ITEM 1. BUSINESS
Summary
We are one of the largest engineering design services firms worldwide and a major U.S. 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 construction services and defense markets, although we perform some limited construction work. We operate through two divisions: 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. For information on our business by segment and geographic regions, please refer to Note 7, “Segment and Related Information” to our “Consolidated Financial Statements and Supplementary Data,” which is included under Item 8 of this report.
Clients, Services and Markets
We market our services to federal government agencies, state and local government agencies, private industry, and international clients through our extensive network of approximately 330 offices and contract-specific job sites across the U.S. and in more than 20 foreign countries. We currently have many active projects, with no single project accounting for more than 7% of our revenues for fiscal 2005.
We focus our expertise on eight key markets: transportation, environmental, facilities, commercial/industrial, water/wastewater, homeland security, defense systems, and installations and logistics.
The following table summarizes our revenues, representative services and representative markets by client type for our fiscal year ended December 30, 2005.
Clients
We provide our services to a broad range of domestic and international clients, including agencies of the U.S. federal government, state and local government agencies and private industry clients located both in the U.S. and abroad. The demand for our services comes from budgeting and capital spending decisions made by the U.S. federal government, state and local government agencies and public and private companies. The following table summarizes the primary client types serviced by our URS and EG&G Divisions for the fiscal year ended December 30, 2005.
ü a primary client type for the division.
- not a primary client type for the division.
U.S. Federal Government. We are a major government contractor for systems engineering and technical assistance, and operations and maintenance, providing services to the Departments of Defense, Homeland Security, Justice, Energy and Treasury, the Environmental Protection Agency, NASA, the United States Postal Service and the General Services Administration. Following a steady decline in uniformed and civilian personnel levels throughout the 1990s, the Department of Defense has used contractors for large, multi-service government outsourcing contracts in support of military operations. Our revenues from U.S. federal government agencies exclude revenues arising from federal grants or matching funds allocated to and passed through state and local government agencies. We serve U.S. federal government clients through both our URS and EG&G Divisions.
State and Local Government. Our state and local government agency clients include various local municipalities, community planning boards, state and municipal departments of transportation and public works, transit authorities, water and wastewater authorities, environmental protection agencies, school boards and authorities, judiciary agencies, public hospitals and airport authorities. In the United States, substantially all spending for infrastructure - transportation facilities, public buildings and water and wastewater systems - is coordinated through these agencies. Our state and local government revenues include those originating from federal grants or matching funds provided to state and local government agencies. Our state and local government clients are primarily served by the URS Division.
Private Industry. Most of our private industry clients are Fortune 500 companies, many with international operations, from a broad range of industries, including chemical, pharmaceutical, oil and gas, power, manufacturing, mining and forest products. Over the past several years, many of these companies have reduced the number of service providers they use, selecting larger, multi-service contractors with international operations in order to control overhead costs. Our private industry clients are served primarily through the URS Division.
International. The focus of our international business is to provide a range of services to our multinational private industry clients and foreign governmental agencies in the Americas (outside the U.S.), Europe and Asia Pacific. Although both the URS and EG&G Divisions work outside of the United States, our international client base is served primarily by the URS Division.
Services
We provide professional planning and design, systems engineering and technical assistance, program and construction management, and operations and maintenance services to the U.S. federal, state, and local government agencies, as well as private industry and international clients. These services are delivered through a network of offices and contract-specific job sites. Although we are typically the prime contractor, in some cases, we provide services as a subcontractor or through joint ventures or partnership agreements with other service providers. The following table summarizes the services provided by our URS and EG&G Divisions for the fiscal year ended December 30, 2005.
ü the division provides the listed service.
- the division does not provide the listed service.
Planning and Design. The planning process is typically used to develop a blueprint or overall scheme for a project. Based on the project requirements identified during the planning process, detailed plans are developed, which may include material specifications, construction cost estimates and schedules. Our planning and design services include the following:
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master planning;
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land-use planning;
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transportation planning;
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technical and economic feasibility studies;
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environmental impact assessments;
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permitting, to ensure compliance with applicable regulations;
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the analysis of alternative designs; and
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the development of conceptual and final design documents.
We provide planning and design services for the construction of new transportation projects and for the renovation and expansion of existing transportation infrastructure, including bridges, highways, roads, airports, mass transit systems and railroads. We also plan and design many types of facilities, such as schools, courthouses, hospitals, corporate offices and retail outlets, as well as water supply and conveyance systems and wastewater treatment plants. Our planning and design capabilities support homeland defense and global threat reduction programs, as well as hazardous waste clean-up activities at military bases and environmental assessment, due diligence and permitting at commercial and industrial facilities. We also provide design support to military clients for major research and development projects.
Systems Engineering and Technical Assistance. We provide a broad range of systems engineering and technical assistance to all branches of the U.S. military for the design and development of new weapons systems and the modernization of aging weapons systems. We have the expertise to support a wide range of platforms including aircraft and helicopters, tracked and wheeled vehicles, ships and submarines, shelters and ground support equipment. Representative systems engineering and technical assistance services include:
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defining operational requirements and developing specifications for new weapons systems;
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reviewing hardware and software design data; and
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developing engineering documentation for these systems.
We support a number of activities including technology insertion, system modification, installation of new systems/equipment, design of critical data packages, and configuration management.
Construction Management. We serve as the client’s representative and monitor the progress, cost and quality of construction projects in process. As construction managers, we typically oversee and coordinate the activities of construction contractors, providing a variety of services, including:
We provide construction management services for transportation, facilities, environmental and water/wastewater projects. Although we have acted as a general contractor or sub-contractor on some demolition and environmental contracts, we generally have not pursued “low bid” fixed-price construction contracts.
Program Management. We provide the technical and administrative services required to manage, coordinate and integrate the multiple and concurrent assignments that comprise a large program - from concept through completion. For large military programs, which typically involve naval, ground, vessel and airborne platforms, our program management services include logistics planning, acquisition management, risk management of weapons systems, safety management and subcontractor management. We also provide program management services for large capital improvement programs, which include planning, coordination, schedule and cost control, and design, construction, and commissioning oversight.
Operations and Maintenance. We provide operations and maintenance services in support of large military and other non-military installations and operations. Our services include:
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management of military base logistics, including overseeing the operation of government warehousing and distribution centers, as well as government property and asset management;
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maintenance, modification, overhaul and life service extension services for military vehicles, vessels and aircraft;
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operation and maintenance of chemical agent disposal systems;
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comprehensive military flight training services; and
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support of high security systems.
Markets
We focus our expertise on eight key markets: transportation, environmental, commercial/industrial, facilities, water/wastewater, homeland security, installations and logistics and defense systems. Our domestic and international network of offices allows us to perform business development and sales activities on a localized basis. In addition, for large-scale projects and multinational clients, we coordinate national and international marketing efforts on a company-wide basis. The following table summarizes the markets served by our URS and EG&G Divisions, as separate reporting segments, for our fiscal year ended December 30, 2005.
ü the division serves this market.
- the division does not serve this market.
Transportation
We provide a full range of planning and design, program management and construction management services for surface transportation, air transportation and rail transportation projects as described below.
Surface Transportation. We provide services for all types of surface transportation systems and networks, including highways, bridges, tunnels and interchanges; toll road facilities; and port and marine structures. Our expertise also includes the planning and design, and operations and maintenance of intelligent transportation systems, such as traffic management centers. Historically, we have emphasized the design of new transportation systems, but in recent years, we also have focused on the rehabilitation and expansion of existing systems.
Air Transportation. We provide comprehensive services for the development of new airports and the modernization and expansion of existing facilities, including airport terminals; hangars and air cargo buildings; air traffic control towers; runways and taxiways; and related airport infrastructure such as roadways, parking garages and people movers. We also specialize in baggage, communications and aircraft fueling systems. We have completed projects at both general aviation and large-hub international airports throughout the world. In the growing area of airport security, we assist airport authorities and owners, and airline carriers in all aspects of security-related projects. For example, we provide a full range of planning and design, program and construction management, and operations and maintenance services for airport security systems, including baggage screening and perimeter access control systems.
Rail Transportation. We provide services to freight and passenger railroads and urban mass transit agencies. We have planned, designed and managed the construction of commuter rail systems, freight rail systems, heavy and light rail transit systems, and high-speed rail systems. Our specialized expertise in transportation structures, including terminals, stations, parking facilities, bridges, tunnels and power, signals and communications systems, complements these capabilities.
Environmental
We provide a variety of services related to protecting, preserving and restoring our air, water and soil quality for U.S. federal, state and local government agencies, and public utilities. Our services include environmental impact assessments, permitting and regulatory compliance, remediation design, program and construction management, demolition and environmental clean-up. We provide air quality monitoring and modeling and design air emissions control systems. We also provide comprehensive services related to the identification, characterization and remediation of hazardous waste sites.
Commercial/Industrial
We provide a broad range of engineering and environmental services to commercial and industrial clients in the private sector, most of which are Fortune 500 companies. Our work includes due diligence and compliance audits, facility site locating and permitting, environmental management and pollution control, waste management and remediation engineering, process engineering and design, and reporting. We also design new buildings and facilities, and assist in property redevelopment.
Facilities
We provide planning, architectural and engineering design, and program and construction management for new facilities and the rehabilitation and expansion of existing facilities. Our work involves a broad range of building types, including education, judicial, correctional, health care, retail, sports, recreational, industrial, research and office facilities. We also provide historic preservation, adaptive reuse and seismic upgrade services.
Water/Wastewater
We provide services for the planning, design and construction of all types of water/wastewater treatment facilities and systems. Services are provided for new and expanded water supply, storage, distribution and treatment systems, municipal wastewater treatment and sewer systems, levees, and watershed, storm water management and flood control systems. We also provide design and seismic retrofit of earth, rock fill and roller-compacted concrete dams, as well as the design of reservoirs and impoundments, including mine tailings disposal and large outfall structures.
Homeland Security
We provide a variety of services to the Department of Homeland Security, the Department of Defense, and other federal and state and local government agencies in support of Homeland Security activities. This work includes conducting threat assessments of public facilities, planning and conducting emergency preparedness exercises, and designing force protection systems and security systems.
In addition, our related global threat reduction services focus on the elimination and dismantlement of nuclear, chemical and biological weapons of mass destruction or “WMDs.” Our services include operating and maintaining chemical agent disposal facilities and providing advisory services for dismantling and eliminating WMDs. We also develop emergency response strategies and conduct first responder training for the military and other federal state and local government agencies.
Installations and Logistics
We assist the U.S. federal government by providing services to support the operations of complex government and military installations and the management of logistics activities for government supply and distribution networks.
Installations Management. We provide comprehensive services for the operation and maintenance of complex government installations, including military bases and test ranges. Our services vary from managing basic base operations to the design, installation and maintenance of complex equipment for testing new weapons.
Logistics. We provide a number of Department of Defense agencies and defense prime contractors with turn key logistics support services focused on developing and managing integrated supply and distribution networks. We oversee warehousing, packaging, delivery, and traffic management for the distribution of government equipment and materials. We also manage depot equipment maintenance, safety, security and contracting.
Defense Systems
We provide a variety of services to the U.S. federal government in support of military activities. These services include Defense Systems & Services, Field Services and Flight Services & Training.
Defense Systems & Services. We provide a variety of weapons system design and modernization services to Department of Defense weapons systems management offices, laboratories, technical centers, support centers, and maintenance activities. Our services include acquisition support for new defense systems, engineering and technical assistance for the modernization of existing systems, and maintenance planning to help extend their service life.
Field Services. Under contract with the U.S. Army, U.S. Air Force, and the U.S. Coast Guard, we maintain, modify and overhaul aircraft, ground vehicles, such as Humvees, tanks, and armored personnel carriers, and associated support equipment. We provide these services for military operations both in the U.S. and abroad.
Flight Services & Training. We provide a variety of services to the U.S. Army, U.S. Air Force, and the U.S. Coast Guard to support undergraduate and graduate-level training for pilots of military fixed wing and rotary wing aircraft. We also assist with the acquisition of military parts for these aircraft.
Major Customer
Our largest client type is the U.S. Federal Government and our largest customer is the U.S. Army. We had multiple contracts with the U.S. Army, which contributed more than 10% of our consolidated revenues, summarized in the following table, for the year ended December 30, 2005, two months ended December 31, 2004 and 2003, and the years ended October 31, 2004 and 2003. 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.
(1) The U.S. Army includes U.S. Army Corps of Engineers.
Competition
Our industry is highly fragmented and intensely competitive. Our competitors are numerous, ranging from small private firms to multi-billion dollar public companies. The technical and professional aspects of our services generally do not require large upfront capital expenditures and therefore 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. To our knowledge, no individual company currently dominates any significant portion of our markets. Competition in our industry is based on quality of performance, reputation, expertise, price, technology, customer relationships, range of service offerings, and domestic and international office networks.
We believe that we are well positioned to compete in our markets because of our solid reputation, our long-term client relationships, our extensive network of offices and our broad range of services. We are one of the largest engineering design services firms worldwide and a major U.S. federal government contractor for systems engineering and technical assistance, operations and maintenance, and program management services. We provide a comprehensive portfolio of services ranging from engineering planning and design to operations and maintenance. In addition, as a result of our national and international network of approximately 330 offices and contract-specific job sites, we can offer our governmental and private clients localized knowledge and expertise that is backed by the support of our worldwide professional staff.
The competitive environments in which each business segment operates are described below:
URS Division. The URS Division’s business segment is highly competitive and characterized by competition primarily based on performance, reputation, expertise, price, technology, customer relationships, range of service offerings, and domestic and international office networks. Our competitors are numerous, ranging from small private firms to multi-billion dollar public companies, and our primary competitors include: AECOM Technology Corporation, Bechtel Group, Inc., CH2M HILL Companies, Ltd., Earth Tech Inc. (a subsidiary of Tyco International, Ltd.), Fluor Corporation, Jacobs Engineering Group Inc., Parsons Brinckerhoff Inc., the Shaw Group, Inc., Tetra Tech, Inc. and Washington Group International, Inc. We believe that we have a lower operating risk profile relative to our competitors since our contract mix has been weighted more towards providing professional engineering and operations and maintenance services via cost-plus, time-and-materials and negotiated fixed-price contracts, which are generally lower risk than lump-sum, low-bid fixed-price contracts.
