UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one) | |
x | QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 30, 2007 | |
OR | |
o | TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period from ____________ to _____________
Commission file number 1-7567
URS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 94-1381538 |
(State or other jurisdiction of incorporation) | (I.R.S. Employer Identification No.) |
600 Montgomery Street, 26th Floor | |
San Francisco, California | 94111-2728 |
(Address of principal executive offices) | (Zip Code) |
(415) 774-2700
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Securities Exchange Act.
Large accelerated filer xAccelerated filer o Non-Accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class | Outstanding at April 30, 2007 |
Common Stock, $.01 par value | 53,026,749 |
URS CORPORATION AND SUBSIDIARIES
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may be identified by words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “will,” and similar terms used in reference to our future revenues, services and business trends; future accounting policies and tax estimates; future retirement benefit obligations: future legal proceedings; future insurance coverage; future capital resources; future effectiveness of our disclosure and internal controls over financial reporting and future economic and industry conditions. We believe that our expectations are reasonable and are based on reasonable assumptions. However, such forward-looking statements by their nature involve risks and uncertainties. We caution that a variety of factors, including but not limited to the following, could cause our business and financial results to differ materially from those expressed or implied in our forward-looking statements: an economic downturn; changes in our book of business; our compliance with government contract procurement regulations; our ability to procure government contracts; our reliance on government appropriations; the ability of the government to unilaterally terminate our contracts; our ability to make accurate estimates and control costs; our and our partners’ ability to bid on, win, perform and renew contracts and projects; environmental issues and liabilities; liabilities for pending and future litigation; the impact of changes in laws and regulations; our ability to maintain adequate insurance coverage; a decline in defense spending; industry competition; our ability to attract and retain key individuals; employee, agent or partner misconduct; risks associated with changes in equity-based compensation requirements; our leveraged position and ability to service our debt; risks associated with international operations; business activities in high security risk countries; project management and accounting software risks; terrorist and natural disaster risks; our relationships with our labor unions; our ability to protect our intellectual property rights; anti-takeover risks and other factors discussed more fully in Management’s Discussion and Analysis of Financial Condition and Results of Operations beginning on page 26, Risk Factors beginning on page 42, as well as in other reports subsequently filed from time to time with the United States Securities and Exchange Commission. We assume no obligation to revise or update any forward-looking statements.
FINANCIAL INFORMATION: | ||
Consolidated Financial Statements | ||
March 30, 2007 and December 29, 2006 | 2 | |
Three months ended March 30, 2007 and March 31, 2006 | 3 | |
Three months ended March 30, 2007 and March 31, 2006 | 4 | |
5 | ||
26 | ||
40 | ||
40 | ||
OTHER INFORMATION: | ||
41 | ||
42 | ||
52 | ||
53 | ||
53 | ||
53 | ||
54 |
PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
URS CORPORATION AND SUBSIDIARIES
(In thousands, except per share data)
March 30, 2007 | December 29, 2006 | ||||||
ASSETS | |||||||
Current assets: | |||||||
Cash and cash equivalents, including $13,155 and $44,557 of short-term money market funds, respectively | $ | 64,854 | $ | 89,502 | |||
Accounts receivable, including retainage of $37,332 and $37,368, respectively | 609,151 | 680,631 | |||||
Costs and accrued earnings in excess of billings on contracts in process | 606,836 | 552,526 | |||||
Less receivable allowances | (41,515 | ) | (50,458 | ) | |||
Net accounts receivable | 1,174,472 | 1,182,699 | |||||
Deferred tax assets | 35,900 | 36,547 | |||||
Prepaid expenses and other assets | 78,486 | 65,405 | |||||
Total current assets | 1,353,712 | 1,374,153 | |||||
Property and equipment at cost, net | 166,064 | 163,142 | |||||
Goodwill | 990,905 | 989,111 | |||||
Purchased intangible assets, net | 3,589 | 3,839 | |||||
Other assets | 44,318 | 50,784 | |||||
$ | 2,558,588 | $ | 2,581,029 | ||||
LIABILITIES, MINORITY INTEREST, AND STOCKHOLDERS’ EQUITY | |||||||
Current liabilities: | |||||||
Book overdrafts | $ | 31,136 | $ | 3,334 | |||
Current portion of long-term debt | 16,472 | 19,120 | |||||
Accounts payable and subcontractors payable, including retainage of $20,626 and $19,515, respectively | 289,895 | 290,651 | |||||
Accrued salaries and wages | 179,486 | 230,905 | |||||
Accrued expenses and other | 63,836 | 73,704 | |||||
Billings in excess of costs and accrued earnings on contracts in process | 126,109 | 168,271 | |||||
Total current liabilities | 706,934 | 785,985 | |||||
Long-term debt | 151,214 | 149,494 | |||||
Deferred tax liabilities | 16,570 | 17,808 | |||||
Other long-term liabilities | 129,362 | 117,586 | |||||
Total liabilities | 1,004,080 | 1,070,873 | |||||
Commitments and contingencies (Note 5) | |||||||
Minority interest | 5,317 | 3,469 | |||||
Stockholders’ equity: | |||||||
Preferred stock, authorized 3,000 shares; no shares outstanding | — | — | |||||
Common shares, par value $.01; authorized 100,000 shares; 53,004 and 52,309 shares issued, respectively; and 52,952 and 52,257 shares outstanding, respectively | 530 | 523 | |||||
Treasury stock, 52 shares at cost | (287 | ) | (287 | ) | |||
Additional paid-in capital | 989,347 | 973,892 | |||||
Accumulated other comprehensive loss | (2,668 | ) | (3,638 | ) | |||
Retained earnings | 562,269 | 536,197 | |||||
Total stockholders’ equity | 1,549,191 | 1,506,687 | |||||
$ | 2,558,588 | $ | 2,581,029 | ||||
See Notes to Consolidated Financial Statements
URS CORPORATION AND SUBSIDIARIES
(In thousands, except per share data)
Three Months Ended | |||||||
March 30, 2007 | March 31, 2006 | ||||||
Revenues | $ | 1,135,595 | $ | 998,149 | |||
Direct operating expenses | 741,554 | 631,304 | |||||
Gross profit | 394,041 | 366,845 | |||||
Indirect, general and administrative expenses | 336,355 | 319,171 | |||||
Operating income | 57,686 | 47,674 | |||||
Interest expense | 3,940 | 5,135 | |||||
Income before income taxes and minority interest | 53,746 | 42,539 | |||||
Income tax expense | 22,306 | 17,993 | |||||
Minority interest in income of consolidated subsidiaries, net of tax | 1,079 | 358 | |||||
Net income | 30,361 | 24,188 | |||||
Other comprehensive income (loss): | |||||||
Minimum pension liability adjustments, net of tax benefit | — | (2,366 | ) | ||||
Foreign currency translation adjustments | 970 | 44 | |||||
Comprehensive income | $ | 31,331 | $ | 21,866 | |||
Earnings per share (Note 1): | |||||||
Basic | $ | .59 | $ | .48 | |||
Diluted | $ | .58 | $ | .47 | |||
Weighted-average shares outstanding (Note 1): | |||||||
Basic | 51,249 | 50,302 | |||||
Diluted | 52,106 | 51,315 |
See Notes to Consolidated Financial Statements
URS CORPORATION AND SUBSIDIARIES
(In thousands)
Three Months Ended | |||||||
March 30, 2007 | March 31, 2006 | ||||||
Cash flows from operating activities: | |||||||
Net income | $ | 30,361 | $ | 24,188 | |||
Adjustments to reconcile net income to net cash from operating activities: | |||||||
Depreciation and amortization | 9,684 | 9,187 | |||||
Amortization of debt issuance costs | 429 | 461 | |||||
Provision for doubtful accounts | 530 | 4,013 | |||||
Deferred income taxes | (249 | ) | (2,712 | ) | |||
Stock-based compensation | 6,636 | 3,777 | |||||
Excess tax benefits from stock-based compensation | (1,500 | ) | (1,187 | ) | |||
Minority interest in net income of consolidated subsidiaries | 1,079 | 358 | |||||
Changes in assets and liabilities: | |||||||
Accounts receivable and costs and accrued earnings in excess of billings on contracts in process | 434 | (24,619 | ) | ||||
Prepaid expenses and other assets | (7,583 | ) | (5,829 | ) | |||
Accounts payable, accrued salaries and wages and accrued expenses | (48,674 | ) | (64,770 | ) | |||
Billings in excess of costs and accrued earnings on contracts in process | (42,162 | ) | 3,927 | ||||
Distributions from unconsolidated affiliates, net | 5,024 | 15,503 | |||||
Other long-term liabilities | (273 | ) | 2,945 | ||||
Other assets, net | (1,962 | ) | (4,781 | ) | |||
Total adjustments and changes | (78,587 | ) | (63,727 | ) | |||
Net cash from operating activities | (48,226 | ) | (39,539 | ) | |||
Cash flows from investing activities: | |||||||
Capital expenditures, less equipment purchased through capital leases | (4,771 | ) | (5,146 | ) | |||
Net cash from investing activities | (4,771 | ) | (5,146 | ) | |||
Cash flows from financing activities: | |||||||
Long-term debt principal payments | (379 | ) | (11,744 | ) | |||
Net borrowings (payments) under the lines of credit and short-term notes | (4,705 | ) | 3,782 | ||||
Net change in book overdrafts | 27,802 | (11 | ) | ||||
Capital lease obligation payments | (3,296 | ) | (3,058 | ) | |||
Excess tax benefits from stock-based compensation | 1,500 | 1,187 | |||||
Proceeds from employee stock purchase plan and exercise of stock options | 7,427 | 12,650 | |||||
Net cash from financing activities | 28,349 | 2,806 | |||||
Net decrease in cash and cash equivalents | (24,648 | ) | (41,879 | ) | |||
Cash and cash equivalents at beginning of period | 89,502 | 101,545 | |||||
Cash and cash equivalents at end of period | $ | 64,854 | $ | 59,666 | |||
Supplemental information: | |||||||
Interest paid | $ | 5,084 | $ | 4,621 | |||
Taxes paid | $ | 26,378 | $ | 6,129 | |||
Equipment acquired through capital leases | $ | 7,470 | $ | 5,054 |
See Notes to Consolidated Financial Statements
4
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
Overview
The terms “we,” “us,” and “our” used in this quarterly report refer to URS Corporation and its consolidated subsidiaries unless otherwise indicated. We operate through two divisions: the URS Division and the EG&G Division. We offer a comprehensive range of professional planning and design, systems engineering and technical assistance, program and construction management, and operations and maintenance services for transportation, facilities, environmental, homeland security, defense systems, installations and logistics, commercial/industrial, and water/wastewater treatment projects. Headquartered in San Francisco, we operate in more than 20 countries with approximately 29,500 employees providing services to the U.S. federal government, state and local government agencies, and private industry clients in the United States and abroad.
The accompanying unaudited interim consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.
You should read our unaudited interim consolidated financial statements in conjunction with the audited consolidated financial statements and related notes contained in our Annual Report on Form 10-K for the fiscal year ended December 29, 2006. The results of operations for the three months ended March 30, 2007 are not indicative of the operating results for the full year or for future years.
In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all normal recurring adjustments that are necessary for a fair statement of our financial position, results of operations and cash flows for the interim periods presented.
The preparation of our unaudited interim consolidated financial statements in conformity with GAAP necessarily requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenues and costs during the reporting periods. Actual results could differ from those estimates. On an ongoing basis, we review our estimates based on information that is currently available. Changes in facts and circumstances may cause us to revise our estimates.
Principles of Consolidation and Basis of Presentation
Our financial statements include the financial position, results of operations and cash flows of our wholly owned subsidiaries and joint ventures required to be consolidated under Financial Accounting Standards Board Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46(R)”). All intercompany transactions and accounts were eliminated in consolidation. We participate in joint ventures formed for the purpose of bidding, negotiating and executing projects. Sometimes we function as the sponsor or manager of the projects performed by the joint venture. Investments in unconsolidated joint ventures and our equity in their earnings are not material to our consolidated financial statements. Investments in unconsolidated joint ventures are accounted for using the equity method.
5
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (Continued)
Cash and Cash Equivalents/Book Overdrafts
We consider all highly liquid investments with acquisition date maturities of three months or less to be cash equivalents. At March 30, 2007 and December 29, 2006, we had book overdrafts for some of our disbursement accounts. These overdrafts represented transactions that had not cleared the bank accounts at the end of the reporting period. We transferred cash on an as-needed basis to fund these items as they cleared the bank in subsequent periods.
At March 30, 2007 and December 29, 2006, cash and cash equivalents included $14.5 million and $38.7 million, respectively, held and used by our consolidated joint ventures.
Earnings Per Share
Basic earnings per share (“EPS”) is computed by dividing net income available for common stockholders by the weighted-average number of common shares outstanding for the period, excluding unvested restricted stock awards and units. Diluted EPS is computed using the treasury stock method for stock options and unvested restricted stock awards and units. The treasury stock method assumes conversion of all potentially dilutive shares of common stock whereby the proceeds from assumed exercises are used to hypothetically repurchase stock at the average market price for the period. Potentially dilutive shares of common stock outstanding include stock options and unvested restricted stock awards and units, which includes consideration of stock-based compensation required by Statement of Financial Accounting Standards No. 123 (Revised), “Share-Based Payment” (“SFAS 123(R)”). Diluted EPS is computed by dividing net income plus preferred stock dividends, if any, by the weighted-average common shares and potentially dilutive common shares that were outstanding during the period.
In accordance with the disclosure requirements of Statement of Financial Accounting Standards No. 128, “Earnings per Share” (“SFAS 128”), a reconciliation of the numerator and denominator of basic and diluted EPS is provided as follows:
Three Months Ended | |||||||
March 30, 2007 | March 31, 2006 | ||||||
(In thousands, except per share data) | |||||||
Numerator — Basic | |||||||
Net income | $ | 30,361 | $ | 24,188 | |||
Denominator — Basic | |||||||
Weighted-average common stock shares outstanding | 51,249 | 50,302 | |||||
Basic earnings per share | $ | .59 | $ | .48 | |||
Numerator — Diluted | |||||||
Net income | $ | 30,361 | $ | 24,188 | |||
Denominator — Diluted | |||||||
Weighted-average common stock shares outstanding | 51,249 | 50,302 | |||||
Effect of dilutive securities | |||||||
Stock options and restricted stock awards and units | 857 | 1,013 | |||||
52,106 | 51,315 | ||||||
Diluted earnings per share | $ | .58 | $ | .47 |
In our computation of diluted EPS, we excluded the following potential shares of issued and unexercised stock options, and unvested restricted stock awards and units, which have an anti-dilutive effect on EPS.
Three Months Ended | |||||||
March 30, 2007 | March 31, 2006 | ||||||
(In thousands) | |||||||
Shares of anti-dilutive stock options and unvested restricted stock awards and units | 1,019 | 2 |
Adopted and Recently Issued Statements of Financial Accounting Standards
We adopted the Financial Accounting Standards Board's Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109,” (“FIN 48”), effective December 30, 2006, which is the beginning of our 2007 fiscal year. FIN 48 prescribes a recognition threshold and measurement process for recording, as liabilities in the financial statements, uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 establishes rules for recognition or de-recognition and measurement and classification of such liabilities; accruals of interest and penalties; accounting for changes in judgment in interim periods; and disclosure requirements for uncertain tax positions. Under FIN 48, we must recognize the impact of an uncertain income tax position on the income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. FIN 48 requires that we report the cumulative effect of applying the interpretation as an adjustment to the beginning balance of retained earnings as of December 30, 2006. A more detailed discussion of the effect of the adoption of FIN 48 is included in Note 8, “Income Taxes.”
In June 2006, the Financial Accounting Standards Board (“FASB”) ratified Emerging Issues Task Force No. 06-3 (“EITF 06-3”), “How Taxes Collected from Customers and Remitted to Governmental Authorities should be Presented in the Income Statement.” The pronouncement addresses disclosure requirements for taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction between a seller and a customer, and may include, but are not limited to, sales, use, value added, certain excise taxes and some industry-specific taxes. A consensus was reached that entities may adopt a policy of presenting these taxes in the income statement on either a gross or a net basis. If such taxes are significant, EITF 06-3 requires disclosure of the accounting method in the accounting policy section of the notes to the financial statements, and if not presented on a net basis, then the amount of such taxes that are recognized on a gross basis must be disclosed. We adopted EITF 06-3 on our effective date of December 30, 2006. We present revenues net of sales and value-added taxes in our results of operations. The amount of taxes we collected from our customers and remitted to governmental authorities are immaterial to our consolidated revenues.
