UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
Commission file number 1-6627
MICHAEL BAKER CORPORATION
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 25-0927646
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Airside Business Park, 100 Airside Drive, Moon Township, PA 15108
(Address of principal executive offices) (Zip Code)
(412) 269-6300
(Registrant's telephone number, including area code)
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 X No
----- -----
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the
Act.)
Large accelerated filer Accelerated filer X Non-accelerated filer
----- ----- -----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act.)
Yes No X
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of October 31, 2006:
-----------------------
Common Stock 8,499,988 shares
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
In this Form 10-Q, the terms "we," "us," or "our" refer to Michael Baker
Corporation and its subsidiaries.
We have prepared the condensed consolidated financial statements which follow,
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC"). Although certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to such rules and regulations, we
believe that the disclosures are adequate to make the information presented not
misleading. The statements reflect all adjustments which are, in the opinion of
management, necessary for a fair presentation of the results for the periods
presented. All such adjustments are of a normal and recurring nature unless
specified otherwise. These condensed consolidated financial statements should be
read in conjunction with our 2005 annual consolidated financial statements and
the notes thereto.
-1-
MICHAEL BAKER CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
For the three months ended
-------------------------------
SEPT. 30, 2006 Sept. 30, 2005
-------------- --------------
(In thousands, except per share
amounts)
Total contract revenues $170,194 $148,733
Cost of work performed 149,985 127,895
-------- --------
Gross profit 20,209 20,838
Selling, general and administrative expenses 18,715 16,706
-------- --------
Income from operations 1,494 4,132
Other income/(expense):
Interest income 48 86
Interest expense (397) (363)
Other, net 284 (312)
-------- --------
Income before income taxes 1,429 3,543
Provision for income taxes 1,753 2,203
-------- --------
NET (LOSS)/INCOME $ (324) $ 1,340
Other comprehensive (loss)/income -
Foreign currency translation adjustments -
net of $0 tax (114) 427
-------- --------
COMPREHENSIVE (LOSS)/INCOME $ (438) $ 1,767
======== ========
BASIC (LOSS)/EARNINGS PER SHARE $ (0.04) $ 0.16
DILUTED (LOSS)/EARNINGS PER SHARE $ (0.04) $ 0.15
======== ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
-2-
MICHAEL BAKER CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
For the nine months ended
-------------------------------
SEPT. 30, 2006 Sept. 30, 2005
-------------- --------------
(In thousands, except
per share amounts)
Total contract revenues $471,644 $435,694
Cost of work performed 407,191 373,837
-------- --------
Gross profit 64,453 61,857
Selling, general and administrative expenses 57,584 48,719
-------- --------
Income from operations 6,869 13,138
Other income/(expense):
Interest income 408 221
Interest expense (972) (1,130)
Other, net 1,080 (136)
-------- --------
Income before income taxes 7,385 12,093
Provision for income taxes 4,863 7,856
-------- --------
NET INCOME $ 2,522 $ 4,237
Other comprehensive income -
Foreign currency translation adjustments - net of tax of
$13 and $0, respectively 431 711
-------- --------
COMPREHENSIVE INCOME $ 2,953 $ 4,948
======== ========
BASIC EARNINGS PER SHARE $ 0.30 $ 0.50
DILUTED EARNINGS PER SHARE $ 0.29 $ 0.49
======== ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
-3-
MICHAEL BAKER CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
SEPT. 30, 2006 Dec. 31, 2005
-------------- -------------
(In thousands,
except share amounts)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 9,905 $ 19,041
Receivables, net 92,094 79,177
Unbilled revenues on contracts in progress 103,498 84,654
Prepaid expenses and other 10,975 8,373
-------- --------
Total current assets 216,472 191,245
-------- --------
PROPERTY, PLANT AND EQUIPMENT, NET 21,220 21,805
OTHER ASSETS
Goodwill 16,728 8,471
Other intangible assets, net 605 190
Other assets 8,523 3,750
-------- --------
Total other assets 25,856 12,411
-------- --------
TOTAL ASSETS $263,548 $225,461
======== ========
LIABILITIES AND SHAREHOLDERS' INVESTMENT
CURRENT LIABILITIES
Accounts payable $ 53,088 $ 45,570
Accrued employee compensation 25,549 25,475
Accrued insurance 12,267 11,544
Other accrued expenses and current liabilities 25,545 23,308
Income taxes payable 5,144 9,827
Billings in excess of revenues on contracts in progress 16,546 13,060
Current deferred tax liability 16,261 13,197
-------- --------
Total current liabilities 154,400 141,981
-------- --------
OTHER LIABILITIES
Long-term debt 22,740 --
Other long-term liabilities 3,462 3,656
-------- --------
Total liabilities 180,602 145,637
-------- --------
SHAREHOLDERS' INVESTMENT
Common Stock, par value $1, authorized 44,000,000 shares,
issued 8,995,525 and 8,985,168 shares at 9/30/06 and
12/31/05, respectively 8,996 8,985
Additional paid-in capital 42,193 42,138
Retained earnings 36,861 34,339
Accumulated other comprehensive loss (273) (704)
Unearned compensation (70) (173)
Less - 495,537 shares of Common Stock in treasury, at
cost, at 9/30/06 and 12/31/05 (4,761) (4,761)
-------- --------
Total shareholders' investment 82,946 79,824
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' INVESTMENT $263,548 $225,461
======== ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
-4-
MICHAEL BAKER CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the nine months ended
-------------------------------
SEPT. 30, 2006 Sept. 30, 2005
-------------- --------------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,522 $ 4,237
Adjustments to reconcile net income to net cash
(used in)/provided by operating activities:
Depreciation and amortization 4,397 3,660
Changes in assets and liabilities:
Increase in receivables and net unbilled revenues (25,842) (10,865)
(Decrease)/increase in accounts payable and
accrued expenses (614) 12,526
(Increase)/decrease in other net assets (4,203) 1,253
-------- --------
Total adjustments (26,262) 6,574
-------- --------
Net cash (used in)/provided by operating activities (23,740) 10,811
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of Buck Engineering, P.C. (10,806) --
Additions to property, plant and equipment (2,960) (3,850)
-------- --------
Net cash used in investing activities (13,766) (3,850)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 22,740 --
Increase in book overdrafts 6,021 --
Payments to acquire treasury stock -- (1,808)
Payments for capital lease obligations (456) (434)
Proceeds from the exercise of stock options 65 379
-------- --------
Net cash provided by/(used in) financing activities 28,370 (1,863)
-------- --------
Net (decrease)/increase in cash and cash equivalents (9,136) 5,098
Cash and cash equivalents, beginning of year 19,041 15,471
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 9,905 $ 20,569
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW DATA
Interest paid $ 496 $ 84
Income taxes paid $ 8,417 $ 1,539
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES
Vehicles and equipment acquired through capital lease
obligations $ 27 $ 555
Equipment acquired on credit $ 14 $ 138
======== ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
-5-
MICHAEL BAKER CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE PERIODS ENDED SEPTEMBER 30, 2006 AND 2005
(UNAUDITED)
NOTE 1 - EARNINGS PER COMMON SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations for the three and nine-month
periods ended September 30, 2006 and 2005.
For the three months ended For the nine months ended
-------------------------- -------------------------
SEPT. 30, Sept. 30, SEPT. 30, Sept. 30,
(In thousands except per share data) 2006 2005 2006 2005
--------- --------- --------- ---------
Net (loss)/income $ (324) $1,340 $2,522 $4,237
Weighted average shares outstanding:
Basic 8,500 8,474 8,497 8,514
Effect of dilutive securities -
Stock options -- 222 216 201
Diluted 8,500 8,696 8,713 8,715
Basic (loss)/earnings per share $(0.04) $ 0.16 $ 0.30 $ 0.50
Diluted (loss)/earnings per share $(0.04) $ 0.15 $ 0.29 $ 0.49
===============================================
As of September 30, 2006 and 2005, we did not have any stock options which were
not included in the computations of diluted shares outstanding because the
option exercise prices were less than the average market prices of our common
shares.
