| STERLING CONSTRUCTION CO INC Item 1A Risk Factors The risk factors described below are those which we believe are the material risks that face the Company |
| Any of these risk factors could significantly and adversely affect our business, prospects, financial condition and results of operations |
| Risks Relating to Our Business If we are unable to accurately estimate the overall risks or costs when we bid on a contract which is ultimately awarded to us, we may achieve a lower than anticipated profit or incur a loss on the contract |
| Substantially all of our revenues and contract backlog are typically derived from fixed unit price contracts |
| Fixed unit price contracts require us to perform the contract for a fixed unit price irrespective of our actual costs |
| As a result, we realize a profit on these contracts only if we successfully estimate our costs and then successfully control actual costs and avoid cost overruns |
| If our cost estimates for a contract are inaccurate, or if we do not execute the contract within our cost estimates, then cost overruns may cause us to incur losses or cause the contract not to be as profitable as we expected |
| This, in turn, could negatively affect our cash flow, earnings and financial position |
| The costs incurred and gross profit realized on those contracts can vary, sometimes substantially, from the original projections due to a variety of factors, including, but not limited to: • onsite conditions that differ from those assumed in the original bid; • delays caused by weather conditions; • contract modifications creating unanticipated costs not covered by change orders; • changes in availability, proximity and costs of materials, including steel, concrete, aggregate and other construction materials (such as stone, gravel and sand), as well as fuel and lubricants for our equipment; • availability and skill level of workers in the geographic location of a project; • our suppliers’ or subcontractors’ failure to perform; • fraud or theft committed by our employees; • mechanical problems with our machinery or equipment; • citations issued by a governmental authority, including the Occupational Safety and Health Administration; • difficulties in obtaining required governmental permits or approvals; • changes in applicable laws and regulations; and • claims or demands from third parties alleging damages arising from our work or from the project of which our work is part |
| Many of our contracts with public sector customers contain provisions that purport to shift some or all of the above risks from the customer to us, even in cases where the customer is partly at fault |
| Our practice in many instances has been to supersede these terms with an agreement to obtain insurance covering both the customer and ourselves |
| In cases where insurance is not obtained, our experience has often been that public sector customers have been willing to negotiate equitable adjustments in the contract compensation or completion time provisions if unexpected circumstances arise |
| If we are unable to obtain insurance, and if public sector customers seek to impose contractual risk-shifting provisions more aggressively, we could face increased risks, which may adversely affect our cash flow, earnings and financial position |
| Page 12 _________________________________________________________________ [84]Table of Contents Economic downturns or reductions in government funding of infrastructure projects, or the cancellation of significant contracts, could reduce our revenues and profits and have a material adverse effect on our results of operations |
| Our business is highly dependent on the amount of infrastructure work funded by various governmental entities, which, in turn, depends on the overall condition of the economy, the need for new or replacement infrastructure, the priorities placed on various projects funded by governmental entities and federal, state or local government spending levels |
| Decreases in government funding of infrastructure projects could decrease the number of civil construction contracts available and limit our ability to obtain new contracts, which could reduce our revenues and profits |
| Contracts that we enter into with governmental entities can usually be canceled at any time by them with payment only for the work already completed |
| In addition, we could be prohibited from bidding on certain governmental contracts if we fail to maintain qualifications required by those entities |
| A sudden cancellation of a contract or our debarment from the bidding process could cause our equipment and work crews to remain idled for a significant period of time until other comparable work became available, which could have a material adverse effect on our business and results of operations |
| Our operations are currently focused in Texas, and any adverse change to the economy or business environment in Texas could significantly affect our operations, which would lead to lower revenues and reduced profitability |
| Our operations are currently concentrated in Texas, and primarily in the Houston area |
| Because of this concentration in a specific geographic location, we are susceptible to fluctuations in our business caused by adverse economic or other conditions in this region, including natural or other disasters |
| A stagnant or depressed economy in Texas generally or in Houston specifically, or in any of the other markets that we serve, could adversely affect our business, results of operations and financial condition |
