TRC Companies 10-K 2007
Documents found in this filing:
Washington, D.C. 20549
Amendment No. 1
x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended June 30, 2006
o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the transition period from to
Commission file number 1-9947
TRC COMPANIES, INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: (860) 298-9692
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. Yes o No x.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities 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 o No x
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 registrants 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. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act:
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x.
The aggregate market value of the registrants common stock held by non-affiliates on December 31, 2006 was approximately $86,000,000.
On December 31, 2006, there were 18,082,252 shares of common stock of the registrant outstanding.
We are filing this Amendment No. 1 to our annual report on Form 10-K/A of TRC Companies, Inc. for the fiscal year ended June 30, 2006 to restate our consolidated balance sheets and statements of changes in shareholders equity contained therein and related disclosures. As described in Note 3 to the consolidated financial statements, subsequent to the issuance of our consolidated financial statements for the fiscal year ended June 30, 2006, we identified an error in the accounting for an exit strategy contract whereby an insurance recoverable of $2,497,000 and an associated tax provision of $899,000 were not recorded during the year ended June 30, 2001. As the error relates to the year ended June 30, 2001, the Company recorded an increase to beginning retained earnings as of July 1, 2003 of $1,598,000 to correct the consolidated financial statements. Accordingly, the accompanying consolidated balance sheets as of June 30, 2006 and 2005 and the consolidated statements of changes in stockholders equity for each of the three years in the period ended June 30, 2006 have been restated from the amounts previously reported. The restatement has no impact on our consolidated statements of operations or cash flows.
For the convenience of the reader, this Form 10-K/A sets forth the originally filed Form 10-K in its entirety. However, the only changes in this Amendment No. 1 on Form 10-K/A to the original Form 10-K filed on February 26, 2007 are those caused by the restatement. This Amendment No. 1 on Form 10-K/A continues to speak as of the date of our original Form 10-K and we have not updated the disclosures to speak as of a later date or to reflect subsequent results, events or developments. Information not affected by the restatement is unchanged and reflects the disclosures made at the time of the filing of the original Form 10-K. Accordingly, this Form 10-K/A should be read in conjunction with our SEC filings made subsequent to the February 26, 2007 filing of the original Form 10-K. The following items have been amended as a result of the restatement and are included in this Amendment No. 1 on Form 10-K/A:
· Part IIItem 1ARisk Factors
· Part IIItem 6Selected Consolidated Financial Data
· Part IIItem 7Managements Discussion and Analysis of Financial Condition and Results of Operations
· Part IIItem 8Consolidated Financial Statements and Supplementary Data
· Part IIItem 9aControls and Procedures
· Part IVItem 15Exhibits and Financial Statement Schedules
Pursuant to the rules of the SEC, Item 15 of Part IV has been amended to contain the currently dated consent of our independent registered public accounting firm and the currently dated certifications from our principal executive officer and principal financial officer, as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. The consent of our independent registered public accounting firm and the certifications of our principal executive officer and principal financial officer are attached to this Amendment No. 1 on Form 10-K/A as Exhibits 23.1, 31.1, 31.2, 32.1 and 32.2 respectively.
We have not amended and do not intend to amend our previously filed Annual Reports on Form 10-K or our Quarterly Reports on Form 10-Q for periods affected by the restatement described herein that ended prior to June 30, 2006. For this reason, the previously issued consolidated financial statements and related financial information for the years ended June 30, 2002, 2003, 2004 and 2005 should no longer be relied upon.
Certain information included in this report, or in other materials we have filed or will file with the Securities and Exchange Commission (the SEC) (as well as information included in oral statements or other written statements made or to be made by us), contains or may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the 1995 Act). Such statements are being made pursuant to the 1995 Act and with the intention of obtaining the benefit of the Safe Harbor provisions of the 1995 Act. Forward-looking statements are based on information available to us and our perception of such information as of the date of this report and our current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. You can identify these statements by the fact that they do not relate strictly to historical or current facts. They contain words such as anticipate, estimate, expect, project, intend, plan, believe, may, can, could, might, or variations of such wording, and other words or phrases of similar meaning in connection with a discussion of our future operating or financial performance, and other aspects of our business, including market share growth, general and administrative expenses, and trends in our business and other characterizations of future events or circumstances. From time to time, forward-looking statements also are included in our other periodic reports on Forms 10-Q and 8-K, in press releases, in our presentations, on our website and in other material released to the public. Any or all of the forward-looking statements included in this report and in any other reports or public statements made by us are only predictions and are subject to risks, uncertainties and assumptions, including those identified below in the Risk Factors section, the Managements Discussion and Analysis of Financial Condition and Results of Operations section, and other sections of this report and in other reports filed by us from time to time with the SEC as well as in press releases. Such risks, uncertainties and assumptions are difficult to predict, beyond our control and may turn out to be inaccurate, causing actual results to differ materially from those that might be anticipated from our forward-looking statements. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. However, any further disclosures made on related subjects in our subsequent reports on Forms 10-K, 10-Q and 8-K should be consulted.
TRC Companies, Inc. (hereinafter collectively referred to as we or us), was incorporated in 1971. We are a national consulting, engineering and construction management firm with approximately 2,500 full- and part-time employees operating out of over 95 locations. We are headquartered in Windsor, Connecticut and our corporate website is www.trcsolutions.com (information on our website has not been incorporated by reference into this Form 10-K). Through a link on the Investor Center section of our website, we make available the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(d) or 15(d) of the Securities and Exchange Act of 1934 (the Exchange Act) as well as reports filed pursuant to Section 16 of the Exchange Act. All such filings are available free of charge.
In 1997, we implemented a growth strategy that contributed to an increase in net service revenue from $51 million for fiscal 1997 to $242 million for fiscal 2006, representing a compound annual growth rate of
19%. A significant feature of this strategy was growth through acquisitions which resulted in a decentralized corporate structure under which decision-making and operating controls in many instances were delegated to local management. As we grew, this business model resulted in a duplicative cost structure and inadequate internal controls that ultimately reduced profitability. For instance:
· seventeen financial systems were being run as of June 30, 2005 resulting in cost inefficiencies, increased costs associated with Section 404 of the Sarbanes-Oxley Act of 2002 (SOX), and data and communication limitations;
· a number of different business entities were maintaining their own accounting, human resource and other support functions and operating without appropriate cost control; and
· risk management processes and execution at some businesses resulted in contract losses and increased administrative costs.
Our new senior management team appointed during fiscal 2006 has developed and is implementing the following action plan to address these issues:
· Build a Senior Management Team. We built a new management team, including a new Chief Operating Officer and Chief Financial Officer.
· Emphasize Integration. We are integrating acquired companies into company-wide systems and standardizing processes, controls and reporting. The seventeen financial systems in place at June 30, 2005 were reduced to three at December 31, 2006, and we are moving to have all our operations managed from a single, common platform.
· Focus on Accountability. As part of our overall integration effort, we are focusing on management accountability, clarifying responsibilities and objectives, and incentives for performance.
· Improve Working Capital. Since June 30, 2005, we have focused on reducing our working capital needs. Days sales outstanding decreased from 120 days at June 30, 2005 to 100 days at December 31, 2006. Efforts to further reduce days sales outstanding continue.
· Rationalize Our Cost Structure. In the process of building an integrated core business, staff is being rationalized, real estate is being consolidated, and functions such as risk management, human resources, purchasing, payroll and cash management are being centralized.
· Improve Internal Controls. Controls over the risk management function have been enhanced such that we believe we should experience reduced losses from contracts compared to our recent experience. As detailed in Part II, Item 9A, Controls and Procedures, we have numerous material weaknesses in internal control over financial reporting. We are working to remediate all material weaknesses in internal control over financial reporting during the course of fiscal 2007 and fiscal 2008 and expect to have all material weaknesses remediated by June 30, 2008.
In addition, we plan to:
· Emphasize Organic Growth. We believe that significant opportunities for additional organic growth exist. As further discussed below under Services, we plan to extend services within our existing market areas as well as expand our existing services geographically.
· Identify Strategic Acquisitions. While organic performance will be our emphasis in the next fiscal year, strategic acquisitions will be selectively evaluated at the appropriate time.
Our services are focused on four principal market areas, namely: Real Estate, Energy, Environmental and Infrastructure. Each area presents different growth opportunities for us.
Our Exit Strategy® program is one of the most innovative and valuable services we offer our clients. The program was pioneered in 1997 and has since created a new market of risk transfers for contaminated properties. We remain a market leader with over ninety-five sites under contract, representing over $230.0 million in remediation work.
Our Exit Strategy program offers our clients an alternative to the continued management of contaminated sites and the perpetual retention of financial liability and risk. Under our program, we assume responsibility and liability for remediation of the site, with our client paying a fixed price backed by insurance from a highly rated insurance company or other financial assurance mechanism. We manage the risk of our Exit Strategy service in two ways. First, prior to undertaking any project under our Exit Strategy program, we complete a thorough due diligence process to understand and quantify the environmental conditions of the property and then design a risk management program to address the specific known and unknown risks. Second, we purchase, for both our clients and our benefit, finite risk cost cap insurance policies from a highly rated insurance company typically in an amount that is significantly higher than the estimated cost to remediate the environmental liability.
Traditionally, our Exit Strategy offering has been especially attractive to clients in the following situations:
· Acquisitions and Divestitures. In typical transactions, neither buyer nor seller wants to be responsible for existing environmental conditions of transferred assets. We solve this dilemma by identifying and quantifying the risk and entering into an Exit Strategy contract with our client to transfer that risk to us.
· Discontinued Operations. When our clients close facilities or purchase redundant facilities as part of a business transaction, they may be faced with the environmental legacy of the properties. By outsourcing the management of these responsibilities to us, our clients can focus their resources on ongoing business operations.
· Multi-Party Superfund Sites. By law, the cleanup of abandoned, environmentally impaired sites is the responsibility of those businesses that sent waste materials to the site during its period of operation. The typically inefficient and lengthy process of negotiating and managing these cleanups increases the legal and administrative cost burden for the potentially responsible parties. By taking sole responsibility for the site, we eliminate the additional costs and expedite the cleanup schedule.
· Brownfields Real Estate Development. The redevelopment of commercially viable but environmentally contaminated property is commonly referred to as brownfields redevelopment. Frequently, the parties interested in these properties, which typically include the responsible party, a municipality, and a developer, cannot agree on the cost of remediation, the allocation of that cost, and who will perform the remediation. Our Exit Strategy program helps to resolve these issues by defining the cost of remediating the brownfield. With the cost of the remedial effort known, the parties can then settle commercial issues of the proposed development.
Opportunities for our Exit Strategy program have been solid due to several market trends including the following:
· Increased Merger & Acquisition Activity. The level of domestic merger and acquisition activity has increased. In addition, certain buyers such as foreign companies and private equity funds tend to be more averse to assuming environmental liabilities than traditional buyers of U.S. companies.
· Industry Consolidation. The increased merger and acquisition activity is also reflective of increased consolidation in certain industries creating more discontinued operations. In the utility industry specifically, the Energy Policy Act encourages consolidation by repealing the Public Utility Holding Company Act which had previously allowed only mergers of contiguous or connected grids.
· New Accounting Standards. Clarifications to Statement of Financial Accounting Standard (SFAS) No. 143, Accounting for Asset Retirement Obligations, by Financial Accounting Standards Board (FASB) Interpretation No. 47, Accounting for Conditional Asset Obligations, have increased the focus on accounting recognition and disclosure of the cost of cleaning up contaminated idle facilities. This increase in recognition and disclosure has prompted companies to explore ways to remove these liabilities from their books.
· Increased Real Estate Prices. Due to developments in certain markets, more contaminated properties are now right-side up, in that the commercial value of the property exceeds projected cleanup costs.
· Urban In-Filling. State and local government policies with respect to suburban sprawl as well as the increasing costs of developing land not previously developed, or greenfield sites, have made previously undesirable contaminated urban sites attractive candidates for redevelopment.
· Brownfields Real Estate Development. We believe that significant opportunities exist to extend our real estate services through the acquisition, redevelopment, and sale of brownfield properties.
Energy has been our fastest growing market and its rate of growth is expected to continue. We are a national leader in providing environmental, engineering and compliance services for electric generating, electric transmission, natural gas transmission and liquefied natural gas projects.
Our comprehensive environmental consulting services offered to energy clients include: site selection and feasibility assessment; multidisciplinary licensing for brownfield and greenfield development sites; acquisition due diligence and auditing; compliance testing; site remediation; and environmental management system development. We provide engineering services for electrical substation and transmission facilities including: power system studies; engineering and design; construction management; testing and commissioning; and engineering, procurement and construction project implementation. Our clients for environmental and energy engineering services include many of the countrys leading utilities and private energy developers, natural gas companies and financial institutions.
Our energy management group provides consulting services on the demand side of the energy market. We assist state governments in assessing energy consumption patterns across large market segments and in designing strategies to reduce consumption. We also assist large energy consumers such as the Department of Defense, building management companies and hospitality chains in reducing their energy costs through increased efficiency or use of alternative energy sources.
Across all energy market segments that we serve, there is a convergence of factors supporting substantial future growth. Increasing demand for energy has now been supplemented by numerous incentives contained in the Federal Energy Policy Act of 2005 (the Act). The following sections briefly analyze energy demand and the federal incentives by market segment:
· Generation. After a slowdown in the construction of new electric generating facilities between 2002 and 2004, plans for the construction of new facilities have increased. The fundamental drivers for this market are: a projected annual growth rate of approximately 2% in the nations peak electricity requirements; limited transmission capacity in certain high demand regions of the country; and transitioning of fuels from higher priced natural gas and oil to lower priced coal.
In addition, the Act contains numerous incentives for new facility siting and development including tax provisions that encourage the use of coal gasification, nuclear and renewable energy sources including wind and other technologies. Many states are adding their own incentives for fuel diversification by setting minimum targets for renewable energy production.
Significant increases in investment are being made in existing power plants. Despite incentives for building new facilities, an investment that expands the capacity or lengthens the life of an existing facility may be the least cost option due to the difficulty of siting and capital costs for a new plant. The Act also provides favorable tax treatment for the installation of emission controls at existing power plants.