NOTE 2 - BUSINESS SEGMENT INFORMATION
Our business segments reflect how management makes resource decisions and
assesses our performance. We have the following two reportable segments:
- Our Engineering segment provides a variety of design and related consulting
services. Such services include program management, design-build,
construction management, consulting, planning, surveying, mapping,
geographic information systems, architectural and interior design,
construction inspection, constructability reviews, site assessment and
restoration, strategic regulatory analysis, regulatory compliance, and
advanced management systems.
- Our Energy segment provides a full range of services for operating energy
production facilities worldwide. These services range from complete
outsourcing solutions to specific services such as training, personnel
recruitment, pre-operations engineering, maintenance management systems,
field operations and maintenance, procurement, and supply chain management.
Many of these service offerings are enhanced by the utilization of this
segment's Managed Services operating model as a service delivery method.
Our Energy segment serves both major and smaller independent oil and gas
producing companies, but does not pursue exploration opportunities for our
own account or own any oil or natural gas reserves.
-6-
We evaluate the performance of our segments primarily based on operating income
before Corporate overhead allocations. Corporate overhead includes functional
unit costs related to finance, legal, human resources, information technology
and communications, and is allocated between our Engineering and Energy segments
based on a three-part formula comprising revenues, assets and payroll.
The following table reflects the required disclosures for our reportable
segments (in millions):
TOTAL CONTRACT REVENUES/INCOME FROM OPERATIONS
For the three months ended For the nine months ended
-------------------------- -------------------------
SEPT. 30, Sept. 30, SEPT. 30, Sept. 30,
2006 2005 2006 2005
--------- --------- --------- ---------
ENGINEERING
Total contract revenues $ 97.8 $ 96.0 $281.8 $281.9
Income from operations before Corporate
overhead 4.8 8.6 20.4 31.2
Less: Corporate overhead (3.5) (3.5) (12.4) (9.9)
------ ------ ------ ------
Income from operations 1.3 5.1 8.0 21.3
------ ------ ------ ------
ENERGY
Total contract revenues 72.4 52.7 189.8 153.8
Income/(loss) from operations before
Corporate overhead 2.1 0.9 4.7 (1.1)
Less: Corporate overhead (1.3) (1.3) (4.6) (3.8)
------ ------ ------ ------
Income/(loss) from operations 0.8 (0.4) 0.1 (4.9)
------ ------ ------ ------
TOTAL REPORTABLE SEGMENTS
Total contract revenues 170.2 148.7 471.6 435.7
Income from operations before Corporate
overhead 6.9 9.5 25.1 30.1
Less: Corporate overhead (4.8) (4.8) (17.0) (13.7)
------ ------ ------ ------
Income from operations 2.1 4.7 8.1 16.4
------ ------ ------ ------
Other Corporate/Insurance expense (0.6) (0.6) (1.2) (3.3)
------ ------ ------ ------
TOTAL COMPANY - INCOME FROM OPERATIONS $ 1.5 $ 4.1 $ 6.9 $ 13.1
====== ====== ====== ======
SEPT. 30, Dec. 31,
2006 2005
--------- --------
Segment assets:
Engineering $144.1 $116.6
Energy 105.1 80.4
------ ------
Subtotal - segments 249.2 197.0
Corporate/Insurance 14.3 28.5
------ ------
Total $263.5 $225.5
====== ======
-7-
NOTE 3 - LONG-TERM DEBT AND BORROWING ARRANGEMENTS
We have an unsecured credit agreement ("the Agreement") with a consortium of
financial institutions. The Agreement provides for a commitment of $60 million
through September 17, 2008. The commitment includes the sum of the principal
amount of revolving credit loans outstanding and the aggregate face value of
outstanding letters of credit. As of September 30, 2006, borrowings totaling
$22.7 million and standby letters of credit ("LOCs") totaling $10.2 million were
outstanding under the Agreement.
The Agreement requires us to meet minimum equity, leverage, interest and rent
coverage, and current ratio covenants. If any of these financial covenants or
certain other conditions of borrowing are not achieved, under certain
circumstances, after a cure period, the banks may demand the repayment of all
borrowings outstanding and/or require deposits to cover the outstanding letters
of credit.
We did not timely file our quarterly reports on Form 10-Q for the second and
third quarters of 2005 and the first quarter of 2006, or our annual report on
Form 10-K for the year ended December 31, 2005. As a result, several covenant
violations related to the timing of our financial reporting occurred under the
Agreement. The lenders waived these violations by allowing us to file our Forms
10-Q for the quarters ended June 30, 2005 and September 30, 2005, our Form 10-K
for the year ended December 31, 2005, and our Form 10-Q for the quarter ended
March 31, 2006, with the SEC by August 15, 2006. These documents were filed
within the specified time period.
Furthermore, we did not meet the SEC's filing deadline for our Form 10-Q for the
second quarter of 2006. Accordingly, our lenders also waived the resulting
covenant violation related to the timing of this filing by allowing us to file
such Form 10-Q by September 30, 2006. This document was also filed within the
specified time period.
NOTE 4 - CONTINGENCIES
We currently believe that amounts recorded as liabilities for certain tax
exposures may ultimately either be recoverable from clients or may otherwise be
reduced through negotiation and settlement efforts. Actual payments could differ
from amounts estimated due to the assessment of certain indirect tax obligations
by tax authorities to our clients in situations where we had the obligation to
charge the client for these taxes, collect the tax and remit it to the tax
authorities, or our successful negotiation of tax penalties and interest at less
than full statutory rates in situations where such penalty and interest
obligations have been estimated and accrued at full statutory rates based on the
best information currently available. Based on information currently available,
these exposures have been determined to reflect probable liabilities. However,
depending on the outcome of future negotiations and discussions with clients and
tax authorities, subsequent conclusions may be reached which indicate that
portions of these additional tax exposures may not require payment and therefore
changes in our estimates could be necessary in future periods. This could result
in favorable effects on our consolidated statements of income in future periods.
Insurance coverage is obtained for catastrophic exposures as well as those risks
required to be insured by law or contract. We require our insurers to meet
certain minimum financial ratings at the time the coverages are placed; however,
insurance recoveries remain subject to the risk that the insurer will be
financially able to pay the claims as they arise. We are insured with respect to
our workers' compensation and general liability exposures subject to deductibles
or self-insured retentions. Loss provisions for these exposures are recorded
based upon our estimates of the aggregate liability for claims incurred. Such
estimates utilize certain actuarial assumptions followed in the insurance
industry.
-8-
We are self-insured for our primary layer of professional liability insurance
through a wholly-owned captive insurance subsidiary. The secondary layer of the
professional liability insurance continues to be provided, consistent with
industry practice, under a "claims-made" insurance policy placed with an
independent insurance company. Under claims-made policies, coverage must be in
effect when a claim is made. This insurance is subject to standard exclusions.
We determine the level of reserves to establish for both insurance-related
claims that are known and have been asserted against us as well as for
insurance-related claims that are believed to have been incurred based on
actuarial analysis, but have not yet been reported to our claims administrators
as of the respective balance sheet dates. We include any adjustments to such
insurance reserves in our consolidated results of operations.
Our professional liability insurance coverage had been placed on a claims-made
basis with Reliance Insurance Group ("Reliance") for the period July 1, 1994
through June 30, 1999. In 2001, the Pennsylvania Insurance Commissioner placed
Reliance into liquidation. We remain uncertain at this time what effect this
action will have on our recoveries with respect to claims made against us or our
subsidiaries when Reliance coverage was in effect. A wholly-owned subsidiary of
ours was subject to one substantial claim which fell within the Reliance
coverage period. This claim was settled in the amount of $2.5 million, and
payment was made by us in 2003. Due to the liquidation of Reliance, we are
currently uncertain what amounts paid to settle this claim will be recoverable
under the insurance policy with Reliance. We are pursuing a claim in the
Reliance liquidation and believe that some recovery will result from the
liquidation, but the amount of such recovery cannot currently be estimated. We
had no related receivables recorded from Reliance as of September 30, 2006.
