscal year ended
December 31, 2002.
During the fiscal year ended February 28, 2001 and through the date
hereof, except as disclosed in the following paragraph, the Company did not
consult Grant Thornton LLP with respect to the application of accounting
principles to a specified transaction, either completed or proposed, or the type
of audit opinion that might be rendered on the Company's consolidated financial
statements, or any other matters or reportable events as set forth in Items
304(a)(2)(i) and (ii) of Regulation S-K.
During the week preceding September 26, 2001, the Company had
discussions with Grant Thornton regarding proforma presentation regarding the
Sterling Transaction.
23
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS.
The by-laws of Sterling Construction Company, Inc. ("Sterling" or the
"Company") provide for such number of directors as is determined from time to
time by the Board of Directors and the Certificate of Incorporation of the
Company provides for the organization of directors into three classes, with
directors elected for three-year staggered terms. There are currently seven
directors.
Age at March 1, Current term Director
Name 2003 expires* since Class
John D. Abernathy 65 2003 1994 II
Robert M. Davies 52 2004 1996 III
Robert W. Frickel 60 2003 2001 II
Joseph P. Harper, Sr. 57 2005 2001 I
Maarten D. Hemsley 53 2004 1998 III
Patrick T. Manning 55 2005 2001 I
Christopher H.B. Mills 50 2004 2001 III
* the director also serves until a successor is elected
John D. Abernathy. Mr. Abernathy has been Chief Operating Officer of Patton
Boggs LLP, a Washington DC law firm, since January 1995. From March 1991 to
February 1994 he was the Managing Director of Summit, Solomon & Feldesman, a New
York City law firm and from July 1983 until June 1990, Mr. Abernathy was
Chairman and Chief Executive Partner of BDO Seidman, a public accounting firm.
He is a director of Pharmaceutical Resources, Inc., a generic drug manufacturer
and of the Company's majority owned subsidiary, Steel City Products, Inc.
("SCPI"). Mr. Abernathy is a certified public accountant.
Robert M. Davies. Mr. Davies was the Company's Chairman and Chief Executive
Officer from May 1997 to July 2001 and was its President from May 1997 to
January 1999. Mr. Davies had previously been a member of the Company's Board
from 1991 until 1994. Mr. Davies was a Vice President of Wexford Capital
Corporation, which acts as the investment manager to several private investment
funds, from 1994 to March 1997. From November 1995 to March 1997 Mr. Davies also
served as Executive Vice President of Wexford Management LLC, a private
investment management company. From September 1993 to May 1994 he was a Managing
Director of Steinhardt Enterprises, Inc., an investment banking company and from
1987 to August 1993, he was Executive Vice President of The Hallwood Group
Incorporated, a merchant banking firm. Mr. Davies is a director of SCPI. Mr.
Davies is a managing director of Menai Capital, L.L.C., a private equity
advisory company, and Managing Director of Greenwich Power, LLC.
Robert W. Frickel. Mr. Frickel is the founder and President of R.W. Frickel
Company, P.C., a certified public accounting firm that provides audit, tax and
consulting services primarily to the construction industry. Prior to the
founding of the R.W. Frickel Company in 1974, Mr. Frickel was employed by Ernst
& Ernst. He attained his CPA license in 1968 and holds a Bachelor of Business
Administration degree from the University of Michigan.
Joseph P. Harper, Sr.. President. Mr. Harper serves as CFO, Treasurer and
Secretary of Sterling Houston Holdings ("SHH") and has been with that company
since 1972. He has performed both estimating and project manager functions as
well as his primary role as CFO. Prior to joining SHH, Mr. Harper worked for
Price Waterhouse and attained his CPA license in 1970. He holds a Bachelor's
degree from St. Joseph College. Mr. Harper was elected the Company's President
in July 2001.
24
Maarten D. Hemsley. Mr. Hemsley was re-elected to the Board of Directors of the
Company and of SCPI in December 1998, having been an employee and director of
the Company or SCPI for many years prior to 1995. In December 1995, he had
resigned his positions with the Company and SCPI but continued to provide
consulting services to both companies through his wholly-owned business,
Bryanston Management, Ltd. Mr. Hemsley served as President, Chief Operating
Officer and Chief Financial Officer of the Company until July 2001, and
currently serves as Chief Financial Officer of both Sterling and SCPI. Mr.
Hemsley has been President of Bryanston Management, Ltd., a financial
consultancy firm, since 1993.
