================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q --------- [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED MAY 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 1-10583 ------- ATC GROUP SERVICES INC. ------------------------------------------------------ (Exact name of Registrant as specified in its charter) DELAWARE 46-0399408 - --------------------------------- ------------------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 104 EAST 25TH STREET, 10TH FLOOR NEW YORK, NEW YORK 10010 - --------------------------------- ------------------------------- (Address of principal executive (Zip Code) offices) Registrant's telephone number, including area code: (212) 353-8280 -------------- NONE ---- (Former name, former address and former fiscal year if changed since last report) 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 ___ No ___ Not Applicable X --- The number of shares outstanding of the Registrant's Common Stock, par value $0.01 per share, as of July 14, 1998 was 1,000. This report is being filed voluntarily with the Securities and Exchange Commission (the "Commission") pursuant to the Registrant's contractual obligation to file with the Commission all information that would be required to be filed on Form 10-K, Form 10-Q or Form 8-K. The Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934. ================================================================================ ATC GROUP SERVICES INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED MAY 31, 1998 - -------------------------------------------------------------------------------- Page ------ PART I - FINANCIAL INFORMATION: Item 1 - Financial Statements: Consolidated Balance Sheets February 28, 1998 and May 31, 1998 (Unaudited)................ F-3 Consolidated Statements of Operations Three months ended May 31, 1997 and 1998 (Unaudited).......... F-4 Consolidated Statements of Stockholders' Equity Three months ended May 31, 1997 and 1998 (Unaudited).......... F-5 Consolidated Statements of Cash Flows Three months ended May 31, 1997 and 1998 (Unaudited).......... F-6 Notes to Consolidated Financial Statements (Unaudited)......... F-7 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations........................... F-19 PART II - OTHER INFORMATION: Items 1-6...................................................... F-23 Signatures..................................................... F-25 F-2 ATC GROUP SERVICES INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS FEBRUARY 28, 1998 AND MAY 31, 1998 (Unaudited) - -------------------------------------------------------------------------------- FEBRUARY 28, MAY 31, 1998 1998 ------------ ----------- (Unaudited) ASSETS - ------ CURRENT ASSETS: Cash and cash equivalents....................................................... $ 5,268,708 $ 1,539,496 Trade accounts receivable, less allowance for doubtful accounts ($3,077,829 at February 28, 1998 and $3,350,882 at May 31, 1998)............... 39,934,302 43,005,533 Unbilled receivables............................................................ 10,196,397 9,441,224 Prepaid expenses and other current assets....................................... 2,422,523 1,467,305 Deferred income taxes........................................................... 2,041,200 2,041,200 Refundable income taxes......................................................... 4,232,505 4,321,489 ------------ ------------ Total current assets........................................................... 64,095,635 61,816,247 PROPERTY AND EQUIPMENT, Net (Note C)............................................. 5,793,928 5,917,736 GOODWILL, net of accumulated amortization ($3,261,108 at February 28, 1998 and $3,907,824 at May 31, 1998)(Note B)....... 106,829,231 105,932,515 COVENANTS NOT TO COMPETE, net of accumulated amortization ($774,589 at February 28, 1998 and $1,197,979 at May 31, 1998)(Note B)......... 5,162,911 4,739,521 DEBT ISSUANCE COSTS, net of accumulated amortization ($107,570 at February 28, 1998 and $352,847 at May 31, 1998)(Note B)........... 5,808,246 6,799,648 OTHER ASSETS.................................................................... 1,365,056 1,650,066 ------------ ------------ $189,055,007 $186,855,733 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ CURRENT LIABILITIES: Short-term debt................................................................. $ 300,000 $ 300,000 Current maturities of long-term debt............................................ 1,420,816 1,559,413 Accounts payable................................................................ 7,738,433 9,872,313 Accrued compensation............................................................ 5,096,880 6,148,563 Accrued payment obligations - ATEC acquisition (Note B)......................... 589,026 215,500 Tender Offer liability (Note B)................................................. 14,278,838 3,681,818 Other accrued expenses.......................................................... 5,231,164 7,640,028 ------------ ------------ Total current liabilities...................................................... 34,655,157 29,417,635 LONG-TERM DEBT, less current maturities (Note D)................................. 120,419,684 124,669,685 OTHER LIABILITIES, including non-current payment obligations (Note B)............ 2,737,185 2,177,100 DEFERRED INCOME TAXES............................................................ 4,606,800 4,606,800 ------------ ------------ Total liabilities.............................................................. 162,418,826 160,871,220 ------------ ------------ COMMITMENTS AND CONTINGENCIES (Notes B and E) STOCKHOLDERS' EQUITY: Common stock, par value $.01 per share; authorized 10,000 shares; issued and outstanding 1,000 shares at February 28, 1998 and May 31, 1998...... 10 10 Additional paid-in capital...................................................... 28,425,589 28,425,589 Additional paid-in capital - restricted Holdings Stock, net of deferred executive compensation.................................. -- 50,844 Retained (Deficit).............................................................. <1,789,418> (2,491,930) ------------ ------------ Total stockholders' equity.................................................... 26,636,181 25,984,513 ------------ ------------ $189,055,007 $186,855,733 ============ ============ See notes to consolidated financial statements. F-3 ATC GROUP SERVICES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS THREE MONTHS ENDED MAY 31, 1997 AND 1998 (Unaudited) - -------------------------------------------------------------------------------- Three Months Ended May 31, ------------------------------------ Predecessor Successor 1997 1998 -------------- -------------- REVENUES............................... $31,374,666 $40,282,914 Reimbursable Costs.................... 4,455,833 5,769,682 ----------- ----------- NET REVENUES........................... 26,918,833 34,513,232 COST OF NET REVENUES................... 14,661,621 18,818,906 ----------- ----------- Gross profit......................... 12,257,212 15,694,326 ----------- ----------- OPERATING EXPENSES: Selling............................... 999,995 1,408,273 General and administrative............ 8,477,336 10,915,077 Provision for bad debts............... 377,439 370,992 ----------- ----------- 9,854,770 12,694,342 ----------- ----------- Operating income..................... 2,402,442 2,999,984 NON-OPERATING EXPENSE (INCOME): Interest expense...................... 498,408 3,795,934 Interest income....................... (51,783) (5,792) Other................................. 9,501 (1,646) ----------- ----------- 456,126 3,788,496 ----------- ----------- Income (loss) before income taxes.... 1,946,316 (788,512) INCOME TAX EXPENSE (BENEFIT)........... 770,000 (86,000) ----------- ----------- NET INCOME (LOSS)...................... $ 1,176,316 $ (702,512) =========== =========== See notes to consolidated financial statements. F-4 ATC GROUP SERVICES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY THREE MONTHS ENDED MAY 31, 1997 AND 1998 (UNAUDITED) - -------------------------------------------------------------------------------- COMMON STOCK ADDITIONAL HOLDINGS ------------ PAID-IN RESTRICTED RETAINED SHARES AMOUNT CAPITAL STOCK-NET EARNINGS TOTAL ------------- ------------ --------------- ---------- --------------- ------------ BALANCE, February 28, 1997............. 7,800,187 $78,002 $28,996,627 $ - $16,364,674 $45,439,303 Sale of common stock at $1.88 to $10.00 per share, upon exercise of stock options and warrants............ 2,800 28 23,910 - - 23,938 Continuing registration costs applied against additional paid in capital.... - - (26,484) - - (26,484) Net income of predecessor.............. - - - - 1,176,316 1,176,316 ------------- ------------ --------------- ---------- -------------- ------------ BALANCE, May 31, 1997.................. 7,802,987 $78,030 $28,994,053 $ - $17,540,990 $46,613,073 ============= ============ =============== ========== ============== ============ COMMON STOCK ADDITIONAL HOLDINGS ------------ PAID-IN RESTRICTED RETAINED SHARES AMOUNT CAPITAL STOCK-NET (DEFECIT) TOTAL ------------- ------------ --------------- ---------- ------------- ------------ BALANCE, February 28, 1998............. 1,000 $ 10 $28,425,589 - $ (1,789,418) $26,636,181 Amortization of deferred compensation costs.................... - - - 50,844 Net (loss) of successor................ - - - - (702,512) (702,512) ------------- ------------ --------------- ---------- -------------- ------------ BALANCE, May 31, 1998.................. 1,000 $ 10 $28,425,589 $50,844 $ (2,491,930) $25,984,513 ============= ============ =============== ========== ============== ============ See notes to consolidated financial statements. F-5 ATC GROUP SERVICES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS THREE MONTHS ENDED MAY 31, 1997 AND 1998 (Unaudited) - -------------------------------------------------------------------------------- Three Months Ended May 31, ---------------------------------- Predecessor Successor 1997 1998 -------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)............................................................................. $ 1,176,316 $ (702,512) Adjustments to reconcile net income (loss) to net cash from operating activities: Depreciation and leasehold amortization...................................................... 239,580 428,964 Amortization of goodwill and covenants....................................................... 