Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
| Restricted Stock
|
| |
| Restricted shares of the Company’s common stock are awarded from time to time to the executive officers and certain key employees of the Company subject to a three-year service restriction, and may not be sold or transferred during the restricted period. Restricted stock compensation is recorded based on the stock price on the grant date and charged to expense ratably through the restriction period. Forfeitures cause the reversal of all previous expense recorded as a reduction of current period expense. The following table summarizes information about restricted stock activity during the nine-month period ended September 30, 2006: |
Expense associated with grants of restricted stock shares and the effect of related forfeitures is presented below (in thousands):
| | Three Months Ended March 31, | |
| | 2007 | | 2006 | |
Restricted stock share expense | | $ | 194 | | $ | 211 | |
Forfeitures | | | - | | | - | |
Restricted stock share expense | | | 194 | | | 211 | |
Tax benefit | | | (75 | ) | | (82 | ) |
Net expense | | $ | 119 | | $ | 129 | |
| | Shares | | Weighted Average Grant Date Fair Value | |
Outstanding at December 31, 2005 | | | 83,900 | | $ | 16.64 | |
Granted | | | 50,800 | | | 19.41 | |
Vested | | | (1,700 | ) | | 15.72 | |
Forfeited | | | (1,500 | ) | | 15.50 | |
Outstanding at September 30, 2006 | | | 131,500 | | $ | 17.73 | |
Unrecognized pretax expense of $0.9 million related to restricted stock share awards is expected to be recognized over the weighted average remaining service period of 1.2 years for awards outstanding at March 31, 2007.
| Expense (benefit) associated with grants of restricted stock and the effect of related forfeitures are presented below (in thousands): |
Restricted Stock Units
On January 11, 2007, restricted stock units were awarded to the executive officers and certain key employees of the Company. The restricted stock units will vest fully on the third anniversary date of the award if the recipient’s employment with the Company has not terminated on or prior to that date. The restricted stock unit awards for executive officers also are subject to the Company’s achievement of a pre-established net income target during the performance period beginning on January 1, 2007 and ending on December 31, 2007. Restricted stock unit compensation is recorded based on the fair value of the restricted stock units on the grant date which is equal to the Company’s stock price and charged to expense ratably through the restriction period. Forfeitures cause the reversal of all previous expense recorded as a reduction of current period expense. The following table summarizes information about restricted stock unit activity during the quarter ended March 31, 2007:
| | Three Months Ended | | Nine Months Ended | |
| | September 30, | | September 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
Restricted stock expense | | $ | 193 | | $ | 149 | | $ | 601 | | $ | 340 | |
Forfeitures | | | – | | | (12 | ) | | (15 | ) | | (116 | ) |
Restricted stock expense, net | | | 193 | | | 137 | | | 586 | | | 224 | |
Tax benefit | | | (75 | ) | | (48 | ) | | (228 | ) | | (78 | ) |
Net expense | | $ | 118 | | $ | 89 | | $ | 358 | | $ | 146 | |
| | | | Weighted | |
| | | | Average | |
| | Restricted | | Award Date | |
| | Stock Units | | Fair Value | |
Outstanding at December 31, 2006 | | | - | | $ | - | |
Awarded | | | 50,830 | | | 25.60 | |
Shares distributed | | | - | | | - | |
Forfeited/Expired | | | - | | | - | |
Outstanding at March 31, 2007 | | | 50,830 | | $ | 25.60 | |
| Unrecognized pretax expense of $1.3 million related to restricted stock awards is expected to be recognized over the weighted average remaining service period of 1.7 years for awards outstanding at September 30, 2006. |
| |
| Deferred Stock Units
|
| |
| Deferred stock units are generally awarded to directors of the Company and represent the Company’s obligation to transfer one share of the Company’s common stock to the grantee at a future date and generally are fully vested on the date of grant. The expense related to the issuance of deferred stock units is recorded in full on the date of grant. |
| |
| Deferred stock units awarded and the associated expense for the three- and nine-month periods ended September 30, 2006 and 2005 are presented in the table below (dollars in thousands): |
Expense associated with awards of restricted stock units and the effect of related forfeitures are presented below (in thousands): | | Three Months Ended | |
| | March 31, | |
| | 2007 | | 2006 | |
Restricted stock unit expense | | $ | 108 | | $ | - | |
Forfeitures | | | - | | | - | |
Restricted stock unit expense | | | 108 | | | - | |
Tax benefit | | | ( 42 | ) | | - | |
Net expense | | $ | 66 | | $ | - | |
| | Three Months Ended | | Nine Months Ended | |
| | September 30, | | September 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
Deferred stock units awarded | | | – | | | 3,200 | | | 24,900 | | | 32,282 | |
| | | | | | | | | | | | | |
Deferred stock units expense | | $ | – | | $ | 61 | | $ | 603 | | $ | 539 | |
Tax benefit | | | – | | | (21 | ) | | (234 | ) | | (189 | ) |
Net expense | | $ | – | | $ | 40 | | $ | 369 | | $ | 350 | |
Unrecognized pretax expense of $1.2 million related to restricted stock unit awards is expected to be recognized over the weighted average remaining service period of 1.1 years for awards outstanding at March 31, 2007.
| The following table summarizes information about deferred stock units activity during the nine-month period ended September 30, 2006: |
| | | | Weighted Average Award Date Fair Value | |
Outstanding at December 31, 2005 | | | 78,432 | | $ | 16.39 | |
Granted | | | 24,900 | | | 24.20 | |
Shares distributed | | | (9,525 | ) | | 15.75 | |
Outstanding at September 30, 2006 | | | 93,807 | | $ | 18.53 | |
Deferred Stock Units
| Stock Options
|
| |
| Stock options granted generally have a term of seven to ten years and are required to have an exercise price equal to the market value of the underlying common stock on the date of grant. A summary of option activity for the first nine months of 2006 follows: |
| | Shares | | Weighted Average Exercise Price | | Weighted Average Remaining Contractual Term (Yrs) | | | |
Outstanding at December 31, 2005 | | | 1,381,476 | | $ | 19.53 | | | | | | | |
Granted | | | 324,000 | | | 19.63 | | | | | | | |
Exercised | | | (233,416 | ) | | 16.79 | | | | | | | |
Forfeited/Expired | | | (152,794 | ) | | 21.60 | | | | | | | |
Outstanding at September 30, 2006 | | | 1,319,266 | | $ | 19.80 | | | 5.0 | | $ | 6,949,148 | |
Exercisable at September 30, 2006 | | | 890,716 | | $ | 20.58 | | | 4.6 | | $ | 4,301,186 | |
| | Options Outstanding | | Options Exercisable | |
| | | | Weighted | | | | | | | | | | | |
| | | | Average | | Weighted | | | | | | Weighted | | | |
| | | | Remaining | | Average | | Aggregate | | | | Average | | Aggregate | |
Range of | | Number | | Contractual | | Exercise | | Intrinsic | | Number | | Exercise | | Intrinsic | |
Exercise Price | | Outstanding | | Term (Yrs) | | Price | | Value | | Exercisable | | Price | | Value | |
$4.00 to $10.00 | | | 29,400 | | | 1.1 | | $ | 8.75 | | $ | 456,582 | | | 29,400 | | $ | 8.75 | | $ | 456,582 | |
$10.01 to $20.00 | | | 769,896 | | | 5.3 | | | 16.45 | | | 6,032,124 | | | 399,346 | | | 15.32 | | | 3,577,602 | |
$20.00 and above | | | 519,970 | | | 4.8 | | | 25.38 | | | 460,442 | | | 461,970 | | | 25.88 | | | 267,002 | |
Total Outstanding | | | 1,319,266 | | | 5.0 | | $ | 19.80 | | $ | 6,949,148 | | | 890,716 | | $ | 20.58 | | $ | 4,301,186 | |
Deferred stock units are generally awarded to directors of the Company and represent the Company’s obligation to transfer one share of the Company’s common stock to the grantee at a future date and generally are fully vested on the date of grant. The expense related to the issuance of deferred stock units is recorded in full on the date of grant. In the first quarter of 2007 and 2006, there were no deferred stock units awarded. The following table summarizes information about deferred stock unit activity during the quarter ended March 31, 2007:
| | | | Weighted | |
| | | | Average | |
| | Deferred | | Award Date | |
| | Stock Units | | Fair Value | |
Outstanding at December 31, 2006 | | | 93,807 | | $ | 18.53 | |
Awarded | | | - | | | - | |
Shares distributed | | | - | | | - | |
Forfeited/Expired | | | - | | | - | |
Outstanding at March 31, 2007 | | | 93,807 | | $ | 18.53 | |
| The intrinsic values above are based on the Company’s closing stock price of $24.28 on September 29, 2006. The weighted-average grant-date fair value of options awarded during the first nine months of 2006 was $8.25. In the first nine months of 2006, the Company collected $3.9 million from stock option exercises that had a total intrinsic value of $2.2 million. The Company recorded a tax benefit from stock option exercises of $0.8 million in additional paid-in capital on the consolidated balance sheet and as a cash flow from financing activities on the consolidated statements of cash flows. Under the fair value provisions of SFAS 123(R), the Company recorded pretax expense of $0.4 million and $2.2 million related to stock option awards in the third quarter and first nine months of 2006, respectively. Unrecognized pretax expense of $1.5 million related to stock options is expected to be recognized over the weighted average remaining service period of 1.1 years for awards outstanding at September 30, 2006. |
Stock Options
Stock options granted generally have a term of seven to ten years and an exercise price equal to the market value of the underlying common stock on the date of grant. A summary of option activity for the first quarter of 2007 follows:
| | Options Outstanding | | Options Exercisable | |
| | | | Weighted | | | | | | | | | | | |
| | | | Average | | Weighted | | | | | | Weighted | | | |
| | | | Remaining | | Average | | Aggregate | | | | Average | | Aggregate | |
Range of | | Number | | Contractual | | Exercise | | Intrinsic | | Number | | Exercise | | Intrinsic | |
Exercise Price | | Outstanding | | Term (Yrs) | | Price | | Value | | Exercisable | | Price | | Value | |
$4.00 - $10.00 | | | 29,400 | | | 0.6 | | $ | 8.75 | | $ | 353,976 | | | 29,400 | | $ | 8.75 | | $ | 353,976 | |
$10.01 - $20.00 | | | 718,208 | | | 4.8 | | | 16.52 | | | 3,069,901 | | | 436,483 | | | 16.05 | | | 2,069,863 | |
$20.00 and above | | | 840,089 | | | 5.3 | | | 25.45 | | | 23,920 | | | 532,802 | | | 25.58 | | | 17,940 | |
Total Outstanding | | | 1,587,697 | | | 5.0 | | $ | 21.10 | | $ | 3,447,797 | | | 998,685 | | $ | 20.92 | | $ | 2,441,779 | |
| | | | | | Weighted | | | |
| | | | Weighted | | Average | | | |
| | | | Average | | Remaining | | Aggregate | |
| | | | Exercise | | Contractual | | Intrinsic | |
| | Shares | | Price | | Term (Yrs) | | Value | |
Outstanding at December 31, 2006 | | | 1,298,392 | | $ | 19.85 | | | | | | | |
Granted | | | 338,455 | | | 25.60 | | | | | | | |
Exercised | | | (37,418 | ) | | 17.04 | | | | | | | |
Forfeited/Expired | | | (11,732 | ) | | 22.67 | | | | | | | |
Outstanding at March 31, 2007 | | | 1,587,697 | | $ | 21.10 | | | 5.0 | | $ | 3,447,797 | |
Exercisable at March 31, 2007 | | | 998,685 | | $ | 20.92 | | | 4.4 | | $ | 2,441,779 | |
The intrinsic values above are based on the Company’s closing stock price of $20.79 on March 30, 2007. The weighted-average grant-date fair value of options granted during the first quarter of 2007 was $10.97. There were 316,000 stock options granted in the first quarter of 2006. In the first quarter of 2007, the Company collected $0.6 million for option exercises that had a total intrinsic value of $0.3 million. In the first quarter of 2006, the Company collected $3.0 million for option exercises that had a total intrinsic value of $1.8 million. In the first quarter of 2007 and 2006,
the Company recorded a tax benefit from stock option exercises of $0.05 million and $0.6 million, respectively, in additional paid in capital on the consolidated balance sheet and as a cash flow from financing activities on the consolidated statement of cash flow for the three months ended March 31, 2007 and 2006. In the first quarter of 2007 and 2006, the Company recorded pretax expense of $1.4 million ($0.9 million after-tax) and $1.2 million ($0.7 million after-tax), respectively, related to stock option awards. Unrecognized pretax expense of $3.5 million related to stock options is expected to be recognized over the weighted average remaining service period of 1.8 years for awards outstanding at March 31, 2007.
For 2007, the Company changed from using the Black-Scholes option-pricing model to the binomial option-pricing model for valuation purposes to more accurately reflect the features of stock options granted.
The fair value of stock options awarded during the first quarter of 2007 was estimated at the date of grant using the binomial option-pricing model based on the assumptions presented in the table below. Volatility, expected term, and high-yield assumptions were based on the Company’s historical experience. The risk-free rate was based on a U.S. treasury note with a maturity similar to the option award’s expected term.
| Prior Year Equity Compensation Expense
|
2007 | |
Volatility | Prior to January 1, 2006, the Company applied the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for stock options. The following table illustrates the effect on net income and earnings per share in the three- and nine-month periods ended September 30, 2005 had the Company applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock Based Compensation, to equity-based compensation (in thousands, except per-share data):
| | 45.0 | % |
Expected term (years) | | | 4.5 | |
Dividend yield | | | 0.0 | % |
Risk-free rate | | | 4.4 | % |
| | Three Months Ended September 30, 2005 | | Nine Months Ended September 30, 2005 | |
Net income, as reported | | $ | 5,760 | | $ | 8,895 | |
Add: Total equity-based compensation expense included in net income, net of related tax benefits | | | 129 | | | 496 | |
Deduct: Total equity-based compensation expense determined under fair value method for all awards, net of related tax effects | | | (654 | ) | | (1,944 | ) |
Pro forma net income | | $ | 5,235 | | $ | 7,447 | |
| | | | | | | |
Basic earnings per share as reported: | | $ | 0.21 | | $ | 0.33 | |
Basic earnings per share pro forma: | | | 0.20 | | | 0.28 | |
| | | | | | | |
Diluted earnings per share as reported: | | $ | 0.21 | | $ | 0.33 | |
Diluted earnings per share pro forma: | | | 0.19 | | | 0.28 | |
During 2006, the fair value of stock options awarded was estimated at the date of grant using the Black-Scholes option-pricing model based on the assumptions presented in the table below. Volatility, dividend yield and expected term assumptions were based on the Company's historical experience. The risk-free rate was based on a U.S. treasury note with a maturity similar to the option award’s expected term.
| In accordance with SFAS 148, Accounting for Stock-Based Compensation - Transition and Disclosure, the equity-based compensation expense recorded in the determination of reported net income during the three and nine months ended September 30,
| 2006 is disclosed in the table above. The pro forma equity-based compensation expense includes the recorded expense and the expense related to stock options that was determined using the fair value method. |
| |
Volatility | Stock Option Grant Practices
| | 41.7 | % |
Expected term (years) | | | 4.8 | |
Dividend yield | Given the recent focus by the Securities and Exchange Commission on historical stock option grant procedures, at the request of its Board of Directors, the Company, in conjunction with outside counsel, investigated historical practices in the granting of stock options from January 1, 2000 to the present, regardless of whether the grants were made to directors, officers or non-officer employees of the Company. The results of the investigation revealed that a number of option grants during this period had option grant dates as set forth in the individual stock option agreements that occurred either prior to or after the dates that the Company’s records evidence approval of the options by the appropriate governing body. |
| | 0.0 | % |
Risk-free rate | In each of the cases where there was a mismatch of the option grant date and the approval date, the investigation concluded that the grant date exercise price was less than the fair market value of the Company’s common stock on the approval date. The resulting cumulative expense related to these option grants was not material to any previously reported historical period, nor is it material in the third quarter of 2006. As such, no financial statements for previously reported periods are being revised, and additional non-cash stock-based compensation expense of $0.2 million was recorded in the third quarter of 2006. The compensation expense had no effect on the Company’s cash position. |
| |
4.3 | No evidence of intentional or fraudulent misconduct in the granting of these stock options was uncovered during the investigation, but the investigation found incomplete documentation of option grants as well as option grant procedures that did not meet best practice standards.% |
3. | COMPREHENSIVE (LOSS) INCOME |
| |
| For the quarters ended September 30, |
For the quarters ended March 31, 2007 and 2006, comprehensive (loss) income was $(13.6) million and $3.5 million, respectively. The Company’s adjustment to net (loss) income to calculate comprehensive (loss) income consisted solely of cumulative foreign currency translation adjustments of $1.7 million and $0.5 million for the quarters ended March 31, 2007 and 2006, and 2005, comprehensive income was $3.5 million and $7.0 million, respectively, with comprehensive income of $14.9 million and $7.5 million for the nine months ended September 30, 2006 and 2005, respectively. The Company’s adjustment to net income to calculate comprehensive income consists solely of cumulative foreign currency translation adjustments of $(2.2) million and $1.2 million for the quarters ended September 30, 2006 and 2005, respectively, and $0.6 million and $(1.4) million for the nine months ended September 30, 2006 and 2005, respectively.