EG&G Division. The EG&G Division’s business segment is highly competitive and characterized by competition primarily based on quality of performance, reputation, expertise, price, technology, customer relationships and range of service offerings. Our competitors are numerous, ranging from small private firms to multi-billion dollar public companies, and our primary competitors include: Anteon International Corporation, DynCorp International LLC, KBR (a subsidiary of Halliburton Company), L-3 Communications Corporation, Raytheon Corporation, and Science Application International Corporation (SAIC). We believe our competitive advantage in this segment include the factors cited above and also include our positive customer satisfaction and performance rating.
Backlog, Designations, Option Years and Indefinite Delivery Contracts
We determine the value of all contract awards that may potentially be recognized as revenues over the life of the contracts. We categorize the value of our book of business into backlog, designations, option years and indefinite delivery contracts, or “IDCs,” based on the nature of the award and its current status. A discussion of our book of business is included below.
Backlog. Our contract backlog consists of the amount billable at a particular point in time for future services under signed contracts, including task orders that are actually issued and funded under IDCs. Our consolidated contract backlog was $3,837.7 million and $3,633.4 million at December 30, 2005 and December 31, 2004, respectively.
Designations. Our clients often designate us as the recipient of future contracts. These “designations” are projects that clients have awarded to us, but for which we do not yet have signed contracts. As of December 30, 2005 and December 31, 2004, the estimated values of our consolidated designations were $1,476.2 million and $1,480.8 million, respectively.
Option Years. A significant portion of the EG&G Division’s contracts are multi-year contracts with a base period, plus option years. The base periods of these contracts can vary from one to five years. The option years are exercised at the option of our clients without requiring us to go through an additional competitive bidding process and would only be canceled through a termination for default or if a client decides to end the project (a termination for convenience). As of December 30, 2005 and December 31, 2004, the estimated values of the option years on our contracts were $1,092.2 million and $1,184.5 million, respectively.
Indefinite Delivery Contracts. Indefinite delivery contracts are signed contracts under which we perform work only when the client issues specific task orders. Generally, the terms of these contracts exceed one year and often include a maximum term and potential value. IDCs generally range from one to twenty years in length. When such task orders are signed and funded, we transfer their value into backlog. As of December 30, 2005 and December 31, 2004, the estimated remaining values of our consolidated IDCs were $5,064.7 million and $4,094.7 million, respectively.
While the value of our book of business is a predictor of future revenues, we have no assurance, nor can we provide assurance that we will ultimately realize the maximum potential values for backlog, designations, option years or indefinite delivery contracts. Based on our historical experience, our backlog has the highest likelihood of being converted into revenues since we have signed contracts with our clients. Although there is a high probability that our designations will eventually convert into revenues, they are not as certain as backlog since our clients have not yet signed a contract with us. Due to the nature of option years, which are exercisable at the option of our clients, the likelihood of their conversion into revenues is lower than that of backlog, but higher than that of designations since we have a signed contract with the client and do not need to go through a competitive bidding process to obtain the option on the contract. Because we do not perform work under IDCs until specific task orders are issued, the value of our IDCs are not as likely to convert into revenues as other categories of our book of business.
Acquisitions
We have historically made strategic acquisitions in order to diversify our client base, increase the range of services we offer and expand the markets we serve. In August 2005, we acquired Austin Ausino, a small engineering and project management firm based in China. The acquisition of Austin Ausino was made to increase our presence and to facilitate the growth of business and services in the China market with our multinational clients.
History
We were originally incorporated in California on May 1, 1957 under the former name of Broadview Research Corporation. On March 28, 1974, we changed our name to URS Corporation. On May 18, 1976, we re-incorporated in Delaware. Since then, we have implemented several name changes as a result of mergers and acquisitions. On February 21, 1990, we changed our name back to URS Corporation.
Regulations
We provide services for contracts that are subject to government oversight, including environmental laws and regulations, general government procurement laws and regulations, and other government regulations and requirements. For more information on risks associated with our government regulations, please refer to the Item 1A, “Risk Factors,” of this report.
Environmental. A portion of our business involves the planning, design, program and construction management and operation and maintenance of pollution control facilities, as well as the assessment, design and management of remediation activities at hazardous waste or Superfund sites and military bases. In addition, we contract with U.S. governmental entities to destroy hazardous materials, including chemical agents and weapons
stockpiles. These activities require us to manage, handle, remove, treat, transport and dispose of toxic or hazardous substances.
Some environmental laws including the Resource Conservation and Recovery Act of 1976, as amended, (“RCRA”), and the Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, (“CERCLA”), as well as other governmental laws can impose liability for the entire cost of the clean-up of contaminated facilities or sites upon present and former owners and operators as well as generators, transporters and persons arranging for the treatment or disposal of such substances. In addition, while we strive to handle hazardous and toxic substances with care and in accordance with safe methods, the possibility of accidents, leaks, spills and the events of force majeure always exist. Humans exposed to these materials, including workers or subcontractors engaged in the transportation and disposal of hazardous materials, and persons in affected areas may be injured or become ill, resulting in lawsuits that expose us to liability and may result in substantial damage awards against us. Liabilities for contamination or human exposure to hazardous or toxic materials 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.
Some of our business operations are covered by Public Law 85-804, which provides for government indemnification against claims and damages arising out of unusually hazardous activities performed at the request of the government. Due to changes in public policies and law, however, government indemnification may not be available in the case of any future claims or liabilities relating to other hazardous activities that we undertake to perform.
Government Procurement. The services we provide to the U.S. federal government are subject to the Federal Acquisition Regulation (“FAR”), the Truth in Negotiations Act (“TINA”), the Cost Accounting Standards (“CAS”), the Service Contract Act (“SCA”), Department of Defense (“DOD”) security regulations and other rules and regulations applicable to government contracts. These laws and regulations affect how we transact business with our government clients and in some instances, impose added costs to our business operations. A violation of specific laws and regulations could lead to fines, contract termination or suspension of future contracts. Our government clients can also terminate or modify any of their contracts with us at their convenience, and many of our government contracts are subject to renewal or extension annually.
Other regulations and requirements. We provide services to the U.S. Department of Defense and other defense-related entities, which require specialized professional qualifications and security clearances. In addition, as engineering design services professionals, we are subject to a variety of local, state and foreign licensing and permit requirements.
Sales and Marketing
Our URS Division performs business development and sales activities primarily through our network of local offices around the world. For large, market-specific projects requiring diverse technical capabilities, we utilize the companywide resources of specific disciplines. This often involves coordinating marketing efforts on a regional, national or global level. Our EG&G Division performs business development and sales activities primarily through its management groups, that address specific markets, such as homeland security and defense systems. In addition, our EG&G Division coordinates national marketing efforts on large projects and for multi-division or multi-market scope efforts. Over the past year, the URS Division and the EG&G Division have jointly pursued several federal defense and homeland security projects, and have been successful in marketing EG&G’s technical capabilities to URS’ established state and local government clients.
Seasonality
We experience seasonal trends in our business caused by holidays, such as Independence Day, Thanksgiving, Christmas and New Year’s Day. Our revenues are typically lower during these times of the year because many of our clients’ employees as well as our own employees do not work during these holidays, resulting in fewer billable hours worked on projects and thus lesser revenues recognized. In addition to the holidays, our business is affected similarly by the seasonal weather when some of our offices have to close temporarily due to severe winter and/or tropical storms.
Fiscal Year Change
Effective January 1, 2005, we adopted a 52/53 week fiscal year ending on the Friday closest to December 31st, with interim quarters ending on the Fridays closest to March 31st, June 30th and September 30th. We filed a transition report on Form 10-Q with the Securities and Exchange Commission (“SEC”) for the two months ended December 31, 2004. Our 2005 fiscal year began on January 1, 2005 and ended on December 30, 2005.
Raw Materials
As a professional services company, our business is not heavily dependent on raw materials. Risks associated with the procurement of raw materials for our construction services projects are generally passed through to our clients. We do not foresee the lack of availability of raw materials as a factor that could have a material adverse effect on our business in the near term.
Insurance
Currently, we have limits of $125.0 million per loss and $125.0 million in the aggregate annually for general liability, professional errors and omissions liability and contractor’s pollution liability insurance (in addition to other policies for some specific projects). These policies include self-insured claim retention amounts of $4.0 million, $7.5 million and $7.5 million, respectively. In some actions, parties may seek punitive and treble damages that substantially exceed our insurance coverage.
Excess limits provided for these coverages are 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. We intend to maintain these policies; however, 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.
Employees
As of February 28, 2006, we had approximately 26,000 full-time employees and 3,200 temporary or part-time workers. The URS Division and the EG&G Division employed approximately 16,200 and 13,000 persons (including temporary and part-time workers), respectively. At various times, we have employed up to several thousand workers on a temporary or part-time basis to meet our contractual obligations. Approximately 2,300 of our employees are covered by collective bargaining agreements. These agreements are subject to amendment on various dates ranging from March 2006 to October 2009.
Available Information
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our web site at www.urscorp.com. These reports, and any amendments to these reports, are made available on our web site as soon as reasonably practicable after we electronically file or furnish the reports with the SEC. You may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-
0330 for further information about the public reference room. The SEC also maintains a web site (www.sec.gov) containing reports, proxy, and other information that we filed with the SEC. In addition, our Corporate Governance Guidelines, the charters for our Audit, Board Affairs and Compensation Committees, and our Code of Business Conduct and Ethics are available on our web site at www.urscorp.COM under the “Corporate Governance” section. A printed copy of this information is also available without charge by sending a written request to: Corporate Secretary, URS Corporation, 600 Montgomery Street, 26th Floor, San Francisco, CA 94111-2728.
ITEM 1A.
ITEM 1A. RISK FACTORS
In addition to the other information included or incorporated by reference in this Form 10-K, the following risk factors could affect our financial condition and results of operations and should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations beginning on page 28 and the consolidated financial statements and related notes beginning on page 59.
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 is cyclical and vulnerable to 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 the 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, profits and overall financial condition may deteriorate.
Unexpected termination of a substantial portion of our book of business could harm our operations and significantly reduce our future revenues.
We account for all contract awards that may be recognized as revenues as our “book of business,” which includes backlog, designations, option years and IDCs. Our backlog consists of the amount billable at a particular point in time, including task orders issued under indefinite delivery contracts. As of December 30, 2005, our backlog was approximately $3.8 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 since clients may terminate or delay projects, or decide not to award task orders under IDCs. Unexpected termination of a substantial portion of our book of business could harm our operations and significantly reduce our future revenues.
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 FAR, TINA, the CAS, the SCA, and 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 to our business operations. Even though we take precautions to prevent and deter fraud and misconduct, 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 incurred costs, if the DCAA believes we have accounted for such costs in a manner
inconsistent with the requirements for the FAR or CAS, and recommend that our U.S. government corporate administrative contracting officer disallow such costs. Historically, we have not experienced significant disallowed costs as a result of such 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 represented approximately 48% and state and local government contracts represented approximately 23%, respectively, of our total revenues for the year ended December 30, 2005. Our inability to win or renew government contracts could harm our operations and significantly reduce or eliminate our profits. Government contracts are typically awarded through a heavily regulated procurement process. Some government contracts are awarded to multiple competitors, causing increases in overall competition and pricing pressure. The competition and pricing pressure, in turn may require us to make sustained post-award efforts to reduce costs in order to realize revenues under these contracts. If we are not successful in reducing the amount of costs we anticipate, our profitability on these 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. Finally, government clients can generally terminate or modify their contracts with us at their convenience.
Each year a portion of our multiple-year government contracts may be subject to legislative appropriations. 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 a portion of our multiple-year government contracts may be subject to legislative appropriations. For example, the passage of the SAFETEA-LU highway and transit bill in August of 2005 has provided matching funds for state transportation projects. Legislatures typically appropriate funds for a given program on a year-by-year basis, even though contract performance may take more than one year. As a result, at the beginning of a project, the related contract may only be partially funded, and additional funding is normally 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, 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.
If we are unable to accurately estimate and control our contract costs, then we may incur losses on our contracts, which may result in decreases in our operating margins and in a significant reduction or elimination of 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 our costs. 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 may result in decreases in our operating margins and in a significant reduction or elimination of 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:
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the application of the “percentage-of-completion” method of accounting, and revenue recognition on contracts, change orders, and contract claims;
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provisions for uncollectible receivables and customer claims and recoveries of costs from subcontractors, vendors and others;
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provisions for income taxes and related valuation allowances;
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value of goodwill and recovarability of other intangible assets;
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valuation of assets acquired and liabilities assumed in connection with business combinations;
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valuation of defined benefit pension plans and other employee benefit plans; and
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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 further in Note 1, “Accounting Policies” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of this report. Our use of this 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 effect of revisions to revenues and estimated costs is 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 and 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 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 affect 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 subsequently 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 that project, which may affect our overall profitability.
If our partners fail to perform their contractual obligations on a project, we could be exposed to legal liability, loss of reputation or reduced 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 investments 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 legal liability, loss of reputation or reduced profits.
Our future revenues depend on our ability to consistently bid and win new contracts and renew existing contracts and, therefore, our failure to effectively obtain future contracts could adversely affect our profitability.
Our future revenues and overall results of operations require us to successfully bid on new contracts and renew existing contracts. Contract proposals and negotiations are complex and frequently involve a lengthy bidding and selection process, which is 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 affect our profitability.
We may be subject to substantial liabilities under environmental laws and regulations.
Our environmental business involves the planning, design, program and construction management and operation and maintenance of pollution control facilities, hazardous waste or Superfund sites and military bases. In addition, we contract 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 “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 RCRA, 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. In addition, the risk of “toxic tort” litigation has increased in recent years as people injured by hazardous substances seek recovery for personal injuries and/or property damages. 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.