| Our industry is highly competitive, with a variety of larger companies with greater resources competing with us, and our failure to compete effectively could reduce the number of new contracts awarded to us or adversely affect our margins on contracts awarded |
| Essentially all of the contracts on which we bid are awarded through a competitive bid process, with awards generally being made to the lowest bidder, but sometimes recognizing other factors, such as shorter contract schedules or prior experience with the customer |
| Within our markets, we compete with many national, regional and local construction firms |
| Some of these competitors have achieved greater market penetration than we have in the markets in which we compete, and some have greater financial and other resources than we have |
| In addition, there are a number of national companies in our industry that are larger than us that, if they so desired, could establish a presence in our markets and compete with us for contracts |
| As a result, we may need to accept lower contract margins in order to compete against these competitors |
| If we are unable to compete successfully in our markets, our relative market share and profits could be reduced |
| Our dependence on subcontractors and suppliers of materials, including petroleum-based products, could increase our costs and impair our ability to complete contracts on a timely basis or at all, which would adversely affect our profits and cash flow |
| We do not bid on contracts unless we have the necessary subcontractors committed for the anticipated scope of the contract and at prices that we have included in our bid |
| Therefore, to the extent that we cannot engage subcontractors, our ability to bid for contracts may be impaired |
| In addition, if a subcontractor is unable to deliver its services according to the negotiated terms for any reason, including the deterioration of its financial condition, we may suffer delays and be required to purchase the services from another source at a higher price |
| Page 13 _________________________________________________________________ [85]Table of Contents We also rely on third-party suppliers to provide all of the materials, including aggregates, concrete, steel and pipe, for our contracts |
| We do not own any quarries, and there are no naturally occurring sources of aggregate in the Houston metropolitan area |
| We do not bid on contracts unless we have commitments from suppliers for the materials required to complete the contract and at prices that we have included in our bid |
| Thus, to the extent that we cannot obtain commitments from our suppliers for materials, our ability to bid for contracts may be impaired |
| In addition, if a supplier is unable to deliver materials according to the negotiated terms of a supply agreement for any reason, including the deterioration of its financial condition, we may suffer delays and be required to purchase the materials from another source at a higher price |
| Diesel fuel and other petroleum-based products are utilized to operate the equipment used in our construction contracts |
| Decreased supplies of those products relative to demand and other factors can cause an increase in their cost |
| Future increases in the costs of fuel and other petroleum-based products used in our business, particularly if a bid has been submitted for a contract and the costs of those products have been estimated at amounts less than the actual costs thereof, could result in a lower profit, or a loss, on a contract |
| We may not be able to fully realize the revenue anticipated by our reported contract backlog |
| As indicated above, at January 1, 2006, our contract backlog was approximately dlra307 million |
| Almost all of our contracts are awarded by public sector customers through a competitive bid process, with the award generally being made to the lowest bidder |
| We add new contracts to our announced contract backlog, typically when we are the low bidder on a public sector contract and have determined that there are no apparent impediments to award of the contract |
| As construction on our contracts progresses, we increase or decrease contract backlog to take account of changes in estimated quantities under fixed unit price contracts, as well as to reflect changed conditions, change orders and other variations from initially anticipated contract revenues and costs, including completion penalties and bonuses |
| We subtract from contract backlog the amounts we bill on contracts |
| Most of the contracts with our public sector customers can be terminated at their discretion |
| Cancellation of one or more contracts that constitute a large percentage of our contract backlog, and our inability to find a substitute contract, would have a material adverse effect on our business, results of operations and financial condition |
| If we are unable to attract and retain key personnel, our ability to bid for and successfully complete contracts may be negatively impacted |
| Our ability to attract and retain reliable, qualified personnel is a significant factor that affects our ability to successfully bid for and profitably complete our work |
| This includes members of our management team, project managers, supervisors, foremen, equipment operators and laborers |
| The loss of the services of any of our management could have a material adverse effect on us |
| Our future success will also depend on our ability to attract and retain highly-skilled personnel |