4. | SHARE INFORMATION |
| |
| Earnings per share have been calculated using the following share information: |
(Loss) earnings per share have been calculated using the following share information:
| | Three Months Ended March 31, | |
| | 2007 | | 2006 | |
Weighted average number of common shares used for basic EPS | | | 27,254,380 | | | 26,918,383 | |
Effect of dilutive stock options, restricted stock, restricted stock units and deferred stock units (Note 2) | | | ─ | | | 428,263 | |
Weighted average number of common shares and dilutive potential common stock used in dilutive EPS | | | 27,254,380 | | | 27,346,646 | |
The effect of stock options, restricted stock, restricted stock units and deferred stock units of 419,088 was not considered in the calculation of loss per share in the first quarter of 2007 as the effect would have been anti-dilutive.
Treasury Stock Retirement
On January 24, 2007, the Company’s Board of Directors approved the retirement of the Company’s treasury stock. Consequently, the Company’s 2,357,464 shares of treasury stock were retired on March 20, 2007, and the number of
| | | Three Months Ended September 30, |
| | | 2006 | | | 2005 | |
Weighted average number of common shares used for basic EPS | | | 27,091,398 | | | 26,793,266 | |
Effect of dilutive stock options and restricted stock | | | 332,254 | | | 251,387 | |
Weighted average number of common shares | | | | | | | |
and dilutive potential common stock used in dilutive EPS | | | 27,423,652 | | | 27,044,653 | |
| | | | | | | |
issued shares was reduced accordingly. The effects on stockholders’ equity included a reduction in common stock by the par value of the shares, and a reduction in additional paid-in capital. | | Nine Months Ended September 30, |
| | | 2006 | | | 2005 | |
Weighted average number of common shares used for basic EPS | | | 27,024,019 | | | 26,764,249 | |
Effect of dilutive stock options and restricted stock | | | 442,564 | | | 178,243 | |
Weighted average number of common shares | | | | | | | |
and dilutive potential common stock used in dilutive EPS | | | 27,466,583 | | | 26,942,492 | |
5. | SEGMENT REPORTING AND GEOGRAPHIC INFORMATIONINCOME TAXES
|
| |
| The Company has three principal operating segments: rehabilitation; tunneling; and Tite Liner®, the Company’s corrosion and abrasion segment. The segments were determined based upon the types of products sold by each segment and each is regularly reviewed and evaluated separately. |
| |
| The following disaggregated financial results are presented on the same basis that management uses to make internal operating decisions. The Company evaluates performance based on stand-alone operating income. |
| |
| Financial information by segment was as follows (in thousands): |
| | Three Months Ended | | Nine Months Ended | |
| | September 30, | | September 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
Revenues | | | | | | | | | |
Rehabilitation | | $ | 118,269 | | $ | 107,821 | | $ | 355,147 | | $ | 336,279 | |
Tunneling | | | 16,002 | | | 35,724 | | | 49,843 | | | 85,123 | |
Tite Liner® | | | 9,805 | | | 11,668 | | | 36,851 | | | 27,929 | |
Total revenues | | $ | 144,076 | | $ | 155,213 | | $ | 441,841 | | $ | 449,331 | |
| | | | | | | | | | | | | |
Gross profit (loss) | | | | | | | | | | | | | |
Rehabilitation | | $ | 28,927 | | $ | 26,596 | | $ | 83,435 | | $ | 81,172 | |
Tunneling | | | (868 | ) | | 2,767 | | | (1,318 | ) | | (2,438 | ) |
Tite Liner® | | | 3,581 | | | 3,487 | | | 12,249 | | | 8,438 | |
Total gross profit | | $ | 31,640 | | $ | 32,850 | | $ | 94,366 | | $ | 87,172 | |
| | | | | | | | | | | | | |
Operating income (loss) | | | | | | | | | | | | | |
Rehabilitation | | $ | 8,225 | | $ | 8,513 | | $ | 21,962 | | $ | 25,320 | |
Tunneling | | | (2,963 | ) | | (1,267 | ) | | (8,087 | ) | | (12,375 | ) |
Tite Liner® | | | 2,085 | | | 2,213 | | | 7,435 | | | 4,639 | |
Total operating income | | $ | 7,347 | | $ | 9,459 | | $ | 21,310 | | $ | 17,584 | |
| In the first nine months of 2005, the Company recorded a claim receivable from the Company’s excess insurance coverage carrier, which benefited gross profit in the rehabilitation segment by $3.4 million. In the first nine months of 2006, the Company recorded $0.5 million related to additional amounts from the same claim. See Note 7 - “Boston Installation” for further discussion. |
| |
| Tunneling posted an operating loss in the third quarter of 2006, primarily due to underutilized equipment. Underutilized equipment costs (primarily operating lease expenses) were $2.3 million in the third quarter of 2006 compared to $1.4 million in the third quarter of 2005. Tunneling’s results in the third quarter of 2005 included $2.9 million ($2.0 million after reserves for certain doubtful receivables and claims from counter-parties of $0.9 million) in claims recognition. Claims are recorded to income when realization of the claim is reasonably assured at an estimated recoverable amount. |
| |
| Tunneling’s gross loss in the first nine months of 2006 was similarly impacted by underutilized equipment costs of $6.8 million during the period, compared to $2.8 million in the first nine months of 2005. In addition, a number of problematic projects in California were nearing completion earlier this year, which also contributed to tunneling’s gross loss. These unfavorable factors were partially offset by $0.7 million in recognized claims and a favorable adjustment of $0.9 million on our large project in Chicago, Illinois, which related to amounts previously reserved for unexpected contingencies, including rain, that did not occur. |
| |
| In the first nine months of 2005, performance in the tunneling segment was adversely impacted by the continuation of projects that encountered unfavorable gross margin developments beginning in the fourth quarter of 2004. There were further adverse margin developments on certain of these projects, mostly occurring in the first half of 2005, with one large project accounting for $5.0 million of the tunneling operating loss in the first nine months of 2005. During the first nine months of 2005, $3.8 million ($2.9 million after reserves for certain doubtful receivables and claims from counterparties of $0.9 million) were recognized. |
On July 13, 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes” and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 was effective for fiscal years beginning after December 15, 2006.
| The following table summarizes revenues, gross profit and operating income by geographic region (in thousands): |
The Company adopted the provisions of FIN 48 on January 1, 2007. The total amount of unrecognized tax benefits as of the date of adoption was $4.1 million. As a result of the implementation of FIN 48, the Company recognized a $2.8 million increase in the liability for unrecognized tax benefits, which was accounted for as approximately $0.3 million cumulative charge to the January 1, 2007 balance of retained earnings, approximately $0.4 million additional deferred tax assets and $2.1 million additional non-current receivables.
| | Three Months Ended September 30, | | Nine Months Ended September 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
Revenues: | | | | | | | | | |
United States | | $ | 108,738 | | $ | 122,157 | | $ | 337,953 | | $ | 355,684 | |
Canada | | | 11,989 | | | 8,741 | | | 31,730 | | | 22,570 | |
Europe | | | 21,206 | | | 19,627 | | | 59,978 | | | 62,295 | |
Other foreign | | | 2,143 | | | 4,688 | | | 12,180 | | | 8,782 | |
Total revenues | | $ | 144,076 | | $ | 155,213 | | $ | 441,841 | | $ | 449,331 | |
| | | | | | | | | | | | | |
Gross profit: | | | | | | | | | | | | | |
United States | | $ | 20,562 | | $ | 23,276 | | $ | 64,431 | | $ | 61,868 | |
Canada | | | 4,279 | | | 3,273 | | | 11,226 | | | 7,720 | |
Europe | | | 6,081 | | | 5,531 | | | 15,473 | | | 15,728 | |
Other foreign | | | 718 | | | 770 | | | 3,236 | | | 1,856 | |
Total gross profit | | $ | 31,640 | | $ | 32,850 | | $ | 94,366 | | $ | 87,172 | |
| | | | | | | | | | | | | |
Operating income: | | | | | | | | | | | | | |
United States | | $ | 2,804 | | $ | 5,427 | | $ | 10,803 | | $ | 9,850 | |
Canada | | | 2,742 | | | 2,053 | | | 6,876 | | | 4,132 | |
Europe | | | 1,299 | | | 1,404 | | | 1,524 | | | 2,342 | |
Other foreign | | | 502 | | | 575 | | | 2,107 | | | 1,260 | |
Total operating income | | $ | 7,347 | | $ | 9,459 | | $ | 21,310 | | $ | 17,584 | |
Included in the balance of unrecognized tax benefits at January 1, 2007 are $1.5 million of tax benefits that, if recognized, would affect the effective income tax rate. The remaining $2.6 million of tax benefits, if recognized, would result in adjustments to other income tax accounts.The Company recognizes interest and penalties accrued related to unrecognized tax benefits in the tax provision. Upon adoption of FIN 48, the Company accrued $0.6 million for interest and penalties. In addition, during the first quarter of 2007, approximately $0.05 million was accrued for interest and penalties.
The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits will change within twelve months of the date of adoption. The Company has certain tax return years subject to statutes of limitation which will close within twelve months of the date of adoption. Unless challenged by tax authorities, the closure of those statutes of limitation is expected to result in the recognition of uncertain tax positions in the amount of approximately $0.4 million.
The Company is subject to taxation in the United States, various states and foreign jurisdictions. The Company’s tax years for 1999 through 2006 are subject to examination by the tax authorities. With few exceptions, the Company is no longer subject to U.S. federal, state, local or foreign examinations by tax authorities for years before 1999.
6. | ACQUIRED INTANGIBLE ASSETSCLOSURE OF TUNNELING BUSINESS
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| Acquired intangible assets include license agreements, customer relationships, patents and trademarks, and non-compete agreements. Intangible assets at September 30, 2006 and December 31, 2005 were as follows (in thousands): |
| | As of September 30, 2006 | |
| | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | |
Amortized intangible assets: | | | | | | | |
License agreements | | $ | 3,894 | | $ | (1,772 | ) | $ | 2,122 | |
Customer relationships | | | 1,797 | | | (361 | ) | | 1,436 | |
Patents and trademarks | | | 14,953 | | | (13,213 | ) | | 1,740 | |
Non-compete agreements | | | 3,247 | | | (2,891 | ) | | 356 | |
Total | | $ | 23,891 | | $ | (18,237 | ) | $ | 5,654 | |
On March 29, 2007, the Company announced plans to exit its tunneling business in an effort to improve its overall financial performance and to better align its operations with its long-term strategic initiatives. The tunneling business is reported as a separate segment for financial reporting purposes. See Note 7 for further information regarding segment reporting.
| | As of December 31, 2005 | |
| | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | |
Amortized intangible assets: | | | | | | | |
License agreements | | $ | 3,894 | | $ | (1,644 | ) | $ | 2,250 | |
Customer relationships | | | 1,797 | | | (271 | ) | | 1,526 | |
Patents and trademarks | | | 14,500 | | | (13,038 | ) | | 1,462 | |
Non-compete agreements | | | 3,239 | | | (2,400 | ) | | 839 | |
Total | | $ | 23,430 | | $ | (17,353 | ) | $ | 6,077 | |
The Company currently expects to substantially complete the exit of its tunneling business by the end of 2007. The Company ceased bidding and accepting new contracts concurrent with the announcement. The Company’s overall disposal strategy involves the sale or completion of all on-going tunneling projects. The Company expects the on-site work related to existing jobs to be substantially completed within the next twelve months and is seeking a buyer or buyers for the business and/or related significant assets. However, there can be no assurances that a suitable buyer or buyers will be identified.
As a result of the exit and disposal activities relating to the closure of its tunneling business, the company anticipates that it will incur pre-tax charges of approximately $21.0 million, of which approximately $8.0 million relate to cash charges which will include approximately $4.5 million relating to property, equipment and vehicle lease terminations and buyouts, approximately $2.5 million relating to employee termination benefits and retention incentives and approximately $1.0 million of other ancillary expenses. During the first quarter of 2007, the Company recorded a
| Amortization expense for the three and nine months ended September 30, 2006 and 2005 and estimated amortization expense for the next five years are as follows (in thousands): |
total of $4.8 million (pre-tax) related to these activities, including accruals for $3.6 million (pre-tax) associated with equipment lease buyouts, $1.1 million (pre-tax) for employee termination benefits and $0.1 million related to debt financing fees paid on March 28, 2007 in connection with certain amendments to the Company’s Senior Notes and credit facility relating to the closure of the tunneling operation.
The Company also incurred impairment charges for goodwill and other intangible assets of $9.0 million during the first quarter of 2007. These impairment charges occurred as a result of a thorough review of the fair value of assets and future cash flows to be generated by the business. This review concluded that insufficient fair value existed to support the value of the goodwill and other intangible assets recorded on the balance sheet.
In addition, the Company announced that it would incur impairment charges of up to $4.0 million for equipment and other assets during the first and second quarters of 2007. In the first quarter of 2007, the Company recorded charges totaling $3.0 million (pre-tax). These charges relate to assets that, at March 31, 2007, currently were not being utilized in the business. The impairment was calculated by subtracting current book values from estimated fair values of each of the idle assets. Fair values were determined using data from recent sales of similar assets and other market information. As of March 31, 2007, the fair value of the remaining fixed assets exceeded the carrying value. These assets are currently being utilized on existing projects.
Each of the above charges has been recorded in the consolidated statement of operations as “Costs of closure of tunneling business” as a component of operating income.
Aggregate amortization expense: | | | 2006 | | | 2005 | |
Three months ended September 30 | | $ | 311 | | $ | 383 | |
Nine months ended September 30 | | | 943 | | | 1,220 | |
| | | | | | | |
Estimated amortization expense: | | | | | | | |
For year ending December 31, 2006 | | $ | 1,254 | | | | |
For year ending December 31, 2007 | | | 1,079 | | | | |
For year ending December 31, 2008 | | | 382 | | | | |
For year ending December 31, 2009 | | | 272 | | | | |
For year ending December 31, 2010 | | | 272 | | | | |
On March 26, 2007, the Company was notified of an award of a $65 million tunneling project in Milwaukee, Wisconsin, which the Company had bid in January 2007. Given the decision to close the tunneling operation, the Company has assigned the project to another contractor who acquired the project from the Company at the Company’s bid price. The Company will have no future obligations to complete the project.
