UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

ý                        Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2005

 

OR

 

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)

 

 

 

Registrant’s telephone number, including area code:  (860) 298-9692

 

 

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, and (2) has been subject to such filing requirements for the past 90 days.    YES  ý    NO  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).    YES  ý    NO  o

 

On May 13, 2005 there were 14,306,239 shares of the registrant’s common stock, $.10 par value, outstanding.

 

 

 

TRC COMPANIES, INC.

 

CONTENTS OF QUARTERLY REPORT ON FORM 10-Q

 

QUARTER ENDED MARCH 31, 2005

 

 

PART I - Financial Information
	Item 1.	Condensed Consolidated Financial Statements (Unaudited)
		Condensed Consolidated Statements of Operations for the three and nine months ended March 31, 2005 and 2004
		Condensed Consolidated Balance Sheets at March 31, 2005 and June 30, 2004
		Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 2005 and 2004
		Notes to Condensed Consolidated Financial Statements
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk
	Item 4.	Controls and Procedures
PART II - Other Information
	Item 1.	Legal Proceedings
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
	Item 6.	Exhibits and Reports on Form 8-K
Signature
Certifications

 

 

2

 

PART I:  FINANCIAL INFORMATION

 

TRC COMPANIES, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Three Months Ended						Nine Months Ended
		March 31,						March 31,
		2005			2004			2005			2004
(in thousands, except per share data)
Gross revenue		$	98,879		$	86,927		$	284,296		$	274,528
Less subcontractor costs and direct charges		37,981			31,240			104,425			101,983
Net service revenue		60,898			55,687			179,871			172,545
Operating costs and expenses:
Cost of services		55,848			46,763			155,560			144,354
General and administrative expenses		3,540			2,056			8,491			6,503
Depreciation and amortization		1,776			1,463			4,748			4,323
		61,164			50,282			168,799			155,180
Income (loss) from operations		(266		)	5,405			11,072			17,365
Interest expense		692			361			1,585			1,099
Income (loss) before taxes		(958		)	5,044			9,487			16,266
Federal and state income tax provision (benefit)		(393		)	2,068			3,889			6,619
Income (loss) before equity earnings and accounting change		(565		)	2,976			5,598			9,647
Equity in earnings (losses) from unconsolidated affiliates, net of taxes		422			(336		)	295			(304		)
Income (loss) before accounting change		(143		)	2,640			5,893			9,343
Cumulative effect of accounting change, net of taxes of $409		—			—			(589		)	—
Net income (loss)		(143		)	2,640			5,304			9,343
Dividends and accretion charges on preferred stock		175			180			575			551
Net income (loss) applicable to common shareholders		$	(318	)	$	2,460		$	4,729		$	8,792
Basic earnings (loss) per common share:
Before accounting change		$	(0.02	)	$	0.18		$	0.38		$	0.65
Cumulative effect of accounting change		—			—			(0.04		)	—
		$	(0.02	)	$	0.18		$	0.34		$	0.65
Diluted earnings (loss) per common share:
Before accounting change		$	(0.02	)	$	0.17		$	0.36		$	0.61
Cumulative effect of accounting change		—			—			(0.04		)	—
		$	(0.02	)	$	0.17		$	0.32		$	0.61
Average shares outstanding:
Basic		14,181			13,801			14,025			13,627
Diluted		14,181			14,658			14,795			15,442

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

 

3

 

TRC COMPANIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

		March 31,			June 30,
		2005			2004
(in thousands, except share data)
ASSETS
Current assets:
Cash		$	3,414		$	3,468
Accounts receivable, less allowances for doubtful accounts (Note 9)		139,958			116,704
Insurance recoverable - environmental remediation (Note 14)		4,769			1,647
Deferred income tax benefits		1,302			312
Income taxes refundable		983			656
Prepaid expenses and other current assets		3,860			2,130
		154,286			124,917
Property and equipment, at cost		47,852			44,612
Less accumulated depreciation and amortization		30,152			27,569
		17,700			17,043
Goodwill (Note 7)		120,836			111,829
Investments in and advances to unconsolidated affiliates and construction joint ventures		6,773			7,030
Long-term insurance receivable (Note 9)		8,556			2,879
Long-term insurance recoverable - environmental remediation (Note 14)		34,369			13,358
Other assets (Note 7)		15,665			5,961
		$	358,185		$	283,017
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt (Note 12)		$	57,787		$	1,229
Accounts payable		26,658			16,024
Accrued compensation and benefits		12,188			13,811
Billings in advance of revenue earned (Note 10)		13,323			6,338
Environmental remediation liability (Note 14)		4,769			1,647
Other accrued liabilities (Note 11)		15,315			8,014
		130,040			47,063
Non-current liabilities:
Long-term debt, net of current portion (Note 12)		2,034			41,398
Deferred income tax liabilities		9,386			8,578
Long-term environmental remediation liability (Note 14)		34,369			13,358
		45,789			63,334
Convertible redeemable preferred stock (Note 13)		14,912			14,823
Commitments and contingencies (Note 14)
Shareholders’ equity:
Capital stock:
Preferred, $.10 par value; 500,000 shares authorized, 15,000 issued and outstanding as convertible redeemable, liquidation preference of $15,000		—			—
Common, $.10 par value; 30,000,000 shares authorized, 15,171,900 and 14,228,921 shares issued and outstanding, respectively, at March 31, 2005 and 14,837,657 and 13,894,678 shares issued and outstanding, respectively, at June 30, 2004		1,517			1,484
Additional paid-in capital		103,455			98,570
Retained earnings		65,369			60,640
		170,341			160,694
Less treasury stock, at cost		2,897			2,897
		167,444			157,797
		$	358,185		$	283,017