425,599 1,320,106 Provision for bad debts...................................................................... 377,439 370,992 Other........................................................................................ (16,338) 299,286 Changes in operating assets and liabilities, net of amounts acquired in acquisitions: Receivables............................................................................... (2,062,365) (2,966,550) Prepaid expenses and other assets......................................................... (115,701) 670,208 Accounts payable and other liabilities.................................................... (2,678,862) 5,220,901 Income taxes payable...................................................................... 458,132 (88,984) ------------ ------------ Net cash flows from operating activities..................................................... (2,196,200) 4,552,411 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of American Testing and Engineering Corp, net of cash acquired....................... (2,420,766) - Purchase of property and equipment............................................................ (256,753) (673,272) Other......................................................................................... 19,510 401,646 ------------ ------------ Net cash flows from investing activities..................................................... (2,658,009) (271,626) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of long-term debt and notes payable, net of issuance costs............. 33,000,000 3,319,417 Proceeds from issuance of common stock, net of expenses....................................... 23,938 - Payment of Tender Offer obligations........................................................... - (11,150,448) Principal payments on long-term debt.......................................................... (21,939,978) (178,966) Other capital transactions.................................................................... (26,484) - ------------ ------------ Net cash flows from financing activities..................................................... 11,057,476 (8,009,997) ------------ ------------ Net change in cash and cash equivalents...................................................... 6,203,267 (3,729,212) CASH AND CASH EQUIVALENTS, Beginning of period.................................................. 2,003,890 5,268,708 ------------ ------------ CASH AND CASH EQUIVALENTS, End of period........................................................ $ 8,207,157 $ 1,539,496 ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash payments for: Interest...................................................................................... $ 559,751 $ 562,519 ============ ============ Income taxes.................................................................................. $ 193,529 $ 2,984 ============ ============ See notes to consolidated financial statements. F-6 ATC GROUP SERVICES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE MONTHS ENDED MAY 31, 1998 (UNAUDITED) - -------------------------------------------------------------------------------- A. GENERAL ACQUISITION OF THE COMPANY BY ACQUISITION HOLDINGS, INC.--ATC Group Services Inc. and subsidiaries ("ATC" or the "Company") became a wholly owned subsidiary of Acquisition Holdings, Inc. ("Holdings") effective February 5, 1998 (the "Merger Date") upon the merger of the Company with Acquisition Corp., a wholly owned subsidiary of Holdings, with ATC being the surviving corporation (the "Merger"). Holdings, through Acquisition Corp., completed an offer to purchase the outstanding common stock of ATC at $12.00 per share using the proceeds from the issuance of 12% senior subordinated notes (the "Notes"), bank borrowings (the "Bank Credit Facilities") and new equity investments. The accompanying financial statements for the Company from February 5, 1998 and subsequent thereto (the "Successor Period"), are attributable to operations of the Company under the successor ownership of Holdings. The predecessor financial statements, representing the period prior to February 5, 1998 (the "Predecessor Period"), relate to the previous ownership of the Company. PRINCIPALS OF CONSOLIDATION--The consolidated financial statements include the accounts of ATC Group Services Inc. and its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated. In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly, in all material respects, the financial position, the results of operations and the cash flows for the periods presented herein. These results of operations are not necessarily indicative of the results to be expected for the full year due to certain seasonality factors and the effects and timing of large service projects. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted. These condensed financial statements should be read in conjunction with the consolidated financial statements and the notes included in the Company's financial statements for the fiscal year ended February 28, 1998, which are included in the Company's Annual Report on Form 10-K. NATURE OF BUSINESS--The Company is a national business services firm providing technical and project management services relating to environmental consulting (the "environmental consulting and engineering" segment) and information technology consulting services (the "information technology consulting" segment). The Company's environmental consulting and engineering segment provides environmental and geotechnical engineering services, architectural engineering services, construction materials testing and analytical testing. The Company's information technology consulting segment provides analysis and design services and system programming services to assist clients in building new or modifying existing computer systems. This business unit also provides support to clients in maintaining computer systems. RECLASSIFICATIONS -- Certain reclassifications have been made to the prior period's financial statements to conform to the current year's presentation. B. MERGER AND BUSINESS ACQUISITIONS MERGER, NOTE OFFERING, AND TENDER OFFER TRANSACTIONS--Acquisition Holdings, Inc. ("Holdings" or "Parent") and its wholly owned subsidiary, Acquisition Corp. ("Issuer"), were organized to effect the acquisition of the Company under the terms and conditions of a Merger Agreement dated November 26, 1997 (the "Merger Agreement"). Pursuant to the Merger Agreement, the Issuer offered (the "Tender Offer") to purchase all the issued and outstanding shares of the Company's Common Stock at a price of $12.00 per share. The Tender Offer was conditioned upon Issuer issuing $100,000,000 of Senior Subordinated Notes (the "Notes"; see Note D) and obtaining sufficient bank financing necessary to consummate the Tender Offer. Effective February 5, 1998, (the "Merger Date") upon satisfaction of the necessary conditions, the Issuer was merged into ATC, with ATC being the surviving corporation (the "Merger"). F-7 The Merger Agreement followed the execution of a stockholders agreement (the "Stockholders Agreement") with George Rubin and Morry F. Rubin (collectively the "Stockholders") requiring the Stockholders to vote 14.8% of their interest in the Company in favor of the Merger. In connection with the Stockholders Agreement, the Stockholders each agreed to and entered into Severance Consulting and Non-Competition Agreements (the "Severance Agreements"). Under these agreements, the Stockholders resigned from their officer positions, agreed to provide certain consulting services as requested by the Company for a period of three years following the consummation of the transactions, and agreed to restrict the Stockholders from competing with the Company's business and restricting certain other activities for a period ranging from three to four years from the effective date of the Merger. In consideration of the Severance Agreements, the Company paid the Stockholders $3.1 million on the Merger Date and will pay $553,430 on each of the next six succeeding quarters commencing April 1, 1998. In connection with the Merger and Tender Offer, the Company, through the Issuer, entered into a new bank credit agreement which provided for a $20,000,000 Term Loan and $30,000,000 Revolving Credit Facility (collectively the "Bank Credit Facilities"). The proceeds of the Term Loan along with the proceeds of the Notes and equity investments in Holdings were used to finance the Tender Offer, repay certain indebtedness including related accrued interest and prepayment penalties, pay a portion of the Severance Agreement consideration, and to pay financing costs and expenses. The acquisition of the Company by Holdings has been accounted for as a purchase. The excess of the purchase cost over the historical book value of the net assets acquired was allocated to the Severance Agreements and the remainder, to goodwill, is being amortized over 30 years. The accompanying consolidated balance sheet reflects the following sources and uses of funds related to the Tender Offer, Merger, Stockholders Agreement and the Bank Credit Facilities (collectively the "Transactions"). Sources of Funds: Notes........................................................ $100,000,000 Bank Term Loan............................................... 20,000,000 Equity investment from Holdings.............................. 30,714,639 Tender Offer obligations to be funded from cash on hand and revolving credit borrowings. (The outstanding balance at May 31, 1998 was $3,681,818)................................ 16,082,850 ------------ $166,797,489 ============ Uses of Funds: Purchase of common stock, warrants and stock options......... $105,473,603 Repay existing debt: Principal.................................................. 42,076,461 Accrued interest........................................... 577,345 Accrued ATEC obligations................................... 754,250 Shareholder Agreement Consideration: Amount paid at Merger Date................................. 3,100,002 Amounts payable in quarterly installments.................. 3,320,578 Financing costs and expenses, including debt prepayment penalty.................................................. 11,495,250 ------------ $166,797,489 ============ F-8 The total consideration paid in connection with the Transactions and allocation of the consideration to the historical book value of assets, covenant not to compete and goodwill is as follows: Consideration: Purchase price of common stock, warrants, and stock options. $105,473,603 Severance Agreements consideration.......................... 