· Transmission. While utilities and private developers have been increasing power generation capacity, it has long been evident that improvements in the nations electric transmission infrastructure are overdue. Limited capacity in high demand regions and reliability concerns prompted Congress to include numerous incentives in the Act for reinforcement and expansion of our nations transmission infrastructure. The Act includes provisions for more favorable rate recovery of capital investments and backstop authority for the Federal Energy Regulatory Commission (FERC) to approve transmission corridors where states cannot resolve siting issues.
We recognized the potential for growth in the transmission market when we acquired E/Pro in 2002. E/Pro is a leading provider of engineering services in the Northeast for power substations and transmission lines. We are now extending these capabilities for transmission and distribution services to other regions of the country.
· Natural Gas. As the nation seeks to reduce its dependence on foreign oil, the conversion to renewables and clean coal will be insufficient to meet the growing demand for energy. Increased natural gas supplies must be part of the interim solution. Demand is projected to grow at an annual rate of 1.5% between 2006 and 2020. To increase gas supplies several actions are necessary: (1) new domestic gas fields must be developed; (2) new facilities to import foreign liquefied natural gas (LNG) must be developed; and (3) the pipeline infrastructure must be reinforced and expanded. We provide consulting services to support each of those actions.
Market demand and incentives in the Act are hastening the development of natural gas fields in the inter-mountain West. We are particularly well-positioned to assist developers of these fields because of our significant local presence and our broad expertise with environmental impact issues.
Currently, LNG is about 2.8% of the United States supply of natural gas. It is projected to grow to 16% by 2030. New LNG terminals are essential to accommodate the import of LNG from foreign sources. The siting and licensing issues are complex, and we believe that we have the leading team in the U.S. to address these issues. We have assisted clients during the development of twenty-one of the thirty-four LNG projects approved by or proposed to the FERC.
We provide consulting services to support our clients extension of natural gas pipelines. We also believe that we have one of the largest staffs for environmental oversight of pipeline construction and for training of operational staffs.
Environmental services have been one of our historic core strengths beginning with air consulting services provided to industrial and utility clients in the 1970s. Over the past decade, our environmental professionals have been the foundation for growth of our Energy practice and our Exit Strategy program. We believe the environmental market will continue to be an incubator of new growth opportunities for us.
Our scientists, engineers and other technical professionals provide services to a wide range of clients including industrial and natural resource companies, railroads, real estate companies, and federal and state agencies. In many instances, our services to these clients are channeled to us by leading law firms or financial institutions. Environmental services provided by us include due diligence assessments to support acquisitions and divestitures by companies; investigation and remediation of impaired sites; licensing of new and expanded facilities; environmental compliance, auditing and support; design and engineering of pollution control and waste management facilities; natural and cultural resource management; and litigation support. We have particular expertise in air quality issues, emissions control and monitoring, and in the building sciences related to indoor environmental exposures.
Demand for environmental services has traditionally been driven by compliance requirements under federal, state and local laws. At the federal level, the most active regulatory programs have been under the Resource Conservation and Recovery Act, the Comprehensive Response, Compensation and Liability Act, the Clean Air Act, and the Clean Water Act. While we expect that requirements under these programs and their state counterparts will continue to be a moderate driver for our services, other market factors are also creating growth opportunities in the following areas:
· Air Quality Issues. We believe that demand for air quality consulting services will continue to grow over the next decade for a variety of reasons, including: (1) control technology requirements in the Clean Air Act, e.g., the Best Available Retrofit Technology requirements for certain air emission sources; (2) new emission reduction requirements in response to global climate change concerns such as regional greenhouse gas initiatives and voluntary emission reduction programs by multinational corporations that are preceding any U.S. federal program; (3) continued litigation over a variety of air issues such as compliance enforcement and toxic tort claims; and (4) the need for new energy sources worldwide. We are well positioned to service this growing market for air quality consulting. We believe that our staff includes some of the worlds top experts in air modeling, meteorology, and exposure analysis. We also believe that we have the largest air emissions measurements staff in the U.S.
· Building Sciences. Indoor environmental exposures have captured national attention with recent emphasis on sick building syndrome and microbial issues (mold). Physical injury claims have initially driven demand for consulting services in this area; however, the related risks of business interruptions and property devaluations are fueling a more significant and sustained market. Insurance companies, commercial and residential developers, building management companies and hospitality chains are increasingly seeking assistance in proactively managing these risks. We are a leading provider of these services with experts in industrial hygiene, toxicology, epidemiology and building construction.
· Transaction Support. Multiple factors have increased the demand for our transaction support services, including: (1) a general increase in the level of merger and acquisition activity; (2) consolidations in many industries; and (3) an increase in activity from foreign companies and private equity funds. We believe that we have a competitive advantage in this market where the
transaction involves energy assets or contaminated properties because of our expertise through our Energy practice and our Exit Strategy program. When we consult on a transaction, opportunities arise to provide additional services that grow the client relationship. This is particularly true for foreign and private equity buyers that do not have in-house expertise on environmental issues.
Our services for our infrastructure clients are primarily related to: (1) expansion of infrastructure capacity in geographic areas where population growth and demographic change is occurring; (2) rehabilitation of overburdened and deteriorating infrastructure systems; and (3) management of risks related to security of public and private facilities. The TRC infrastructure business has evolved into nine distinct service lines:
Building Systems: Building automation systems and design, central plant design, integrated systems design, facility commissioning, facility energy management program implementation, and structural analysis for building rehabilitation.
Construction Management: Program management, project management, construction engineering and inspection, QA/QC, estimating and scheduling
Geographic Information Systems & Mapping: Data modeling, terrain analysis, shoreline management analysis, total station mapping, terrain analysis, GIS services and resource mapping.
Geotechnical Engineering: Subsurface exploration, laboratory testing, geotechnical assessments, seismic engineering and quality assurance testing.
Hydraulics and Hydrological Studies: Aquifer testing, ground water modeling & yield analysis, scour and erosion studies, storage/distribution systems, FEMA studies, and watershed modeling.
Land Development: Planning, design and construction management of development projects for municipal and private sector clients including master planning; land survey, traffic studies, storm water management, utility design, and site engineering.
Municipal Engineering: Planning, design and construction management of potable water and wastewater treatment systems; master drainage planning; street, roadway and site drainage; dam analysis and design and master drainage planning.
Transportation: Planning, design and construction management of road, highway, bridge and aviation facilities, including EIS studies, marine engineering, seismic analysis and traffic engineering,
Security: Vulnerability assessments; engineering and structural improvements for public and private infrastructure facilities; design and implementation of security and surveillance systems; blast resistance design, disaster recovery planning and force protection analysis.
We believe that the overall market for our infrastructure services is strong and growing and that legislation such as The Safe Accountable Flexible and Efficient Transportation Equity ActA Legacy for Users (SAFETEA-LU), as well as other programs at the federal, state and local levels will fuel substantial market activity.
We provide services to a broad range of private and public sector clients. The approximate percentage of fiscal 2006, 2005 and 2004 net service revenue attributable to private versus public sector clients is as follows:
No single client accounts for more than 10% of our net service revenue in any of the years indicated above.
The table below provides representative clients during the past five years:
The markets for many of our services are highly competitive. There are numerous engineering and consulting firms and other organizations that offer many of the same services offered by us. These firms range in size from small local firms to large national firms having substantially greater financial, management and marketing resources than we do. Competitive factors include reputation, performance, price, geographic location and availability of skilled technical personnel.
Despite the competitive nature of our markets, the majority of our work comes from repeat orders from long-term clients because we are one of the leading service providers in the markets we address. For example, we believe that we are one of the top providers of licensing services for large energy projects. Further, we believe we are the market leader in complete outsourcing of site remediation services through our Exit Strategy program. In general, we believe that we have a competitive advantage when we can provide innovative services that offer integrated solutions to clients seeking to reduce operational and environmental risks.
At June 30, 2006, our net contract backlog (excluding the estimated costs of pass-through charges) was approximately $235.0 million, as compared to approximately $213.0 million at June 30, 2005. Approximately 60% of backlog is typically completed in one year. In addition to this net contract backlog, we hold open order contracts from various clients and government agencies. As work under these contracts is authorized and funded, we include this portion in our net contract backlog. While most contracts contain cancellation provisions, we are unaware of any material work included in backlog that will be canceled or delayed.
As of June 30, 2006, we had approximately 2,500 full- and part-time employees. Approximately 85% of these employees are engaged in performing environmental, energy and infrastructure engineering and consulting, risk management, construction management and information management services for clients. Many of these employees have masters degrees or their equivalent, and a number have Ph.D. degrees. Our professional staff includes program managers, professional engineers and scientists, construction specialists, computer programmers, systems analysts, attorneys and others with degrees and experience that enable us to provide a diverse range of services. Other employees are engaged in executive, administrative and support activities. Except for limited circumstances within our infrastructure business, none of our employees are represented by a union. We consider our relationships with our employees to be good.
We have contracts with agencies of the U.S. government and various state agencies that are subject to examination and renegotiation. We believe that adjustments resulting from such examination or renegotiation proceedings, if any, will not have a material impact on our operating results, financial position or cash flows.
For fiscal 2006, 2005 and 2004, agencies of the U.S. government (principally the U.S. Environmental Protection Agency and the U.S. Department of Defense) accounted for 3%, 4% and 5%, respectively, of our net service revenue. Agencies of state and local governments accounted for 18%, 22% and 24%, respectively, of our net service revenue over those same periods.
Our businesses are subject to various rules and regulations at the federal, state and local government levels. We believe that we are in compliance with these rules and regulations. We have the appropriate licenses to bid and perform work in the locations in which we operate. We have not experienced any significant limitations on our business as a result of regulatory requirements. We do not believe any changes in law or changes in industry practice would limit bidding on future projects.
We have a number of trademarks, service marks, copyrights and licenses. None of these are considered material to our business as a whole.
We do not believe that our compliance with federal, state and local laws and regulations relating to the protection of the environment will have any material effect on capital expenditures, earnings or competitive position.
The risk factors listed below, in addition to those described elsewhere in this report, could materially and adversely affect our business, financial condition, results of operations or cash flows. Our business operations could also be affected by additional factors that are not presently known to us or that we currently consider to be immaterial to our operations.
We have incurred significant losses in fiscal 2006 and 2005, and may continue to incur such losses in the future. If we continue to incur significant losses and are unable to access sufficient working capital from our operations or through external financing, we may be unable to fund future operations.
As reflected in our consolidated financial statements, we have incurred net losses applicable to common shareholders of $24.6 million and $8.0 million in our fiscal years ended June 30, 2006 and 2005, respectively. In addition, our working capital has declined from approximately $71.1 million as of June 30, 2005 to $25.0 million at June 30, 2006. We are taking action to return the Company to profitability and generate positive cash flow from operations. Specifically, we are enhancing our controls over project acceptance, which we believe will significantly reduce the level of contract losses; we are increasing the level of experience of our accounting personnel in order to improve internal controls and reduce compliance costs; we are improving the timeliness of customer invoicing, and enhancing our collection efforts, which we believe will result in fewer write-offs of project revenue and in lower levels of bad debt expense, reducing our reliance on our revolving credit agreement; and we are improving project management, which we believe will result in significantly higher levels of project profitability. If we are unable to improve our operating performance we may not have sufficient working capital to fund our operations.
We finance our operations through borrowings under our credit facility and also through cash generated by our operating activities. We failed to comply with certain covenants under our prior revolving credit facility. As such, we had been required to enter into forbearance agreements with our previous lenders and we were operating under a forbearance agreement until the July 17, 2006 refinancing. On July 17, 2006, we entered into a new $50.0 million revolving credit facility and paid off the amount outstanding under the prior loan agreement. Our new credit facility contains covenants which, among other things, require us to: maintain minimum levels of earnings before interest, taxes, depreciation, and amortization; maintain a minimum level of backlog; and sets a maximum limit on capital expenditures. Any future failure to comply with our covenants under our credit facility could result in events of default which, if not cured or waived, could trigger prepayment obligations and also could result in higher fees or other costs similar to those incurred in fiscal 2006. If we were forced to refinance borrowings under our credit facility, we can provide no assurance that we would be successful in obtaining such refinancing. Even if such refinancing were available, the terms could be less favorable, and our results of operations and financial condition could be adversely affected by increased loan fees and interest rates on amounts borrowed.
Our continuing failure to timely file certain periodic reports with the SEC poses significant risks to our business, each of which could materially and adversely affect our financial condition and results of operations.
We did not timely file with the SEC our Forms 10-K for fiscal 2006 and 2005, or our interim reports on Forms 10-Q for fiscal 2006, and we have not yet filed with the SEC our Forms 10-Q for the quarterly periods ended September 30, 2006 and December 31, 2006. Consequently, we are not compliant with the reporting requirements under the Securities Exchange Act of 1934 (the Exchange Act) or the
requirements of the New York Stock Exchange (the NYSE). Our inability to timely file our periodic reports with the SEC involves a number of potentially significant risks, including:
· If the NYSE ceases to grant us extensions to file our periodic reports, it has the right to begin proceedings to delist our common stock. A delisting of our common stock could have a material adverse effect on us by, among other things:
· reducing the liquidity and market price of our common stock;
· reducing the number of investors willing to hold or acquire our common stock, thereby restricting our ability to obtain equity financing; and
· violating private placement stock purchase agreements.
· A breach could be declared under our revolving credit facility if our lenders cease to grant us extensions to file our periodic reports, which may result in the lenders declaring our outstanding loans due and payable in whole or in part.
· We may have difficulty retaining our clients and obtaining new clients and in obtaining project bonding.
· We may have difficulty retaining or hiring key employees.
· We are not eligible to use a registration statement to offer and sell publicly tradable securities, which prevents us from accessing the public capital markets.
· Until we are current in our SEC filings, there will not be adequate current public information available to permit certain resales of restricted securities pursuant to Rule 144 under the Securities Act, which could have a detrimental effect on our relations with individuals or entities who hold restricted securities.
Our strategic objectives include continued expansion of value-added services. We depend on our core businesses to generate profits and cash flow to fund our growth. Although the services that we provide are spread across a variety of industries, disruptions such as a general economic downturn or higher interest rates could negatively affect the demand for our services across a variety of industries which could adversely affect our ability to generate profits and cash flows that we require to meet our growth objectives.
We estimate that contracts with agencies of the U.S. government and various state and local governments represent approximately 21% of our net service revenue. Therefore, we are materially dependent on various contracts with such governmental agencies. Companies engaged in government contracting are subject to certain unique business risks. Among these risks are dependence on appropriations and administrative allotment of funds, and changing policies and regulations. These contracts may also be subject to renegotiation of profits or termination at the option of the government. The stability and continuity of that portion of our business depends on the periodic exercise by the government of contract renewal options, our continued ability to negotiate favorable terms and the continued awarding of task orders to us.