| Competition for these employees is intense, and we could experience difficulty hiring and retaining the personnel necessary to support our business |
| If we do not succeed in retaining our current employees and attracting new highly-skilled employees, our reputation may be harmed and our future earnings may be negatively impacted |
| Our contracts may require us to perform extra or change order work, which can result in disputes and adversely affect our working capital, profits and cash flows |
| Our contracts generally require us to perform extra or change order work as directed by the customer even if the customer has not agreed in advance on the scope or price of the extra work to be performed |
| This process may result in disputes over whether the work performed is beyond the Page 14 _________________________________________________________________ [86]Table of Contents scope of the work included in the original project plans and specifications or, if the customer agrees that the work performed qualifies as extra work, the price that the customer is willing to pay for the extra work |
| These disputes may not be settled to our satisfaction |
| Even when the customer agrees to pay for the extra work, we may be required to fund the cost of that work for a lengthy period of time until the change order is approved by the customer and we are paid by the customer |
| To the extent that actual recoveries with respect to change orders or amounts subject to contract disputes or claims are less than the estimates used in our financial statements, the amount of any shortfall will reduce our future revenues and profits, and this could have a material adverse effect on our reported working capital and results of operations |
| In addition, any delay caused by the extra work may adversely impact the timely scheduling of other project work and our ability to meet specified contract milestones |
| Our failure to meet schedule or performance requirements of our contracts could adversely affect us |
| In most cases, our contracts require completion by a scheduled acceptance date |
| Failure to meet any such schedule could result in additional costs being incurred, penalties and liquidated damages being assessed against us, and these could exceed projected profit margins on the contract |
| Performance problems on existing and future contracts could cause actual results of operations to differ materially from those anticipated by us and could cause us to suffer damage to our reputation within the industry and among our customers |
| Timing of the award and performance of new contracts could have an adverse effect on our operating results and cash flow |
| At any point in time, a substantial portion of our revenues may be derived from a limited number of large construction contracts |
| It is generally very difficult to predict whether and when new contracts will be offered for tender, as these contracts frequently involve a lengthy and complex design and bidding process, which is affected by a number of factors, such as market conditions, financing arrangements and governmental approvals |
| Because of these factors, our results of operations and cash flows may fluctuate from quarter to quarter and year to year, and the fluctuation may be substantial |
| The uncertainty of the timing of contract awards may also present difficulties in matching the size of work crews with contract needs |
| In some cases, we may maintain and bear the cost of a ready work crew that is larger than currently required, in anticipation of future employee needs for existing contracts or expected future contracts |
| In addition, the timing of the revenues, earnings and cash flows from our contracts can be delayed by a number of factors, including adverse weather conditions such as prolonged or intense periods of rain, storms or flooding, delays in receiving material and equipment from suppliers and changes in the scope of work to be performed |
| Those delays, if they occur, could have an adverse effect on our operating results for a particular period |
| Our dependence on a limited number of customers could adversely affect our business and results of operations |
| Due to the size and nature of our construction contracts, one or a few customers have in the past and may in the future represent a substantial portion of our consolidated revenues and gross profits in any one year or over a period of several consecutive years |
| For example, in 2005, approximately 75prca of our revenues was generated from three customers |
| Similarly, our contract backlog frequently reflects multiple contracts for individual customers; therefore, one customer may comprise a significant percentage of contract backlog at a certain point in time |
| An example of this is TXDOT, with which we had 20 separate contracts representing an aggregate of approximately 79prca of our contract backlog at January 1, 2006 |
| The loss of business from any one of those customers could have a material adverse effect on our business or results of operations |
| Because we do not maintain any Page 15 _________________________________________________________________ [87]Table of Contents reserves for payment defaults, a default or delay in payment on a significant scale could materially adversely affect our business, results of operations and financial condition |
| We may incur higher costs to acquire and maintain equipment necessary for our operations, and the market value of our equipment may decline |