6,420,580 Financing costs and expenses less amount related to debt issuance................................................... 4,828,614 ------------ 116,722,797 Allocation of Consideration: Net assets acquired......................................... 51,214,836 Fair value adjustments: Non-compete agreement....................................... 4,700,000 Other....................................................... (301,537) ------------ Excess purchase consideration................................. 61,109,498 Predecessor basis adjustment.................................. (2,289,050) ------------ Goodwill.................................................... $ 58,820,448 ============ Holdings is not engaged in any activities other than those related to its ownership interest in ATC. A majority interest in Holdings is owned by affiliates of Weiss, Peck & Greer, L.L.C. ("Weiss Peck"), who was also a party to the Merger Agreement. Other actual and beneficial owners of Holdings include ATC management and employees who made equity contributions or elected to receive options to purchase common stock of Holdings in replacement of their "in-the-money" ATC stock options. Weiss Peck is a private investment firm, founded in 1970, which manages in excess of $14 billion in public equities and fixed-income securities for institutional and individual clients worldwide. In addition to its money management activities, the firm has a twenty-seven year history as an investor of equity capital in over 200 venture capital and private equity transactions. Investments of its Private Equity Group are made through affiliated funds with $230 million of committed capital. BUSINESS ACQUISITIONS--The following acquisitions have been accounted for as purchases. The acquired company's assets and liabilities are included in the accompanying consolidated balance sheets at fair value at the date of purchase. The acquired company's operations subsequent to the acquisition are included in the accompanying consolidated statements of operations. The preliminary purchase price allocation for the fiscal 1998 acquisitions are subject to change when additional information concerning asset and liability valuations is obtained. Therefore, the final allocation may differ from the preliminary allocation. Fiscal 1998 BING YEN & ASSOCIATES, INC.--On November 26, 1997 ATC purchased all of the outstanding stock of Bing Yen & Associates, Inc. ("Bing Yen"). Bing Yen provides geotechnical and structural forensic services to a wide variety of clients in the western United States and is located in Tustin, California. The purchase price was comprised of the following consideration: Amounts paid to seller: Cash......................................................... $2,200,000 Note payable at 8% due January 2, 1998....................... 550,000 Notes payable at 8% due in three annual installments commencing January 1999..................................... 1,150,000 ---------- 3,900,000 Liabilities assumed: Current liabilities.......................................... 313,254 Direct expenses of transaction............................... 50,000 ---------- $4,263,254 ========== F-9 In addition, a maximum aggregate principal amount of $1,500,000 in unsecured contingent achievement promissory notes will be issued if certain minimum net revenue levels are achieved, resulting in a maximum total consideration to seller of $5,400,000. The notes payable of $1,150,000 are subject to setoffs if actual net assets as of the closing date are below warranted amounts, for trade receivables not collected within one year of the closing date and under certain other specified conditions. The preliminary purchase price allocation is as follows: Cash........................................................... $ 163,680 Accounts receivable, net....................................... 2,292,191 Work in process................................................ 5,122 Prepaid expense................................................ 10,746 Property and equipment......................................... 142,241 Covenant not to compete........................................ 50,000 Goodwill....................................................... 1,595,324 Other assets................................................... 3,950 ---------- $4,263,254 ========== ENVIRONMENTAL WARRANTY, INC.--On November 4, 1997, ATC purchased 90.9% of the outstanding stock of Environmental Warranty, Inc. ("E.W.I."), a property and casualty insurance brokerage firm specializing in environmental insurance products. The purchase price was comprised of the following consideration: Amounts paid to sellers: Cash......................................................... $ 150,000 Notes payable, net of imputed interest at 8.0%............... 582,424 Payment commitments.......................................... 275,000 ATC Common Stock (33,000 shares)............................. 365,062 ---------- 1,372,486 Liabilities assumed: Current liabilities.......................................... 314,811 Direct expenses of transaction............................... 25,000 ---------- $1,712,297 ========== The notes payable are due in three annual installments commencing November 1998 and are subject to certain setoffs. The payment commitments are also due in three installments commencing November 1999. ATC issued 33,000 shares of restricted common stock valued at 11 1/16 per share. The preliminary purchase price allocation is as follows: Cash and equivalents........................................... $ 169,350 Receivables.................................................... 158,391 Prepaid and other current assets............................... 2,875 Property and other............................................. 15,384 Goodwill....................................................... 1,366,297 ---------- $1,712,297 ========== BCM ENGINEERS, INC.--On August 20, 1997 ATC purchased certain assets and assumed certain liabilities of the environmental consulting and engineering services division of the Smith Technology Corporation, which operated primarily as BCM Engineers, Inc. ("BCM"). BCM is a leading municipal water and wastewater environmental engineering firm and provides services in water, environmental compliance and site investigations, remedial design and engineering, asbestos, and air quality management. BCM serves major industrial clients in the chemical, petrochemical, oil and gas manufacturing, water supply, commercial development and utilities industries from multiple locations in the east and Gulf Coast. F-10 The purchase price was comprised of the following consideration: Amounts paid to seller or to others on behalf of seller: Cash........................................................ $ 5,425,539 Notes payable............................................... 2,950,000 Less note payable offset.................................... (200,000) ----------- 8,175,539 Liabilities assumed: Current liabilities......................................... 2,833,665 Non current liabilities..................................... 1,356,151 Direct expenses related to acquisition...................... 112,133 ----------- $12,477,488 =========== Notes payable includes a $200,000 note which became due September 20, 1997 and was subject to offset for reductions in net assets and for unrecorded liabilities arising through the closing date of the transaction. Based on the closing balance sheet provided by the Seller, the Company will offset the $200,000 in full. In addition, based on unrealized work in process warranted by the seller and other claims, an additional $2,750,000 has been reflected as an offset of short-term debt in the accompanying consolidated balance sheet. The preliminary purchase price allocation is summarized as follows: Accounts receivable, net of allowance.......................... $ 4,710,960 Work in process................................................ 3,684,939 Other current assets........................................... 7,357 Other assets................................................... 1,327,270 Covenants not to compete....................................... 100,000 Goodwill....................................................... 2,646,962 ----------- $12,477,488 =========== Prior Acquisitions AMERICAN TESTING AND ENGINEERING CORPORATION--On May 24, 1996 ATC purchased certain assets and assumed certain liabilities of American Testing and Engineering Corporation ("ATEC"), a national environmental consulting firm. ATEC provides environmental engineering and consulting services through a large network of branch and regional offices. Under the original purchase agreement, the Company was contingently liable to ATEC for additional purchase consideration up to $10,750,000 if certain conditions were met. The seller since met certain of these contingent consideration requirements in the quarter ended May 31, 1997 and the Company began to amortize the associated goodwill in this period. In addition, in connection with the issuance of the Senior Secured Notes on May 29, 1997, the Company and the seller executed an amendment to the original purchase agreement and agreed to remove or modify the remaining contingent consideration requirements. As a result of the foregoing, the Company paid $2,420,766 on May 30, 1997 and is obligated to make monthly payments through February 1999. Additionally, the Company has the option to purchase certain properties from the seller for $1,700,000 in fiscal 2002. As a result of sellers warranties of purchased trade receivables and work in process that were not realized, the Company is entitled to set-offs of $618,835 against the option price to acquire certain properties in fiscal 2002. If the Company does not exercise its option, the set-offs will be refunded by the seller. Amounts are included in other assets in the accompanying consolidated balance sheets. In connection with the purchase agreement, the Company has issued an irrevocable letter of credit in the amount of $500,000 to secure the Company's performance of its payment obligations. The letter of credit is renewable by the seller until such time the Company has paid the purchase obligations in full. No amounts have been drawn against the letter of credit. F-11 PRO FORMA FINANCIAL INFORMATION (UNAUDITED) - The following unaudited pro forma information sets forth the results of operations of ATC as if the Merger and Tender Offer and ATC's purchases of BCM, EWI and Bing Yen had occurred on March 1, 1997: PRO FORMA THREE MONTHS ENDED MAY 31, ---------------------------- 1997 1998 ------------ ------------ Revenues.................................................. $ 41,549,577 $ 40,282,914 Operating Income.......................................... 