In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurement,” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. It is effective for us beginning in fiscal year 2008. We are currently in the process of determining the effect that the adoption of this statement will have on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, “Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans,” (“SFAS 158”). This statement requires (1) recognition on the balance sheet of an asset for a defined benefit plan’s overfunded status or a liability for such a plan’s underfunded status, (2) measurement of a defined benefit plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year, and (3) recognition, as a component of other comprehensive income, the changes in a defined benefit plan’s funded status that are not recognzied as components of net perioidc benefit cost. We adopted the recognition and disclosure provisions of SFAS 158, effective on December 29, 2006, which was the end of our fiscal year 2006. The requirement to measure our defined benefit plan assets and benefit obligations as of the date of our fiscal year-end will be effective for us for the fiscal year ending in December 2008.
Property and Equipment
Property and equipment consists of the following:
March 30, 2007 | December 29, 2006 | ||||||
(In thousands) | |||||||
Equipment | $ | 178,867 | $ | 174,996 | |||
Furniture and fixtures | 23,197 | 22,729 | |||||
Leasehold improvements | 48,807 | 47,431 | |||||
Construction in progress | 6,651 | 8,897 | |||||
257,522 | 254,053 | ||||||
Accumulated depreciation and amortization | (146,028 | ) | (140,271 | ) | |||
111,494 | 113,782 | ||||||
Capital leases (1) | 126,962 | 118,196 | |||||
Accumulated amortization | (72,392 | ) | (68,836 | ) | |||
54,570 | 49,360 | ||||||
Property and equipment at cost, net | $ | 166,064 | $ | 163,142 |
(1) Our capital leases consist primarily of equipment, and furniture and fixtures.
As of March 30, 2007 and March 31, 2006, we capitalized internal-use software development costs of $68.1 million and $61.7 million, respectively. We amortize the capitalized software costs using the straight-line method over an estimated useful life of ten years.
We depreciate property and equipment using the following estimated useful lives:
Estimated Useful Life | |
Equipment | 4 - 10 years |
Capital leases | 3 - 10 years |
Furniture and fixtures | 5 - 10 years |
Leasehold improvements | 6 months - 20 years |
Depreciation expense related to property and equipment was $9.4 million and $8.8 million for the three months ended March 30, 2007 and March 31, 2006, respectively.
Amortization expense related to purchased intangible assets was $0.3 million and $0.4 million for the three months ended March 30, 2007 and March 31, 2006, respectively.
8
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (Continued)
NOTE 3. EMPLOYEE RETIREMENT PLANS
Executive Plan
During December 2006, we entered into a new employment agreement with our Chief Executive Officer (“CEO”), which included an amended and restated Supplemental Executive Retirement Agreement (the “Executive Plan”) to provide the CEO with an annual lifetime retirement benefit and other benefits. The Executive Plan benefits are based on the CEO's “final average annual compensation,” which is the sum of the CEO's base salary plus target bonus established for him under our incentive compensation program during a consecutive 36-month period in his final 60 months of employment in which the average was the highest, but, solely for purposes of the calculations, the base salary shall not be higher than $950,000 nor shall the target bonus be higher than 120% of the base salary.
Under the terms of the Executive Plan, we are obligated to fund into a rabbi trust the lump sum value of the Executive Plan benefits within 15-days of the earlier of (1) a request by the CEO or (2) the termination of the CEO’s employment for any reason, including death. The components of our net periodic pension costs related to the Executive Plan for the three months ended March 30, 2007 and March 31, 2006 were as follows:
Three Months Ended | |||||||
March 30, 2007 | March 31, 2006 | ||||||
(In thousands) | |||||||
Amortization of net (gain)/loss | $ | (2 | ) | $ | 8 | ||
Service cost | 172 | — | |||||
Interest cost | 153 | 140 | |||||
Net periodic benefit cost | $ | 323 | $ | 148 |
Radian SERP and SCA
The URS Division maintains two non-qualified defined benefit plans, a supplemental executive retirement plan and a salary continuation agreement (the “Radian SERP and SCA”), which were acquired as part of the Dames & Moore Group, Inc. acquisition in 1999. Their purpose is to supplement the retirement benefits provided by other benefit plans upon the participants attaining minimum age and years of service requirements. The components of our net periodic pension costs related to the Radian SERP and SCA for the three months ended March 30, 2007 and March 31, 2006 were as follows:
Three Months Ended | |||||||
March 30, 2007 | March 31, 2006 | ||||||
(In thousands) | |||||||
Amortization of net loss | $ | 17 | $ | 17 | |||
Service cost | 1 | — | |||||
Interest cost | 154 | 157 | |||||
Net periodic benefit cost | $ | 172 | $ | 174 |
9
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (Continued)
Final Salary Pension Fund
As part of the acquisition of the Dames & Moore Group, Inc., we assumed the Dames & Moore United Kingdom Final Salary Pension Fund (the “Final Salary Pension Fund”). The components of our net periodic pension costs relating to the Final Salary Pension Fund for the three months ended March 30, 2007 and March 31, 2006 were as follows:
Three Months Ended | |||||||
March 30, 2007 | March 31, 2006 | ||||||
(In thousands) | |||||||
Service cost (1) | $ | — | $ | 187 | |||
Interest cost | 277 | 217 | |||||
Expected return on plan assets | (127 | ) | (101 | ) | |||
Amortization of: | |||||||
Transition obligation | — | 20 | |||||
Net loss | 48 | 45 | |||||
Net periodic benefit cost (2) | $ | 198 | $ | 368 |
(1) | Pursuant to a formal curtailment plan effective in December 2006, we eliminated the accrual of defined benefits for all future services and therefore, we incurred no service costs related to the Final Salary Pension Fund for the three months ended March 30, 2007. |
(2) | We used the current rate method in translating our net periodic pension costs to the US dollar. |
We expect to make cash contributions during fiscal year 2007 of approximately $0.5 million to the Final Salary Pension Fund.
EG&G Pension Plan and Post-retirement Medical Plan
The EG&G Division maintains a defined benefit pension plan (the “EG&G pension plan”) and post-retirement medical plan (the “EG&G post-retirement medical plan”). These plans cover some of the EG&G Division’s hourly and salaried employees as well as the EG&G employees of a joint venture in which the EG&G Division participates.
10
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (Continued)
EG&G Pension Plan
The components of our net periodic pension costs relating to the EG&G pension plan for the three months ended March 30, 2007 and March 31, 2006 were as follows:
Three Months Ended | |||||||
March 30, 2007 | March 31, 2006 | ||||||
(In thousands) | |||||||
Service cost | $ | 1,750 | $ | 1,825 | |||
Interest cost | 2,500 | 2,350 | |||||
Expected return on plan assets | (2,850 | ) | (2,300 | ) | |||
Amortization of: | |||||||
Prior service cost | (525 | ) | (525 | ) | |||
Net loss | 250 | 425 | |||||
Net periodic benefit cost | $ | 1,125 | $ | 1,775 |
During the three months ended March 30, 2007, we made cash contributions of $1.7 million to the EG&G pension plan for the 2007 plan year. We currently expect to make additional cash contributions of approximately $6.3 million to the EG&G pension plan for the remaining quarters of 2007.
EG&G Post-retirement Medical Plan
The components of our net periodic pension costs relating to the EG&G post-retirement medical plan for the three months ended March 30, 2007 and March 31, 2006 were as follows:
Three Months Ended | |||||||
March 30, 2007 | March 31, 2006 | ||||||
(In thousands) | |||||||
Service cost | $ | 65 | $ | 75 | |||
Interest cost | 79 | 76 | |||||
Expected return on plan assets | (75 | ) | (59 | ) | |||
Amortization of: | |||||||
Net loss | 10 | — | |||||
Net periodic benefit cost | $ | 79 | $ | 92 |
11
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (Continued)
NOTE 4. LONG-TERM DEBT
Long-term debt consists of the following:
March 30, 2007 | December 29, 2006 | ||||||
(In thousands) | |||||||
Bank term loans | $ | 114,000 | $ | 114,000 | |||
Obligations under capital leases | 50,864 | 46,688 | |||||
Notes payable, foreign credit lines and other indebtedness | 2,822 | 7,926 | |||||
Total current and long-term debt | 167,686 | 168,614 | |||||
Less: | |||||||
Current portion of long-term debt | — | 4,704 | |||||
Current portion of notes payable, foreign credit lines and other indebtedness | 1,301 | 1,647 | |||||
Current portion of capital leases | 15,171 | 12,769 | |||||
Long-term debt | $ | 151,214 | $ | 149,494 |
Credit Facility
All loans outstanding under our Credit Facility bear interest at either LIBOR or our bank’s base rate plus an applicable margin, at our option. The applicable margin will change based upon our credit rating as reported by Moody’s Investor Services and Standard & Poor’s. The LIBOR margins range from 0.625% to 1.75% and the base rate margins range from 0.0% to 0.75%. As of March 30, 2007 and December 29, 2006, the LIBOR margin was 1.00% for both the term loan and revolving line of credit. As of March 30, 2007 and December 29, 2006, the interest rates on our term loan were 6.35% and 6.36%, respectively.
As of March 30, 2007, we were in compliance with all of the covenants of our Credit Facility.
Revolving Line of Credit
Three Months Ended March 30, 2007 | Year Ended December 29, 2006 | ||||||
(In millions, except percentages) | |||||||
Effective average interest rates paid on the revolving line of credit | 8.2 | % | 7.6 | % | |||
Average daily revolving line of credit balances | $ | 6.9 | $ | 0.4 | |||
Maximum amounts outstanding at any one point | $ | 40.3 | $ | 21.8 | |||
Other Indebtedness
Notes payable, foreign credit lines and other indebtedness. As of March 30, 2007 and December 29, 2006, we had outstanding amounts of $2.8 million and $7.9 million, respectively, in notes payable and foreign lines of credit. Notes payable consists primarily of notes used to finance the purchase of office equipment, computer equipment and furniture. The weighted average interest rates of these notes were approximately 6.9% and 6.1% as of March 30, 2007 and December 29, 2006, respectively.
We maintain foreign lines of credit, which are collateralized by the assets of our foreign subsidiaries and in some cases, parent guarantees. As of March 30, 2007, we had $13.8 million in lines of credit available under these facilities, with no amount outstanding. As of December 29, 2006, we had $13.8 million in lines of credit available under these facilities, with $4.6 million outstanding. The interest rate was 6.2% as of December 29, 2006.
Capital Leases. As of March 30, 2007 and December 29, 2006, we had $50.9 million and $46.7 million in obligations under our capital leases, respectively, consisting primarily of leases for office equipment, computer equipment and furniture.
Maturities
As of March 30, 2007, the amounts of our long-term debt outstanding (excluding capital leases) that mature in the next five years and thereafter, are as follows:
(In thousands) | ||||
Less than one year | $ | 1,301 | ||
Second year | 9,034 | |||
Third year | 20,340 | |||
Fourth year | 48,868 | |||
Fifth year | 37,191 | |||
Thereafter | 88 | |||
$ | 116,822 |
In the ordinary course of business, we are subject to certain contractual guarantees and governmental audits or investigations. We are also involved in various legal proceedings that are pending against us and our subsidiaries alleging, among other things, breach of contract or tort in connection with the performance of professional services, the various outcomes of which cannot be predicted with certainty. We are including information regarding the following proceedings in particular:
· | Saudi Arabia: One of our subsidiaries, LSI provided aircraft maintenance support services on F-5 aircraft under contracts (the “F-5 Contract”) with a Saudi Arabian government ministry (the “Ministry”). LSI completed its operational performance under the F-5 Contract in November 2000 and the Ministry has yet to pay a $12.2 million account receivable owed to LSI. In addition, in 2004, the Ministry directed payment of a performance bond outstanding under the F-5 contract for approximately $5.6 million. The following legal proceedings ensued: |
13
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (Continued)
Two Saudi Arabian landlords have pursued claims over disputed rents in Saudi Arabia. The Saudi Arabian landlord of the Al Bilad complex received a judgment in Saudi Arabia against LSI for $7.9 million. During the quarter ended March 30, 2007, Al Bilad received payment of this judgment out of the $12.2 million receivable held by the Ministry. As a result, we have reduced both our receivable and a reserve against the Saudi Arabian judgment regarding the Al Bilad complex to reflect the payment made by the Ministry. Another landlord has obtained a judgment in Saudi Arabia against LSI for $1.2 million and LSI successfully appealed this decision in June 2005 in Saudi Arabia, which was remanded for future proceedings. We continue to review our legal position and strategy regarding these judgments.
LSI is involved in a dispute relating to a tax assessment issued by the Saudi Arabian taxing authority (“Zakat”) against LSI of approximately $5.1 million for the years 1999 through 2002. LSI disagreed with the Zakat assessment and on June 6, 2006, the Zakat and Tax Preliminary Appeal Committee ruled partially in favor of LSI by reducing the tax assessment to approximately $2.2 million. LSI has appealed the decision of the Zakat and Tax Preliminary Appeal Committee in an effort to eliminate or further reduce the assessment, and, as a part of that appeal, posted a bond in the full amount of the remaining tax assessment. LSI will continue to defend this matter vigorously.
In November 2004, LSI filed suit against the Ministry in the United States District Court for the Western District of Texas. The suit seeks damages for, among other things, intentional interference with commercial relations caused by the Ministry's wrongful demand of the performance bond; breach of the F-5 Contract; unjust enrichment and promissory estoppel, and seeks payment of the $12.2 million account receivable. In March 2005, the Ministry filed a motion to dismiss, which the District Court denied. In November 2005, the Ministry filed another motion to dismiss, to which the District Court responded by ordering the parties to conduct further discovery, which is ongoing. On April 12, 2007, the Ministry filed a supplemental brief in support of its motion to dismiss. LSI intends to continue to pursue this matter vigorously.
· | Lebanon: Our 1999 acquisition of Dames and Moore Group, Inc. included the acquisition of a wholly owned subsidiary, Radian International, LLC (“Radian”). Prior to the acquisition, Radian entered into a contract with the Lebanese Company for the Development and Reconstruction of Beirut Central District, S.A.L (“Solidere”). Under the contract, Radian was to provide environmental remediation services at the Normandy Landfill site located in Beirut, Lebanon (the “Normandy Project”). Radian subcontracted a portion of these services to Mouawad - Edde SARL. The contract with Solidere required the posting of a Letter of Guarantee, which was issued by Saradar Bank, Sh.M.L. ("Saradar") for $8.5 million. Solidere drew upon the full value of the Letter of Guarantee. The contract also provided for the purchase of project-specific insurance. The project-specific insurance policy was issued by Alpina Insurance Company ("Alpina"). |
Radian and Solidere initially sought to resolve their disputes through arbitration proceedings before the International Chamber of Commerce (“ICC”). Solidere alleges that Radian’s activities and services resulted in the production of chemical and biological pollutants, including methane gas, at the Normandy Project. In July 2004, an ICC arbitration panel ruled against Radian. Among other things, the ICC ordered Radian to: i) prepare a plan to remediate the production of methane gas at the Normandy Site; and, ii) pay approximately $2.4 million in attorney fees and other expenses. The ICC also authorized Solidere to withhold project payments.
14
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (Continued)
Since the July 2004 ruling, numerous other legal actions have been initiated. On January 20, 2006, Radian initiated a new ICC arbitration proceeding against Solidere alleging, in part, that Solidere's lack of cooperation prevented Radian from complying with the July 2004 ruling. In response to Radian’s January 20, 2006 filing, Solidere terminated Radian's contract and, on February 13, 2006, initiated a separate ICC arbitration proceeding against both Radian and URS Corporation, a Delaware corporation (DE), the indirect parent of Radian, claiming that URS Corporation (DE) is responsible for Radian’s liabilities since both entities operated as a single economic enterprise. Solidere’s February 13, 2006 filing seeks to recover the costs to remediate the Normandy Site, damages resulting from delays in project completion, and past and future legal costs. On February 20, 2006, Radian amended its January 20, 2006 filing to include Solidere's unwarranted termination of Radian's contract.