We have been named as a defendant or co-defendant in other legal proceedings
wherein damages are claimed. Such proceedings are not uncommon to our business.
After consultations with counsel, management believes that we have recognized
adequate provisions for probable and reasonably estimable liabilities associated
with these proceedings, and that their ultimate resolutions will not have a
material impact on our consolidated financial statements.
At September 30, 2006, we had certain guarantees and indemnifications
outstanding which could result in future payments to third parties. These
guarantees generally result from the conduct of our business in the normal
course. Our outstanding guarantees were as follows at September 30, 2006:
Maximum Related liability
undiscounted balance recorded
(Dollars in millions) future payments at 9/30/06
--------------- -----------------
Standby letters of credit:
Insurance related $10.0 $--
Other 0.2 --
Performance and payment bonds $ 4.6 $--
===== ===
Our banks issue LOCs on our behalf under the Agreement as discussed more fully
in Note 3. As of September 30, 2006, most of our outstanding LOCs were issued to
insurance companies to serve as collateral for payments the insurers are
required to make under certain of our self-insurance programs. These LOCs may be
drawn upon in the event that we do not reimburse the insurance companies for
claims payments made on our behalf. Such LOCs renew automatically on an annual
basis unless either the LOCs are returned to the
-9-
bank by the beneficiaries or our banks elect not to renew them.
Bonds are provided on our behalf by certain insurance carriers. As of September
30, 2006, performance and payment bonds totaling $4.6 million were outstanding.
The beneficiaries under these performance and payment bonds may request payment
from our insurance carriers in the event that we do not perform under the
project or if subcontractors are not paid. We do not expect any amounts to be
paid under our outstanding bonds at September 30, 2006. In addition, we believe
that our bonding lines will be sufficient to meet our bid and performance
bonding needs for at least the next year.
NOTE 5 - INCOME TAXES
We account for income taxes under the asset and liability method pursuant to
Statement of Financial Accounting Standards No. ("SFAS") 109, "Accounting for
Income Taxes." We base our consolidated effective income tax rate for interim
periods on our estimated annual consolidated effective income tax rate, which
includes estimates of the taxable income and revenue for jurisdictions in which
we operate. In certain foreign jurisdictions, our subsidiaries are subject to a
deemed profits tax that is assessed based on revenue. In other foreign
jurisdictions or situations, our subsidiaries are subject to income taxes based
on taxable income. In certain of these situations, our estimated income tax
payments during the year (which are withheld from client invoices at statutory
rates) may significantly exceed the tax due per the income tax returns when
filed; however, no practical method of refund can be effected. As a result,
related income tax assets are routinely assessed for realizability, and
valuation allowances against these tax assets are recorded in the event that it
is more likely than not that such tax assets will not be realized. Certain
foreign subsidiaries do not have earnings and profits for United States ("U.S.")
tax purposes; therefore, losses from these subsidiaries do not generate a tax
benefit in the calculation of our consolidated income tax provision. If these
foreign subsidiaries had positive earnings and profits for U.S. tax purposes,
these foreign losses would reduce both the deferred tax liability that was set
up on the future remittance back to the U.S. and our effective income tax rate.
In addition, valuation allowances against tax benefits of foreign net operating
losses may be recorded as a result of our inability to generate sufficient
taxable income in certain foreign jurisdictions.
As a result of the foregoing, depending upon foreign revenues and relative
profitability, we may report very high effective income tax rates. The amount of
these taxes, when proportioned with U.S. tax rates and income amounts, can cause
our consolidated effective income tax rate to fluctuate significantly.
As of September 30, 2006, our full year estimated effective income tax rate was
64% as compared to 65% as of September 30, 2005. As a comparison, our full year
estimated effective income tax rate was 50% as of June 30, 2006. The increase in
our effective income tax rate during the third quarter of 2006 is attributable
to our lower than expected actual operating results for the third quarter of
2006 and a reduction in our estimated domestic and foreign income before taxes
for the fourth quarter of 2006. The difference between our 2006 full year
estimated effective income tax rate of 64% and the amount shown in the
accompanying consolidated statement of income for the nine months ended
September 30, 2006 is due to the settlement of a state income tax audit.
NOTE 6 - STOCK-BASED COMPENSATION
We adopted SFAS 123R, "Share-Based Payment," on January 1, 2006, using the
modified prospective method. Among other things, SFAS 123R requires us to
expense the fair value of stock options. The expensing of stock options was
previously an optional accounting method that we adopted voluntarily on January
1, 2003, as permitted under SFAS 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure." The transitional effects of SFAS 123R
did not have an impact on net income for the third quarter or first nine months
of 2006 since we did not have any remaining unvested portions of options granted
prior to January 1,
-10-
2003. Prior to our adoption of SFAS 123R, the benefits of tax deductions in
excess of recognized compensation costs were reported as operating cash flows.
SFAS 123R requires such excess tax benefits to be reported as a financing cash
inflow. The adoption of SFAS 123R did not have an impact on our operating or
financing cash flows in the first nine months of 2006. We are currently
evaluating the effect of adopting the transition method described in Financial
Accounting Standards Board Staff Position 123R-3, "Transition Election to
Accounting for the Tax Effects of Share-Based Payment Awards." We have one year
from the date we adopted SFAS 123R to complete our evaluation.
If compensation expense for our stock incentive plans had been determined based
on the fair value at the grant dates for awards under those plans for the three
and nine-month periods ended September 30, 2005, consistent with the method
prescribed by SFAS 123R, our pro forma net income and earnings per share amounts
would have been as follows:
For the three For the nine
months ended months ended
(In thousands) Sept. 30, 2005 Sept. 30, 2005
-------------- --------------
Net income, as reported $1,340 $4,237
Add: Stock-based employee compensation expense included
in reported net income, net of related tax effects 23 50
Deduct: Total stock-based employee compensation expense
determined under fair value method, net of related
tax effects (24) (66)
------ ------
Pro forma net income $1,339 $4,221
====== ======
For the three For the nine
months ended months ended
Sept. 30, 2005 Sept. 30, 2005
-------------- --------------
Reported earnings per share:
Basic $0.16 $0.50
Diluted 0.15 0.49
Pro forma earnings per share:
Basic 0.16 0.50
Diluted $0.15 $0.48
===== =====
Our share-based compensation expense recognized in net income was $102,000 and
$90,000 in the first nine months of 2006 and 2005, respectively. The total
income tax benefit recognized in net income for all share-based compensation
arrangements was $45,000 and $40,000 in the first nine months of 2006 and 2005,
respectively.
As of September 30, 2006, we had two stock option plans. Under the 1995 Stock
Incentive Plan (the "Plan"), we were authorized to grant options for an
aggregate of 1,500,000 shares of Common Stock to key employees through December
14, 2004. Under the amended 1996 Non-employee Directors' Stock Incentive Plan
(the "Directors' Plan"), we may grant options and restricted shares for an
aggregate of 400,000 shares of Common Stock to non-employee board members
through February 18, 2014. Under both plans, the exercise price of each option
equals the average market price of our stock on the date of grant. Unless
otherwise established, one-fourth of the options granted to key employees became
immediately vested and the remaining three-fourths vested in equal annual
increments over three years under the now expired Plan, while the options under
the Directors' Plan become fully vested on the date of grant. Vested options
remain exercisable for a
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period of ten years from the grant date under both plans.