Patrick T. Manning. Chairman and Chief Executive Officer. Mr. Manning joined SHH
in 1971 and led that company's move into the Houston market in 1978. He
currently serves as President and CEO of SHH. Before 1971, Mr. Manning was
President of Oakland Construction Company, a custom home builder in suburban
Detroit. Mr. Manning has served on a variety of construction industry
committees, including the Gulf Coast Trenchless Association and the Houston
Contractors' Association, where he served as a member of the Board of Directors
and as President from 1987 to 1993. He attended Michigan State University from
1969 to 1972. Mr. Manning is the brother of James Manning, a founder of SHH. Mr.
Manning was elected the Company's Chairman and Chief Executive Officer in July
2001.
Christopher H.B. Mills. Mr. Mills is Chief Investment Officer of J.O. Hambro
Capital Management, an investment management company based in the United
Kingdom. Prior to his founding of J.O. Hambro Capital Management in 1993, Mr.
Mills was employed by Montagu Investment Management and its successor company
Invesco MIM as an investment manager and director from 1975 to 1993. He is Chief
Executive of North Atlantic Smaller Companies Investment Trust plc, ("NASCIT"),
a 12% shareholder in the Company and of American Opportunity Trust plc. Mr.
Mills serves as a director and is a shareholder of J.O. Hambro Capital
Management and a director of Lesco, Inc., a company based in the United States
that manufactures and sells fertilizer and lawn products.
EXECUTIVE OFFICERS.
The following are the names, ages, positions and a brief description of
the business experience during the last five years of the executive officers of
the Company and its subsidiaries who are not also directors of the Company, all
of whom serve until they resign or are removed by the Board of Directors. The
business histories of executive officers who are also directors (Messrs. Harper,
Hemsley and Manning) are set forth above under the heading "Directors."
Roger M. Barzun (61): Vice President, Secretary and General Counsel. Mr. Barzun
has been a Vice President, Secretary and General Counsel of the Company since
August 1991 and was a Senior Vice President from May 1994 until July 2001. He is
also Secretary and General Counsel of SCPI. Mr. Barzun has been a lawyer since
1968 and is a member of the New York and Massachusetts bars.
Terrance W. Allan (51): President, Steel City Products, Inc. Mr. Allan has been
an officer of SCPI for more than the last five years. He was appointed President
of SCPI in May 2000 and Chief Executive Officer in May 2002.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's officers and directors, and persons who own more than 10% of a
registered class of the Company's equity securities ("Insiders") to file reports
of beneficial ownership and certain changes in ownership with the Securities and
Exchange Commission and to furnish the Company with copies of those reports.
Based solely on a review of those reports and amendments thereto
furnished to the Company during the Transition Period or written representations
by Insiders that no reports were required to be filed, the Company believes that
during the fiscal year ended December 31, 2002 all Section 16(a) filing
requirements applicable to the Company's Insiders were satisfied, except as
noted in the following paragraphs.
25
NASCIT, a beneficial owner of greater than 10% of the Company's common
stock, did not timely report beneficial ownership of 605,520 shares of common
stock beneficially owned by it. Beneficial ownership of these shares was
reported on a Form 3 Report filed in February 2002.
Mr. Christopher Mills, a director of the Company, did not timely report
beneficial ownership of 605,520 shares of common stock beneficially owned by him
as an executive director and co-investment adviser of NASCIT and 12,000 options
granted to him on July 23, 2001. Beneficial ownership of these shares was
reported on a Form 3 Report filed in February 2002.
Mr. Joseph P. Harper, Sr., President and a director of the Company, did
not timely report beneficial ownership of 3,773 shares of common stock, a
warrant granted on July 19, 2001 for the right to acquire 46,236 shares of
common stock, and a warrant granted on October 31, 2001 for the right to acquire
1,019 shares of common stock. Beneficial ownership of these shares was reported
on a Form 4 Report filed in February 2002.
REPORT OF THE AUDIT COMMITTEE FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002.
The Audit Committee reviews the Company's financial reporting process
on behalf of the Board of Directors. Three independent directors, Mr. Abernathy,
Mr. Frickel, and Mr. Mills are members of the Audit Committee. The Committee
operates under a written Charter adopted by the Board in June 2000. Management
has the primary responsibility for the financial statements and the reporting
process. The Company's independent auditors are responsible for expressing an
opinion on the conformity of the Company's financial statements with generally
accepted accounting principles and whether the Company's financial statements
present fairly, in all material respects, the financial position and results of
operations of the Company.