1,676,483 2,999,984 Net income (loss)......................................... $ <1,102,069> $ (702,512) C. PROPERTY AND EQUIPMENT Property and equipment is comprised of the following: FEBRUARY 28, MAY 31, 1998 1998 ------------ ------------ Office equipment......................................... $ 5,345,109 $ 5,913,192 Laboratory and field equipment........................... 3,967,605 3,628,304 Transportation equipment................................. 582,524 585,064 Leasehold improvements................................... 1,111,823 1,123,173 ------------ ------------ 11,007,061 11,249,733 Less accumulated depreciation............................ <5,213,133> (5,331,997) ------------ ------------ Property and Equipment, net.............................. $ 5,793,928 $ 5,917,736 ============ ============ D. DEBT AND CREDIT AGREEMENTS BANK CREDIT FACILITIES--On January 29, 1998, a credit facility with various lending institutions was established providing the Company senior secured credit facilities consisting of a $20 million Term Loan and a $30 million Revolving Credit Facility (the "Bank Credit Facilities"). The Revolving Credit Facility is available to the Company for working capital and general corporate purposes, including certain permitted acquisitions. Revolving loans mature on January 29, 2003. At the Company's option, revolving loans will accrue interest at either (a) an adjusted rate based on the Eurodollar rate plus a margin of 2.25% or (b) the base rate (effectively the prime rate) plus a margin of 1.25%. The loan margins are subject to quarterly decreases based upon improvements in the Company's leverage ratio. Interest is payable monthly and the Company pays a revolving loan commitment fee of 1/2 of 1% on a quarterly basis. The Term Loan amortizes quarterly commencing in February 1999 initially at $750,000 per quarter, increasing to $1,000,000 per quarter in February 2000, $1,500,000 per quarter in February 2001 and $1,750,000 per quarter in February 2002 with the final loan maturity on January 29, 2003. F-12 The Bank Credit Facilities require the Company to meet certain financial tests, including minimum interest coverage and maximum leverage ratios beginning as of and for the quarter ended May 31, 1998. The Bank Credit Facilities also contain covenants which, among other things, limit the ability of the Company to incur additional indebtedness, pay dividends, enter into transactions with affiliates, form subsidiaries, enter into sale-leaseback transactions, make capital expenditures, loans, investments or lease payments, merge, consolidate or acquire or dispose of assets, voluntary prepay or amend other indebtedness, incur liens and encumbrances and other matters customarily restricted in loan agreements of this type. For the quarter ended May 31, 1998, the Company was in default of certain financial covenants. The Company's lenders have provided an interim waiver with respect to the defaults. Under the waiver, the Company has approximately $3.4 million of availability under its revolving line of credit as of July 15, 1998. The Company is in discussion with its lenders and believes the covenant provisions of the credit agreement will be amended. Accordingly, the Company continues to classify its outstanding debt as long term in accordance with the existing loan maturity dates. The final classification of the Company's outstanding bank debt and 12% Senior Secured Notes, will be in accordance with the terms of any final credit agreement. The Bank Credit Facilities contain customary events of default, including payment defaults, breach of representations and warranties, covenant defaults, cross defaults, certain events of bankruptcy and insolvency, ERISA, judgement defaults, failure of any guarantee or security agreement supporting the Company's obligations under the Bank Credit Facilities to be in full force and effect, and a change of control of the Company's Parent or the Company. The obligations of the Company under the Bank Credit Facilities are unconditionally guaranteed by the Company's Parent and any direct or indirect subsidiaries of the Company. In addition, the obligations of the Company under the Bank Credit Facilities are secured by substantially all of the assets of the Company. 12% SENIOR SUBORDINATED NOTES DUE 2008--The 12% Senior Subordinated Notes due 2008 were issued January 29, 1998 pursuant to an indenture agreement and became obligations of the Company as of the Merger Date. Interest accrues at 12% per annum and is payable semiannually in arrears on each January 15 and July 15, commencing July 15, 1998. The Notes are unsecured obligations of the Company, ranking subordinate in right of payment to all senior indebtedness (as defined) as of the Merger Date, and ranking pari passu in right of payment with any future senior subordinated indebtedness and senior in right of payment to all other subordinated obligations of the Company. The Notes will be redeemable, in whole of in part, at the Company's option on or after January 15, 2003 at redemption prices set forth in the Note indenture agreement. Up to 35% of the aggregate principal amount of the Notes may be redeemed on or prior to January 15, 2001 with the net cash proceeds of a public offering at redemption prices and terms in accordance with the Note indenture agreement. The Note indenture agreement provides noteholders the option to have their notes purchased in the event of a change in control. In addition, the Note indenture contains covenants restricting the incurrence of additional indebtedness, payment of dividends, sales of assets, incurrence of liens, mergers and acquisitions and conduct of the business to existing businesses. 8.18% SENIOR SECURED NOTES--On May 29, 1997, the Company issued $32,500,000 of 8.18% Senior Secured Notes to a group of financial institutions. The proceeds were used in part to repay the Company's bridge credit facility outstanding as of February 28, 1997. In connection with the issuance of the 8.18% Senior Secured Notes, the Company had entered into a bank credit agreement providing a $15,000,000 revolving line of credit. Amounts outstanding under the bank revolver and the 8.18% Senior Secured Notes were repaid in full using proceeds of the 12% Senior Subordinated Notes due 2008 and the Bank Credit Facilities. F-13 E. COMMITMENTS AND CONTINGENCIES LITIGATION--GENERAL LITIGATION--Joseph I. Peters v. George Rubin, et al, Civ. Action No. 16026-NC, Court of Chancery, New Castle County, Delaware. On or about November 12, 1997, a summons and complaint were filed in the Delaware Court on behalf of Joseph I. Peters, as plaintiff. On or about December 18, 1997, an amended complaint was filed (the "Amended Complaint"). The Amended Complaint names the Company, the members of the Company's board of directors, Weiss Peck and the WPG Corporate Development Associates V, L.P., a Weiss Peck affiliate, as defendants. The Amended Complaint challenges the Tender Offer and Merger. The Amended Complaint seeks class action status on behalf of the stockholders of the Company. The plaintiff in the action claims that the offer price for the Company's Common Stock is inadequate and that the defendants have breached their fiduciary duties to the plaintiff and other stockholders of the Company. The plaintiff seeks, among other things, to enjoin the Transactions or compensatory damages. On January 7, 1998, a motion to dismiss was filed by Weiss Peck and WPG Corporate Development Associates V, L.P, a Weiss Peck affiliate. On January 13, 1998, answers to the complaint were filed by the Company and the remaining defendants. The parties to the action are currently conducting discovery. The Company believes the allegations contained in the Amended Complaint are without merit and intends to defend the action vigorously; however, there can be no assurance of the outcome. First Fidelity Bank, N.A., et al v. Hill International, Inc. et al., Superior Court of New Jersey, Law Division, Burlington County, Docket No. Bur- L-03400-95, filed December 19, 1995. Irvin E. Richter, et al v. ATC Group Services Inc., et al. United States District Court, District of New Jersey, Civ. No. 96 CV 5818 (JBS) filed December 6, 1996. On December 19, 1995, a second amended complaint was filed in the above-entitled action which joined the Company as a defendant and included a count against the Company seeking recovery of certain assets purchased from Hill on the grounds that plaintiff banks held security interests in the assets and that Hill was in default under the security agreement creating such alleged security interests. The original plaintiffs in this action were First Fidelity Bank, N.A. and United Jersey Bank, N.A. The primary defendants were Hill and certain of its subsidiaries, and Irvin Richter, David Richter, Janice Richter and William Doyle. Irvin Richter and David Richter are officers and stockholders of Hill. In April 1996, the Company filed a cross-claim against Hill, Irvin Richter and David Richter alleging breach of contract and fraud, among other allegations, and seeking unspecified damages, including punitive damages, and equitable relief. In August, 1996, Hill and the Richters filed an answer denying ATC's cross- claims, a cross-claim against ATC and a third party claim against certain members of ATC's management and an employee. The cross-claim and third party claim seek unspecified damages, including punitive damages, for defamation, breach of the Richters' non-competition agreements and securities fraud. The defamation claims are based (i) on plaintiff banks' allegation of fraud against Hill and the Richters in their amended complaint, which Hill and the Richters allege was based on defamatory statements made by ATC in settlement discussions with the plaintiff banks and (ii) on a letter alleged to contain defamatory statements which was sent to an account debtor of the Company by an employee. In its answer, the Company both denies that it made defamatory statements and asserts that the defamation allegations fail to state legally valid claims. The breach of contract and securities claims are based on allegations that ATC made representations concerning a registration rights agreement to be provided in connection with options