On June 30, 2006, URS Corporation (DE) filed a separate complaint in the United States District Court for the District of Delaware seeking to enjoin Solidere’s attempt to include URS Corporation (DE) as a party in the arbitration before the ICC because Radian is maintained as a distinct legal entity separate from URS Corporation (DE) and therefore URS Corporation (DE) is not responsible for any of Radian’s liabilities.
On June 28, 2006, Mouawad - Edde SARL, filed a request for arbitration (to which we responded) with the ICC against Radian and URS Corporation seeking to recover $22 million for its alleged additional costs. Mouawad - Edde SARL alleges that it is entitled to a sizable increase in the value of its subcontract for additional work it claims to have performed on the Normandy Project.
In July 2004, Saradar filed a claim for reimbursement in the First Court in Beirut, Lebanon, to recover the $8.5 million paid on the Letter of Guarantee from Radian and co-defendant Wells Fargo Bank, N.A. Saradar alleges that it is entitled to reimbursement for the amount paid on the Letter of Guarantee. In February 2005, Radian responded to Saradar’s claim by filing a Statement of Defense. In April 2005, Saradar also filed a reimbursement claim against Solidere. Radian contends that it is not obligated to reimburse Saradar. The matter is currently under submission by the First Court in Beirut. The current instability in Lebanon may delay the Court’s ruling.
In October 2004, Alpina notified Radian of a denial of insurance coverage. Radian filed a breach of contract and bad faith claim against Alpina in the United States District Court for the Northern District of California in October 2004 seeking declaratory relief and monetary damages. In July 2005, Alpina responded to Radian’s claim by filing a motion to dismiss based on improper venue, which the District Court granted. The District Court’s decision, however, did not consider the underlying merits of Radian’s claim and Radian appealed the matter to the United States Court of Appeals for the Ninth Circuit in September 2005. Radian continues discussions with Alpina and its other insurance carriers to resolve the matter.
In December 2006, Zurich Insurance Company (“Zurich”), as successor in interest to Alpina, American International Specialty Lines Insurance Company (“AISLIC”), Radian, and URS Corporation, finalized a settlement agreement in which Zurich and AISLIC agreed to fund a substantial portion of the cost of defending some of the claims filed by Solidere in the ICC arbitration.
As of March 30, 2007, Solidere had withheld project payments owed to Radian amounting to $10.1 million. We have recorded this amount as accounts receivable and retainage. In addition, we recorded $5.6 million in consolidated costs and accrued earnings in excess of billings on contracts in process.
Radian will vigorously continue to pursue its claims against Solidere and Alpina. Radian and URS Corporation will also continue to defend vigorously the claims asserted against them.
· | Tampa-Hillsborough County Expressway Authority: In 1999, URS Corporation Southern, a wholly owned subsidiary, entered into an agreement ("Agreement") with the Tampa-Hillsborough County Expressway Authority (the “Authority”) to provide foundation design, project oversight and other services in connection with the construction of the Lee Roy Selmon Elevated Expressway structure (the “Expressway”) in Tampa, Florida. Also, URS Holdings, Inc., a wholly owned subsidiary, entered into a subcontract agreement with an unrelated third party to provide geotechnical services in connection with the construction of roads to access the Expressway. In 2004, during construction of the elevated structure, one pier subsided substantially, causing significant damage to a segment of the elevated structure, though no significant injuries occurred as a result of the incident. The Authority has completed remediation of the Expressway. |
In October 2005, the Authority filed a lawsuit in the Thirteenth Judicial Circuit of Florida against URS Corporation Southern, URS Holdings, Inc. and an unrelated third party, alleging breach of contract and professional negligence resulting in damages to the Authority exceeding $120 million. Sufficient information is not currently available to assess liabilities associated with the remediation. In April 2006, the Authority's Builder's Risk insurance carrier, Westchester Surplus Lines Insurance Company ("Westchester"), filed a subrogation action against URS Corporation Southern in the Thirteenth Judicial Circuit of Florida for $2.9 million that Westchester has paid to the Authority and for any future amounts paid by Westchester for claims which the Authority has submitted for losses caused by the subsidence of the pier. URS Corporation Southern removed Westchester's lawsuit to United States District Court for the Middle District of Florida and filed multiple counterclaims against Westchester for insurance coverage under the Westchester policy.
One of URS Corporation Southern’s and URS Holding Inc’s excess insurance carriers, Arch Specialty Insurance Company (“Arch”), which was responsible for $15 million in excess coverage, has informed URS Corporation Southern and URS Holdings, Inc, that they believe the initial notice of claim provided by our insurance broker was untimely under the Arch excess policies. URS Corporation Southern and URS Holdings, Inc, rejected Arch’s position.
URS Corporation Southern and URS Holdings, Inc. will continue to defend this matter vigorously.
· | Rocky Mountain Arsenal: In January 2002, URS Group, Inc., a wholly owned subsidiary, was awarded a contract by Foster Wheeler Environmental, Inc., to perform, among other things, foundation demolition and remediation of contaminated soil at the Rocky Mountain Arsenal in Colorado. URS Group, Inc. believes that contractual misrepresentations resulted in contract cost overruns in excess of $10.0 million, of which $4.4 million is included in our costs and accrued earnings in excess of billings on contracts in process. In October 2004, URS Group, Inc. filed a complaint asserting a breach of contract seeking recovery of the cost overruns against Foster Wheeler Environmental, and Tetra Tech FW, Inc. both subsidiaries of Tetra Tech, Inc. (“Tetra”), in District Court for the County of Denver in the State of Colorado. In June 2006, a $1.1 million judgment was issued by the District Court against Tetra on the matter. However, URS Group, Inc. believes that the recent judgment, even though issued in its favor, did not adequately address the underlying merits of URS Group Inc.’s claims and therefore, URS Group, Inc. appealed the recent judgment to the Colorado Court of Appeals in June 2006. URS Group, Inc. intends to continue to vigorously attempt to collect the contract cost overruns of $10.0 million. |
Currently, we have limits of $125.0 million per loss and $125.0 million in the aggregate for general liability, professional errors and omissions liability and contractor’s pollution liability insurance (in addition to other policies for some specific projects). The general liability policy includes a self-insured claim retention of $4.0 million (or $10.0 million in some circumstances). The professional errors and omissions liability and contractor’s pollution liability insurance policies each include a self-insured claim retention amount of $10.0 million. Parties may seek damages that substantially exceed our insurance coverage.
Excess insurance policies above our primary policy limits provide for coverages on a “claims made” basis, covering only claims actually made and reported during the policy period currently in effect. Thus, if we do not continue to maintain these policies, we will have no coverage for claims made after the termination date even for claims based on events that occurred during the term of coverage. While we intend to maintain these policies, we may be unable to maintain existing coverage levels. We have maintained insurance without lapse for many years with limits in excess of losses sustained.
Although the outcome of our contingencies cannot be predicted with certainty and no assurances can be provided, based on our previous experience in such matters, we do not believe that the resolution of the matters described above and any of our contingencies described above, individually or collectively, are likely to materially exceed established loss accrual, or otherwise be material to our consolidated financial position. However, the resolution of outstanding contingencies is subject to inherent uncertainty and it is reasonably possible that such resolution could have an adverse effect on us.
As of March 30, 2007, we had the following guarantee obligations and commitments:
We have guaranteed the credit facility of one of our joint ventures, in the event of a default by the joint venture. This joint venture was formed in the ordinary course of business to perform a contract for the federal government. The term of the guarantee is equal to the remaining term of the underlying credit facility, which will expire on September 30, 2007. The amount of the guarantee was $9.5 million at March 30, 2007.
As of March 30, 2007, the amount of the guarantee used to collateralize the credit facility of our UK operating subsidiary and bank guarantee lines of our European subsidiaries was $9.8 million.
We also maintain a variety of commercial commitments that are generally made to support provisions of our contracts. In addition, in the ordinary course of business, we provide letters of credit to clients and others against advance payments and to support other business arrangements. We are required to reimburse the issuers of letters of credit for any payments they make under the letters of credit.
From time to time, we may provide guarantees related to our services or work. If our services under a guaranteed project are later determined to have resulted in a material defect or other material deficiency, then we may be responsible for monetary damages or other legal remedies. When sufficient information about claims on guaranteed projects is available and monetary damages or other costs or losses are determined to be probable, we recognize such guarantee losses. Currently, we have no material guarantee claims for which losses have been recognized.
We have an agreement to indemnify one of our joint venture lenders up to $25.0 million for any potential losses, damages, and liabilities associated with lawsuits in relation to general and administrative services we provide to the joint venture. Currently, we have no indemnified claims.
NOTE 6. SEGMENT AND RELATED INFORMATION
We operate our business through two segments: the URS Division and the EG&G Division. Our URS Division provides a comprehensive range of professional planning and design, program and construction management, and operations and maintenance services to the U.S. federal government, state and local government agencies, and private industry clients in the United States and internationally. Our EG&G Division provides planning, systems engineering and technical assistance, operations and maintenance, and program management services to various U.S. federal government agencies, primarily the Departments of Defense and Homeland Security.
These two segments operate under separate management groups and produce discrete financial information. Management also reviews the operating results of these two segments separately. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. The information disclosed in our consolidated financial statements is based on the two segments that comprise our current organizational structure.
The following table presents summarized financial information of our reportable segments. “Eliminations” in the following tables include elimination of inter-segment sales and elimination of investments in subsidiaries. The segment balance sheet information presented below is included only for informational purposes. We do not allocate resources or measure performance based upon the balance sheet amounts of individual segments. Our long-lived assets primarily consist of our property and equipment.
March 30, 2007 | ||||||||||
Net Accounts Receivable | Property and Equipment at Cost, Net | Total Assets | ||||||||
(In thousands) | ||||||||||
URS Division | $ | 895,252 | $ | 147,903 | $ | 1,209,415 | ||||
EG&G Division | 279,220 | 14,101 | 308,660 | |||||||
1,174,472 | 162,004 | 1,518,075 | ||||||||
Corporate | — | 4,060 | 1,766,052 | |||||||
Eliminations | — | — | (725,539 | ) | ||||||
Total | $ | 1,174,472 | $ | 166,064 | $ | 2,558,588 |
December 29, 2006 | ||||||||||
Net Accounts Receivable | Property and Equipment at Cost, Net | Total Assets | ||||||||
(In thousands) | ||||||||||
URS Division | $ | 908,038 | $ | 145,732 | $ | 1,229,156 | ||||
EG&G Division | 274,661 | 13,173 | 306,336 | |||||||
1,182,699 | 158,905 | 1,535,492 | ||||||||
Corporate | — | 4,237 | 1,699,534 | |||||||
Eliminations | — | — | (653,997 | ) | ||||||
Total | $ | 1,182,699 | $ | 163,142 | $ | 2,581,029 |
Three Months Ended March 30, 2007 | ||||||||||
Revenues | Inter-segment Revenues | Consolidated | ||||||||
(In thousands) | ||||||||||
URS Division | $ | 791,561 | $ | 1,812 | $ | 793,373 | ||||
EG&G Division | 344,034 | 973 | 345,007 | |||||||
Eliminations | — | (2,785 | ) | (2,785 | ) | |||||
1,135,595 | — | 1,135,595 | ||||||||
Corporate | — | — | — | |||||||
Total | $ | 1,135,595 | $ | — | $ | 1,135,595 |
Three Months Ended March 31, 2006 | ||||||||||
Revenues | Inter-segment Revenues | Consolidated | ||||||||
(In thousands) | ||||||||||
URS Division | $ | 638,247 | $ | 5,140 | $ | 643,387 | ||||
EG&G Division | 359,902 | 455 | 360,357 | |||||||
Eliminations | — | (5,595 | ) | (5,595 | ) | |||||
998,149 | — | 998,149 | ||||||||
Corporate | — | — | — | |||||||
Total | $ | 998,149 | $ | — | $ | 998,149 |
We define segment contribution as total segment operating income (which is net income before income taxes and interest expense) before allocation of various segment expenses, including stock-based compensation expenses.
Three Months Ended March 30, 2007 | |||||||
Contribution | Depreciation and Amortization | ||||||
(In thousands) | |||||||
URS Division | $ | 57,964 | $ | 8,485 | |||
EG&G Division | 17,167 | 954 | |||||
Eliminations | (223 | ) | — | ||||
74,908 | 9,439 | ||||||
Corporate | (17,222 | ) | 245 | ||||
Total | $ | 57,686 | $ | 9,684 |
Three Months Ended March 31, 2006 | |||||||
Contribution | Depreciation and Amortization | ||||||
(In thousands) | |||||||
URS Division | $ | 44,880 | $ | 7,905 | |||
EG&G Division | 16,007 | 1,038 | |||||
Eliminations | (354 | ) | — | ||||
60,533 | 8,943 | ||||||
Corporate | (12,859 | ) | 244 | ||||
Total | $ | 47,674 | $ | 9,187 |
We define our segment operating income (loss) as total segment net income, before income tax and interest expense. Our long-lived assets primarily consist of our property and equipment. As a result of adopting SFAS123(R) at the beginning of fiscal year 2006, we recorded stock compensation as a corporate expense. A reconciliation of segment contribution to segment operating income for the three months ended March 30, 2007 and March 31, 2006 is as follows:
19
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (Continued)
Three Months Ended March 30, 2007 | ||||||||||||||||
URS Division | EG&G Division | Corporate | Eliminations | Consolidated | ||||||||||||
(In thousands) | ||||||||||||||||
Contribution | $ | 57,964 | $ | 17,167 | $ | (17,222 | ) | $ | (223 | ) | $ | 57,686 | ||||
Unallocated SFAS 123(R) expenses | (2,640 | ) | (522 | ) | 3,162 | — | — | |||||||||
Other miscellaneous unallocated expenses | (57 | ) | (405 | ) | 462 | — | — | |||||||||
Operating income (loss) | $ | 55,267 | $ | 16,240 | $ | (13,598 | ) | $ | (223 | ) | $ | 57,686 |
Three Months Ended March 31, 2006 | ||||||||||||||||
URS Division | EG&G Division | Corporate | Eliminations | Consolidated | ||||||||||||
(In thousands) | ||||||||||||||||
Contribution | $ | 44,880 | $ | 16,007 | $ | (12,859 | ) | $ | (354 | ) | $ | 47,674 | ||||
Unallocated SFAS 123(R) expenses | (2,415 | ) | (457 | ) | 2,872 | — | — | |||||||||
Other miscellaneous unallocated expenses | (133 | ) | (229 | ) | 362 | — | — | |||||||||
Operating income (loss) | $ | 42,332 | $ | 15,321 | $ | (9,625 | ) | $ | (354 | ) | $ | 47,674 |
Geographic areas
Our revenues, and property and equipment at cost, net of accumulated depreciation by geographic areas are shown below.
Three Months Ended | |||||||
March 30, 2007 | March 31, 2006 | ||||||
(In thousands) | |||||||
Revenues | |||||||
United States | $ | 1,027,257 | $ | 905,693 | |||
International | 114,589 | 94,191 | |||||
Eliminations | (6,251 | ) | (1,735 | ) | |||
Total revenues | $ | 1,135,595 | $ | 998,149 |
No individual foreign country contributed more than 10% of our consolidated revenues for the three months ended March 30, 2007 and March 31, 2006.
March 30, 2007 | December 29, 2006 | ||||||
(In thousands) | |||||||
Property and equipment at cost, net | |||||||
United States | $ | 145,367 | $ | 142,709 | |||
International | 20,697 | 20,433 | |||||
Total property and equipment at cost, net | $ | 166,064 | $ | 163,142 |
Major Customers
We have multiple contracts with the U.S. Army, which collectively contributed more than 10% of our total consolidated revenues; however, we are not dependent on any single contract on an ongoing basis, and the loss of any contract would not have a material adverse effect on our business.
URS Division | EG&G Division | Total | ||||||||
(In millions) | ||||||||||
Three months ended March 30, 2007 | ||||||||||
The U.S. Army (1) | $ | 30.4 | $ | 174.8 | $ | 205.2 | ||||
Three months ended March 31, 2006 | ||||||||||
The U.S. Army (1) | $ | 27.9 | $ | 183.5 | $ | 211.4 |
(1) | The U.S. Army includes the U.S. Army Corps of Engineers. |
NOTE 7. STOCK-BASED COMPENSATION AND STOCK REPURCHASE PROGRAM
We recognize stock-based compensation expense, net of estimated forfeitures, over the service periods of the stock-based compensation awards on a straight-line basis in indirect, general, and administrative (“IG&A”) expenses of our Consolidated Statements of Operations and Comprehensive Income. We used the Black-Scholes option-pricing model to measure the estimated fair value of stock-based option awards issued under our Stock Incentive Plans and our Employee Stock Purchase Plan (“ESPP”). We allocated our stock-based compensation expenses entirely to IG&A expenses because the proportional expenses that would otherwise have been allocated to direct costs are not material. Stock option awards expire ten years from the date of grant. Stock options, restricted stock awards, and restricted stock units vest over service periods that range from three to four years. SFAS 123(R) requires the estimation of forfeitures at the time of grant and then a re-measurement at least annually in order to estimate the amount of share-based awards that will ultimately vest. We estimate the forfeiture rate based on our historical experience.