| We have traditionally owned most of the construction equipment used to build our projects, and we do not bid on contracts for which we do not have, or cannot quickly procure (whether through acquisition or lease), the necessary equipment |
| To the extent that we are unable to buy construction equipment necessary for our needs, either due to a lack of available funding or equipment shortages in the marketplace, we may be forced to rent equipment on a short-term basis, which could increase the costs of completing contracts |
| In addition, our equipment requires continuous maintenance for which we maintain our own repair facilities |
| If we are unable to continue to maintain the equipment in our fleet, we may be forced to obtain third-party repair services, which could increase our costs |
| The market value of our equipment may unexpectedly decline at a faster rate than anticipated |
| Such a decline would reduce the borrowing base under our construction business credit facility, thereby reducing the amount of credit available to us and impeding our ability to expand our business consistent with historical levels |
| Unanticipated adverse weather conditions may cause delays, which could slow completion of our contracts and negatively affect our revenues and cash flow |
| Because all of our construction projects are built outdoors, work on our contracts is subject to unpredictable weather conditions |
| For example, evacuations due to Hurricane Rita in September 2005 resulted in our inability to perform work on all Houston-area contracts for several days |
| Lengthy periods of wet weather will generally interrupt construction, and this can lead to under-utilization of crews and equipment, resulting in less efficient rates of overhead recovery |
| While revenues can be recovered following a period of bad weather, it is generally impossible to recover the efficiencies, and hence, we may suffer reductions in the expected profit on contracts |
| An inability to obtain bonding could limit the number of contracts that we are able to pursue |
| As is customary in the construction business, we are required to provide surety bonds to secure our performance under construction contracts |
| Our ability to obtain surety bonds primarily depends upon our capitalization, working capital, past performance, management expertise and reputation and certain external factors, including the overall capacity of the surety market |
| Surety companies consider those factors in relation to the amount of our contract backlog and their underwriting standards, which may change from time to time |
| For instance, we recently outgrew the bonding limits of our prior surety bonding company and arranged a new source of bonding |
| Events that affect the insurance and bonding markets generally may result in bonding becoming more difficult to obtain in the future, or being available only at a significantly greater cost |
| Our inability to obtain adequate bonding, and, as a result, to bid on new contracts, could have a material adverse effect on our future revenues and business prospects |
| Our operations are subject to hazards that may cause personal injury or property damage, thereby subjecting us to liabilities and possible losses, which may not be covered by insurance |
| Our workers are subject to the usual hazards associated with providing services on construction sites |
| Operating hazards can cause personal injury and loss of life, damage to, or destruction of, property, plant and equipment and environmental damage |
| We self-insure our workers’ compensation claims, subject to stop-loss insurance coverage |
| We also maintain insurance coverage in amounts and against the risks that we believe are consistent with industry practice, but this insurance may not be adequate to cover all losses or liabilities that we may incur in our operations |
| Insurance liabilities are difficult to assess and quantify due to unknown factors, including the severity of an injury, the determination of our liability in proportion to other parties, the number of incidents not reported and the effectiveness of our safety program |
| If we were to experience insurance claims or costs above our estimates, we might also be required to use working capital to satisfy these claims Page 16 _________________________________________________________________ [88]Table of Contents rather than to maintain or expand our operations |
| To the extent that we experience a material increase in the frequency or severity of accidents or workers’ compensation claims, or unfavorable developments on existing claims, our operating results and financial condition could be materially and adversely affected |
| Environmental and other regulatory matters could adversely affect our ability to conduct our business and could require expenditures that could have a material adverse effect on our results of operations and financial condition |
| Our operations are subject to various environmental laws and regulations relating to the management, disposal and remediation of hazardous substances and the emission and discharge of pollutants into the air and water |
| We could be held liable for the contamination created not only by our own activities but also by the historical activities of others on our project sites or on properties that we acquire |
| Our operations are also subject to laws and regulations relating to workplace safety and worker health, which, among other things, regulate employee exposure to hazardous substances |