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. Accordingly, 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.
Our liability for damages due to legal proceedings may adversely affect us and result in a significant loss.
Various legal proceedings are pending against us in connection with the performance of our professional services and other actions by us, the outcome of which cannot be predicted with certainty. For example, in performing our services we may be exposed to 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 annually for general liability, professional errors and omissions liability and contractor’s pollution liability insurance (in addition to other policies for some specific projects). These policies include self-insured claim retention amounts of $4.0 million, $7.5 million and $7.5 million, respectively. 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. 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.
A general decline in U.S. defense spending could harm our operations and significantly reduce our future revenues.
Revenues under contracts with the U.S. Department of Defense and other defense-related clients represented approximately 36% of our total revenues for the year ended December 30, 2005. 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. 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 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 various companies, the top twenty engineering design firms only accounted for approximately 45% of the total design firm revenues in 2004. Our competitors are numerous, ranging from small private firms to multi-billion dollar public 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.
Recent changes in accounting for equity-related compensation will impact our financial statements and could impact our ability to attract and retain key employees.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (Revised), “Share-Based Payment” (“SFAS 123(R)”). SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. Pro forma disclosure is no longer an alternative upon adoption of SFAS 123(R).
We adopted SFAS 123(R) on December 31, 2005, which was the first day of our 2006 fiscal year and are in the process of evaluating the full impact of SFAS 123(R). We anticipate that the adoption will have a material impact on our financial position and results of operations. During fiscal year 2005 and prior periods, we elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) in accounting for our stock-based compensation plans.
In light of the impact of the adoption of SFAS 123(R), 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 rather than granting stock options to selected employees. 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.
Our indebtedness could limit our ability to finance future operations or engage in other business activities.
As of December 30, 2005, we had $318.6 million of total outstanding indebtedness and $68.9 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. In addition, our current credit facility contains financial ratios and other covenants, which may limit our ability to, among other things:
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incur additional indebtedness;
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create liens securing debt or other encumbrances on our assets; and
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enter into transactions with our stockholders and affiliates.
Although we are in compliance with all current credit facility covenants, our indebtedness could limit our ability to finance future operations or engage in other business activities.
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 dividends and other payments 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, may 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 December 30, 2005, our debt service obligations, comprised of principal and interest (excluding capital leases), during the next twelve months will be approximately $26 million. Based on the current outstanding indebtedness of $270.0 million under our new credit facility (“New 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 $1.6 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 approximately 10% and 9% of our revenues from international operations for the years ended December 30, 2005 and October 31, 2004, respectively. International business is subject to a variety of risks, including:
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lack of developed legal systems to enforce contractual rights;
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greater risk of uncollectible accounts and longer collection cycles;
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currency fluctuations;
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logistical and communication challenges;
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potentially adverse changes in laws and regulatory practices, including export license requirements, trade barriers, tariffs and tax laws;
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changes in labor conditions;
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exposure to liability under the Foreign Corrupt Practices Act and export control and anti-boycott laws; and
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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 depend on third party support for our Enterprise Resource Program (“ERP”) system and, as a result, we may incur unexpected costs that could harm our results of operations, including the possibility of abandoning our current ERP system and migrating to another ERP system.
We use accounting and project management information systems supported by Oracle Corporation. As of December 30, 2005, approximately 62% of our total revenues were processed on this ERP system. We depend on the vendor to provide long-term software maintenance support for our ERP system. Oracle Corporation may discontinue further development, integration or long-term software maintenance support for our ERP system. In the event we are unable to obtain necessary long-term third party software maintenance support, we may be required to incur unexpected costs that could harm our results of operations, including the possibility of abandoning our current ERP system and migrating all of our accounting and project management information systems to another ERP system.
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 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.
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 $986.6 million as of December 30, 2005. Our balance sheet includes goodwill and other net intangible assets, the values of which are material. 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.
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 December 30, 2005, approximately 8% 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.
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 certain 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.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
As of December 30, 2005, we had approximately 350 facility leases in locations throughout the world. The lease terms range from a minimum of three months to a maximum of 25 years with options for renewal, expansions, contraction and termination, sublease rights and allowances for improvements. Our significant lease agreements expire at various dates through the year 2022. We believe that our current facilities are sufficient for the operation of our business and that suitable additional space in various local markets is available to accommodate any needs that may arise.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
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 8, “Commitments and Contingencies” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 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 annually for general liability, professional errors and omissions liability and contractor’s pollution liability insurance (in addition to other policies for some specific projects). These policies include self-insured claim retention amounts of $4.0 million, $7.5 million and $7.5 million, respectively. In some actions, parties may seek punitive and treble damages that substantially exceed our insurance coverage.
Excess limits provided for these coverages are 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. We intend to maintain these policies; however, 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 8, “Commitments and Contingencies” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 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.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE REGISTRANT
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Market information
Our common stock is listed on the New York Stock Exchange (“NYSE”) and the Pacific Exchange under the symbol “URS.” At March 6, 2006, we had approximately 3,938 stockholders of record. The following table sets forth the high and low closing sale prices of our common stock for the periods indicated.
We have not paid cash dividends since 1986, and at the present time, we do not anticipate paying dividends on our outstanding common stock in the near future. In addition, we are precluded from paying dividends on our outstanding common stock pursuant to our New Credit Facility with our lender and the indentures governing our 111/2% Senior Notes (“111/2% notes”). Please refer to Note 5, “Current and Long-Term Debt” and Note 9, “Stockholders’ Equity” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of this report.
Stock-Based Compensation Plans
Information regarding our stock-based compensation awards outstanding and available for future grants as of December 30, 2005 is presented in Note 9, “Stockholders’ Equity” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of this report.
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 stock shares during the fourth quarter of 2005. No purchases were made pursuant to a publicly announced repurchase plan or program.
(1)
Our 1991 Stock Incentive Plan and 1999 Equity Incentive Plan (collectively, the “Stock Incentive Plans”) allow our employees to surrender shares of our common stock as payment toward the exercise cost and tax withholding obligations associated with the exercise of stock options or the vesting of restricted or deferred stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data for the year ended December 30, 2005, the two months ended December 31, 2004 (1), the two months ended December 31, 2003 (unaudited), and the fiscal years ended October 31, 2004, 2003, 2002, and 2001 is derived from our audited consolidated financial statements and reflects our August 2002 acquisition of EG&G, which was accounted for under the purchase method of accounting. The selected financial data also reflects charges of $33.1 million, $28.2 million and $7.6 million for costs incurred to extinguish our debt during the years ended December 30, 2005, October 31, 2004 and 2002, respectively. You should read the selected financial data presented below in conjunction with the information contained in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and the notes thereto contained in Item 8, “Consolidated Financial Statements and Supplementary Data,” of this report.
SELECTED FINANCIAL DATA
(In thousands, except per share data)
ITEM 7.
ITEM 7. 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 section in conjunction with Item 1A, “Risk Factors,” of this report beginning on page 14 and the consolidated financial statements and notes thereto contained in Item 8, “Consolidated Financial Statements and Supplementary Data,” of this report.
Fiscal Year Change
Effective January 1, 2005, we adopted a 52/53 week fiscal year ending on the Friday closest to December 31st, with interim quarters ending on the Fridays closest to March 31st, June 30th and September 30th. We filed a transition report on Form 10-Q with the SEC for the two months ended December 31, 2004. Our 2005 fiscal year began on January 1, 2005 and ended on December 30, 2005.
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 limited construction work. As a services company, 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 driven by 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.
Fiscal Year 2005 Revenues
Consolidated revenues for the year ended December 30, 2005 increased 15.8% over the consolidated revenues for the year ended October 31, 2004.
Revenues from our federal government clients for the year ended December 30, 2005 increased approximately 17% compared with the year ended October 31, 2004. The increase reflects continued growth in demand for the services we provide to the DOD and the Department of Homeland Security (“DHS”), as a result of additional spending on engineering and technical services and operations and maintenance activities related to sustained U.S. military operations in the Middle East, and on security preparedness activities in the U.S. A significant portion of this increase was also related to disaster recovery services provided to U.S. federal agencies following Hurricanes Katrina, Rita and Wilma. In addition, we experienced an increase in environmental and facilities projects under both existing contracts and new contract awards in 2005.
Revenues from our state and local government clients for the year ended December 30, 2005 increased approximately 29% compared with the year ended October 31, 2004. During 2005, many states experienced increases in tax receipts and, as a result, have increased their general fund budgets. The increase in general fund budgets and the
improved economic and fiscal situation contributed to increases in funding at the state and local government level for infrastructure projects, including transportation programs. The recent passage of the TEA-21 successor highway and transit bill, SAFETEA-LU, in August 2005 also had a positive effect on revenues from our state and local government clients. SAFETEA-LU provides $287 billion in federal matching funds for state transportation projects. In addition, we experienced growth from the water/wastewater and school facilities portions of the state and local market.
Our revenues from domestic private sector clients for the year ended December 30, 2005 were flat compared with the year ended October 31, 2004. Capital spending among many of our domestic private sector clients remained constrained. However, we experienced revenue growth in some areas. We have shifted our resources into rapidly emerging areas of the environmental market driven by new environmental regulations, such as the Clean Air Interstate Rule and the Clean Air Mercury Rule, which were issued by the U.S. Environmental Protection Agency during 2005. As a result, revenues increased in the emissions control portion of our power sector business. We have also shifted our focus towards building longer-term relationships with multinational corporations by migrating from one-off consulting contracts to longer-term Master Service Agreements (“MSAs”) in order to leverage our scale and diverse our service offerings. The shift reduced our marketing expenses and improved our professional labor utilization levels. It resulted in a flatter growth profile for our domestic private sector business as a whole as the market opportunities shift.
Revenues from our international clients for the year ended December 30, 2005 increased approximately 20% compared with the year ended October 31, 2004. Approximately 3% of the increase was due to foreign currency exchange fluctuations. The remainder of the increase was due to growth in our MSAs and work for public sector clients outside the U.S., primarily in transportation, facilities and infrastructure work and environmental services. The growth in our international business reflects the successful implementation of our strategy to diversify beyond environmental services into the facilities and infrastructure markets internationally. We have also been successful in leveraging our size, global office network and established relationships with multinational clients in the U.S. to win new assignments abroad.
Financing Activities
During the year ended December 30, 2005, we sold 4,000,393 shares of our common stock through a public offering. We used the net proceeds of $130.3 million from this common stock offering and cash available on hand to pay $127.2 million of our 111/2% notes and $18.8 million of tender premiums and expenses. In addition, we borrowed $350.0 million under our New Credit Facility and used other available cash to pay off $353.8 million of outstanding term loan borrowings under the old senior secured credit facility (“Old Credit Facility”).
Cash Flows and Debt
During the year ended December 30, 2005, we generated $200.4 million in net cash provided by operating activities. Our ratio of debt to total capitalization (total debt divided by the sum of debt and total stockholders’ equity) decreased from 34% at December 31, 2004 to 19% at December 30, 2005. (See “Consolidated Statements of Cash Flows” to our “Consolidated Financial Statements” included under Item 8 of this report.) The decrease in our debt to total capitalization ratio reflects our continued focus on de-leveraging our balance sheet.
Business Trends
Federal Government
Revenues from our federal government clients grew steadily during 2005 and we expect revenue growth from our federal government clients to continue in fiscal year 2006, based on secured funding by the DOD and the DHS. A $453.5 billion appropriation for the DOD has been approved for fiscal 2006. The budget includes baseline budget increases in Operations and Maintenance funding and Research, Development, Test and Evaluation funding - two of the largest service offerings in the EG&G Division’s business. The DOD budget also includes an initial $50 billion in supplemental spending to fund operations in Iraq and Afghanistan for fiscal 2006. In addition, Congress approved fiscal 2006 appropriations for the DHS. The bill provides approximately $2.7 billion in discretionary funding for the Federal Emergency Management Agency (“FEMA”), and approximately $3.4 billion for first responder grants and training assistance, including $365.0 million for discretionary transportation and infrastructure grants, and rail, transit and port security grants.
We expect to see a continuation of additional federal government opportunities in the operations and maintenance, military construction, emergency response and the homeland security markets. Furthermore, federal government opportunities to provide environmental services for military sites under existing DOD contracts may also increase. In addition, due to the size of our federal contracting business, we may see increased federal government opportunities for our URS and EG&G Divisions as a result of 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.
We expect that the volume of work from defense technical services and military equipment maintenance contracts related to maintenance and modification work for military vehicles and weapons will continue to increase in fiscal year 2006, due to the continuing high level of military activities in the Middle East. We expect this trend to continue during and after the military efforts in Iraq. However, because operations and maintenance and field-based services generally provide lower margins than most other services we offer, we expect our gross profit margin percentage to continue to decrease slightly while the demand for such services continues at a high volume.
Finally, we see the latest round of the Base Realignment and Closure, or BRAC, activities as a multi-year opportunity for our federal business. The DOD budget for fiscal 2006 includes $1.9 billion for the implementation of BRAC with the objective of reducing global military infrastructure. On October 27, 2005, the U.S. House of Representatives approved the final list of bases targeted for realignment or closure. Many of these bases will require environmental, planning and design services before they can be closed or redeveloped. Accordingly, the BRAC program may result in additional federal government opportunities for our URS Division, though it may have both positive and negative impacts on our EG&G Division.
State and Local Government
We expect revenues from our state and local government clients to continue to increase during fiscal year 2006 compared to fiscal year 2005. Generally, states have recovered from the recent recession and their economies and revenues continue to improve. General fund spending for all 50 states grew in fiscal 2005, and we expect the positive trend to continue in fiscal year 2006 based on the improved funding at the state level and an increased political focus on infrastructure investment. For example, the recent passage of the long-delayed $287 billion highway and transit funding bill, SAFETEA-LU, will provide matching funds for state transportation projects through 2009. SAFETEA-LU includes $226 billion in funding for highway projects and $53 billion for transit programs.
We also expect that the devastation caused by Hurricanes Katrina and Rita will result in a focus on re-building infrastructure in and around New Orleans and more broadly across the Gulf coast, bringing increased opportunities for significant new infrastructure projects across that region.