7. | COMMITMENTS AND CONTINGENCIESSEGMENT REPORTING
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| Litigation
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| In the third quarter of 2002, an accident on an Insituform® cured-in-place-pipe (“CIPP”) process project in Des Moines, Iowa resulted in the death of two workers and the injury of five workers. The Company fully cooperated with Iowa’s state OSHA in the investigation of the accident. Iowa OSHA issued a citation and notification of penalty in connection with the accident, including several willful citations. Iowa OSHA proposed penalties of $808,250. The Company challenged Iowa OSHA’s findings and, in the fourth quarter of 2003, an administrative law judge reduced the penalties to $158,000. In the second quarter of 2004, the Iowa Employment Appeal Board reinstated many of the original penalties, ordering total penalties in the amount of $733,750. The Company appealed the decision of the Employment Appeal Board to the Iowa District Court for Polk County, which, in the first quarter of 2005, reduced the penalties back to $158,000. The Company appealed the decision of the Iowa District Court and, on February 8, 2006, the Company’s appeal was heard by the Iowa Court of Appeals. On March 17, 2006, the Court of Appeals issued its opinion, vacating all citations issued under the general industry standards (all citations except two serious citations) and reducing total penalties against the Company to $4,500. Thereafter, the Employment Appeal Board filed a petition for further review to the Iowa Supreme Court, and the Company filed a resistance to the petition. On September 29, 2006, the Iowa Supreme Court granted the Employment Appeal Board’s petition for further review, and set the case for consideration during the week of December 4, 2006. In a companion action brought by the Employment Appeal Board against the City of Des Moines (events arising out of the Des Moines accident), the Iowa Supreme Court recently reversed the Iowa Court of Appeal’s earlier decision, which previously had affirmed the dismissal of all citations and penalties previously issued/assessed against the City of Des Moines. In so reversing, the Iowa Supreme Court reinstated two serious citations and penalties of $9,000 against the City of Des |
The Company has three principal operating segments: rehabilitation; tunneling; and Tite Liner®, the Company’s corrosion and abrasion segment (“Tite Liner”). The segments were determined based upon the types of products and services sold by each segment and each is regularly reviewed and evaluated separately.
The following disaggregated financial results have been prepared using a management approach that is consistent with the basis and manner with which management internally disaggregates financial information for the purpose of making internal operating decisions. The Company evaluates performance based on stand-alone operating income.
Financial information by segment was as follows (in thousands):
| | Three Months Ended March 31, | |
| | 2007 | | 2006 | |
Revenues: | | | | | |
Rehabilitation | | $ | 103,321 | | $ | 111,658 | |
Tunneling | | | 15,966 | | | 19,384 | |
Tite Liner® | | | 11,661 | | | 12,522 | |
Total revenues | | $ | 130,948 | | $ | 143,564 | |
| | | | | | | |
Gross profit (loss): | | | | | | | |
Rehabilitation | | $ | 15,417 | | $ | 25,334 | |
Tunneling | | | 187 | | | (616 | ) |
Tite Liner® | | | 4,966 | | | 3,947 | |
Total gross profit | | $ | 20,570 | | $ | 28,665 | |
| | | | | | | |
Operating (loss) income: | | | | | | | |
Rehabilitation | | $ | (6,120 | ) | $ | 6,460 | |
Tunneling | | | (18,736 | )(1) | | (3,029 | ) |
Tite Liner® | | | 3,355 | | | 2,347 | |
Total operating (loss) income | | $ | (21,501 | )(1) | $ | 5,778 | |
| (1) | Includes $16.8 million of charges associated with the closure of the tunneling business. |
The following table summarizes revenues, gross profit and operating (loss) income by geographic region (in thousands):
| | Three Months Ended March 31, | |
| | 2007 | | 2006 | |
Revenues: | | | | | |
United States | | $ | 96,981 | | $ | 113,331 | |
Canada | | | 10,831 | | | 9,073 | |
Europe | | | 20,448 | | | 17,085 | |
Other foreign | | | 2,688 | | | 4,075 | |
Total Revenues | | $ | 130,948 | | $ | 143,564 | |
| | | | | | | |
Gross Profit: | | | | | | | |
United States | | $ | 12,095 | | $ | 20,992 | |
Canada | | | 3,517 | | | 2,993 | |
Europe | | | 3,684 | | | 3,657 | |
Other foreign | | | 1,274 | | | 1,023 | |
Total Gross Profit | | $ | 20,570 | | $ | 28,665 | |
| | | | | | | |
Operating (loss) income: | | | | | | | |
United States | | $ | (22,294 | )(1) | $ | 4,235 | |
Canada | | | 1,524 | | | 1,617 | |
Europe | | | (1,722 | ) | | (703 | ) |
Other foreign | | | 991 | | | 629 | |
Total Operating (Loss) Income | | $ | (21,501 | )(1) | $ | 5,778 | |
| Moines. In so reversing,(1) | Includes $16.8 million of charges associated with the Iowa Supreme Court reinstated two serious citations and penalties of $9,000 against the City of Des Moines. The Company cannot predict the effect that the Iowa Supreme Court’s ruling in the City of Des Moines case will have on the Company’s pending case before the court. |
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| In December 2003, Environmental Infrastructure Group, L.P. (“EIG”) filed suit in the District Court of Harris County, Texas, against several defendants, including Kinsel Industries, Inc. (“Kinsel”), a wholly owned subsidiaryclosure of the Company, seeking unspecified damages. The suit alleges, among other things, that Kinsel failed to pay EIG monies due under a subcontractor agreement. In February 2004, Kinsel filed an answer, generally denying all claims, and also filed a counter-claim against EIG based upon EIG’s failure to perform work required of it under the subcontract. In June 2004, EIG amended its complaint to add the Company as an additional defendant and included a claim for lost opportunity damages. In December 2004, the Company and Kinsel filed third-party petitions against the City of Pasadena, Texas, on the one hand, and Greystar-EIG, LP, Grey General Partner, LLC and Environmental Infrastructure Management, LLC (collectively, the “Greystar Entities”), on the other hand. EIG also amended its petition to add a fraud claim against Kinsel and the Company and also requested exemplary damages. The original petition filed by EIG against Kinsel seeks damages for funds that EIG claims should have been paid to EIG on a wastewater treatment plant built for the City of Pasadena. Kinsel’s third-party petition against the City of Pasadena seeks approximately $1.4 million in damages to the extent EIG’s claims against Kinsel have merit and were appropriately requested. The third-party petition against the Greystar Entities seeks damages based upon fraudulent conveyance, alter ego and single business enterprise (the Greystar Entities are the successors-in-interest to all or substantially all of the assets of EIG, now believed to be defunct). Following the filing of the third-party petitions, the City of Pasadena filed a motion to dismiss based upon lack of jurisdiction claiming the City is protected by sovereign immunity. The trial court denied the City’s motion and the suit was stayed pending appeal of the City’s motion to the Court of Appeals in Corpus Christi, Texas. On March 16, 2006, the Texas Court of Appeals affirmed the trial court’s denial of the City’s motion. The City appealed the matter to the Texas Supreme Court, where the matter is now pending. The Company believes that the factual allegations and legal claims made against it and Kinsel are without merit and intends to vigorously defend them. tunneling business. |
| In 1990, the Company initiated proceedings against Cat Contracting, Inc., Michigan Sewer Construction Company, Inc. and Inliner U.S.A., Inc. (subsequently renamed FirstLiner USA, Inc.), along with another party, alleging infringement of certain of the Company’s in-liner patents. In August 1999, the United States District Court in Houston, Texas found that one of the Company’s patents was willfully infringed and awarded $9.5 million in damages. After subsequent appeals, the finding of infringement has been affirmed, but the award of damages and finding of willfulness are subject to rehearing. The Company anticipates that the court will reinstate the award of damages to the Company of at least $9.5 million, plus interest. The Company, after investigation, believes that the defendants may have viable sources to satisfy at least some portion of final judgment received by the Company. The parties engaged in a trial from March 14-16, 2006 and from July 11-14, 2006. The Company currently is awaiting the decision of the court. At September 30, 2006, the Company had not recorded any receivable related to this matter. |
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| On June 3, 2005, the Company filed a lawsuit in the United States District Court in Memphis, Tennessee against Per Aarsleff A/S, a publicly traded Danish company, and certain of its subsidiaries and affiliates. Since approximately 1980, Per Aarsleff and its subsidiaries held licenses for the Insituform CIPP process in various countries in Northern and Eastern Europe, Taiwan, Russia and South Africa. Per Aarsleff also is a 50% partner in the Company’s German joint venture and a 25% partner in the Company’s manufacturing company in Great Britain. The Company’s lawsuit seeks, among other things, monetary damages in an unspecified amount for the breach by Per Aarsleff of its license and implied license agreements with the Company and for royalties owed by Per Aarsleff under the license and implied license agreements. In March 2006, Per Aarsleff’s 50%-owned Taiwanese subsidiary (“PIEC’) filed a motion for summary judgment, claiming that the Company’s patents had expired in Taiwan. PIEC also filed a counterclaim seeking to recover payments paid to the Company on the same grounds. The Company has filed responses to PIEC’s motion and the issues have been submitted to the court. On May 12, 2006, the Company amended its lawsuit in Tennessee to (i) seek damages based upon Per Aarsleff’s continued use of Company-patented technology in Denmark, Sweden and Finland following termination of the license agreements, (ii) seek damages based upon Per Aarsleff’s use of Company trade secrets in connection with the operation of its Danish manufacturing facility and (iii) seek an injunction against Per Aarsleff’s continued operation of its manufacturing facility. Per Aarsleff filed its answer and affirmative defenses to the Company’s amended complaint on May 25, 2006. At September 30, 2006, excluding the effects of the claims specified in the lawsuit, Per Aarsleff owed the Company approximately $0.5 million related to royalties due under the various license and implied license agreements based upon royalty reports prepared and submitted by Per Aarsleff. The Company believes that these receivables are fully collectible at this time. At September 30, 2006, the Company had not recorded any receivable related to this lawsuit. The Company also has filed a separate legal action in Germany against Per Aarsleff relating to its conduct involving the parties’ joint venture company in Germany and is reviewing transactions between Per Aarsleff and the parties’ joint venture companies in Germany and Italy to determine whether all transactions between Per Aarsleff and such companies were fair and at arms’-length prices. The Company estimates its aggregate claims in these matters to be in excess of $10.0 million. Due to the uncertainties of litigation, as well as issues regarding the collectibility of damage awards, there can be |
8. | ACQUIRED INTANGIBLE ASSETS |
Acquired intangible assets include license agreements, customer relationships, patents and trademarks, and non-compete agreements. Intangible assets at March 31, 2007 and December 31, 2006 were as follows (in thousands):
| | As of March 31, 2007 | |
| | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | |
Amortized intangible assets: | | | | | | | |
License agreements | | $ | 3,894 | | $ | (1,853 | ) | $ | 2,041 | |
Customer relationships | | | 1,797 | | | (421 | ) | | 1,376 | |
Patents and trademarks | | | 16,126 | | | (13,365 | ) | | 2,761 | |
Non-compete agreements | | | 313 | | | (313 | ) | | ─ | |
Total | | $ | 22,130 | | $ | (15,952 | ) | $ | 6,178 | |
| | As of December 31, 2006 | |
| | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | |
Amortized intangible assets: | | | | | | | |
License agreements | | $ | 3,894 | | $ | (1,813 | ) | $ | 2,081 | |
Customer relationships | | | 1,797 | | | (391 | ) | | 1,406 | |
Patents and trademarks | | | 16,048 | | | (13,283 | ) | | 2,765 | |
Non-compete agreements | | | 3,252 | | | (3,056 | ) | | 196 | |
Total | | $ | 24,991 | | $ | (18,543 | ) | $ | 6,448 | |
Amortization expense for the three months ended March 31, 2007 and 2006 and estimated amortization expense for the next five years are as follows (in thousands):
| | Quarter Ended March 31, | |
| | 2007 | | 2006 | |
Aggregate amortization expense | | $ | 217 | | $ | 307 | |
| | | | | | | |
Estimated amortization expense: | | | | | | | |
For year ending December 31, 2007 | | $ | 733 | | | | |
For year ending December 31, 2008 | | | 578 | | | | |
For year ending December 31, 2009 | | | 283 | | | | |
For year ending December 31, 2010 | | | 283 | | | | |
For year ending December 31, 2011 | | | 283 | | | | |
| no assurance regarding these litigations at this time or as to the amount of money, if any, that the Company may ultimately recover against Per Aarsleff. |
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9. | Boston InstallationCOMMITMENTS AND CONTINGENCIES
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| In August 2003, the Company began a CIPP process installation in Boston. The $1.0 million project required the Company to line 5,400 feet of a 109-year-old, 36- to 41-inch diameter unusually shaped hand-laid rough brick pipe. Many aspects of this project were atypical of the Company’s normal CIPP process installations. Following installation, the owner rejected approximately 4,500 feet of the liner and all proposed repair methods. All rejected liner was removed and re-installed, and the Company recorded a loss of $5.1 million on this project in the year ended December 31, 2003. During the first quarter of 2005, the Company, in accordance with its agreement with the client, inspected the lines. During the course of such inspection, it was determined that the segment of the liner that was not removed and re-installed in early 2004 was in need of replacement in the same fashion as all of the other segments replaced in 2004. The Company completed its assessment of the necessary remediation and related costs and began work with respect to such segment late in the second quarter of 2005. The Company’s remediation work with respect to this segment was completed during the third quarter of 2005. The Company incurred costs of approximately $2.4 million with respect to the 2005 remediation work, which were accrued for in the second quarter of 2005. |
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| Under the Company’s “Contractor Rework” special endorsement to its primary comprehensive general liability insurance policy, the Company filed a claim with its primary insurance carrier relative to rework of the Boston project. The carrier has paid the Company the primary coverage of $1 million, less a $250,000 deductible, in satisfaction of its obligations under the policy. |
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| The Company’s excess comprehensive general liability insurance coverage is in an amount far greater than the estimated costs associated with the liner removal and re-installation. The Company believes the “Contractor Rework” special endorsement applies to the excess insurance coverage; it has already incurred costs in excess of the primary coverage and |
| it notified its excess carrier of the claim in 2003. The excess insurance carrier denied coverage in writing without referencing the “Contractor Rework” special endorsement,Litigation
In the third quarter of 2002, an accident on an Insituform® cured-in-place-pipe (“CIPP”) process project in Des Moines, Iowa resulted in the death of two workers and the injury of five workers. The Company fully cooperated with Iowa’s state OSHA in the investigation of the accident. Iowa OSHA issued a citation and notification of penalty in connection with the accident, including several willful citations. Iowa OSHA proposed penalties of $808,250. The Company challenged Iowa OSHA’s findings, and in the fourth quarter of 2003, an administrative law judge reduced the penalties to $158,000. In the second quarter of 2004, the Iowa Employment Appeal Board reinstated many of the original penalties, ordering total penalties in the amount of $733,750. The Company appealed the decision of the Employment Appeal Board to the Iowa District Court for Polk County, which, in the first quarter of 2005, reduced the penalties back to $158,000. The Company appealed the decision of the Iowa District Court and, on February 8, 2006, the Company’s appeal was heard by the Iowa Court of Appeals. On March 17, 2006, the Court of Appeals issued its opinion, vacating all citations issued under the general industry standards (all citations except two serious citations) and reducing total penalties against the Company to $4,500. Thereafter, the Employment Appeal Board filed a petition for further review to the Iowa Supreme Court, and the Company filed a resistance to the petition. On September 29, 2006, the Iowa Supreme Court granted the Employment Appeal Board’s petition for further review, and set the case for consideration during the week of December 4, 2006. On February 16, 2007, the Iowa Supreme Court issued its ruling, reversing the prior ruling of the Iowa Court of Appeals and subsequently indicated that it did not believe that the “Contractor Rework” special endorsement applied to the excess insurance coverage. |
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| In March 2004, the Company filed a lawsuit in United States District Court in Boston, Massachusetts against its excess insurance carrier for such carrier’s failure to acknowledge coverage and to indemnify the Company for the entire loss in excess of the primary coverage. In March 2005, the court granted the Company’s partial motion for summary judgment, concluding that the Company’s policy with its excess insurance carrier followed form to the Company’s primary insurance carrier’s policy. On May 25, 2006, the court entered an order denying a motion for reconsideration previously filed by the excess insurance carrier, thereby reaffirming its earlier opinion. In September 2006, the Company filed a motion for summary judgment as to the issue of whether the primary insurance carrier’s policy provided coverage for the underlying claim and as to the issue of damages ($6.4 millionin actual damages and $1.1million in pre-judgment interest). The excess insurance carrier also filed a motion for summary judgment as to the issue of primary coverage. The court has scheduled a hearing for November 20, 2006 to hear all pending motions.