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

 

4

 

TRC COMPANIES, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Nine Months Ended
		March 31,
		2005			2004
(in thousands)
Cash flows from operating activities:
Net income		$	5,304		$	9,343
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,747			4,323
Cumulative effect of accounting change		589			—
Provision for doubtful accounts		1,205			2,219
Change in deferred taxes and other non-cash items		388			357
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable (current and long-term)		(23,421		)	(13,883		)
Billings in advance of revenue earned		6,946			1,859
Insurance recoverable (current and long-term)		1,617			1,388
Prepaid expenses and other current assets		(1,406		)	(369		)
Accounts payable		9,064			1,006
Accrued compensation and benefits		(2,319		)	(492		)
Environmental remediation liability (current and long-term)		(1,617		)	(1,388		)
Income taxes payable		234			(594		)
Other accrued liabilities		4,227			(479		)
Net cash provided by operating activities		5,558			3,290
Cash flows from investing activities:
Additions to property and equipment		(3,880		)	(3,376		)
Acquisition of businesses, net of cash acquired		(15,200		)	(4,734		)
Investments in and advances to unconsolidated affiliates and construction joint ventures		(764		)	(1,879		)
Decrease (increase) in other assets, net		(5		)	253
Net cash used in investing activities		(19,849		)	(9,736		)
Cash flows from financing activities:
Net borrowings under revolving credit facility		14,700			3,500
Payments on long-term debt and other		(1,219		)	(1,650		)
Proceeds from exercise of stock options and warrants		756			1,306
Proceeds from note receivable		—			146
Net cash provided by financing activities		14,237			3,302
Decrease in cash		(54		)	(3,144		)
Cash, beginning of period		3,468			5,120
Cash, end of period		$	3,414		$	1,976

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

 

5

 

TRC COMPANIES, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

March 31, 2005 and 2004

(in thousands, except per share data)

 

1.                                       Company Background and Basis of Presentation

 

TRC Companies, Inc. (“the Company”) is a customer-focused company that creates and implements sophisticated and innovative solutions to the challenges facing America’s environmental, energy and infrastructure markets.  The Company conducts its activities under one business segment which involves providing engineering and consulting services to commercial organizations and governmental agencies primarily in the United States of America.

 

The condensed consolidated financial statements include the Company and its subsidiaries after elimination of intercompany accounts and transactions.  Investments in which the Company has the ability to exercise significant influence, but not control, are accounted for by the equity method.  Investments in which the Company does not have the ability to exercise significant influence are accounted for by the cost method.  Certain contracts are executed jointly through alliances and joint ventures with unrelated third parties.  The Company recognizes its proportional share of such joint venture revenue, costs and operating profits in its Condensed Consolidated Statements of Operations.

 

During the three months ended March 31, 2005, the Company determined that equity in earnings from unconsolidated affiliates was material to the overall financial statements.  As a result, pursuant to Rule 7-04 of SEC Regulation S-X, the Company presented equity in earnings (losses) from unconsolidated affiliates, net of income taxes, as a separate income statement line that is not included in income from operations.  This had no effect on consolidated net income, net cash flows and equity.  All periods presented have been adjusted to reflect this change in presentation.

 

The Condensed Consolidated Balance Sheet at March 31, 2005 and the Condensed Consolidated Statements of Operations for the three and nine months ended March 31, 2005 and 2004 and the Condensed Statements of Cash Flows for the nine months ended March 31, 2005 and 2004 have been prepared pursuant to the interim period reporting requirements of Form 10-Q.  Consequently, the financial statements are unaudited, but, in the opinion of the Company, include all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of the results for the interim periods.  Also, certain information and footnote disclosures usually included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted.  These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K as of and for the year ended June 30, 2004.

 

 

6

 

2.                                       Change in Accounting for Investments

 

Effective July 1, 2004, the Company adopted the provisions of Emerging Issues Task Force (“EITF”) 03-16, “Accounting for Investments in Limited Liability Companies”, issued by the Financial Accounting Standards Board (“FASB”).  EITF 03-16 requires that investments in limited liability companies be accounted for similarly to a limited partnership investment.  As a result, investors are required to apply the equity method of accounting at a much lower ownership threshold than the 20% threshold applied under Accounting Principles Board (“APB”) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock”.  The new accounting guidance in EITF 03-16 required the Company to change its method of accounting for its 19.9% investment in a start-up energy savings company from the cost method to the equity method.  Accordingly, the Company recorded an adjustment in the three months ended September 30, 2004 for the cumulative effect of this change in accounting principle equal to its pro rata share of the energy savings company’s losses, up to the carrying amount, since making the investment in fiscal 2001.  The cumulative effect of the accounting change decreased net income for the nine months ended March 31, 2005 by $589 (net of income taxes of $409) or $0.04 per diluted share.