Domestic Private Industry
We expect revenues from our domestic private industry clients to increase slightly during the 2006 fiscal year compared to fiscal year 2005. The domestic private industry market has shown modest but steady improvement, particularly in the power sector and the oil and gas market. We will continue our focus on shifting resources to emerging areas of the environmental market and migrating from one-off consulting contracts to longer-term MSAs.
We expect this shift will continue to reduce our marketing expenses and improve our professional labor utilization levels.
International
Notwithstanding the impact of foreign currency exchange rates, we expect revenues from our international business clients to continue to increase in fiscal year 2006. The increase in MSAs in our domestic private sector business has benefited and strengthened revenues from our international private sector clients. In addition, we may see further international opportunities due to the European Union’s recent environmental directives and regulations, following the adoption of the Kyoto Protocol, the selection of London, where URS has a local presence, as the host city for the 2012 Olympics, and increased demand for our facilities design services for the United Kingdom Ministry of Defense and for the U.S. DOD at military installations overseas.
In the Asia-Pacific region, strong economic growth is expected 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. Due to the rapid growth in China, many multinational companies have expanded their presence in that country. Through the August 2005 acquisition of Austin Ausino, a small engineering and project management firm based in China, we have added to our established environmental consulting business in China to meet the needs of these multinational companies. While not expected to be a significant contributor to our fiscal year 2006 revenues, this acquisition may provide opportunities for us to build new relationships with these multinational companies, which could expand our growth worldwide.
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 have to team with a general contractor in order to obtain the design-build contract, rather than contracting directly with our client. Design-build delivery mechanisms provide enhanced opportunities, but also involve greater financial risk than traditional design-bid-build programs, where we contract directly with our client.
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 material contracting mechanisms.
We adopted SFAS 123(R) on December 31, 2005, the beginning of our fiscal year 2006. This adoption will have a material impact on our financial statements. (See further discussion at Note 1, “Accounting Policies” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of this report.)
We believe that our expectations regarding our business trends are reasonable and are based on reasonable assumptions. However, such forward-looking statements, by their nature, involve risks and uncertainties. You should consider this discussion of business trends in conjunction with Item 1A, “Risk Factors,” of this report beginning on page 14.
Results of Operations
Consolidated
The Year Ended December 30, 2005 Compared with the Year Ended October 31, 2004
Our consolidated revenues for the year ended December 30, 2005 increased by 15.8% compared with the year ended October 31, 2004. The increase was due to the higher volume of work performed in each of our client categories during the year ended December 30, 2005, compared with the year ended October 31, 2004.
The following table presents our consolidated revenues by client type for the years ended December 30, 2005 and October 31, 2004.
Revenues from our federal government clients for the year ended December 30, 2005 increased by 17% compared with the year ended October 31, 2004. The increase reflects continued growth in operations and maintenance work for the U.S. military associated with the continued high level of activities in the Middle East, and systems engineering and technical assistance services for the development, testing and evaluation of weapons systems. The volume of task orders issued under IDCs for the federal government continued to increase, particularly for facilities and environmental projects and emergency preparedness exercises.
The majority of our work in the state and local government, the domestic private industry and the international sectors is derived from our URS Division. Further discussion of the factors and activities that drove changes in operations on a segment basis for the year ended December 30, 2005 can be found beginning on page 34.
Our consolidated direct operating expenses for the year ended December 30, 2005, which consist of direct labor, subcontractor costs and other direct expenses, increased by 19.4% compared with the year ended October 31, 2004. The factors that caused revenue growth also drove a corresponding increase in our direct operating expenses. Volume increases in work on existing contracts with lower profit margins and 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 year ended December 30, 2005 increased by 9.7% compared with the year ended October 31, 2004, due to the increase in our revenue volume described previously. Our gross margin percentage, however, fell from 36.7% to 34.8%. The decrease in gross profit margin percentage was caused by a change in revenue mix between the two periods, with a higher volume of revenue during the year ended December 30, 2005 coming from contracts with profit margins that were lower than our 2004 portfolio of contracts, and an increase in revenues from subcontractor and other direct costs, which generate lower profit margins than revenues earned on our direct labor.
Our consolidated indirect, general and administrative (“IG&A”) expenses for the year ended December 30, 2005 increased by 10.1% compared with the year ended October 31, 2004. This increase was due to the following items:
Indirect expenses as a percentage of revenues decreased to 30.3% for the year ended December 30, 2005 from 31.9% for the year ended October 31, 2004 due to an increase in labor hours chargeable to revenue-generating activities.
Our consolidated interest expense for the year ended December 30, 2005 decreased due to lower debt balances.
Our effective income tax rates for the year ended December 30, 2005 increased to 42.3% from 39.1% for the year ended October 31, 2004, due to accounting adjustments related to historical purchase accounting recorded in the fourth quarter of 2005, offset by hurricane-related tax credits and adjustments to our income tax reserves. (See further discussion at Note 4, “Income Taxes” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of this report.)
Our consolidated operating income, net income and earnings per share increased as a result of the factors previously described.
Reporting Segments
The Year Ended December 30, 2005 Compared with the Year Ended October 31, 2004
URS Division
The URS Division’s revenues for the year ended December 30, 2005 increased 13% compared with the year ended October 31, 2004. The increase in revenues was due to the various factors discussed below in each of our client markets.
The following table presents the URS Division’s revenues by client type for the years ended December 30, 2005 and October 31, 2004.
Revenues from the URS Division’s federal government clients for the year ended December 30, 2005 increased by approximately 6% compared with the year ended October 31, 2004. In part, this increase was related to our work supporting federal clients such as FEMA, which is now part of the DHS, the Army Corps of Engineers and the U.S. Postal Service, in disaster recovery efforts following Hurricanes Katrina, Rita, and Wilma. The increase was also driven by additional environmental and facilities projects under existing contracts with the DOD. Revenues from homeland security projects also contributed to this growth, as we continue to provide a range of engineering services to the DHS.
Revenues from our state and local government clients for the year ended December 30, 2005 increased by approximately 29% compared with the year ended October 31, 2004. The increase reflects an improvement in the states’ economies and general funds, fueled by increased state tax revenues. Generally, states have recovered from the recent recession, and have begun to increase spending on programs for which we provide services, such as surface transportation. We also continued to experience revenue increases from school facilities and water/wastewater projects. In addition, the recent passage of SAFETEA-LU has had a positive impact on revenues from our state and local government clients.
Revenues from our domestic private industry clients for the year ended December 30, 2005 were flat compared with the year ended October 31, 2004. Spending among many of our private sector clients remained constrained. However, we experienced revenue growth in the emissions control portion of our power sector business as we shifted our resources into rapidly emerging areas of the environmental market driven by new environmental regulations, such as the Clean Air Interstate Rule and the Clean Air Mercury Rule, which were issued by the U.S. Environmental Protection Agency during 2005. We also shifted our focus towards building longer-term relationships with multinational corporations by migrating from one-off consulting contracts to longer-term MSAs in order to leverage our scale and diverse our service offerings.
We have also successfully increased the number of client relationships managed under MSAs, as the number of stand-alone consulting assignments continued to decline. Revenues from our oil and gas clients also grew due to higher gasoline prices, which increased oil and gas company revenues, leading to additional investment in gas infrastructure projects.
Revenues from our international clients for the year ended December 30, 2005 increased by 20% compared with the year ended October 31, 2004. Approximately 3% of this increase was due to foreign currency exchange fluctuations. The remainder of the increase was due to our continuing efforts to diversify beyond environmental work into the facilities and infrastructure markets. The Asia-Pacific region benefited from strong economic growth, leading to increased funding for facilities and infrastructure programs, including transportation and water/wastewater projects.
In addition, the increased global demand for mineral resources has resulted in additional projects for the mining industry. In Europe, we continued to benefit from more stringent environmental directives from the European Union, leading to increased work in environmental impact statements (including sustainability issues), water and wastewater projects, and carbon emissions control projects.
The URS Division’s direct operating expenses for the year ended December 30, 2005 increased by 18% compared with the year ended October 31, 2004. The factors that caused revenue growth also drove an increase in our direct operating expenses. Direct operating expenses increased at a higher percentage than revenues as a result of increases in subcontractor costs and other direct expenses.
The URS Division’s gross profit for the year ended December 30, 2005 increased by 7% compared with the year ended October 31, 2004, primarily due to the increase in revenue volume previously described. Our gross profit margin percentage decreased to 38.9% for the year ended December 30, 2005 from 41.2% for the year ended October 31, 2004. Our gross profit margin percentage decreased primarily because our subcontractor costs and other direct costs, which generally bear lower profit margins than our direct labor costs, accounted for a higher percentage of our total direct operating expenses during the year ended December 30, 2005 (59.1%), compared with the year ended October 31, 2004 (54.0%).
The URS Division’s IG&A expenses for the year ended December 30, 2005 increased by 5% compared with the year ended October 31, 2004. This increase was due to an additional $28.1 million in employee-related expenses due to both an increase in headcount and an increase in costs per employee. The remainder of the increase was due to a $6.7 million increase in indirect labor, a $7.5 million increase in sales and business development expenses, a 3.7 million increase in rental expense, and a $4.1 million increase in travel expense. These increases were offset by a $5.2 million decrease in bad debt expense and a $3.1 million decrease in depreciation and amortization expense.
EG&G Division
The EG&G Division’s revenues for the year ended December 30, 2005 increased by 21% compared with the year ended October 31, 2004. This increase was driven by the high level of military activity in the Middle East, resulting in a higher volume of operations and maintenance work and greater demand for modification work for military vehicles and weapons systems. Revenues from the specialized systems engineering and technical assistance services that we provide for the development, testing and evaluation of weapons systems also increased. In addition, revenues generated from activities in the homeland security and logistics management markets increased during the year.
The EG&G Division’s direct operating expenses for the year ended December 30, 2005 increased by 23% compared with the year ended October 31, 2004. Higher revenues drove an increase in our direct operating expenses. In addition, a greater volume of work on existing contracts with lower profit margins caused direct operating expenses to increase faster than revenues.
The EG&G Division’s gross profit for the year ended December 30, 2005 increased by 18% compared with the year ended October 31, 2004. The increase in gross profit was primarily due to higher revenues from existing defense technical services and military equipment maintenance contracts. However, our gross profit margin percentage decreased to 26.9% for the year ended December 30, 2005 from 27.7% for the year ended October 31, 2004 because a significant portion of the revenue increase was generated by operations and maintenance and field-based services, which generally carry lower margins than most other services provided by the EG&G Division.
The EG&G Division’s IG&A expenses for the year ended December 30, 2005 increased by 18% compared with the year ended October 31, 2004. The increase was primarily due to a higher business volume. The EG&G Division’s indirect expenses are generally variable in nature and, as such, any increase in business volume tends to result in higher indirect expenses. Of the total increase, approximately $35.8 million was due to increases in indirect labor and employee-related expenses, both resulting from an increase in headcount and an increase in costs per employee. Indirect expenses as a percentage of revenues decreased to 22.2% for the year ended December 30, 2005 from 22.8% for the year ended October 31, 2004.
Two Months Ended December 31, 2004 Compared with Two Months Ended December 31, 2003
Consolidated
Two Months Ended December 31, 2004 Compared with Two Months Ended December 31, 2003
Our consolidated revenues for the two months ended December 31, 2004 increased by 15.8% compared with the same period in the prior year. The two months ended December 31, 2004 included more working days than the two months ended December 31, 2003. Approximately half of the revenue increase resulted from revenues generated during the additional days in which services were provided to clients. The remaining increase was due to an increase in the volume of work performed during the two months ended December 31, 2004, compared with the same period in the prior year. The following table presents our consolidated revenues by client type for the two months ended December 31, 2004 and 2003.
Revenues from our federal government clients for the two months ended December 31, 2004 increased by 22% compared with the same period in the prior year. The increased number of working days in the two-month period ended December 31, 2004 contributed approximately nine of the 22% increase in revenues from our federal government clients. The remainder of the increase reflects the continued growth in defense-related work, as we continued to benefit from additional military spending on engineering and technical services and operations and maintenance activities. As a result of increased military activity, our work volume increased under existing outsourcing contracts to provide engineering and technical services to refurbish and upgrade military equipment and
systems. We also continued to benefit from increased task orders issued under IDCs for the federal government for facilities and environmental projects.
The majority of our work in the state and local government, the domestic private industry and the international sectors is derived from our URS Division. Further discussion of the factors and activities that drove changes in operations on a segment basis for the two months ended December 31, 2004 can be found beginning on page 40.
Our consolidated direct operating expenses for the two months ended December 31, 2004, which consist of direct labor, subcontractor costs and other direct expenses, increased by 17.5% compared with the same period in the prior year. The factors that caused revenue growth also drove an increase in our direct operating expenses. Volume increases in work on existing contracts with lower profit margins caused direct operating expenses to increase at a faster rate than revenues.
Our consolidated gross profit for the two months ended December 31, 2004 increased by 12.7% compared with the same period in the prior year, primarily due to the increase of our revenue volume described previously. Our gross margin percentage, however, fell from 35.8% to 34.8%. The decrease in gross profit margin percentage was caused by a change in revenue mix between the two periods, with a higher volume of revenue coming from contracts with profit margins that were lower than those typically achieved through our historic portfolio of contracts.
Our consolidated indirect, general and administrative (“IG&A”) expenses for the two months ended December 31, 2004 increased by 22.7% compared with the same period in the prior year. Our employee benefit costs, including holiday, healthcare, workers’ compensation and retirement-related costs, increased $24.9 million, or 37.6%, over the same period in the prior year. Of that amount, the cost of our employees’ holiday benefits during the two months ended December 31, 2004 increased $9.7 million, or 14.5%, over the previous year.