In this context, the Audit Committee has reviewed and discussed with
management and the independent auditors the audited financial statements. The
Audit Committee has discussed with the independent auditors the matters required
to be discussed by Statement on Accounting Standards No. 61 ("Communication with
Audit Committees"). In addition, the Audit Committee has received from the
independent auditors the written disclosures required by Independence Standards
Board No. 1 ("Independence Discussions with Audit Committees") and discussed
with them their independence from the Company and its management.
In September 2001, the Company elected to change its independent
auditors.
The following table sets forth the aggregate fees billed to the Company
for the year ended December 31, 2002 by its current independent auditors, Grant
Thornton LLP:
Audit fees $171,000
Financial information systems design and implementation --
All other fees $ 5,000
Audit fees include the fees for the separate audits of SCPI and SHH as
well as the consolidated audit of the Company and resolution of issues that
arose during the audit process.
Items included in the "all other" category include services related to
acquisition issues and other matters. The Audit Committee determined that
services provided in the "all other" category did not impair the independence of
Grant Thornton, LLP.
In reliance on the reviews and discussions referred to above, the Audit
Committee recommended to the Board of Directors, and the Board has approved that
the audited financial statements be included in the Company's Annual Report on
Form 10-K for the year ended December 31, 2002 for filing with the Securities
and Exchange Commission.
26
ITEM 11. EXECUTIVE COMPENSATION.
This item contains information about compensation, stock options and
awards, employment arrangements and other information concerning the executive
officers of the Company and of its subsidiaries, SHH and SCPI.
SUMMARY COMPENSATION TABLE.
The following table sets forth all compensation for the 2002, 2001 and
2000 fiscal years paid on or before December 31, 2002 to those who served as the
Company's Chief Executive Officer during fiscal 2002 and to the other executive
officers of the Company who were serving at the end of the 2002 fiscal year for
services rendered in all capacities to the Company and its subsidiaries and
whose total annual salary and bonus exceeded $100,000 in fiscal 2002. Also
included is the compensation paid to an executive officer of SCPI who is not,
however, an executive officer of the Company.
Annual Compensation Long-term compensation
Other Securities
Fiscal Annual Underlying All Other
Name and Principal Position Year Salary Bonus** Compensation* Options/SARs Compensation
--------------------------- ------ ------ ------- ------------- ------------ ------------
Robert M. Davies(1) 2002 -- -- -- -- --
Former Chairman & Chief 2001 $ 22,395 -- -- -- --
Executive Officer
2000 $124,028 -- -- -- --
Patrick T. Manning(2) 2002 $225,000 -- -- 3,500 --
Chairman & Chief Executive 2001 $ 98,077 -- -- 3,700 --
Officer
Joseph P. Harper, Sr.(2) 2002 $225,000 -- -- 3,500 --
President 2001 $ 98,077 -- -- 3,700 --
Maarten D. Hemsley(3) 2002 $ 80,396 -- -- -- --
Chief Financial Officer 2001 $ 65,146 -- -- -- --
2000 $129,392 -- -- -- --
Terrance W. Allan(4) 2002 $177,424 $25,118 -- 5,000 --
President - SCPI 2001 $124,385 $40,771 -- -- --
2000 $132,072 $60,515 -- -- --
* Excludes perquisites and other personal benefits if the aggregate
amount of such items of compensation was less than the lesser of either $50,000
or 10% of the total annual salary and bonus of the named executive officer.
** Does not include bonuses earned and accrued during Fiscal 2002 that are
to be paid during Fiscal 2003.
1. Mr. Davies was elected Chairman, Chief Executive Officer and President
in May 1997 and resigned those positions in July 2001. Mr. Davies
remains a director of the Company.
2. In July 2001, Mr. Manning was elected Chairman and Chief Executive
Officer of the Company and Mr. Harper was elected President of the
Company. Both Mr. Manning and Mr. Harper are compensated by
Texas-Sterling Construction, LP, a subsidiary of SHH, under a long-term
employment agreements, except with respect to stock options and other
stock awards. Compensation is included only for the period of ownership
of SHH by the Company since July 2001.
27
3. In December 1998, Mr. Hemsley was elected President, Chief Operating
Officer and Chief Financial Officer of the Company. Following the
Sterling Transaction in July 2001, he remains Chief Financial Officer
of the Company.