| Violations of those laws and regulations could subject us to substantial fines and penalties, cleanup costs, third-party property damage or personal injury claims |
| In addition, these laws and regulations have become, and are becoming, increasingly stringent |
| Moreover, we cannot predict the nature, scope or effect of legislation or regulatory requirements that could be imposed, or how existing or future laws or regulations will be administered or interpreted, with respect to products or activities to which they have not been previously applied |
| Compliance with more stringent laws or regulations, as well as more vigorous enforcement policies of the regulatory agencies, could require us to make substantial expenditures for, among other things, pollution control systems and other equipment that we do not currently possess, or the acquisition or modification of permits applicable to our activities |
| Our acquisition strategy involves a number of risks |
| In addition to organic growth of our construction business, we intend to pursue growth through the acquisition of companies or assets that may enable us to expand our project skill-sets and capabilities, enlarge our geographic markets, add experienced management and increase critical mass to enable us to bid on larger or more complex contracts |
| However, we may be unable to implement this growth strategy if we cannot reach agreement on potential acquisitions on acceptable terms or for other reasons |
| Moreover, our acquisition strategy involves certain risks, including: • difficulties in the integration of operations and systems; • the key personnel and customers of the acquired company may terminate their relationships with the acquired company; • we may experience additional financial and accounting challenges and complexities in areas such as tax planning and financial reporting; • we may assume or be held liable for risks and liabilities (including for environmental-related costs) as a result of our acquisitions, some of which we may not discover during our due diligence; • our ongoing business may be disrupted or receive insufficient management attention; and • we may not be able to realize the cost savings or other financial benefits we anticipated |
| Future acquisitions may require us to obtain additional equity or debt financing, which may not be available on terms acceptable to us |
| Moreover, to the extent that any acquisition results in additional goodwill, it will reduce our tangible net worth, which might have an adverse effect on our credit and bonding capacity |
| We may be unable to sustain our historical revenue growth rate |
| Our revenue has grown rapidly in recent years |
| However, we may be unable to sustain our recent revenue growth rate for a variety of reasons, including limits on additional growth in our current markets, less success in competitive bidding for contracts, limitations on access to necessary working capital and investment Page 17 _________________________________________________________________ [89]Table of Contents capital to sustain growth, limitations on access to bonding to support increased contracts and operations, the inability to hire and retain essential personnel and to acquire equipment to support growth, and the inability to identify acquisition candidates and successfully integrate them into our business |
| A decline in our revenue growth could have a material adverse effect on our financial condition and results of operations if we are unable to reduce the growth of our operating expenses at the same rate |
| Terrorist attacks have impacted, and could continue to negatively impact, the US economy and the markets in which we operate |
| Terrorist attacks, like those that occurred on September 11, 2001, have contributed to economic instability in the United States, and further acts of terrorism, violence or war could affect the markets in which we operate, our business and our expectations |
| Armed hostilities may increase, or terrorist attacks, or responses from the United States, may lead to further acts of terrorism and civil disturbances in the United States or elsewhere, which may further contribute to economic instability in the United States |
| These attacks or armed conflicts may affect our operations or those of our customers or suppliers and could impact our revenues, our production capability and our ability to complete contracts in a timely manner |
| Our discontinued operations subject us to continuing liabilities and other risks |
| We will remain subject to the liabilities of Steel City Products’ distribution business until it is sold |
| For further information on Steel City Products, see Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations |
| Because we have reclassified the business as being held for sale, customers may become concerned about the continued viability of the business and may purchase their products elsewhere, and suppliers may become concerned about the continued viability of the business and limit shipments to us, thereby decreasing the revenues and income earned by the business |
| For similar reasons, we may have difficulty attracting and retaining qualified personnel, the business’s reputation may be harmed, and future earnings may be negatively impacted |
| We may also have difficulty finding a purchaser for the business, and we will incur costs in connection with the disposition of the business and could continue to remain responsible for certain liabilities after a sale |