The increase in the cost of our employees’ holiday benefits was caused by applying the accounting method we used to recognize the cost of holidays in a two-month reporting period compared to an annual reporting period. Typically, at the beginning of each fiscal year, we estimate the cost of the holidays we provide to our employees during the full year. These costs are then recognized over the course of the year, in proportion to our labor costs, as our labor costs are incurred. This estimate is updated as necessary during the course of the year. As a result, in a typical fiscal year, during the two months that end on December 31, we recognize approximately one-sixth (1/6) of our annual holiday cost. However, the two months ended December 31, 2004 was a transition period between our fiscal year that ended October 31, 2004, and our next fiscal year, which began on January 1, 2005. The transition period was considered a complete accounting cycle, and therefore we expensed the costs of all holidays that actually fell during the transition period rather than one-sixth of a full year’s holiday costs. As a result, the transition period effectively included the costs of approximately four holidays, rather than the costs of approximately one and one-half holidays, which were recognized in the two months ended December 31, 2003.
The remaining increase in employee benefit costs occurred primarily because of the higher number of working days, and the additional employees necessary to perform the services required by the increased volume of our revenue-generating activities and the higher costs associated with those employee benefits.
During the two months ended December 31, 2004, our travel expenses increased by $3.2 million over the same period in the prior year because of the additional work days in the period and the increased volume of work. The remaining increases were incurred for internal and external program support and other general and administrative costs resulting from a higher business volume.
Our consolidated interest expense for the two months ended December 31, 2004 decreased due to lower debt balances.
Our effective income tax rates for the two months ended December 31, 2004 and 2003 were 49% and 40%, respectively. The higher effective income tax rate for the two months ended December 31, 2004 was the result of foreign operating losses in subsidiaries that operate in jurisdictions with income tax rates lower than the U.S. federal statutory rate and some non-deductible expenses.
Our consolidated operating income, net income and earnings per share decreased as a result of the factors previously described.
Reporting Segments
Two Months Ended December 31, 2004 Compared with Two Months Ended December 31, 2003
URS Division
The URS Division’s revenues for the two months ended December 31, 2004 increased 10.2% compared with the same period in the prior year. Approximately seven of the 10% increase in revenues was due to more working days in the two months ended December 31, 2004 than the two months ended December 31, 2003. The remaining increase in revenues was due to the various factors discussed below in each of our client markets.
The following table presents the URS Division’s revenues by client type for the two months ended December 31, 2004 and 2003.
Revenues from our federal government clients in the URS Division for the two months ended December 31, 2004 increased by 10% compared with the same period in the prior year. The increased number of working days in the two months ended December 31, 2004 contributed to approximately two-thirds of the increase in revenues from our federal government clients. The remainder of the increase was driven by growth in our federal business, including environmental and facilities projects under existing contracts. Revenues from homeland security projects also contributed to this growth as we continued to provide a range of engineering services to the DHS. This work includes designs to help protect federal facilities from terrorists as well as disaster recovery services for the Federal Emergency Management Agency, which is now a part of DHS.
Revenues from our state and local government clients for the two months ended December 31, 2004 increased by approximately 12% compared with the same period in the prior year. Approximately three-fourths of the increase was attributable to the increased number of working days in the two months ended December 31, 2004. The remainder of the increase reflects growth in the work volume provided to our state and local government clients. This market continued to be affected by the budget deficits that state and local governments have faced over the past two years. We have begun to see selected pockets of growth emerge in some parts of the country, particularly in the Southeast; however, the West and the Midwest remained weak, with spending on capital projects significantly below historic levels. In addition, the continuing delay in the passage of the successor bill to TEA-21 continued to negatively impact our revenues in this market. However, we continued to benefit from our successful strategy to shift resources away from surface transportation projects to other portions of the state and local government market - such as K-12 schools, water/wastewater and air transportation - where funding is more stable or growing.
Revenues from our domestic private industry clients for the two months ended December 31, 2004 increased by approximately 5% compared with the same period in the prior year, primarily as a result of the additional working days in the two months ended December 31, 2004. Although we saw some indications of recovery in capital spending by our domestic private industry clients, many of our clients, particularly in the manufacturing and chemical industries, remained cautious. However, our strategic focus of the past several years to win MSAs with major domestic private industry clients in the pharmaceutical, automotive, oil and gas, and power sectors helped to offset the decline in revenues in this part of the business. We also benefited from stricter air pollution control limits under the Clean Air Act, which has resulted in increased revenues from emissions control projects at power plants.
Revenues from our international clients for the two months ended December 31, 2004 increased by 23% compared with the same period in the prior year. Approximately two-thirds of the increase was attributable to the additional working days in the two months ended December 31, 2004 and one-fourth of the increase was due to foreign currency exchange fluctuations. The remainder of the increase was due to growth in our Asia Pacific and European regions. The revenue growth in the Asia Pacific region was due to increases in surface and air transportation projects in Australia and New Zealand, driven in part by improvements in the respective country’s economies. The revenue growth in Europe was due to increases in facilities and environmental projects.
The URS Division’s direct operating expenses for the two months ended December 31, 2004 increased by 10.2% compared with the same period in the prior year. The factors that caused revenue growth also drove an increase in our direct operating expenses.
The URS Division’s gross profit for the two months ended December 31, 2004 increased by 10.2% compared with the same period in the prior year, primarily due to the increase in revenue volume previously described. Our gross profit margin percentage remained the same at 38.6% for the two-month periods ended December 31, 2004 and 2003.
The URS Division’s IG&A expenses for the two months ended December 31, 2004 increased by 22.4% compared with the same period in the prior year. This increase was due to an additional $15.5 million in employee benefit costs, including an $8.9 million increase in the cost of our employees’ holiday benefit for reasons described previously, and higher healthcare, workers’ compensation and retirement costs. The remainder of the increase was due to $2.4 million in indirect labor, $1.6 million in sales and business development expenses, $1.5 million in rent expense, $1.9 million in travel expense, $1.3 million in bad debt expense and $1.0 million in other miscellaneous general and administrative expenses. These increases were primarily due to the additional work days in the period and the increased volume of work.
EG&G Division
The EG&G Division’s revenues for the two months ended December 31, 2004 grew by 28.2% compared with the same period in the prior year. Approximately two-thirds of the increase was driven by continued growth in defense-related work, as we continued to benefit from additional military spending on engineering and technical services, and operations and maintenance activities. In addition, due to increased military activity, our work under existing outsourcing contracts to provide engineering and technical services to refurbish and upgrade military equipment and systems increased. This work involved improvements to communications equipment, weapons systems, and engines on aircraft and ground vehicles such as tanks, high-mobility multipurpose wheeled vehicles and various armored personnel carriers. Homeland security revenues remained strong, with increased work in the design, development and conduct of security preparedness exercises around the country. The remainder of the increase was attributable to the increased number of working days in the two months ended December 31, 2004 compared to the two months ended December 31, 2003.
The EG&G Division’s direct operating expenses for the two months ended December 31, 2004 increased by 31.6% compared with the same period in the prior year. Higher revenues drove an increase in our direct operating expenses. In addition, a greater volume of work on existing contracts with lower profit margins caused direct operating expenses to increase faster than revenues.
The EG&G Division’s gross profit for the two months ended December 31, 2004 increased by 20.0% compared with the same period in the prior year. The increase in gross profit was primarily due to increased revenues from existing defense technical services and military equipment maintenance contracts; however, gross profit grew at a slower rate than revenue because the contracts that generated most of the increase in revenue generated lower gross profit compared to our historic portfolio of contracts. Our gross profit margin percentage decreased to 27.8 % for the two months ended December 31, 2004 from 29.7% for the two months ended December 31, 2003.
The EG&G Division’s IG&A expenses for the two months ended December 31, 2004 increased by 27.0% compared with the same period in the prior year. The increase was primarily due to a higher business volume. The EG&G Division’s indirect expenses are generally variable in nature, and as such, any increase in business volume
tends to result in higher indirect expenses. Of the total increase, approximately $8.9 million was due to volume increases in employee benefit costs, including a $0.8 million increase in the cost of our employees’ holiday benefit for reasons described previously, and higher healthcare, workers’ compensation and retirement costs. Other employee-related expenses, such as travel and recruiting expenses, increased by $1.4 million, due to a higher employee headcount as a result of the increase in work volume. Indirect expenses as a percentage of revenues decreased to 23.7% for the two months ended December 31, 2004 from 23.9% for the two months ended December 31, 2003.
Year Ended October 31, 2004 Compared with Year Ended October 31, 2003
Consolidated
Our consolidated revenues for the fiscal year ended October 31, 2004 increased by 6.1%, compared with the same period in the prior year. The increase in our revenues was primarily due to a higher volume of work performed for our federal government and international clients. This increase was offset by a decrease in revenues from our domestic private industry clients. The following table presents our consolidated revenues by client type for the fiscal years ended October 31, 2004 and 2003.
Revenues from our federal government clients for the fiscal year ended October 31, 2004 increased by 16% compared with the same period in the prior year. This increase was driven by a higher level of activity under contracts with the DOD and the DHS. Due to the heightened military operations tempo, our work under existing outsourcing contracts to repair and maintain military equipment increased. Our services with the DHS have grown, with an increased volume of work under contracts with the U.S. Customs Service, the Federal Emergency Management Agency, and a new contract with the U.S. Coast Guard. We also continued to benefit from increased task orders issued
under federal government IDCs for facilities and environmental projects, and from increased spending on homeland security projects.
The majority of our work in the state and local government, the domestic private industry and the international sectors is derived from our URS Division. Further discussion of the factors and activities that drove changes in operations on a segment basis for the fiscal year ended October 31, 2004 can be found beginning on page 44.
Our consolidated direct operating expenses for the fiscal year ended October 31, 2004, which consisted of direct labor, subcontractor costs and other direct expenses, increased by 6.8% compared with the same period in the prior year. Our increased revenues drove an increase in our direct operating expenses. In addition, volume increases in work on existing contracts with lower profit margins caused direct operating expenses to increase faster than revenues.
Our consolidated gross profit for the fiscal year ended October 31, 2004 increased by 5.1% compared with the same period in the prior year, primarily due to the increase of our revenue volume described previously. Our gross margin percentage, however, fell from 37.1% to 36.7%. The decrease in gross profit margin percentage was caused by a change in revenue mix with significant volume increases coming from contracts with profit margins that were lower than the average profit margin achieved through our historical portfolio of contracts.
Our consolidated indirect, general and administrative expenses for the fiscal year ended October 31, 2004 increased by 7.9%, compared with the same period in the prior year. We incurred $28.2 million of costs related to the extinguishment of debt during fiscal year 2004. Our employee benefits, including our healthcare, workers’ compensation and pension-related costs, increased by $40.8 million primarily because of the increased number of employees necessary to perform the services required by the overall increase in the volume of our revenue generating activities, and increase in healthcare costs, workers’ compensation expenses and pension-related benefits. Bad debt expense increased by $6.0 million because we provided allowances against receivables that have not yet been collected as the economy weakened. The increased volume of work also drove an increase in other variable indirect, general and administrative expenses, such as office supplies and miscellaneous equipment rental and purchases, by $4.9 million. In addition, our travel expenses increased by $7.2 million due to increased travel related to sales and business development efforts and increased airfare costs.
Our consolidated interest expense for the fiscal year ended October 31, 2004 decreased due to the redemption of $260.0 million of our 111/2% notes and 121/4% notes and other repayments of our long-term debt.
Our effective income tax rates for the fiscal year ended October 31, 2004 decreased to 39.1% from 40.0% in fiscal year 2003, primarily due to a one-time adjustment to the tax-basis of the purchase price of EG&G.
Our consolidated operating income, net income and earnings per share resulted from the factors previously described.
Reporting Segments
URS Division
The URS Division’s revenues for the fiscal year ended October 31, 2004 decreased slightly compared with the same period in the prior year. This decrease was due to a decline in revenues from domestic private industry clients. This decline was offset by revenue growth from our federal government clients, the effects of foreign currency exchange rates and revenue growth in our international business.
The following table presents the URS Division’s revenues by client type for the fiscal years ended October 31, 2004 and 2003.
Revenues from our federal government clients in the URS Division for the fiscal year ended October 31, 2004 increased by 6% compared with the same period in the prior year. This increase was driven by growth in environmental and facilities projects for federal clients as well as an increased volume of work providing program and construction management services for DOD agencies. Revenues from homeland security projects also contributed to this growth as we continued to provide a range of engineering services to the DHS.
Revenues from our state and local government clients for the fiscal year ended October 31, 2004 were flat compared with the same period in the prior year. Our revenues continued to be affected by the budget deficits that state and local government faced over the past two years. However, this market stabilized during fiscal year 2004 as we began to see pockets of strength emerge in some parts of the country. Spending in the Southeastern states has returned nearly to pre-2001 levels and Florida, Georgia, Texas and Maryland, have showed some signs of recovery. However, the West, particularly California, and the Midwest remained weak, with spending for capital projects significantly below historic levels. In addition, the continuing delay in the passage of the successor bill to TEA-21 contributed to the delay of several major transportation projects. We have mitigated some of these unfavorable conditions by shifting resources away from surface transportation projects to other portions of the state and local government market, such as water/wastewater, air transportation, and facilities, where funding is more stable or growing.
Revenues from our domestic private industry clients for the fiscal year ended October 31, 2004 decreased by approximately 10% compared with the same period in the prior year. Many of our private sector clients continued to struggle during fiscal year 2004, which resulted in constrained spending on capital projects. Some portions of this market, including power and oil and gas, began to recover during 2004. However, other portions of the private sector, such as the chemical and pharmaceutical industries, remained weak. Our strategic focus of the past several years to win MSAs with major domestic private industry clients in the oil and gas, manufacturing and power sectors helped to offset the decline in revenues in this part of the business. Stricter air pollution control regulations under the Clean Air Act, which has resulted in increased revenues from emissions control projects at power plants, has also helped to offset the decline in our private sector revenues.
Revenues from our international clients for the fiscal year ended October 31, 2004 increased by 19% compared with the same period in the prior year. Approximately 10% of the increase was due to foreign currency exchange fluctuations and 9% was due to growth in our Asia Pacific and European regions. The revenue growth in the Asia Pacific region was due to increases in surface and air transportation projects in Australia and New Zealand, driven in part by improvements in the respective country’s economies. The revenue growth in Europe was due to increases in facilities and environmental projects for the United Kingdom Ministry of Defense and the U.S. Department of Defense.