21
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (Continued)
The following table presents our stock-based compensation expenses related to stock options, restricted stock awards and units, and the related income tax benefits recognized for the three months ended March 30, 2007 and March 31, 2006.
Three Months Ended | |||||||
March 30, 2007 | March 31, 2006 | ||||||
(In millions) | |||||||
Stock-based compensation expenses: | |||||||
Restricted stock awards and units | $ | 5.7 | $ | 1.7 | |||
Stock options | 0.9 | 2.1 | |||||
Stock-based compensation expenses | $ | 6.6 | $ | 3.8 | |||
Total income tax benefits recognized in our net income related to stock-based compensation expenses | $ | 2.6 | $ | 1.1 |
Restricted Stock Awards and Units
In light of the impact associated with the adoption of SFAS 123(R), since its adoption, we have issued only restricted stock awards and units, rather than stock options, to selected employees in order to minimize the volatility of our stock-based compensation expense. Restricted stock awards and units generally vest over service periods that range from three to four years. Beginning in fiscal year 2006, we also awarded restricted stock awards and units with both a service vesting condition and a performance vesting condition. The performance vesting condition was determined based on the achievement of annual financial targets established at the beginning of the fiscal year.
We continue to record compensation expense related to restricted stock awards and units over the applicable vesting periods as required previously under APB 25 and now under SFAS 123(R). We measured such compensation expense at the fair market value of the restricted stock awards and units at the grant date. As of March 30, 2007, we had unrecognized stock-based compensation expense of $61.5 million related to non-vested restricted stock awards and units. A summary of the status and changes of our non-vested restricted stock awards and units, according to their contractual terms, as of March 30, 2007 and during the three months ended March 30, 2007 is presented below:
Three Months Ended March 30, 2007 | |||||||
Shares | Weighted-Average Grant Date Fair Value | ||||||
Non-vested at December 29, 2006 | 1,342,018 | $ | 41.68 | ||||
Granted | 454,702 | $ | 43.15 | ||||
Vested | (65,793 | ) | $ | 42.04 | |||
Forfeited | (10,269 | ) | $ | 42.63 | |||
Non-vested at March 30, 2007 | 1,720,658 | $ | 42.05 |
22
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (Continued)
Stock Incentive Plans
We did not grant any stock options during the three months ended March 30, 2007. A summary of the status and changes of the stock options under our Stock Incentive Plans, according to the contractual terms, as of March 30, 2007 and for the three months ended March 30, 2007 is presented below:
Shares | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term (in years) | Aggregate Intrinsic Value (in thousands) | ||||||||||
Outstanding at December 29, 2006 | 2,368,308 | $ | 22.56 | ||||||||||
Exercised | (174,137 | ) | $ | 20.98 | |||||||||
Forfeited/expired/cancelled | (7,418 | ) | $ | 25.97 | |||||||||
Outstanding at March 30, 2007 | 2,186,753 | $ | 22.68 | 5.68 | $ | 43,537 | |||||||
Options exercisable at end of period | 1,867,695 | $ | 22.07 | 5.40 | $ | 38,330 |
The aggregate intrinsic value in the preceding table represents the total pre-tax intrinsic value, based on our closing price of $42.59 as of March 30, 2007, which would have been received by the option holders had all option holders exercised their options as of that date. As of March 30, 2007, we had unrecognized stock-based compensation expense of $1.4 million related to non-vested stock option awards.
The following table summarizes information about stock options outstanding at March 30, 2007, under our Stock Incentive Plans:
Outstanding | Exercisable | |||||||||||||||
Range of Exercise Prices | Number Outstanding | Weighted-Average Remaining Contractual Life | Weighted-Average Exercise Price | Number Exercisable | Weighted-Average Exercise Price | |||||||||||
$10.18 - $13.56 | 101,250 | 6.0 | $ | 13.05 | 101,250 | $ | 13.05 | |||||||||
$13.57 - $16.95 | 110,924 | 2.8 | $ | 15.38 | 110,924 | $ | 15.38 | |||||||||
$16.96 - $20.34 | 226,693 | 4.9 | $ | 18.45 | 226,693 | $ | 18.45 | |||||||||
$20.35 - $23.73 | 658,327 | 4.7 | $ | 22.02 | 658,327 | $ | 22.02 | |||||||||
$23.74 - $27.12 | 1,024,961 | 6.6 | $ | 25.32 | 728,903 | $ | 25.05 | |||||||||
$27.13 - $30.51 | 50,000 | 7.8 | $ | 29.31 | 30,000 | $ | 29.20 | |||||||||
$30.52 - $33.85 | 11,598 | 5.2 | $ | 31.95 | 11,598 | $ | 31.95 | |||||||||
$33.86 - $37.61 | 3,000 | 8.2 | $ | 35.00 | — | $ | — | |||||||||
2,186,753 | 5.7 | $ | 22.68 | 1,867,695 | $ | 22.07 | ||||||||||
Our Board of Directors authorized a stock repurchase program in March 2007. The stock repurchase program was designed to offset the earnings per share dilution that would result from the issuance of additional shares under our equity incentive and employee stock purchase plans. We are authorized to repurchase up to one million shares of our common stock plus the cumulative number of additional shares issued or deemed issued under our Stock Incentive Plans and ESPP (excluding shares issuable upon the exercise of options granted prior to December 30, 2006) for the period from December 30, 2006 through January 1, 2010. As of March 30, 2007, we had not repurchased any shares under this stock repurchase program.
NOTE 8. INCOME TAXES
On July 13, 2006, the FASB issued FIN 48, which 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, we must recognize the impact of an uncertain income tax position on the income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority.
On December 30, 2006, the beginning of our 2007 fiscal year, we adopted the provisions of FIN 48. As of December 30, 2006, we had $20.1 million of unrecognized tax benefits. The cumulative effect of the adoption of FIN 48 was a reduction in retained earnings of $4.3 million. Included in the balance of unrecognized tax benefits at the date of adoption are $13.8 million of tax benefits, which if recognized, would affect our effective tax rate.
We recognize accrued interest related to unrecognized tax benefits in interest expense and penalties in operating expenses. Accrued interest and penalties as of the adoption date of FIN 48 were $7.4 million. We are subject to federal, state and local taxation in the U.S. and in foreign jurisdictions. With a few exceptions in jurisdictions that are immaterial, we are no longer subject to U.S. federal, state, local or foreign examinations by tax authorities for years before 1998. Our 2004 tax year is currently under examination by the U.S. tax authorities.
We expect that, within the next twelve months, we will make an estimated settlement payment of $3.4 million on one uncertain tax position relating to the deductibility of acquired intangibles. We expect that we will recover the value of this settlement through amortization. There was not a material change in estimates during the quarter ended March 30, 2007.
24
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (Continued)
NOTE 9. VARIABLE INTEREST ENTITIES
We participate in joint ventures, partnerships, and partially-owned limited liability companies formed for the purpose of bidding, negotiating and executing projects. Sometimes we function as the sponsor or manager of the projects performed by these entities. Some of these entities are variable interest entities (“VIE”) as defined by FIN 46(R). We consolidate one of the limited liability companies, Advatech, LLC (“Advatech”), of which we are a 60% owner and the primary beneficiary. We have not guaranteed any bank debt on behalf of Advatech. One of our subsidiaries has guaranteed the performance of Advatech’s contractual obligations. Advatech provides design, engineering, construction and construction management services to its customers relating to a specific technology involving flue gas desulfurization processes. Advatech’s total revenues were $101.5 million and $41.3 million for the three months ended March 30, 2007 and March 31, 2006, respectively. In addition, we consolidated the following assets of Advatech into our financial statements as of March 30, 2007 and December 29, 2006:
March 30, 2007 | December 29, 2006 | ||||||
(In thousands) | |||||||
Cash | $ | 14,121 | $ | 38,627 | |||
Net accounts receivable | 50,094 | 64,839 | |||||
Other assets | 32,847 | 25,295 | |||||
$ | 97,062 | $ | 128,761 |
NOTE 10. SUBSEQUENT EVENT
On April 2, 2007, we acquired CRI Resources, Inc. (“CRI”), a privately-held company specializing in leasing demolition and wrecking equipment, through a debt-for-equity swap under Chapter 11 of the United States Bankruptcy Court Central District of California Los Angeles Division. The purchase price was approximately $17.7 million, which represents the amount of our receivable from CRI and an amount we pursued as a creditor claim in their bankruptcy proceedings.
NOTE 11. SUPPLEMENTAL GUARANTOR INFORMATION
Prior to the quarter ended September 29, 2006, we were required to provide supplemental guarantor information because substantially all of our domestic operating subsidiaries had guaranteed our obligations under our 11½% Senior Notes (“11½% Notes”). Each of the subsidiary guarantors had fully and unconditionally guaranteed our obligations on a joint and several basis. On September 15, 2006, we redeemed and retired the outstanding amount of $2.8 million of our 11½% Notes. Therefore, the supplemental guarantor disclosure information is no longer required.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those described here. You should read this discussion in conjunction with: the section “Risk Factors,” beginning on page 42; the consolidated financial statements and notes thereto contained in Item 1, “Consolidated Financial Statements;” and the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended December 29, 2006, which was previously filed with the Securities and Exchange Commission (“SEC”).
OVERVIEW
Business Summary
We are one of the world’s largest engineering design services firms and a major federal government contractor for systems engineering and technical assistance, and operations and maintenance services. Our business focuses primarily on providing fee-based professional and technical services in the engineering and defense markets, although we perform some construction work. As a result, we are labor and not capital intensive. We derive income from our ability to generate revenues and collect cash from our clients through the billing of our employees’ time and our ability to manage our costs. We operate our business through two segments: the URS Division and the EG&G Division.
Our revenues are dependent upon our ability to attract qualified and productive employees, identify business opportunities, allocate our labor resources to profitable markets, secure new contracts, renew existing client agreements and provide outstanding services. Moreover, as a professional services company, the quality of the work generated by our employees is integral to our revenue generation.
Our costs are driven primarily by the compensation we pay to our employees, including fringe benefits, the cost of hiring subcontractors and other project-related expenses, and administrative, marketing, sales, bid and proposal, rental and other overhead costs.
Revenues for Three Months Ended March 30, 2007
Consolidated revenues for the three months ended March 30, 2007 increased 13.8% over the consolidated revenues for the three months ended March 31, 2006. This increase was driven by a significant acceleration in revenue growth in our state and local government business, as well as robust demand for the services we provide to private sector clients and international clients. Conversely, we experienced a modest decrease in federal sector revenues compared to the first quarter of fiscal 2006.
Because our business continues to grow and change, during the fiscal year ended December 29, 2006, we implemented a new process and refined our definitions for identifying contract revenues by client type. For our discussion and analysis of the quarter ended March 30, 2007 compared with the quarter ended March 31, 2006, we have reallocated the revenue identified with each market sector for the quarter ended March 31, 2006 on the basis of the new system adopted in fiscal 2006 to provide comparability with the allocation for the quarter ended March 30, 2007. This reallocation of revenues has no effect on our segment reporting.
Revenues from our federal government clients for the three months ended March 30, 2007 decreased approximately 4% compared with the corresponding period last year. This decrease reflects a decline in revenues from a number of the contracts we hold with the Federal Emergency Management Agency (“FEMA”) to provide services, on a contingency basis, during emergencies and natural disasters. In the first quarter of 2006, we experienced unusually high demand under these contracts due to hurricane recovery activities in the Gulf Coast region. However, in the first quarter of 2007, this work was reduced significantly due to fewer disasters of the scale we experienced a year ago.
Another factor contributing to the decline was a temporary slowdown in demand for the operations and maintenance services we provide to the U.S. Army related to military activities in the Middle East. This slowdown was caused by short-term funding uncertainty in the second half of 2006 associated with the 2007 Department of Defense (“DoD”) appropriations bill. With the passage of the bill last fall, demand has returned to previous levels, and we expect revenues from operations and maintenance services to grow in the second half of our 2007 fiscal year.
Decreased demand in these areas of our federal business was partially offset by strong performance in other areas of our core federal business. We continued to experience high demand for the systems engineering and logistics management services we provide to the DoD. In addition, we experienced an increase in environmental, engineering and facilities projects, primarily under large bundled contracts in support of long-term DoD initiatives such as the Military Transformation and Base Realignment and Closure (“BRAC”) programs. Demand also was high for the services we provide to the Department of Homeland Security (“DHS”) for security preparedness and disaster response planning.
Revenues from our state and local government clients for the three months ended March 30, 2007 increased approximately 20% compared with the corresponding period last year. The increase reflects strong state economic conditions, fueled by increased state tax revenues. The passage of the highway and transit bill, the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (“SAFETEA-LU”) in 2005 also continued to have a positive effect on revenues from our state and local government clients. In addition, we benefited from the approval of major bond initiatives over the last few years, to fund infrastructure improvement programs. As a result, states have increased spending on infrastructure improvement programs involving surface transportation systems, schools and water/wastewater treatment facilities.
Revenues from our domestic private industry clients for the three months ended March 30, 2007 increased 46% compared with the corresponding period last year. These results were driven by exceptionally high procurement activity in the emission control portion of our power sector work, as well as growth in our traditional engineering and environmental business. Our emission control business involves helping utilities comply with federal emissions regulations, such as the Clean Air Interstate and Clean Air Mercury Rules, which have accelerated mandates to reduce sulfur dioxide and mercury emissions. We also saw a significant increase in the engineering and environmental work we perform for multinational corporations under Master Service Agreements (“MSAs”), particularly from clients in the oil and gas sector. In addition, a portion of the revenue growth from private sector clients was due to a high level of subcontractor services and equipment cost pass-through under some contracts.
Revenues from our international clients for the three months ended March 30, 2007 increased approximately 22% compared with the corresponding period last year. Excluding the effect of foreign currency fluctuations, international revenues increased 18% due to favorable economic trends in Europe and Asia-Pacific, as well as growth in the work we perform for multinational clients outside the United States under MSAs. In Europe, stringent environmental regulations continue to drive demand for services under our MSAs, particularly with multinational clients in the oil and gas industry. We also benefited from a high level of procurement for transportation projects in the UK. In the Asia Pacific region, we continued to benefit from strong economic growth and increased government investment in water supply and transportation infrastructure.
Cash Flows and Debt
During the three months ended March 30, 2007, we used $48.2 million in cash from operations. (See “Consolidated Statements of Cash Flows” to our “Consolidated Financial Statements” included under Item 1 of this report.) While net income increased during the first quarter of 2007 compared with the same period in 2006, cash flows from operations decreased by $8.7 million due primarily to advance payments previously received from and subsequently used on a flue gas desulphurization project, the timing of distributions from our unconsolidated affiliates and increases in tax and bonus payments, offset by the timing of payments from clients on accounts receivable and the timing of payments to vendors and subcontractors.
Our ratio of debt to total capitalization (total debt divided by the sum of debt and total stockholders’ equity) remained the same at 10% as of March 30, 2007 and December 29, 2006.
Business Trends
We continue to see favorable long-term trends in the federal sector, including sustained demand for the operations and maintenance services we provide to the DoD to support military operations, as well as increased opportunities in the area of systems engineering and technical assistance services for the research, development, testing and evaluation of weapons systems. While the DoD baseline budget for 2007 was approved in September 2006, a supplemental funding bill for military operations in Iraq for the remainder of 2007 could potentially be delayed because of a dispute between Congress and the Administration over timetables for troop withdrawal. Delays in supplemental funding could have a short-term effect on our operations and maintenance business, particularly if work slows as a result or available funds are reallocated to support immediate priorities. However, the longer-term DoD budget outlook is positive. In February, the Administration submitted a $481.4 billion baseline DoD budget for 2008, an 11.3% increase from 2007, excluding the supplemental funding bill currently under debate.