| As a result, we may record a loss from discontinued operations, and we may also incur a loss upon the sale of the business |
| In addition, we may have contractual or other further liabilities with respect to the discontinued operations after a sale of the distribution business is completed |
| Risks Related to Our Financial Results and Financing Plans Actual results could differ from the estimates and assumptions that we use to prepare our financial statements |
| To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, or US GAAP, management is required to make estimates and assumptions as of the date of the financial statements which affect the reported values of assets and liabilities, revenues and expenses, and disclosures of contingent assets and liabilities |
| Areas requiring significant estimates by our management include contract costs and profits, application of percentage-of-completion accounting, and revenue recognition of contract change order claims; provisions for uncollectible receivables and customer claims and recoveries of costs from subcontractors, suppliers and others; valuation of assets acquired and liabilities assumed in connection with business combinations; accruals for estimated liabilities, including litigation and insurance reserves; and the value of our deferred tax assets |
| Our actual results could differ from those estimates |
| In particular, as is more fully discussed in Item 7 |
| —Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “Critical Accounting Policies,” we recognize contract revenue using the percentage-of-completion method |
| Under this method, estimated contract revenue is recognized by applying the percentage of completion of the contract for Page 18 _________________________________________________________________ [90]Table of Contents the period to the total estimated revenue for the contract |
| Estimated contract losses are recognized in full when determined |
| Contract revenue and total cost estimates are reviewed and revised on a continuous basis as the work progresses and as change orders are initiated or approved, and adjustments based upon the percentage of completion are reflected in contract revenue in the accounting period when these estimates are revised |
| To the extent that these adjustments result in an increase, a reduction or an elimination of previously reported contract profit, we recognize a credit or a charge against current earnings, as appropriate, which could be material |
| We may need to raise additional capital in the future for working capital, capital expenditures and/or acquisitions, and we may not be able to do so on favorable terms or at all, which would impair our ability to operate our business or achieve our growth objectives |
| In addition to our bank lines of credit, we have in the past relied upon financing from our management and directors to support a portion of our growth, but we do not expect to utilize that source for financing in the future |
| In addition, our growth has benefited in part from our utilization of net operating loss carry-forwards, or NOL’s, to reduce the amounts that we have paid for income taxes, and we expect our NOL’s to be fully utilized in 2007 |
| To the extent that cash flow from operations is insufficient to make future investments, make acquisitions or provide needed additional working capital, we may require additional financing from other sources of funds |
| Our ability to obtain such additional financing in the future will depend in part upon prevailing capital market conditions, as well as conditions in our business and our operating results; those factors may affect our efforts to arrange additional financing on terms satisfactory to us |
| We have pledged substantially all of our fixed assets as collateral in connection with our credit facilities, and our bonding capacity is dependent on maintaining an acceptable level of unencumbered working capital |
| As a result, we may have difficulty in obtaining additional financing in the future if the financing requires us to pledge our assets as collateral |
| In addition, under our credit facilities, we must obtain the consent of our lenders to incur any amount of additional debt from other sources (subject to certain exceptions) |
| If future financing is obtained by the issuance of additional shares of common stock, our existing stockholders may suffer dilution |
| If adequate funds are not available, or are not available on acceptable terms, we may not be able to make future investments, take advantage of acquisitions or other opportunities, or respond to competitive challenges |
| We are subject to financial and other covenants under our credit facilities that could limit our flexibility in managing our business |
| Our construction business and our discontinued operations each has a revolving credit facility that restricts the borrower from engaging in certain activities, including restrictions on the ability (subject to certain exceptions) to: • make distributions and dividends; • incur liens or encumbrances; • incur further indebtedness; • guarantee obligations; • dispose of a material portion of assets or otherwise engage in a merger with a third party; • pledge accounts receivable, in the case of the Steel City Products revolving credit facility; and • incur negative income for two consecutive quarters, in the case of the construction business revolving credit facility |