 

3.                                       Recently Issued Accounting Standards

 

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN No. 47”).  The interpretation clarifies the requirement to record abandonment liabilities stemming from legal obligations when the retirement depends on a conditional future event.  FIN No. 47 requires that the uncertainty about the timing or method of settlement of a conditional retirement obligation be factored into the measurement of the liability when sufficient information exists.  FIN No. 47 is effective for fiscal years ending after December 31, 2005, and the Company does not believe this interpretation will have a material impact on its financial results.

 

In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment” (“SFAS No. 123R”), which is a revision of SFAS No. 123.  As modified by the SEC in April 2005, the revised statement is effective at the beginning of the first fiscal year beginning after June 15, 2005. SFAS No. 123R must be applied to new awards and previously granted awards that are not fully vested on the effective date.  The Company currently accounts for stock-based compensation using the intrinsic value method.  Accordingly, compensation cost for previously granted awards that were not recognized under SFAS No. 123 will be recognized under SFAS No. 123R.  However, had the Company adopted SFAS No. 123R in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share in Note 5 on page 11 of this report.

 

SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under current literature.  This requirement will reduce net operating cash flow and increase net financing cash flow in periods after adoption.  While the Company cannot accurately estimate what those amounts will be in the future (as they depend on, among other things, when employees exercise stock options), the amounts of operating cash

 

 

7

 

flows recognized for such excess tax deductions were $616 and $932 during the nine months ended March 31, 2005 and 2004, respectively.

 

In March 2005, the SEC issued Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB No. 107”) to provide the SEC staff’s views and guidance in applying the provisions of SFAS No. 123R.  SAB No. 107 was issued to assist companies with the initial implementation of SFAS No. 123R, express the SEC’s views on the interaction between SFAS No. 123R and certain SEC rules and regulations, and provide interpretations regarding the valuation of share-based payment arrangements for public companies.  The Company will apply the new guidance provided in SAB No. 107 prospectively and the Company does not believe that applying the new guidance will have any impact on its financial results.

 

In December 2004, the FASB issued Staff Position 109-1 (“FSP 109-1”), Application of FASB Statement No. 109 (“FASB No. 109”), “Accounting for Income Taxes”, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004. FSP 109-1 clarifies guidance that applies to the new deduction for qualified domestic production activities.  When fully phased-in, the deduction will be up to 9% of the lesser of “qualified production activities income” or taxable income.  FSP 109-1 clarifies that the deduction should be accounted for as a special deduction under FASB No. 109 and will reduce tax expense in the period or periods that the amounts are deductible on the tax return.  Any tax benefits resulting from the new deduction will be effective for the Company’s fiscal year ending June 30, 2006.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances), and is effective for instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.  The provisions regarding guidance for accounting for mandatorily redeemable non-controlling interests in subsidiaries that would not be liabilities under SFAS No. 150 have been deferred for an indefinite period.  The adoption of the currently effective provisions of this standard did not have a material impact on the Company’s results of operations or financial position.  The Company has specifically reviewed whether its redeemable preferred stock is within the scope of this standard, and, due to the redemption value being subject to a floor share price, the monetary amount at inception was not deemed to be fixed or known.  As a result, the Company’s redeemable preferred stock does not fall within the scope of this standard.  The Company is currently reviewing the deferred provisions and assessing their impact.

 

 

8

 

4.                                     Earnings per Share

 

Earnings per share (“EPS”) is computed in accordance with the provisions of SFAS No. 128, “Earnings per Share”.  Basic EPS is determined as net income (loss) applicable to common shareholders divided by the weighted average common shares outstanding during the period.  Diluted EPS reflects the potential dilutive effect of outstanding stock options and warrants and the conversion of the Company’s preferred stock.  For purposes of computing diluted EPS the Company uses the treasury stock method.  Additionally, when computing dilution related to the preferred stock, conversion is assumed as of the beginning of the period.

 

For the three months ended March 31, 2005, the Company reported a net loss; therefore, diluted EPS was equal to basic EPS.  For the three months ended March 31, 2004 and the nine months ended March 31, 2005, assumed conversion of the preferred stock would have slightly increased rather than decreased EPS (would have been “anti-dilutive”).  Therefore, conversion was not assumed for purposes of computing diluted EPS, and as a result, 814 and 930 shares were excluded from the calculation of diluted EPS for the three months ended March 31, 2004 and for the nine months ended March 31, 2005, respectively.  For the nine months ended March 31, 2004, assumed conversion of the preferred stock was dilutive, therefore, conversion was assumed for purposes of computing diluted EPS.  The number of outstanding stock options and warrants excluded from the diluted EPS calculations (as they were anti-dilutive) were 644 for the three months ended March 31, 2004, and 788 and 664 for the nine months ended March 31, 2005 and 2004, respectively.  The following tables set forth the computations of basic and diluted EPS:

 

		Three Months Ended March 31,
		2005						2004
		Diluted			Basic			Diluted			Basic
Net income (loss)		$	(143	)	$	(143	)	$	2,640		$	2,640
Dividends and accretion charges on preferred stock		(175		)	(175		)	(180		)	(180		)
Net income (loss) applicable to common shareholders		$	(318	)	$	(318	)	$	2,460		$	2,460
Weighted average common shares outstanding		14,181			14,181			13,801			13,801
Potential common shares:
Stock options and warrants		—			—			841			—
Contingently issuable shares		—			—			16			—
Convertible preferred stock		—			—			—			—
Total potential common shares		14,181			14,181			14,658			13,801
Earnings (loss) per share		$	(0.02	)	$	(0.02	)	$	0.17		$	0.18