The following table summarizes all stock option activity for both plans during
the nine months ended September 30, 2006:
Weighted average
Shares subject exercise price
to option per share
-------------- ----------------
BALANCE AT DECEMBER 31, 2005 419,130 $11.57
------- ------
Options granted -- --
Options exercised (10,357) 6.28
Options forfeited or expired -- --
------- ------
BALANCE AT SEPTEMBER 30, 2006 408,773 $11.70
======= ======
The following table summarizes information about stock options outstanding under
both plans as of September 30, 2006:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- ----------------------------
Number of Average Weighted average Number of Weighted average
Range of exercise prices options life* exercise price options exercise price
------------------------ --------- ------- ---------------- --------- ---------------
$4.8125 - $9.0000 113,079 1.9 $ 7.06 113,079 $ 7.06
$9.5313 - $12.850 134,428 2.4 10.42 134,428 10.42
$15.035 - $20.160 161,266 4.6 16.02 161,266 16.02
------- --- ------ ------- -------
TOTAL 408,773 3.1 $11.70 408,773 $11.70
======= === ====== ======= ======
* Average life remaining in years
NOTE 7 - BUSINESS ACQUISITION, GOODWILL AND OTHER INTANGIBLE ASSETS
On April 6, 2006, we purchased 100% of the stock of Buck Engineering, P.C.
("Buck"), a North Carolina-based planning and environmental engineering firm
with a nationally recognized stream and wetland restoration program. Buck is a
market leader in stream restoration design and is well respected for its
expertise in environmental planning, applied research and extensive training
programs. Buck had 2005 revenues of approximately $13 million and approximately
60 employees at the time of our acquisition. Buck's assets consisted primarily
of receivables and fixed assets totaling $2.9 million and $0.6 million,
respectively, as of this date. The acquisition was accounted for under the
purchase method in accordance with SFAS 141, "Business Combinations," and in
accordance therewith, the total purchase price of approximately $10.9 million
was allocated to the assets acquired and liabilities assumed based upon their
estimated fair values. This allocation resulted in an increase of $8.3 million
and $0.8 million to the Engineering segment's goodwill and other intangible
asset balances, respectively. The results of operations of Buck have been
included in our consolidated financial statements since April 2006. Revenues
related to the Buck acquisition totaled $1.8 million and $2.2 million for the
second and third quarters of 2006, respectively. In addition, we entered into
two-year employment agreements with two of the three sellers. The purchase price
allocation for this acquisition has been finalized.
-12-
Goodwill and other intangible assets consist of the following (in thousands):
SEPT. 30, 2006 Dec. 31, 2005
-------------- -------------
Goodwill:
Engineering $ 9,263 $1,006
Energy 7,465 7,465
------- ------
Total goodwill 16,728 8,471
------- ------
Other intangible assets, net of accumulated amortization
of $2,244 and $1,810, respectively 605 190
------- ------
Goodwill and other intangible assets, net $17,333 $8,661
======= ======
Under SFAS 142, our goodwill balance is not being amortized and goodwill
impairment tests are being performed at least annually. We completed our most
recent annual impairment review during the second quarter of 2006, and no
impairment charge was required.
As of September 30, 2006, our other intangible assets balance comprises a
non-compete agreement (totaling $2.0 million, which is fully amortized) from our
1998 purchase of Steen Production Services, Inc., as well as intangibles related
to a customer list and contract backlog (totaling $849,000 with accumulated
amortization of $244,000) from our 2006 purchase of Buck. Amortization expense
on our other intangible assets was $206,000 and $434,000 for the three and
nine-month periods ended September 30, 2006, and $71,000 and $214,000 for the
three and nine-month periods ended September 30, 2005, respectively.
Estimated future amortization expense for other intangible assets as of
September 30, 2006 is as follows (in thousands):
Three months ending December 31, 2006 $122
Fiscal year 2007 208
Fiscal year 2008 113
Fiscal year 2009 86
Fiscal year 2010 40
Thereafter 36
----
TOTAL $605
====
NOTE 8 - RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the SEC issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" ("SAB 108"). SAB 108
provides interpretive guidance on how the effects of prior-year uncorrected
misstatements should be considered when quantifying misstatements in the current
year financial statements. SAB 108 requires registrants to quantify
misstatements using both an income statement and balance sheet approach and then
evaluate whether either approach results in a misstatement that, when all
relevant quantitative and qualitative factors are considered, is material. If
prior year errors that had been previously considered immaterial now are
considered material based on either approach, no restatement is required as long
as management properly applies its previous approach and all relevant facts and
circumstances were considered. If prior years' financial statements are not
restated, the cumulative effect adjustment is recorded in opening retained
earnings as of the beginning of the fiscal year of adoption. SAB 108 is
effective for our first fiscal year ending after November 15, 2006. We are
currently assessing the impact the adoption of SAB 108 will have on our
financial statements.
-13-
In September 2006, the Financial Accounting Standards Board ("FASB") issued SFAS
157, "Fair Value Measurements," which defines fair value, establishes guidelines
for measuring fair value and expands disclosures regarding fair value
measurements. SFAS 157 does not require any new fair value measurements but
rather eliminates inconsistencies in guidance found in various prior accounting
pronouncements. SFAS 157 is effective for fiscal years beginning after November
15, 2007 and interim periods within those fiscal years. Earlier adoption is
permitted, provided that financial statements have not yet been issued for that
fiscal year, including financial statements for an interim period within that
fiscal year. We expect to adopt the provisions of SFAS 157 on January 1, 2008
and do not expect there will be any impact on our consolidated financial
statements.
In July 2006, the FASB issued FIN 48, "Accounting for Uncertainty in Income
Taxes." FIN 48 provides guidance on the measurement, recognition, classification
and disclosure of, as well as the interim period accounting for, uncertain tax
positions. We will be required to adopt the provisions of FIN 48 effective
January 1, 2007. We are currently evaluating the impact that FIN 48 will have on
our consolidated financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
BUSINESS OVERVIEW
We provide engineering and energy expertise for public and private sector
clients worldwide. Our primary services include engineering design for the
transportation and civil infrastructure markets, operation and maintenance of
oil and gas production facilities, architectural and environmental services, and
construction management services for buildings and transportation projects. We
view our short and long-term liquidity as being dependent upon our results of
operations, changes in working capital and our borrowing capacity.
BUSINESS ENVIRONMENT
Our operations are affected by appropriations of public funds for infrastructure
and other government-funded projects, capital spending levels in the private
sector, and the demand for our services in the engineering and energy markets.
We could also be affected by additional external factors such as price
fluctuations and capital expenditures in the energy industry.
In 2005, the U.S. Congress approved a new, six-year $286.5 billion
transportation infrastructure bill entitled SAFETEA-LU, the Safe, Accountable,
Flexible, Efficient Transportation Equity Act--A Legacy for Users. This new
level of guaranteed funding reflects an increase of approximately 46% over its
predecessor, TEA-21. With this new bill enacted, we have seen an increase in
state spending on transportation infrastructure projects in the first nine
months of 2006, and we expect this activity to grow at a more accelerated rate
in the final quarter of 2006 and into 2007. During the first quarter of 2006, we
were selected as the lead designer for a $183 million design/build highway
reconstruction project on Interstate 15 in Ogden, Utah. In addition, we received
a multi-million dollar, multi-year contract to provide engineering design
services for the new Interstate 90/Central Viaduct bridge in Cleveland, Ohio.
During the second quarter, we were selected by the District of Columbia
Department of Transportation to provide architectural and engineering services
for its transportation infrastructure. Furthermore, our second quarter
acquisition of Buck Engineering will enable us
-14-
to provide Buck's nationally recognized stream and wetlands restoration program
to interested clients, particularly Departments of Transportation. In the third
quarter, we were selected to provide construction management and inspection
services totaling $4.4 million for the reconstruction of five miles of
Interstate 79 near Pittsburgh, Pa. For the past several years, we have observed
increased federal spending activity on Departments of Defense ("DoD") and
Homeland Security ("DHS") activities, including the Federal Emergency Management
Agency ("FEMA") and have, in turn, focused more marketing and sales activity on
these agencies (DoD and DHS) of the federal government. As a result of this
strategy, we increased our revenues from U.S. federal government contracting
activity in excess of 100 percent since 2002. Additional government spending in
these areas, or on transportation infrastructure, could result in profitability
and liquidity improvements for us. Significant contractions in any of these
areas could unfavorably impact our profitability and liquidity. In March 2004,
we announced that we had been awarded a five-year contract with FEMA for up to
$750 million to serve as the Program Manager to develop, plan, manage,
implement, and monitor the Multi-Hazard Flood Map Modernization Program for
flood hazard mitigation across the United States and its territories.