While we increasingly pursue economically driven markets, our business is materially dependent on the continued enforcement by federal, state and local governments of various environmental regulations.
In a period of relaxed environmental standards or enforcement, our business could be adversely impacted by private industry being less willing to allocate funds to consulting services related to environmental enforcement.
The markets for many of our services are highly competitive. There are numerous professional architectural, engineering and consulting firms and other organizations which offer many of the services offered by us. We compete with many companies, some of which have greater resources than we do. Competitive factors include reputation, performance, price, geographic location and availability of technically skilled personnel. In addition, we face competition from the use by our clients of in-house staff.
We are, and expect in the future to be, named as a defendant in legal actions claiming damages in connection with engineering and construction projects and other matters. These are typically actions that arise in the normal course of business, including employment-related claims, contractual disputes, professional liability, or claims for personal injury or property damage. To date, we have been able to obtain liability insurance for the operation of our business. However, if we sustain damages that materially exceed our insurance coverage or that are not insured, there could be a material adverse effect on our liquidity which could impair our operations.
If our subcontractors fail to perform their contractual obligations on a project, we could be exposed to loss of reputation and additional financial or performance obligations that could result in reduced profits or losses.
We often hire subcontractors for our projects. The success of these projects depends, in varying degrees, on the satisfactory performance of our subcontractors. If our subcontractors do not meet their obligations, we may be unable to adequately perform and deliver our contracted services. Under these circumstances, we may be required to make additional investments and expend additional resources to ensure the adequate performance and delivery of the contracted services. These additional obligations have resulted in reduced profits or, in some cases, significant losses for us with respect to certain projects. In addition, the inability of our subcontractors to adequately perform on certain projects could hurt our competitive reputation and ability to obtain future projects.
Circumstances or events which could create large cash outflows include losses resulting from fixed-price contracts, remediation of environmental liabilities, adverse legal awards, unexpected costs or losses resulting from acquisitions, project completion delays, failure of clients to pay, professional liability or personal injury claims, among others. We cannot provide assurance that we will have sufficient liquidity or the credit capacity to meet all of our cash needs if we encounter significant working capital requirements as a result of these or other factors.
Because we have grown in part through acquisitions, goodwill and other acquired intangible assets represent a substantial portion of our assets. Goodwill was approximately $126.3 million as of June 30, 2006. We also have other identifiable intangible assets of $6.8 million, net of accumulated amortization as of June 30, 2006. Goodwill and identifiable intangible assets are assessed for impairment at least annually or whenever events or changes in circumstances indicate that the carrying value of the asset may not be
recoverable. If we make additional acquisitions, it is likely that we will record additional goodwill and intangible assets on our financial statements. We reported a net loss to common shareholders of $24.6 million for the fiscal year ended June 30, 2006, including impairment charges totaling $2.2 million relating to the write-off of trade names due to our decisions to both concentrate on enhancing our TRC brand and discontinue the use of numerous other brands in our continuing operations, and $0.3 million goodwill impairment related to the disposition of our Bellatrix Environmental Consultants, L.L.C. business unit, as well as a loss on disposal before taxes of $5.3 million related to our divestiture of the Pacific Land Design, Inc. and Pacific Land Design Roseville, Inc. entities (together PacLand) within our discontinued operations. If we continue to report losses in the future, the likelihood of needing to record additional impairment charges increases. If a determination that a significant impairment in value of our goodwill, unamortized intangible assets or long-lived assets occurs, such determination could require us to write off a substantial portion of our assets. Such a write off would materially affect our earnings and shareholders equity.
Our common stock has experienced substantial price volatility. In addition, the stock market has experienced price and volume fluctuations that have affected the market price of many companies and that have often been unrelated to the operating performance of these companies. The overall market and the price of our common stock may continue to fluctuate greatly. The trading price of our common stock may be significantly affected by various factors, including:
· Our financial results, including revenue, profits, days sales outstanding, backlog, and other measures of financial performance or financial condition;
· Announcements by us or our competitors of significant events, including acquisitions;
· Resolution of threatened or pending litigation;
· Changes in investors and analysts perceptions of our business or any of our competitors businesses;
· Investors and analysts assessments of reports prepared or conclusions reached by third parties;
· Changes in legislation;
· Broader market fluctuations;
· General economic or political conditions;
· Material internal control weaknesses;
· Continued failure to timely file periodic reports; and
· Stock exchange delisting.
Additionally, volatility or a lack of positive performance in our stock price may adversely affect our ability to retain or attract key employees. Many of these key employees are granted stock options, the value of which is dependent on the performance of our stock price.
Our implementation of, and compliance with changes in accounting rules, including new accounting rules and interpretations, could adversely affect our operating results or cause unanticipated fluctuations in our operating results in future periods.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new Securities and Exchange Commission (SEC) regulations, and New York Stock Exchange rules, are creating additional disclosure and other compliance and remediation requirements for us. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest appropriate resources to comply with evolving standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance and remediation activities.
During the past two years, we have made substantial changes in our senior management team, including our Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. In addition, a number of other management positions have recently been filled. Because of the lack of familiarity of the new management team with our company, there is the risk that our new management team will not be able to execute our business plan and that initiatives could be implemented that would adversely affect the business.
The success of our business depends on our ability to attract and retain qualified employees. We need talented and experienced personnel in a number of areas to support our core business activities. An inability to attract and retain sufficient qualified personnel could harm our business. Turnover among certain critical staff could have a material adverse effect on our ability to implement our strategies and on our results of operations.
In fiscal 2007, we began implementation of a new company-wide enterprise resource planning (ERP) system, principally for accounting and project management. During fiscal 2007, we plan to convert all of our operating units to our new ERP system. In the event we do not complete the project according to plan, we may experience difficulty in accurately and timely reporting financial information. In addition, unforeseen complications could negatively impact project data flow and billing information which could result in reduced cash flows due to delays in issuing invoices to our clients or other reasons, which could adversely affect the timely collection of cash. Further, it is possible that the cost or schedule of completing this project could exceed our current projections and negatively impact future operating results.
As we disclose in Part II, Item 9A, Controls and Procedures of this Form 10-K/A, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures and internal control over financial reporting were not effective as of June 30, 2006. While we are in the process of correcting our internal control weaknesses, the material weaknesses in internal control over financial reporting that have been identified will not be remediated until numerous internal controls are implemented and operate for a period of time, are tested, and we are able to conclude that such internal controls are operating effectively. Pending the successful completion of such implementation and testing of the internal controls, we will perform additional procedures to reduce the risk that material weaknesses in internal control over financial reporting result in material errors to the financial statements. We cannot
provide assurance that these procedures will be successful in identifying material errors that may exist in the financial statements. Any failure to implement and maintain the improvements in the internal controls over our financial reporting, or difficulties encountered in the implementation of these improvements in our controls, could result in errors in the financial statements that would not be prevented or detected, or cause us to fail to meet our reporting obligations. We cannot assure you that we will not identify additional material weaknesses in our internal controls in the future. Any failure to improve the identified material weakness or any identification of any additional material weaknesses could cause investors to lose confidence in our reported financial information which could have a negative impact on the trading price of our stock.
A significant portion of our historic growth strategy had been to acquire other companies. We may continue to acquire companies on a selective basis as an element of our long-term growth objectives. Acquisitions involve risks that include the risk of paying more than the target company is worth and the risk of not successfully integrating the target company into our operations.
Our services involve significant risks that may substantially exceed the fees we derive from our services. Our business activities expose us to potential liability for professional negligence, personal injury and property damage among other things. We cannot predict the magnitude of such potential liabilities. In addition, our ability to perform certain services is dependent on our ability to obtain adequate insurance as well as bid, performance and payment bonds.
We obtain insurance from insurance companies to cover our potential risks and liabilities. It is possible that we may not be able to obtain adequate insurance to meet our needs, may have to pay an excessive amount for the insurance coverage we want, or may not be able to acquire any insurance for certain types of business risks. In addition, our ability to obtain bonding is dependent on financial performance and has been significantly curtailed by our late filing of financial reports. An inability to obtain certain insurance, as well as bonds, could result in our inability to provide certain services that could result in lower revenues, lower profits, or losses.
Various legal proceedings are currently pending against us and certain of our subsidiaries. We cannot predict the outcome of these proceedings with certainty. In some actions, parties are seeking damages that exceed our insurance coverage or for which we are not insured. If we sustain damages that exceed our insurance coverage or that are not covered by insurance, there could be a material adverse effect on our business, operating results, financial condition or cash flows.
Our engagements often involve a variety of projects some of which are large scale and complex. Our performance on projects depends in large part upon our ability to manage the relationship with our clients and to effectively manage the project and deploy appropriate resources, including third-party contractors and our own personnel, in a timely manner. If we miscalculate, or fail to properly manage, the resources or time we need to complete a project with capped or fixed fees, or the resources or time we need to meet contractual obligations, our operating results could be adversely affected. Further, any defects, errors or failures to meet our clients expectations could result in claims for damages against us.
We account for a significant portion of our contracts on the percentage-of-completion method of accounting. Generally our use of this method results in recognition of revenue and profit ratably over the life of the contract based on the proportion of costs incurred to date to total costs expected to be incurred. The effect of revisions to revenue and estimated costs, including the achievement of award and other fees, is recorded when the amounts are known and can be reasonably estimated. The uncertainties inherent in the estimating process make it possible for actual costs to vary from estimates that could result in reductions or reversals of previously recorded revenue and profit. Such differences could be material.
We generally enter into three principal types of contracts with our clients: fixed-price, time-and-materials, and cost-plus. Under our fixed-price contracts, we receive a fixed price irrespective of the actual costs we incur and, consequently, we are exposed to a number of risks. These risks include: underestimation of costs, problems with new technologies, unforeseen costs or difficulties, delays, price increases for materials, poor project management or quality problems, and economic and other changes that may occur during the contract period. Under our time-and-materials contracts, we are paid for labor at negotiated hourly billing rates and for other expenses. Profitability on these contracts is driven by billable headcount and cost control. Many of our time-and-materials contracts are subject to maximum contract values and, accordingly, revenue relating to these contracts is recognized as if these contracts were fixed-price contracts. Under our cost-plus contracts, some of which are subject to contract ceiling amounts, we are reimbursed for allowable costs and fees which may be fixed or performance-based. If our costs exceed the contract ceiling or are not allowable under the provisions of the contract or any applicable regulations, we may not be able to obtain reimbursement for all such costs.
Accounting for a fixed-price contract requires judgments relative to assessing the contracts estimated risks, revenue and estimated costs as well as technical issues. Due to the size and nature of many of our contracts, the estimation of overall risk, revenue and cost at completion is difficult and subject to many variables. Changes in underlying assumptions, circumstances or estimates may adversely affect future period financial performance. If we are unable to accurately estimate the overall revenue or costs on a contract, we may experience a lower profit or incur a loss on the contract.
Our net contract backlog as of June 30, 2006 was approximately $235 million. We cannot guarantee that the net service revenue projected in our backlog will be realized or, if realized, will result in profits. In addition, project cancellations or scope adjustments may occur from time to time with respect to contracts reflected in our backlog. These types of backlog reductions could adversely affect our revenue and margins. Accordingly, our backlog as of any particular date is an uncertain indicator of our future earnings.
We provide our services through a network of 95 offices located nationwide. We lease approximately 706,500 square feet of office and commercial space to support these operations. In addition, a subsidiary of ours owns a 26,000 square foot office/warehouse building in Austin, Texas. This property is subject to a deed of trust in favor of the lenders under our principal credit facility. All properties are adequately maintained and are suitable and adequate for the business activities conducted therein. In connection with the performance of certain Exit Strategy projects, some of our subsidiaries have taken title to sites on which those activities are being performed.
We are subject to claims and lawsuits typical of those filed against engineering and consulting companies. We carry liability insurance, including professional liability insurance, against such claims, subject to certain deductibles and policy limits. Except as described herein, we are of the opinion that the resolution of these claims and lawsuits will not likely have a material adverse effect on our business, operating results, financial position and cash flows.
In re: Tropicana Garage Collapse Litigation - Superior Court New Jersey, Atlantic County, 2004. One of our subsidiaries has been named as a defendant, along with a number of other companies, in litigation brought on behalf of individuals claiming damages for alleged injuries, including death, related to a collapse of several floors of a parking garage under construction in Atlantic City, New Jersey. That subsidiary has also been named a defendant in other actions for business claims related to the parking garage. The subsidiary (along with other contractors) is covered under an insurance program specific to this project (the wrap-up program). To the extent the wrap-up program is exhausted, the subsidiary will rely on its own insurance coverage. While accepting coverage under a reservation of rights under the subsidiarys professional liability insurance policy, the subsidiarys carrier has denied coverage and filed a declaratory judgment action with respect to coverage under two other policies which provide commercial general liability coverage. The subsidiary had a limited inspection role in connection with the construction, and we believe that it has meritorious defenses. However, an adverse decision in these cases could result in substantial damages. The ultimate outcome of this matter cannot be predicted with certainty at this time, and could have a material adverse effect on our business, operating results, financial position and cash flows.
Godosis v. Cal-Tran Associates, et al, New York Supreme Court, New York County, 2004, and Cal-Tran Associates v. City of New York, et al, New York Supreme Court, Queens County, 2005. One of our subsidiaries was engaged by the New York City Department of Transportation (NYCDOT) to provide construction support services with respect to the replacement of an overpass bridge in Queens, New York. A motorist and his wife commenced litigation alleging that, during demolition of a portion of the existing bridge, two sections fell onto the roadway beneath and that the motorist was injured. The subsidiary (along with other project contractors) has been named in the suit. In a separate action, the general contractor on that project has sued the City of New York as well as the subsidiary and other contractors on the project alleging, among other things, that it was wrongfully defaulted by the City of New York in connection with the project. The subsidiary had no significant on-site role and we believe that the subsidiary was not the cause of the collapse. Although the ultimate outcome of this matter cannot be predicted with certainty at this time, and could have a material adverse effect, management believes the subsidiary has meritorious defenses and is adequately insured. In a separate but related matter, the subsidiary entered into an agreement in September 2005 with NYCDOT under which the subsidiary assigned its subcontract for the project to an unrelated entity, paid that entity $0.3 million and NYCDOT $0.5 million and agreed for a limited period of time not to bid on engagements with New York City agencies. These settlement amounts, which were fully accrued at June 30, 2005, were paid in fiscal 2006.