 

 

9

 

		Nine Months Ended March 31,
		2005						2004
		Diluted			Basic			Diluted			Basic
Income before accounting change		$	5,893		$	5,893		$	9,343		$	9,343
Cumulative effect of accounting change		(589		)	(589		)	—			—
Net income		5,304			5,304			9,343			9,343
Dividends and accretion charges on preferred stock		(575		)	(575		)	—			(551		)
Net income applicable to common shareholders		$	4,729		$	4,729		$	9,343		$	8,792
Weighted average common shares outstanding		14,025			14,025			13,627			13,627
Potential common shares:
Stock options and warrants		692			—			804			—
Contingently issuable shares		78			—			79			—
Convertible preferred stock		—			—			932			—
Total potential common shares		14,795			14,025			15,442			13,627
Earnings per share:
Before accounting change		$	0.36		$	0.38		$	0.61		$	0.65
Cumulative effect of accounting change		(0.04		)	(0.04		)	—			—
		$	0.32		$	0.34		$	0.61		$	0.65

 

 

10

 

5.             Stock Options

 

The Company has a non-qualified stock option plan for employees and directors which is described more fully in Note 12 of the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2004.  The Company applies the provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations to account for stock options issued.  Accordingly, no compensation cost has been recognized for stock options issued as exercise prices were not less than the fair value of the common stock at the grant date.  If compensation costs for stock options issued had been determined based on the fair value at the grant date under SFAS No. 123, “Accounting for Stock-Based Compensation”, pro forma net income (loss) and EPS for the three and nine months ended March 31, 2005 and 2004 would have been as follows:

 

		Three Months Ended						Nine Months Ended
		March 31,						March 31,
		2005			2004			2005			2004
Income (loss) before accounting change		$	(143	)	$	2,640		$	5,893		$	9,343
Cumulative effect of accounting change		—			—			(589		)	—
Net income (loss), as reported		(143		)	2,640			5,304			9,343
Dividends and accretion charges on preferred stock		175			180			575			551
Net income (loss) applicable to common shareholders, as reported		(318		)	2,460			4,729			8,792
Less stock-based employee compensation expense determined under fair-value based method for all awards, net of taxes		(553		)	(218		)	(970		)	(1,211		)
Net income (loss), pro forma		$	(696	)	$	2,422		$	4,334		$	8,132
Net income (loss) applicable to common shareholders , pro forma		$	(871	)	$	2,242		$	3,759		$	7,581
Earnings (loss) per share, as reported:
Basic		$	(0.02	)	$	0.18		$	0.34		$	0.65
Diluted		(0.02		)	0.17			0.32			0.61
Earnings (loss) per share, pro forma:
Basic		$	(0.06	)	$	0.16		$	0.27		$	0.56
Diluted		(0.06		)	0.15			0.25			0.52

 

6.             Acquisitions

 

During the nine months ended March 31, 2005, the Company completed eight acquisitions.  The two largest acquisitions consummated were Pacific Land Design, Inc. (“PacLand”) and Environomics, LLC (“Environomics”) which are discussed below.

 

 

11

 

Environomics provides high-level consulting for indoor air quality mold issues for existing and new construction. A key aspect of Environomics’ business model is its involvement in identifying procedures for building owners and contractors to allow them to minimize the potential for indoor air quality issues in new or remodeled facilities.  The initial purchase price of $4,134 (before contingent consideration) consisted of cash of $3,369 (net of cash acquired) and approximately 43 shares of the Company’s common stock valued at $765.  As a result of this acquisition, goodwill of $655 and other intangible assets of $1,673 were recorded.  The preliminary purchase price allocations have been completed, however it is anticipated that there will be changes to the preliminary allocations as fair values of property, equipment and intangible assets are finalized.  Any such changes are not expected to have a material impact on the results of operations or financial condition of the Company in future periods.  This acquisition was completed in December 2004.

 

PacLand provides site planning, land use and environmental entitlement, civil engineering, and traffic and transportation design consulting for large-scale commercial land owners, private developers, REITs and national retailers.  The initial purchase price of $6,946 (before contingent consideration) consisted of cash of $4,621 and three-year promissory notes totaling $2,325.  As a result of this acquisition, goodwill of $443 and other intangible assets of $4,840 were recorded.  The preliminary purchase price allocations have been completed, however it is anticipated that there will be changes to the preliminary allocations as fair values of property, equipment and intangible assets are finalized.  Any such changes are not expected to have a material impact on the results of operations or financial condition of the Company in future periods.  This acquisition was completed in January 2005.

 

The total purchase price for the eight acquisitions completed during the nine months ended March 31, 2005, was $18,820 (before contingent consideration), consisting of a combination of cash, promissory notes and common stock of the Company.  As a result of these acquisitions, goodwill of $3,246 and other intangible assets of $10,393 were recorded.  The goodwill and intangible assets recorded in connection with these transactions are deductible for income tax purposes.  The Company may make additional payments for these acquisitions if certain financial objectives, primarily operating income targets, are achieved, with such payments resulting in additional goodwill.  The acquisitions have been accounted for using the purchase method of accounting in accordance with SFAS No. 141, “Business Combinations” and the allocation of identifiable intangible assets in accordance with SFAS No. 142 “Goodwill and Other Intangible Assets”.  The impact of these acquisitions on operating results was not material; therefore, no pro forma information is presented.