issued to the Richters as consideration for their non-competition agreements. In its answer, the Company denies that an agreement concerning registration rights was ever reached and asserts that any such rights were forfeited or suspended by the Richters in any case as a result of their conduct in connection with the asset purchase. ATC also disputes that the Richters sustained damages on the grounds, among others, that the options were non-transferable and because ATC's stock price never exceeded the exercise price at any point where the options would have been exercisable. These related cases are in the discovery phase. In January, 1997, the plaintiff banks dismissed their claim against ATC. On December 6, 1996, Hill and the Richters commenced an action against ATC and the same officers and employees of ATC alleging essentially the same claims in federal court as in the state action. This action is entitled Irwin E. Richter et al. v. ATC Group Services, et al., Civ. No. 96-5818 (JBS), U.S. District Court for the District of New Jersey, December 6, 1996. ATC has answered, raising the same defenses and additional defenses related to the timeliness of the federal securities claims. The case is currently in the discovery phase. It does not create a risk of double recovery. In the Company's opinion, the outcome of this matter will not have a significant effect on the Company's financial position or future results of operations and cash flows, although no assurances can be given in this regard. F-14 Commonwealth of Massachusetts v. TLT Construction Corp. et al., Civ. Action No. 96-02281 F, Superior Court of Middlesex County, Massachusetts. This is an action brought by the Commonwealth of Massachusetts in April 1996, against the architects and general contractor on a renovation and construction project on the Suffolk County Courthouse in Massachusetts. The basis of the lawsuit is that one or more damp-proofing products specified by the architect defendants and installed by the contractor defendant made employees in the courthouse ill because of the off-gassing of harmful vapors. Dennison Environmental Services Inc., ("Dennison") an ATC subsidiary, was joined on August 13, 1996, as a third party defendant by TLT Construction Corporation, the general contractor, because Dennison performed some air quality testing of the air in the courthouse for the Commonwealth of Massachusetts during the construction process. The contractor alleges that it acted in reliance on these tests in continuing to install the material after the test report was given to it by the state. ATC's position is that it did not commit any error or omission in this case, that ATC made no representation to the contractors or material supplier and had no privity with them and that Dennison's opinion concerning short term, during- construction health effects of the off-gassing could not be justifiably relied upon with respect to the long-term performance and health effects of the product or its installation. This case is in the discovery phase. At this point, ATC considers the case to be without merit, and ATC intends to vigorously defend the action. Notice of this claim has been made to ATC's professional liability insurer. At the time that notice of this claim was filed, the Company had in effect a professional liability insurance policy in the amount of $10.0 million with a deductible of $250,000. Barrett-Moeller et al. v. ATC Associates Inc., Civ. Action No. 97-01037D, Superior Court of Middlesex County, Massachusetts. This is an action arising out of the same set of occurrences as gave rise to Commonwealth of Massachusetts v. TLT Construction, Corp. described above. The action was brought by a group of employees who worked in the Suffolk County Courthouse during the period in which the off-gassing of harmful vapors was alleged to have occurred. The suit seeks damages for personal injury in an unspecified amount. Notice of this claim has been made to ATC's professional liability insurer. At the time that notice of this claim was filed, the Company had in effect a professional liability insurance policy in the amount of $10.0 million with a deductible of $250,000. Joan Spencer v. TLT Construction et al., Civ. Action No. 97-4161C, Superior Court of Middlesex County, Massachusetts. This is an action arising out of the same set of occurrences as gave rise to Commonwealth of Massachusetts v. TLT Construction, Corp. described above. The action was brought by an employee who worked in the Suffolk County Courthouse during the period in which the off- gassing of harmful vapors was alleged to have occurred. The suit seeks damages for personal injury in an unspecified amount. Notice of this claim has been made to ATC's professional liability insurer. At the time that notice of this claim was filed, the Company had in effect a professional liability insurance policy in the amount of $10.0 million with a deductible of $250,000. Cambridge Housing Authority v. CON-TEST, Inc. and ATC Group Services Inc., Superior Court of Middlesex County, Massachusetts. This action was brought on October 1, 1997 for damages in excess of $1,000,000 alleging that Con-Test, Inc. breached its contract with Cambridge Housing Authority and was negligent in performing asbestos survey work preparatory to a housing project re- modernization project. ATC was joined as a party on the theory of continuous business enterprise successor liability. ATC has filed an answer denying that it was a successor to Con-Test under Massachusetts's law and asserting that it should therefore have no liability for Con-Test's alleged acts or omissions. The Company believes that the case is without merit because ATC does not meet the definition of successor liability in the State of Massachusetts. ATC has filed a notice of claim with Con-Test's insurance company which has assumed the defense of the action. F-15 State of New York Department of Taxation and Finance. The Company has received a notice of audit from the New York State Department of Taxation and Finance ("NYDTF") for the three fiscal years 1993, 1994 and 1995. The agent has issued an audit report, which is expected to be the basis of a formal assessment estimated to be approximately $200,000. ATC's most recent communications with the NYDTF indicate that it is probable that ATC will incur a liability for back taxes in an approximate amount of $200,000 which the Company has recorded as a liability as of February 28, 1998. Professional Service Industries, Inc. v. ATC Group Services Inc. and Thomas Bowker, Superior Court, Norfolk County, Massachusetts, June 19, 1997, Civ. No. 97-01146. The complaint alleges that ATC interfered with a non-competition agreement between Mr. Bowker, currently an ATC employee, and PSI. An injunction has been issued by the court against ATC and Mr. Bowker prohibiting them from competitive acts within certain geographic areas. The case is currently on hold pending mediation between the parties in an attempt to settle the case. If settlement is not achieved through the mediation process, ATC intends to continue to vigorously defend the claim. Etzel v. ATC Etzel Place II, L.P. V. ATC Environmental Inc., Missouri Etzel Place II, L.P. v. ATC Environmental Inc. Action No. 982-01473, Missouri Circuit Court, Twenty-Second Judicial Circuit (St. Louis City). This action was brought on June 2, 1998 and alleges that ATC breached its contract with the plaintiff and was negligent in performing asbestos survey services in connection with an asbestos removal project. Plaintiff requests damages in the amount of $241,062.40. ATC believes it performed all services properly and intends to vigorously defend this action. Notice of this claim has been made under ATC's professional liability and pollution liability insurance policy. The insurance policy is subject to a $150,000 self-insured retention amount. Although the Company believes this claim will not result in a material loss, no assurance in this regard can be given. 1100 Airport North Partnership V. Atc Group Services Inc., Superior Court of, 1100 Airport North Partnership v. ATC Group Services Inc., Cause No. 02D01-9804- CP-813, Superior Court of Allen County Indiana. This action was filed on May 1, 1998 and arises out of ATC's lease of office space in Fort Wayne, Indiana. The Plaintiff seeks damages and attorneys fees for ATC's alleged breach of the lease. On July 1, 1998, a default judgment was entered against ATC in the amounts of $302,116.13 and $1,443.00 for damages and attorneys fees, respectively. ATC believes it has sufficient grounds to vacate the default judgement and has meritorious defenses in this action. Although the Company believes this claim will not result in a material loss, no assurance in this regard can be give. ADMINISTRATIVE VIOLATIONS Indiana Department of Environmental Management v. ATC Associates Inc. ATC received a Notice of Violation ("NOV") and Proposed Agreed Order, EPA I.D. No. IND 004939765, dated June 9, 1997, on June 12, 1997 and a revised NOV and Proposed Agreed Order on April 22, 1998. The revised Proposed Agreed Order sought a penalty in the amount of $78,400 for alleged violations of the federal hazardous waste regulations and Indiana hazardous waste regulations arising out of the handling of hazardous wastes at ATC's Indianapolis laboratory. A final settlement was agreed to among the parties resulting in a net liability of $27,225 to the Company. PROBABLE CLAIMS One Parkway Project. ATC has received notice of related potential claims by R.M. Shoemaker Co., a Pennsylvania construction firm, and four of its workers arising out of ATC's performance of asbestos abatement survey, design and project monitoring services. The services were performed by ATC's Burlington, New Jersey office on a project known as the One Parkway Project. The claims allege that ATC: (i) failed to locate certain asbestos-containing materials in a high rise building during its inspection of the facility; (ii) failed to include these undiscovered materials in the design specifications for an asbestos abatement project in connection with a renovation project on the building; and (iii) failed to properly clearance inspect and test the areas on which abatement had been performed prior to demobilization of the asbestos abatement project. The claimants allege that ATC's acts or omissions resulted in additional corrective actions including remobilization of certain areas, delays of the renovation project and exposure of construction workers to asbestos contamination. R.M. Shoemaker has