McConnell v. Dominguez, New Mexico First Judicial District Court, Santa Fe County, 2005. One of our subsidiaries has been named as a defendant, along with a number of other defendants, in litigation brought by the personal representative of a pilot killed in a helicopter crash. It is alleged that in the course of conducting an aerial inspection of a power transmission line in New Mexico, the helicopter collided with the line. The subsidiary had a design role with respect to modifications to a portion of the transmission line several years before the alleged accident, and management believes the subsidiary has meritorious defenses and is adequately insured. The ultimate outcome of this matter cannot be predicted at this time. However it could have a material adverse effect on our business, operating results, financial position and cash flows.
Willis v. TRC, U.S. District Court, Central District of Louisiana, 2005. We are a defendant in litigation brought by the seller of a small civil engineering firm which we acquired in September 2004. The seller, an individual, is alleging that we breached certain provisions of the stock purchase agreement related to the acquisition. We have counterclaimed alleging breach of contract and fraud, including securities fraud, on the part of the seller. Although the ultimate outcome cannot be predicted at this time, an adverse resolution of this matter could have a material adverse effect on our business, operating results, financial position and cash flows.
City of Rowlett v. Hunter Associates, Inc., et. al. in the 101st District Court of Dallas County, Texas, 2006. One of our subsidiaries was named as a defendant in a lawsuit brought by the City of Rowlett, Texas. The City is alleging that the design of a sewer line did not adequately address potential corrosion issues. The outcome of this case cannot be predicted at this time; however, damages alleged are substantial and an ultimate adverse determination of the case could have a material adverse effect on our business, operating results, financial position and cash flows.
East Palo Alto Hotel Development, LLC v. Lowney Associates, et al, California Superior Court, San Francisco County, 2006. One of our subsidiaries was named as a defendant in a lawsuit brought by East Palo Alto Hotel Development, LLC. The subsidiary contracted with the developer of a hotel complex in East Palo Alto, California to provide geotechnical investigation and related services in connection with the development of the complex. The developer claims costs for delay and extra work alleging that the subsidiary was negligent in characterizing the extent of settlement to be encountered in construction of the project. The subsidiary is continuing to investigate this matter. We believe the subsidiary has meritorious defenses and is adequately insured.
Fagin et. al. v. TRC Companies, Inc. et. al., in the 44th District Court of Dallas County, Texas, 2005. Sellers of a business acquired by TRC in 2000 allege that the purchase price was not accurately calculated based on the net worth of the acquired business and allege that certain earnout payments to be made pursuant to the purchase agreement for the business were not properly calculated. The case is in the initial discovery phase, and the ultimate outcome of this matter cannot be predicted at this time. Management believes it has meritorious defenses, but an adverse determination in this matter could have a material adverse effect on our business, operating results, financial position and cash flows.
East River Realty Company LLC v. TRC Companies, Inc. et. al., United States District Court for the Southern District of New York, 2006. The owner of sites on which we are performing demolition and environmental remediation services pursuant to an Exit Strategy contract brought an action for injunctive relief and damages alleging that we were obligated to enroll the sites into an alternate New York state voluntary regulatory cleanup program. Although we believed we had meritorious defenses, we entered into a settlement agreement with the plaintiff which stayed the proceedings and any damage claims and under which we consented to enrolling certain of the sites into the alternate program subject to the plaintiff obtaining certain required consents. In addition, the plaintiff agreed to pay certain costs of ours and indemnify us from future costs related to the program.
Miguel Zanabria and Monica Arce v. The Bank of New York Company, Inc. et. al.; Monica Arce and Miguel Zanabria v. the Bank of New York Company, Inc., et. al.; Jose Vaca v. The Bank of New York Company, Inc., United States District Court for the Southern District of New York, 2006. In November 2006, a subsidiary of ours was named as a defendant (along with a number of other defendants) in these three cases which are pending in the United States District Court for the Southern district of New York and are styled under the caption In Re World Trade Center Lower Manhattan Disaster Site Litigation. The Complaints allege that the plaintiffs were workers involved in construction, demolition, excavation, debris removal and clean-up in the buildings surrounding the World Trade Center site, and that plaintiffs were injured. As the cases have just been brought, there is insufficient information to assess the subsidiarys involvement in these matters.
Our accrual for litigation-related losses that were probable and estimable, primarily those discussed above, was $3.5 million at June 30, 2006 and $3.1 million at June 30, 2005. We have also recorded insurance recovery receivables related to these accruals of $1.8 million at June 30, 2006 and $0.8 million at June 30, 2005. As additional information about current or future litigation or other contingencies becomes available, we will assess whether such information warrants the recording of additional accruals relating to those contingencies. Such additional accruals could potentially have a material impact on our business, operating results, financial position and cash flows.
During the fiscal year ended June 30, 2006, we issued an aggregate of 74,893 shares of unregistered common stock with a market value of $1.1 million as additional consideration earned in the fiscal year on acquisitions completed in prior years. We also issued 55,359 shares of unregistered common stock with a market value of $692 thousand in lieu of the quarterly cash dividends on our convertible redeemable preferred stock. In addition in March 2006, we sold 2,162,163 shares of common stock in a private placement (including 942,980 shares of treasury stock) at a price of $9.25 per share, resulting in net proceeds of $19.9 million. All such shares were issued to accredited investors pursuant to the exemption afforded by Section 4(2) of the Securities Act of 1933, as amended.
Our common stock is traded on the New York Stock Exchange under the symbol TRR. The following table sets forth the high and low per share prices for the common stock for the fiscal years ended June 30, 2006 and 2005 as reported on the New York Stock Exchange:
As of December 5, 2006, there were 260 shareholders of record and, as of that date, we estimate there were approximately 2,200 beneficial owners holding our common stock in nominee or street name.
To date we have not paid any cash dividends on our common stock. The payment of dividends in the future will be subject to financial condition, capital requirements and earnings. However, future earnings are expected to be used for expansion of our operations, and cash dividends are not currently anticipated.
The following table provides information as of June 30, 2006 for compensation plans under which our equity securities are authorized for issuance:
The following table provides summarized information with respect to our operations and financial position. The data set forth below should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations and our financial statements and the notes thereto. See Note 3 for a discussion of the restatement of certain balance sheet data for the five year period ended June 30, 2006 related to the accounting for an insurance recoverable on an exit strategy contract in fiscal 2001. We previously restated our fiscal 2004 and 2003 financial statement primarily to correctly account for certain components of our exit strategy program. Our consolidated financial statements for 2002 have also been previously restated; however, the restated consolidated financial statements for fiscal 2002 have not been audited.
(1) We completed nine acquisitions in fiscal 2005, one acquisition in fiscal 2004, and seven acquisitions in each of fiscal 2003 and 2002 which impacted period to period comparisons. See Note 9 to the accompanying consolidated financial statements for a discussion of acquisitions completed in fiscal years 2005 and 2004.
(2) During the three months ended September 30, 2005, the Company determined that the provision for doubtful accounts was incorrectly classified in cost of services within operating costs and expenses. Management has concluded that the misclassification was not material to the consolidated financial statements, and accordingly, the prior periods presented have been corrected by presenting the provision for doubtful accounts as a separate line item.
(3) During fiscal 2006, the Company recorded an impairment charge for $2.2 million related to trade-name intangible assets. During fiscal 2005, the Company recorded impairment charges of $3.6 million related to its CEG joint venture. See Note 10 to the accompanying consolidated financial statements for a discussion of our goodwill and intangible assets.
(4) The Company sold PacLand and committed to sell Bellatrix in the fourth quarter of fiscal 2006. See Notes 2 and 9 to the accompanying consolidated financial statements for discussions of our discontinued operations.
(5) In fiscal 2004, we changed the method of accounting for certain investments. See Note 2 to the accompanying consolidated financial statements for a discussion.
(6) Amounts reflect the restatement discussed in Note 3 to the consolidated financial statements.
(7) Amounts have been restated to reflect matter discussed in Note 3 to the consolidated financial statements.
You should read the following discussion of our results of operations and financial condition in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that are based upon current expectations and assumptions that are subject to risks and uncertainties. Actual results and the timing of certain events may differ materially from those projected in such forward-looking statements due to a number of factors, including those discussed in the section entitled Forward-Looking Statements on page 3.
Subsequent to the issuance of our consolidated financial statements for the fiscal year ended June 30, 2006 contained in our Annual Report on Form 10-K filed with the SEC on February 26, 2007, we determined that we did not record an insurance recoverable and the related tax provision on an exit strategy contract during the year ended June 30, 2001. Accordingly, we have restated our consolidated financial statements by correcting the consolidated balance sheet increasing insurance recoverableenvironmental remediation by $2,497,000, decreasing deferred tax assets by $899,000, and increasing stockholders equity by $1,598,000 as of June 30, 2006 and 2005. The correction has no impact on the consolidated statements of operations for the periods discussed in this managements discussion and analysis. The restatement is discussed further in the Explanatory Note in the forepart of this Amendment No. 1 on Form 10-K/A and in Note 3 Restatement of Previously Issued Financial Statements included in Item 8 of this Amendment No. 1 on Form 10-K/A.
We are an engineering, consulting, and construction management firm that provides integrated services to the environmental, energy, infrastructure, and real estate markets. Our multidisciplinary project teams provide turnkey services to help our clients implement complex projects from initial concept to delivery and operation. A broad range of commercial, industrial, and government clients depend on us for customized and complete solutions to their toughest business challenges. We provide ours services to commercial organizations and governmental agencies almost entirely in the United States of America.
We derive our revenue from fees for professional and technical services. As a service company, we are labor-intensive rather than capital-intensive. Our revenue is driven by our ability to attract and retain qualified and productive employees, identify business opportunities, secure new and renew existing client contracts, provide outstanding services to our clients and execute projects successfully. Our income (loss) from operations is derived from our ability to generate revenue and collect cash under our contracts in excess of our direct costs, subcontractor costs, other contract costs, and general and administrative (G&A) expenses.
The types of contracts with our clients and the approximate percentage of net service revenue (NSR) for the years ended June 30, 2006, 2005 and 2004 from each contract type are as follows:
In the course of providing our services, we routinely subcontract services. Generally, these subcontractor costs are passed through to our clients and, in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and consistent with industry practice, are included in gross revenue. Because subcontractor services can change significantly from project to project, changes
in gross revenue may not be indicative of business trends. Accordingly, we also report NSR, net of subcontractor costs and other direct reimbursable costs, which is gross revenue less the cost of subcontractor services and other direct reimbursable costs, and our discussion and analysis of financial condition and results of operations uses NSR as a point of reference.
For analytical purposes only, we categorize our revenue into two types: acquisition and organic. Acquisition revenue consists of revenue derived from newly acquired companies during the first twelve months following their respective acquisition dates. Organic revenue consists of our total revenue less any acquisition revenue.
Our cost of services includes professional compensation and related benefits, together with certain direct and indirect overhead costs such as rents, utilities and travel. Professional compensation represents the majority of these costs. Our general and administrative expenses are comprised primarily of our corporate headquarters costs related to corporate executive management, finance, accounting, administration and legal. These costs are generally unrelated to specific client projects and can vary as expenses are incurred to support corporate activities and initiatives.
Our revenue, expenses and operating results may fluctuate significantly from year to year as a result of numerous factors, including:
· Unanticipated changes in contract performance that may affect profitability, particularly with contracts that are fixed-price or have funding limits;
· Seasonality of the spending cycle of our public sector clients, notably state and local government entities, and the spending patterns of our commercial sector clients;
· Budget constraints experienced by our federal, state and local government clients;
· Acquisitions or the integration of acquired companies;
· Divestitures or discontinuance of operating units;
· Employee hiring, utilization and turnover rates;
· The number and significance of client contracts commenced and completed during the period;
· Creditworthiness and solvency of clients;
· The ability of our clients to terminate contracts without penalties;
· Delays incurred in connection with a contract;
· The size, scope and payment terms of contracts;
· Contract negotiations on change orders and collections of related accounts receivable;
· The timing of expenses incurred for corporate initiatives;
· Reductions in the prices of services offered by our competitors;
· Changes in accounting rules; and
· General economic or political conditions.
As previously announced, effective as of December 31, 2005, Richard Ellison, our former Chief Executive Officer, retired from that position and Christopher Vincze, our then Chief Operating Officer,
was appointed Chief Executive Officer. On March 6, 2006, we announced the appointment of Timothy Belton as our new Chief Operating Officer. In addition, effective April 30, 2006, Harold C. Elston, Jr., our then Chief Financial Officer, retired from that position and Carl d. Paschetag, Jr. was appointed Chief Financial Officer, effective April 30, 2006.
On March 6, 2006, we sold 2,162,163 shares (the Shares) of our common stock, $0.10 par value per share, at a price of $9.25 per share (the Private Placement) pursuant to a Purchase Agreement (the Purchase Agreement) by and among us and the investors named therein (the Investors). Of the shares sold, 943 thousand were issued from treasury and 1.2 million were newly issued. The Private Placement resulted in $20.0 million in gross proceeds that were used by us to reduce debt and for general corporate purposes. The Private Placement was made pursuant to the exemption from registration provided in Regulation D, Rule 506, under Section 4(2) of the Securities Act of 1933, as amended (the Act). The Private Placement requires us to register the shares by December 31, 2007 or pay a penalty. We accrued $300 thousand related to this provision in the third quarter of fiscal 2006.