 

During the nine months ended March 31, 2005, the Company recorded additional purchase price payments of $5,819 related to acquisitions completed in prior years, including 75 shares of the Company’s common stock valued at $1,182, resulting in additional goodwill.  The additional purchase price payments were earned as a result of the acquired entities achieving certain financial objectives, primarily operating income targets.  The Company also recorded an adjustment to purchase price allocation of $58 during the nine months ended March 31, 2005 for an acquisition completed in prior years, with the amount of the

 

 

12

 

adjustment decreasing goodwill.  At March 31, 2005 and June 30, 2004, the Company had liabilities for additional purchase price payments of $4,644 and $2,439, respectively.  These amounts are included in Other Accrued Liabilities on the Condensed Consolidated Balance Sheets.

 

7.                                       Goodwill and Intangible Assets

 

At March 31, 2005, the Company had $120,836 of goodwill, representing the cost of acquisitions in excess of values assigned to the underlying net assets of acquired companies.  In accordance with SFAS No. 142, goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to impairment testing at least annually.  The assessment of goodwill involves the estimation of the fair value of the Company’s one reporting unit as defined by SFAS No. 142.

 

In performing its goodwill assessment, the Company relies on a number of factors including the current market capitalization, 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 management’s judgment in applying them to the analysis of goodwill impairment.  Management completed this assessment during the third quarter of fiscal 2005 based on information as of the December 31, 2004 assessment date and determined that no impairment existed. No indications of impairment existed at March 31, 2005.

 

The changes in the carrying amount of goodwill for the nine months ended March 31, 2005 and the year ended June 30, 2004 are as follows:

 

		March 31,			June 30,
		2005			2004
Goodwill, beginning of period		$	111,829		$	102,748
Current period acquisitions		3,246			627
Additional purchase price payments - prior year acquisitions		5,819			8,450
Other purchase price adjustments		(58		)	4
Goodwill, end of period		$	120,836		$	111,829

 

 

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Identifiable intangible assets as of March 31, 2005 and June 30, 2004 are included in Other Assets on the Condensed Consolidated Balance Sheets and were comprised of:

 

		March 31, 2005						June 30, 2004
		Gross						Gross
		Carrying			Accumulated			Carrying			Accumulated
		Amount			Amortization			Amount			Amortization
Identifiable intangible assets with determinable lives:
Contract backlog		$	2,270		$	1,460		$	1,241		$	1,147
Customer relationships		11,339			681			3,207			317
Other		100			58			100			46
		13,709			2,199			4,548			1,510
Identifiable intangible assets with indefinite lives:
Trade names		2,797			17			1,642			—
Other		803			305			726			300
		3,600			322			2,368			300
		$	17,309		$	2,521		$	6,916		$	1,810

 

Identifiable intangible assets are amortized over the weighted average periods of three to 36 months for contract backlog, 10 to 15 years for customer relationships, 15 years for trade names and trade marks and up to six years for other assets. The amortization of intangible assets during the three months ended March 31, 2005 and 2004 was $381 and $148, respectively.  The amortization of intangible assets during the nine months ended March 31, 2005 and 2004 was $711 and $463, respectively.  Estimated amortization of intangible assets for future periods is as follows: remainder of fiscal 2005 - $383; fiscal 2006 - - $1,447; fiscal 2007 - $1,157; fiscal 2008 - $1,021; fiscal 2009 - $971; fiscal 2010 and thereafter - $7,501.  These estimates do not reflect the impact of any future acquisitions.

 

8.             Changes in Contract Estimates

 

In the ordinary course of periodically updating the estimates to complete certain Exit Strategy contracts, the Company decreased the estimated cost on two contracts and increased the estimated costs on three contracts.  The net effect of these changes in estimates resulted in a decrease in both net service revenue and operating income of approximately $895 and $1,276 for the three and nine months ended March 31, 2005, respectively.  Costs in excess of the original contract value, are recoverable from a finite risk cost cap insurance policy at a lower profit margin.

 

 

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9.             Accounts Receivable

 

The current portion of accounts receivable at March 31, 2005 and June 30, 2004 was comprised of the following:

 

		March 31,			June 30,
		2005			2004
Billed		$	83,672		$	77,017
Unbilled		61,322			45,180
Retainage		5,391			4,239
		150,385			126,436
Less allowances for doubtful accounts		10,427			9,732
		$	139,958		$	116,704

 

A substantial portion of unbilled receivables represents billable amounts recognized as revenue, primarily in the last month of the fiscal period.  Management expects that the majority of unbilled amounts will be billed and collected within one year.  Retainage represents amounts billed but not paid by the customer which, pursuant to contract terms, are due at completion.

 

The Long-Term Insurance Receivables at March 31, 2005 and June 30, 2004 of $8,556 and $2,879, respectively, relate to unbilled amounts on Exit Strategy contracts and represent amounts held by the insurance company which are released as work on a project is completed.

 

10.           Billings in Advance of Revenue Earned

 

Billings in Advance of Revenue Earned represents amounts billed or collected in accordance with contractual terms in advance of when the work is performed.  These advance payments primarily relate to the Company’s Exit Strategy program.