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| During the second quarter of 2005, the Company, in consultation with outside legal counsel, determined that the likelihood of recovery from the excess insurance carrier was probable and that the amount of such recovery was estimable. An insurance claims expert retained by the Company’s outside legal counsel reviewed the documentation produced with respect to the claim and, based on this review, provided the Company with an estimate of the costs that had been sufficiently documented and substantiated to date. The excess insurance carrier’s financial viability also was investigated during this period and was determined to have a strong rating of A+ with the leading insurance industry rating service. Based on these factors, the favorable court decision in March 2005 and the acknowledgement of coverage and payment from the Company’s primary insurance carrier, the Company believes that recovery from the excess insurance carrier is both probable and estimable and recorded a receivable in the amount of $6.1 million in connection with the Boston project in the second quarter of 2005. |
| The total claim receivable was $7.5 million at September 30, 2006 and is composed of documented remediation costs and pre-judgment interest as outlined in the table below: |
| | Documented Remediation Costs | | Pre-judgment Interest | | Total | |
| | (in thousands) | |
Claim recorded June 30, 2005 | | $ | 5,872 | | $ | 275 | | $ | 6,147 | |
Interest recorded July through December 31, 2005 | | | - | | | 165 | | | 165 | |
Additional documented remediation costs recorded in the second quarter of 2006 | | | 526 | | | - | | | 526 | |
Interest recorded January 1 through June 30, 2006 | | | - | | | 535 | | | 535 | |
Interest recorded in quarter ended September 30, 2006 | | | - | | | 138 | | | 138 | |
Claim receivable balance, September 30, 2006 | | $ | 6,398 | | $ | 1,113 | | $ | 7,511 | |
reinstating all citations issued under the general industry standards, including several willful citations, and reinstating penalties in the amount of $733,750. Thereafter, the Company filed a Motion for Reconsideration with the Iowa Supreme Court, which motion was denied on March 29, 2007. The case will now be remanded back to the District Court for entry of judgment consistent with the Iowa Supreme Court’s opinion. The Company currently is reviewing its options regarding further judicial review of this matter. During the first quarter of 2007, the Company recorded $0.5 million related to this matter. The penalties assessed were fully reserved.
In December 2003, Environmental Infrastructure Group, L.P. (“EIG”) filed suit in the District Court of Harris County, Texas, against several defendants, including Kinsel Industries, Inc. (“Kinsel”), a wholly owned subsidiary of the Company, seeking unspecified damages. The suit alleges, among other things, that Kinsel failed to pay EIG monies due under a subcontractor agreement. In February 2004, Kinsel filed an answer, generally denying all claims, and also filed a counter-claim against EIG based upon EIG’s failure to perform work required of it under the subcontract. In June 2004, EIG amended its complaint to add the Company as an additional defendant and included a claim for lost opportunity damages. In December 2004, the Company and Kinsel filed third-party petitions against the City of Pasadena, Texas, and Greystar-EIG, LP, Grey General Partner, LLC and Environmental Infrastructure Management, LLC (collectively, the “Greystar Entities”). EIG also amended its petition to add a fraud claim against Kinsel and the Company and also requested exemplary damages. The original petition filed by EIG against Kinsel seeks damages for funds that EIG claims should have been paid to EIG on a wastewater treatment plant built for the City of Pasadena. Kinsel’s third-party petition against the City of Pasadena seeks approximately $1.4 million in damages to the extent EIG’s claims against Kinsel have merit and were appropriately requested. The third-party petition against the Greystar Entities seeks damages based upon fraudulent conveyance, alter ego and single business enterprise (the Greystar Entities are the successors-in-interest to all or substantially all of the assets of EIG, now believed to be defunct). Following the filing of the third-party petitions, the City of Pasadena filed a motion to dismiss based upon lack of jurisdiction claiming the City is protected by sovereign immunity. The trial court denied the City’s motion and the suit was stayed pending appeal of the City’s motion to the Court of Appeals in Corpus Christi, Texas. On March 16, 2006, the Texas Court of Appeals affirmed the trial court’s denial of the City’s motion. The City appealed the matter to the Texas Supreme Court, where the matter is now pending. The Company believes that the factual allegations and legal claims made against it and Kinsel are without merit and intends to vigorously defend them.
| Department of Justice Investigation
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| The Company has incurred costs in responding to two United States government subpoenas relating to the investigation of alleged public corruption and bid rigging in the Birmingham, Alabama metropolitan area during the period from 1997 to 2003. The Company has produced hundreds of thousands of documents in an effort to fully comply with these subpoenas, which the Company believes were issued to most, if not all, sewer repair contractors and engineering firms that had public sewer projects in the Birmingham area. Indictments of public officials, contractors, engineers and contracting and engineering companies were announced in February, July and August of 2005, including the indictment of a former joint venture partner of the Company. A number of those indicted, including the Company’s former joint venture partner and its principals, have been convicted or pleaded guilty. One additional trial is scheduled to begin later this fall. The Company has been advised by the government that it is not considered a target of the investigation at this time. The investigation is ongoing and the Company may have to continue to incur substantial costs in complying with its obligations in connection with the investigation. The Company has been fully cooperative throughout the investigation. |
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| Other Litigation
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| The Company is involved in certain other litigation incidental to the conduct of its business and affairs. Management, after consultation with legal counsel, does not believe that the outcome of any such other litigation will have a material adverse effect on its consolidated financial condition, results of operations or cash flows. |
In 1990, the Company initiated proceedings against Cat Contracting, Inc., Michigan Sewer Construction Company, Inc. and Inliner U.S.A., Inc. (subsequently renamed FirstLiner USA, Inc.), along with another party, alleging infringement of certain in-liner Company patents. In August 1999, the United States District Court in Houston, Texas found that one of the Company’s patents was willfully infringed and awarded $9.5 million in damages. After subsequent appeals, the finding of infringement has been affirmed, but the award of damages and finding of willfulness was subject to rehearing. The Company believed that it had a strong position in upholding the original damage award and, after investigation, concluded that the defendants had a viable source to collect all or a portion of the award if confirmed. On the basis of these determinations, the Company decided to aggressively pursue the rehearing on damages. The damages hearing was completed in the third quarter of 2006. The Company currently is awaiting the Court’s decision. At March 31, 2007, the Company had not recorded any receivable related to this matter.
| GuaranteesOn June 3, 2005, the Company filed a lawsuit in the United States District Court in Memphis, Tennessee against Per Aarsleff A/S, a publicly traded Danish company, and certain of its subsidiaries and affiliates. Since approximately 1980, Per Aarsleff and its subsidiaries held licenses for the Insituform CIPP process in various countries in Northern and Eastern Europe, Taiwan, Russia and South Africa. Per Aarsleff also is a 50% partner in the Company’s German joint venture and a 25% partner in the Company’s manufacturing company in Great Britain. The Company’s lawsuit seeks, among other things, monetary damages in an unspecified amount for the breach by Per Aarsleff of its license and implied license agreements with the Company and for royalties owed by Per Aarsleff under the license and implied license agreements. On May 12, 2006, the Company amended its lawsuit in Tennessee to (i) seek damages based upon Per Aarsleff’s continued use of Company-patented technology in Denmark, Sweden and Finland following termination of the license agreements, (ii) seek damages based upon Per Aarsleff’s use of Company trade secrets in connection with the operation of its Danish manufacturing facility and (iii) seek an injunction against Per Aarsleff’s continued operation of its manufacturing facility. Per Aarsleff filed its Answer and Affirmative Defenses to the Company’s Amended Complaint on May 25, 2006. On October 25, 2006, Per Aarsleff filed a two count counterclaim against the Company seeking to recover royalties payments paid to the Company. On December 29, 2006, the Company and Per Aarsleff’s 50%-owned Taiwanese subsidiary (“PIEC”) settled their respective claims against each other in exchange for PIEC paying the Company $375,000, which amount was paid on December 29, 2006 (settlement of Taiwanese claims only, remainder of lawsuit continues). At March 31, 2007, excluding the effects of the claims specified in the lawsuit, Per Aarsleff owed the Company approximately $0.5 million related to royalties due under the various license and implied license agreements (over and above the Taiwanese settlement amount) based upon royalty reports prepared and submitted by Per Aarsleff.
|
| The Company has entered into several contractual joint ventures in order to develop joint bids on contracts for its installation business and tunneling operations. In these cases, the Company could be required to complete the joint venture partner’s portion of the contract if the partner were unable to complete its portion. The Company would be liable for any amounts for which the Company itself could not complete the work and for which a third party contractor could not be located to complete the work for the amount awarded in the contract. While the Company would be liable for additional costs, these costs would be offset by any related revenues due under that portion of the contract. The Company has not experienced material adverse results from such arrangements. Based on these facts, while there can be no assurances, the Company currently does not anticipate any future material adverse impact on its consolidated financial position, results of operations or cash flows from these arrangements. |
| |
| The Company also has many contracts that require the Company to indemnify the other party against loss from claims of patent or trademark infringement. The Company also indemnifies its surety against losses from third party claims. The Company has not experienced material losses under these indemnification provisions and, while there can be no assurances, currently does not anticipate any future material adverse impact on its consolidated financial position, results of operations or cash flows from these provisions. |
| |
| The Company regularly reviews its exposure under all its engagements, including performance guarantees by contractual joint ventures and indemnification of its surety. As a result of the most recent review, the Company has determined that the risk of material loss is remote under these arrangements and has not recorded a liability for these risks at September 30, 2006. |
The Company believes that these receivables are fully collectible at this time. At March 31, 2007, the Company had not recorded any receivable related to this lawsuit.
Boston Installation
In August 2003, the Company began a CIPP process installation in Boston. The $1.0 million project required the Company to line 5,400 feet of a 109-year-old, 36- to 41-inch diameter unusually shaped hand-laid rough brick pipe. Many aspects of this project were atypical of the Company’s normal CIPP process installations. Following installation, the owner rejected approximately 4,500 feet of the liner and all proposed repair methods. All rejected liner was removed and re-installed, and the Company recorded a loss of $5.1 million on this project in the year ended December 31, 2003. During the first quarter of 2005, the Company, in accordance with its agreement with the client, inspected the lines. During the course of such inspection, it was determined that the segment of the liner that was not removed and re-installed in early 2004 was in need of replacement in the same fashion as all of the other segments replaced in 2004. The Company completed its assessment of the necessary remediation and related costs and began work with respect to such segment late in the second quarter of 2005. The Company’s remediation work with respect to this segment was completed during the third quarter of 2005. The Company incurred costs of approximately $2.4 million with respect to the 2005 remediation work, which costs were accrued for in the second quarter of 2005.
Under the Company’s “Contractor Rework” special endorsement to its primary comprehensive general liability insurance policy, the Company filed a claim with its primary insurance carrier relative to rework of the Boston project. The carrier has paid the Company the primary coverage of $1 million, less a $250,000 deductible, in satisfaction of its obligations under the policy.
The Company’s excess comprehensive general liability insurance coverage is in an amount far greater than the costs associated with the liner removal and re-installation. The Company believes the “Contractor Rework” special endorsement applies to the excess insurance coverage; it incurred costs in excess of the primary coverage and it notified its excess carrier of the claim in 2003. The excess insurance carrier denied coverage in writing without referencing the “Contractor Rework” special endorsement, and subsequently indicated that it did not believe that the “Contractor Rework” special endorsement applied to the excess insurance coverage.
In March 2004, the Company filed a lawsuit in United States District Court in Boston, Massachusetts against its excess insurance carrier for such carrier’s failure to acknowledge coverage and to indemnify the Company for the entire loss in excess of the primary coverage. In March 2005, the Court granted the Company’s partial motion for summary judgment, concluding that the Company’s policy with its excess insurance carrier followed form to the Company’s primary insurance carrier’s policy. On May 25, 2006, the Court entered an order denying a motion for reconsideration previously filed by the excess insurance carrier, thereby reaffirming its earlier opinion. In September 2006, the Company filed a motion for summary judgment as to the issue of whether the primary insurance carrier’s policy provided coverage for the underlying claim and as to the issue of damages ($6.4 million in actual damages and $1.4 million in pre-judgment interest). The excess insurance carrier also filed a motion for summary judgment as to the issue of primary coverage. The Court heard oral arguments on the motions on November 20, 2006. The parties are now awaiting a ruling from the Court.
During the second quarter of 2005, the Company, in consultation with outside legal counsel, determined that the likelihood of recovery from the excess insurance carrier was probable and that the amount of such recovery was estimable. An insurance claims expert retained by the Company’s outside legal counsel reviewed the documentation produced with respect to the claim and, based on this review, provided the Company with an estimate of the costs that had been sufficiently documented and substantiated to date. The excess insurance carrier’s financial viability also was investigated during this period and was determined to have a strong rating of A+ with the leading insurance industry rating service. Based on these factors, the favorable court decision in March 2005 and the acknowledgement of coverage and payment from the Company’s primary insurance carrier, the Company believes that recovery from the excess insurance carrier is both probable and estimable and has recorded an insurance claim receivable in connection with this matter.
The total claim receivable was $7.8 million at March 31, 2007 and is composed of documented remediation costs and pre-judgment interest as outlined in the table below:
| | Documented Remediation Costs | | Pre-judgment Interest | | Total | |
| | (in thousands) | |
Claim recorded June 30, 2005 | | $ | 5,872 | | $ | 275 | | $ | 6,147 | |
Interest recorded July through December 31, 2005 | | | - | | | 165 | | | 165 | |
Additional documented remediation costs recorded in the second quarter of 2006 | | | 526 | | | - | | | 526 | |
Interest recorded in 2006 and 2007 | | | - | | | 949 | | | 949 | |
Claim receivable balance, March 31, 2007 | | $ | 6,398 | | $ | 1,389 | | $ | 7,787 | |
Department of Justice Investigation
The Company has incurred costs in responding to two United States government subpoenas relating to the investigation of alleged public corruption and bid rigging in the Birmingham, Alabama metropolitan area during the period from 1997 to 2003. The Company has produced hundreds of thousands of documents in an effort to comply fully with these subpoenas, which the Company believes were issued to most, if not all, sewer repair contractors and engineering firms that had public sewer projects in the Birmingham area. Indictments of public officials, contractors, engineers and contracting and engineering companies were announced in February, July and August of 2005, including the indictment of a former joint venture partner of the Company. A number of those indicted, including the Company’s former joint venture partner and its principals, have been convicted or pleaded guilty and have now been sentenced and fined. The Company has been advised by the government that it is not considered a target of the investigations at this time. The investigations are ongoing and the Company may have to continue to incur substantial costs in complying with its obligations in connection with the investigations. The Company has been fully cooperative throughout the investigations.
Other Litigation
The Company is involved in certain other litigation incidental to the conduct of its business and affairs. Management, after consultation with legal counsel, does not believe that the outcome of any such other litigation will have a material adverse effect on its consolidated financial condition, results of operations or cash flows.
Guarantees and Indemnification Obligations
The Company has entered into several contractual joint ventures in order to develop joint bids on contracts for its business. In these cases, the Company could be required to complete the joint venture partner’s portion of the contract if the partner were unable to complete its portion. The Company would be liable for any amounts for which the Company itself could not complete the work and for which a third party contractor could not be located to complete the work for the amount awarded in the contract. While the Company would be liable for additional costs, these costs would be offset by any related revenues due under that portion of the contract. The Company has not experienced material adverse results from such arrangements. Based on these facts, while there can be no assurances, the Company currently does not anticipate any future material adverse impact on its consolidated financial position, results of operations or cash flows.
The Company also has many contracts that require the Company to indemnify the other party against loss from claims of patent or trademark infringement. The Company also indemnifies its surety against losses from third party claims of subcontractors. The Company has not experienced material losses under these provisions and, while there can be no assurances, currently does not anticipate any future material adverse impact on its consolidated financial position, results of operations or cash flows.