4. Mr. Allan is compensated only by SCPI, except with respect to stock
options and stock awards.
OPTION GRANTS IN THE LAST FISCAL YEAR.
Options were granted to individuals named in the Summary Compensation
Table, above, during the fiscal year ended December 31, 2002, as summarized in
the table below:
Option Grants in Fiscal Year Period
Potential Realized
value at Assumed
Annual Rates of
Stock Price
Individual Grants Appreciation for
Option Term
Number of % of Total
Securities Options Granted Exercise
Name Underlying Options to Employees in Price Expiration 5%($) 10%($)
Granted (#) Fiscal 2002 ($/Share) Date
Patrick T. Manning 3,500 5.3% $1.73 July 24, 2012 $3,797 $ 9,622
Joseph P. Harper, Sr. 3,500 5.3% $1.73 July 24, 2012 $3,797 $ 9,622
Terrance W. Allan 5,000 7.6% $1.50 April 5, 2012 $4,717 $11,953
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES.
The following table sets forth certain information based upon the fair
market value per share of the Common Stock at December 31, 2002 ($1.75) or the
day closest to the Company's December 31, 2002 fiscal year end on which trades
were made, with respect to stock options held at that date by each of the
individuals named in the Summary Compensation Table, above. The "value" of
unexercised in-the-money options is the difference between the market value of
the Common Stock subject to the options at December 31, 2002 and the exercise
price of the option shares. During fiscal 2002, there were no option exercises
by any of these individuals.
Number of Securities Underlying Value of Unexercised In-the-Money
Unexercised Options at Fiscal Year End Options at Fiscal Year End
-------------------------------------- ---------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- --------------------- ----------- ------------- ----------- -------------
Robert M. Davies 538,992 6,000 $ 534,093 $1,500
Patrick T. Manning 1,234 5,966 $ 309 $ 687
Joseph P. Harper, Sr. 1,234 5,966 $ 309 $ 687
Maarten D. Hemsley 436,424 -- $ 305,625 --
Terrance W. Allan 32,000 3,750 $ 15,125 $ 938
COMPENSATION OF DIRECTORS.
Until 2001, all non-employee directors received annual stock option
grants on May 1 each year under the Non-Employee Director Stock Option Plan
covering 3,000 shares of Common Stock, which were immediately exercisable at an
option price equal to the market value on the date of grant. The maximum number
of shares issuable under the Plan was reached with the grants of options for an
aggregate of 7,000 shares to the five non-employee directors on May 1, 2001. In
July 2001, the three non-employee directors were issued options for 12,000
shares each under the 2001 Stock Incentive Plan. During fiscal 2002, each
non-employee director who did not otherwise receive compensation from the
Company was entitled an annual director's fee of $12,500. All fees are
28
payable quarterly in arrears. All directors are entitled to reimbursement for
out-of-pocket expenses incurred in attending meetings.
See also "Employment Contracts and Termination of Employment and
Change-in-Control Arrangements,".
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS.
Mr. Davies. Mr. Davies was elected Chairman, President and Chief Executive
Officer of the Company in May 1997. He had previously been a director of the
Company from 1991 until 1994. He was compensated at the rate of $5,000 per month
under a one-year consulting agreement until June 1998, when he entered into an
employment agreement at the same rate. Mr. Davies also received reimbursement of
expenses incurred by him in carrying out his duties and responsibilities. In
October 1998, Mr. Davies voluntarily took a 10% salary reduction, which amount
was added to a subordinated note issued to him at the time of the Sterling
Transaction. In December 1998, Mr. Davies also entered into a two-year
employment agreement with OTI that provided for a base salary of $60,000, plus a
car allowance. Both the Sterling and OTI employment agreements expired on
February 28, 2001. The Sterling employment agreement continued on a
month-to-month basis until July 2001 when Mr. Davies resigned as an executive of
the Company.
Mr. Manning. Mr. Manning is Chief Executive Officer of the Company.
Texas-Sterling Construction, LP, a subsidiary of SHH has a three-year employment
agreement with Mr. Manning dated July 18, 2001. The agreement provides for a
base annual salary of $200,000 per year and Mr. Manning is entitled to receive
an annual bonus of $100,000 in respect of any fiscal year during which SHH
achieves 75% or greater of approved budgeted EBITDA for such fiscal year, so
long as budgeted EBITDA is at least equal to actual EBITDA achieved in the prior
year. An additional incentive bonus is payable if actual performance exceeds
budget. The agreement provides that Mr. Manning shall be subject to a
non-compete provision for two years after employment with SHH ceases; payment
for which shall be $1,000 per month for the twenty-four month period.