 

11.           Other Accrued Liabilities

 

At March 31, 2005 and June 30, 2004, Other Accrued Liabilities was comprised of the following:

 

		March 31,			June 30,
		2005			2004
Additional purchase price payments		$	4,644		$	2,439
Contract costs		6,152			1,935
Lease obligations		1,690			1,658
Other		2,829			1,982
		$	15,315		$	8,014

 

 

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12.                                 Debt

 

The Company maintains a banking arrangement with Wachovia Bank, National Association in syndication with three additional banks that provides a revolving credit facility to support operating and investing activities.  In March 2005, the agreement was amended with the maximum amount available pursuant to the credit facility increased to $80,000 from $60,000 and the term extended to March 2008.  Borrowings under the agreement are limited to a multiple of rolling twelve month EBITDA and bear interest at Wachovia’s base rate or the Eurodollar rate plus or minus applicable margins and would be due and payable in March 2008 when the agreement expires, unless it is extended as management expects.  Borrowings under the agreement are collateralized by accounts receivable.  At March 31, 2005 borrowings pursuant to the agreement were $55,200 at an average interest rate of 4.8%, compared to $40,500 of borrowings at an average interest rate of 2.9% at June 30, 2004.

 

The credit facility provides for affirmative and negative covenants that limit, among other things, the Company’s ability to incur other indebtedness, dispose of assets, pay cash dividends on its common stock and make certain investments.  In addition, the agreement includes certain restrictive covenants, including, but not limited to, the minimum ratio of adjusted EBITDA to interest expense, income taxes and the current portion of long-term debt (“coverage ratio”), and the minimum ratio of adjusted current assets to adjusted total liabilities.

 

The Company was not in compliance with the coverage ratio at March 31, 2005, due to the unanticipated net loss in the three months ended March 31, 2005.  The Company obtained a waiver of this covenant requirement from its lenders for the period ended March 31, 2005.  The Company also notified its lenders that it will not be in compliance with the coverage ratio for at least the next four fiscal quarters, and will most likely not be in compliance with the leverage ratio for the quarter ending June 30, 2005.  The waiver does not cover the subsequent twelve month period; therefore, for purposes of this report, the Company has classified the borrowings outstanding at March 31, 2005 as a current liability.  The Company is in the process of reaching agreement with its lenders to amend the covenants before June 30, 2005 such that the Company would expect to be in compliance with the amended covenants for the next twelve months.

 

13.           Convertible Redeemable Preferred Stock

 

In December 2001 the Company completed a private placement of $15,000 of a newly designated class of Preferred Stock with Fletcher International, Ltd., an affiliate of Fletcher Asset Management, Inc. (“Fletcher”) of New York City.  The Preferred Stock is convertible into 408 shares of the Company’s common stock at a conversion price of $36.72 per share. The Preferred Stock issued to Fletcher has a five-year term with a 4% annual dividend payable at the Company’s option in either cash or common stock.   The Preferred Stock was recorded net of issuance costs of $453.

 

The Company will have the right to redeem the Preferred Stock for cash if  the price of its common stock exceeds 175% of the conversion price for any 15 business days in a 20 consecutive business day period.  Following 48 months of issuance, Fletcher may require the Company to redeem the Preferred Stock for common stock.  On the five-year expiration date, any shares of Preferred Stock still outstanding are to be redeemed, at the Company’s option, in either cash or shares of common stock.  If the Preferred Stock is redeemed for common shares the number of  shares to be issued would equal the quotient of the par value

 

 

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of the Preferred Stock outstanding divided by the average market price of the Company’s common stock at the redemption date. The average market price is defined as the volume weighted average price of the Company’s common stock over forty business days ending on and including the third business day before the redemption date, but not greater than the average of the common stock for the first five or last five business days of such forty business day period.   The maximum number of common shares that can be issued upon redemption is 932.  The maximum number of shares applies when the average market price of the Company’s common stock is $16.09 per share or less.

 

For purposes of calculating diluted EPS the Company includes, if dilutive, the greater of (1) the potential number of common shares issued assuming conversion or (2) the potential number of common shares issued assuming redemption. See Note 4 beginning on page 9 of this report for the number of contingently issuable shares included in diluted EPS during the three and nine months ended March 31, 2005 and 2004.

 

14.           Commitments and Contingencies

 

The Company has entered into several long-term contracts pursuant to its Exit Strategy program under which the Company is obligated to complete the remediation of environmental conditions at a site.  The Company assumes the risk for remediation costs for pre-existing site environmental conditions and believes that through in-depth technical analysis, comprehensive cost estimation and creative remedial approaches it is able to execute pricing strategies which protect the Company’s return on these projects.  The Company’s customer pays a fixed price and, as additional protection, a finite risk cost cap insurance policy is obtained from leading insurance companies with a minimum A.M. Best rating of A-Excellent (e.g. American International Group) which 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.

 

Upon signing of the contract, a majority of the contract price is deposited in a restricted account held by the insurance company, and the Company is paid by the insurance company from such proceeds.  Any portion of the initial contract price not retained by the insurance company is transferred to the Company and is included under Current Liabilities on the Company’s Condensed Consolidated Balance Sheets under the item termed Billings in Advance of Revenue Earned.  This amount is reduced as the Company performs under the contract and recognizes revenue.  The Company believes that it is adequately protected from risks on these projects and that adverse developments, if any, will not have a material impact on its operating results, financial position or cash flows.