On July 17, 2006, we and certain of our subsidiaries, together (the Borrower), entered into a secured credit agreement (the Credit Agreement) and related security documentation with Wells Fargo Foothill, Inc., as lender and administrative agent. The Credit Agreement provides the Borrower with a five-year senior revolving credit facility of up to $50.0 million based upon a borrowing base formula on accounts receivable. Amounts outstanding under the new credit facility bear interest at the greater of 7.75% and prime rate plus a margin of 1.25% to 2.25%, or the greater of 5.0% and LIBOR plus a margin of 2.25% to 3.25%, based on average excess availability. The Credit Agreement contains covenants the most restrictive of which require us to maintain a minimum EBITDA (in thousands) of $3,112, $5,783, $8,644 and $12,278 for the quarter, two quarter, three quarter and four quarter periods ended or ending September 30, 2006, December 31, 2006, March 31, 2007 and June 30, 2007, respectively. Thereafter, the minimum EBITDA covenant increases in approximately equal annual increments to $24.0 million for the fiscal year ended June 30, 2010. We must maintain average monthly backlog of $190.0 million. Capital expenditures are limited (in thousands) to $9,619, $10,099 and $10,604 for the fiscal years ended June 30, 2007, 2008, and 2009 and thereafter, respectively. The Borrowers obligations under the Credit Agreement are secured by a pledge of substantially all of the assets of the Borrower and guaranteed by substantially all of our subsidiaries that are not borrowers pursuant to a Guaranty. The Credit Agreement also contains cross-default provisions which become effective if the Company defaults on other indebtedness. The proceeds of the Credit Agreement were utilized to repay the then existing credit facility in full.
On July 19, 2006, we and substantially all of our subsidiaries entered into a three-year subordinated loan agreement (the Subordinated Loan Agreement) with Federal Partners, L.P. (Federal Partners), a stockholder of ours, pursuant to which we borrowed $5.0 million from Federal Partners. The loan bears interest at a fixed rate of 9% per annum. In addition, we issued a ten-year warrant to purchase up to 66 thousand shares of our common stock to Federal Partners at an exercise price equal to $.01 per share, pursuant to the terms and conditions of a Warrant Agreement, dated July 19, 2006, between us and Federal Partners.
On October 31, 2006, the Credit Agreement was amended (the First Amendment) to modify certain of the terms under the Credit Agreement which among other things, waived certain schedule requirements related to post-closing deliverables, changed the definition of Eligible Unbilled Accounts under the Credit Agreement, and changed the schedule for delivery of certain reports.
On November 29, 2006, the Credit Agreement was amended (the Second Amendment) to modify certain of the terms under the Credit Agreement which changed the delivery date for our Fiscal 2006
Annual Report on Form 10-K to on or before December 31, 2006 and increased the letter of credit usage limit from $5.0 million to $7.0 million.
On December 29, 2006, the Credit Agreement was further amended (the Third Amendment) to modify certain of the terms under the Credit Agreement which changed the delivery date for our Fiscal 2006 Annual Report on Form 10-K to on or before January 31, 2007.
On January 31, 2007, the Credit Agreement was further amended (the Fourth Amendment) to modify certain of the terms under the Credit Agreement to change the delivery date for our Fiscal 2006 Annual Report on Form 10-K to on or before February 28, 2007, to permit an investment by us in certain real estate located in New Jersey through a joint venture in Center Avenue Holdings, LLC, to permit us to receive a loan from the City of Lowell, Massachusetts in connection with the relocation of our Lowell, Massachusetts office and to permit the divestiture of Omni Environmental, Inc. (Omni). As of February 23, 2007, Omni has not been sold.
On December 1, 2006, we entered into a Purchase and Exchange Agreement (the Exchange Agreement) with Fletcher International, Ltd. (Fletcher) pursuant to which the 15,000 shares of Series A-1 Cumulative Convertible Preferred Stock held by Fletcher which were redeemable in common stock as of December 14, 2006, were exchanged for 1.1 million shares of common stock, thereby retiring the Preferred Stock. As part of the Exchange Agreement, Fletcher also purchased an additional 204 thousand shares of common stock at $9.79 per share, the closing price of the common stock on the New York Stock Exchange on December 1, 2006. The closing of the transactions under the Exchange Agreement occurred on December 7, 2006.
Impairment of Long-Lived Assets
During the fourth quarter of fiscal 2006, in conjunction with our decision to unite its various subsidiaries under one trade name, we assigned useful lives to its trade name intangible assets which were previously classified as indefinite-lived intangible assets. As required by SFAS 142, prior to beginning to amortize the assets, we tested for impairment, concluding their carrying values exceeded their fair values. Accordingly, we recorded impairment charges totaling $2.2 million during the fourth quarter of 2006.
Additional restructuring activities were initiated in the second, third and fourth quarter of fiscal 2006. As a result, employee related severance charges (in thousands) of $448, $55 and $78 were recorded in the second, third and fourth quarter, respectively of fiscal 2006. In addition, facility closure costs of $436 thousand were recorded in the second quarter of fiscal 2006, primarily for facilities in Dallas and Ft. Worth, Texas.
In June 2006, we sold the Pacific Land Design, Inc. and Pacific Land Design Roseville, Inc. entities (together PacLand). The sale was part of a settlement between us and the original sellers of PacLand, acquired by us in January 2005. The sellers sued us to collect on certain promissory notes issued by us in connection with the acquisition. We asserted defenses to such promissory notes and counterclaimed for breach of fiduciary duty and securities fraud as well as requested indemnification against losses for breach by the sellers of the stock purchase agreement related to the transaction. Pursuant to the settlement, we received $1,300 and transferred all of the assets of PacLand to an entity designated by the original sellers. In addition, the settlement included releases from all claims related to the Stock Purchase Agreement and Employment Agreements related to our purchase of PacLand including further payments under the Stock Purchase Agreement and Promissory Notes issued in connection with the transaction. As a result of the settlement we recorded a loss on disposition of $5,336 in the fourth quarter of fiscal 2006.
In the fourth quarter of fiscal 2006, we committed to a plan to sell the Bellatrix business unit back to its original owner. Bellatrix was purchased by us in the first quarter of fiscal 2005. The sale was finalized on August 31, 2006, the first quarter of fiscal 2007, and included all fixed assets of the Bellatrix business unit, as well as associated goodwill and intangible assets. We received a cash payment of $400 thousand, a promissory note of $88 thousand due on August 31, 2007 yielding interest at a rate of 6% per year, as well as 3 thousand shares of TRC common stock, with a fair value of $33 thousand on the date of sale. We recorded a goodwill impairment charge of $268 thousand in the fourth quarter of fiscal 2006 related to the Bellatrix transaction.
Our financial statements have been prepared in accordance with U.S. GAAP. These principles require the use of estimates and assumptions that affect amounts reported and disclosed in the financial statements and related notes. Actual results could differ from these estimates and assumptions. We use our best judgment in the assumptions used to value these estimates, which are based on current facts and circumstances, prior experience and other assumptions that are believed to be reasonable. Our accounting policies are described in Note 2 of the Notes to consolidated financial statements contained in Item 8 of this Annual Report on Form 10-K. We believe the following critical accounting policies reflect the more significant judgments and estimates used in preparation of our consolidated financial statements and are the policies which are most critical in the portrayal of our financial position and results of operations:
Revenue Recognition: We recognize contract revenue in accordance with American Institute of Certified Public Accountants Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts (SOP 81-1). Pursuant to SOP 81-1, certain Exit Strategy contracts are segmented into two profit centers: (1) remediation and (2) operation, maintenance and monitoring. We earn our revenue from fixed-price, time-and-materials and cost-plus contracts as described below.
We recognize revenue on fixed-price contracts using the percentage-of-completion method. Under this method for revenue recognition, we estimate the progress towards completion to determine the amount of revenue and profit to recognize on all significant contracts. We generally utilize an efforts-expended cost-to-cost approach in applying the percentage-of-completion method under which revenue is earned in proportion to total costs incurred divided by total costs expected to be incurred.
Under the percentage-of-completion method, recognition of profit is dependent upon the accuracy of a variety of estimates including engineering progress, materials quantities, achievement of milestones and other incentives, penalty provisions, labor productivity and cost estimates. Such estimates are based on various judgments we make with respect to those factors and can be difficult to accurately determine until the project is significantly underway. Due to uncertainties inherent in the estimation process, actual completion costs often vary from estimates. Pursuant to SOP 81-1, if estimated total costs on any contract indicate a loss, we charge the entire estimated loss to operations in the period the loss first becomes known.
If actual costs exceed the original contract price, payment of additional costs will be pursuant to a change order, contract modification, or claim.
Unit price contracts are a subset of fixed-price contracts. Under unit price contracts, our clients pay a set fee for each service or unit of production. We recognize revenue under unit price contracts as we complete the related service transaction for our clients. If our costs per service transaction exceed original estimates, our profit margins will decrease and we may realize a loss on the project unless we can receive payment for the additional costs.
Under time-and-materials contracts, we negotiate hourly billing rates and charge our clients based on the actual time that we expend on a project. In addition, clients reimburse us for actual out-of-pocket costs of materials and other direct reimbursable expenses that we incur in connection with our performance under the contract. Our profit margins on time-and-materials contracts fluctuate based on actual labor and overhead costs that we directly charge or allocate to contracts compared to negotiated billing rates. Revenue on time-and-materials contracts is recognized based on the actual number of hours we spend on the projects plus any actual out-of-pocket costs of materials and other direct reimbursable expenses that we incur on the projects.
Cost-Plus Fixed Fee. Under cost-plus fixed fee contracts, we charge clients for our costs, including both direct and indirect costs, plus a fixed negotiated fee. In negotiating a cost-plus fixed fee contract, we estimate all recoverable direct and indirect costs and then add a fixed profit component. The total estimated cost plus the negotiated fee represents the total contract value. We recognize revenue based on the actual labor costs, plus non-labor costs we incur, plus the portion of the fixed fee we have earned to date. We invoice for our services as revenue is recognized or in accordance with agreed upon billing schedules.
Cost-Plus Fixed Rate. Under our cost-plus fixed rate contracts, we charge clients for our costs plus negotiated rates based on our indirect costs. In negotiating a cost-plus fixed rate contract, we estimate all recoverable direct and indirect costs and then add a profit component, which is a percentage of total recoverable costs, to arrive at a total dollar estimate for the project. We recognize revenue based on the actual total costs we have expended plus the applicable fixed rate. If the actual total costs are lower than the total costs we have estimated, our revenue from that project will be lower than originally estimated.
Change orders are modifications of an original contract that effectively change the provisions of the contract. Change orders typically result from changes in scope, specifications or design, manner of performance, facilities, equipment, materials, sites, or period of completion of the work. Claims are amounts in excess of the agreed contract price that we seek to collect from our clients or others for client-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.
Costs related to change orders and claims are recognized when they are incurred. Change orders are included in total estimated contract revenue when it is probable that the change order will result in a bona fide addition to contract value and can be reliably estimated. Claims are included in total estimated contract revenues only to the extent that contract costs related to the claims have been incurred and when it is probable that the claim will result in a bona fide addition to contract value which can be reliably estimated. No profit is recognized on claims until final settlement occurs.
Other Contract Matters
We have fixed-price Exit Strategy contracts to remediate environmental conditions at contaminated sites. Under most Exit Strategy contracts, the majority of the contract price is deposited into a restricted account with an insurer. These proceeds, less any insurance premiums and fees for a policy to cover potential cost overruns and other factors, are held by the insurer and used to pay us as work is performed. The arrangement with the insurer provides for the deposited funds to earn interest at the one-year
constant maturity U.S. Treasury Bill rate. The interest is recorded when earned and reported as interest income from contractual arrangements on the consolidated statement of operations.
The net proceeds held by the insurer, and interest growth thereon, are recorded as an asset (current and long-term restricted investment) on our consolidated balance sheet, with a corresponding liability related to the net proceeds (current and long-term deferred revenue). Consistent with our other fixed price contracts, we recognize revenue on Exit Strategy contracts using the percentage-of-completion method. Under this method for revenue recognition, we estimate the progress towards completion to determine the amount of revenue and profit to recognize on all significant contracts. We utilize an efforts-expended cost-to-cost approach in applying the percentage-of-completion method under which revenue is earned in proportion to total costs incurred, divided by total costs expected to be incurred. When determining the extent of progress towards completion on Exit Strategy contracts, prepaid insurance premiums and fees are amortized, on a straight-line basis, to cost incurred over the life of the related insurance policy. Pursuant to SOP 81-1, certain Exit Strategy contracts are classified as pertaining to either remediation or operation, maintenance and monitoring.
In instances where we establish that: (1) costs exceed the contract value and interest growth thereon and (2) such costs are covered by insurance, we record an insurance recovery up to the amount of our insured costs. An insurance gain, that is, an amount to be recovered in excess of our recorded costs, is not recognized until all contingencies relating to our insurance claim have been resolved. We define the resolution of contingencies, with respect to insurance claims, as the receipt of insurance proceeds. Insurance recoveries are reported as insurance recoverable on our consolidated statement of operations. Pursuant to SOP 81-1, if estimated total costs on any contract indicate a loss, we charge the entire estimated loss to operations in the period the loss first becomes known.
Federal Acquisition Regulations (FAR), which are applicable to our federal government contracts and may be incorporated in many local and state agency contracts, limit the recovery of certain specified indirect costs on contracts. Cost-plus contracts covered by FAR or with certain state and local agencies also require an audit of actual costs and provide for upward or downward adjustments if actual recoverable costs differ from billed recoverable costs. Most of our federal government contracts are subject to termination at the discretion of the client. Contracts typically provide for reimbursement of costs incurred and payment of fees earned through the date of such termination.
These contracts are subject to audit by the government, primarily the Defense Contract Audit Agency (DCAA), which reviews our overhead rates, operating systems and cost proposals. During the course of its audits, the DCAA may disallow costs if it determines that we have improperly accounted for such costs in a manner inconsistent with Cost Accounting Standards. Our last audit was for fiscal 1999 and resulted in a $42 thousand adjustment. Historically, we have not had any material cost disallowances by the DCAA as a result of audit; however, there can be no assurance that DCAA audits will not result in material cost disallowances in the future.
Allowances for Doubtful Accounts: Allowances for doubtful accounts are maintained for estimated losses resulting from the failure of our clients to make required payments. Allowances for doubtful accounts have been determined through reviews of specific amounts deemed to be uncollectible and estimated write-offs as a result of clients who have filed for bankruptcy protection, plus an allowance for other amounts for which some loss is determined to be probable based on current circumstances. If the financial condition of clients or our assessment as to collectibility were to change, adjustments to the allowances may be required.
Stock-Based Compensation: On July 1, 2005, we adopted SFAS No. 123 (revised 2004), Share-Based Payment, (SFAS 123(R)) which requires the measurement and recognition of compensation expense for all stock-based awards made to our employees and directors including employee stock options, employee stock purchase plans, and other stock-based awards based on estimated fair values. SFAS 123(R) supersedes previous accounting under Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) for periods beginning in fiscal year 2006. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107) providing supplemental implementation guidance for SFAS 123(R). We have applied the provisions of SAB 107 in our adoption of SFAS 123(R).