Mr. Harper. Mr. Harper is President of the Company. Texas-Sterling Construction,
LP, a subsidiary of SHH has a three-year employment agreement with Mr. Harper
dated July 18, 2001. The agreement provides for a base annual salary of $200,000
per year for the first two years and $170,000 for the third year. Mr. Harper is
entitled to receive an annual bonus of $100,000 in respect of any fiscal year
during which SHH achieves 75% or greater of approved budgeted EBITDA for such
fiscal year, so long as budgeted EBITDA is at least equal to actual EBITDA
achieved in the prior year. An additional incentive bonus is payable if actual
performance exceeds budget. The agreement provides that Mr. Harper shall be
subject to a non-compete provision for two years after employment with SHH
ceases; payment for which shall be $1,000 per month for the twenty-four month
period.
Mr. Hemsley. Mr. Hemsley was employed by and was a director of the Company or
SCPI for several years prior to 1995. In 1995, he resigned his positions with
the Company and entered into a consulting agreement with the Company through his
wholly-owned company, Bryanston Management, Ltd. In December 1998, Mr. Hemsley
was elected to the Board of Directors and was appointed President, Chief
Operating Officer and Chief Financial Officer of the Company subject to an
employment agreement at the same rate of compensation as the Bryanston
consulting agreement of $85,000 per annum (of which 10% was later deferred under
a voluntary salary reduction, which deferral amount was converted into a
subordinated note in July 2001). In December 1998, Mr. Hemsley also entered into
a two-year employment agreement with OTI which provided for a base salary of
$40,000 annually, plus a car allowance. Both the Sterling and OTI employment
agreements expired on February 28, 2001. The Sterling employment agreement
continued on a month-to-month basis until July 2001, when the agreement was
amended to extend the employment period for one year at an annual rate of
$76,500. In July 2002, Mr. Hemsley's salary was increased to $85,000 per year
and his employment agreement was extended for three years.
Mr. Allan. SCPI has an employment agreement with Mr. Allan that commenced May 1,
2000 that provides for a base salary of $133,000 with annual salary increases.
Payment of the increase due September 2001 and part of his regular salary was
voluntarily deferred by Mr. Allan in light of the Chapter 11 filing of Ames
Department Stores,
29
one of SCPI's largest customers. The deferral was reflected as an accrued
liability of the Company. In January 2002, Mr. Allan began receiving his entire
regular salary. In January 2002, the bonus provisions of Mr. Allan's employment
agreement were modified to reflect his participation in a new bonus plan for all
members of SCPI's management. Pursuant to the new bonus program, Mr. Allan is
entitled to a profit-based bonus reflecting achievement of budgeted EBITDA,
ranging from 8% of his base salary if 75% of the budgeted level is achieved, to
51% of base salary if EBITDA equals twice the budgeted level. In addition, Mr.
Allan is entitled to a discretionary bonus of up to one-third of the
profit-based bonus paid. The initial term of Mr. Allan's agreement expires on
September 30, 2003, and may be extended thereafter on a year-to-year basis.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION.
In the fiscal year ended December 31, 2001, Mr. Davies, Mr. Abernathy,
Mr. Ross Pirasteh and Mr. Lever were members of the Compensation Committees of
both the Company and of SCPI. In July 2001, all members except Mr. Abernathy
resigned from the Compensation Committee and Mr. Frickel and Mr. Mills became
members. Mr. Frank and Mr. Harper serve on the Compensation Committee of SCPI.
Prior to July 2001, Mr. Davies was an executive officer of the Company, but none
of the Company's executive officers served as a director or member of the
Compensation Committee (or any other committee serving an equivalent function)
of any other entity, whose executive officers serve as a director or member of
the Company's Compensation Committee.
The Board of Directors intends that any transactions with officers,
directors and affiliates will be entered into on terms no less favorable to the
Company than could be obtained from unrelated third parties and that they will
be approved by a majority of the directors of the Company who are independent
and disinterested with respect to the proposed transaction.