In September 2006, Congress also approved a 7% increase in the DHS budget for 2007, which includes $4.3 billion for port security programs and $3.4 billion for emergency preparedness and prevention. These two items fund a large portion of our homeland security work. In addition, we anticipate infrastructure, facilities and environmental projects at military sites under new and existing DoD contracts will increase. We may also see increased opportunities for our URS and EG&G Divisions through the increasing use of large “bundled” contracts issued by the DoD, which typically require the provision of a full range of services at multiple sites throughout the world.
Finally, we expect that the most recent round of BRAC activities, which are designed to realign and reduce U.S. military infrastructure worldwide, will provide additional growth opportunities for our federal business over the next several years. Many of the U.S.’s military bases will require planning, design and environmental services before they can be realigned, closed or redeveloped. In February, Congress approved $2.5 billion to fund BRAC projects in fiscal 2007 and the President’s 2008 budget request includes $8.2 billion in BRAC funding.
We expect general fund spending by state and local government clients to continue to grow for the remainder of the 2007 fiscal year. Given the growing need to rebuild and modernize aging infrastructure and increasing tax receipts at the state level, we anticipate increased spending on infrastructure programs for which we provide services. We also expect the $287 billion highway funding bill, SAFETEA-LU, to continue to provide stable funding for current and new transportation projects through 2009. In February, Congress approved $48 billion for new highway and transit projects under SAFETEA-LU for fiscal 2007. In addition, we anticipate increased spending for major infrastructure programs because of bond issues that were approved by voters across the country over the last few years to fund highway, public building, and school improvement projects. During the first quarter of 2007, states and municipalities sold more than $100 billion in bonds for infrastructure work to implement these voter-approved bond initiatives.
While increased spending on infrastructure projects is beneficial to our business, rising costs of raw materials are leading to higher construction bids and depleting funds more quickly than many state and municipal agencies anticipated. In some cases, this is resulting in delays in the start-up of planning and design projects. We may also experience some project delays because of staffing shortages at some state and municipal agencies, which is impacting their ability to manage multiple large infrastructure programs concurrently.
We expect revenues from our domestic private industry clients to continue to increase for the remainder of the 2007 fiscal year. Many of our private industry clients are increasing capital expenditures as capacity utilization has grown to meet strong demand and to comply with new environmental regulations. We anticipate that the sustained profitability of clients in the oil and gas, power and mining sectors will continue to drive capital investment.
In addition, we anticipate continued growth in the emissions control portion of the power sector business, resulting from the requirements of the Clean Air Interstate and Clean Air Mercury Rules. These new rules are accelerating the requirements for power companies to cut sulfur dioxide and mercury emissions. We also expect to continue to benefit from our growing number of MSA contracts with multinational companies, further reducing the number of stand-alone consulting assignments and marketing costs associated with pursuing these assignments while improving our labor utilization levels.
The growth in MSAs in our domestic private sector business also has strengthened revenues from our international private sector clients. In Europe, we expect increasing demand for our engineering and facilities design services for the United Kingdom Ministry of Defense and for the U.S. DoD at military installations overseas. In addition, we may see further international opportunities due to more stringent environmental regulations from the European Union and increased investment in infrastructure. In the Asia-Pacific region, we expect strong economic growth to increase opportunities in the infrastructure market, and the increased global demand for mineral resources is expected to provide additional opportunities in the mining sector.
Other
Our federal government and state and local government clients have been increasing their use of design-build delivery mechanisms, where we are the designer, but generally team up with a construction contractor in order to obtain the design-build contract. Design-build delivery mechanisms provide high margins, but also involve greater financial risk than traditional design-bid-build programs, where we contract directly with our clients.
We are experiencing an increase in the use of lump-sum fixed price contracts by our clients, which often include higher margins, but also present more financial risk than cost-plus and time-and-materials contracting mechanisms.
Some state and local government projects have been delayed due to the rising raw material costs and a shortage of government staff to implement new projects.
RESULTS OF OPERATIONS
Consolidated
Three Months Ended | |||||||||||||
March 30, 2007 | March 31, 2006 | Increase (decrease) | Percentage increase (decrease) | ||||||||||
(In millions, except percentages) | |||||||||||||
Revenues | $ | 1,135.6 | $ | 998.1 | $ | 137.5 | 13.8 | % | |||||
Direct operating expenses | 741.6 | 631.3 | 110.3 | 17.5 | % | ||||||||
Gross profit | 394.0 | 366.8 | 27.2 | 7.4 | % | ||||||||
Indirect, general and administrative expenses | 336.3 | 319.2 | 17.1 | 5.4 | % | ||||||||
Operating income | 57.7 | 47.6 | 10.1 | 21.2 | % | ||||||||
Interest expense | 3.9 | 5.1 | (1.2 | ) | (23.5 | %) | |||||||
Income before taxes | 53.8 | 42.5 | 11.3 | 26.6 | % | ||||||||
Income tax expense | 22.3 | 18.0 | 4.3 | 23.9 | % | ||||||||
Minority interest in income of consolidated subsidiaries, net of tax | 1.1 | 0.3 | 0.8 | 266.7 | % | ||||||||
Net income | $ | 30.4 | $ | 24.2 | $ | 6.2 | 25.6 | % | |||||
Diluted earnings per share | $ | .58 | $ | .47 | $ | 0.11 | 23.4 | % |
Three Months ended March 30, 2007 compared with March 31, 2006
Our consolidated revenues for the three months ended March 30, 2007 increased by 13.8% compared with the corresponding period last year. The increase was due primarily to higher volumes of work performed for the state and local government clients, domestic private industry clients, and international clients during the three months ended March 30, 2007, compared with the same period last year.
The following table presents our consolidated revenues by client type for the three months ended March 30, 2007 and March 31, 2006.
Three Months Ended | |||||||||||||
March 30, 2007 | March 31, 2006 | Increase (decrease) | Percentage increase (decrease) | ||||||||||
Revenues | (In millions, except percentages) | ||||||||||||
Federal government clients | $ | 463 | $ | 484 | $ | (21 | ) | (4 | %) | ||||
State and local government clients | 254 | 212 | 42 | 20 | % | ||||||||
Domestic private industry clients | 304 | 208 | 96 | 46 | % | ||||||||
International clients | 115 | 94 | 21 | 22 | % | ||||||||
Total Revenues | $ | 1,136 | $ | 998 | $ | 138 | 14 | % | |||||
Revenues from our federal government clients for the three months ended March 30, 2007 decreased approximately 4% compared with the corresponding period last year. This decrease reflects a decline in revenues from a number of contracts we hold with the FEMA to provide services, on a contingency basis, during emergencies and natural disasters. In the first quarter of 2006, we experienced unusually high demand under these FEMA contracts due to hurricane recovery activities in the Gulf Coast region. However, in the first quarter of 2007, our work was reduced significantly due to fewer disasters of the scale the Gulf Coast region experienced a year ago.
Another factor contributing to the decline was a temporary slowdown in demand for the operations and maintenance services we provide to the U.S. Army related to military activities in the Middle East. This slowdown was caused by short-term funding uncertainty in the second half of 2006 associated with the 2007 DoD appropriations bill. With the passage of the bill last fall, demand has returned to previous levels, and we expect revenues from operations and maintenance services to grow in the second half of our 2007 fiscal year.
Decreased demand in these areas of our federal business was partially offset by strong performance in other areas of our core federal business. We continued to experience high demand for the systems engineering and logistics management services provided by our EG&G Division to the DoD. In addition, our URS Division experienced an increase in environmental, engineering and facilities projects, primarily under large bundled contracts in support of long-term DoD initiatives such as the Military Transformation and BRAC programs. Demand also was high for the services we provide to the DHS for security preparedness and disaster response planning.
We derive the majority of our work in the state and local government, domestic private industry and international sectors from our URS Division. Further discussion of the factors and activities that drove changes in operations on a segment basis for the three months ended March 30, 2007 can be found beginning on page 33.
Our consolidated direct operating expenses for the three months ended March 30, 2007, which consist of direct labor, subcontractor costs and other direct expenses, increased by 17.5% compared with the corresponding period last year. The factors that caused revenue growth also drove a corresponding increase in our direct operating expenses. An increase in the amount of subcontractor and other direct costs caused direct operating expenses to increase at a faster rate than revenues.
Our consolidated gross profit for the three months ended March 30, 2007 increased by 7.4% compared with the corresponding period last year, due to the increase in our revenue volume described previously. Because of the increased use of subcontractors and acquisitions of project-related materials, which bear lower profit margins than projects performed by our employees, our gross profit for the three months ended March 30, 2007 grew at a slower pace than our revenues.
Our consolidated indirect, general and administrative (“IG&A”) expenses for the three months ended March 30, 2007 increased by 5.4% compared with the corresponding period last year. Approximately $13.6 million of the increase was due to employee benefit costs, resulting from both an increase in headcount and an increase in cost per employee, including an increase in stock compensation cost of $2.8 million. In addition, there was an increase in indirect labor of $5.5 million, primarily because of our higher employee headcount.
Our consolidated interest expense for the three months ended March 30, 2007 decreased due to lower debt balances and repayments of our long-term debt.
Our effective income tax rates for the three months ended March 30, 2007 and March 31, 2006 were 41.5% and 42.3%, respectively.
Our consolidated operating income and net income increased because of the factors previously described.
Reporting Segments
Three months ended March 30, 2007 compared with March 31, 2006
Revenues | Direct Operating Expenses | Gross Profit | Indirect, General and Administrative | Operating Income (Loss) | ||||||||||||
(In millions, except percentages) | ||||||||||||||||
Three months ended March 30, 2007 | ||||||||||||||||
URS Division | $ | 793.4 | $ | 497.1 | $ | 296.3 | $ | 241.0 | $ | 55.3 | ||||||
EG&G Division | 345.0 | 247.1 | 97.9 | 81.7 | 16.2 | |||||||||||
Eliminations | (2.8 | ) | (2.6 | ) | (0.2 | ) | — | (0.2 | ) | |||||||
1,135.6 | 741.6 | 394.0 | 322.7 | 71.3 | ||||||||||||
Corporate | — | — | — | 13.6 | (13.6 | ) | ||||||||||
Total | $ | 1,135.6 | $ | 741.6 | $ | 394.0 | $ | 336.3 | $ | 57.7 | ||||||
Three months ended March 31, 2006 | ||||||||||||||||
URS Division | $ | 643.3 | $ | 374.7 | $ | 268.6 | $ | 226.3 | $ | 42.3 | ||||||
EG&G Division | 360.4 | 261.8 | 98.6 | 83.3 | 15.3 | |||||||||||
Eliminations | (5.6 | ) | (5.2 | ) | (0.4 | ) | — | (0.4 | ) | |||||||
998.1 | 631.3 | 366.8 | 309.6 | 57.2 | ||||||||||||
Corporate | — | — | — | 9.6 | (9.6 | ) | ||||||||||
Total | $ | 998.1 | $ | 631.3 | $ | 366.8 | $ | 319.2 | $ | 47.6 | ||||||
Increase (decrease) for the three months ended March 30, 2007 and March 31, 2006 | ||||||||||||||||
URS Division | $ | 150.1 | $ | 122.4 | $ | 27.7 | $ | 14.7 | $ | 13.0 | ||||||
EG&G Division | (15.4 | ) | (14.7 | ) | (0.7 | ) | (1.6 | ) | 0.9 | |||||||
Eliminations | 2.8 | 2.6 | 0.2 | — | 0.2 | |||||||||||
137.5 | 110.3 | 27.2 | 13.1 | 14.1 | ||||||||||||
Corporate | — | — | — | 4.0 | (4.0 | ) | ||||||||||
Total | $ | 137.5 | $ | 110.3 | $ | 27.2 | $ | 17.1 | $ | 10.1 | ||||||
Percentage increase (decrease) for the three months ended March 30, 2007 vs. March 31, 2006 | ||||||||||||||||
URS Division | 23.3 | % | 32.7 | % | 10.3 | % | 6.5 | % | 30.7 | % | ||||||
EG&G Division | (4.3 | %) | (5.6 | %) | (0.7 | %) | (1.9 | %) | 5.9 | % | ||||||
Eliminations | (50.0 | %) | (50.0 | %) | (50.0 | %) | — | (50.0 | %) | |||||||
Corporate | — | — | — | 41.7 | % | 41.7 | % | |||||||||
Total | 13.8 | % | 17.5 | % | 7.4 | % | 5.4 | % | 21.2 | % |
The URS Division’s revenues for the three months ended March 30, 2007 increased 23.3% compared with the corresponding period last year. The increase in revenues was due to the various factors discussed below.
The following table presents the URS Division’s revenues, net of inter-company eliminations, by client type for the three months ended March 30, 2007 and March 31, 2006.
Three Months Ended | |||||||||||||
March 30, 2007 | March 31, 2006 | Increase | Percentage increase (decrease) | ||||||||||
Revenues | (In millions, except percentages) | ||||||||||||
Federal government clients | $ | 118 | $ | 124 | $ | (6 | ) | (5 | %) | ||||
State and local government clients | 254 | 212 | 42 | 20 | % | ||||||||
Domestic private industry clients | 304 | 208 | 96 | 46 | % | ||||||||
International clients | 115 | 94 | 21 | 22 | % | ||||||||
Total revenues | $ | 791 | $ | 638 | $ | 153 | 24 | % | |||||
Revenues from the URS Division’s federal government clients for the three months ended March 30, 2007 decreased by 5% compared with the corresponding period last year. This decrease reflects a decline in revenues from a number of contracts we hold with the FEMA to provide services, on a contingency basis, during emergencies and natural disasters. In the first quarter of 2006, we experienced unusually high demand under these FEMA contracts due to hurricane recovery activities in the Gulf Coast region. In the first quarter of 2007, our work was reduced significantly due to fewer disasters of the scale the Gulf Coast region experienced a year ago. By contrast, we experienced an increase in environmental, engineering and facilities projects, primarily under large bundled contracts for the DoD. We also performed work for the DoD in support of the BRAC program, which is designed to realign and consolidate U.S. military infrastructure worldwide. Demand also was high for the services we provide to the DHS for security preparedness and disaster response planning.
Revenues from our state and local government clients for the three months ended March 30, 2007 increased by 20% compared with the corresponding period last year. In the first quarter, we experienced favorable market conditions in this sector of our business as states increased infrastructure spending on surface transportation, schools and water/wastewater projects. The passage of SAFETEA-LU in 2005 also continued to have a positive effect on revenues from our state and local government clients. In addition, we benefited from increased spending for major infrastructure programs as a result of bond issues that were approved over the last few years to fund highway, public building, school and water/wastewater improvement projects in many states. During the first quarter of 2007, states and municipalities sold more than $100 billion in bonds for infrastructure work as they began implementing these voter-approved bond initiatives.
Revenues from our domestic private industry clients for the three months ended March 30, 2007 increased by 46% compared with the corresponding period last year. These results were primarily driven by exceptionally high procurement activity in the emission control portion of our power sector work, as well as growth in our traditional engineering and environmental business. Our emission control business involves helping utilities comply with federal emissions regulations, such as the Clean Air Interstate and Clean Air Mercury Rules, which have accelerated mandates to reduce sulfur dioxide and mercury emissions.
We also saw a significant increase in the engineering and environmental work we perform for multinational corporations under MSAs, particularly from clients in the oil and gas sector. Many of our oil and gas industry clients have achieved record profitability as a result of higher fuel prices and are using a portion of these profits to fund capital improvement projects. These projects include refinery upgrades, environmental control improvements, and pipeline and remediation projects. We also benefited from strong demand for engineering and environmental services because of increased capital expenditures by clients in the energy and mining sectors. In addition, a portion of the revenue growth from private sector clients was due to a high level of subcontractor services and equipment cost pass-through under some contracts.
Revenues from our international clients for the three months ended March 30, 2007 increased by 22% compared with the corresponding period last year. Approximately 4% of the increase was due to net foreign currency gains. The remaining 18% of the increase was largely the result of favorable economic trends in Europe and Asia-Pacific, as well as growth in the work we perform for multinational clients outside the U.S. under MSAs.
In Europe, stringent environmental regulations continue to drive demand for services under our MSAs, particularly with multinational clients in the oil and gas industry. We also benefited from a high level of procurement for transportation projects in the UK. In the Asia Pacific region, we continued to benefit from strong economic growth and increased government investment in water supply and transportation infrastructure.
