

3.	Revenue from Contracts with Customers

Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in the new revenue standard. The contract transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The majority of Sterling's contracts have a single performance obligation as the promise to transfer the individual goods or services is not separately identifiable from other promises in the contracts and, therefore, not distinct. Some of the contracts have multiple performance obligations, most commonly due to the contract covering multiple phases of the project life cycle (design and construction). For contracts with multiple performance obligations, Sterling allocates the contract transaction price to each performance obligation using its best estimate of the standalone selling price of each distinct good or service in the contract. The primary method used to estimate standalone selling price is the expected cost plus a margin approach, under which Sterling forecasts the expected costs of satisfying a performance obligation and then adds an appropriate margin for that distinct good or service.

Performance Obligations Satisfied Over Time

Revenue for Sterling's heavy civil construction segment contracts that satisfy the criteria for over time recognition (formerly known as percentage-of-completion method) is recognized as the work progresses. The majority of the revenue is derived from long-term, heavy civil construction contracts and projects that typically span between 12 to 36 months. Sterling's heavy civil construction contracts will continue to be recognized over time because of the continuous transfer of control to the customer as all of the work is performed at the customer’s site and, therefore, the customer controls the asset as it is being constructed. This continuous transfer of control to the customer is further supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay Sterling for costs incurred plus a reasonable profit and take control of any work in process. Under the new revenue standard, the cost-to-cost measure of progress continues to best depict the transfer of control of assets to the customer, which occurs as the Company incurs costs. Contract costs include labor, material and indirect costs. Revenue from products and services transferred to customers over time accounted for 85%, 89% and 100% of revenue for the years ended December 31, 2018, 2017 and 2016, respectively.

Performance Obligations Satisfied at a Point in Time

Revenue for the residential construction segment contracts that do not satisfy the criteria for over time recognition is recognized at a point in time. Substantially all of the revenue recognized at a point in time is for work performed by the residential construction segment. Unlike the heavy civil construction segment that uses a cost-to-cost input measure for performance, the residential construction segment utilizes an output measure for performance based on the completion of a unit of work (e.g., residential foundation). The typical time frame for completion of a residential foundation is less than one month. Upon fulfillment of the performance obligation, the customer is provided an invoice (or equivalent) demonstrating transfer of control to the customer. Sterling believes that point in time recognition remains appropriate for this segment and will continue to recognize revenues upon completion of the performance obligation and issuance of an invoice. Revenue from goods and services transferred to customers at a point in time accounted for 15% and 11% of revenue for the years ended December 31, 2018 and 2017, respectively. There was not a residential segment, and therefore no point in time revenue, in 2016.

Contract modifications are routine in the performance of Sterling's contracts. Contracts are often modified to account for changes in the contract specifications or requirements. In most instances, contract modifications are for goods or services that are not distinct, and, therefore, are accounted for as part of the existing contract.

Assurance-type warranties are the only warranties provided by the Company and, as such, Sterling does not recognize revenue on warranty-related work. Sterling generally provides a 1 to 2 year warranty for workmanship under its contracts when completed. Warranty claims historically have been insignificant.

Pre-contract costs are generally charged to expense as incurred, but in certain cases their recognition may be deferred if specific probability criteria are met. Sterling had no significant deferred pre-contract costs at December 31, 2018.

Backlog

On December 31, 2018, Sterling had $850.7 million of remaining performance obligations in its heavy civil construction segment, which is also referred to as backlog. Sterling expects to recognize approximately 75% of its backlog as revenue during the next twelve months, and the balance thereafter.

Contract Estimates

Accounting for long-term contracts and programs involves the use of various techniques to estimate total contract revenue and costs. For long-term contracts, Sterling estimates the profit on a contract as the difference between the total estimated revenue and expected costs to complete a contract and recognizes that profit over the life of the contract.

Contract estimates are based on various assumptions to project the outcome of future events that often span several years. These assumptions include labor productivity and availability, the complexity of the work to be performed, the cost and availability of materials and the performance of subcontractors. 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. Changes in estimated revenues and gross margin resulted in a net increase of $7.1 million and $0.9 million for the years ended December 31, 2018 and 2017, respectively, included in “Operating income” on the consolidated statements of operations. Changes in estimated revenues and gross margin during the year ended December 31, 2016 resulted in a net decrease of $6.3 million included in operating loss. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined.