 

Four Exit Strategy contracts entered into by the Company involved the Company entering into consent decrees with government authorities and assuming the obligation for the settling responsible parties’ environmental remediation liability for the sites.  The Company’s expected remediation costs (Current and Long-Term Environmental Remediation Liability items in the Condensed Consolidated Balance Sheets) are fully funded by the contract price received and are fully insured by an environmental remediation cost cap policy (Current and Long-Term Insurance Recoverable items in the Condensed Consolidated Balance Sheets).  At March 31, 2005, the remediation for one of the projects was complete and the Company had begun long-term maintenance and monitoring at that site.  During the nine months ended March 31, 2005, the Company recorded, as non-cash transactions, environmental remediation liabilities of approximately $25,750 and

 

 

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corresponding insurance recoverables related to two new Exit Strategy contracts where the Company entered into additional consent decrees related to the assumption of environmental liabilities.

 

The Company and its subsidiaries are subject to claims and lawsuits typical of those filed against engineering and consulting companies.  The Company carries liability insurance, including professional liability insurance, against such claims subject to certain deductibles and policy limits.  Management is of the opinion that the resolution of these claims and lawsuits (including the ones described immediately below) will not likely have a material adverse effect on the Company’s operating results, financial position or cash flows.

 

A subsidiary of the Company has been named as a defendant, along with a number of other companies, in litigation in New Jersey Superior Court brought on behalf of individuals claiming damages for alleged injuries related to a collapse of several floors of a parking garage under construction in Atlantic City, New Jersey.  The Company’s subsidiary had a limited inspection role in connection with the construction.  The subsidiary is insured for this matter under a project wrap-up policy and management believes that it has meritorious defenses and that this matter will not likely have a material adverse effect on the Company’s operating results, financial position or cash flows.

 

The same subsidiary was engaged to provide Construction Support Services with respect to the replacement of an overpass bridge in Queens, New York.  A motorist and his wife have 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.  The subsidiary had no on-site role and management believes that it was not responsible for any collapse.  Management believes it has meritorious defenses, is adequately insured, and that this matter will not likely have a material adverse effect on the Company’s operating results, financial position or cash flows.

 

The Company’s indirect cost rates applied to contracts with the U.S. Government and various state agencies are subject to examination and renegotiation.  The Company believes that adjustments resulting from such examination or renegotiation proceedings, if any, will not have a material impact on the Company’s operating results, financial position or cash flows.

 

The Company indemnifies its directors and officers to the maximum extent permitted under the laws of the State of Delaware.

 

 

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TRC COMPANIES, INC.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Three and Nine Months Ended March 31, 2005 and 2004

 

Management’s Discussion and Analysis contains statements that are forward-looking.  These statements are based upon current expectations and assumptions that are subject to risks and uncertainties.  Actual results could differ materially due to a number of factors.  See the discussion in “Forward-Looking Statements” below.

 

Critical Accounting Policies

 

The Company’s financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.  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.  Management uses its 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.  The Company’s accounting policies are described in Note 2 to the Notes to Consolidated Financial Statements of the Annual Report on Form 10-K for the year ended June 30, 2004.  Management believes the following critical accounting policies reflect the more significant judgments and estimates used in preparation of the Company’s consolidated financial statements and are the policies which are most critical in the portrayal of the Company’s financial position and results of operations:

 

Long-Term Contracts:  The Company recognizes 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”.  The Company records revenue on its cost-type and time and material contracts based upon direct labor costs and other direct contract costs incurred.  The Company has fixed price Exit Strategy contracts to remediate environmental conditions at contaminated sites under which the Company and its customers are protected against cost overruns by insurance policies.  Revenue (and related costs) from these fixed price contracts is recognized using the efforts-expended, percentage-of-completion method of accounting based on total costs incurred to date as compared to total costs estimated at completion.  Contract costs include direct labor costs, subcontractor costs, other direct costs and indirect costs.  The Company’s method of revenue recognition requires the Company to prepare estimates of costs to complete for contracts in progress.  In making such estimates, judgments are required to evaluate contingencies, such as potential variances in schedule and labor and other contract costs, liability claims, contract disputes or achievement of contractual performance standards.  Changes in total estimated contract costs and losses, if any, are recognized in the period they are determined.

 

Allowances for doubtful accounts:  Allowances for doubtful accounts are maintained for estimated losses resulting from the failure of our customers to make required payments.  Allowances for doubtful accounts have been determined through reviews of specific amounts deemed to be uncollectible, potential write-offs as a result of customers who have filed for bankruptcy protection, plus an allowance for other amounts for which some loss is determined to be probable based on

 

 

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current circumstances.  If the financial condition of customers or the Company’s assessment as to collectibility were to change, adjustments to the allowances may be required.

 

Income taxes:  At March 31, 2005, the Company had approximately $5.9 million of gross deferred income tax benefits.  The realization of a portion of these benefits is dependent on the Company’s estimates of future taxable income and its tax planning strategies.  A $0.5 million valuation allowance has been recorded in relation to certain state loss carryforwards which will more likely than not expire unused.  Management believes 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.

 

Acquisitions:  Assets and liabilities acquired in business combinations are recorded at their estimated fair values at the acquisition date.  At March 31, 2005, the Company had approximately $120.8 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 Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, 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 reporting unit below its carrying value.