Approximately $491 million of this contract value was included in our backlog as
of September 30, 2006. During the first quarter of 2006, we were awarded new
work from DoD and DHS, including contracts with the Baltimore and New Orleans
Districts of the U.S. Army Corp of Engineers. In addition, we were awarded a
five-year, $2 million contract by the National Park Service to provide a
comprehensive array of environmental services. During the second quarter of
2006, we were initially awarded a five-year, up to $750 million
performance-based contract from FEMA to provide program management and
individual housing inspection services to assess damage caused by natural
disasters. A protest was filed by another bidder and later dismissed relative to
this award, and FEMA is currently conducting a re-selection process. An
additional protest has been filed by yet another bidder. While we believe that
we have provided an acceptable proposal with respect to qualification and
pricing, we can give no assurance that we will be re-selected or when such
re-selection process will be completed. As such, no related amounts have been
included in our backlog as of September 30, 2006. During the third quarter, we
were awarded a five year, up to $50 million contract by the DHS to provide
program and project management services for facilities and engineering projects
within the US-VISIT program.
During 2005, our Energy segment received an onshore Managed Services contract in
the Powder River Basin of Wyoming from Storm Cat Energy, to operate and maintain
its coal bed methane production facilities, which are adjacent to the Huber
properties (an existing Energy client). Additionally, during the second quarter
of 2006, we received a five-year, multi-million dollar contract from Escambia
Operating Company, LLC, to operate and maintain its gas producing properties and
facilities at the Big Escambia Field in Alabama. In the third quarter, we
received a five year, multi-million dollar Managed Services contract from Brooks
Range Petroleum Corporation to provide exploration, development and operations
services for their prospect fields on the North Slope of Alaska. Offshore in the
Gulf of Mexico, we were awarded during the first quarter of 2006 a two-year,
multi-million dollar contract by Stone Energy to provide operations and
maintenance labor services. We have also continued to increase our presence into
the deepwater Gulf of Mexico and international markets, where oil and gas
producers are currently investing significant amounts of capital for new
projects. Internationally, during the first quarter of 2006, we received a
contract from the West African Gas Pipeline Company to provide training services
for operations and maintenance of the West African Gas Pipeline System. Critical
to our continued success in all of these areas is exemplary compliance with all
applicable health, safety and environmental regulations. As evidence of our
commitment in this regard, we were awarded during the second quarter of 2006,
the National Safety Award for Excellence by the U.S. Department of Interior's
Minerals Management Service. During the third quarter, we received a $1 million,
multi-phase contract from Grupo Delta to customize and implement a logistics
asset management system for Petroleos Mexicanos.
-15-
RESULTS OF OPERATIONS
The following table reflects a summary of our operating results (excluding
intercompany transactions) for the periods ended September 30, 2006 and 2005
(dollars in millions). We evaluate the performance of our segments primarily
based on income from operations before Corporate overhead allocations. Corporate
overhead includes functional unit costs related to finance, legal, human
resources, information technology and communications, and is allocated between
our Engineering and Energy segments based on a three-part formula comprising
revenues, assets and payroll.
TOTAL CONTRACT REVENUES/INCOME FROM OPERATIONS
For the three months ended For the nine months ended
------------------------------- -------------------------------
SEPT. 30, 2006 Sept. 30, 2005 SEPT. 30, 2006 Sept. 30, 2005
-------------- -------------- -------------- --------------
ENGINEERING
Total contract revenues $97.8 $96.0 $281.8 $281.9
Income from operations before Corporate overhead 4.8 8.6 20.4 31.2
Percentage of Engineering revenues 4.9% 9.0% 7.2% 11.1%
Less: Corporate overhead (3.5) (3.5) (12.4) (9.9)
Percentage of Engineering revenues (3.6)% (3.7)% (4.4)% (3.5)%
----- ----- ------ ------
Income from operations 1.3 5.1 8.0 21.3
Percentage of Engineering revenues 1.3% 5.3% 2.8% 7.6%
----- ----- ------ ------
ENERGY
Total contract revenues 72.4 52.7 189.8 153.8
Income/(loss) from operations before Corporate
overhead 2.1 0.9 4.7 (1.1)
Percentage of Energy revenues 2.9% 1.7% 2.5% (0.7)%
Less: Corporate overhead (1.3) (1.3) (4.6) (3.8)
Percentage of Energy revenues (1.8)% (2.5)% (2.4)% (2.5)%
----- ----- ------ ------
Income/(loss) from operations 0.8 (0.4) 0.1 (4.9)
Percentage of Energy revenues 1.1% (0.8)% 0.1% (3.2)%
----- ----- ------ ------
-16-
For the three months ended For the nine months ended
-------------------------- -------------------------
SEPT. 30, Sept. 30, SEPT. 30, Sept. 30,
2006 2005 2006 2005
(continued) --------- --------- --------- ---------
TOTAL REPORTABLE SEGMENTS
Total contract revenues 170.2 148.7 471.6 435.7
Income from operations before Corporate
overhead 6.9 9.5 25.1 30.1
Percentage of total reportable
segment revenues 4.1% 6.4% 5.3% 6.9%
Less: Corporate overhead (4.8) (4.8) (17.0) (13.7)
Percentage of total reportable
segment revenues (2.8)% (3.2)% (3.6)% (3.1)%
------ ------ ------ ------
Income from operations 2.1 4.7 8.1 16.4
Percentage of total reportable
segment revenues 1.2% 3.2% 1.7% 3.8%
------ ------ ------ ------
Other Corporate/Insurance expense (0.6) (0.6) (1.2) (3.3)
------ ------ ------ ------
TOTAL COMPANY - INCOME FROM OPERATIONS $ 1.5 $ 4.1 $ 6.9 $ 13.1
Percentage of total Company revenues 0.9% 2.8% 1.5% 3.0%
====== ====== ====== ======
TOTAL CONTRACT REVENUES
Total contract revenues increased 14% in the third quarter of 2006 relative to
the third quarter of 2005. Engineering revenues for the third quarter of 2006
increased 2% over the third quarter of 2005. The new SAFETEA-LU legislation
helped to fuel a 12% increase in Engineering's transportation-related revenues
and the acquisition of Buck Engineering in the beginning of the second quarter
of 2006 contributed $2.2 million in additional revenues for the third quarter of
2006. Partially offsetting these increases in Engineering's revenues were lower
revenues from FEMA which totaled approximately $25 million and $30 million in
the third quarters of 2006 and 2005, respectively. As a result of achieving
certain performance levels on this FEMA project during the second quarter of
2006, the Engineering segment recognized incentive awards totaling $0.2 million
on the map modernization project with FEMA during the third quarter of 2006. As
a comparison, FEMA incentive awards totaled $1.8 million for the third quarter
of 2005. The eligible FEMA incentive award pool was lower during the third
quarter of 2006 due to lower revenue volume. In the Energy segment, revenues for
the third quarter of 2006 increased 37% over the third quarter of 2005. Revenue
increases were associated with additional contracts in the Gulf of Mexico and
two new managed services contracts, including the onshore Storm Cat Energy
contract to operate and maintain its coal bed methane production facilities in
the Powder River Basin of Wyoming and the onshore Escambia project to operate
and maintain its oil and gas producing properties and facilities at the Big
Escambia Field in Alabama.