Variable Consideration

The transaction price for contracts may include variable consideration, which includes increases to transaction price for approved and unapproved change orders, claims and incentives, and reductions to transaction price for liquidated damages. Change orders, claims and incentives are generally not distinct from the existing contract due to the significant integration service provided in the context of the contract and are accounted for as a modification of the existing contract and performance obligation. Change orders may include changes in specifications or designs, manner of performance, facilities, equipment, materials, sites and period of completion of the work. Either Sterling or its customers may initiate change orders. Change orders that are unapproved as to both price and scope are evaluated as claims. Sterling estimates variable consideration for a performance obligation at the most likely amount to which the Company expects to be entitled (or the most likely amount Sterling expects to incur in the case of liquidated damages), utilizing estimation methods that best predict the amount of consideration to which the Company will be entitled (or will be incurred in the case of liquidated damages). Sterling includes variable consideration in the estimated transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur or when the uncertainty associated with the variable consideration is resolved. Sterling's estimates of variable consideration and determination of whether to include estimated amounts in transaction price are based largely on an assessment of its anticipated performance and all information (historical, current and forecasted) that is reasonably available to Sterling. The Company considers claims to be amounts in excess of approved contract prices that the Company seeks to collect from its customers or others for customer-caused delays, errors in specifications and designs, contract terminations, change orders that are either in dispute or are unapproved as to both scope and price, or other causes of unanticipated additional contract costs. The effect of variable consideration on the transaction price of a performance obligation is recognized as an adjustment to revenue on a cumulative catch-up basis. To the extent unapproved change orders and claims reflected in transaction price (or excluded from transaction price in the case of liquidated damages) are not resolved in Sterling's favor, or to the extent incentives reflected in transaction price are not earned, there could be reductions in, or reversals of, previously recognized revenue.

The Company has projects that it is in the process of negotiating, or awaiting final approval of, unapproved change orders and claims with its customers. The Company is proceeding with its contractual rights to recoup additional costs incurred from its customers based on completing work associated with change orders, including change orders with pending change order pricing, or claims related to significant changes in scope which resulted in substantial delays and additional costs in completing the work. Unapproved change order and claim information has been provided to Sterling's customers and negotiations with the customers are ongoing. If additional progress with an acceptable resolution is not reached, legal action will be taken.

Based upon Sterling's review of the provisions of its contracts, specific costs incurred and other related evidence supporting the unapproved change orders and claims, together in some cases as necessary with the views of the Company’s outside claim consultants, Sterling concluded that it was appropriate to include in project price amounts of $9.3 million and $10.0 million, at December 31, 2018 and 2017, respectively, in “Costs and estimated earnings in excess of billings on uncompleted contracts” on its consolidated balance sheets. However, unapproved change order and claim amounts are subject to negotiations which may cause actual results to differ materially from estimated and recorded amounts.

Revenue by Heavy Civil Construction Category

Sterling's heavy civil construction segment's portfolio of products and services consists of over 150 active contracts. The following series of tables presents Sterling's heavy civil construction revenue disaggregated by several categories.

Revenue by major end market (amounts in thousands):



	Years Ended December 31,
	2018		2017		2016
Heavy Highway	$	513,231	$	579,157	$	542,011
Commercial	120,388		48,314		31,664
Aviation	111,824		77,399		27,926
Water Containment and Treatment	66,928		59,593		39,918
Other	73,600		85,503		48,604
Heavy Civil Construction Revenue	$	885,971	$	849,966	$	690,123

Revenue by contract type (amounts in thousands):



	Years Ended December 31,
	2018		2017		2016
Fixed Unit Price	$	733,047	$	755,840	$	665,862
Lump Sum and Other	152,924		94,126		24,261
Heavy Civil Construction Revenue	$	885,971	$	849,966	$	690,123

Each of these contract types presents advantages and disadvantages. Typically, Sterling assumes more risk with lump-sum contracts. However, these types of contracts offer additional profits when the work is completed for less than originally estimated. Under fixed-unit price contracts, Sterling's profit may vary if actual labor-hour costs vary significantly from the negotiated rates. Also, because some contracts can provide little or no fee for managing material costs, the components of contract cost can impact profitability.

Contract Balances

The timing of revenue recognition, billings and cash collections results in billed accounts receivable and costs and estimated earnings in excess of billings on uncompleted contracts (contract assets) on the consolidated balance sheet. In Sterling's heavy civil construction segment, amounts are billed as work progresses in accordance with agreed-upon contractual terms, either at periodic intervals (e.g., biweekly or monthly) or upon achievement of contractual milestones. Generally, billing occurs subsequent to revenue recognition, resulting in contract assets. However, Sterling sometimes receives advances or deposits from its customers, before revenue is recognized, resulting in billings in excess of costs and estimated earnings on uncompleted contracts (contract liabilities). These assets and liabilities are reported on the consolidated balance sheet on a contract-by-contract basis at the end of each reporting period. Changes in the contract asset and liability balances during the year ended December 31, 2018 and 2017, were not materially impacted by any other factors.

The two tables below set forth the costs incurred and earnings accrued on uncompleted contracts (revenues) compared with the billings on those contracts through December 31, 2018 and 2017 and reconcile the net excess billings to the amounts included in the consolidated balance sheets at those dates (amounts in thousands).



	As of December 31,
	2018			2017
Costs incurred and estimated earnings on uncompleted contracts	$	3,445,126		$	2,380,866
Billings on uncompleted contracts	(3,465,991		)	(2,406,128		)
Excess of billings over costs incurred and estimated earnings	$	(20,865	)	$	(25,262	)

Included in the accompanying balance sheets under the following captions (amounts in thousands):



	As of December 31,
	2018			2017
Costs and estimated earnings in excess of billings on uncompleted contracts	$	41,542		$	37,112
Billings in excess of costs and estimated earnings on uncompleted contracts	(62,407		)	(62,374		)
Net amount of billings in excess of costs and estimated earnings on uncompleted contracts	$	(20,865	)	$	(25,262	)

Revenues recognized and billings on uncompleted contracts include cumulative amounts recognized as revenues and billings in prior years.