In December 1998, KTI purchased approximately 1.7 million shares of the
Company's common stock, representing 35% of the common stock outstanding after
the purchase, at the market price of $0.50 per share. In conjunction with the
private placement of stock, KTI committed under a loan agreement to lend the
Company up to $11.5 million (see Notes 1 and 5 to the Consolidated Financial
Statements). Funding under the KTI Loan was used principally to enable OTI to
finance the Business Plan for New Heights, pursuant to an Investment Agreement
between New Heights, OTI and KTI (see Note 13 to the Consolidated Financial
Statements). In December 1998, New Heights appointed KTI to manage its facility,
pursuant to an Operating and Maintenance Agreement and OTI entered into a
non-exclusive License Agreement for the use of waste rubber recycling technology
owned by KTI's subsidiary, KTI Recycling.
Pursuant to these transactions, in January 1999, KTI nominated two
directors, Ross Pirasteh and Martin Sergi, to each of the Boards of Directors of
Sterling and OTI. In March 2000, Mr. Jack Polak was elected to the Company's
Board of Directors as KTI's third nominee under the Investment Agreement between
KTI and the Company. Pursuant to the Unwinding Agreements, the resignations of
Messrs Pirasteh, Sergi and Polak from the Boards of the Company and OTI became
effective on July 3, 2001.
In October 1999, certain shareholders of SHH exercised their right to
sell a second tranche of equity to OTI, thus increasing OTI's equity ownership
from 7% to 12%. The equity purchase was financed through the issuance of notes,
of which $559,000 was due to be repaid to Mr. Davies and Mr. Hemsley in October
2000. The notes which provided for interest payments at the rate of 14% per
annum, were extended by agreement until July 2001 when they were restructured
pursuant to the Sterling Transaction.
See also "Compensation of Directors", "Employment Contracts and
Termination of Employment and Change-in-Control Arrangements" and "Item 13.
Certain Relationships and Related Transactions."
30
REPORT ON EXECUTIVE COMPENSATION IN THE 2002 FISCAL YEAR.
This report has been prepared by the Compensation Committee of the
Board of Directors and addresses the Company's compensation policies with
respect to the Chief Executive Officer and executive officers of the Company in
general for the fiscal year ended December 31, 2002. The Company has no
operating business of its own, but is a holding company of operating businesses.
The Company has elected to include in the Summary Compensation Table certain
information concerning an executive officer of SCPI, who is not, however, an
executive officer of the Company and accordingly, a discussion of his
compensation is included here. Reference is made generally to the information
under the heading "Employment Contracts and Termination of Employment and
Change-in-Control Arrangements".
Compensation Policy. The overall intent in respect of executive
officers is to establish levels of compensation that provide appropriate
incentives in order to command high levels of individual performance and thereby
increase the value of the Company to its stockholders and that are sufficiently
competitive to attract and retain the skills required for the success and
profitability of the Company. The principal components of executive compensation
are salary, bonus and stock options.
Chief Executive Officer's Compensation. The compensation for Mr. Davies
prior to July 2001 and Mr. Manning after July 2001 was determined to be
appropriate by the members of the Committees serving at the time based on the
nature of the position; the expertise and responsibility that the position
requires; the Chief Executive Officer's prior experience in former employment;
and the subjective judgement of the members of the Committee of a reasonable
level of compensation.
Other Executive Officers. Mr. Allan is included in the Company's
disclosures relating to compensation because of his importance to the success of
the Company on a consolidated basis. Mr. Allan's employment agreement was
reviewed and approved by the Company's Compensation Committee and by the SCPI
Compensation Committee.
Salary. Since all of the executive officers named in the Summary
Compensation Table are long-term employees of the Company and/or SCPI and SHH,
their salaries in fiscal 2002 were based on the level of their prior salaries
and the subjective judgement of the members of the Company's and SCPI's
Compensation Committees as to the value of the executive's past contribution and
potential future contribution to the business.
Bonuses. Until January 2002, the bonus payable to Mr. Allan under his
employment agreement consisted of an Annual Management Bonus and an additional
Annual Executive Bonus. The Annual Management Bonus was paid from a pool of
funds equal to 8% of SCPI's consolidated net income before interest, taxes,
depreciation and amortization, prepared in accordance with generally accepted
accounting principles consistently applied. The Annual Executive Bonus was based
on achievement of certain defined profit levels, which were not met in fiscal
2001 or 2000. In 2002, Mr. Allan's employment agreement was amended to provide
for Mr. Allan's participation in a new bonus plan