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STRL > SEC Filings for STRL > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.


We are a company that operates in one segment, heavy civil construction, through our subsidiaries, and which specializes in the building, reconstruction and repair of transportation and water infrastructure in Texas, Utah, Nevada, Arizona and California and other states where we see opportunities. We have strategically expanded our operations, either by establishing an office in a new market, often after having successfully bid on and completed a project in that market, or by acquiring a company that gives us an immediate entry into a market. On August 1, 2011, we expanded our operations into Arizona and California with the acquisitions of JBC and Myers.

Critical Accounting Policies.

On an ongoing basis, the Company evaluates the critical accounting policies used to prepare its consolidated financial statements, including, but not limited to, those related to:
Revenue recognition

Contracts receivable, including retainage

Valuation of property and equipment, goodwill and other long-lived assets

Construction joint ventures

Income taxes

Segment reporting

Our significant accounting policies are described in Note 1, and conform to the FASB's Accounting Standards Codification (or GAAP or ASC).

Use of Estimates.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the 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. 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 under the percentage-of-completion method, the valuation of long-lived assets, and income taxes. Management continually evaluates all of its estimates and judgments based on available information and experience; however, actual amounts could differ from those estimates.

Contract Revenue Recognition

The majority of our contracts with our customers are "fixed unit price." Under such contracts, we are committed to providing materials or services required by a contract at fixed unit prices (for example, dollars per cubic yard of concrete poured or per cubic yard of earth excavated). Most of our state and municipal contracts provide for termination of the contract for the convenience of the owner, with provisions to pay us only for work performed through the date of termination.

Credit risk is minimal with public owners since the Company ascertains that funds have been appropriated by the governmental project owner prior to commencing work on such projects. While most public contracts are subject to termination at the election of the government entity, in the event of termination the Company is entitled to receive the contract price for completed work and reimbursement of termination-related costs. Credit risk with private owners is minimized because of statutory mechanics liens, which give the Company high priority in the event of lien foreclosures following financial difficulties of private owners.

We use the percentage-of-completion accounting method for construction contracts. Revenue is recognized as costs are incurred in an amount equal to cost plus the related expected profit based on the percentage of completion method of accounting in the ratio of costs incurred to estimated final costs. Our contracts generally take 12 to 36 months to complete. Contract costs consist of direct costs on contracts, including labor, materials, amounts payable to subcontractors and those indirect costs related to contract performance, such as indirect salaries and wages, equipment maintenance, repairs, fuel and depreciation, insurance and payroll taxes. Contract cost is recorded as incurred, and revisions in contract revenue and cost estimates are reflected in the accounting period when known. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability, including those changes arising from contract penalty provisions and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined. An amount attributable to contract claims is included in revenues when realization is probable and the amount can be reasonably estimated. The Company generally provides a one to two-year warranty for workmanship under its contracts. Warranty claims historically have been insignificant.

The accuracy of our revenue and profit recognition in a given period is dependent on the accuracy of our estimates of the revenues and costs to finish uncompleted contracts. Our estimates for all of our significant contracts use a highly detailed "bottom up" approach, and we believe our experience allows us to produce reliable estimates. However, our projects can be highly complex, and in almost every case, the profit margin estimates for a contract will either increase or decrease to some extent from the amount that was originally estimated at the time of bid. Because we have a large number of projects of varying levels of size and complexity in process at any given time, these changes in estimates can sometimes offset each other without materially impacting our overall profitability. However, large changes in revenue or cost estimates can have a significant effect on profitability. There are a number of factors that can contribute to changes in estimates of contract cost and profitability. The most significant of these include the completeness and accuracy of the original bid, recognition of costs associated with scope changes, extended overhead due to customer-related and weather-related delays, subcontractor and supplier performance issues, site conditions that differ from those assumed in the original bid (to the extent contract remedies are unavailable), the availability and skill level of workers in the geographic location of the project and changes in the availability and proximity of materials. The foregoing factors, as well as the stage of completion of contracts in process and the mix of contracts at different margins, may cause fluctuations in gross profit between periods, and these fluctuations may be significant. Results for 2012 and 2011 were adversely affected by revisions to estimated profitability on a number of construction projects. See "Recent Developments ? Financial Results for 2012, Operational Issues and Outlook for 2013 Financial Results" above and "Results of Operations ? Fiscal Year Ended December 31, 2012 Compared with Fiscal Year Ended December 31, 2011" for further discussion of the impact on our financial results.

Contracts Receivable, Including Retainage

Contracts receivable are generally based on amounts billed to the customer. At December 31, 2012 and 2011, contracts receivable included $18.1 million and $22.6 million of retainage, respectively, which is being withheld by customers until completion of the contracts. All other contracts receivable include only balances approved for payment by the customer.