The URS Division’s direct operating expenses for the fiscal year ended October 31, 2004 decreased by 2.0% compared with the same period in the prior year. This was due to a decrease of $51.3 million in total subcontractor and other direct costs, which are comprised of travel, supplies and other incidental project costs, offset by an increase in direct labor of $23.6 million. The decrease in subcontractor costs and other direct costs was driven by the winding down of several large subcontracts and improved cost control on supplies and other incidental project costs.
The URS Division’s gross profit for the fiscal year ended October 31, 2004 increased by 2.6% compared with the same period in the prior year. Our gross profit margin percentage increased to 41.2% for the fiscal year ended October 31, 2004 from 40.1% for the fiscal year ended October 31, 2003. Our gross profit margin percentage increased primarily because a greater percentage of our revenues were generated by direct labor, rather than subcontract or other direct costs during the fiscal year ended October 31, 2004 (46.0%), compared with the fiscal year ended October 31, 2003 (43.3%). The use of our direct labor on the performance of our contracts generally generates higher profit margins than the use of subcontractors.
The URS Division’s IG&A expenses for the fiscal year ended October 31, 2004 increased by 3.0% compared with the same period in the prior year. This increase was primarily due to increases of $22.0 million in employee benefits costs resulting primarily from healthcare costs, workers’ compensation expenses and pension-related benefits. Costs associated with employer taxes, employee recruitment and retention, and severance expenses also contributed to the increase in employee benefits costs.
EG&G Division
The EG&G Division’s revenues for the fiscal year ended October 31, 2004 grew by 21.8% compared with the same period in the prior year. This increase was driven by an overall growth in defense-related work, including the services required to refurbish and upgrade military equipment and systems. This work involved improvements to communications equipment, weapons systems, and engines on aircraft and ground vehicles such as tanks, high-mobility multipurpose wheeled vehicles and various armored personnel carriers. Homeland security revenues remained strong, with increased work in the design, development and conduct of security preparedness exercises around the country.
The EG&G Division’s direct operating expenses for the fiscal year ended October 31, 2004 increased by 25.5% compared with the same period in the prior year. Direct operating expenses increased as revenues grew; however, there was more revenue growth from operations and maintenance contracts in fiscal year 2004 than fiscal year 2003. Since these contracts generated lower profit margins, direct operating expenses increased faster than revenues.
The EG&G Division’s gross profit for the fiscal year ended October 31, 2004 increased $35.9 million over the previous year, reflecting the margins achieved through the revenue increases described above. The EG&G Division’s gross margin percentage decreased to 27.7% for the fiscal year ended October 31, 2004 from 29.8% for the fiscal year ended October 31, 2003. The decrease resulted from an increase in the volume of operations and maintenance and field-based services, which generally carry lower margins than the services typically provided by the EG&G Division. As a result, gross profit grew at a slower rate than revenues.
The EG&G Division’s IG&A expenses for the fiscal year ended October 31, 2004 increased by 12.6% compared with the same period in the prior year. The increase in indirect expenses was primarily due to a higher business volume. The EG&G Division’s indirect expenses are generally variable in nature and as such, an increase in business volume typically results in an increase in indirect expenses. Employee benefits increased by approximately $20.7 million and other employee-related expenses, such as travel and recruiting expenses, increased by $6.4 million due to a higher employee headcount as a result of the increased volume of work. In fiscal year 2004, there was also an increase of $4.5 million in indirect expenses not reimbursable under U.S. government contracts. These increases were offset by a $3.7 million decrease in pension costs, $2.8 million of which was the result of the EG&G pension plan amendment and $0.9 million of which was the result of a higher than expected return on pension plan assets for fiscal year 2004 compared with fiscal year 2003. Indirect expenses as a percentage of revenues decreased to 22.8% for the fiscal year ended October 31, 2004 from 24.7% for the fiscal year ended October 31, 2003 due to an increase in labor utilization as explained above.
Liquidity and Capital Resources
Our primary sources of liquidity were cash flows from operations, borrowings under our credit lines and public common stock offerings during the fiscal years ended December 30, 2005 and October 31, 2004. Our primary uses of cash have been to fund our working capital and capital expenditures, and to service and retire our debt. We believe that we have sufficient cash flows 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 sources of funding to address significant changes in our business at reasonable rates and terms, as necessary, based on our past experience with business acquisitions.
We are dependent on the cash flows generated by our subsidiaries and, consequently, on their ability to collect on their respective accounts receivable. Substantially all of our cash flows are generated by our subsidiaries. As a result, the funds necessary to meet our debt service obligations are provided in large part by distributions or advances from our subsidiaries. The financial condition and operational requirements of our subsidiaries may limit our ability to obtain cash from them. See further discussion at Note 14, “Supplemental Guarantor Information” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of this report.
Billings and collections on accounts receivable can impact our operating cash flows. Management places significant emphasis on collection efforts, has assessed the allowance accounts for receivables as of December 30, 2005 and has deemed them 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 impact our ability to consistently collect cash from them to meet our operating needs.
Operating Activities
The increase in cash flows from operating activities for the year ended December 30, 2005 compared with the year ended October 31, 2004 was primarily due to the increase in net income, and an increase in Accounts Payable and Subcontractors Payable and Billings in Excess of Costs and Accrued Earnings on Contracts in Process, resulting from the timing of payments, offset by increases in Accounts Receivables and Accrued Earnings in Excess of Billings on Contracts in Process, resulting from the timing of collections.
The decrease in cash flow from operating activities for the year ended October 31, 2004 compared with the year ended October 31, 2003 was primarily due to increases in Accounts Receivables and Accrued Earnings in Excess of Billings on Contracts in Process, resulting from the timing of collections, and a decrease in deferred income tax liabilities, offset by non-cash debt extinguishment costs and an increase in Accounts Payable and Subcontractors Payable, resulting from the timing of payments.
Investing Activities
As a professional services organization, we are not capital intensive. Our capital expenditures have historically 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, during the year ended December 30, 2005 and the years ended October 31, 2004 and 2003 were $23.0 million, $19.0 million, and $18.2 million, respectively. For the two months ended December 31, 2004 and 2003, capital expenditures, excluding purchases financed through capital leases, were $1.6 million and $2.8 million, respectively.
Financing Activities
On June 8, 2005, we sold an aggregate of 4,000,393 shares of our common stock through a public offering. The offering price of our common stock was $34.50 per share and the total offering proceeds to us were $130.3 million, net of underwriting discounts and commissions and other offering-related expenses of $7.8 million.
We used the net proceeds from this common stock offering and cash available on hand to pay $127.2 million of our 111/2% notes and $18.8 million of tender premiums and expenses. In addition, we retired $353.8 million of the term loans outstanding under the Old Credit Facility during the second quarter of fiscal year 2005, and entered into a New Credit Facility of $350.0 million on June 28, 2005. As a result of the debt retirement and terms of the New Credit Facility, our interest expense has been reduced substantially compared to prior years. As a result of this debt retirement, we recognized a pre-tax charge of $33.1 million, which consisted of tender/call premiums and expenses of $19.4 million and the write-off of $13.7 million in unamortized financing fees, issuance costs and debt discounts. In addition, during the first quarter of fiscal year 2005, we retired the remaining $10.0 million in outstanding balance of our 121/4% notes. We also retired the entire outstanding balance of $1.8 million of our 61/2% debentures on August 15, 2005.
Cash flows from financing activities of $184.8 million during the year ended December 30, 2005 consisted primarily of the following activities:
During fiscal year 2004, we sold an aggregate of 8.1 million shares of our common stock through an underwritten public offering. The offering price of our common stock was $26.50 per share, and we received total offering proceeds of $204.3 million, net of $10.5 million in underwriting discounts and commissions and other offering-related expenses.
We used the net proceeds from this common stock offering plus the borrowings under our Credit Facility and cash available on hand to redeem $70.0 million of our 111/2% notes and $190.0 million of our 121/4% notes. As a result of these redemptions, we recognized a pre-tax charge of $28.2 million during our fiscal year 2004, consisting of the write-off of $8.5 million in unamortized financing fees, debt issuance costs and debt discounts, and payments of $19.7 million for call premiums.
Cash flows from financing activities of $43.5 million during the year ended October 31, 2004 consisted primarily of the following activities:
Cash flows from financing activities of $155.3 million during the year ended October 31, 2003 consisted primarily of the following activities:
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Net payments under the line of credit of $27.3 million;
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Net payment of $118.2 million of the term loans under the Old Credit Facility;
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Payment of $14.8 million in capital lease obligation and short-term notes payable (net of borrowings);
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Change in book overdraft of $13.0 million; and
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Proceeds from the sale of common stock from the employee stock purchase plan and exercise of stock options of $17.8 million.
The table below contains information about our contractual obligations and commercial commitments followed by narrative descriptions as of December 30, 2005:
(1)
Amounts shown exclude remaining original issue discounts of $27 thousand and $66 thousand for our 111/2% notes and notes payable, respectively.
(2)
These pension funding requirements for the EG&G pension plans, 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 $11.2 million into a rabbi trust for our CEO’s SERP upon receiving a 15-day notice, his death or the termination of his employment for any reason.
(3) Purchase obligations consist primarily of software maintenance contracts.
(4) These operating leases are predominantly real estate leases.
Off-balance Sheet Arrangements. The following is a list of our off-balance sheet arrangements:
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As of December 30, 2005, we had a total available balance of $68.9 million in standby letters of credit under our New Credit Facility. Letters of credit are used 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. Our New Credit Facility covers the issuance of our standby letters of credit and is critical for our normal operations. If we default on the New Credit Facility, our ability to issue or renew standby letters of credit would impair our ability to maintain normal operations.
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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 $6.5 million; however, it was temporarily increased to $11.5 million from December 19, 2005 through January 31, 2006, to address temporary working capital needs of the joint venture. It reverted back to the original amount of $6.5 million on February 1, 2006.
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From time to time, we have provided 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, 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.
New Credit Facility. On June 28, 2005, we entered into a new credit facility consisting of a 6-year term loan of $350.0 million and a 5-year Revolving Line of Credit of $300.0 million, against which up to $200.0 million can be used to issue letters of credit. As of December 30, 2005, we had $270.0 million outstanding under the term loan, $68.9 million in letters of credit, and no amount outstanding under the Revolving Line of Credit.
Our Revolving Line of Credit is used to fund daily operating cash needs and to support our standby letters of credit. During the ordinary course of business, the use of our Revolving Line of Credit is a function of collection and disbursement activities. Our daily cash needs generally follow a predictable pattern that parallels our payroll cycles, which dictate, as necessary, our short term borrowing requirements.
Principal amounts under the term loan will become due and payable on a quarterly basis: 15% of the principal will be payable in four equal quarterly payments beginning in the third quarter of 2008, 20% of the principal will be due during the next four quarters, and 65% will be due in the final four quarters ending on June 28, 2011. Our Revolving Line of Credit expires and is payable in full on June 28, 2010. At our option, we may repay the loans under our New Credit Facility without premium or penalty.
All loans outstanding under our New Credit Facility bear interest at either LIBOR or the 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 (“Moody’s”) and Standard & Poor’s. The LIBOR margin will range from 0.625% to 1.75% and the base rate margin will range from 0.0% to 0.75%. As of December 30, 2005, the LIBOR margin was 1.00% for
both the term loan and the Revolving Line of Credit. As of December 30, 2005, the interest rate on our term loan was 5.53%.
A substantial number of our domestic subsidiaries are guarantors of the New Credit Facility on a joint and several basis. Initially, the obligations are collateralized by our guarantors’ capital stock. The collateralized obligations will be eliminated if we reach an investment grade credit rating of “Baa3” from Moody’s and “BBB-” from Standard & Poor’s. If our credit rating were to fall to or below “Ba2” from Moody’s or “BB” from Standard & Poor’s, we would be required to provide a secured interest in substantially all of our existing and subsequently acquired personal and real property, in addition to the collateralized guarantors’ capital stock. Although the capital stock of the non-guarantor subsidiaries are not required to be pledged as collateral, the terms of the New Credit Facility restrict the non-guarantors’ assets, with some exceptions, from being used as a pledge for future liens (a “negative pledge”). Moody’s upgraded our credit rating from “Ba2” to “Ba1” on June 20, 2005. On July 26, 2005, Standard & Poor’s upgraded our credit rating from “BB” to “BB+.” As of December 30, 2005, our credit rating remained the same.
Our New Credit Facility contains financial covenants. We are required to maintain: (a) a maximum ratio of total funded debt to total capital of 40% or less and (b) a minimum interest coverage ratio of not less than 3.0:1. The interest coverage ratio is calculated by dividing consolidated Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”), as defined in our New Credit Facility agreement, by consolidated cash interest expense.
The New Credit Facility also contains customary events of default and customary affirmative and negative covenants, some of which are dependent upon our credit ratings and include, but are not limited to, limitations on mergers, consolidations, acquisitions, asset sales, restrictions against dividend payments, stock redemptions or repurchases, transactions with stockholders and affiliates, liens, capital leases, negative pledges, sale-leaseback transactions, indebtedness, contingent obligations and investments.
As of December 30, 2005, we were in compliance with all the covenants of the New Credit Facility.
Old Senior Secured Credit Facility. The Old Credit Facility consisted of two term loans, term loan A and term loan B, and a revolving line of credit. The Old Credit Facility was terminated and repaid in full on June 28, 2005. As of December 31, 2004, we had $353.8 million in principal amounts outstanding under the term loan facilities with an interest rate of 4.42%. We had also drawn $18.0 million against the revolving line of credit and had outstanding standby letters of credit aggregating to $55.3 million, reducing the amount available to us under the revolving credit facility to $151.7 million.
Revolving Line of Credit.