alleged that it sustained damages in the amount of $1,500,000 for additional abatement costs plus additional damages for delay. The workers' exposure claims have not been quantified. No suit has been filed. F-16 At this point, the Company believes that it was not responsible for the alleged problems on this project. ATC's responsibilities on the project were limited, and ATC believes that the alleged omissions which allegedly resulted in the alleged losses were outside the scope of the Company's contractual responsibilities. The Company has served notice of these claims upon its professional liability insurer. This coverage is subject to a $250,000 deductible. Bob Moore Construction/Garden Ridge, Inc. ATC has received notice of a potential claim arising out of ATC's performance of soil compaction testing for Bob Moore Construction, Inc., the general contractor on a retaining wall construction project for Garden Ridge, Inc., a garden supply chain, in Norcross, Georgia. The retaining wall eventually failed. Independent consultants performed investigations and prepared reports to determine the cause of failure. Reports initially concluded that the failure was due to a flaw in the design prepared by the wall manufacture and installation firm. Both consultants concluded that the soil work was properly performed. Since then, consultants have prepared follow-up reports, and the contractor has requested ATC's involvement in mediation discussions regarding the responsibility for repairs with respect to the various parties involved in the project. Total costs to repair the project currently total $960,000. ATC is evaluating the follow-up reports to determine ATC's potential liability or responsibility, if any. ATC currently believes that it performed all services properly and that it should have no liability. In any case, ATC believes its share of liability should amount to only a small portion of the total costs. Notice of this claim has been made under ATC's professional liability insurance policy. The professional liability insurance is subject to a $250,000 deductible. Although the Company believes this claim will not result in a material loss, no assurance in this regard can be given. Argosy Casino, Lawrenceburg, Indiana. ATC has received notice of potential claims arising out of geotechnical analyses for which American Testing and Engineering Corporation originally provided the geotechnical analyses and on which ATC subsequently performed the design of a Tensar/soil stabilized earth slope. The stabilized earth/geogrid engineered slope failed at the interface between the compacted subgrade and the first geogrid layer. A tentative settlement reached among the parties to this claim would result in ATC's payment of $266,000 in corrective costs, of which ATC expects contribution from other parties in an amount of $40,000 to $80,000. The Company has recorded a reserve of the minimum expected loss in the accompanying consolidated balance sheet. Notice of this claim has been made under ATC's professional liability insurance policy. The professional liability insurance is subject to a $250,000 deductible. Smith Technology Acquisition Claims. ATC has filed two claims for recoupment against Smith Technology Corporation ("Smith") arising out of the Agreement for Sale and Purchase of Business Assets of August 19, 1998, between ATC and Smith ("the Agreement"). The first claim asserted a recoupment against the full amount of the $200,000 30-day note and a return of conditionally assumed liabilities in the total amount of $135,000. These remedies were asserted to partially recoup a deficiency in the Adjusted Equity Value as stated on Smith's closing Engineering Division Balance Sheet from that warranted in the purchase agreement. On March 27, 1998, ATC asserted a second set of recoupment claims arising under the Agreement for various value, liability, and loss issues in the amount of $5,127,859 against the $2,750,000 note payable to Smith which had been assigned to Chase Manhattan Bank. On April 13, 1998, ATC served a corrective amendment to this claim asserting an additional claim amount of $21,475. This resulted in a total claim amount of $5,149,334. The amount of claim outstanding after set-off of the full amount of the note is $2,499,334. Of this amount, ATC believes that $850,000 of the amount claimed for third party liability claims should be covered by insurance, resulting in non- recoverable claim in the amount of $1,649,334 net of a $100,000 non-refundable payment. A portion of this unrecoverable claim has been expensed in the accompanying consolidated statement of operations, and the balance is expected to be recorded as an additional cost associated with the acquisition as amounts are incurred. On May 22, 1998, ATC filed notice to Smith and Chase Bank of Smith's breach of the convenants of the Agreement in failing to turn over $606,604.39 of ATC's cash receipts. Smith and Chase have thus far refused to turn over these funds on the basis of their allegation that a dispute between Smith and ATC exists concerning certain payments and recoupment claims under the Agreement as described above. Although ATC believes it is entitled to these funds under the Agreement, no assurance can be given that the release of such funds can be obtained without legal action. F-17 TG Kentucky, Lebanon, Kentucky. The potential claim arises out of a contract to perform preliminary geotechnical investigations at the TG Kentucky Facility, Lebanon, Kentucky, for James M. Gray Construction Company ("Gray"). ATC issued geotechnical engineering reports bases on its investigations. Gray alleges that it encountered differing site conditions from those identified in ATC's geotechnical reports. Gray asserts it could incur over $500,000 in additional costs to finish the project considering these alleged unexpected conditions. Allegations have been made against ATC for costs over budget. ATC believes it performed all services properly and that it should incur no liability. Notice has been given to ATC's professional liability insurer. The policy is subject to the $150,000 self-insured retention amount. Although the Company believes this claim will not result in a material loss, no assurance in this regard can be given. F. INDUSTRY SEGMENT DATA The Company provides services through its environmental consulting and engineering segment and its information technology consulting segment. Industry segment data for fiscal 1998 and 1999 are as follows: Environmental Information Adjustments & & Engineering Technology Elimination's Total --------------- --------------- --------------- --------------- FISCAL 1998 - ----------- Quarter Ended May 31, 1997 -------------------------- Revenues............................. $ 29,361,911 $2,240,299 $ (227,544) $ 31,374,666 Operating income..................... 2,231,443 170,999 - 2,402,442 Depreciation and amortization........ 230,735 8,845 - 239,580 Capital expenditures................. 236,266 20,487 - 256,753 Identifiable Assets as of May 31, 1997 $101,676,015 $5,751,650 $(3,205,661) $104,222,004 -------------------------------------- Fiscal 1999 - ----------- Quarter Ended May 31, 1998 -------------------------- Revenues.............................. $ 37,749,386 $2,724,736 <191,208> $ 40,282,914 Operating income...................... 2,658,958 341,026 - 2,999,984 Depreciation and amortization......... 412,449 16,515 - 428,964 Capital expenditures.................. 672,165 1,107 - 673,272 Identifiable Assets as of May 31, 1998 184,981,259 6,199,893 <4,325,409> $186,855,733 -------------------------------------- F-18 ATC GROUP SERVICES INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- RECENT DEVELOPMENTS Tender Offer and Merger. The Company became a wholly owned subsidiary of Acquisition Holdings, Inc. ("Holdings") upon the merger of ATC with Acquisition Corp., a wholly owned subsidiary of Holdings, with ATC being the surviving corporation (the "Merger"). Acquisition Corp. offered (the "Tender Offer") and completed the purchase of the issued and outstanding shares of the Company's Common Stock at a price of $12.00 per share. The Tender Offer was consummated using the proceeds from the issuance of $100,000,000 of 12% Senior Subordinated Notes (the "Notes"), borrowings under a new bank credit facility (the "Bank Credit Facilities") and equity investments in Holdings. The accompanying financial statements for the Company from February 5, 1998 (the "Successor Period") are attributable to operations of the Company under the successor ownership of Holdings. The predecessor financial statements, representing the period prior to February 5, 1998 (the "Predecessor Period"), relates to the previous ownership of the Company. Prior to the Tender Offer and Merger, the Company had entered into two separate Severance, Consulting and Noncompetition Agreements (the "Severance Agreements") with two officers of the Company. The Severance Agreements provided for the resignation of the officers upon completion of the Merger and the terms of a non-compete agreement. The Tender Offer and Merger, issuance of the Notes, execution of the Bank Credit Facilities and Severence Agreements, are collectively referred to as the "Transactions". The Company has acquired twelve businesses since 1993. The three most recent acquisitions which have been consummated include: (i) the purchase by the Company of all of the stock of Bing Yen & Associates, Inc. ("Bing Yen") on November 26, 1997; (ii) the purchase by the Company of substantially all of the stock of Environmental Warranty, Inc. ("EWI") on November 4, 1997; and (iii) the purchase by the Company of certain assets and the assumption by the Company of certain liabilities on August 20, 1997 of the Engineering Division of Smith Technology Corporation which operated primarily as BCM Engineers Inc. ("BCM"). As a result of the Merger, the consolidated financial statements for the Successor Period are presented on a different basis of accounting than that of the Predecessor Period and are therefore not directly comparable. OVERVIEW General. ATC is a leading national provider of professional consulting, engineering and testing services within the environmental and construction materials industries. Management believes the Company is also a leading provider of integrated environmental information management technology services. The Company provides a broad range of services to a diverse client base of over 8,000 customers. The Company provides its services through a network of 74 branch offices located