Many of the contracts under which the Company performs work contain retainage provisions. Retainage refers to that portion of billings made by the Company but held for payment by the customer pending satisfactory completion of the project. Retainage on active contracts is classified as a current asset regardless of the term of the contract and is generally collected within one year of the completion of a contract.

Based upon a review of outstanding contracts receivable, historical collection information and existing economic conditions, management has determined that all contracts receivable at December 31, 2012, including retainage, are fully collectible, and, accordingly, no allowance for doubtful accounts against contracts receivable was necessary. Contracts receivable are written off based on individual credit evaluation and specific circumstances of the customer, when such treatment is warranted.

Valuation of Long-Lived Assets.

Long-lived assets, which include property, equipment and acquired intangible assets, including goodwill, 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 fair values and 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. Goodwill must be reviewed for impairment at least annually, and we completed our most recent annual impairment review for historical goodwill during the fourth quarter of 2012. It indicated that there was no impairment in goodwill. Note 8 to the Consolidated Financial Statements discusses the three valuation approaches used by the Company to determine the fair value of the Company's equity for purposes of evaluating whether there is an indication of goodwill impairment. These valuation approaches are impacted by a number of factors but the key ones are the Company's stock price, the Company's financial performance relative to its peer group, the financial performance of the peer group, the estimated control premium and the estimated forecasted cash flows. The valuation approaches contain uncertainty regarding the estimates used. One of the largest uncertainties relates to government and state spending which management expects to increase in the next few years. There are a number of other uncertainties with respect to our future financial performance that could impact estimated future cash flows. These are discussed in a number of places including "Item IA. Risk Factors." We determined that the fair value of the Company's equity was approximately 3% above the carrying value of the Company's equity, and therefore a modest change in estimated forecasted cash flows could result in an impairment of goodwill. In 2011, we determined that there was an impairment in goodwill of $67.0 million, which has been recognized as a charge in 2011. At December 31, 2012, we had goodwill with a remaining carrying amount of approximately $54.8 million.

Income Taxes.

Deferred tax assets and liabilities are recognized based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and, where necessary, establish a valuation allowance. We are subject to the alternative minimum tax, or AMT, and payments of AMT result in a reduction of our deferred tax liability.

Segment Reporting.

We operate in one segment and have only one reportable segment and one reporting unit component, heavy civil construction. In making this determination, we considered that each project has similar characteristics, includes similar services and similar types of customers and is subject to similar regulatory and economic environments. We organize, evaluate, and manage our financial information around each project when making operating decisions and assessing overall performance. Even if our local offices were to be considered separate components of our heavy civil construction operating segment, those components could be aggregated into a single reporting unit for purposes of testing goodwill for impairment under ASC 280 and EITF D-101 because our local offices all have similar economic characteristics and are similar in all of the following areas:

The nature of the products and services - each of our local offices perform similar construction projects - they build, reconstruct and repair roads, highways, bridges, light rail and water, waste water and storm drainage systems.

The nature of the production processes - our heavy civil construction services rendered in the construction process for each of our construction projects performed by each local office is the same - they excavate dirt, remove existing pavement and pipe, lay aggregate or concrete pavement, pipe and rail and build bridges and similar large structures in order to complete our projects.

The type or class of customer for products and services - substantially all of our customers are state departments of transportation, cities, counties, and regional water, rail and toll-road authorities. A substantial portion of the funding for the state departments of transportation to finance the projects we construct is furnished by the federal government.

The methods used to distribute products or provide services - the heavy civil construction services rendered on our projects are performed primarily with our own field work crews (laborers, equipment operators and supervisors) and equipment (backhoes, loaders, dozers, graders, cranes, pug mills, crushers, and concrete and asphalt plants).

The nature of the regulatory environment - we perform substantially all of our projects for federal, state and municipal governmental agencies, and all of the projects that we perform are subject to substantially similar regulation under U.S. and state department of transportation rules, including prevailing wage and hour laws; codes established by the federal government and municipalities regarding water and waste water systems installation; and laws and regulations relating to workplace safety and worker health of the U.S. Occupational Safety and Health Administration and to the employment of immigrants of the U.S. Department of Homeland Security.

The economic characteristics of our local offices are similar. While profit margin objectives included in contract bids have some variability from contract to contract, our profit margin objectives are not differentiated by our chief operating decision maker or our office management based on local office location. Instead, the projects undertaken by each local office are primarily competitively-bid, fixed-unit or negotiated lump-sum price contracts, all of which are bid based on achieving gross margin objectives that reflect the relevant skills required, the contract size and duration, the availability of our personnel and equipment, the makeup and level of our existing backlog, our competitive advantages and disadvantages, prior experience, the contracting agency or customer, the source of contract funding, anticipated start and completion dates, construction risks, penalties or incentives and general economic conditions.