The Company regularly reviews its exposure under all its engagements, including performance guarantees by contractual joint ventures and indemnification of its surety. As a result of the most recent review, the Company has determined that the risk of material loss is remote under these arrangements and has not recorded a liability for these risks at March 31, 2007 on its consolidated balance sheet.
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8.10.
| FINANCINGS |
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| In February 2006, the Company entered into a new agreement with Bank of America, N.A. pursuant to which the Company procured a new revolving credit facility, which provides a borrowing capacity of $35 million, any portion of which may be used for the issuance of standby letters of credit. The credit facility requires the Company to pay interest at variable rates based on, among other things, the Company’s consolidated leverage ratio. The Company is also required to pay the bank a quarterly fee on the unused portion of the credit facility. The credit facility is subject to the same restrictive covenants and default provisions as the Company’s Series A Senior Notes and the Series 2003-A Senior Notes. The new facility does not require a minimum cash balance, as was required under the Company’s previous credit facility. The new credit facility matures on April 30, 2008. |
| At September 30, 2006, the Company was in compliance with its debt covenants, and expects to maintain compliance throughout 2006 and beyond. The table below sets forth the Company’s debt covenants: |
Credit Facility
On March 28, 2007, the Company amended its $35 million credit facility with Bank of America, N.A., to incorporate by reference certain amendments to its Senior Notes, Series 2003-A, due April 24, 2013, described below. In connection with the amendment, the Company paid Bank of America, N.A., an amendment fee of 0.05% of the borrowing capacity of the Credit Facility, or $17,500.
In March 2007, the Company borrowed $5.0 million on the credit facility. These amounts were repaid in April 2007. There were no borrowings on the credit facility in the first quarter of 2006.
Senior Notes
On March 28, 2007, the Company amended its $65 million Senior Notes, Series 2003-A, due April 24, 2013, to include in the definition of EBITDA all non-recurring charges taken during the year ending December 31, 2007 relating to the Company’s exit from the tunneling operation to the extent deducted in determining consolidated net income for such period, subject to a maximum amount of $34,200,000. In connection with the amendment, the Company paid the noteholders an amendment fee of 0.05% of the outstanding principal balance of each series of Senior Notes, or $32,500.
In February 2007, the Company made the final scheduled payment of $15.7 million on its Senior Notes, Series A, due February 14, 2007.
At March 31, 2007, the Company was in compliance with all debt covenants, and expects to be in compliance for the balance of 2007.
Description of Covenant
| Fiscal Quarter
| Amended Covenant(2)
| Actual Ratio
or Amount(2)
|
$110 million 8.88% Senior Notes,
Series A, due February 14, 2007
and $65 million 6.54% Senior
Notes, Series 2003-A, due April 24,
2013
| | | |
Fixed Charge Coverage Ratio(1)
| Third quarter 2006 | No less than 2.25 to 1.0 | 2.97 |
| Fourth quarter 2006 | No less than 2.25 to 1.0 | n/a |
| First quarter 2007 and thereafter | No less than 2.50 to 1.0 | n/a |
| | | |
Ratio of consolidated indebtedness to EBITDA(1)
| | No greater than 3.00 to 1.0 | 1.52 |
| | | |
Consolidated net worth(1)
| | No less than the sum of $260
million plus 50% of net
income after December 31,
2004; $273.7 million
required as of September 30,
2006
| $328.0
million at
September 30, 2006
|
| | | |
Ratio of consolidated indebtedness to
consolidated capitalization(1)
| | No greater than 0.45 to 1.0 | 0.23
at September 30, 2006
|
| | | |
__________________________
(1) | The ratios are calculated as defined in the Note Purchase Agreements, as amended, which have been incorporated into the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 as exhibits 10.2 and 10.3. |
(2) | The ratios for each quarter are based on rolling four-quarter calculations of profitability. |
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9.11.
| NEW ACCOUNTING PRONOUNCEMENTS |
On January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, and interpretation of FASB Statement No. 109 which describes a comprehensive model for the measurement, recognition, presentation and disclosure of uncertain tax positions in financial statements. Under the interpretation, financial statements are required to reflect expected future tax consequences of such positions presuming the tax authorities’ full knowledge of the position and all relevant facts, but without considering time values. See Note 5 for a discussion of the Company’s adoption of FIN 48.
| |
| See discussion of SFAS No.123(R), Share-Based Payment in Note 2 to these financial statements.
|
| |
| In July 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, which describes a comprehensive model for the measurement, recognition, presentation and disclosure of uncertain tax positions in the financial statements. Under the interpretation, the financial statements will reflect expected future tax consequences of such positions presuming the tax authorities’ full knowledge of the position and all relevant facts, but without considering time values. The Company is assessing the impact this interpretation may have in its future financial statements.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
| |
| In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit and Other Postretirement Plans, under which companies must recognize a net liability or asset to report the funded status of defined benefit and other postretirement benefit plans on their balance sheets. This standard is not expected to have a significant effect on the Company’s balance sheet as the Company does not sponsor defined benefit retirement plans.
|
The following is management’s discussion and analysis of certain significant factors that have affected our financial condition, and results of operations and cash flows during the periods included in the accompanying unaudited consolidated financial statements. This discussion should be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 20052006 (“20052006 Annual Report”). See the discussion of our critical accounting policies and risk factors in our 20052006 Annual Report. There have been no material changesOn January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, which is discussed in Note 5 to our risk factors during the third quarter and nine months ended September 30, 2006. A change to our critical accounting policies related to equity-based compensation is described herein.consolidated financial statements contained in this report.
FORWARD -LOOKINGFORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains various forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) that are based on information currently available to the management of Insituform Technologies, Inc. and on management’s beliefs and assumptions. When used in this document, the words “anticipate,” “estimate,” “believe,” “plan,” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. Such statements are subject to risks and uncertainties and include among others, our belief with respect to estimated and anticipated costs to complete ongoing projects, our belief that our documentation will substantiate contract claim conditions, our expectation with respect to the completion dates of ongoing projects and the amount of backlog we will perform, our belief of the amounts we may recover for pending tunneling claims, our intention to obtain work that is comparable with our tunneling operation’s core competency, our belief with respect to anticipated levels of operating expenses, our belief that we have adequate resources and liquidity to fund future cash requirements and debt repayments, and our expectation with respect to the anticipated growth of our businesses.businesses and our belief with respect to the strength of our trademark and degree of market penetration. Our actual results may vary materially from those anticipated, estimated or projected due to a number of factors, such as the competitive environment for our products and services, the availability and pricing of raw materials and transportation used in our operations, increased competition upon expiration of our patents or the inadequacy of one or more of our patents to protect our operations, our ability to reduce the level of underutilized tunneling equipment, our ability to implement steam-inversion process equipment and other logistics cost reduction initiatives, the geographical distribution and mix of our work, our ability to attract business at acceptable margins, the strength of our marketing and sales skills, foreseeable and unforeseeable issues in projects that make it difficult or impossible to meet projected margins, the timely award cancellation or change in scopecancellation of projects, our ability to maintain adequate insurance coverage for our business activities, political circumstances impeding the progress of our work, our ability to remain in compliance with the financial covenants included in our financing documents, the regulatory environment, weather conditions, the outcome of our pending litigation, our ability to enter new markets and implement our global growth initiatives, the accuracy of our current estimates of aggregate fair value of the tunneling segment’s fixed assets that will be realizable in sales transactions, the accuracy of our current projections of the cash costs of lease termination or buyout payments, employee retention incentives and severance benefits and other shutdown expenses, our ability to complete the tunneling segment’s existing contracts on a timely and profitable basis, our ability to redeploy net value of the tunneling segment’s fixed assets into our rehabilitation and Tite Liner® business segments on an efficient and profitable basis and other factors set forth in reports and other documents filed by us with the Securities and Exchange Commission from time to time. We do not assume a duty to update forward-looking statements. Please use caution and do not place reliance on forward-looking statements.
EXECUTIVE SUMMARY
Insituform Technologies, Inc. is a worldwide company specializing in trenchless technologies to rehabilitate, replace, maintain and install underground pipes. We have three principal operating segments: rehabilitation; tunneling;rehabilitation, tunneling, and Tite Liner®. These segments have been determined based on the types of products sold, and each is reviewed and evaluated separately. While we use a variety of trenchless technologies, our CIPPthe Insituform® cured-in-place-pipe (“CIPP”) process contributed 72.0%76.0% of our revenues in the first nine monthsquarter of 2006 and 67.2% of our revenues in the first nine months of 2005.2007.
Revenues are generated principally in the United States, Canada, the United Kingdom, the Netherlands, France, Belgium, Spain, Switzerland, Chile, Mexico and Poland and include product sales and royalties from our joint ventures in Europe and Asia, and fromour unaffiliated licensees and sub-licensees throughout the world. The United States remains our single largest market, representing approximately 76.5%74.1% of total revenue in the first nine monthsquarter of 2006 and 79.2% of total revenue in the first nine months of 2005.2007. See Note 57 to the consolidated financial statements contained in this report for additional segment and geographic information and disclosures.
RESULTS OF OPERATIONS - Three and Nine Months Ended September 30,March 31, 2007 and 2006 and 2005
The following table highlightsKey financial data for the results for eachfirst quarter of 2007 compared to the segments and periods presentedfirst quarter of 2006 is as follows (dollars in thousands):
Three Months Ended September 30, 2006
| | | Quarter Ended March 31, 2007 | |
Segment | | Revenues | | Gross Profit (Loss) | | Gross Profit (Loss) Margin | | Operating Expenses | | Operating Income (Loss) | | Operating Income (Loss) Margin | | | Revenues | | Gross Profit | | Gross Profit Margin | | Operating Expense (1) | | Operating Income (Loss)(1) | | Operating Income (Loss) Percentage | |
Rehabilitation | | $ | 118,269 | | $ | 28,927 | | | 24.5 | % | $ | 20,702 | | $ | 8,225 | | | 7.0 | % | | $ | 103,321 | | $ | 15,417 | | | 14.9 | % | $ | 21,537 | | $ | (6,120 | ) | | -5.9 | % |
Tunneling | | | 16,002 | | | (868 | ) | | -5.4 | | | 2,095 | | | (2,963 | ) | | -18.5 | | | | 15,966 | | | 187 | | | 1.2 | | | 18,923 | | | (18,736 | ) | | -117.3 | |
Tite Liner® | | | 9,805 | | | 3,581 | | | 36.5 | | | 1,496 | | | 2,085 | | | 21.3 | | | | 11,661 | | | 4,966 | | | 42.6 | | | 1,611 | | | 3,355 | | | 28.8 | |
Total | | $ | 144,076 | | $ | 31,640 | | | 22.0 | % | $ | 24,293 | | $ | 7,347 | | | 5.1 | % | |
TOTAL | | | $ | 130,948 | | $ | 20,570 | | | 15.7 | % | $ | 42,071 | | $ | (21,501 | ) | | -16.4 | % |
Three Months Ended September 30, 2005 | | Quarter Ended March 31, 2006 | |
Segment | | Revenues | | Gross Profit (Loss) | | Gross Profit (Loss) Margin | | Operating Expense | | Operating Income (Loss) | | Operating Income (Loss) Percentage | |
Rehabilitation | | $ | 111,658 | | $ | 25,334 | | | 22.7 | % | $ | 18,874 | | $ | 6,460 | | | 5.8 | % |
Tunneling | | | 19,384 | | | (616 | ) | | -3.2 | | | 2,413 | | | (3,029 | ) | | -15.6 | |
Tite Liner® | | | 12,522 | | | 3,947 | | | 31.5 | | | 1,600 | | | 2,347 | | | 18.7 | |
TOTAL | | $ | 143,564 | | $ | 28,665 | | | 20.0 | % | $ | 22,887 | | $ | 5,778 | | | 4.0 | % |
Segment | | Revenues | | Gross Profit | | Gross Profit Margin | | Operating Expenses | | Operating Income (Loss) | | Operating Income (Loss) Margin | |
Rehabilitation | | $ | 107,821 | | $ | 26,596 | | | 24.7 | % | $ | 18,083 | | $ | 8,513 | | | 7.9 | % |
Tunneling | | | 35,724 | | | 2,767 | | | 7.7 | | | 4,034 | | | (1,267 | ) | | - 3.5 | |
Tite Liner® | | | 11,668 | | | 3,487 | | | 29.9 | | | 1,274 | | | 2,213 | | | 19.0 | |
Total | | $ | 155,213 | | $ | 32,850 | | | 21.2 | % | $ | 23,391 | | $ | 9,459 | | | 6.1 | % |
Nine Months Ended September 30, 2006
Segment | | Revenues | | Gross Profit (Loss) | | Gross Profit (Loss) Margin | | Operating Expenses | | Operating Income (Loss) | | Operating Income (Loss) Margin | |
Rehabilitation | | $ | 355,147 | | $ | 83,435 | | | 23.5 | % | $ | 61,473 | | $ | 21,962 | | | 6.2 | % |
Tunneling | | | 49,843 | | | (1,318 | ) | | -2.6 | | | 6,769 | | | (8,087 | ) | | -16.2 | |
Tite Liner® | | | 36,851 | | | 12,249 | | | 33.2 | | | 4,814 | | | 7,435 | | | 20.2 | |
Total | | $ | 441,841 | | $ | 94,366 | | | 21.4 | % | $ | 73,056 | | $ | 21,310 | | | 4.8 | % |
Nine Months Ended September 30, 2005
Segment | | Revenues | | Gross Profit (Loss) | | Gross Profit (Loss) Margin | | Operating Expenses | | Operating Income (Loss) | | Operating Income (Loss) Margin | |
Rehabilitation | | $ | 336,279 | | $ | 81,172 | | | 24.1 | % | $ | 55,852 | | $ | 25,320 | | | 7.5 | % |
Tunneling | | | 85,123 | | | (2,438 | ) | | -2.9 | | | 9,937 | | | (12,375 | ) | | -14.5 | |
Tite Liner® | | | 27,929 | | | 8,438 | | | 30.2 | | | 3,799 | | | 4,639 | | | 16.6 | |
Total | | $ | 449,331 | | $ | 87,172 | | | 19.4 | % | $ | 69,588 | | $ | 17,584 | | | 3.9 | % |
(1) | Consolidated and tunneling operating expenses for the quarter ended March 31, 2007 include $16.8 million in charges associated with the closure of our tunneling business. |
The following table summarizes the increases (decreases) in key financial data for the three and nine monthsquarter ended September 30, 2006March 31, 2007 as compared with the same periodsperiod in 20052006 (dollars in thousands):
| | Three Months Ended September 30, 2006 vs. 2005 | | Nine Months Ended September 30, 2006 vs. 2005 | | | Quarter Ended | |
| | Total Increase (Decrease) | | Percentage Increase (Decrease) | | Total Increase (Decrease) | | Percentage Increase (Decrease) | | | March 31, 2007 vs. 2006 | |
Consolidated | | | | | | | | | | |
| | | Total | | Percentage | |
| | | Increase | | Increase | |
| | | (Decrease) | | (Decrease) | |
All Segments | | | | | | |
Revenues | | $ | (11,137 | ) | | -7.2 | % | $ | (7,490 | ) | | -1.7 | % | | $ | (12,616 | ) | | -8.8 | % |
Gross profit | | | (1,210 | ) | | -3.7 | | | 7,194 | | | 8.3 | | | | (8,095 | ) | | -28.2 | |
Operating expenses | | | 902 | | | 3.9 | | | 3,468 | | | 5.0 | | |
Operating income | | | (2,112 | ) | | -22.3 | | | 3,726 | | | 21.2 | | |
Operating expenses (1) | | | | 19,184 | | 83.8 | |
Operating income (1) | | | | (27,279 | ) | | -472.1 | |
| | | | | | | | | | | | | | | | | | | |
Rehabilitation | | | | | | | | | | | | | | | | | | | |
Revenues | | | 10,448 | | | 9.7 | | | 18,868 | | | 5.6 | | | | (8,337 | ) | | -7.5 | |
Gross profit | | | 2,331 | | | 8.8 | | | 2,263 | | | 2.8 | | | | (9,917 | ) | | -39.1 | |
Operating expenses | | | 2,619 | | | 14.5 | | | 5,621 | | | 10.1 | | | | 2,663 | | 14.1 | |
Operating income | | | (288 | ) | | -3.4 | | | (3,358 | ) | | -13.3 | | | | (12,580 | ) | | -194.7 | |
| | | | | | | | | | | | | | | | | | | |
Tunneling | | | | | | | | | | | | | | | | | | | |
Revenues | | | (19,722 | ) | | -55.2 | | | (35,280 | ) | | -41.4 | | | | (3,418 | ) | | -17.6 | |
Gross profit | | | (3,635 | ) | | -131.4 | | | 1,120 | | | 45.9 | | | | 803 | | 130.4 | |
Operating expenses | | | (1,939 | ) | | -48.1 | | | (3,168 | ) | | -31.9 | | | | (333 | ) | | -13.8 | |
Operating income | | | (1,696 | ) | | -133.9 | | | 4,288 | | | 34.7 | | |
Costs of closure of tunneling business | | | | 16,843 | | N/A | |
Operating income (1) | | | | (15,707 | ) | | -518.5 | |
| | | | | | | | | | | | | | | | | | | |
Tite Liner® | | | | | | | | | | | | | | | | | | | |
Revenues | | | (1,863 | ) | | -16.0 | | | 8,922 | | | 31.9 | | | | (861 | ) | | -6.9 | |
Gross profit | | | 94 | | | 2.7 | | | 3,811 | | | 45.2 | | | | 1,019 | | 25.8 | |
Operating expenses | | | 222 | | | 17.4 | | | 1,015 | | | 26.7 | | | | 11 | | 0.6 | |
Operating income | | | (128 | ) | | -5.8 | | | 2,796 | | | 60.3 | | | | 1,008 | | 42.9 | |
| | | | | | | | | | | | | | | | | | | |
Interest Expense | | | (451 | ) | | -20.8 | | | (1,319 | ) | | -20.4 | | |
Taxes | | | 402 | | | 20.1 | | | 3,180 | | | 87.8 | | |
Interest Expense and Taxes | | | | | | | |
Interest expense | | | | (316 | ) | | (17.5 | ) |
Taxes on income | | | | (7,976 | ) | | (500.5 | ) |
(1) | Consolidated and tunneling operating expenses for the quarter ended March 31, 2007 include $16.8 million in charges associated with the closure of our tunneling business. |
Overview
Consolidated net earnings were essentially unchanged$18.3 million lower in the thirdfirst quarter of 20062007 compared to the thirdfirst quarter of 2005. Rehabilitation revenues increased by 9.7% in2006. During the thirdfirst quarter of 2006 compared2007, charges of $16.8 million (pre-tax) related to the thirdtunneling closure were recorded. The combined after-tax loss from the tunneling closure charges and operating loss from the tunneling segment during the first quarter of 2005 due to improvements in crew productivity, while gross profit increased due to the higher revenues.was $13.1 million, or $(0.48) per diluted share. The first nine months of 2006 saw rehabilitation revenue growth of only 5.6%, due to slow market conditions in late 2005, while gross profit increased by 2.8%. Rehabilitation resultsafter-tax charges recognized in the first nine months of 2005 include the benefit of an insurance claim receivable. See Note 7 - “Boston Installation” for further discussion. The tunneling business continued to struggle with underutilized equipment in the third quarter of 20062007 for the tunneling closure were $11.8 million, or $(0.43) per diluted share, and experienced larger gross profit andthe tunneling business’s after-tax operating losses inloss for the thirdfirst quarter of 2006 compared to the third quarter of 2005. Sales of tunneling property and equipment resulted in gains of $1.4 million in the third quarter of 2006 and $1.6 million in the first nine months of 2006. We continue to investigate alternatives to reduce the level of equipment in the tunneling business. Tite Liner® saw lower revenues, but flat gross profit in the third quarter of 2006 compared to the third quarter of 2005. Tite Liner®’s third quarter of 2006, while very strong,2007 was compared to an exceptionally strong third quarter for Tite Liner®’s South American operations in the third quarter of 2005. However, Tite Liner®’s gross profit margin was stronger in the third quarter of 2006 at 36.5% compared to 29.9% in the third quarter of 2005 due to efficiencies gained from sustained volume throughout 2006. Tite Liner®’s stronger gross margins prevented a steeper decrease in operating income in the third quarter of 2006 compared to the third quarter of 2005.