in 35 states covering every major market of the United States. In 1993, the Company initiated a strategy of controlled growth through acquisitions to build a national infrastructure and to broaden its range of technical services. The Company has created a national infrastructure through the completion of 12 acquisitions since May 1993. ATC has thereby also expanded its service mix by adding construction materials testing and engineering, lead risk management, indoor air quality management, water and wastewater management and information management technology services. The Company's rapid growth is primarily attributable to the acquisition of assets of American Testing and Engineering Corporation ("ATEC") in May 1996 and the acquisition of assets of BCM in August 1997. ATEC, with its large network of regional and branch offices, positioned the Company as a national provider of professional environmental consulting, testing and engineering services. As a result of the BCM acquisition, ATC has become a high-quality provider of consulting, engineering and design services in water supply and treatment, wastewater systems, air quality management, traditional environmental site investigations, site assessments and storage tank management services. Subsequent to each acquisition that it has made, the Company has implemented cost reduction measures, including integration of offices, introduction of flexible staffing programs and reduction of duplicative corporate overhead costs. F-19 RESULTS OF OPERATIONS Three Months Ended May 31, 1998 Compared with Three Months Ended May 31, 1997 - ----------------------------------------------------------------------------- Revenues in the three months ended May 31, 1998 increased 28.4% to $40,282,914, compared with $31,374,666 in the three months ended May 31, 1997. This increase was primarily attributable to revenues associated with the BCM acquisition which was consummated on August 20, 1997 and the acquisitions of EWI and Bing Yen which were completed in November 1997. Revenues in the three months ended May 31, 1998 from ATC's branch offices having comparable operations in the three months ended May 31, 1997 increased 3.0% to $32,303,847, compared with $31,374,666 in the three months ended May 31, 1997. Revenues in the three months ended May 31, 1998 attributable to the acquisition of BCM totaled $6,333,194. Revenues attributable to the acquisition of EWI and Bing Yen totaled $1,645,873 million or 4.1% of revenues in the three months ended May 31, 1998. Revenues were not affected by the Transactions. Reimbursable costs represent direct project expenses billed to environmental and engineering segment clients. For the three months ended May 31, 1998, reimbursable costs increased 29.5% to $5,769,682, compared with $4,455,833 in the three months ended May 31, 1997. Reimbursable costs as a percentage of revenues remained approximately the same, 14.3% for the three months ended May 31, 1998 compared with 14.2% in the three months ended May 31, 1997. Reimbursable costs were not affected by the Transactions. Gross profit in the three months ended May 31, 1998 increased 28.0% to $15,694,326, compared with $12,257,212 in the three months ended May 31, 1997. Gross margin remained the same, 45.5% in the three months ended May 31, 1998, and 1997. Operating expenses in the three months ended May 31, 1998 increased 28.8% to $12,694,342, compared with $9,854,770 in the three months ended May 31, 1997. Operating expenses increased as a percentage of net revenues to 36.8% in the three months ended May 31, 1998, compared with 36.6% in the three months ended May 31, 1997. Employee costs increased 41.5% to $5,927,641, or 17.2% of net revenues, in the three months ended May 31, 1998 compared with $4,187,830, or 15.6% of net revenues, in the three months ended May 31, 1997. These increases in total cost were due to employees hired in connection with the expansion of ATC's operations. Other increases in operating expenses resulted from higher facility costs and administrative expenses resulting from the growth in operations and increased employee levels. Additionally, in the three months ended May 31, 1998, amortization of goodwill and intangibles increased to $1,320,106, compared with $425,599 in the three months ended May 31, 1997 reflecting the additional goodwill amortization resulting from acquisitions and the Transactions. Operating income in the three months ended May 31, 1998 increased 24.9% to $2,999,984 compared with $2,402,442 in the three months ended May 31, 1997. Operating income decreased as a percentage of net revenues to 8.7% in the three months ended May 31, 1998, compared with 8.9% in the three months ended May 31, 1997. Non-operating expense in the three months ended May 31, 1998 increased to $3,788,496 compared with of $456,126 in the three months ended May 31, 1997. The increase in non-operating expense is attributable to increased interest expense due to the 12% Senior Subordinated Notes and bank debt outstanding during the quarter. Income tax (benefit) expense in the three months ended May 31, 1998 was $<86,000>, compared with $770,000 in the three months ended May 31, 1997. During the three months ended May 31, 1998 and 1997, the Company's effective tax rates were 10.9% and 39.6%, respectively. The effective tax rate for the three months ended May 31, 1998 results from non deductible goodwill amortization related to the Transactions. As a result of the foregoing, the Company incurred a net loss of $<702,512> compared with net income of $1,176,316 in the three months ended May 31, 1997. Net income (loss) decreased as a percentage of net revenues to <2.0>% in the three months ended May 31, 1998 compared with 4.4% in the three months ended May 31, 1997. F-20 INFORMATION SYSTEMS AND THE YEAR 2000 The Company is in the process of addressing Year 2000 issues. The Company is currently engaged in a comprehensive project to convert its accounting and management information system to a system consisting of new hardware and packaged software recently purchased from a large vendor who has represented that these systems are Year 2000 compliant. The Company's information technology segment, which provides information system support services to both the Company and the Company's clients, is currently operating on systems that are Year 2000 compliant. ATC's remaining operations are generally dependent only on personal computers and off-the-shelf commercial word processing, drafting, spreadsheet and engineering software. Year 2000 compliant versions of these systems are currently available, and the Company will convert to these compliant systems over the next year and a half as the Company upgrades its operational personal computer systems in the ordinary course to the most recently issued software releases. LIQUIDITY AND CAPITAL RESOURCES The Company's principal sources of liquidity are cash flow from operations and available borrowings under a Revolving Credit Facility established under the Bank Credit Facilities. The Revolving Credit Facility provides the Company with an aggregate of up to $30.0 million of senior secured financing to be used for working capital and general corporate purposes (including permitted acquisitions). It is expected that the Company's principal uses of liquidity will be to provide working capital, finance capital expenditures, fund costs associated with acquisitions and meet debt service requirements. As a result of the consummation of the Transactions, the Company is highly leveraged. Except to the extent set forth below, there will be no mandatory payments of principal on the Notes scheduled prior to their maturity. Based upon current operations, anticipated cost savings and future growth, the Company believes that its cash flow from operations, together with available borrowings under the Revolving Credit Facility will be adequate to meet its anticipated requirements for working capital, capital expenditures and scheduled principal and interest payments, although the Company believes that its ability to repay the Notes and amounts outstanding under its Bank Credit Facilities at maturity will require additional financing. There can be no assurance, however, that any such additional financing will be available at such time to the Company, or that any such available financing will be on terms favorable to the Company. Furthermore, there can be no assurance that the Company's business will continue to generate cash flow at or above current levels or that estimated cost savings or growth can be achieved. The Notes impose certain limitations on the ability of the Company and its subsidiaries to, among other things, incur additional indebtedness, incur liens, pay dividends or make certain other restricted payments, consummate certain asset sales, enter into certain transactions with affiliates, issue preferred stock, merge or consolidate with any other person or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of the assets of the Company and its subsidiaries. In addition, the New Credit Facility contains other and more restrictive covenants effectively prohibiting the Company from prepaying the Notes. The Bank Credit Facility also requires the Company to maintain specified financial ratios and satisfy certain financial tests. The Company's ability to meet such financial ratios and tests may be affected by events beyond its control; there can be no assurance that the Company will be able to meet such tests. For the quarter ended May 31, 1998, the Company was in default of certain financial covenants. The Company's lenders have provided an interim waiver with respect to the defaults. Under the waiver, the Company has approximately $3.4 million of availability under its revolving line of credit as of July 15, 1998. The Company is in discussion with its lenders and believes the covenant provisions of the credit agreement will be amended. Accordingly, the Company continues to classify its outstanding debt as long term in accordance with the existing loan maturity dates. The final classification of the Company's outstanding bank debt and 12% Senior Secured Notes, will be in accordance with the terms of any final credit agreement. The Company conducts part of its operations through its subsidiaries. As a result, the Company relies, in part, upon payment from its subsidiaries for the funds necessary to meet its obligations, including the payment of interest on and principal of the Notes. The ability of the subsidiaries to make such payments will be subject to, among