Results of Operations.

Backlog at December 31, 2012

At December 31, 2012, our backlog of construction projects was $656 million, as compared to $616 million at December 31, 2011. Our Company was awarded $643 million of new contracts in 2012, excluding acquired contracts, compared to $595 million of new contracts in 2011. Our contracts are typically completed in 12 to 36 months. At December 31, 2012, there was approximately $63 million excluded from our consolidated backlog where we were the apparent low bidder, but had not yet been formally awarded the contract or the contract price had not been finalized. Backlog includes $77 million attributable to our share of estimated revenues related to joint ventures where we are a noncontrolling joint venture partner. As discussed further in "Item 1. Business?Recent Developments?Financial Results for 2012, Operational Issues and Outlook for 2013 Financial Results," based on our current estimates, the gross margin in our backlog is lower than the gross margin of 7.5% realized in 2012 as a result of operational issues and lower infrastructure capital expenditures by federal and state governments.

We do, however, expect that our markets will ultimately recover from the conditions discussed in "Item 1. Business" and that our backlog and revenues will grow and gross margins, net income and earnings per share will return to levels more consistent with historical rates of return. However, we cannot predict the timing of such a return to historical normalcy in our markets. We believe that the Company is in sound financial condition and has the resources and management experience to weather current market conditions and to continue to compete successfully for projects as they become available at acceptable profit margin levels. See "Item 1. Business - Our Markets, Competition and Customers" for a more detailed discussion of our markets and their funding sources.

Fiscal Year Ended December 31, 2012 Compared with Fiscal Year Ended December 31,


                                                                2012                  2011             % Change
                                                               (Dollar amounts in thousands)
Revenues                                                   $       630,507       $       501,156            25.8 %
Gross profit                                               $        47,472       $        39,837            19.2
General and administrative expenses                                (35,187 )             (24,785 )          42.6
Goodwill impairment                                                     --               (67,000 )            NM
Unusual items                                                         (511 )                (676 )            NM
Other income (expense)                                               3,205                   390              NM
Operating income (loss)                                             14,979               (52,234 )            NM
Gains (losses) on the sale of short-term investments                 1,797                    94              NM
Interest income                                                      1,301                 1,655           (21.4 )
Interest expense                                                      (944 )              (1,231 )         (23.3 )
Income (loss) before income taxes and earnings
attributable to noncontrolling interests                            17,133               (51,716 )            NM
Income tax benefit (expense)                                           579                17,012           (96.3 )
Net income (loss)                                                   17,712               (34,704 )            NM
Noncontrolling owners' interests in earnings of
subsidiaries and joint ventures                                    (18,009 )              (1,196 )            NM
Net income (loss) attributable to Sterling common
stockholders                                               $          (297 )     $       (35,900 )         (99.2 )
Gross margin                                                           7.5 %                 8.0 %          (6.3 )
Operating margin (deficit)                                             2.4 %               (10.4 )%           NM
Contract backlog, end of year                              $       656,000       $       616,000             6.5

NM - Not meaningful.


Revenues for 2012 increased 25.8% compared with the prior year. Most of this increase is attributable to revenues from contracts performed in Arizona and California which totaled $168.9 million in 2012 as compared to $19.5 million in 2011. Prior to the August 1, 2011 acquisitions of JBC and Myers, we did not perform any work in these states. Since our acquisition of these entities they have performed well in their respective markets. We also had higher revenues in Utah, Nevada, and Texas reflecting higher activity levels and improvements in estimated profitability in certain projects. During 2012, results included $43.7 million of revenues and $11.8 million of gross profit attributable to our share of the results from a construction project joint venture in which we were a minority participant. The joint venture's construction project is substantially complete, and we do not anticipate a significant amount of additional earnings from this joint venture in future periods.

Gross Profit.

Gross profit increased $7.6 million for 2012 compared with the prior year. Gross margins declined to 7.5% in 2012 from 8.0% in 2011 due to net downward revisions of estimated revenues and gross margins on a number of construction projects, primarily in Texas. Upward revisions on projects in Utah substantially offset the downward revisions for Texas projects in 2012. Downward revisions for Texas projects had a significant impact on 2011 gross profits as well. These upward revisions were primarily related to the joint venture project which is substantially complete discussed under "Revenues" above. The net revisions to contract estimates were the result of different factors affecting various contracts, some positively and some negatively. While there are a number of factors which cause the costs incurred and gross profit realized on our contracts to vary, sometimes substantially, from our original projections, the primary factors which resulted in downward revisions in estimates in 2012 were:

conditions or contract requirements that differed from those assumed in the original bid or contract;
lower than expected activity levels; and
delays in quickly identifying and taking measures to address issues which arose during production.