Our revolving line of credit information is summarized as follows:
111/2% Senior Notes. As of December 30, 2005 and December 31, 2004, we had outstanding amounts of $2.8 million and $130.0 million, respectively, of the original outstanding principal, due 2009. On June 15, 2005, we accepted tenders for and retired $127.2 million of the 111/2% notes. Interest is payable semi-annually in arrears on March 15 and September 15 of each year. These notes are effectively subordinate to our New Credit Facility, capital leases and notes payable.
See further discussion at Note 5, “Current and Long-Term Debt” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of this report.
121/4% Senior Subordinated Notes(“121/4% notes”). On February 14, 2005, we retired the entire outstanding balance of $10 million of our 121/4% notes. As of December 31, 2004, we owed $10 million.
See further discussion at Note 5, “Current and Long-Term Debt” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of this report.
61/2% Convertible Subordinated Debentures (“61/2% debentures”). On August 15, 2005, we retired the entire outstanding balance of $1.8 million of our 61/2% debentures. As of December 31, 2004, we owed $1.8 million.
Notes Payable, Foreign Credit Lines and other indebtedness. As of December 30, 2005 and December 31, 2004, we had outstanding amounts of $9.6 million and $13.4 million, respectively, in notes payable and foreign lines of credit. Notes payable primarily include notes used to finance the purchase of office equipment, computer equipment and furniture. The weighted average interest rates of the notes were approximately 5.6% and 5.8% as of December 30, 2005 and December 31, 2004, respectively.
We maintain foreign lines of credit, which are collateralized by the assets of our foreign subsidiaries and letters of credit. As of December 30, 2005, we had $10.0 million in lines of credit available under these facilities, with no amounts outstanding. As of December 31, 2004, we had $16.4 million in lines of credit available under these facilities, with $8.5 million outstanding. The interest rates were 6.6% and 8.6% as of December 30, 2005 and December 31, 2004, respectively.
Capital Leases. As of December 30, 2005 and December 31, 2004, we had $36.2 million and $32.0 million in obligations under our capital leases, respectively, consisting primarily of leases for office equipment, computer equipment and furniture.
Operating Leases. As of December 30, 2005 and December 31, 2004, we had approximately $415.8 million and $462.9 million, respectively, in obligations under our operating leases, consisting primarily of real estate leases.
Other Activities
Related-Party Transactions. On January 19, 2005, affiliates of Blum Capital Partners, L.P. (collectively, “Blum Affiliates”) sold 2,000,000 shares of our common stock in an underwritten secondary offering, pursuant to a registration statement that we previously filed in accordance with the terms of an existing registration rights agreement. The general partner of Blum Capital Partners, L.P. was a member of our Board of Directors.
On October 21, 2005, according to the terms of the registration rights agreement, Blum Affiliates requested that we register their remaining 3,580,907 shares of our common stock, which they sold on December 6, 2005.
Derivative Financial Instruments. We are exposed to risk of changes in interest rates as a result of borrowings under our New Credit Facility. During fiscal year 2005, 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.
Other Commitments. Consistent with industry practice, when performing environmental remediation or other services, we will at times provide a guarantee related to the materials, workmanship and fitness of a project site; however, we cannot estimate the amount of any guarantee until a determination has been made that a material defect has occurred.
Income Taxes
As of December 30, 2005, for federal income tax purposes, we had available domestic net operating loss (“NOL”) of $3.0 million. Utilization of the NOL is limited pursuant to Section 1503 of the Internal Revenue Code and will be utilized against the income of our insurance company subsidiary. This NOL will be carried forward and will expire in fiscal year 2022. We also have $20.0 million of foreign NOLs available, which will expire at various dates. These foreign NOLs are available only to offset income earned in foreign jurisdictions.
Our deferred tax assets arose from temporary differences in the recognition of accruals, primarily compensation and loss-related accruals, available NOLs and allowances for doubtful accounts. Our current deferred tax assets at December 30, 2005 increased slightly from the balance at October 31, 2004 due to an increase in various loss accruals, which was offset by a decrease in payroll-related accruals. Our current deferred tax liabilities primarily arose from temporary differences in the recognition of costs and accrued earnings in excess of billings on contracts in process, which increased as of December 30, 2005 compared to the balance as of October 31, 2004. Total tax deductible goodwill resulting from the Dames & Moore and EG&G acquisitions amounted to $350.1 million. As of December 30, 2005, $183.5 million of goodwill was unamortized for tax purposes. The difference between tax and financial statement cumulative amortization on tax deductible goodwill gave rise to a long-term deferred tax liability. Our net non-current deferred tax liabilities as of December 30, 2005 decreased from the balance at October 31, 2004 due to increases in deferred tax assets related to pension liabilities and reserves. These increases were greater than the increases in deferred tax liabilities related to tax deductible goodwill. During 2005 we performed analysis related to recent audit activities and historic fluctuations in foreign currency translation. As a result, we reduced our reserves for tax contingencies in the areas of transfer pricing, state and local taxes, and foreign exchange gains and losses.
Valuation allowances for deferred tax assets are established when necessary to reduce deferred tax assets to the amount expected to be realized. Based on expected future operating results, we believe that realization of deferred tax assets in excess of the valuation allowance is more likely than not.
Earnings from our foreign subsidiaries are indefinitely reinvested outside of our home tax jurisdiction and thus pursuant to Accounting Principles Board Opinion No. 23, “Accounting for Income Taxes - Special Areas,” we do not recognize a deferred tax liability for the tax effect of the excess of the book over tax basis of our investments in our foreign subsidiaries and it is not practicable to calculate the amount of taxes that would be due upon remittance.
See further discussion at Note 4, “Income Taxes” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of this report.
Critical Accounting Policies and Estimates
The preparation of our financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, the reported amounts of revenues and expenses during the reporting period, and the related disclosures of contingent assets and liabilities at the date of financial statements, which are included in Item 8 of this report. Application of these accounting policies involves the exercise of judgment and the use of assumptions as to future uncertainties based on information available to us as of the date of the financial statements. Consequently, our actual results could differ from our estimates. See Note 1, “Accounting Policies” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of this report.
Significant accounting policies that we believe are important to understanding our results of operations and financial positions are discussed below. Information regarding our other accounting policies is included under Item 8, “Consolidated Financial Statements and Supplementary Data,” of this report.
Revenue Recognition
Our revenues arise primarily from the professional and technical services performed by our employees or, in certain cases, by subcontractors we engage to perform on our behalf under contracts we enter into with our clients. The revenues we recognize, therefore, are derived from our ability to charge our clients for those services under our contracts. A more detailed discussion of our revenue recognition on contract types is included in Note 1, “Accounting Policies” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of this report.
We enter into three major types of contracts: “cost-plus contracts,” “fixed-price contracts” and “time-and-materials contracts.” Within each of the major contract types are variations on the basic contract mechanism. Fixed-price contracts generally present us with the highest level of financial and performance risk, but often also provide the highest potential financial returns. Cost-plus contracts present us with lower risk, but generally provide lower returns and often include more onerous terms and conditions. Time-and-materials contracts generally represent the time spent by our professional staff at stated or negotiated billing rates.
We account for our professional planning, design and various other types of engineering projects, including systems engineering and program and construction management contracts on the “percentage-of-completion” method, wherein revenue is recognized as project progress occurs. Service-related contracts, including operations and maintenance services and a variety of technical assistance services, are accounted for over the period of performance, in proportion to the costs of performance, evenly over the period or over units of production. If our estimate of costs at completion on any contract indicates that a loss will be incurred, we charge the entire estimated loss to operations in the period the loss becomes evident.
The use of the percentage of completion revenue recognition method requires us to make estimates and exercise judgment regarding the project’s expected revenues, costs and the extent of progress towards completion. We have a history of making reasonably dependable estimates of the extent of progress towards completion, contract revenue and contract completion costs on our long-term engineering and construction contracts. However, due to uncertainties inherent in the estimation process, it is possible that our completion costs may vary from our estimates.
Most of our percentage-of-completion projects follow the “cost-to-cost” method of determining the percentage of completion. Under the cost-to-cost method, we make periodic estimates of our progress towards project completion by analyzing costs incurred to date, plus an estimate of the amount of costs that we expect to incur until the completion of the project. Revenue is then calculated on a cumulative basis (project-to-date) as the total contract value multiplied by the current percentage-of-completion. The revenue for the current period is calculated as cumulative revenues less project revenues already recognized. The process of estimating costs on engineering and construction projects combines professional engineering, cost estimating, pricing and accounting skills. The recognition of revenues and profit is dependent upon the accuracy of a variety of estimates, including engineering progress, materials quantities, achievement of milestones and other incentives, penalty provisions, labor productivity and cost estimates. Such estimates are based on various judgments we make with respect to those factors and are difficult to accurately determine until the project is significantly underway.
For some contracts, using the cost-to-cost method in estimating percentage-of-completion may overstate the progress on the project. For projects where the cost-to-cost method does not appropriately reflect the progress on the projects, we use alternative methods such as actual labor hours, for measuring progress on the project and recognize revenue accordingly. For instance, in a project where a large amount of permanent materials are purchased, including the costs of these materials in calculating the percentage-of-completion may overstate the actual progress on the project. For these types of projects, actual labor hours spent on the project may be a more appropriate measure of the progress on the project.
Once contract performance is underway, we may experience changes in conditions, client requirements, specifications, designs, materials and expectations regarding the period of performance. Such changes may be initiated
by us or by our clients. The majority of such changes presents little or no financial risk to us. Generally, a “change order” will be negotiated between our client and ourselves to reflect how the change is to be resolved and who is responsible for the financial impact of the change. Occasionally, however, disagreements can arise regarding changes, their nature, measurement, timing and other characteristics that impact costs and, therefore, revenues. When a change becomes a point of dispute between our client and us, we then consider it as a claim.
Costs related to change orders and claims are recognized when they are incurred. Change orders are included in total estimated contract revenue when it is probable that the change order will result in a bona fide addition to contract value and can be reliably estimated. Claims are included in total estimated contract revenues, only to the extent that contract costs related to the claims have been incurred and when it is probable that the claim will result in a bona fide addition to contract value which can be reliably estimated. No profit is recognized on claims until final settlement occurs. This can lead to a situation where costs are recognized in one period and revenues are recognized in a subsequent period when a client agreement is obtained or claims resolution occurs.
We have contracts with the U.S. government that contain provisions requiring compliance with the FAR, and the CAS. These regulations are generally applicable to all of our federal government contracts and are partially or fully incorporated in many local and state agency contracts. They limit the recovery of certain specified indirect costs on contracts subject to the FAR. Cost-plus contracts covered by the FAR provide for upward or downward adjustments if actual recoverable costs differ from the estimate billed under forward pricing arrangements. Most of our federal government contracts are subject to termination at the convenience of the client. Contracts typically provide for reimbursement of costs incurred and payment of fees earned through the date of such termination.
Federal government contracts are subject to the FAR and some state and local governmental agencies require audits, which are performed for the most part by the DCAA. The DCAA audits our overhead rates, cost proposals, incurred government contract costs, and internal control systems. During the course of its audits, the DCAA may question incurred costs if it believes we have accounted for such costs in a manner inconsistent with the requirements of the FAR or CAS and recommend that our U.S. government corporate administrative contracting officer disallow such costs. Historically, we have not experienced significant disallowed costs as a result of such audits. However, we can provide no assurance that the DCAA audits will not result in material disallowances of incurred costs in the future.
Goodwill
Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) requires that we perform an assessment for impairment of goodwill and other intangible assets at least annually. Accordingly, we have completed our annual review of the recoverability of goodwill as of December 30, 2005, which indicated that we had no impairment of goodwill. In addition to our annual test, we regularly evaluate whether events and circumstances have occurred which may indicate a possible impairment of goodwill.
We believe the methodology we use in testing for impairment of goodwill, which includes significant judgments and estimates, provides us with a reasonable basis for determining whether an impairment charge should be taken.
In evaluating whether there is an impairment of goodwill, we calculate the estimated fair value of our company by using a methodology that considers discounted projections of our cash flows and the fair values of our debt and equity.
We first determine our estimated projected cash flows and estimated residual values of each of our reporting units and discount those cash flows and residual values based on a selected discount rate (a discounted cash flows approach) to arrive at an estimated fair value of each reporting unit. The determination of our discount rate considers our cost of capital and the cost of capital of some of our industry peers. We then consider the average closing sales price of our common stock and the fair market value of our interest-bearing obligations to arrive at an estimate of fair value (a market multiple approach). Our final estimate of fair value is established considering our market multiple and discounted cash flows approaches.
We allocate our final estimate of fair value to our reporting units based on the relative proportion of each reporting unit’s estimated discounted cash flows to the total. A reporting unit, as defined in SFAS 142, is an operating segment or a component of a segment where (a) the component constitutes a business for which discrete financial information is available, and (b) management regularly reviews the operating results of that component. Our reporting units consist of the EG&G Division, the domestic operations of the URS Division and the international operations of the URS Division.
We then compare the resulting fair values by reporting units to the respective net book values, including goodwill. If the net book value of a reporting unit exceeds its fair value, we measure the amount of the impairment loss by comparing the implied fair value (which is a reasonable estimate of the value of goodwill for the purpose of measuring an impairment loss) of the reporting unit’s goodwill to the carrying amount of that goodwill. To the extent that the carrying amount of a reporting unit’s goodwill exceeds its implied fair value, we recognize a goodwill impairment loss at that time. In evaluating whether there was an impairment of goodwill, we also take into consideration changes in our business mix and changes in our discounted cash flows, in addition to our average closing stock price.
Allowance for Uncollectible Accounts Receivable
We reduce our accounts receivable and costs and accrued earnings in excess of billings on contracts in process by establishing an allowance for amounts that, in the future, may become uncollectible or unrealizable, respectively. We determine our estimated allowance for uncollectible amounts based on management’s judgments regarding our operating performance related to the adequacy of the services performed or products delivered, the status of change orders and claims, our experience settling change orders and claims and the financial condition of our clients, which may be dependent on the type of client and current economic conditions that the client may be subject to.