The URS Division’s direct operating expenses for the three months ended March 30, 2007 increased by 32.7% compared with the corresponding period last year. The factors that caused revenue growth also drove a corresponding increase in our direct operating expenses. An increase in the amount of subcontractor and other direct costs caused direct operating expenses to increase at a faster rate than revenues.
The URS Division’s gross profit for the three months ended March 30, 2007 increased by 10.3% compared with the corresponding period last year, primarily due to the increase in revenue volume previously described. Because of the increased use of subcontractors and acquisitions of project-related materials, which bear lower profit margins than projects performed by our employees, the URS Division’s gross profit for the three months ended March 30, 2007 grew at a slower pace than revenues.
The URS Division’s IG&A expenses for the three months ended March 30, 2007 increased by 6.5% compared with the corresponding period last year. Approximately $7.2 million of the increase was due to employee benefit costs resulting from both an increase in employee headcount and an increase in cost per employee, including stock compensation cost. The majority of the remaining increase was due to a $5.2 million increase in indirect labor.
EG&G Division
The EG&G Division’s revenues for the three months ended March 30, 2007 decreased by 4.3% compared with the corresponding period last year. The decrease reflects a temporary slowdown in demand for operations and maintenance services we provided to the U.S. Army related to military activity in the Middle East. This slowdown was caused by short-term funding uncertainty in the second half of 2006 associated with the 2007 DoD appropriations bill. With the passage of this bill last fall, demand for operations and maintenance services is returning to previous levels, and we expect revenues from operations and maintenance services to grow in the second half of our 2007 fiscal year. By contrast, demand grew for our engineering and technical assistance to research, develop, test and evaluate weapons systems. We also experienced increased demand in the logistics management services we provide to a variety of federal agencies. Demand also was high for the services we provide to the DHS for security preparedness and disaster response planning.
The EG&G Division’s direct operating expenses for the three months ended March 30, 2007 decreased by 5.6% compared with the corresponding period last year. The decrease in revenues drove a decrease in our direct operating expenses. The decrease in the use of subcontractors caused direct operating expenses to decrease at a faster rate than revenues.
The EG&G Division’s gross profit for the three months ended March 30, 2007 decreased by 0.7% compared with the corresponding period last year. Because of the decreased use of subcontractors, which bear lower profit margins than projects performed by our employees, the EG&G Division’s gross profit for the three months ended March 30, 2007 decreased at a slower pace than revenues.
The EG&G Division’s IG&A expenses for the three months ended March 30, 2007 decreased by 1.9% compared with the corresponding period last year. The decrease was primarily due to a lower business volume. The EG&G Division's indirect expenses are generally variable in nature and, as such, any decrease in business volume tends to result in lower indirect expenses.
Three Months Ended, | |||||||
March 30, 2007 | March 31, 2006 | ||||||
(In millions) | |||||||
Cash flows used by operating activities | $ | (48.2 | ) | $ | (39.5 | ) | |
Cash flows used by investing activities | (4.8 | ) | (5.1 | ) | |||
Cash flows provided by financing activities | 28.3 | 2.8 |
During the three months ended March 30, 2007, our primary sources of liquidity were cash flows from financing activities. Our primary uses of cash are to fund our working capital and capital expenditures and to service our debt. We believe that we have sufficient resources to fund our operating and capital expenditure requirements, as well as service our debt, for the next 12 months and beyond. If we experience a significant change in our business, such as the consummation of a significant acquisition, we would likely need to acquire additional sources of financing. We believe that we would be able to obtain adequate resources to address significant changes in our business at reasonable rates and terms, as necessary, based on our experience with business acquisitions.
Billings and collections on accounts receivable can affect our operating cash flows. Our management has placed significant emphasis on collection efforts, has assessed the adequacy of our allowance for doubtful accounts receivable as of March 30, 2007 and has deemed it to be adequate; however, future economic conditions may adversely impact some of our clients’ ability to pay our bills or the timeliness of their payments. Consequently, it may also affect our ability to consistently collect cash from our clients and meet our operating needs. Billings in excess of cost as of March 30, 2007 and December 29, 2006 were $126.1 million and $168.3 million, respectively. The decrease in billings in excess of cost was primarily due to advance payments previously received from and subsequently used on a flue gas desulphurization project. Changes in contract terms or the position within the collection cycle of contracts, for which our joint ventures, partnerships and partially-owned limited liability companies have received advance payments, can affect our operating cash flows.
Operating Activities
Our cash flows from operating activities are typically negative in the first quarter of our fiscal year because of bonus payments made in addition to regular quarterly tax payments. The decrease in cash flows from operating activities was primarily due to advance payments previously received from and subsequently used on a flue gas desulphurization project, timing of distributions from our unconsolidated affiliates and increases in tax payments and bonus payments. These decreases were partially offset by the timing of payments to vendors and subcontractors and by changes in accounts receivable, resulting from the timing of payments from clients.
Investing Activities
As a professional services organization, we are not capital intensive. Capital expenditures historically have been primarily for computer-aided design, accounting and project management information systems, and general- purpose computer equipment to accommodate our growth. Capital expenditures, excluding purchases financed through capital leases and business acquisitions, during the three months ended March 30, 2007 and March 31, 2006 were $4.8 million and $5.1 million, respectively.
Financing Activities
The increase in cash flows from financing activities was primarily due to changes in book overdrafts.
The following table contains information about our contractual obligations and commercial commitments followed by narrative descriptions as of March 30, 2007.
Payments and Commitments Due by Period | ||||||||||||||||
Contractual Obligations | Less Than | After 5 | ||||||||||||||
(Debt payments include principal only): | Total | 1 Year | 1-3 Years | 4-5 Years | Years | |||||||||||
(In thousands) | ||||||||||||||||
As of March 30, 2007: | ||||||||||||||||
Credit Facility: | ||||||||||||||||
Term loan | $ | 114,000 | $ | — | $ | 28,500 | $ | 85,500 | $ | — | ||||||
Capital lease obligations | 50,864 | 15,171 | 23,627 | 11,459 | 607 | |||||||||||
Notes payable, foreign credit lines and other indebtedness (1) | 2,867 | 1,314 | 901 | 564 | 88 | |||||||||||
Total debt | 167,731 | 16,485 | 53,028 | 97,523 | 695 | |||||||||||
Pension funding requirements (2) | 126,185 | 13,595 | 32,690 | 20,156 | 59,744 | |||||||||||
Purchase obligations (3) | 5,651 | 3,054 | 2,597 | — | — | |||||||||||
Interest (4) | 31,069 | 10,811 | 16,396 | 3,836 | 26 | |||||||||||
Asset retirement obligations | 4,326 | 184 | 572 | 1,317 | 2,253 | |||||||||||
Other contractual obligations (5) | 26,045 | 7,484 | 10,112 | 3,411 | 5,038 | |||||||||||
Operating lease obligations (6) | 439,547 | 96,309 | 158,616 | 103,695 | 80,927 | |||||||||||
Total contractual obligations | $ | 800,554 | $ | 147,922 | $ | 274,011 | $ | 229,938 | $ | 148,683 | ||||||
(1) | Amounts shown exclude remaining original issue discounts of $45 thousand for notes payable. |
(2) | These pension funding requirements for the EG&G pension plans, the Dames & Moore Final Salary Pension Fund in the United Kingdom, the Radian International, L.L.C. Supplemental Executive Retirement Plan and Salary Continuation Agreement, and the supplemental executive retirement plan (“SERP”) with our CEO are based on actuarially determined estimates and management assumptions. We are obligated to fund approximately $11.8 million into a rabbi trust for our CEO’s SERP within 15-days of the earlier of (1) a request by the CEO or (2) the termination of the CEO’s employment for any reason, including death. |
(3) | Purchase obligations consist primarily of software maintenance contracts. |
(4) | Interest for the next five years, which excludes non-cash interest, is determined based on the current outstanding balance of our debt and payment schedule at the estimated interest rate as of March 30, 2007. |
(5) | Other contractual obligations include contractual payments to former employees and Financial Accounting Standards Board's Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109,” (“FIN 48”) tax liabilities, including interest. |
(6) | These operating leases are predominantly real estate leases. |
Off-balance Sheet Arrangements. The following is a list of our off-balance sheet arrangements:
· | As of March 30, 2007, we had $62.6 million in standby letters of credit under our Credit Facility. We use letters of credit primarily to support insurance programs, bonding arrangements and real estate leases. We are required to reimburse the issuers of letters of credit for any payments they make under the outstanding letters of credit. The Credit Facility covers the issuance of our standby letters of credit and is critical for our normal operations. If we default on the credit facility, our ability to issue or renew standby letters of credit would impair our ability to maintain normal operations. |
· | We have guaranteed the credit facility of one of our joint ventures, in the event of a default by the joint venture. This joint venture was formed in the ordinary course of business to perform a contract for the federal government. The term of the guarantee is equal to the remaining term of the underlying credit facility, which will expire on September 30, 2007. The amount of the guarantee was $9.5 million at March 30, 2007. |
· | As of March 30, 2007, the amount of the guarantee used to collateralize the credit facility of our UK operating subsidiary and bank guarantee lines of our European subsidiaries was $9.8 million. |
· | From time to time, we provide guarantees related to our services or work. If our services under a guaranteed project are later determined to have resulted in a material defect or other material deficiency, then we may be responsible for monetary damages or other legal remedies. When sufficient information about claims on guaranteed projects is available and monetary damages or other costs or losses are determined to be probable, we recognize such guarantee losses. Currently, we have no guarantee claims for which losses have been recognized. |
· | We have an agreement to indemnify one of our joint venture lenders up to $25.0 million for any potential losses and damages, and liabilities associated with lawsuits in relation to general and administrative services we provide to the joint venture. Currently, we have no indemnified claims. |
Credit Facility. Our senior credit facility (“Credit Facility”) consists of a six-year term loan of $350.0 million and a five-year revolving line of credit of $300.0 million, against which up to $200.0 million is available to issue letters of credit. As of March 30, 2007, we had $114.0 million outstanding under the term loan, $62.6 million outstanding in letters of credit and no amount outstanding under the revolving line of credit.
All loans outstanding under our Credit Facility bear interest at either LIBOR or our bank’s base rate plus an applicable margin, at our option. The applicable margin will change based upon our credit rating as reported by Moody’s Investor Services and Standard & Poor’s. The LIBOR margins range from 0.625% to 1.75% and the base rate margins range from 0.0% to 0.75%. As of March 30, 2007 and December 29, 2006, the LIBOR margin was 1.00% for both the term loan and revolving line of credit. As of March 30, 2007 and December 29, 2006, the interest rates on our term loan were 6.35% and 6.36%, respectively.
As of March 30, 2007, we were in compliance with all of the covenants of our Credit Facility.
Revolving Line of Credit. A summary of our revolving line of credit information is as follows:
Three Months Ended March 30, 2007 | Year Ended December 29, 2006 | ||||||
(In millions, except percentages) | |||||||
Effective average interest rates paid on the revolving line of credit | 8.2 | % | 7.6 | % | |||
Average daily revolving line of credit balances | $ | 6.9 | $ | 0.4 | |||
Maximum amounts outstanding at any one point | $ | 40.3 | $ | 21.8 | |||
Notes payable, foreign credit lines and other indebtedness. As of March 30, 2007 and December 29, 2006, we had outstanding amounts of $2.8 million and $7.9 million, respectively, in notes payable and foreign lines of credit. Notes payable consists primarily of notes used to finance the purchase of office equipment, computer equipment and furniture. The weighted average interest rates of these notes were approximately 6.9% and 6.1% as of March 30, 2007 and December 29, 2006, respectively.
We maintain foreign lines of credit, which are collateralized by the assets of our foreign subsidiaries and in some cases, parent guarantees. As of March 30, 2007, we had $13.8 million in lines of credit available under these facilities, with no amount outstanding. As of December 29, 2006, we had $13.8 million in lines of credit available under these facilities, with $4.6 million outstanding. The interest rate was 6.2% as of December 29, 2006.
Capital Leases. As of March 30, 2007 and December 29, 2006, we had $50.9 million and $46.7 million in obligations under our capital leases, respectively, consisting primarily of leases for office equipment, computer equipment and furniture.
Operating Leases. As of March 30, 2007, we had approximately $439.5 million in obligations under our operating leases, consisting primarily of real estate leases.
Other Activities
Derivative Financial Instruments. We are exposed to risk of changes in interest rates as a result of borrowings under our Credit Facility. During the three months ended March 30, 2007, we did not enter into any interest rate derivatives due to our assessment of the costs/benefits of interest rate hedging. However, we may enter into derivative financial instruments in the future depending on changes in interest rates.
Income Taxes
On July 13, 2006, the FASB issued FIN 48, which 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, we must recognize the impact of an uncertain income tax position on the income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority.
On December 30, 2006, the beginning of our 2007 fiscal year, we adopted the provisions of FIN 48. As of December 30, 2006, we had $20.1 million of unrecognized tax benefits. The cumulative effect of the adoption of FIN 48 was a reduction in retained earnings of $4.3 million. Included in the balance of unrecognized tax benefits at the date of adoption were $13.8 million of tax benefits, which if recognized, would affect our effective tax rate.
We recognize accrued interest related to unrecognized tax benefits in interest expense and penalties in operating expenses. Accrued interest and penalties as of the adoption date of FIN 48 were $7.4 million. We are subject to federal, state and local taxation in the U.S. and in foreign jurisdictions. With a few exceptions in jurisdictions that are immaterial, we are no longer subject to U.S. federal, state, local or foreign examinations by tax authorities for years before 1998. Our 2004 tax year is currently under examination by the U.S. tax authorities.
We expect that, within the next twelve months, we will make an estimated settlement payment on one uncertain tax position relating to the deductibility of acquired intangibles. As a result of this settlement, the total unrecognized tax benefit is expected to decrease by $3.4 million. We also expect that we will recover the value of the lost deduction through amortization in amended returns and in those yet to be filed through the year 2013. There is no material change in estimates during the quarter ended March 30, 2007.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions in the application of certain accounting policies that affect amounts reported in our consolidated financial statements and related footnotes included in Item 1 of this report. In preparing these financial statements, we have made our best estimates and judgments of certain amounts, after considering materiality. Historically, our estimates have not materially differed from actual results. Application of these accounting policies, however, involves the exercise of judgment and the use of assumptions as to future uncertainties. Consequently, actual results could differ from our estimates.
The accounting policies that we believe are most critical to an investor’s understanding of our financial results and condition, and require complex management judgment are included in our Annual Report on Form 10-K for the year ended December 29, 2006. To date, there have been no material changes to these critical accounting policies during the three months ended March 30, 2007, except for the adoption of FIN 48.
Adopted and Recently Issued Statements of Financial Accounting Standards
We adopted FIN 48, effective December 30, 2006, which is the beginning of our 2007 fiscal year. FIN 48 prescribes a recognition threshold and measurement process for recording, as liabilities in the financial statements, uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 establishes rules for recognition or de-recognition and measurement and classification of such liabilities; accruals of interest and penalties; accounting for changes in judgment in interim periods; and disclosure requirements for uncertain tax positions. Under FIN 48, we must recognize the impact of an uncertain income tax position on the income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. FIN 48 requires that we report the cumulative effect of applying the interpretation as an adjustment to the beginning balance of retained earnings as of December 30, 2006. A more detailed discussion of the effect of the adoption of FIN 48 is included in Note 8, “Income Taxes” of our consolidated financial statements under Item 1 of this report.
In June 2006, the Financial Accounting Standards Board (“FASB”) ratified Emerging Issues Task Force No. 06-3 (“EITF 06-3”), “How Taxes Collected from Customers and Remitted to Governmental Authorities should be Presented in the Income Statement.” The pronouncement addresses disclosure requirements for taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction between a seller and a customer, and may include, but are not limited to, sales, use, value added, certain excise taxes and some industry-specific taxes. A consensus was reached that entities may adopt a policy of presenting these taxes in the income statement on either a gross or a net basis. If such taxes are significant, EITF 06-3 requires disclosure of the accounting method in the accounting policy section of the notes to the financial statements, and if not presented on a net basis, then the amount of such taxes that are recognized on a gross basis must be disclosed. We adopted EITF 06-3 on our effective date of December 30, 2006. We present revenues net of sales and value-added taxes in our results of operations. The amount of taxes we collected from our customers and remitted to government authorities are immaterial to our consolidated revenues.