For the first nine months of 2006, total contract revenues increased 8% over the
corresponding period in 2005. In the Engineering segment, revenues for the first
nine months of 2006 were unchanged when compared to the first nine months of
2005. Engineering revenues were positively impacted by an 8% increase in
transportation-related revenues as a result of the new SAFETEA-LU legislation
and an increase in revenues related to the Buck acquisition totaling $4.0
million. Offsetting the increase in Engineering's revenues was a reduction in
subcontractor costs related to the previously mentioned map modernization
program management project with FEMA. Total revenue from FEMA was $75 million
and $90 million in the first nine months of 2006 and 2005, respectively. The
higher FEMA revenue in the first nine months of 2005 is primarily
-17-
associated with the cost of building the information infrastructure required for
the project which was completed in 2005. As a result of achieving certain
performance levels on this FEMA project during the fourth quarter of 2005 and
first half of 2006, the Engineering segment recognized revenue associated with
incentive awards totaling $1.6 million during the first nine months of 2006. As
a comparison, the Engineering segment recognized revenue of $4.7 million in the
first nine months of 2005 related to incentive awards on the FEMA project. The
eligible FEMA incentive award pool was lower during the first nine months of
2006 due to lower revenue volume. In the Energy segment, revenues for the first
nine months of 2006 increased 23% over the first nine months of 2005. Revenue
increases were again associated with additional contracts in the Gulf of Mexico
and the onshore managed services contracts with Storm Cat Energy and Escambia.
Energy's revenues for the first nine months of 2006 also benefited from the
scheduled shut down of liquefied natural gas facilities in Nigeria, for which we
provided operations and maintenance services during the first quarter of 2006.
During the shut-down period, high levels of effort are expended to complete
preventative and other maintenance to put the facility back into service
quickly. These activities generate revenue in a short period of time which does
not recur until the next shut-down period.
GROSS PROFIT
Gross profit expressed as a percentage of revenues decreased to 11.9% for the
third quarter of 2006 from 14.0% in the third quarter of 2005. The Engineering
segment's gross profit percentage decreased to 14.4% in the third quarter of
2006 from 17.1% in the third quarter of 2005. This decrease in gross profit
expressed as a percentage of revenues was negatively impacted by $1.7 million in
legal costs incurred during the third quarter of 2006 in connection with
litigation and a protest on the FEMA Housing Inspection Services contract and
the settlement of a contract-related claim totaling $0.4 million. Additionally,
the Engineering segment's third quarter 2006 gross profit was adversely impacted
by lower incentive awards on the FEMA project and, to a lesser extent, lower
labor utilization rates as compared to the third quarter of 2005. Engineering's
labor utilization rates during the third quarter of 2006 were lower by 1%. These
lower Engineering labor utilization rates in the third quarter of 2006 are
attributable to a higher level of Baker labor worked in the third quarter of
2005 in connection with the FEMA map modernization contract combined with
multiple delays of anticipated projects in the third quarter of 2006. The Energy
segment's gross profit percentage decreased to 9.3% in the third quarter of 2006
from 9.4% in the third quarter of 2005. The Energy segment was adversely
affected by the loss of two projects in Venezuela and lower profitability
associated with certain international contracts, as partially offset by
increased profitability on domestic contracts.
Gross profit expressed as a percentage of revenues decreased to 13.7% in the
first nine months of 2006 from 14.2% in the first nine months of 2005. The
Engineering segment's gross profit percentage decreased to 16.9% in the first
nine months of 2006 from 19.3% in the first nine months of 2005. This decrease
in gross profit expressed as a percentage of revenues was impacted by the
aforementioned flat Engineering revenues and lower incentive awards on the FEMA
project, coupled with legal fees incurred in relation to the litigation and
protest on the FEMA Housing Inspection Services contract which resulted in a
total of $2.2 million in costs being accrued during the second and third
quarters of 2006. In addition, Engineering's labor utilization rates were lower
by 2% when compared to the first nine months of 2005 and negatively impacted
Engineering's gross profit percentage expressed as a percentage of revenues.
These lower labor utilization rates in the first nine months of 2006 are
attributable to a higher level of Baker labor worked in the first nine months of
2005 in connection with the FEMA map modernization contract combined with a
higher level of proposal activity in the first half of 2006, including our
effort to acquire the FEMA Housing Inspection Services contract (which was
subsequently protested), and multiple delays of anticipated projects. The Energy
segment's gross profit percentage increased to 9.5% in the first nine months of
2006 from 6.9% in the first nine months of 2005. This increase in gross profit
as a percentage of revenues relates to the turnaround of our Energy segment's
computerized maintenance management and operations assurance services business,
which contributed $1.0
-18-
million of gross profit in the first nine months of 2006 versus a gross loss of
$0.6 million in the first nine months of 2005, and a performance-based incentive
bonus totaling $0.6 million that was earned on a project in our managed services
business during the first quarter of 2006.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative ("SG&A") expenses, including Corporate
overhead, expressed as a percentage of total contract revenues decreased to
11.0% in the third quarter of 2006 from 11.2% in the third quarter of 2005. This
decrease in SG&A expenses expressed as a percentage of revenues resulted, in
part, from a favorable third quarter 2006 settlement of $0.5 million with a
casualty insurance provider (which lowered Corporate overhead), combined with
our 14% increase in revenues. In addition, despite additional corporate
professional fees of $0.6 million in the third quarter of 2006 associated with
the restatement of our consolidated financial statements for the periods 2001
through the first quarter of 2005, professional fees were lower when compared to
the third quarter of 2005. Partially offsetting these amounts were increases in
personnel-related expenses due to increased headcount. In the Engineering
segment, SG&A expenses expressed as a percentage of revenues increased to 13.0%
in the third quarter of 2006 from 11.8% in the third quarter of 2005. In the
Engineering segment, controllable SG&A expenses in the third quarter of 2006
increased by $1.2 million due primarily to increases in bid and proposal costs,
legal and other professional fees, and project management training and
personnel-related costs. In the Energy segment, SG&A expenses expressed as a
percentage of revenues decreased to 8.2% in the third quarter of 2006 from 10.2%
in the third quarter of 2005. This decrease in SG&A expenses expressed as a
percentage of revenues is attributable to relatively flat SG&A expenses coupled
with a 37% increase in revenues.
SG&A expenses, including Corporate overhead, expressed as a percentage of total
contract revenues increased to 12.2% in the first nine months of 2006 from 11.2%
in the first nine months of 2005. This overall increase in SG&A expenses
expressed as a percentage of revenues reflects increased Corporate overhead
costs related to increased headcount, as well as professional fees of $1.8
million incurred during the first nine months of 2006 that were associated with
the restatement of our consolidated financial statements for the periods 2001
through the first quarter of 2005. In the Engineering segment, SG&A expenses
expressed as a percentage of revenues increased to 14.0% in the first nine
months of 2006 from 11.8% in the first nine months of 2005. In addition to the
increase in allocated corporate overhead expenses, the Engineering segment's
controllable SG&A expenses increased by $3.4 million for the first nine months
of 2006 due primarily to increases in bid and proposal costs, legal and other
professional fees, and project management training and personnel-related costs
over the first nine months of 2005. In the Energy segment, SG&A expenses
expressed as a percentage of revenues decreased to 9.5% in the first nine months
of 2006 from 10.1% in the first nine months of 2005. This decrease in SG&A
expenses expressed as a percentage of revenues is attributable to the 23%
increase in revenues coupled with relatively flat segment overhead expenses
expressed in dollars. During the first nine months of 2006, the Energy segment
incurred professional fees of $0.7 million for audit and tax services related to
our payment of past due taxes.
OTHER INCOME
Interest income was negligible for both the third quarter of 2006 and 2005. For
the first nine months of 2006, interest income was higher as compared to the
first nine months of 2005 due to interest income of $0.1 million collected in
connection with a favorable claim settlement. Interest expense was approximately
the same for both third quarters and first nine months of 2006 and 2005,
respectively. For the first nine months of 2006, interest expense included $0.5
million on our net borrowed position and $0.4 million on certain previously
underpaid taxes. As a comparison, interest expense for the first nine months of
2005 included $1.0 million on previously underpaid taxes. Certain of these taxes
were paid during the fourth quarter of 2005 and
-19-
first nine months of 2006, thereby resulting in the lower interest expense
accruals in the first nine months of 2006. Other income, net for the third
quarter and first nine months of 2006 relates to equity earnings from two
unconsolidated minority-owned ventures totaling $0.4 million and $0.7 million,
respectively. In addition, the third quarter of 2006 included a currency-related
loss totaling $0.1 million, while the first nine months of 2006 included
currency-related gains totaling $0.3 million as well as $0.1 million related to
the aforementioned claim settlement which impacted the first quarter of 2006. As
a comparison, other expense, net for the third quarter and first nine months of
2005 primarily related to a write-down totaling $0.6 million associated with an
unconsolidated Energy subsidiary as the result of Hurricanes Katrina and Rita,
partially offset by equity earnings from another unconsolidated minority-owned
venture.