 

In performing its goodwill assessment, the Company relies on a number of factors including the current market capitalization, 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 management’s judgment in applying them to the analysis of goodwill impairment. Since management’s judgment is involved in performing goodwill valuation analyses, there is risk that the carrying value of goodwill may be overstated or understated.  Management completed its goodwill assessment during the third quarter of fiscal 2005 based on information as of the December 31, 2004 assessment date and determined that no impairment existed. No indications of impairment existed at March 31, 2005. There can be no assurance that future events will not result in impairment of goodwill or other assets.

 

Results of Operations

 

The operational environment in the third quarter of fiscal 2005 reflected similar economic and industry trends as the last several quarters.  State and local government markets remain competitive, and ongoing delays in the passage of the successor bill to the Transportation Equity Act for the 21st Century slowed spending on new state transportation projects. While state spending continues to be an issue in the short term, our backlog for transportation-related work continued to grow in the quarter.

 

Industrial client spending for consulting services was essentially flat, though our backlog for Exit Strategy projects increased over the previous quarter. Demand for our commercial land development and redevelopment services, including brownfields development, remained strong. The labor market for civil engineers for land development projects has been tight in many areas, demanding an ongoing focus on recruiting to secure senior professionals.  We are seeing increased activity in the security services markets, including infrastructure and transportation security. High energy prices and favorable energy legislation continue to support activity in various energy

 

 

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production and distribution projects, including wind energy projects and evaluation of various options for new energy pipelines and import terminals for LNG.

 

As for the past two quarters, demand for our emissions stack testing services has been soft, primarily because of the delays in large federal government incineration burns for chemical and biological weapons destruction.  Management understands that these delays have been due to a variety of technical and safety environmental reasons and not because of budget restrictions.  Therefore, it is expected that all of the planned work will be required.  Current expectations are that this portion of the business will return to normal in the next fiscal year.

 

The Company’s focus areas of high population change, including the New York / mid Atlantic, Gulf Coast and Southwestern US regions is gaining momentum and Management plans to continue this emphasis going forward.  Practically, all of our services are related to the fourteen infrastructure needs to satisfy demographic changes.

 

The Company derives its revenue from fees for providing engineering and consulting services.  The types of contracts with our customers and the approximate percentage of Net Service Revenue (“NSR”) for the nine months ended March 31, 2005 from each contract type are as follows:

 

•      Time and material		51	%
•      Fixed price or lump sum		34	%
•      Cost reimbursable		15	%

 

In the course of providing its services, the Company routinely subcontracts drilling, laboratory analyses, construction equipment and other services.  These costs are passed directly through to customers and, in accordance with industry practice, are included in gross revenue.  Because subcontractor costs and direct charges can vary significantly from project to project, the Company considers NSR, which is gross revenue less subcontractor costs and direct charges, as its primary measure of revenue growth.

 

 

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The following table presents the percentage relationships of items in the Condensed Consolidated Statements of Operations to NSR:

 

		Three Months Ended				NineMonths Ended
		March 31,				March 31,
		2005		2004		2005		2004
Net service revenue		100.0	%	100.0	%	100.0	%	100.0	%
Operating costs and expenses:
Cost of services		91.7		84.0		86.5		83.7
General and administrative expenses		5.8		3.7		4.7		3.8
Depreciation and amortization		2.9		2.6		2.6		2.5
Income (loss) from operations		(0.4	)	9.7		6.2		10.0
Interest expense		1.1		0.7		0.9		0.6
Income (loss) before taxes		(1.5	)	9.0		5.3		9.4
Federal and state income tax provision		(0.6	)	3.7		2.2		3.8
Income (loss) before equity earnings and accounting change		(0.9	)	5.3		3.1		5.6
Equity in earnings (losses) from unconsolidated affiliates		0.7		(0.6	)	0.2		(0.2	)
Income (loss) before accounting change		(0.2	)	4.7		3.3		5.4
Cummulative effect of accounting change		—		—		(0.4	)	—
Net income (loss)		(0.2	)	4.7		2.9		5.4
Dividends and accretion charges on preferred stock		0.3		0.3		0.3		0.3
Net income (loss) applicable to common shareholders		(0.5	)%	4.4	%	2.6	%	5.1

 

Gross revenue increased $12.0 million, or 13.7%, to $98.9 million during the three months ended March 31, 2005, from $86.9 million in the same period last year.  Gross revenue increased $9.8 million, or 3.6%, to $284.3 million during the nine months ended March 31, 2005, from $274.5 million in the same period last year.  The increases were primarily related to acquisitions completed in fiscal 2005.

 

NSR increased $5.2 million, or 9.4%, to $60.9 million during the three months ended March 31, 2005, from $55.7 million during the same period last year.  NSR increased $7.4 million, or 4.2%, to $179.9 million during the nine months ended March 31, 2005, from $172.5 million during the same period last year.  Acquisitions provided $6.7 million and $8.6 million of NSR during the three and nine months ended March 31, 2005, respectively.  NSR from acquired companies is considered part of acquisition growth during the twelve months following the date acquired.

 

Both NSR and income from operations from organic activities decreased during both the three and nine months ended March 31, 2005 compared to the same period last year, primarily due to the temporary postponement of several large government-related emissions tests and the softness in the transportation market which resulted in an estimated NSR decrease of approximately $1.1 million and $3.3 million, respectively, for the three and nine months ended March 31, 2005 and an estimated operating income decrease of approximately $1.8 million and $4.8 million, respectively, for the three and nine months ended March 31, 2005.  The impact of these delays was in addition to

 

 

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