| Our credit facilities contain financial covenants that require us to maintain, in the case of the construction business revolving credit facility, a specified debt ratio and cash flow coverage ratio, and in the case of the Steel City Products revolving credit facility, a specified fixed charge coverage ratio |
| Our ability to borrow funds for any purpose will depend on our satisfying these tests |
| If we are unable to meet the terms of the financial covenants or fail to comply with any of the other restrictions contained in our credit facility agreements, an event of default could occur |
| An event of default, if Page 19 _________________________________________________________________ [91]Table of Contents not waived by our lenders, could result in the acceleration of any outstanding indebtedness, causing that debt to become immediately due and payable |
| If such an acceleration occurs, we may not be able to repay the indebtedness on a timely basis |
| Because our construction business credit facility is secured by substantially all of the construction business fixed assets and the Steel City Products revolving credit facility is secured by substantially all of the Steel City Products’ assets, acceleration of this debt could result in foreclosure of those assets |
| In addition, the Steel City Products revolving credit facility includes a subjective acceleration clause |
| In the event of a foreclosure, we could be unable to conduct our business and may be forced to discontinue operations |
| We may not be able to utilize all of our NOL’s if we experience an ownership change, and, even absent an ownership change, we expect that our NOL’s will be fully utilized by 2008 |
| At December 31, 2005, we had NOL’s of approximately dlra26dtta6 million |
| These NOL’s will expire in the years 2008 through 2020, although the amount available in any year to offset our net taxable income will be reduced if we experience an “ownership change” as defined in the Internal Revenue Code of 1986, as amended, or the Code |
| The tax laws pertaining to NOL’s may be changed from time to time such that the NOL’s may not be available to shield our future income from federal taxation |
| Finally, we expect that most of our federally-taxable income will be offset by NOL’s through 2007, which is when we expect to have used up all of our NOL’s |
| After the NOL’s become unavailable to us or are fully utilized, our future income will not be shielded from federal income taxation, thereby reducing funds otherwise available for general corporate purposes |
| Changes to the current tax laws could result in the imposition of entity level taxation on our construction operating subsidiary, which would result in a reduction in our anticipated cash flow |
| Our construction operating subsidiary is organized as a Texas limited partnership, which generally is not subject to entity level federal income or state franchise tax in the jurisdiction in which it is organized and operates |
| Current laws may change, subjecting our construction operating subsidiary to entity level taxation |
| For example, because of state budget deficits, the Texas legislature has been considering and evaluating ways to subject partnerships to entity level taxation through the imposition of state income, franchise or other forms of taxation |
| If Texas were to impose an entity-level tax upon our construction operating subsidiary, there would be a reduction in our net income and after-tax cash flow |
| We will be exposed to risks relating to the evaluations of internal controls over financial reporting required by Section 404 of the Sarbanes-Oxley Act of 2002 |
| We are currently in the process of evaluating our internal control systems to allow management to report on, and our independent auditors to attest as to the effectiveness of, our internal controls over financial reporting |
| We will be completing the systems and process evaluations and testing (and making any necessary remediation) required to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 |
| These systems are designed to produce accurate financial reports and to prevent fraudulent financial activity |
| We expect to be required to comply with Section 404 beginning with our Annual Report on Form 10-K for the year ending December 31, 2006 |
| However, we cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations |
| Furthermore, upon completion of this process, we may identify control deficiencies of varying degrees of severity under applicable SEC and Public Company Accounting Oversight Board rules and regulations, which may remain un-remediated |
| As a public company, we will be required to report, among other things, control deficiencies that constitute a “material weakness” or changes in internal controls that, or that are reasonably likely to, materially affect internal controls over financial reporting |
| A “material weakness” is a significant control weakness, or combination of significant deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected |
| If we fail to implement the requirements of Section 404 in a timely manner, we may be subject to sanctions or investigation by Page 20 _________________________________________________________________ [92]Table of Contents regulatory authorities such as the SEC or The Nasdaq National Market on which the Company’s common stock is traded |
| In addition, if any material weakness or deficiency is identified or is not remedied, investors may lose confidence in the accuracy of our reported financial information, and our stock price could be significantly adversely affected as a result |