Consolidated operating expenses increased by $0.9$1.3 million or 3.9%,$(0.05) per diluted share. The decision to close this business, and the impact of these charges are more fully described in the third quarter of 2006 and $3.5 million, or 5.0%, in the first nine months of 2006 compared to the same periods in 2005 due primarily to the following:
| Three Months Ended September 30, 2006 vs. 2005 | Nine Months Ended September 30, 2006 vs. 2005 |
| Increase (Decrease) | Increase (Decrease) |
| (dollars in thousands) |
Incentive compensation expense | $1,155 | | $2,461 | |
Stock option expense | 690 | | 2,488 | |
Other equity compensation expense | (12 | ) | 423 | |
Legal expenses | 166 | | 1,292 | |
Other | (1,097 | ) | (3,196 | ) |
Total increase | $902 | | $3,468 | |
Incentive compensation expense increased in the third quarter and first nine months of 2006 due to our results approximating our incentive compensation targets, whereas such targets were not met in the same periods in 2005. Equity compensation expense was higher in the third quarter and first nine months of 2006 compared to the same periods in 2005 due to the implementation of new accounting rules which require the recording of expense for stock options issued from our equity incentive plans. Pretax stock option expense, which was not recorded in the prior-year periods, was $0.7 and $2.5 million in the third quarter and first nine months of 2006, respectively. See Note 26 to the consolidated financial statements contained herein.
Aside from the tunneling closure charges, the decrease in this reportconsolidated net income was principally due to lower revenues in all segments, along with weaker gross profit margins in our rehabilitation business caused by weakness in the U.S. rehabilitation market. This weakness resulted not only in serious shortfalls in backlog available, but also in the compression of margins due to increased competitive pricing pressure. Gross profit margin for further discussionour Tite Liner® business increased to 42.6% in the first quarter of equity-based compensation. All other2007, as compared to 31.5% in the first quarter of 2006, despite slightly lower revenues for the quarter. This increase was due to favorable project closeouts experienced during the quarter, along with improved operational efficiencies in Canada and the United States. The tunneling business also experienced lower revenues due to delayed start-up on new projects. Gross profit margins in tunneling continued to be weak due to the impact of underutilized equipment expenses.
Consolidated operating expenses, which includes employee, facilities, consulting and other expenses, decreasedexcluding the tunneling closure charges, were $2.3 million higher in the thirdfirst quarter and first nine months of 20062007 compared to the same periods in 2005first quarter of 2006 primarily due to lowered operating expensesinvestments we made in ongoing growth initiatives on a global basis, including increasing the sales force in the tunnelingUnited States rehabilitation business to stimulate growth, increasing international business development efforts, accelerating the growth of Insituform Blue™, our potable water rehabilitation division, and North American rehabilitation businesses whichincreasing marketing and technology development spending. In addition we recorded $0.5 million related to recent restructuring efforts.penalties assessed by Iowa OSHA in connection with an accident which occurred in 2002 in Des Moines, Iowa. See Note 9 for more information regarding this matter.
Intellectual Property and Other Legal Matters
In the past few years, we have increased our emphasis on protecting the intellectual property that is at the core of our business. As part of this effort, we have actively prosecutedpursued a number of legal proceedings seeking to collect damages and to enforce other remedies against third parties based upon patent infringement, breach of license and implied license agreements, and unauthorized use of trade secrets involving our proprietary intellectual property.
In one such case filed against Cat Contracting, Inc., Michigan Sewer Company and FirstLiner USA, Inc. in the United States District Court in Houston, Texas, we had received a judgment of $9.5 million in 1999 based upon the infringement of certain in-liner patents we owned. Upon subsequent appeal, the finding of infringement was upheld, but the award of damages, including the finding of willfulness, was subject to rehearing. We believed that we had a strong position in upholding the original damage award and, after investigation, we also concluded that the defendants had a viable source to collect all or a portion of the award, if confirmed. On the basis of these determinations, we decided to aggressively pursue the rehearing on damages. The damages rehearing was completed in the third quarter of 2006, and we currently are awaiting the court’s decision. No receivable related to this matter has been recorded in the consolidated financial statements as of March 31, 2007.
In June 2005, after investigation, we commenced a lawsuit in the United States District Court in Memphis, Tennessee against our long-time international partner, Per Aarsleff A/S, a Danish public company, and certain of its subsidiaries and
affiliates. The suit alleges breach by these entities of license agreements and implied license agreements with us involving our proprietary intellectual property relating to the InsituformInsituform® CIPP process. We seek monetary damages for breach of our license agreements and implied license agreements between the Per Aarsleff entities and our company and for royalties owed by the Per Aarsleff entities to us under these agreements. We recentlyIn 2006, we amended our complaint against the Per Aarsleff entities to include additional damage claims based upon Per Aarsleff’s continued use of our patented technology in Denmark, Sweden and Finland following the termination of the license agreements and Per Aarsleff’s use of our trade secrets in its Danish tube manufacturing facility. Our amended complaint also seeks an injunction against Per Aarsleff’s continued operation of the tube manufacturing facility. In April 2006, we filed a separate patent infringement action in Denmark against Per Aarsleff seeking to enjoin its continued use of an inversion device covered by one of our European patents. We also have filed a separate legal actionactions in Germany against Per Aarsleff relating to its conduct involving our joint venture company in Germany and are reviewingwith respect to transactions between Per Aarsleff and our German joint venture companies in Germany and Italy to determine whether all transactions between Per Aarsleff and such companiescompany, which we believe were fair and at prices other than arms’-length prices.-length. We estimate the aggregate claims in these matters to be in excess of $10.0 million.million; however, no claims receivable has been recorded in our consolidated financial statements. Due to the uncertainties of litigation, as well as issues regarding the collectibility of damage awards, there can be no assurance regarding these litigations at this time or as to the amount of money, if any, that we may ultimately recover against Per Aarsleff. This case currently is set for trial in the second quarter of 2008.
In June 2005, we filed a petition in State Court in St. Louis County, Missouri against Reynolds, Inc., certain of its subsidiaries and affiliates and an officer of Reynolds, Inc. This suit recentlyThe case subsequently was movedremoved to the United States District Court in St. Louis.
The suit alleges that Reynolds, among other things, (i) tortiously interfered with a non-competition and confidentiality agreement we had with a former employee and (ii) misappropriated our trade secrets. In April 2005, the St. Louis County Court had entered a temporary injunction against our former employee, finding that he had violated the terms of his non-competition and confidentiality agreement with us and had retained, misappropriated and disseminated to Reynolds, Inc. property of our company for the benefit of Reynolds. In light of the court’s April 2005 findings, we amended our petition to add Reynolds as a defendant in the action. This case currently is set for trial in the second quarter of 2007.
As discussed in previous reports, we also are vigorously pursuing a number of tunneling claims, and continue to incur significant legal costs and expenses in prosecuting such actions. As of September 30, 2006,March 31, 2007, we had approximately $17.0$18.4 million in tunneling claims, of which approximately $6.5$7.5 million has been recognized.
We have recorded significant expenses, including attorneys’ fees and other litigation costs, in connection with the prosecution of these intellectual property lawsuits, tunneling claims and other legal matters. For the ninethree months ended September 30,March 31, 2007 and 2006, and 2005, we incurred attorneys’ fees and litigation costs of approximately $4.5$1.5 million and $3.2$1.4 million, respectively, with respect to these lawsuits and other legal matters. Other than $6.5$7.5 million and $7.5$7.8 million in receivables at March 31, 2007 related to tunneling claims and our claim against our excess insurance carrier (see Note 79 “Boston Installation”), respectively,, respectively, we have not recorded any receivable related to these lawsuits. We have vigorously pursued these lawsuits based upon our business judgment that the possibility of recovery of substantial damages, the granting of the requested injunctive relief and other ancillary benefits arising from our proactive protection of our intellectual property, justifies the expenses previously incurred and currently projected. Because of the substantial uncertainty at this time with respect to the liability and/or damages outcomes, including the collectibility of any damages awarded, we cannot estimate a dollar amount or range of recovery from these lawsuits at this time.
Rehabilitation Segment
Revenues
Revenues decreased by 7.5% in the first quarter of 2007 compared to the first quarter of 2006 due primarily to lower workable backlog caused by persistent, weak market conditions in the United States. In recent quarters, there has been a larger percentage of smaller-diameter installation projects in the U.S. marketplace. This trend also has contributed to lower revenue. Rehabilitation contract backlog was $11.6 million lower at the beginning of the first quarter of 2007 compared to the beginning of the first quarter of 2006, and it was $23.5 million lower in the United States at the beginning of the first quarter of 2007 compared to the beginning of the first quarter of 2006. Increased revenues were generated year over year in Europe and Canada, where the market conditions remain strong.
As previously announced, based on our market visibility along with various market surveys, the U.S. sewer rehabilitation market has been flat to declining in the last year. Current projections for 2007 call for spending growth in this market to be between negative 1% and positive 3%. We also have announced that we are taking several actions to restore profitability and to stimulate growth going forward, including the expansion of sewer rehabilitation work outside of the United States, acceleration of the growth of Insituform Blue™ by expanding crew capabilities and the sales force to pursue worldwide opportunities, and proactively challenging the complacency among U.S. infrastructure policy-makers. In the meantime, to ensure that we continue to achieve the productivity gains that we experienced in 2006, we have
slightly reduced the level of U.S. sewer rehabilitation crew resources to better reflect current demand. This should enable us to redirect certain resources to international operations, Insituform Blue™ and other potential growth segments.
Gross Profit and Margin
Rehabilitation gross profit decreased by 39.1% in the first quarter of 2007 compared to the first quarter of 2006, primarily due to the low backlog described above. The weak market conditions also have resulted in heightened competitive pricing pressure that has compressed gross profit margins. The gross profit margin percentage decreased by 7.8 margin points to 14.9% in the first quarter of 2007 from 22.7% in the first quarter of 2006. In 2006, gross profit included the benefit of a $1.2 million claim relating to unanticipated job costs incurred in the first quarter of 2006. During the first quarter of 2007, we recorded a negative adjustment to this claim in the amount of $0.3 million upon final settlement.
Operating Expenses
Rehabilitation operating expenses increased 14.1% in the first quarter of 2007 compared to the first quarter of 2006. This increase was due primarily to an increase in our U.S. sales force in an effort to stimulate growth in the market. In addition, we incurred increased expenses related to our increased focus on Insituform Blue™, increased business development efforts in international markets and increased investments in marketing research and technology research and development.
Operating Loss and Margin
Decreased gross profit margins and increased operating expenses resulted in a sharp decrease of 194.7% in operating income for the first quarter of 2007 compared to the first quarter of 2006. The operating margin, which is operating (loss) income as a percentage of revenue, decreased to (5.9)% in the first quarter of 2007 compared to 5.8% in the first quarter of 2006.
Insituform Blue™
During 2006, we launched a new potable water infrastructure division under the name Insituform Blue™. Under Insituform Blue™, we operate with a variety of technologies geared to the global drinking water market. In the first quarter of 2007, Insituform Blue™ did not have a material effect on our consolidated results of operations. Insituform Blue™ is expected to generate modest operating losses for the next few years as we establish this business.
Tite Liner® Segment
Revenues
Tite Liner® revenues decreased 6.9% or $0.9 million in the first quarter of 2007 compared to the first quarter of 2006, due primarily to a reduction in work in South America. Contract Backlogbacklog in the Tite Liner® segment was $7.4 million lower at the beginning of the first quarter of 2007 compared to the beginning of the first quarter of 2006 with $3.4 million of the decrease in South America. Tite Liner®’s revenues from North American (U.S. and Canada) and Latin American operations were $0.4 million and $0.8 million, respectively, higher during the first quarter of 2007 compared to the first quarter of 2006, while revenues from South American operations were $2.1 million lower during the first quarter of 2007 compared to the first quarter of 2006.