In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurement,” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. It is effective for us beginning in fiscal year 2008. We are currently in the process of determining the effect that the adoption of this statement will have on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, “Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans,” (“SFAS 158”). This statement requires (1) recognition on the balance sheet of an asset for a defined benefit plan’s overfunded status or a liability for such a plan’s underfunded status, (2) measurement of a defined benefit plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year, and (3) recognition, as a component of other comprehensive income, the changes in a defined benefit plan’s funded status that are not recognized as components of net periodic benfit cost. We adopted the recognition and disclosure provisions of SFAS 158, effective on December 29, 2006, which was the end of our fiscal year 2006. The requirement to measure our defined benefit plan assets and benefit obligations as of the date of our fiscal year-end will be effective for us for the fiscal year ending in December 2008.
Interest rate risk
We are exposed to changes in interest rates as a result of our borrowings under our Credit Facility. Based on outstanding indebtedness of $114.0 million under our Credit Facility at March 30, 2007, if market rates average 1% higher in the next twelve months, our net of tax interest expense would increase by approximately $0.7 million. Conversely, if market rates average 1% lower in the next twelve months, our net of tax interest expense would decrease by approximately $0.7 million.
Foreign currency risk
The majority of our transactions are in U.S. dollars; however, our foreign subsidiaries conduct businesses in various foreign currencies. Therefore, we are subject to currency exposures and volatility because of currency fluctuations, inflation changes and economic conditions in these countries. We attempt to minimize our exposure to foreign currency fluctuations by matching our revenues and expenses in the same currency for our contracts. We had $1.0 million of foreign currency translation gains for the three months ended March 30, 2007 and $44 thousand of foreign currency translation gains for the three months ended March 31, 2006. The currency exposure is not material to our consolidated financial statements.
Attached as exhibits to this Form 10-Q are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the Exchange Act). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications and should be read in conjunction with the certifications for a more complete understanding.
Evaluation of Disclosure Controls and Procedures
Our CEO and CFO are responsible for establishing and maintaining “disclosure controls and procedures” (as defined in rules promulgated under the Exchange Act) for our company. Based on their evaluation as of the end of the period covered by this report, our CEO and CFO have concluded that our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in this quarterly report was (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and (2) accumulated and communicated to our management, including our principal executive and principal financial officers, to allow timely decisions regarding required disclosures.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended March 30, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
The company’s management, including the CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any system’s design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of a system’s control effectiveness into future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
OTHER INFORMATION
Various legal proceedings are pending against us and certain of our subsidiaries alleging, among other things, breach of contract or tort in connection with the performance of professional services, the outcome of which cannot be predicted with certainty. See Note 5, “Commitments and Contingencies,” to our “Consolidated Financial Statements” included under Part I - Item 1 of this report for a discussion of some of these legal proceedings. In some actions, parties are seeking damages, including punitive or treble damages that substantially exceed our insurance coverage.
Currently, we have limits of $125.0 million per loss and $125.0 million in the aggregate for general liability, professional errors and omissions liability and contractor’s pollution liability insurance (in addition to other policies for some specific projects). The general liability policy includes a self-insured claim retention of $4.0 million (or $10.0 million in some circumstances). The professional errors and omissions liability and contractor’s pollution liability insurance policies each include a self-insured claim retention amount of $10.0 million each. Parties may seek damages that substantially exceed our insurance coverage.
Excess insurance policies above our primary limits provide for coverages on a “claims made” basis, covering only claims actually made and reported during the policy period currently in effect. Thus, if we do not continue to maintain these policies, we will have no coverage for claims made after the termination date, even for claims based on events that occurred during the term of coverage. While we intend to maintain these policies, we may be unable to maintain existing coverage levels. We have maintained insurance without lapse for many years with limits in excess of losses sustained.
Although the outcome of our legal proceedings cannot be predicted with certainty and no assurances can be provided, based on our previous experience in such matters, we do not believe that any of the legal proceedings described in Note 5, “Commitments and Contingencies,” to our “Consolidated Financial Statements” included under Part I - Item 1 of this report individually or collectively, are likely to materially exceed established loss accruals or our various professional errors and omissions, project-specific and potentially other insurance policies. However, the resolution of outstanding claims and litigation is subject to inherent uncertainty and it is reasonably possible that such resolution could have an adverse effect on us.
There have been no material changes to the Risk Factors that were disclosed in Part I, Item 1A of our Form 10-K since the year ended on December 29, 2006. In addition to the other information included or incorporated by reference in this quarterly report on Form 10-Q, the following factors could affect our financial condition and results of operations:
Demand for our services is cyclical and vulnerable to economic downturns. If the economy weakens, then our revenues, profits and our financial condition may deteriorate.
Demand for our services in our infrastructure and defense markets is cyclical and vulnerable to sudden economic downturns, which may result in clients delaying, curtailing or canceling proposed and existing projects. For example, there was a decrease in our URS Division revenues of $77.9 million, or 3.4%, in fiscal year 2002 compared to fiscal year 2001 as a result of the general economic decline. Our clients may demand better pricing terms and their ability to pay our invoices may be affected by a weakening economy. Our government clients may face budget deficits that prohibit them from funding proposed and existing projects. Our business traditionally lags the overall recovery in the economy; therefore, our business may not recover immediately when the economy improves. If the economy weakens, then our revenues, net income and overall financial condition may deteriorate.
We may not realize the full amount of revenues reflected in our book of business, which could harm our operations and significantly reduce our future revenues.
We account for all contract awards that may eventually be recognized as revenues as our “book of business,” which includes backlog, designations, option years and indefinite delivery contracts (“IDCs”). Our backlog consists of the amount billable at a particular point in time, including task orders issued under IDCs. As of March 30, 2007, our backlog was approximately $5.0 billion. Our designations consist of projects that clients have awarded us, but for which we do not yet have signed contracts. Our option year contracts are multi-year contracts with base periods, plus option years that are exercisable by our clients without the need for us to go through another competitive bidding process. Our IDCs are signed contracts under which we perform work only when our clients issue specific task orders. Our book of business estimates may not result in actual revenues in any particular period because clients may modify or terminate projects and contracts and may decide not to exercise contract options or issue task orders. If we do not realize a substantial amount of our book of business, our operations could be harmed and our future revenues could be significantly reduced.
As a government contractor, we are subject to a number of procurement laws, regulations and government audits; a violation of any such laws and regulations could result in sanctions, contract termination, forfeiture of profit, harm to our reputation or loss of our status as an eligible government contractor.
We must comply with and are affected by federal, state, local and foreign laws and regulations relating to the formation, administration and performance of government contracts. For example, we must comply with the Federal Acquisition Regulation (the “FAR”), the Truth in Negotiations Act, the Cost Accounting Standards (“CAS”), the Services Contract Act and the DoD security regulations, as well as many other laws and regulations. These laws and regulations affect how we transact business with our clients and in some instances, impose additional costs on our business operations. Even though we take precautions to prevent and deter fraud, misconduct and non-compliance, we face the risk that our employees or outside partners may engage in misconduct, fraud or other improper activities. Government agencies, such as the U.S. Defense Contract Audit Agency (“DCAA”), routinely audit and investigate government contractors. These government agencies review and audit a government contractor’s performance under its contracts and cost structure, and compliance with applicable laws, regulations and standards. In addition, during the course of its audits, the DCAA may question our incurred project costs, and if the DCAA believes we have accounted for such costs in a manner inconsistent with the requirements for the FAR or CAS, the DCAA auditor may recommend to our U.S. government corporate administrative contracting officer to disallow such costs. Historically, we have not experienced significant disallowed costs as a result of government audits. However, we can provide no assurance that the DCAA or other government audits will not result in material disallowances for incurred costs in the future. Government contract violations could result in the imposition of civil and criminal penalties or sanctions, contract termination, forfeiture of profit, and/or suspension of payment, any of which could make us lose our status as an eligible government contractor. We could also suffer serious harm to our reputation.
Because we depend on federal, state and local governments for a significant portion of our revenue, our inability to win or renew government contracts during regulated procurement processes could harm our operations and significantly reduce or eliminate our profits.
Revenues from federal government contracts and state and local government contracts represented approximately 41% and 22%, respectively, of our total revenues for the three months ended March 30, 2007. Government contracts are awarded through a regulated procurement process. The federal government has increasingly relied upon multi-year contracts with pre-established terms and conditions, such as IDCs, that generally require those contractors who have previously been awarded the IDC to engage in an additional competitive bidding process before a task order is issued. The increased competition, in turn, may require us to make sustained efforts to reduce costs in order to realize revenues and profits under government contracts. If we are not successful in reducing the amount of costs we incur, our profitability on government contracts will be negatively impacted. Moreover, even if we are qualified to work on a government contract, we may not be awarded the contract because of existing government policies designed to protect small businesses and underrepresented minority contractors. Our inability to win or renew government contracts during regulated procurement processes could harm our operations and significantly reduce or eliminate our profits.
Each year some government contracts may be dependent on the legislative appropriations process. If legislative appropriations are not made in subsequent years of a multiple-year government contract, then we may not realize all of our potential revenues and profits from that contract.
Each year the funding for some of our government contracts may be dependent on the legislative appropriations process. For example, the passage of the SAFETEA-LU highway and transit bill in August of 2005 has provided additional funding for state transportation projects in which we provide services. Legislatures may appropriate funds for a given project on a year-by-year basis, even though the project may take more than one year to perform. As a result, at the beginning of a project, the related contract may only be partially funded, and additional funding is committed only as appropriations are made in each subsequent year. These appropriations, and the timing of payment of appropriated amounts, may be influenced by, among other things, the state of the economy, competing political priorities, curtailments in the use of government contracting firms, rise in raw material costs, delays associated with a lack of a sufficient number of government staff to oversee contracts, budget constraints, the timing and amount of tax receipts and the overall level of government expenditures. If appropriations are not made in subsequent years of a multiple-year contract, we may not realize all of our potential revenues and profits from that contract.
Our government contracts may give the government the right to modify, delay, curtail or terminate our contracts at their convenience at any time prior to their completion and, if we do not replace these contracts, then we may suffer a decline in revenues.
Government projects in which we participate as a contractor or subcontractor may extend for several years. Generally, government contracts include the right for the government to modify, delay, curtail or terminate contracts and subcontracts at their convenience any time prior to their completion. Any decision by a government client to modify, delay, curtail or terminate our contracts at their convenience may result in a decline in revenues.
If we are unable to accurately estimate and control our contract costs, then we may incur losses on our contracts, which could decrease our operating margins and significantly reduce or eliminate our profits.
It is important for us to control our contract costs so that we can maintain positive operating margins. We generally enter into three principal types of contracts with our clients: cost-plus, fixed-price and time-and-materials. Under cost-plus contracts, which may be subject to contract ceiling amounts, we are reimbursed for allowable costs and fees, which may be fixed or performance-based. If our costs exceed the contract ceiling or are not allowable under the provisions of the contract or any applicable regulations, we may not be reimbursed for all of the costs we incur. Under fixed-price contracts, we receive a fixed price regardless of what our actual costs will be. Consequently, we realize a profit on fixed-price contracts only if we control our costs and prevent cost over-runs on the contracts. Under time-and-materials contracts, we are paid for labor at negotiated hourly billing rates and for other expenses. Profitability on our contracts is driven by billable headcount and our ability to manage costs. Under each type of contract, if we are unable to control costs, we may incur losses on our contracts, which could decrease our operating margins and significantly reduce or eliminate our profits.
Our actual results could differ from the estimates and assumptions that we use to prepare our financial statements, which may significantly reduce or eliminate our profits.
To prepare financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions as of the date of the financial statements, which affect the reported values of assets and liabilities and revenues and expenses and disclosures of contingent assets and liabilities. Areas requiring significant estimates by our management include:
• the application of the “percentage-of-completion” method of accounting, and revenue recognition on contracts, change orders, and contract claims;
• provisions for uncollectible receivables and customer claims and recoveries of costs from subcontractors, vendors and others;
• provisions for income taxes and related valuation allowances;
• value of goodwill and recoverability of other intangible assets;
• valuation of assets acquired and liabilities assumed in connection with business combinations;
• valuation of defined benefit pension plans and other employee benefit plans;
• valuation of stock-based compensation expense; and
• accruals for estimated liabilities, including litigation and insurance reserves.
Our actual results could differ from those estimates, which may significantly reduce or eliminate our profits.
Our use of the “percentage-of-completion” method of accounting could result in reduction or reversal of previously recorded revenues and profits.
A substantial portion of our revenues and profits are measured and recognized using the “percentage-of-completion” method of accounting, which is discussed in Note 1, “Accounting Policies,” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of our Annual Report on Form 10-K. Our use of this accounting method results in recognition of revenues and profits ratably over the life of a contract, based generally on the proportion of costs incurred to date to total costs expected to be incurred for the entire project. The effects of revisions to revenues and estimated costs are recorded when the amounts are known or can be reasonably estimated. Such revisions could occur in any period and their effects could be material. Although we have historically made reasonably reliable estimates of the progress towards completion of long-term engineering, program management, construction management or construction contracts in process, the uncertainties inherent in the estimating process make it possible for actual costs to vary materially from estimates, including reductions or reversals of previously recorded revenues and profits.
If our goodwill or intangible assets become impaired, then our profits may be significantly reduced or eliminated.
Because we have grown through acquisitions, goodwill and other intangible assets represent a substantial portion of our assets. Goodwill and other net purchased intangible assets were $994.5 million as of March 30, 2007. If any of our goodwill or intangible assets were to become impaired, we would be required to write off the impaired amount, which may significantly reduce or eliminate our profits.
Our failure to successfully bid on new contracts and renew existing contracts with private and public sector clients could adversely reduce or eliminate our profitability.
Our business depends on our ability to successfully bid on new contracts and renew existing contracts with private and public sector clients. Contract proposals and negotiations are complex and frequently involve a lengthy bidding and selection process, which are affected by a number of factors, such as market conditions, financing arrangements and required governmental approvals. For example, a client may require us to provide a bond or letter of credit to protect the client should we fail to perform under the terms of the contract. If negative market conditions arise, or if we fail to secure adequate financial arrangements or the required governmental approval, we may not be able to pursue particular projects, which could adversely reduce or eliminate our profitability.
If we fail to timely complete, miss a required performance standard or otherwise fail to adequately perform on a project, then we may incur a loss on that project, which may reduce or eliminate our overall profitability.
We may commit to a client that we will complete a project by a scheduled date. We may also commit that a project, when completed, will achieve specified performance standards. If the project is not completed by the scheduled date or fails to meet required performance standards, we may either incur significant additional costs or be held responsible for the costs incurred by the client to rectify damages due to late completion or failure to achieve the required performance standards. The uncertainty of the timing of a project can present difficulties in planning the amount of personnel needed for the project. If the project is delayed or canceled, we may bear the cost of an underutilized workforce that was dedicated to fulfilling the project. In addition, performance of projects can be affected by a number of factors beyond our control, including unavoidable delays from weather conditions, unavailability of vendor materials, changes in the project scope of services requested by clients or labor disruptions. In some cases, should we fail to meet required performance standards, we may also be subject to agreed-upon financial damages, which are determined by the contract. To the extent that these events occur, the total costs of the project could exceed our estimates and we could experience reduced profits or, in some cases, incur a loss on a project, which may reduce or eliminate our overall profitability.
If our partners fail to perform their contractual obligations on a project, we could be exposed to liability, loss of reputation or reduced or eliminated profits.
We sometimes enter into subcontracts, joint ventures and other contractual arrangements with outside partners to jointly bid on and execute a particular project. The success of these joint projects depends upon, among other things, the satisfactory performance of the contractual obligations of our partners. If any of our partners fails to satisfactorily perform its contractual obligations, we may be required to make additional expenditures and provide additional services to complete the project. If we are unable to adequately address our partner’s performance issues, then our client could terminate the joint project, exposing us to liability, loss of reputation or reduced or eliminated profits.
We may be subject to substantial liabilities under environmental laws and regulations.