SFAS 123(R) requires companies to estimate the fair value of stock-based awards on the date of grant using an option pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our consolidated statements of operations. We adopted SFAS 123(R) using the modified prospective transition method which requires the application of the accounting standard starting from July 1, 2005. The consolidated financial statements as of and for the year ended June 30, 2006 reflect the impact of SFAS 123(R). Total non-cash stock-based compensation expense for the year ended June 30, 2006 was $1.3 million, which consisted primarily of stock-based compensation expense related to employee stock option awards recognized under SFAS 123(R).
Upon adoption of SFAS 123(R), we selected the Black-Scholes option pricing model as the most appropriate method for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of highly subjective and complex assumptions which determine the fair value of stock-based awards, including the options expected term and the price volatility of the underlying stock. We have determined that historical volatility is most reflective of the market conditions and the best indicator of expected volatility.
The following table highlights the impact that each of the various assumptions has on determining the fair value of an option or award when using an option-pricing model:
(A) Presumes exercise price is less than fair value
Income Taxes: At June 30, 2006 and 2005, we had approximately $25.3 million and $18.0 million, respectively, of gross deferred income tax benefits. The realization of a portion of these benefits is dependent on our estimates of future taxable income and our tax planning strategies. A $1.4 million valuation allowance has been recorded in relation to certain state loss carryforwards which will more likely than not expire unused and state deferred tax assets from which a benefit is not likely to be realized. We believe that sufficient taxable income will be earned in the future to realize the remaining deferred income tax benefits. However, the realization of these deferred income tax benefits can be impacted by changes to tax codes, statutory tax rates and future taxable income levels. At June 30, 2006 and 2005, we had approximately $13.3 million and $13.8 million, respectively, of gross deferred income tax liabilities which related primarily to depreciation and amortization.
Business Acquisitions: Assets and liabilities acquired in business combinations are recorded at their estimated fair values on the acquisition date. At June 30, 2006, we had approximately $126.3 million of
goodwill, representing the cost of acquisitions in excess of fair values assigned to the underlying net assets of acquired companies. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142), goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to annual impairment testing. Additionally, goodwill is tested between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the unit below its carrying value. The assessment of goodwill involves the estimation of the fair value of our units as defined by SFAS 142.
We completed our required annual assessment of the recoverability of goodwill for fiscal 2006. In performing our goodwill assessment we used current market capitalization and other factors as the best evidence of fair value. We also consider a number of other factors including the operating results, business plans, economic projections, anticipated future cash flows and a discount rate reflecting the risk inherent in future cash flows. There are inherent uncertainties related to these factors and managements judgment in applying them to the analysis of goodwill impairment. Management completed this assessment during the third quarter of fiscal 2006, based on information as of the December 31, 2005 assessment date, and determined that no impairment existed. Since the assessment date, our market capitalization has declined; however, at June 30, 2006, our market capitalization was in excess of our carrying amount, and management determined that no impairment existed at June 30, 2006. There can be no assurance that future events will not result in an impairment of goodwill or other assets.
Long-Lived Assets: We periodically assess the recoverability of the unamortized balance of our long-lived assets, including intangible assets, based on expected future profitability and undiscounted expected cash flows and their contribution to our overall operations. Should the review indicate that the carrying value is not fully recoverable, the excess of the carrying value over the fair value of the other intangible assets would be recognized as an impairment loss.
Consolidation: We determine whether we have a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity (VIE) under generally accepted accounting principles.
Voting Interest Entities. Voting interest entities are entities in which: (i) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the obligation to absorb losses, the right to receive residual returns and the right to make decisions about the entitys activities. Voting interest entities are consolidated in accordance with Accounting Research Bulletin (ARB) No. 51, Consolidated Financial Statements, (ARB 51) as amended. ARB 51 states that the usual condition for a controlling financial interest in an entity is ownership of a majority voting interest. Accordingly, we consolidate voting interest entities in which we have a majority voting interest.
Variable Interest Entities. VIEs are entities that lack one or more of the characteristics of a voting interest entity. A controlling financial interest in a VIE is present when an enterprise has a variable interest, or a combination of variable interests, that will absorb a majority of the VIEs expected losses, receive a majority of the VIEs expected residual returns, or both. The enterprise with a controlling financial interest, known as the primary beneficiary, consolidates the VIE. In accordance with FASB Interpretation (FIN) No. 46(R), Consolidation of Variable Interest Entities, we consolidate all VIEs of which we are the primary beneficiary.
We determine whether we are the primary beneficiary of a VIE by first performing a qualitative analysis of the VIE that includes a review of, among other factors, its capital structure, contractual terms, which interests create or absorb variability, related party relationships and the design of the VIE.
Equity-Method Investments. When we do not have a controlling financial interest in an entity but exert significant influence over the entitys operating and financial policies (generally defined as owning a voting interest of 20% to 50% for a corporation or 3% - 5% to 50% for a partnership or Limited Liability
Company) and have an investment in common stock or in-substance common stock, we account for our investment in accordance with the equity method of accounting prescribed by APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock.
Insurance Matters, Litigation and Contingencies: In the normal course of business, we are subject to certain contractual guarantees and litigation. Generally, such guarantees relate to project schedules and performance. Most of the litigation involves us as a defendant in contractual disputes, professional liability, personal injury and other similar lawsuits. We maintain insurance coverage for various aspects of our business and operations. However, we have elected to retain a portion of losses that may occur through the use of various deductibles, limits and retentions under our insurance programs. This practice may subject us to some future liability for which we are only partially insured or are completely uninsured. In accordance with SFAS No. 5, Accounting for Contingencies, we record in our consolidated balance sheets amounts representing our estimated losses from claims and settlements when such losses are deemed probable and estimable. Otherwise, these losses are expensed as incurred. Costs of defense are expensed as incurred. If the estimate of a probable loss is a range, and no amount within the range is more likely, we accrue the lower limit of the range. As additional information about current or future litigation or other contingencies becomes available, management will assess whether such information warrants the recording of additional expenses relating to those contingencies. Such additional expenses could potentially have a material impact on our results of operations and financial position.
In fiscal 2006, we continued to face many of the challenges that negatively affected our performance in fiscal 2005. Operating results were not favorable and were significantly impacted by poor operating performance and by certain charges. Specifically, operating performance results were not favorable due to the following pre-tax costs:
· Approximately $8.2 million resulting from three significant loss contracts;
· Approximately $8.1 million to increase our allowance for doubtful accounts for specific receivables that management determined it would no longer pursue collection of;
· $5.8 million of accounting-related costs primarily associated with Sarbanes-Oxley compliance efforts and the restatement of our consolidated financial statements;
· Approximately $3.4 million of costs relating to compliance with our forbearance agreements with our lenders and our engagement of Glass & Associates, Inc. for the provision of restructuring services;
· An impairment charge of approximately $2.2 million to adjust the carrying value of certain trade name intangible assets;
· Approximately $1.0 million for restructuring; and,
· A loss on disposal charge of approximately $5.3 million related to the divestiture of PacLand included in discontinued operations.
We are taking action to significantly reduce these levels of losses and costs. Specifically, we are enhancing our controls over project acceptance, which we believe will significantly reduce the level of contract losses; we are increasing the level of experience of our accounting personnel in order to improve our internal controls and reduce compliance costs; we are improving the timeliness of customer invoicing, and enhancing our collection efforts, which we believe will result in fewer write-offs of project revenue and in lower levels of bad debt expense; and we are improving project management, which we believe will result in significantly higher levels of project profitability.
Despite the unfavorable results business activity remains strong across all of our markets:
Real Estate: Industry activity has remained strong. Backlog for Exit Strategy projects remains stable but our backlog of real estate development and investment projects increased, and demand for our commercial land development and redevelopment services (including brownfield development) remains strong. The labor market for civil engineers for land development projects remains tight in many areas, demanding an ongoing focus on recruiting senior professionals. We envision continued growth in this market in 2007.
Energy: The nation is in the early stages of a multi-year build-out of the electric transmission grid. Years of underinvestment coupled with an increasingly favorable regulatory environment has provided an extraordinary business climate for those serving this market. According to a recent Department of Energy (DOE) study, $50 billion to $100 billion of investment is needed to modernize the grid. Transmission owners are responding to these needs and financial incentives of high returns on equity with large investments providing excellent opportunities for our services including: permitting/licensing, engineering, construction for the electric transmission system and development of renewable energy projects. We are well established in the geographic regions where demand for services is the highest.
Environmental: Market demand for environmental services remains solid, driven by a combination of regulatory requirements and economic factors. Regulatory focus on new emissions of concern (e.g. mercury, small particulates) is increasing short to mid-term demand for air quality consulting and air measurement services. Climate change initiatives at the state level, and ultimately the federal level, will sustain market growth for air services beyond the mid-term. By contrast, the demand for remediation services is being driven less by regulatory requirements and more by the economics of the real estate market. The remediation of Brownfield sites in certain urban areas now makes financial sense as governments provide incentives to convert these sites into productive use. Real estate developers and owners are also increasing their demand for building science services (e.g. mold, water intrusion, indoor air quality) as insurers demand that they better manage risks associated with issues of construction quality.
Infrastructure: The recent passage of the TEA-21 successor highway and transit bill, SAFETEA-LU, will continue to provide stable funding for current and new transportation projects. Additionally, all 50 states now have approved budgets for fiscal year 2007; however, some states are moving more quickly than others to release funding and initiate projects. With improving conditions in many states and certainty regarding federal funding, we anticipate growth in this market in 2007.
The following table presents the percentage relationships of items in the consolidated statements of operations to NSR for the years ended June 30:
Results of Operations
2006 Compared to 2005
Gross revenue increased $37.8 million, or 10.4%, to $401.2 million in fiscal 2006 from $363.4 million in fiscal 2005. Acquisitions provided $13.6 million of gross revenue growth in fiscal 2006, while gross revenue from organic activities grew by $24.2 million in that same period. The increase in the organic gross revenue was primarily due to the following: (1) increased demand for our energy related engineering services, resulting in an $9.6 million increase in our revenues for these services in 2006; (2) a $14.0 million increase resulting from a significant contract entered into in late 2005, under which we were engaged to engineer, procure and construct a collection system and electrical substation for a wind farm; and (3) a $3.8 million increase in our emissions group revenue, due primarily to several large government related contracts that were postponed in 2005, and recommenced in 2006. These increases were offset by a $7.1 million decline in revenue due to a significant infrastructure security contract, which was substantially complete in 2005.
Net service revenue (NSR) increased $19.0 million, or 8.5%, to $242.4 million in fiscal 2006 from $223.4 million in fiscal 2005. Acquisitions provided $9.7 million of NSR growth in fiscal 2006, while NSR from organic activities increased by $9.3 million in fiscal 2006 compared to fiscal 2005. The growth in organic NSR was due, in part, to a $4.8 million increase in demand for our energy related engineering services. In addition, NSR increased $10.1 million in 2006 as a result of an exit strategy contract entering into insurance coverage during fiscal 2005. During 2005, NSR was reduced as a result of the Company recording significant subcontractor costs without a corresponding offset to gross revenue (the offsetting income was recorded to insurance recoverables). On exit strategy contracts we record proceeds from the restricted account held by the insurer as revenue up until the restricted account is depleted. Insurance proceeds received after the restricted account is depleted are recorded as insurance recoverables. The contract was substantially complete during 2005. The above increases were partially offset by $4.7 million less NSR from a significant infrastructure security contract, which was substantially complete in 2005.
Interest income from contractual arrangements increased $1.5 million, or 57.3%, to $4.1 million in fiscal 2006 from $2.6 million in fiscal 2005 primarily due to higher one-year constant maturity T-Bill rates.
Insurance recoverables decreased $13.9 million, or 93.0%, to $1.1 million in fiscal 2006 from $15.0 million in fiscal 2005 due to the aforementioned Exit Strategy contract where costs were incurred that were covered by insurance. The contract was substantially complete in 2005.
Cost of services (COS) increased $11.5 million, or 5.2%, to $232.0 million in fiscal 2006 from $220.5 million in fiscal 2005. Acquisitions accounted for approximately $7.8 million, or 67.8%, of the increase in fiscal 2006 compared to 2005 while organic cost of services accounted for $3.7 million or 32.2% of the increase. The increase in the organic COS growth was primarily due to a $4.2 million increase in billable headcount to support the increased demand for our energy related engineering services and a $6.2 million increase in contract losses primarily associated with three large contracts. The increases were partially offset by costs savings realized from various restructuring activities undertaken during the fourth quarter of fiscal 2005 and throughout 2006.
General and administrative expenses increased $9.9 million, or 67.8%, to $24.6 million in fiscal 2006 from $14.7 million in fiscal 2005. The 2006 increase is primarily attributable to the following: (1) $3.4 million of costs relating to compliance with our forbearance agreements with our lenders and our engagement of Glass & Associates, Inc. for the provision of restructuring services; (2) $2.6 million of accounting and related costs primarily associated with the restatements of our consolidated financial statements; and (3) $2.2 million in employee related costs including $0.9 million in incentive compensation costs primarily related to the amendment of certain existing compensation arrangements and $0.8 million (of the $1.3 million total) of stock-based compensation charges which are included in general and administrative expenses resulting from our adoption of SFAS 123(R).
Goodwill and intangible asset write-offs decreased $1.4 million, or 40.1%, to $2.2 million in fiscal 2006 from $3.6 million in fiscal 2005. During the fourth quarter of fiscal 2006, in conjunction with managements
decisions to unite our various subsidiaries under one trade name, we assigned useful lives to our trade names which were previously classified as indefinite-lived intangible assets. As a result, we determined that the carrying value of trade names exceeded the fair value generated by those assets, and, we recorded an impairment charge of approximately $2.2 million during the fourth quarter of 2006. During the fourth quarter of fiscal 2005, it became clear that a technical error which occurred during the installation phase of a long-term contract would result in a significant reduction of total expected revenue under this contract. The reduction of revenue put the seventeen year contract into a forward loss position. The impact of the loss contract triggered an impairment evaluation of the goodwill within our Co-Energy (CEG) subsidiary. Based on our 50% co-investors unwillingness to provide further financial support and a review of the financial condition of the investment, including near-term prospects, we decided not to provide the additional investment necessary to allow for recovery of CEG. Therefore, in June 2005, we recorded an impairment charge of $2.6 million to write-off CEG goodwill and a $1.0 million impairment charge to write-off the intangible assets of CEG.