INCOME TAXES
We had a provision for income taxes of 64% for the first nine months of 2006,
which reflects our forecasted effective tax rate for the year ending December
31, 2006. For the first nine months of 2005, we had a provision for income taxes
of 65%. As a comparison, our full year estimated effective income tax rate as of
June 30, 2006 was 50%. The increase in our effective income tax rate during the
third quarter of 2006 is attributable to our lower than expected actual
operating results for the third quarter of 2006 and a reduction in our estimated
domestic and foreign income before taxes for the fourth quarter of 2006. The
variance between the U.S. federal statutory rate and our effective income tax
rate for these periods is due primarily to taxes on foreign revenue and income
which we are not able to offset with U.S. foreign tax credits, and to foreign
losses with no U.S. tax benefit. Our effective rate is also negatively impacted
by state income taxes, permanent items that are not deductible for U.S. tax
purposes and Nigerian income taxes that are levied on a deemed income basis. The
difference between our 2006 full year estimated effective income tax rate of 64%
and the amount shown in the accompanying consolidated statement of income for
the nine months ended September 30, 2006 is due to the settlement of a state
income tax audit for approximately $0.1 million.
CONTRACT BACKLOG
(In millions) SEPT. 30, 2006 Dec. 31, 2005
-------------- -------------
Engineering $1,040.4 $1,109.2
Energy 241.3 212.6
-------- --------
Total $1,281.7 $1,321.8
======== ========
In both the Engineering and Energy segments, backlog consists of that portion of
uncompleted work that is represented by signed or executed contracts. As
contract revenue is recognized, backlog is reduced. Certain of our contracts
with the Federal government and other clients may be terminated at will, or
option years may not be exercised; therefore, no assurance can be given that all
backlog will be realized.
As of September 30, 2006 and December 31, 2005, $491 million and $566 million of
our backlog, respectively, relates to a five-year, $750 million contract in the
Engineering segment to assist FEMA in conducting a large-scale overhaul of the
nation's flood hazard maps, which commenced late in the first quarter of 2004.
This contract includes data collection and analysis, map production, product
delivery, and effective program management; and seeks to produce digital flood
hazard data, provide access to flood hazard data and maps via the Internet, and
implement a nationwide state-of-the-art infrastructure that enables all-hazard
mapping. Due to the task order structure of the contract, realization of the
timing and amount of the original contract value of $750 million remains
difficult to predict. FEMA has identified specific program objectives and
priorities which it intends to accomplish under this program. As the initial
task orders are completed and progress against objectives is measured, we will
become better able to predict realization of this contract award. We
-20-
may at a time in the future reduce the related FEMA backlog accordingly.
In our Energy segment, we also consider purchase orders from clients for labor
services as backlog. These purchase orders typically have a twelve-month term.
Most purchase orders have cancellation clauses with thirty-day notice
provisions.
During the third quarter of 2006, our Engineering segment was awarded a
five-year, up to $50 million contract by the DHS to provide program and project
management services for facilities and engineering projects within the US-VISIT
program. In addition, our Energy segment was awarded a five-year,
multi-million-dollar managed services contract from Brooks Range Petroleum
Corporation to provide exploration, development and operations services for
their prospect fields on the North Slope of Alaska during the third quarter of
2006.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $23.7 million for the first nine
months of 2006, as compared to net cash provided by operating activities of
$10.8 million for the same period in 2005. The increase in cash used in
operating activities for first nine months of 2006 resulted primarily from
income tax payments totaling $8.4 million and an increase in both of our
segments' accounts receivable balances.
Net cash used in investing activities was $13.8 million and $3.9 million for the
first nine months of 2006 and 2005, respectively. The cash used in investing
activities for the first nine months of 2006 reflects the net cash paid for the
acquisition of Buck Engineering totaling $10.8 million and capital expenditures
of $3.0 million. In comparison, the cash used in investing activities for the
first nine months of 2005 reflects only capital expenditures. The 2006 and 2005
capital expenditure amounts primarily relate to computer software and equipment
purchases totaling $1.5 and $2.1 million and office and field equipment
purchases totaling $1.2 million and $1.4 million, respectively.
Net cash provided by financing activities was $28.4 million for the first nine
months of 2006 as compared to net cash used in financing activities of $1.9
million for the first nine months of 2005. The cash provided by financing
activities for 2006 relates to borrowings under our credit facility totaling
$22.7 million, which were used to finance the acquisition of Buck as well as
additional short-term working capital needs. In addition, our book overdrafts
increased in the amount of $6.0 million. The first nine months of 2006 and 2005
were also impacted by payments on capital lease obligations totaling $0.5
million and $0.4 million and proceeds from the exercise of stock options
totaling $0.1 million and $0.4 million, respectively. We also made payments
totaling $1.8 million during the first nine months of 2005 to repurchase Common
Stock under our stock repurchase program.
Working capital increased to $62.1 million at September 30, 2006 from $49.3
million at December 31, 2005. Our current ratio was 1.40:1 and 1.35:1 at the end
of the third quarter of 2006 and year-end 2005, respectively.
We have an unsecured credit agreement (the "Agreement") with a consortium of
financial institutions. The Agreement provides for a commitment of $60 million
through September 17, 2008. The commitment includes the sum of the principal
amount of revolving credit loans outstanding and the aggregate face value of
outstanding letters of credit. As of September 30, 2006, borrowings totaling
$22.7 million and letters of credit totaling $10.2 million were outstanding
under the Agreement. The Agreement requires us to meet minimum equity, leverage,
interest and rent coverage, and current ratio covenants. If any of these
financial covenants or certain other conditions of borrowing are not achieved,
under certain circumstances, after a cure
-21-
period, the banks may demand the repayment of all borrowings outstanding and/or
require deposits to cover the outstanding letters of credit. We expect to be in
compliance with these financial covenants for at least the next year.
We did not timely file our quarterly reports on Form 10-Q for the second and
third quarters of 2005 and the first quarter of 2006, or our annual report on
Form 10-K for the year ended December 31, 2005. As a result, several covenant
violations related to the timing of our financial reporting occurred under the
Agreement. The lenders waived these violations by allowing us to file our Forms
10-Q for the quarters ended June 30, 2005 and September 30, 2005, our Form 10-K
for the year ended December 31, 2005, and our Form 10-Q for the quarter ended
March 31, 2006, with the SEC by August 15, 2006. These documents were filed
within the specified time period.
Furthermore, we did not meet the SEC's filing deadline for our Form 10-Q for the
second quarter of 2006. Accordingly, our lenders also waived the resulting
covenant violation related to the timing of this filing by allowing us to file
such Form 10-Q by September 30, 2006. This document was also filed within the
specified time period. We expect to file our future quarterly and annual SEC
filings on a timely basis.
Our borrowing capacity under the Agreement is available for short-term working
capital needs and to support strategic opportunities that management identifies.
Our strategy is to better position ourselves for growth in our Engineering and
Energy segments through selected opportunistic acquisitions that complement our
experience, skill and geographic presence. We consider acquisitions and
investments as components of our growth strategy and intend to use both existing
cash and the borrowings under the Agreement to fund such endeavors. If we commit
to funding future acquisitions, we may need to adjust our credit facilities to
reflect a longer repayment period on borrowings used for acquisitions.
We acquire computer equipment and software, as well as office space, furniture
and fixtures, motor vehicles, and other equipment through operating leases. The
use of operating leases reduces the level of capital expenditures that would
otherwise be necessary to operate both segments of our business.
After giving effect to the foregoing, management believes that the combination
of cash anticipated to be generated from operations and our existing credit
facility will be sufficient to meet our operating and capital expenditure
requirements for at least the next year.