A portion of our environmental business involves the planning, design, program management, construction management and operation and maintenance of pollution control facilities, hazardous waste or Superfund sites and military bases. In addition, we have contracts with U.S. governmental entities to destroy hazardous materials, including chemical agents and weapons stockpiles. These activities may require us to manage, handle, remove, treat, transport and dispose of toxic or hazardous substances. We must comply with a number of governmental laws that strictly regulate the handling, removal, treatment, transportation and disposal of toxic and hazardous substances. Under the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”) and comparable state laws, we may be required to investigate and remediate regulated hazardous materials. CERCLA and comparable state laws typically impose strict, joint and several liabilities without regard to whether a company knew of or caused the release of hazardous substances. The liability for the entire cost of clean up can be imposed upon any responsible party. Other principal federal environmental, health and safety laws affecting us include, but are not limited to, the Resource Conservation and Recovery Act, the National Environmental Policy Act, the Clean Air Act, the Clean Air Interstate Rule, the Clean Air Mercury Rule, the Occupational Safety and Health Act, the Toxic Substances Control Act and the Superfund Amendments and Reauthorization Act. Our business operations may also be subject to similar state and international laws relating to environmental protection. Liabilities related to environmental contamination or human exposure to hazardous substances, or a failure to comply with applicable regulations could result in substantial costs to us, including clean-up costs, fines and civil or criminal sanctions, third party claims for property damage or personal injury or cessation of remediation activities. Our continuing work in the areas governed by these laws and regulations exposes us to the risk of substantial liability; however, we are currently not subject to any material claims under environmental laws and regulations.
Our liability for damages due to legal proceedings may adversely affect us and result in a significant loss.
In performing our services, we may be exposed to legal proceedings in connection with cost overruns, personal injury claims, property damage, labor shortages or disputes, weather problems and unforeseen engineering, architectural, environmental and geological problems. In some actions, parties may seek damages that exceed our insurance coverage. Currently, we have limits of $125.0 million per loss and $125.0 million in the aggregate for general liability, professional errors and omissions liability and contractor’s pollution liability insurance (in addition to other policies for some specific projects). The general liability policy includes a self-insured claim retention of $4.0 million (or $10.0 million in some circumstances). The professional errors and omissions liability and contractor’s pollution liability insurance policies include a self-insured claim retention amount of $10.0 million each. Our services may require us to make judgments and recommendations about environmental, structural, geotechnical and other physical conditions at project sites. If our performance, judgments and recommendations are later found to be incomplete or incorrect, then we may be liable for the resulting damages. Various legal proceedings are pending against us in connection with the performance of our professional services and other actions by us. Although the outcome of our legal proceedings cannot be predicted with certainty and no assurance can be provided as to a favorable outcome, based on our previous experience in these matters, we do not believe that any of our legal proceedings, individually or collectively, are likely to exceed established loss accruals or our various professional errors and omissions, project-specific and other insurance policies. However, the resolution of outstanding claims is subject to inherent uncertainty and it is reasonably possible that any resolution could have an adverse effect on us. If we sustain damages that exceed our insurance coverage or for which we are not insured, our results of operations and financial condition could be harmed.
Changes in environmental laws, regulations and programs could reduce demand for our environmental services, which could in turn negatively impact our revenues.
Our environmental services business is driven by federal, state, local and foreign laws, regulations and programs related to pollution and environmental protection. For example, passage of the Clean Air Interstate and Clean Air Mercury environmental rules has increased our emissions control business. On the other hand, a relaxation or repeal of these laws and regulations, or changes in governmental policies regarding the funding, implementation or enforcement of these programs, could result in a decline in demand for environmental services, which could in turn negatively impact our revenues.
A decline in U.S. defense spending or a change in budgetary priorities could harm our operations and significantly reduce our future revenues.
Revenues under contracts with the DoD and other defense-related clients represented approximately 33% of our total revenues for the three months ended March 30, 2007. While spending authorization for defense-related programs has increased significantly in recent years due to greater homeland security and foreign military commitments, as well as the trend to outsource federal government jobs to the private sector, these spending levels may not be sustainable. For example, the DoD budget declined in the late 1980s and the early 1990s, resulting in DoD program delays and cancellations. Future levels of expenditures and authorizations for these programs may decrease, remain constant or shift to programs in areas where we do not currently provide services. As a result, a general decline in U.S. defense spending or a change in budgetary priorities could harm our operations and significantly reduce our future revenues.
Our overall market share will decline if we are unable to compete successfully in our industry.
Our industry is highly fragmented and intensely competitive. According to the publication Engineering News-Record, based on information voluntarily reported by 500 design firms, the top ten engineering design firms only accounted for approximately 32% of the total design firm revenues in 2005. Our competitors are numerous, ranging from small private firms to multi-billion dollar companies. In addition, the technical and professional aspects of our services generally do not require large upfront capital expenditures and provide limited barriers against new competitors.
Some of our competitors have achieved greater market penetration in some of the markets in which we compete and have substantially more financial resources and/or financial flexibility than we do. As a result of the number of competitors in the industry, our clients may select one of our competitors on a project due to competitive pricing or a specific skill set. If we are unable to maintain our competitiveness, our market share will decline. These competitive forces could have a material adverse effect on our business, financial condition and results of operations by reducing our relative share in the markets we serve.
Our failure to attract and retain key employees could impair our ability to provide services to our clients and otherwise conduct our business effectively.
As a professional and technical services company, we are labor intensive, and therefore our ability to attract, retain and expand our senior management and our professional and technical staff is an important factor in determining our future success. From time to time, it may be difficult to attract and retain qualified individuals with the expertise and in the timeframe demanded by our clients. For example, some of our government contracts may require us to employ only individuals who have particular government security clearance levels. In addition, we rely heavily upon the expertise and leadership of our senior management. The failure to attract and retain key individuals could impair our ability to provide services to our clients and conduct our business effectively.
Employee, agent, or partner misconduct or our failure to comply with laws or regulations could weaken our ability to win contracts with government clients, which could result in decreasing revenues.
As a federal, state and local government contractor, misconduct, fraud, non-compliance with applicable laws and regulations, or other improper activities by one of our employees, agents, or partners could have a significant negative impact on our business and reputation. Such misconduct could include the failure to comply with government procurement regulations, regulations regarding the protection of classified information, laws regarding the pricing of labor and other costs in government contracts, regulations on lobbying or similar activities, environmental laws and any other applicable laws or regulations. For example, we regularly provide services that may be highly sensitive or that relate to critical national security matters; if a security breach were to occur, our ability to procure future government contracts could be severely limited. Other examples of potential misconduct include time card fraud and violations of the Anti-Kickback Act. The precautions we take to prevent and detect these activities may not be effective, and we could face unknown risks or losses. Our failure to comply with applicable laws or regulations or acts of misconduct could subject us to fines and penalties, loss of security clearance and suspension or debarment from contracting, which could weaken our ability to win future contract with government clients.
Recent changes in accounting for equity-related compensation have impacted our financial statements and could negatively impact our ability to attract and retain key employees.
We adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) on December 31, 2005. At that time, we evaluated our current stock-based compensation plans and employee stock purchase plans. In order to minimize the volatility of our stock-based compensation expense, we are currently issuing restricted stock awards and units to selected employees rather than granting stock options. We also revised our employee stock purchase plan from a 15% discount on our stock price at the beginning or the end of the six-month offering period, whichever is lower, to a 5% discount on our stock price at the end of the six-month offering period. These changes to our equity-related compensation may negatively impact our ability to attract and retain key employees.
Our indebtedness could limit our ability to finance future operations or engage in other business activities.
As of March 30, 2007, we had $114.0 million of total outstanding indebtedness and $62.6 million in letters of credit outstanding against our revolving line of credit. This level of indebtedness could negatively affect us because it may impair our ability to borrow in the future and make us more vulnerable in an economic downturn. Our current credit facility contains customary financial, affirmative and negative covenants for a company with a similar financial position to ours. As of March 30, 2007, we were in compliance with all the covenants of our credit facility.
Because we are a holding company, we may not be able to service our debt if our subsidiaries do not make sufficient distributions to us.
We have no direct operations and no significant assets other than investments in the stock of our subsidiaries. Because we conduct our business operations through our operating subsidiaries, we depend on those entities for payments and dividends to generate the funds necessary to meet our financial obligations. Legal restrictions, including local regulations and contractual obligations associated with secured loans, such as equipment financings, could restrict our subsidiaries’ ability to pay dividends or make loans or other distributions to us. The earnings from, or other available assets of, these operating subsidiaries may not be sufficient to make distributions to enable us to pay interest on our debt obligations when due or to pay the principal of such debt at maturity. As of March 30, 2007, our debt service obligations, comprised of principal and interest (excluding capital leases), during the next twelve months will be approximately $5.4 million. Based on the current outstanding indebtedness of $114.0 million under our current credit facility, if market rates were to average 1% higher during that same twelve-month period, our net of tax interest expense would increase by approximately $0.7 million.
Our international operations are subject to a number of risks that could harm our operations and significantly reduce our future revenues.
As a multinational company, we have operations in over 20 countries and we derived 10% and 9% of our revenues from international operations for the three months ended March 30, 2007 and March 31, 2006, respectively. International business is subject to a variety of risks, including:
• lack of developed legal systems to enforce contractual rights;
• greater risk of uncollectible accounts and longer collection cycles;
• currency fluctuations;
• logistical and communication challenges;
• potentially adverse changes in laws and regulatory practices, including export license requirements, trade barriers, tariffs and tax laws;
• changes in labor conditions;
• exposure to liability under the Foreign Corrupt Practices Act and export control and anti-boycott laws; and
• general economic and political conditions in foreign markets.
These and other risks associated with international operations could harm our overall operations and significantly reduce our future revenues. In addition, services billed through foreign subsidiaries are attributed to the international category of our business, regardless of where the services are performed and conversely, services billed through domestic operating subsidiaries are attributed to a domestic category of clients, regardless of where the services are performed. As a result, our international risk exposure may be more or less than the percentage of revenues attributed to our international operations.
Our business activities may require our employees to travel to and work in high security risk countries, which may result in employee death or injury, repatriation costs or other unforeseen costs.
As a multinational company, our employees often travel to and work in high security risk countries around the world that are undergoing political, social and economic upheavals resulting in war, civil unrest, criminal activity or acts of terrorism. For example, we have employees working in high security risk countries located in the Middle East and Southwest Asia. As a result, we may be subject to costs related to employee death or injury, repatriation or other unforeseen circumstances.
We rely on third party software to run our critical accounting, project management, and financial information systems, and as a result, any sudden loss, disruption or unexpected costs to maintain such systems could significantly increase our operational expense as well as disrupt the management of our business operations.
We rely on third party software to run our critical accounting, project management and financial information systems. For example, we relied on one software vendor’s products to process approximately 68% of our total revenues as of March 30, 2007. We also depend on our third party software vendors to provide long-term software maintenance support for our information systems. Software vendors may decide to discontinue further development, integration or long-term software maintenance support for our information systems, in which case we may need to abandon one or more of our current information systems and migrate some or all of our accounting, project management and financial information to other systems, thus increasing our operational expense as well as disrupting the management of our business operations.
Force majeure events, including natural disasters and terrorists’ actions have negatively impacted and could further negatively impact the economies in which we operate, which may affect our financial condition, results of operations or cash flows.
Force majeure events, including natural disasters, such as Hurricane Katrina that affected the Gulf Coast in August 2005, and terrorist attacks, such as those that occurred in New York and Washington, D.C. on September 11, 2001, could negatively impact the economies in which we operate. For example, Hurricane Katrina caused several of our Gulf Coast offices to close, interrupted a number of active client projects and forced the relocation of our employees in that region from their homes. In addition, during the September 11, 2001 terrorist attacks, several of our offices were shut down due to terrorist attack warnings.
We typically remain obligated to perform our services after a terrorist action or natural disaster unless the contract contains a force majeure clause relieving us of our contractual obligations in such an extraordinary event. If we are not able to react quickly to force majeure, our operations may be affected significantly, which would have a negative impact on our financial condition, results of operations or cash flows.
Negotiations with labor unions and possible work actions could divert management attention and disrupt operations. In addition, new collective bargaining agreements or amendments to agreements could increase our labor costs and operating expenses.
As of March 30, 2007, approximately 7% of our employees were covered by collective bargaining agreements. The outcome of any future negotiations relating to union representation or collective bargaining agreements may not be favorable to us. We may reach agreements in collective bargaining that increase our operating expenses and lower our net income as a result of higher wages or benefits expenses. In addition, negotiations with unions could divert management attention and disrupt operations, which may adversely affect our results of operations. If we are unable to negotiate acceptable collective bargaining agreements, we may have to address the threat of union-initiated work actions, including strikes. Depending on the nature of the threat or the type and duration of any work action, these actions could disrupt our operations and adversely affect our operating results.
We have only a limited ability to protect our intellectual property rights, which are important to our success. Our failure to protect our intellectual property rights could adversely affect our competitive position.
Our success depends, in part, upon our ability to protect our proprietary information and other intellectual property. We rely principally on trade secrets to protect much of our intellectual property where we do not believe that patent or copyright protection is appropriate or obtainable. However, trade secrets are difficult to protect. Although our employees are subject to confidentiality obligations, this protection may be inadequate to deter or prevent misappropriation of our confidential information. In addition, we may be unable to detect unauthorized use of our intellectual property or otherwise take appropriate steps to enforce our rights. Failure to obtain or maintain trade secret protection would adversely affect our competitive business position. In addition, if we are unable to prevent third parties from infringing or misappropriating our trademarks or other proprietary information, our competitive position could be adversely affected.
Delaware law and our charter documents may impede or discourage a merger, takeover or other business combination even if the business combination would have been in the best interests of our current stockholders.
We are a Delaware corporation and the anti-takeover provisions of Delaware law impose various impediments to the ability of a third party to acquire control of us, even if a change in control would be beneficial to our existing stockholders. In addition, our board of directors has the power, without stockholder approval, to designate the terms of one or more series of preferred stock and issue shares of preferred stock, which could be used defensively if a takeover is threatened. Our incorporation under Delaware law, the ability of our board of directors to create and issue a new series of preferred stock and provisions in our certificate of incorporation and by-laws could impede a merger, takeover or other business combination involving us or discourage a potential acquirer from making a tender offer for our common stock, even if the business combination would have been in the best interests of our current stockholders.
Stock Purchases
The following table sets forth all purchases made by us or any “affiliated purchaser” as defined in Rule 10b-18(a)(3) of the Securities Exchange Act of 1934, as amended, of our common shares during the first quarter of 2007.
Period | (a) Total Number of Shares Purchased (1) | (b) Average Price Paid per Share | (c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2) | (d) Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs | |||||||||
(In thousands, except average price paid per share) | |||||||||||||
December 30, 2006 - January 26, 2007 | — | — | — | — | |||||||||
January 27, 2007 - February 23, 2007 | 22 | $ | 44.33 | — | — | ||||||||
February 24, 2007 - March 30, 2007 | — | — | — | 1,546 | |||||||||
Total | 22 | — | 1,546 |
(1) | All purchases were made pursuant to our Stock Incentive Plans, which allow our employees to surrender shares of our common stock as payments toward the exercise cost and tax withholding obligations associated with the exercise of stock options or the vesting of restricted or deferred stock. |
(2) | On March 26, 2007, we announced that our Board of Directors approved a common stock repurchase program that will allow the repurchase of up to one million shares of our common stock plus additional shares issued or deemed issued under our Stock Incentive Plans and ESPP for the period from December 30, 2006 through January 1, 2010 (excluding shares issuable upon the exercise of options granted prior to December 30, 2006). Our stock repurchase program will terminate on January 1, 2010. No purchases have been made pursuant to this publicly-announced repurchase program during the quarter ended March 30, 2007. |
None.
None.
None.
ITEM 6. EXHIBITS
(a) Exhibits
10.1 | 2007 URS Corporation Annual Incentive Compensation Plan pursuant to the 1999 Incentive Compensation Plan, filed as Exhibit 10.1 to our Form 8-K, dated March 22, 2007, and incorporated herein by reference. |
10.2 | Form of Director Indemnification Agreement filed as Exhibit 10.4 to our Form 10-Q for the quarter ended April 30, 2004, agreed to between URS Corporation and Douglas W. Stotlar, and incorporated herein by reference. |
31.1 | Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. FILED HEREWITH. |
31.2 | Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. FILED HEREWITH. |
32 | Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. FILED HEREWITH. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
URS CORPORATION | ||
Dated: May 8, 2007 | By: | /s/ Reed N. Brimhall |
Reed N. Brimhall | ||
Vice President, Controller and Chief Accounting Officer |
Exhibit No.
Description
31.1 Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.