The provision for doubtful accounts increased $3.1 million or 62.7% to $8.1 million in fiscal 2006 from $5.0 million in fiscal 2005. The increase is due to several specific receivables that management determined it would no longer pursue collection of and an increase in our gross revenue.
Depreciation and amortization increased $0.8 million, or 12.5%, to $7.0 million in fiscal 2006 from $6.2 million in fiscal 2005. The increase in depreciation and amortization expense in fiscal 2006 is primarily due to additional depreciation expense resulting from capital expenditures completed in fiscal 2006 and 2005.
As a result of the above factors, the operating loss increased by $17.3 million, or 191.8%, to a $26.3 million loss in fiscal 2006 from a $9.0 million loss in fiscal 2005. Acquisitions provided $1.5 million of operating income in fiscal 2006. The operating loss, exclusive of acquisitions, increased by $18.8 million due to the reasons above.
Equity in earnings from unconsolidated affiliates, net of taxes decreased $0.3 million, or 97.4%, to $9.0 thousand in fiscal 2006 from $0.3 million in fiscal 2005. In October 2004, we exercised an option to redeem our investment in an environmental liability management company formed by a customer. As a result, we received $0.9 million and recognized a gain of $0.5 million during fiscal 2005 as equity in earnings from unconsolidated affiliates. The amount earned was related to cost savings generated on an environmental remediation program managed by us.
Discontinued operations, net of taxes decreased $3.4 million, to a $3.3 million loss in fiscal 2006 from income of $0.2 million in fiscal 2005. In the fourth quarter of fiscal 2006 the Company sold PacLand and committed to sell Bellatrix. The fiscal 2005 results include approximately ten months of activity for Bellatrix (a first quarter fiscal 2005 acquisition) and six months of activity for PacLand (a third quarter fiscal 2005 acquisition). The fiscal 2006 results include a $0.3 million (pre-tax) impairment charge on the assets held for sale of Bellatrix and a $5.3 million (pre-tax) loss on disposal related to the PacLand divestiture.
In fiscal 2006, interest expense increased $2.1 million, or 86.4%, to $4.5 million from $2.4 million in fiscal 2005. The increase was due to higher interest rates charged throughout the year due to forbearance agreements with our lenders resulting from events of default on our revolving credit facility. The weighted average interest rate increased from 4.1% in fiscal 2005 to 8.5% in fiscal 2006. The average balance outstanding on our credit facility increased from $47.6 million in fiscal 2005 to $48.7 million in fiscal 2006.
The federal and state income tax provision (benefit) represents an effective rate of 33.2% in fiscal 2006 and 33.0% in fiscal 2005. We believe that there will be sufficient taxable income in future periods to enable utilization of available deferred income tax benefits.
2005 Compared to 2004
Fiscal 2005 operating results were not favorable and were significantly impacted by poor operating performance and by certain charges. Specifically, operating performance results were not favorable due to: (1) increasing organic operating costs despite declining organic revenue, primarily at our infrastructure offices; (2) higher than anticipated Sarbanes-Oxley compliance costs; and (3) the postponement of several large government-related emissions tests. Additionally, we incurred significant costs associated with loss contracts identified during fiscal 2005. We also recorded several charges, cumulatively equal to approximately $6.4 million, that were either not incurred (or incurred to a lesser extent) in fiscal 2004, including the following:
· Approximately $1.6 million to increase our allowance for doubtful accounts for specific receivables that management determined it would no longer pursue collection of;
· Approximately $2.0 million for contract loss reserves;
· Approximately $1.1 million to write off certain distributed generation assets (electrical generators, related equipment and engineering designs) whose value has declined primarily due to high natural gas costs;
· Approximately $0.9 million for restructuring costs to reduce and rebalance the workforce within a portion of our infrastructure group; and
· Approximately $0.8 million for a settlement with the New York City Department of Transportation related to an infrastructure group contract for construction support services.
As discussed in Note 2 to the consolidated financial statements, pursuant to the requirements of FIN 46(R), we consolidated the financial statements of Co-Energy in the fourth quarter of fiscal 2004 and all of fiscal 2005 as it was determined that we were the primary beneficiary of Co-Energy (a variable interest entity or VIE). As such, the fiscal 2004 financial data presented only reflects the operations of CEG for the fourth quarter of fiscal 2004.
Gross revenue increased $9.0 million, or 2.5%, to $363.4 million in fiscal 2005 from $354.4 million in fiscal 2004. Acquisitions provided $12.3 million of gross revenue growth in fiscal 2005, while gross revenue from organic activities experienced a $3.3 million decline in fiscal 2005 compared to fiscal 2004 primarily due to a decrease in exit strategy revenues as discussed in the NSR section below.
NSR decreased $5.4 million, or 2.4%, to $223.4 million in fiscal 2005 from $228.8 million in fiscal 2004. Acquisitions provided $11.2 million of NSR growth in fiscal 2005, while NSR from organic activities
experienced a $16.6 million decline in fiscal 2005 compared to fiscal 2004. Organic activities continued to be affected by challenging economic conditions, particularly for large capital projects which generally lag behind initial periods of economic upturns. NSR from organic activities decreased during fiscal 2005 compared to fiscal 2004, primarily due to the postponement of several large government-related emissions tests and the softness in the infrastructure market which resulted in an estimated NSR decrease of approximately $10.9 million in fiscal 2005. In addition, organic NSR decreased $14.0 million which was primarily attributable to an Exit Strategy contract which went into insurance coverage during fiscal 2005. On exit strategy contracts, we record proceeds from the restricted account held by the insurer as revenue up until the restricted account is depleted. Insurance proceeds received after the restricted account is depleted are recorded as insurance recoverables. During 2004, prior to the exit strategy contract reaching insurance coverage, proceeds were recorded as revenue whereas in fiscal 2005 insurance proceeds received were reported as an insurance recoverable. The adverse impacts of the above items were partially offset by $3.9 million of higher revenue attributable to increased demand from our energy clients.
Interest income from contractual arrangements increased $0.7 million, or 37.3%, to $2.6 million in fiscal 2005 from $1.9 million in fiscal 2004 primarily due to higher one-year constant maturity T-Bill rates.
Insurance recoverables increased $15.0 million, to a $15.0 million gain in fiscal 2005 from an $18 thousand loss in fiscal 2004 due to the Exit Strategy contract where costs were incurred that were covered by insurance.
COS increased $25.5 million, or 13.1%, to $220.5 million in fiscal 2005 from $195.0 million in fiscal 2004. Acquisitions accounted for approximately $9.0 million, or 35.3%, of the increase in fiscal 2005 compared to fiscal 2004 while organic cost of services increased $16.5 million or 64.7%. Specifically, organic COS increased due to the approximately $7.5 million of cost increases at two of our operations that principally service the infrastructure market. The increased costs were primarily attributable to new office openings, increases in staff headcount and higher than expected marketing costs. These additional costs were not supported by a corresponding increase in NSR. As a result a $0.9 million restructuring charge was recorded in the fourth quarter of fiscal 2005 to reduce the workforce within these offices. Organic COS also increased by $3.1 million to support growing customer demand from our energy clients. To serve this increase in demand, we increased our billable headcount. In addition, organic COS in fiscal 2005 includes the following charges: (1) approximately $2.0 million of contract loss reserves; (2) a $1.1 million write-off related to certain distributed generation assets whose value has declined primarily due to high natural gas costs; and (3) a $0.8 million settlement with the New York City Department of Transportation related to a contract for construction support services.
General and administrative expenses increased $6.1 million, or 71.1%, to $14.7 million in fiscal 2005 from $8.6 million in fiscal 2004. In fiscal 2005, we incurred approximately $3.8 million of costs in connection with our efforts to become compliant with the requirements of Sarbanes-Oxley. The remainder of the increase was primarily related to a $1.5 million increase in litigation related costs and other internal costs related to Sarbanes-Oxley.
Provision for doubtful accounts increased $1.8 million and 58.0% to $5.0 million in fiscal 2005 from $3.1 million in fiscal 2004. The increase is due to approximately $1.6 million for doubtful accounts charges incurred in the year ended June 30, 2005 for specific receivables that management determined it would no longer pursue collection of.
During the fourth quarter of fiscal 2005, it became clear that a technical error which occurred during the installation phase of a long-term contract would result in a significant reduction of total expected revenue under this contract. The reduction of revenue put the seventeen year contract into a forward loss position. The impact of the loss contract triggered an impairment evaluation of the goodwill within the CEG reporting unit. Based on our 50% co-investors unwillingness to provide further financial support and a review of the financial condition of the investment, including near-term prospects, we decided not to
provide the additional investment necessary to allow for any anticipated recovery of CEG. As required by SFAS 142, we performed a two-step interim impairment test to confirm and quantify the impairment. During step one, we determined that the goodwill recorded in the CEG reporting unit was impaired because the fair value of the reporting unit was less than the carrying value of the reporting units net assets. The fair value of the reporting unit was estimated using the discounted cash flow method. In order to quantify the impairment, we performed step two by allocating the fair value of the CEG reporting unit to the reporting units individual assets and liabilities utilizing the purchase price allocation guidance of SFAS 141. The resulting implied value of the CEG reporting units goodwill was $0, primarily as a result of managements decision, subsequent to June 30, 2005, not to provide the additional investment necessary to allow for any anticipated recovery of CEG. Therefore, in June 2005, we recorded an impairment charge of $2.6 million to write off the goodwill and we recorded a $1.0 million impairment charge to write-off the intangible assets of CEG.
Depreciation and amortization increased $0.5 million, or 8.1%, to $6.2 million in fiscal 2005 from $5.7 million in fiscal 2004. The increase in depreciation and amortization expense in fiscal 2005 is primarily due to: (1) the amortization of intangible assets related to acquisitions completed in fiscal 2005 and (2) the additional depreciation expense resulting from capital expenditures in fiscal 2005 and 2004.
As a result of the above factors, the operating income decreased by $27.2 million, or 149.3%, to a $9.0 million loss in fiscal 2005 from $18.2 million in income in fiscal 2004. Acquisitions provided $2.9 million of income from operations in fiscal 2005. Operating income (loss), exclusive of acquisitions, decreased by $30.1 million due to the reasons above.
Equity in earnings (losses) from unconsolidated affiliates, net of taxes increased $0.6 million to $0.3 million earnings in fiscal 2005 from a loss of $0.3 million in fiscal 2004. In October 2004, we exercised an option to redeem our investment in an environmental liability management company formed by a customer. As a result, we received $0.9 million and recognized a gain of $0.5 million during the three months ended March 31, 2005 as equity in earnings from unconsolidated affiliates. The amount earned was related to cost savings generated on an environmental remediation program managed by us. Equity in earnings for CEG was $0 in fiscal 2005 as CEG was consolidated as a VIE. The CEGs equity loss of $0.3 million in fiscal 2004 was for the first three fiscal quarters of the year prior to the consolidation of CEG.
In fiscal 2005, interest expense increased $0.9 million, or 66.8%, to $2.4 million from $1.5 million in fiscal 2004. The increase resulted primarily from higher borrowings to finance acquisitions and higher interest rates throughout the year.
The federal and state income tax provision (benefit) represents an effective rate of 33.0% in fiscal 2005 and 41.5% in fiscal 2004. This decrease was primarily due to losses incurred by certain entities for which no associated state tax benefit has been derived as well as minority interest losses on which no tax benefit is available in fiscal 2005.
Our operations have not been materially affected by inflation or changing prices because most contracts of a longer term are subject to adjustment or have been priced to cover anticipated increases in labor and other costs and the remaining contracts are short term in nature.
We primarily rely on cash from operations and financing activities, including borrowings under our revolving credit facility, to fund operations. Our liquidity is assessed in terms of our overall ability to generate cash to fund our operating and investing activities and to reduce debt.
Cash flows provided by operating activities were $9.6 million in fiscal 2006, compared to $21.4 million in fiscal 2005. In fiscal 2006, we reported a net loss of $23.8 million while we generated cash from operating activities of $9.6 million. Sources of cash generated from operating activities during fiscal 2006 consisted primarily of: (1) a $19.1 million reduction in restricted investments due to work performed on Exit Strategy contracts in excess of both increases in restricted investments for new Exit Strategy contracts and interest earned on the restricted investments; (2) $8.1 million of non-cash expense for an increase in the allowance for doubtful accounts; (3) $7.8 million in non-cash expenses for depreciation and amortization; (4) a $4.6 million decrease in insurance recoverable due to insurance proceeds received related to Exit Strategy contracts; (5) a $5.1 million decrease in accounts receivable due to increased collection efforts; (6) a $4.4 million increase in accrued compensation and benefits; (7) $5.3 million in non-cash expenses related to discontinued operations; (8) a $3.1 million increase in accounts payable; and (9) $2.2 million of non-cash expense for intangible asset write-offs. The sources of cash were partially offset by uses of cash and consisted primarily of the (1) $23.8 million net loss; (2) a $20.5 million decrease in deferred revenue that resulted from work performed primarily on Exit Strategy contracts being in excess of prepayments received on work to be performed; and (3) an $8.7 million increase in deferred income taxes and incomes taxes payable.
Accounts receivable include both: (1) billed receivables associated with invoices submitted for work previously completed and (2) unbilled receivables (work in progress). The unbilled receivables are primarily related to work performed in the last few months of the fiscal year. The magnitude of accounts receivable for a professional services company is typically evaluated as days sales outstanding (DSO), which we calculate by dividing both current and long-term receivables by the most recent four-month average of daily gross revenue after adjusting for acquisitions. DSO, which measures the collections turnover of both billed and unbilled receivables, has decreased to 110 at June 30, 2006 from 120 at June 30, 2005. Our goal is to reduce DSO to less than 100 days.
Under Exit Strategy contracts, the majority of the contract price is deposited into a restricted account with an insurer. These proceeds, less any insurance premiums for a policy to cover potential cost overruns and other factors, are held by the insurer and used to pay us as work is performed. The arrangement with the insurer provides for deposited funds to earn interest at the one-year constant maturity T-Bill rate. If the deposited funds do not grow at the rate anticipated when the contract was executed, over time the deposit balance may be less than originally expected. However, an insurance policy provides coverage for cost increases from unknown or changed conditions up to a specified maximum amount significantly in excess of the estimated cost of remediation.