Gross Profit and Margin
Tite Liner®’s gross profit increased by 25.8% in the first quarter of 2007 compared to the first quarter of 2006 due primarily to favorable closeouts of projects during the quarter. Tite Liner®’s gross profit margin percentages were 42.6% and 31.5% in the first quarter of 2007 and 2006, respectively. The higher gross profit margin in the first quarter of 2007 was due principally to improved margins worldwide resulting from the aforementioned project closeouts and improved operational efficiencies.
Operating Expenses
Operating expenses in the Tite Liner® business were basically unchanged in the first quarter of 2007 compared to the first quarter of 2006. Operating expenses as a percentage of revenue had a slight increase to 13.8% in the first quarter of 2007 compared to 12.8% in the first quarter of 2006, primarily as a result of slightly lower revenues.
Operating Income and Margins
Operating income increased by 42.9% in the first quarter of 2007 compared to the first quarter of 2006 due to the factors described above. The operating margin increased to 28.8% in the first quarter of 2007 compared to 18.7% in the first quarter of 2006.
Tunneling Segment
See Note 6 regarding our decision to close the tunneling business and the impact on the first quarter of 2007.
Revenues
Tunneling’s revenues were down by 17.6% in the first quarter of 2007 compared to the first quarter of 2006 due to the slower start of new projects during the period. In addition, during the first quarter of 2006, there were a number of larger projects that were coming to a close. Excluding the Milwaukee project, discussed below, there remained approximately $60 million in projects to be completed as of March 31, 2007. We anticipate that these projects will be substantially completed during 2007, with all projects completed by mid-year 2008.
On March 26, 2007, we were awarded a $65 million tunneling project in Milwaukee, Wisconsin, which had been bid in January 2007. Given the decision to close the tunneling operation, we have assigned the project to another contractor who acquired the project from us at our bid price. We will have no future obligations to complete the project.
Gross Profit and Margin
Tunneling posted a gross profit in the first quarter of 2007 of $0.2 million compared to a gross loss of $0.6 million in the first quarter of 2006. During the first quarter of 2006, there were a number of problematic, low margin projects that were in the final stages of completion, which contributed to the gross loss. Underutilized equipment costs (primarily equipment lease expenses) were $2.1 million in the first quarter of 2007 as compared to $1.9 million in the first quarter of 2006.
At March 31, 2007, there were approximately $18.0 million in outstanding claims against third parties relating to, among other things, differing site conditions and defective specifications. Of this amount, $7.5 million had been recorded to income through March 31, 2007. Claims in the amount of $0.2 million were recognized in gross profit in the first quarter of 2007. There were no claims recoveries recorded in the first quarter of 2006. In accordance with our accounting policies, we record a claim to income when the realization of the claim is reasonably assured, and we can estimate a recoverable amount.
During 2006, and into 2007, we continued our increased efforts regarding tunneling claims and aggressive pursuit of all outstanding claims, either through discussions and/or negotiations with our clients, alternative dispute resolution proceedings or, if necessary, litigation.
Operating Expenses
Operating expenses, excluding tunneling closure charges, decreased 13.8% in the first quarter of 2007 compared to the first quarter of 2006, due to continued reductions in administrative staffing and related costs to adjust to a lower operating base. Operating expenses as a percentage of revenue were 13.0% in the first quarter of 2007 compared to 12.4% in the first quarter of 2006, due primarily to the drop in revenue in the first quarter of 2007.
Tunneling Closure Charges
In the first quarter of 2007, we recorded $16.8 million (pre-tax) of charges associated with the closure of the tunneling business, which was announced on March 29, 2007. See Note 6 for a discussion regarding these charges. We anticipate that further charges will be recorded in 2007 as the business progresses toward liquidation/sale and assets are sold or disposed.
Operating Loss and Margin
Tunneling’s operating loss increased by $15.7 million in the first quarter of 2007 compared to the first quarter of 2006 due primarily to the charges recorded in the first quarter of 2007 related to the closure of the tunneling business. Tunneling closure charges were $16.8 million during the first quarter of 2007. Tunneling’s operating loss without these charges was $1.9 million, or $1.1 million less than last year’s first quarter, as projects were more profitable in 2007 and operating expenses were lowered. A tabular presentation of the costs of closure and the effect on the tunneling segment’s operating loss is set forth below (in thousands):
| | Quarter Ended | | Quarter Ended | |
| | March 31, 2007 | | March 31, 2006 | |
| | | | | |
Operating loss, as reported | | | ($18,736 | ) | | ($ 3,029 | ) |
Costs of closure of tunneling business | | | 16,843 | | | ─ | |
Operating loss, less tunneling closure costs | | | ($ 1,893 | ) | | ($ 3,029 | ) |
INTEREST AND OTHER INCOME (EXPENSE)
Interest Expense
Interest expense declined approximately $0.3 million in the first quarter of 2007, compared to the same period in 2006 due to the following factors (in thousands):
| | Three Months Ended March 31, 2007 vs. 2006 | |
| | Total Increase (Decrease) | |
Debt principal amortization - Series A Notes | | $ | (349 | ) |
Interest on short-term borrowings and other | | | 33 | |
Total decrease in interest expense | | $ | (316 | ) |
Interest Income
Interest income was $0.9 million in the first quarter of 2007 compared to $0.5 million in the first quarter of 2006. Interest income in the first quarter of 2007 includes $0.1 million related to pre-judgment interest on an insurance claim receivable from our excess insurance coverage carrier. In addition to the insurance claim, interest income increased due to higher interest rates on deposits due to better market conditions.
Other Income
Other income was $0.7 million in the first quarter of 2007 compared to $0.1 million in the first quarter of 2006. The principal drivers of the increase in other income were related to foreign currency transaction gains from the repatriation of foreign cash, along with gains on disposals of fixed assets.
TAXES ON INCOME
(Tax benefit) taxes on (loss) income decreased in the first quarter of 2007 compared to the first quarter of 2006 due primarily to decreased taxable income in the quarter. Our effective tax rate for the first quarter of 2007 was 30.0% compared to 34.5% in the first quarter of 2006. This decrease was due primarily to lower income in the United States where tax rates generally are higher than other tax jurisdictions in which we operate.
CONTRACT BACKLOG
Contract backlog is management’sour expectation of revenues to be generated from received, signed and uncompleted contracts, whosethe cancellation of which is not anticipated at the time of reporting. Contract backlog excludes any term contract amounts for which there is not specific and determinable work released and projects where we have been advised that we are the low bidder, but have not formally been awarded the contract. The following table sets forth our consolidated backlog by segment:
Backlog | | September 30, 2006 | | June 30, 2006 | | March 31, 2006 | | December 31, 2005 | | September 30, 2005 | | | | | | | | | | | | |
| | | (in millions) | | | (in millions) | |
Rehabilitation | | $ | 201.2 | | $ | 186.8 | | $ | 216.2 | | $ | 213.3 | | $ | 207.8 | | | $ | 187.2 | | $ | 201.7 | | $ | 201.2 | | $ | 186.8 | | $ | 216.2 | |
Tunneling | | | 80.7 | | 70.1 | | 50.2 | | 66.3 | | 83.6 | | | | 60.6 | | | 75.7 | | | 80.7 | | | 70.1 | | | 50.2 | |
Tite Liner® | | | 13.2 | | 15.6 | | 20.1 | | 20.2 | | 10.7 | | | | 14.5 | | | 12.8 | | | 13.2 | | | 15.6 | | | 20.1 | |
Total | | $ | 295.1 | | $ | 272.5 | | $ | 286.5 | | $ | 299.8 | | $ | 302.1 | | | $ | 262.3 | | $ | 290.2 | | $ | 295.1 | | $ | 272.5 | | $ | 286.5 | |
The dollar amount of the backlog is not necessarily indicative of future earningsrevenues relative to the performance of such work. Although backlog represents only those contracts that are considered to be firm, there can be no assurance that cancellation or scope adjustments will not occur with respect to such contracts.
Rehabilitation Segment
Revenues
Revenues increased by 9.7% in the rehabilitation segment in the third quarter of 2006 compared to the third quarter of 2005 due to increased crew productivity and the strengthening of the rehabilitation market in the United States. With crew productivity improvements, we have been able to generate more revenue with fewer crews in the third quarter and first nine months of 2006 compared to the same periods in 2005. With the rehabilitation market in the United States rebounding after a slow period in late 2005, we have been able to obtain sufficient workable backlog to keep our crews deployed on profitable work.
Revenues increased only 5.6% in the first nine months of 2006 compared to the first nine months of 2005. This growth is lower than recent trends due to a significant market softening, to the point of contraction, in the United States in late 2005. During this slow period, there was heightened competition for fewer projects, resulting in low-margin pricing, and a decrease in our workable backlog during the first half of 2006. Rather than obtain work at low margins, we were able to take advantage of better margins when the slow period was followed by modest growth in the first quarter of 2006, and even stronger growth in the second and third quarters of 2006.
Backlog in the rehabilitation segment increased $14.4 million, or 7.7%, to $201.2 million at September 30, 2006 compared to $186.8 million at June 30, 2006. The increase is due to much stronger market activity in the second and third quarters of 2006, following a period of slow bidding activity in late 2005 lasting into the first quarter of 2006. However, due to changing market behavior, the incubation period between contract awards and release of workable backlog has grown longer. Consequently, there are a significant number of apparent low-bid (ALB) projects that are not included in our reported backlog amounts above.
Due to stronger market activity in the second and third quarters of 2006 in rehabilitation, ALB projects increased by 22% from the end of 2005.
Gross Profit and Margin
Rehabilitation gross profit increased by 8.8% in the third quarter of 2006 compared to the third quarter of 2005 due primarily to higher revenues and increased crew efficiencies, partially offset by higher material costs. Crew efficiencies enabled us to generate higher revenue on essentially flat labor costs. In contrast, material costs increased significantly, driven primarily by resin costs. Resin, a petroleum based product, is subject to pricing volatility, and is a significant raw material in our CIPP process. In many cases, we have the ability to pass price increases to our customers. However, to the extent we may have longer-term contracts with fixed pricing, our ability to pass through such price increases may be limited. In the third quarter of 2006, our ability to pass through such raw material price increases, along with increased crew efficiencies, has enabled us to maintain a gross profit margin of 24.5% compared to 24.7% in the third quarter of 2005.
Rehabilitation gross profit in the first nine months of 2006 increased by 2.8%, largely due to similar factors as described above. In addition, gross profit in the first nine months of 2005 included a $3.4 million benefit from a claim recognized against our excess liability insurance carrier. In the first nine months of 2006, we recorded an additional $0.5 million related to additional amounts from the same claim. We record claims only when the realization of the claim is reasonably assured at an estimated recoverable amount. Excluding the effect of the claims recognized, gross profit would have increased by $5.2 million to $82.9 million in the first nine months of 2006 compared to $77.7 million in the first nine months of 2005. Likewise, gross profit margin would have been 23.3% in the first nine months of 2006 compared to 23.1% in the first nine months of 2005.
A table reconciling gross profit, excluding the effect of insurance claims, to gross profit, as reported, is provided in the table below for the first nine months of 2006 compared to the same period in 2005 (dollars in thousands):
| | Nine Months Ended September 30, | |
| | 2006 | | 2005 | |
Gross profit, excluding insurance claims | | $ | 82,909 | | $ | 77,725 | |
Gross profit margin, excluding insurance claims | | | 23.3 | % | | 23.1 | % |
Effect of insurance claims recognition | | | 526 | | | 3,447 | |
Gross profit, as reported | | $ | 83,435 | | $ | 81,172 | |
Gross profit margin, as reported | | | 23.5 | % | | 24.1 | % |
Operating Expenses
Operating expenses increased 14.5% in the third quarter of 2006 compared to the third quarter of 2005 due to higher corporate expenses, including incentive compensation, equity compensation and legal expenses. Operating expenses, as a percentage of revenue, were 17.5% in the third quarter of 2006 compared to 16.8% in the third quarter of 2005.
Likewise, operating expenses increased by 10.1% in the first nine months of 2006 compared to the first nine months of 2005. Operating expenses, as a percentage of revenue, were 17.3% in the first nine months of 2006 compared to 16.6% in the first nine months of 2005.
Operating Income and Margin
Higher revenues and gross profit, offset by higher operating expenses, combined to cause operating income to be relatively flat in the third quarter of 2006 compared to the third quarter of 2005. However, rehabilitation operating margin, which is operating income as a percentage of revenue, declined to 7.0% in the third quarter of 2006 compared to 7.9% in the third quarter of 2005.
The factors described above caused operating income to decrease by 13.3% in the first nine months of 2006 compared to the first nine months of 2005. The operating margin also decreased to 6.2% in the first nine months of 2006, compared to 7.5% in the first nine months of 2005.
Tunneling Segment
Revenues
Tunneling’s revenues were 55.2% lower in the third quarter of 2006 compared to the third quarter of 2005 due to fewer active projects and lower backlog. The combination of management’s focus on completing existing jobs and a more selective bidding strategy caused tunneling’s backlog to decline sharply over the last several quarters through the second quarter of 2006. The same factors have similarly impacted tunneling’s revenues in the first nine months of 2006 compared to the first nine months of 2005.
In consideration of the time lag between winning a bid and the commencement of a project, revenue is expected to remain below year-ago levels through the end of 2006. However, with the completion of several problem tunneling jobs, management has been able to renew its efforts to obtain profitable work that is compatible with tunneling’s core mining competency. Consequently, backlog has increased from $70.1 million at June 30, 2006 to $80.7 million at September 30, 2006. This represents an increase of $14.4 million compared to December 31, 2005 and a decrease of $2.9 million compared to September 30, 2005.
Gross Profit and Margin
Tunneling’s gross loss was $0.9 million in the third quarter of 2006 compared to gross profit of $2.8 million in the third quarter of 2005. The gross loss in the third quarter of 2006 was primarily due to underutilized equipment costs. Underutilized equipment costs (primarily depreciation and operating lease expenses) were $2.3 million in the third quarter of 2006 compared to $1.4 million in the third quarter of 2005. As a result of the completion of several problematic low-margin or loss jobs and the slow addition of new work, there is considerable tunneling equipment that is idle, resulting in underutilized equipment costs. Excluding underutilized equipment costs, tunneling would have posted a gross profit of $1.5 million, or 9.1%, in the third quarter of 2006. Tunneling’s gross profit in the third quarter of 2005 included the recognition of two claims totaling $2.9 million. Excluding the effects of underutilized equipment and claims recognition tunneling would have posted a gross profit of $1.2 million, or 3.5%, in the third quarter of 2005.
Tunneling’s gross loss was $1.3 million in the first nine months of 2006 comparedCompany’s decision to $2.4 million in the first nine months of 2005. Tunneling’s gross loss in the first nine months of 2006 also included underutilized equipment costs of $6.8 million offset by claims revenue of $0.7 million. Tunneling’s gross loss in the first nine months of 2005 included underutilized equipment costs of $2.8 million and claims revenue of $3.8 million. Excluding the effects of underutilized equipment and claims, tunneling’s gross profit would have been $4.8 million, or 9.6%, in the first nine months of 2006 compared to a gross loss of $3.4 million, or a negative 4.0%, in the first nine months of 2005.
Gross profit (loss), excluding the effect of underutilized equipment and recognized claims, is presented in the table below and reconciled to reported gross profit (dollars in thousands):
| | Three Months Ended September 30, | | Nine Months Ended September 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
Gross profit (loss), excluding underutilized equipment and claims | | $ | 1,463 | | $ | 1,248 | | $ | 4,784 | | $ | (3,422 | ) |
Gross profit margin, excluding underutilized equipment and claims | | | 9.1 | % | | 3.5 | % | | 9.6 | % | | -4.0 | % |
Underutilized equipment costs | | | (2,331 | ) | | (1,412 | ) | | (6,777 | ) | | (2,845 | ) |
Claims recognized | | | - | | | 2,931 | | | 675 | | | 3,829 | |
Gross profit (loss), as reported | | $ | (868 | ) | $ | 2,767 | | $ | (1,318 | ) | $ | (2,438 | ) |
Gross profit margin, as reported | | | -5.4 | % | | 7.7 | % | | -2.6 | % | | -2.9 | % |
The table above demonstrates tunneling performance as if the level of equipment were reduced to an appropriate level for its operations and excludes the effects of claims recognized. The low margins and loss in the three- and nine-month periods ended September 30, 2005 are due to the adverse effects of low-margin and loss jobs that were ongoing in those periods.