At December 31, 2012, we had approximately 91 contracts-in-progress which were less than 90% complete of various sizes, of different expected profitability and in various stages of completion. The nearer a contract progresses toward completion, the more visibility we have in refining our estimate of total revenues (including incentives, delay penalties and change orders), costs and gross profit. Thus gross profit as a percent of revenues can increase or decrease from comparable and sequential quarters due to variations among contracts and depending upon the stage of completion of contracts.

General and administrative expenses

General and administrative expenses for 2012 included a full year of general and administrative expenses for JBC and Myers which we acquired on August 1, 2011 as well as an increase in compensation related expenses and professional fees. As a percent of revenues, general and administrative expenses in 2012 were higher at 5.7% compared with 5.1% for the prior year and included a signing bonus of $250,000 paid to our newly appointed CEO and $670,000 in compensation for our retiring CEO.

Goodwill Impairment.

During the fourth quarter of 2011, the Company completed an evaluation of the carrying value of goodwill resulting in an impairment charge of $67.0 million. This charge had an impact of $41.8 million on the net loss attributable to Sterling common stockholders (net of the related tax benefits and reduced for the amount attributable to noncontrolling interest owners) or $2.55 per diluted share. No goodwill impairment charge was recorded in 2012. See Note 8 to the Consolidated Financial Statements.

Income taxes.

Our effective income tax rates for 2012 and 2011 were (3.4)% and 32.9%, respectively, and varied from the statutory rate primarily as a result of net income attributable to noncontrolling interest owners which are taxed to those owners rather than Sterling. In addition, the effective tax rate for 2012 was impacted by non-taxable interest income, and the effective tax rate for 2011 was impacted by the portion of the goodwill impairment attributable to goodwill that is not deductible for tax purposes.

Net income attributable to noncontrolling interests.

Net income attributable to noncontrolling interest owners increased in 2012 compared with 2011 and is primarily related to net income attributable to the 20% noncontrolling interest owners in RLW. This subsidiary was 80% owned until December 31, 2012 when we acquired the remaining 20% interest. As discussed further in Note 2 to the consolidated financial statements, the members of RLW, including the Company, agreed to amend RLW's operating agreement effective January 1, 2012 to provide that any goodwill impairment, including the 2011 fourth quarter goodwill impairment, is not to be allocated to RLW for the purpose of calculating the distributions to be made to the RLW noncontrolling interest holders. This amendment resulted in an increase in the net income attributable to RLW's noncontrolling interests of $6.7 million during 2012. This increase is included in "Noncontrolling owners' interests in earnings of subsidiaries and joint ventures" in the accompanying consolidated statements of operations with an increase in the "Current obligation for noncontrolling owners' interest in subsidiaries and joint ventures" in the consolidated balance sheet. This increase has a related tax impact of $2.4 million which increased the tax benefit for 2012.

Fiscal Year Ended December 31, 2011 Compared with Fiscal Year Ended December 31, 2010.

                                                                2011                    2010            % Change
                                                                (Dollar amounts in thousands)
Revenues                                                   $       501,156         $       459,893            9.0 %
Gross profit                                                        39,837                  62,705          (36.5 )
General and administrative expenses                                (24,785 )               (24,895 )         (0.4 )
Goodwill impairment                                                (67,000 )                    --             NM
Unusual items                                                         (676 )                    --             NM
Other income (expense)                                                 390                  (1,900 )           NM
Operating income (loss)                                            (52,234 )                35,910             NM
Gains (losses) on the sale of short-term investments                    94                     (38 )           NM
Interest income                                                      1,655                   1,809           (8.5 )
Interest expense                                                    (1,231 )                (1,187 )          3.7
Income (loss) before income taxes and earnings
attributable to noncontrolling interests                           (51,716 )                36,494             NM
Income tax benefit (expense)                                        17,012                 (10,270 )           NM
Net income (loss)                                                  (34,704 )                26,224             NM
Noncontrolling owners' interests in earnings of
subsidiaries and joint ventures                                     (1,196 )                (7,137 )        (83.2 )
Net income (loss) attributable to Sterling common
stockholders                                               $       (35,900 )       $        19,087             NM
Gross margin                                                           8.0 %                  13.6 %        (41.0 )
Operating margin (deficit)                                           (10.4 )%                  7.8 %           NM
Contract backlog, end of year                              $       616,000         $       522,000           18.0

NM - not meaningful


Revenues increased 9.0% or $41.3 million in fiscal year 2011 over fiscal year 2010. The increase was primarily due to increased production levels in 2011 as a result of execution on contracts awarded in Texas markets in 2010, increased revenues resulting from a higher level of activity on joint ventures in which we participate, primarily in Utah, and $19.5 million in revenues in Arizona and California attributable to JBC and Myers which were acquired on August 1, 2011. . . .

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