This Quarterly Report on Form 10-Q, particularly the "Management's Discussion
and Analysis of Financial Condition and Results of Operations" section in Part
I, contains forward-looking statements concerning our future operations and
performance. Forward-looking statements are subject to market, operating and
economic risks and uncertainties that may cause our actual results in future
periods to be materially different from any future performance suggested herein.
Factors that may cause such differences include, among others: increased
competition, increased costs, changes in general market conditions, changes in
industry trends, changes in the regulatory environment, changes in our
relationships and/or contracts with FEMA, changes in anticipated levels of
government spending on infrastructure, including SAFETEA-LU, changes in loan
relationships or sources of financing, changes in management, and changes in
information systems. Such forward-looking statements are made pursuant to the
Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Currently, our primary interest rate risk relates to our variable-rate debt
obligations, which totaled $22.7 million as of September 30, 2006. Assuming a
10% increase in interest rates on these variable-rate debt obligations (i.e., an
increase from the actual weighted average interest rate of 7.06% as of September
30, 2006, to a weighted average interest rate of 7.76%), annual interest expense
would be approximately $160,000 higher in 2006 based on the outstanding balance
of variable-rate debt obligations as of September 30, 2006. We also have
variable rate investments, which totaled $0.3 million as of September 30, 2006.
Assuming a 10% increase in interest rates on these variable-rate investments
(i.e., an increase from the actual weighted average interest rate of 4.44% as of
September 30, 2006, to a weighted average interest rate of 4.88%), annual
interest income would be approximately $1,000 higher in 2006 based on the
outstanding balance of variable-rate investments as of September 30, 2006.
Accordingly, we have no material exposure to interest rate risk, nor do we have
any interest rate swap or exchange agreements.
We have several foreign subsidiaries that transact portions of their local
activities in currencies other than the U.S. Dollar. In assessing our exposure
to foreign currency exchange rate risk, we recognize that the majority of our
foreign subsidiaries' assets and liabilities reflect ordinary accounts
receivable and payable balances. These receivable and payable balances are
substantially settled in the same currencies as the functional currencies of the
related foreign subsidiaries, thereby not exposing us to material transaction
gains and losses. Assuming that foreign currency exchange rates could change
unfavorably by 10%, we would have no material exposure to foreign currency
exchange rate risk. We have no foreign currency exchange contracts.
Based on the nature of our business, we have no direct exposure to commodity
price risk.
ITEM 4. CONTROLS AND PROCEDURES
CONCLUSIONS REGARDING THE EFFECTIVENESS OF DISCLOSURE CONTROLS AND PROCEDURES
We carried out an evaluation, under the supervision and with participation of
our management, including our Chief Executive Officer ("CEO") and Chief
Financial Officer ("CFO"), of our disclosure controls and procedures, as such
term is defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), as of September 30, 2006. This
evaluation considered our various procedures designed to ensure that information
required to be disclosed by us in reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the rules and forms of the Securities and Exchange
Commission and that such information is accumulated and communicated to
management, including our CEO and CFO, as appropriate to allow timely decisions
regarding required disclosure. Based upon that evaluation, which included the
matters discussed below, our CEO and CFO concluded that our disclosure controls
and procedures were not effective as of September 30, 2006. Notwithstanding the
material weaknesses discussed below, our management has concluded that the
financial statements included in this Form 10-Q fairly present in all material
respects our financial position, results of operations and cash flows for the
periods presented in conformity with generally accepted accounting principles in
the United States ("GAAP").
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of a company's annual or interim financial statements would not be
prevented or detected. The following material weaknesses were identified by
management as of September 30, 2006:
1. We did not maintain effective controls, including monitoring, over the
accounting for our sales and
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use taxes. Specifically, we did not have a complement of operations
and accounting personnel aware of the tax ramifications of entering a
new jurisdiction which resulted in misstating accrued sales and use
tax accounts. Additionally, this control deficiency could result in a
misstatement in the aforementioned accounts that would result in a
material misstatement to the annual or interim consolidated financial
statements that would not be prevented or detected. Accordingly, we
have determined that this control deficiency constitutes a material
weakness.
2. We did not maintain effective controls over the accounting for our
incurred but not reported ("IBNR") insurance-related liabilities as
required under GAAP. Specifically, we did not properly account for
adjustments and increased activity in evaluating the liabilities. This
control deficiency resulted in an adjustment to our condensed
consolidated financial statements for the second quarter of fiscal
year 2005. This control deficiency could result in a misstatement in
the aforementioned IBNR liabilities that would result in a material
misstatement to the annual or interim consolidated financial
statements that would not be prevented or detected. Accordingly, we
have determined that this control deficiency constitutes a material
weakness.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
Except as discussed below, there was no change in our "internal control over
financial reporting" (as such term is defined in Rule 13a-15(f) and 15d-15(f)
under the Exchange Act) that occurred during the quarter ended September 30,
2006, and that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
PLAN FOR REMEDIATION
We believe the steps described below, together with others that are ongoing or
that we plan to take, will remediate the material weaknesses previously
discussed:
(1) We established a tax function with a qualified tax director supported
by internal and external resources (began in July 2005).
(2) We have supplemented our existing accounting and finance staff with
additional internal and external resources as appropriate. We will
continue to add financial personnel as necessary to provide adequate
resources with appropriate levels of experience and knowledge of GAAP
(began in July 2005).
(3) We have enhanced our review and documentation of accounting estimates.
This includes but is not limited to estimates of our sales and use tax
liabilities and insurance reserves (commenced in October 2005).
In addition, we have implemented the following procedures to improve our
internal control over financial reporting:
(1) We have emphasized certain key controls in an effort to mitigate
significant risks and strengthen our control environment. In this
regard, we have elevated within the company the awareness and
communication of tax-related contingencies and financial reporting
risks associated with insurance reserves (began in June 2005).
(2) We have enhanced our monitoring of accounts by deploying account
reconciliation software that facilitates access and review of
reconciliations (deployment began in August 2005).
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On March 28, 2006, Alltech, Inc. a competitor for the 2006 FEMA Housing
Inspection Contract ("the Contract") filed suit against us in the U.S. District
Court for the Eastern District of Virginia alleging, among other claims, that we
had misappropriated trade secrets and seeking, in addition to other relief, a
temporary restraining order to prevent us from using such alleged trade secrets
in our bid to FEMA for the Contract. On April 6, 2006, the Court refused to
grant a temporary restraining order, and on September 12, 2006, Alltech
voluntarily dismissed its lawsuit without explanation. Separately, following an
award by FEMA of the Contract to us and the Partnership for Response and
Recovery (PaRR) in June 2006, Alltech filed a protest with the Government
Accountability Office (GAO) on June 23, 2006. As a result of the filing of that
protest, FEMA issued a stop-work order to us and PaRR. We intervened in the
protest. On August 18, 2006, FEMA advised GAO that it was going to take
corrective action, and in response, GAO dismissed the protest on August 21,
2006. On September 25, 2006, PaRR filed a protest with GAO challenging FEMA's
corrective action. FEMA has solicited revised proposals for the Contract from
us, PaRR, and Alltech, but has notified all bidders that it does not intend to
award the contract until PaRR's protest has been resolved.
Additionally, see discussion in Note 4 to the accompanying condensed
consolidated financial statements.
ITEM 1A. RISK FACTORS
There were no material changes in the risk factors disclosed in our Form 10-K
for the year ended December 31, 2005.
ITEM 6. EXHIBITS
(a) The following exhibits are included herewith as a part of this Report:
Exhibit No. Description
----------- -----------
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a-14(a)
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14(a)
32.1 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MICHAEL BAKER CORPORATION
/s/ William P. Mooney Dated: November 8, 2006
--------------------------------------
William P. Mooney
Executive Vice President and
Chief Financial Officer
/s/ Craig O. Stuver Dated: November 8, 2006
--------------------------------------
Craig O. Stuver
Senior Vice President, Corporate
Controller and Treasurer (Chief
Accounting Officer)
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