As underutilized equipment costs represented a significant factor in tunneling’s gross loss in the third quarter and first nine months of 2006, we continue to explore alternatives to reduce the level of equipment to fitclose the tunneling operation’s ongoing business model. Sales of tunneling property and equipment resulted in gains of $1.4 million and $1.6 million in the third quarter and first nine months of 2006, respectively. However, there can be no assurances that further opportunities for property and equipment reduction in the tunneling business will be available to us.
Some of the problems experienced on a number of completed tunneling projects may have related claims that could benefit gross profit in future periods. At September 30, 2006, our tunneling operation, had approximately $17.0 million in outstanding claims against third parties relating to, among other things, differing site conditions and defective customer specifications. Of this amount, $6.5 million had been recorded in the financial statements through September 30, 2006, none of which occurred in the third quarter. Claims of $0.7 million were recognized in the first nine months of 2006. In accordance with our accounting policies, we record a claim to income when realization of the claim is reasonably assured, and we can estimate a recoverable amount.
During 2005 and 2006, we redoubled our efforts regarding tunneling claims and have aggressively pursued all outstanding claims, either through discussions and/or negotiations with our clients, alternative dispute resolution proceedings or, if necessary, litigation.
While we believe our tunneling operation will return to profitability, to the extent additional losses persist, we may have exposure to the recovery of our goodwill of $8.9 million associated with the tunneling segment.
Operating Expenses
Operating expensesdiscussed above, backlog in the tunneling segment decreasedwill decline throughout the remainder of 2007 as current projects are completed and new projects are not being bid or accepted. We currently anticipate that all projects will be completed by 48.1% inmid-2008, with the third quartermajority of 2006 and by 31.9% in the first nine months of 2006 compared to the same periods in 2005. Operating expenses were lower in the third quarter and first nine months of 2006 due to reductions in administrative staffing and related costs to adjust to a lower operating base, partially offset by higher corporate expenses allocated to tunneling for increased management efforts to run the business. Operating expenses as a percentage of revenue were 13.1% and 13.6% in the third quarter and first nine months of 2006, respectively, compared to 11.3% and 11.7% in the same periods of 2005, respectively.
Operating Loss and Margin
Tunneling’s operating loss widened by $1.7 million in the third quarter of 2006 compared to the third quarter of 2005 due primarily to the effects of claims recognized in 2005. Tunneling’s operating margin was a negative 18.5% in the third quarter of 2006 compared to a negative 3.5% in the third quarter of 2005.
Tunneling’s operating loss narrowed by $4.3 million in the first nine months of 2006 compared to the first nine months of 2005 due to the completion of several problem projects earlier this year. Tunneling’s operating margin was a negative 16.2% in the first nine months of 2006 compared to a negative 14.5% in the first nine months of 2005.
Tite Liner® Segment
Revenues
Tite Liner® revenues decreased by 16.0% in the third quarter of 2006 compared to the third quarter of 2005 as the third quarter of last year was an exceptionally strong quarter, particularly for our South American operations. Revenues from our South American operations were $2.6 million lower in the third quarter of 2006 compared to the third quarter of 2005, while revenues from our North American (U.S. and Canada) operations increased by $0.7 million in the third quarter of 2006 compared to the third quarter of 2005.
Tite Liner® revenues were 31.9% higher in the first nine months of 2006 compared to the same period last year due to very strong revenue in the first half of 2006. Backlog, which can be an indicator of future revenues, was $11.6 million, or 134.0% higher at the beginning of 2006 compared to the backlog at the beginning of 2005.
Tite Liner® normally experiences increased demand during periods of high prices for oil and other mined commodities. At September 30, 2006, Tite Liner® backlog was $13.2 million, which was $2.6 million, or 24.5%, higher than the backlog level at September 30, 2005. As such, it is expected that revenues will remain strong through the end of 2006. However, revenues may not necessarily be above year-ago levels in the fourth quarter of 2006.
Gross Profit and Margin
Despite a decrease in third quarter 2006 revenues, gross profit was slightly higher in the third quarter of 2006 compared to the third quarter of 2005 due to stronger gross profit margins in the U.S. and South America. Stronger margins resulted from efficiencies gained through sustained volume throughout 2006. Gross profit margins were 36.5% in the third quarter of 2006 compared to 29.9% in the third quarter of 2005.
Gross profit was 45.2% higher in the first nine months of 2006 compared to the first nine months of 2005 due to higher revenues and efficiencies gained from higher volume. Gross profit margins were also higher at 33.2% in the first nine months of 2006 compared to 30.2% in the first nine months of 2005.
Operating Expenses
Operating expenses were 17.4% higher in the third quarter of 2006 compared to the third quarter of 2005 due primarily to additional staffing and additional corporate expenses to support anticipated growth in the Tite Liner® business. As a percentage of revenue, operating expenses were 15.3% in the third quarter of 2006 compared to 10.9% in the third quarter of 2005. Operating expenses were higher as a percentage of revenue due to lower revenues in the third quarter of 2006 compared to the third quarter of 2005.
Similar factors caused operating expenseswork to be 26.7% highercompleted in the first nine months of 2006 compared to the first nine months of 2005. However, due to higher revenues in 2006 compared to 2005, operating expenses as a percentage of revenue decreased to 13.1% compared to 13.6% in the first nine months of 2005.
Operating Income and Margin
Operating income was only 5.8% lower in the third quarter of 2006 compared to the third quarter of 2005 despite the decrease in revenues. Our slightly higher gross profit on stronger gross margins prevented a steeper decrease in operating income. Operating margin, which is operating income as a percentage of revenue, strengthened to 21.3% in the third quarter of 2006 compared to 19.0% in the third quarter of 2005.
Higher revenues through the first nine months of 2006 caused operating income to increase by 60.3% during the period compared to the first nine months of 2005. Due to our strengthening gross profit margin, the operating margin likewise increased to 20.2% in the first nine months of 2006 compared to 16.6% the first nine months of 2005.
INTEREST AND OTHER INCOME (EXPENSE)
Interest Expense
Interest expense declined approximately $0.5 million and $1.3 million in the third quarter and first nine months of 2006, respectively, compared to the same periods in 2005 due to the following factors (dollars in thousands):
| Three Months Ended September 30, 2006 vs. 2005 | | Nine Months Ended September 30, 2006 vs. 2005 |
| Total Increase (Decrease) | | Total Increase (Decrease) |
Debt principal amortization - Series A Notes | $ (349) | | $ (1,047) |
Increased rates due to debt amendments on March 16, 2005 | - | | 84 |
Interest on short-term borrowings and other | (102) | | (356) |
Total decrease in interest expense | $(451) | | $ (1,319) |
Interest Income
Interest income was $0.8 million and $2.5 million in the third quarter and first nine months of 2006, respectively, compared to $0.4 million and $1.4 million in the third quarter and first nine months of 2005, respectively. Interest income in the third quarter of 2006 includes $0.1 million related to pre-judgment interest on an insurance claim receivable from our excess insurance coverage carrier. For the first nine months of 2006, we recorded $0.7 million in interest income related to this insurance claim, which is $0.4 million more than what was recorded in the first nine months of 2005. The claim amount was adjusted in the second quarter of 2006 for additional amounts determined to be included in the claim, and additional interest was also recorded to recognize a higher pre-judgment interest rate. In addition to the insurance claim, interest is higher due to improved cash balances and higher interest rates on deposits due to better market conditions and improved treasury practices.
Other Income
Other income was $1.5 million and $1.9 million in the third quarter and first nine months of 2006, respectively, compared to other expense of $0.2 million and $0.4 million in the same periods in 2005. The primary components of other income in the third quarter of 2006 included gains of $1.4 million on the disposition of tunneling property and equipment. Likewise, gains of $1.6 million were recorded on dispositions of tunneling property and equipment in the first nine months of 2006.
Taxes on Income
Taxes on income increased in the third quarter and first nine months of 2006 compared to the same periods in 2005 due primarily to higher pre-tax income and a higher effective tax rate. Our effective tax rate was 30.4% and 32.9% in the third quarter and first nine months of 2006, respectively, compared to 26.9% and 30.0% in the same periods in 2005.2007.
CRITICAL ACCOUNTING POLICIES
Discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the financial statement dates. Actual results may differ from these estimates under different assumptions or conditions.
Our critical accounting policies are disclosed in our 2005 Annual Report on Form 10-K. However, with the January 1, 2006 adoption of Statement of Financial Accounting Standards No. 123(R), Share Based Payment, we have included a description of our accounting for equity-based compensation below.
Accounting for Equity-Based Compensation
We record expense for equity-based compensation awards, including stock appreciation rights, restricted shares of common stock, performance awards, stock options and stock units based on the fair value recognition provisions contained in SFAS 123(R), Share Based Payment. Fair value is determined using either the Black-Scholes option pricing model for stock option awards, or our closing stock price on the grant date for restricted shares of our common stock or deferred stock units. Assumptions regarding volatility, expected term, dividend yield and risk-free rate are required for the Black-Scholes model. Volatility and expected term assumptions are based on our historical experience. The risk-free rate is based on a U.S. treasury note with a maturity similar to the option award’s expected term. Discussion of our implementation of SFAS 123(R) is described in Note 2 to the consolidated financial statements contained in this report.
LIQUIDITY AND CAPITAL RESOURCES
Cash and Equivalents
| | September 30, 2006 | | December 31, 2005 | | | March 31, 2007 | | December 31, 2006 | |
| | (in thousands) | | | (in thousands) | |
Cash and cash equivalents | | $ | 75,125 | | $ | 77,069 | | | $ | 79,676 | | $ | 96,393 | |
Cash restricted - in escrow | | | 5,289 | | | 5,588 | | | | 1,288 | | 934 | |
Total | | $ | 80,414 | | $ | 82,657 | | |
We expect the principal use of funds for the foreseeable future will be for capital expenditures, working capital, debt servicing and investments. Our primary source of cash is operating activities. Besides operating activities, we occasionally borrow under our line of credit to fund operating activities, including working capital investments. In 2007, we anticipate developing a plan to create a new capital structure that is aligned with our long-term growth opportunities. Information regarding our cash flows for the first ninethree months ofended March 31, 2007 and 2006 and 2005 is further discussed below and is presented in our consolidated statements of cash flows contained in this report.
We believe we have adequate resources and liquidity to fund future cash requirements and debt repayments with cash generated from operations, existing cash balances, additional short- and long-term borrowingsborrowing and the sale of assets, for the next twelve months.
We have entered into various financial obligations and commitments in the course of our ongoing operations and financing strategies. Financial obligations are considered to represent known future cash payments that we are required to make under existing contractual arrangements, such as debt and lease agreements. These obligations may result from both general financing activities or from commercial arrangements that are directly supported by related revenue-producing activities. Commercial commitments represent our contingent obligations, which become payable only if certain pre-defined events were to occur, such as funding financial guarantees. See Note 79 to the consolidated financial statements contained in this report for further discussion.
The following table provides a summary of our financial obligations and commercial commitments as of September 30, 2006March 31, 2007 (in thousands). This table includes cash obligations related to principal outstanding under existing debt agreements and operating leases.
We are exposed to the effect of interest rate changes and of foreign currency and commodity price fluctuations. We currently do not use derivative contracts to manage these risks.
Our objectives in managing exposure to interest rate changes are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, we maintain fixed rate debt whenever possible.debt. The fair value of our long-term debt, including current maturities was approximately $75.5 millionand the amount outstanding on the line of credit facility, approximated its carrying value at September 30, 2006.March 31, 2007. Market risk was estimated to be $2.9$0.3 million as the potential increase in fair value resulting from a hypothetical 10%1.0% decrease in our debt-specificdebt specific borrowing rates at September 30, 2006.March 31, 2007.
We have exposure to the effect of limitations on supply and changes in commodity pricing relative to a variety of raw materials that we purchase and use in our operating activities, most notably, resin, fuel, pipe, fiber and concrete. We manage this risk by entering into agreements with our suppliers, as well as purchasing in bulk, when possible. We also manage this risk by continuously updating our estimation systems for bidding contracts so that we are able to price our products and services appropriately to our customers. However, we face exposure on contracts in process that have already been priced and are not subject to any cost adjustments in the contract. This exposure is potentially more significant on our longer term projects, particularly in the tunneling segment. We do not currently hold or issue derivative financial instruments for hedging purposes.
We entered into a resin supply contract effective March 29, 2005, for the purchase and sale of certain proprietary resins we use in our North American operations. The contract provides for the exclusive sale of our proprietary resins by the vendor to us or to third parties that we designate. The contract has an initial term from March 29, 2005 until December 31, 2007, and shall renew for successive 12-month periods until the contract is terminated by either party upon 180-days’ prior written notice to the other party with an effective termination date of the end of the contract term.
We maintain internal controls and procedures designed to ensure that we are able to collect the information subject to required disclosure in reports we file with the United States Securities and Exchange Commission, and to process, summarize and disclose this information within the time specified by the rules set forth by the Securities and Exchange Commission.
There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2006March 31, 2007 that materially affected, or are reasonably likely to affect, our internal control over financial reporting.
In the third quarter of 2002, an accident on an Insituform CIPP Process project in Des Moines, Iowa resulted in the death of two workers and the injury of five workers. We fully cooperated with Iowa’s state OSHA in the investigation of the accident. Iowa OSHA issued a Citation and Notification of Penalty in connection with the accident, including several willful citations. Iowa OSHA proposed penalties of $808,250. We challenged Iowa OSHA’s findings, and in the fourth quarter of 2003, an administrative law judge reduced the penalties to $158,000. In the second quarter of 2004, the Iowa Employment Appeal Board reinstated many of the original penalties, ordering total penalties in the amount of $733,750. We appealed the decision of the Employment Appeal Board to the Iowa District Court for Polk County, which, in the first quarter of 2005, reduced the penalties back to $158,000. We appealed the decision of the Iowa District Court and, on February 8, 2006, our appeal was heard by the Iowa Court of Appeals. On March 17, 2006, the Court of Appeals issued its opinion, vacating all citations issued under the general industry standards (all citations except two serious citations) and reducing total penalties to $4,500. Thereafter, the Employment Appeal Board filed a petition for further review with the Iowa Supreme Court, and we filed a resistance to the petition. On September 29, 2006, the Iowa Supreme Court granted the Employment Appeal Board’s petition for further review, and set the case for consideration during the week of December 4, 2006. In a companion action brought by the Employment Appeal Board against the City of Des Moines (events arising out of the Des Moines accident),On February 16, 2007, the Iowa Supreme Court recently reversedissued its ruling, reversing the prior ruling of the Iowa Court of Appeal’s earlier decision, which previously had affirmed the dismissal ofAppeals and reinstating all citations issued under the general industry standards, including several willful citations, and reinstating penalties previously issued againstin the Cityamount of Des Moines. In so reversing,$733,750. Thereafter, we filed a Motion for Reconsideration with the Iowa Supreme Court, reinstated two serious citations and penaltieswhich motion was denied on March 29, 2007. The case will now be remanded back to the District Court for entry of $9,000 againstjudgment consistent with the City of Des Moines. We cannot predict the effect that the recent Iowa Supreme Court ruling will have onCourt’s opinion. We currently are reviewing our pending case before the court.options regarding further judicial review of this matter.
We are involved in certain other actions incidental to the conduct of our business and affairs. Management, after consultation with legal counsel, does not believe that the outcome of any such other litigation will have a material adverse effect on our consolidated financial condition, results of operations or cash flows.