Investing activities used cash of approximately $11.4 million in fiscal 2006 compared to $35.4 million in fiscal 2005. The investments in fiscal 2006 consisted of $7.8 million for capital expenditures for additional information technology and other equipment to support business growth and $5.2 million for additional purchase price payments related to acquisitions completed in prior years. Partially offsetting cash used for capital expenditures and additional purchase price payments for acquisitions were $1.4 million of restricted investments related to Exit Strategy projects.
During fiscal 2006, financing activities provided cash of $1.5 million. This consisted of $19.9 million of proceeds from the issuance of common stock and $0.2 million of proceeds received by us upon the exercise of stock options and warrants. On March 6, 2006, we sold 2,162,163 shares of our common stock, $0.10 par value per share, at a price of $9.25 per share pursuant to a Purchase Agreement by and among us and the investors named therein. Of the shares sold, 942,980 were issued from treasury and 1,219,183 were newly issued. The Private Placement resulted in $20.0 million in gross proceeds that were used by us to reduce debt and for general corporate purposes. The private placement was made pursuant to the exemption from registration provided in Regulation D, Rule 506, under Section 4(2) of the Securities Act of 1933, as amended. Partially offsetting the sources of cash from the common stock offering and the exercise of stock
options and warrants were uses of cash of $17.9 million to repay balances owed on our revolving credit facility and $0.8 million in payments on long-term debt.
Cash flows provided by operating activities were $21.4 million in fiscal 2005, compared to $10.3 million in fiscal 2004. Sources of cash generated from operating activities during fiscal 2005 consisted primarily of: (1) $17.3 million from increases in accounts payable (primarily related to higher subcontractor costs in Q4 fiscal 2005 compared to Q4 fiscal 2004); (2) $15.5 million from an increase in deferred revenues (related to the award of new Exit Strategy contracts in fiscal 2005); (3) an $8.1 million increase in environmental remediation liabilities; (4) $7.1 million from an increase in other accrued liabilities (primarily due to (1) increased Sarbanes-Oxley and audit costs in fiscal 2005 and an (2) an increase in contract loss reserves); (5) a $5.8 million increase in restricted investments (primarily related to the award of new Exit Strategy contracts in fiscal 2005); and, (6) non-cash expenses of $10.9 million ($6.6 million for depreciation and amortization, $5.0 million for the provision for doubtful accounts and a $0.7 million benefit for changes in deferred taxes and other non-cash items). The cash provided was partially offset by: (1) a $21.7 million increase in accounts receivable which is explained below; (2) a $9.1 million increase in long-term prepaid insurance (related to the award of new Exit Strategy contracts in fiscal 2005); and (3) a $4.3 million increase in insurance recoverable primarily related to one Exit Strategy project.
Investing activities used cash of $35.4 million in fiscal 2005 compared to $11.1 million in fiscal 2004. The investments in fiscal 2005 consisted of: (1) $17.6 million for acquisitions (approximately $13.1 million for fiscal 2005 acquisitions and approximately $4.5 million for additional purchase price payments related to acquisitions completed in prior years); (2) $6.3 million for capital expenditures for additional information technology and other equipment to support business growth; and (3) $12.3 million of restricted investments related to Exit Strategy projects. The cash used was partially offset by $0.8 million for investments in unconsolidated affiliates.
During fiscal 2005, financing activities provided cash of $13.9 million, consisting of $14.5 million of net borrowings from our credit facility to support investing activities and $1.4 million from the exercise of stock options and warrants, partially offset by $2.0 million to repay long-term debt.
Debt at June 30, 2006 and 2005 is comprised of the following (in thousands):
At June 30, 2006, we had borrowings outstanding pursuant to our revolving credit facility of $37.1 million at an interest rate of 10.5% (which includes the additional 2% per the forbearance agreement as noted below), compared to $55.0 million of borrowings outstanding at an average interest rate of 5.2% at June 30, 2005. Events of default occurred under the credit agreement as a result of our failure to timely deliver audited financial statements for the fiscal year ended June 30, 2005 and our violation of the coverage and leverage ratios due to lower than expected earnings. As a result, on November 2, 2005, January 24, 2006, February 15, 2006 and March 15, 2006, we entered into forbearance agreements and global amendments to the credit agreement with our lenders that extended through July 15, 2006. Under the terms of these agreements, the lenders agreed to continue to make loans under the credit agreement and forbear in the exercise of their rights and remedies under the credit agreement. The maximum amount available under the credit agreement was reduced to $49.6 million following our $20.0 million equity financing which closed in March 2006 and further reduced to $48.0 million by June 30, 2006. The
forbearance agreement contained a covenant that required the Company to maintain a minimum availability of $4.5 million (increasing to $5.8 million by virtue of the cash received in the PacLand settlement), which effectively reduced the maximum amount available under the credit agreement to $42.2 million at June 30, 2006. We had $5.1 million in unused availability that we could borrow at June 30, 2006.
Under the forbearance agreement, we were required to pay an additional 2% interest on outstanding loans under the credit agreement and to provide the lenders or their consultants full access to our financial records and provide the lenders with certain financial and other deliverables. We also agreed that we would not, without the consent of the lenders, incur additional indebtedness, pledge any of our assets, pay any cash dividends or make any distributions to our shareholders, except with respect to the payment of dividends or the redemption of preferred stock with common stock, become a party to a merger, consolidation, or acquisition or sell or otherwise dispose of our assets. In addition, borrowings under the credit agreement were collateralized by all our assets.
On July 17, 2006 we entered into a secured credit agreement (the Credit Agreement) and related security documentation with Wells Fargo Foothill, Inc., as lender and administrative agent, and we entered into a three-year subordinated loan agreement (the Subordinated Loan) with Federal Partners, L.P., a significant stockholder of TRC, pursuant to which we borrowed $5.0 million. The Credit Agreement provides us with a five-year senior revolving credit facility of up to $50.0 million determined on a borrowing base formula on accounts receivable. Amounts outstanding under the new credit facility bear interest at the greater of 7.75% and prime rate plus a margin of 1.25% to 2.25%, or the greater of 5.0% and LIBOR plus a margin of 2.25% to 3.25%, based on average excess availability. The Credit Agreement contains covenants which, among other things, require us to maintain a minimum EBITDA (in thousands) of $3,112, $5,783, $8,644 and $12,278 for the quarter, two quarter, three quarter and four quarter periods ended or ending September 30, 2006, December 31, 2006, March 31, 2007 and June 30, 2007, respectively. Thereafter, the minimum EBITDA covenant increases in approximately equal annual increments to $24.0 million for the fiscal year ended June 30, 2010. We must maintain average monthly backlog of $190.0 million. Capital expenditures are limited (in thousands) to $9,619, $10,099 and $10,604 for the fiscal years ended June 30, 2007, 2008, and 2009 and thereafter, respectively.
Our obligations under the Credit Agreement are secured by a pledge of substantially all of our assets and guaranteed by substantially all of our subsidiaries that are not borrowers. The Credit Agreement also contains cross-default provisions which become effective if the Company defaults on other subordinated loan agreements. The proceeds of the Credit Agreement were utilized to repay the existing credit facility in full.
The Subordinated Loan bears interest at a fixed rate of 9% per annum. In addition, in connection with the subordinated loan we issued a ten-year warrant to purchase up to 66 thousand shares of our common stock to Federal Partners at an exercise price equal to $.01 per share, pursuant to the terms and conditions of a Warrant Agreement dated July 19, 2006, between us and Federal Partners.
Annual maturities of the subordinated notes during each of the fiscal years ending June 30, 2007, 2008, 2009, 2010, 2011, and thereafter (in thousands) are $300, $377, $0, $0, $0 and $1,160, respectively.
Annual maturities of the capitalized lease obligations during each of the fiscal years ending June 30, 2007, 2008, 2009, 2010, 2011, and thereafter (in thousands) are $208, $167, $157, $149, $149 and $686, respectively.
We have had several recent financing events as described in this Report, the most recent of which occurred in December 2006. Based on our current operating plans, we believe that the existing cash resources, cash forecasted by our plans to be generated by operations, and our availability on our existing line of credit will be sufficient to meet working capital and capital requirements.
The following table sets forth, as of June 30, 2006, certain information concerning our obligations to make future principal and interest payments (variable interest components used interest rates of between 8.25% to 10.50% for estimating future interest payment obligations) under contracts, such as debt and lease agreements. The rate used to project the future interest payments on our subordinated notes was 8.25%. The rate used to project the future interest payments on our long-term debt was 10.50% and included the 2.0% additional interest discussed in the Liquidity and Capital Resources section above:
We have entered into several long-term contracts pursuant to our Exit Strategy program under which we are obligated to complete the remediation of environmental conditions at sites. See Note 18 to the accompanying consolidated financial statements for additional discussion of the obligations pursuant to Exit Strategy contracts.
We do not have any off-balance sheet arrangements other than operating leases for most of our office facilities and certain equipment. Rental expense for operating leases was approximately $13.6 million in fiscal 2006, $12.9 million in fiscal 2005, and $12.3 million in fiscal 2004. Minimum operating lease obligations payable in future years (i.e., primarily base rent) are included above in Contractual Obligations.
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). This interpretation of FASB Statement No. 109, Accounting for Income Taxes (SFAS 109), prescribes a recognition threshold or measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In order to minimize the diversity in practice existing in the accounting for income taxes, FIN 48 also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As this interpretation is effective for fiscal years beginning after December 15, 2006, we will adopt FIN 48 on July 1, 2007. The cumulative effect of applying the provisions of FIN 48 will be reported as an adjustment to the opening balance of retained earnings for that fiscal year, presented separately. The cumulative effect of the change on retained earnings in the statement of financial position will be disclosed in the year of adoption only. We have not completed our evaluation of the effect of adoption of FIN 48. However, due to the fact that we have established tax positions in previously filed tax returns and are expected to take tax positions in future tax returns to be reflected in the financial statements, the adoption of FIN 48 may have a significant impact on our financial position or results of operations.
In October 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157 Fair Value Measurements (SFAS 157). This standard establishes a framework for measuring fair value and expands disclosures about fair value measurement of our assets and liabilities. This standard also requires that the fair value measurement be determined based on the assumptions that market participants would use in pricing an asset or liability. SFAS 157 is effective for financial statements issued for fiscal
years beginning after November 15, 2007 and, generally, must be applied prospectively. We will adopt this standard on July 1, 2008. We are currently evaluating the effect, if any, that the adoption of SFAS 157 will have on our consolidated financial statements.
In September 2006, the SEC issued SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, (SAB 108). SAB 108 requires that registrants quantify errors using both a balance sheet and income statement approach and evaluate whether either approach results in a misstated amount that, when all relevant quantitative and qualitative factors are considered, is material. SAB 108 is effective on July 1, 2007. We are currently evaluating the effect, if any, that the adoption of SAB 108 will have on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159 The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115, (SFAS 159). This Standard permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected to expand the use of fair value measurement, which is consistent with the Boards long-term measurement objectives for accounting for financial instruments. We will adopt this standard on July 1, 2008. We are currently evaluating the effect, if any, that the adoption of SFAS 159 will have on our consolidated financial statements.
We currently do not utilize derivative financial instruments that expose us to significant market risk. We are exposed to interest rate risk under our credit agreement. At June 30, 2006, our credit facility provided for borrowings at a base rate (the greater of the federal funds rate plus 0.50% per annum or the banks reference rate) plus a margin which ranged from 0.50% to 0.25% per annum. Events of default occurred under the credit agreement, among other things, as a result of our failure to deliver timely audited financial statements for the fiscal year ended June 30, 2005 and our violation of the coverage and leverage ratios. As a result, on November 2, 2005, January 24, 2006, February 15, 2006 and March 15, 2006, we entered into forbearance agreements and global amendments to our credit agreement with our lenders that extended through July 15, 2006. Under the terms of these agreements, the lenders agreed to continue to make loans under the credit agreement and forbear in the exercise of their rights and remedies under the credit agreement. The maximum amount available under the credit agreement reduced to $49.6 million following our $20.0 million equity financing which closed in March 2006 and further reduced to $48.0 million at June 30, 2006. However, the forbearance agreement contained a covenant that required us to maintain a minimum availability of $4.5 million (increasing to $5.8 million by virtue of the cash received in the PacLand settlement), which effectively reduced the maximum amount available under the credit agreement. We were also required to pay an additional 2% interest on outstanding loans under the credit agreement, to provide the lenders or their consultants full access to our financial records and to provide the lenders with certain financial and other deliverables.
As previously discussed in Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations under the heading of Liquidity and Capital Resources, on July 17, 2006, we entered into a $50.0 million credit facility and repaid amounts outstanding under our previous credit facility.
At June 30, 2006, we had $37.1 million outstanding on our revolving credit facility at an interest rate of 10.5%. If both the borrowings outstanding and interest rates in effect at June 30, 2006 were to remain outstanding under the new credit facility for fiscal 2007, interest expense would be approximately $3.9 million. Using the same assumptions, interest expense would increase by $390 thousand if interest rates are 10% higher and decrease by $390 thousand if interest rates are 10% lower.
To the Board of Directors and Stockholders of
We have audited the accompanying consolidated balance sheets of TRC Companies, Inc. and subsidiaries (the Company) as of June 30, 2006 and 2005, and the related consolidated statements of operations, changes in shareholders equity, and cash flows for each of the three years in the period ended June 30, 2006. Our audits also included the financial statement schedule listed in the Index at Item 8. These financial statements and the financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of TRC Companies, Inc. and subsidiaries as of June 30, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, the Company (1) adopted SFAS No. 123 (Revised 2004), Share-Based Payment, effective July 1, 2005, (2) changed its method of accounting for investments in certain limited liability companies effective July 1, 2004 as a result of adopting EITF 03-16, Investments in Limited Liability Companies, and (3) adopted the provisions of FIN 46(R), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, in fiscal 2004.
As discussed in Note 3 to the consolidated financial statements, the accompanying consolidated balance sheets and consolidated statements of changes in shareholders equity have been restated.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Companys internal control over financial reporting as of June 30, 2006, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 21, 2007 (May 24, 2007 as to the effects of the material weakness related to estimating, job costing and revenue recognition controls) expressed an unqualified opinion on managements assessment of the effectiveness of the Companys internal control over financial reporting and an adverse opinion on the effectiveness of the Companys internal control over financial reporting because of material weaknesses.
TRC Companies, Inc.
See accompanying notes to consolidated financial statements.
TRC Companies, Inc.