other things, applicable state laws. Claims of creditors of the Company's subsidiaries will generally have priority as to the assets of such subsidiaries over the claims of the Company. F-21 The Company has historically financed its operations through internally generated funds, public and private equity and debt financings and borrowings under its credit facilities. As of May 31, 1998, working capital was $32.4 million, compared with working capital of $29.4 million at February 28, 1998, an increase of $3.0 million. The increase in working capital was primarily due to the net borrowings of bank debt under the Company's Revolving Credit Facility. As a result of the Tender Offer and Merger and the Company's prior acquisitions, the Company has a negative tangible net worth, primarily as a result of goodwill amounts recognized in connection with these transactions. During the three months ended May 31, 1998, net cash flows used in operating activities were $4,552,411 primarily due to operating income before interest as interest on the 12% Notes is paid semiannually commencing in July 1998, offset in part by increases in accounts receivable and unbilled receivables. Net cash flows used in investing activities were $271,626, resulting from purchases of property and equipment less the proceeds from the sale of certain assets relating to a laboratory operation. Net cash flows used by financing activities were $8,009,997, primarily representing payments of Tender Offer obligations and net bank borrowings under the Company's Revolving Credit Facility. During the three months ended May 31, 1997, net cash flows used in operating activities were $2,196,200 primarily due to the decrease in accounts payable and other liabilities, a portion of which was related to payments of liabilities from acquisitions, and an increase in billed and unbilled receivables. Net cash flows used in investing activities were $2,658,009, resulting from the additional purchase consideration paid for ATEC and purchases of property and equipment. Net cash flows provided by financing activities were $11,057,476, primarily representing the proceeds of the 8.18% Senior Secured Notes, less repayment of the previously outstanding bridge credit facility. SEASONALITY ATC typically experiences a slow down in business activities during the winter months and an increase in business activities during the summer months. This is due to seasonal fluctuations in construction and remediation activities. As a result, operating results may vary from period to period. For fiscal 1998, comparable quarterly revenues as a percentage of relevant annual revenues were 24.6%, 26.6%, 25.0% and 23.8%. F-22 PART II - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS: LITIGATION--GENERAL LITIGATION--Joseph I. Peters v. George Rubin, et al, Civ. Action No. 16026-NC, Court of Chancery, New Castle County, Delaware. On or about November 12, 1997, a summons and complaint were filed in the Delaware Court on behalf of Joseph I. Peters, as plaintiff. On or about December 18, 1997, an amended complaint was filed (the "Amended Complaint"). The Amended Complaint names the Company, the members of the Company's board of directors, Weiss Peck and the WPG Corporate Development Associates V, L.P., a Weiss Peck affiliate, as defendants. The Amended Complaint challenges the Tender Offer and Merger. The Amended Complaint seeks class action status on behalf of the stockholders of the Company. The plaintiff in the action claims that the offer price for the Company's Common Stock is inadequate and that the defendants have breached their fiduciary duties to the plaintiff and other stockholders of the Company. The plaintiff seeks, among other things, to enjoin the Transactions or compensatory damages. On January 7, 1998, a motion to dismiss was filed by Weiss Peck and WPG Corporate Development Associates V, L.P, a Weiss Peck affiliate. On January 13, 1998, answers to the complaint were filed by the Company and the remaining defendants. The parties to the action are currently conducting discovery. The Company believes the allegations contained in the Amended Complaint are without merit and intends to defend the action vigorously; however, there can be no assurance of the outcome. First Fidelity Bank, N.A., et al v. Hill International, Inc. et al., Superior Court of New Jersey, Law Division, Burlington County, Docket No. Bur-L-03400-95, filed December 19, 1995. Irvin E. Richter, et al v. ATC Group Services Inc., et al. United States District Court, District of New Jersey, Civ. No. 96 CV 5818 (JBS) filed December 6, 1996. On December 19, 1995, a second amended complaint was filed in the above-entitled action which joined the Company as a defendant and included a count against the Company seeking recovery of certain assets purchased from Hill on the grounds that plaintiff banks held security interests in the assets and that Hill was in default under the security agreement creating such alleged security interests. The original plaintiffs in this action were First Fidelity Bank, N.A. and United Jersey Bank, N.A. The primary defendants were Hill and certain of its subsidiaries, and Irvin Richter, David Richter, Janice Richter and William Doyle. Irvin Richter and David Richter are officers and stockholders of Hill. In April 1996, the Company filed a cross-claim against Hill, Irvin Richter and David Richter alleging breach of contract and fraud, among other allegations, and seeking unspecified damages, including punitive damages, and equitable relief. In August, 1996, Hill and the Richters filed an answer denying ATC's cross-claims, a cross- claim against ATC and a third party claim against certain members of ATC's management and an employee. The cross-claim and third party claim seek unspecified damages, including punitive damages, for defamation, breach of the Richters' non-competition agreements and securities fraud. The defamation claims are based (i) on plaintiff banks' allegation of fraud against Hill and the Richters in their amended complaint, which Hill and the Richters allege was based on defamatory statements made by ATC in settlement discussions with the plaintiff banks and (ii) on a letter alleged to contain defamatory statements which was sent to an account debtor of the Company by an employee. In its answer, the Company both denies that it made defamatory statements and asserts that the defamation allegations fail to state legally valid claims. The breach of contract and securities claims are based on allegations that ATC made representations concerning a registration rights agreement to be provided in connection with options issued to the Richters as consideration for their non- competition agreements. In its answer, the Company denies that an agreement concerning registration rights was ever reached and asserts that any such rights were forfeited or suspended by the Richters in any case as a result of their conduct in connection with the asset purchase. F-23 Commonwealth of Massachusetts v. TLT Construction Corp. et al., Civ. Action No. 96-02281 F, Superior Court of Middlesex County, Massachusetts. This is an action brought by the Commonwealth of Massachusetts in April 1996, against the architects and general contractor on a renovation and construction project on the Suffolk County Courthouse in Massachusetts. The basis of the lawsuit is that one or more damp-proofing products specified by the architect defendants and installed by the contractor defendant made employees in the courthouse ill because of the off-gassing of harmful vapors. Dennison Environmental Services Inc., ("Dennison") an ATC subsidiary, was joined on August 13, 1996, as a third party defendant by TLT Construction Corporation, the general contractor, because Dennison performed some air quality testing of the air in the courthouse for the Commonwealth of Massachusetts during the construction process. The contractor alleges that it acted in reliance on these tests in continuing to install the material after the test report was given to it by the state. ATC's position is that it did not commit any error or omission in this case, that ATC made no representation to the contractors or material supplier and had no privity with them and that Dennison's opinion concerning short term, during-construction health effects of the off- gassing could not be justifiably relied upon with respect to the long-term performance and health effects of the product or its installation. This case is in the discovery phase. At this point, ATC considers the case to be without merit, and ATC intends to vigorously defend the action. Notice of this claim has been made to ATC's professional liability insurer. At the time that notice of this claim was filed, the Company had in effect a professional liability insurance policy in the amount of $10.0 million with a deductible of $250,000. ITEM 2. CHANGES IN SECURITIES: Not Applicable ITEM 3. DEFAULTS UPON SENIOR SECURITIES: For the quarter ended May 31, 1998, the Company was in default of certain financial covenants. The Company's lenders have provided an interim waiver with respect to the defaults. Under the waiver, the Company has approximately $3.4 million of availability under its revolving line of credit as of July 15, 1998. The Company is in discussion with its lenders and believes the covenant provisions of the credit agreement will be amended. Accordingly, the Company continues to classify its outstanding debt as long term in accordance with the existing loan maturity dates. The final classification of the Company's outstanding bank debt and 12% Senior Secured Notes, will be in accordance with the terms of any final credit agreement. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS: Not Applicable ITEM 5. OTHER INFORMATION: Not Applicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K: (a) Exhibits: Not applicable (b) Reports on Form 8-K: Not Applicable F-24 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. ATC GROUP SERVICES INC. ----------------------------------- (Registrant) Dated: July 15 1998 /s/ Nicholas J. Malino - -------------------- ----------------------------------- Nicholas J. Malino President (Principal Executive Officer) Dated: July 15, 1998 /s/ Paul Grillo - -------------------- ----------------------------------- Paul Grillo Executive Vice President and Chief Financial Officer (Principal Financial Officer) Dated: July 15, 1998 /s/ Wayne A. Crosby - -------------------- ----------------------------------- Wayne A. Crosby Controller (Principal Accounting Officer) F-25