Deferred income taxes
We use the asset and liability approach for financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances based on our judgments and estimates are established when necessary to reduce deferred tax assets to the amount expected to be realized in future operating results. Management believes that realization of deferred tax assets in excess of the valuation allowance is more likely than not. Our estimates are based on facts and circumstances in existence as well as interpretations of existing tax regulations and laws applied to the facts and circumstances, with the help of professional tax advisors. Therefore, we estimate and provide for amounts of additional income taxes that may be assessed by the various taxing authorities.
Other long-term liabilities
Included in other long-term liabilities are estimated liabilities related to defined benefit pension and postretirement programs. These liabilities represent actuarially determined estimates of our future obligations associated with providing these benefit programs to some of our employees. The actuarial studies and estimates are dependent on assumptions made by management, which include discount rates, life expectancy of participants, long-term rates of return on plan assets, and rates of increase in compensation levels. These assumptions are determined based on the current economic environment at year-end.
Adopted and Other Recently Issued Statements of Financial Accounting Standards
In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, “Inventory Costs, and Amendment of Accounting Research Bulletin No. 43 (“ARB No. 43”), Chapter 4” (“SFAS 151”). SFAS 151 amends the guidance in ARB No. 43 Chapter 4, “Inventory Pricing,” by clarifying that abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) be recognized as current period charges. The
provisions of SFAS 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS 151 will not have a material effect on our consolidated financial statements.
In December 2004, the FASB issued SFAS 123(R). This statement replaces Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and supersedes APB 25. SFAS 123(R) also amends Statement of Financial Accounting Standards No. 95, “Statement of Cash Flows,” to require reporting of excess tax benefits from the exercises of stock-based compensation awards as a financing cash inflow rather than as an operating cash inflow. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 to provide implementation guidance on SFAS 123(R). The FASB has also issued interpretative guidance. In April 2005, the SEC adopted Rule 4-01(a) of Regulation S-X, which deferred the required effective date of SFAS 123(R) to our fiscal year 2006, which began on December 31, 2005 (the “Effective Date”).
We adopted SFAS 123(R) on December 31, 2005, the beginning of our fiscal year 2006, rather than during the year ended December 30, 2005, and are currently in the process of implementing this new pronouncement by using the modified prospective transition method. As a result of this adoption, we are required to recognize the cost of all stock-based compensation awards granted, modified, settled or vested in interim or fiscal periods beginning in our fiscal year 2006. Since we accounted for our stock-based compensation in accordance with APB 25 through the year ended December 30, 2005, the adoption of SFAS 123(R) will have a material impact on our financial statements. In order to minimize the volatility of our stock-based compensation expense arising from the adoption of SFAS 123(R), we are currently issuing restricted stock awards and units rather than granting stock options to selected employees. We also modified our ESPP, effective January 1, 2006, to reduce the discount at which employees may purchase common stock from 15% to 5% of the fair market value and to apply the discount only at the end of each of the six-month offering periods.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143” (“FIN 47”). FIN 47 clarifies the term conditional asset retirement obligation as used in SFAS No. 143, “Accounting for Asset Retirement Obligations,” and provides further guidance as to when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 became effective for us in fiscal year 2005. The adoption of FIN 47 did not have a material effect on our consolidated financial statements.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), which replaces Accounting Principles Board Opinion No. 20, “Accounting Changes,” and Statement of Financial Accounting Standards No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS 154 requires retroactive application of a change in accounting principle to prior period financial statements unless it is impracticable or if another pronouncement mandates a different method. SFAS 154 also requires that a change in the method of depreciation, amortization or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate resulting from a change in accounting principle. It is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Depending on the type of accounting change, the adoption of SFAS 154 may have a material impact on our consolidated financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate risk
We are exposed to changes in interest rates as a result of our borrowings under our New Credit Facility. Based on outstanding indebtedness of $270.0 million under our New Credit Facility at December 30, 2005, if market rates average 1% higher in the next twelve months, our net of tax interest expense would increase by approximately $1.6 million. Conversely, if market rates average 1% lower in the next twelve months, our net of tax interest expense would decrease by approximately $1.6 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 $5.9 million of foreign currency translation loss for the year ended December 30, 2005 and $1.9 million of foreign currency translation gain for the year ended December 31, 2004. The currency exposure is not material to our consolidated financial statements.
ITEM 8.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of URS Corporation:
We have completed an integrated audit of URS Corporation’s 2005 consolidated financial statements and of its internal control over financial reporting as of December 30, 2005 and audits of its consolidated financial statements for the fiscal years ended October 31, 2004 and 2003 and for the two-month period ended December 31, 2004, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated Financial Statements
In our opinion, the consolidated financial statements listed in the index appearing under Item 15 (a)(1) present fairly, in all material respects, the financial position of URS Corporation and its subsidiaries (the “Company”) at December 30, 2005 and December 31, 2004, and the results of their operations and their cash flows for each of the years ended December 30, 2005, October 31, 2004 and October 31, 2003 and the two-month period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Internal Control over Financial Reporting
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 30, 2005 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 30, 2005, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/PricewaterhouseCoopers LLP
San Francisco, California
March 13, 2006
URS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
See Notes to Consolidated Financial Statements
URS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In thousands, except per share data)
See Notes to Consolidated Financial Statements
URS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In thousands)
See Notes to Consolidated Financial Statements
URS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See Notes to Consolidated Financial Statements
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ACCOUNTING POLICIES
Business
The terms “we,” “us,” and “our” used in these financial statements 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 29,200 employees providing services to federal, state and local governments, and private industry clients in the United States and abroad.
Effective January 1, 2005, we adopted a 52/53 week fiscal year ending on the Friday closest to December 31st, with interim quarters ending on the Fridays closest to March 31st, June 30th and September 30th. We filed a transition report on Form 10-Q with the Securities and Exchange Commission (“SEC”) for the two months ended December 31, 2004. Our 2005 fiscal year began on January 1, 2005 and ended on December 30, 2005.
The unaudited interim consolidated financial statements for the two months ended December 31, 2003 and the related notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.
In the opinion of management, the 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.
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”). 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 are accounted for using the equity method. All significant intercompany transactions and accounts have been eliminated in consolidation.
Use of Estimates
The preparation of our consolidated financial statements in conformity with generally accepted accounting principles necessarily requires us to make estimates and assumptions that affect the reported amount of assets and liabilities and related disclosures at the balance sheet dates, and the reported amounts of revenues and expenses during the reporting period. 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.
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Revenue Recognition
We earn our revenues from cost-plus, fixed-price and time-and-materials contracts. If estimated total costs on any contract indicate a loss, we charge the entire estimated loss to operations in the period the loss becomes known. The cumulative effect of revisions to revenue, estimated costs to complete contracts, including penalties, incentive awards, change orders, claims, anticipated losses, and others are recorded in the accounting period in which the events indicating a loss are known and the loss can be reasonably estimated. Such revisions could occur at any time and the effects may be material.
The majority of our contracts are for professional planning, design and various other types of engineering projects, including systems engineering, and program and construction management. We account for such contracts on the “percentage-of-completion” method, wherein revenue is recognized as costs are incurred. Under the percentage-of-completion method of revenue recognition, we estimate the progress towards completion to determine the amount of revenue and profit to recognize on all significant contracts. We generally utilize a cost-to-cost approach in applying the percentage-of-completion method, where revenue is earned in proportion to total costs incurred, divided by total costs expected to be incurred. For some contracts, using the cost-to-cost method in estimating percentage-of-completion may overstate the progress on the project. For instance, in a project where a large amount of permanent materials are purchased, including the costs of these materials in calculating the percentage-of-completion may overstate the actual progress on the project. For these types of projects, actual labor hours spent on the project may be a more appropriate measure of the progress on the project. For projects where the cost-to-cost method does not appropriately reflect the progress on the projects, we use alternative methods, such as actual labor hours, for measuring progress on the project and recognize revenue accordingly.
Under the percentage-of-completion method, recognition of profit is dependent upon the accuracy of a variety of estimates, including engineering progress, materials quantities, achievement of milestones, incentives, penalty provisions, labor productivity, cost estimates and others. Such estimates are based on various professional judgments we make with respect to those factors and are difficult to accurately determine until the project is significantly underway.
We have a history of making reasonably dependable estimates of the extent of progress towards completion, contract revenue and contract completion costs on our long-term engineering and construction contracts. However, due to uncertainties inherent in the estimation process, it is possible that actual completion costs may vary from estimates.
Cost-Plus Contracts. We have four major types of cost-plus contracts:
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Cost-Plus Fixed Fee. Under cost-plus fixed fee contracts, we charge our clients for our costs, including both direct and indirect costs, plus a fixed negotiated fee. In negotiating a cost-plus fixed fee contract, we estimate all recoverable direct and indirect costs and then add a fixed profit component. The total estimated cost plus the negotiated fee represents the total contract value. We recognize revenues based on the actual labor costs, derived from hours of labor effort, plus non-labor costs we incur, and the portion of the fixed fee we have earned to date. We invoice for our services as revenues are recognized or in accordance with agreed-upon billing schedules. Aggregate revenues from cost-plus fixed fee contracts may vary based on the actual number of labor hours worked and other actual contract costs incurred. However, if actual labor hours and other contract costs exceed the original estimate agreed to by our client, we generally must obtain a change order, contract modification, or successfully prevail in a claim in order to receive additional revenues relating to the additional costs (see “Change Orders and Claims”).
•
Cost-Plus Fixed Rate. Under our cost-plus fixed rate contracts, we charge clients for our costs plus negotiated rates based on our indirect costs. In negotiating a cost-plus fixed rate contract, we estimate all recoverable direct and indirect costs and then add a profit component, which is a percentage of total
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
recoverable costs to arrive at a total dollar estimate for the project. We recognize revenues based on the actual total number of labor hours and other costs we expend at the cost plus fixed rate we negotiated. Similar to cost-plus fixed fee contracts, aggregate revenues from cost-plus fixed rate contracts may vary and we generally must obtain a change order, contract modification, or successfully prevail in a claim in order to receive additional revenues relating to any additional costs that exceed the original contract estimate (see “Change Orders and Claims”).
•
Cost-Plus Award Fee. Some cost-plus contracts provide for award fees or a penalty based on performance criteria in lieu of a fixed fee or fixed rate. Other contracts include a base fee component plus a performance-based award fee. In addition, we may share award fees with subcontractors and/or our employees. We record accruals for fee sharing on a monthly basis as related award fee revenue is earned. We generally recognize revenues to the extent of costs actually incurred plus a proportionate amount of the fee expected to be earned. We take the award fee or penalty on contracts into consideration when estimating sales and profit rates, and we record revenues related to the award fees when there is sufficient information to assess anticipated contract performance. On contracts that represent higher than normal risk or technical difficulty, we defer all award fees until an award fee letter is received. Once an award letter is received, the estimated or accrued fees are adjusted to the actual award amount.
•
Cost-Plus Incentive Fee. Some of our cost-plus contracts provide for incentive fees based on performance against contractual milestones. The amount of the incentive fees varies, depending on whether we achieve above-, at-, or below-target results. We recognize revenues on these contracts assuming that we will achieve at-target results, unless we estimate our cost at completion to be materially above or below target. If our estimated cost to complete the project indicates that our performance is, or will be, below target, we adjust our revenues down to the below-target estimate. If our estimate to complete the project indicates that our performance is above target, we do not adjust our revenues up to correspond with our estimated higher level of performance unless authorization to recognize additional revenues is obtained from appropriate levels of management.
Labor costs and subcontractor services are the principal components of our direct costs on cost-plus contracts, although some include materials and other direct costs. Some of these contracts include a provision that the total actual costs plus the fee will not exceed a guaranteed price negotiated with the client. Others include rate ceilings that limit the reimbursement for general and administrative costs, overhead costs and materials handling costs. The accounting for these contracts appropriately reflects such guaranteed price or rate ceilings. Certain of our cost-plus contracts are subject to maximum contract values and accordingly, revenues relating to these contracts are recognized as if these contracts were fixed-price contracts.
Fixed-Price Contracts. We enter into two major types of fixed-price contracts:
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Firm Fixed-Price (“FFP”). Under FFP contracts, our clients pay us an agreed amount negotiated in advance for a specified scope of work. We recognize revenues on FFP contracts using the percentage-of-completion method described above. We do not adjust our revenues downward if we incur costs above or below our original estimated costs. Prior to completion, our recognized profit margins on any FFP contract depend on the accuracy of our estimates and will increase to the extent that our current estimates of aggregate actual costs are below amounts previously estimated. Conversely, if our current estimated costs exceed prior estimates, our profit margins will decrease and we may realize a loss on a project. In order to increase aggregate revenue on the contract, we generally must obtain a change order, contract modification, or successfully prevail in a claim in order to receive payment for the additional costs (see “Change Orders and Claims”).
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
•
Fixed-Price Per Unit (“FPPU”). Under our FPPU contracts, clients pay us a set fee for each service or production transaction that we complete. We are generally guaranteed a minimum number of service or production transactions at a fixed price, but our actual profit margins on any FPPU contract depend on the number of service transactions we ultimately complete. We recognize revenues under FPPU contracts as we complete and bill the related service transactions to our clients. If our current estimates of the aggregate average costs per service transaction turn out to exceed our prior estimates, our profit margins will decrease and we may realize a loss on the project. In order to increase aggregate revenues on a contract, we generally must obtain a change order, contract modification, or successfully prevail in a claim in order to receive payment for the additional costs (see “Change Orders and Claims”). Certain of our FPPU contracts are subject to maximum contract values and accordingly, revenues relating to these contracts are recognized as if these contracts were FFP contracts.
Time-and-Materials Contracts. Under our time-and-materials contracts, we negotiate hourly billing rates and charge our clients based on the actual time that we spend on a project. In addition, clients reimburse us for our actual out-of-pocket costs of materials and other direct incidental expenditures that we incur in connection with our performance under the contract. Our profit margins on time-and-materials contracts fluctuate based on actual labor and overhead costs that we directly charge or allocate to contracts compared with negotiated billing rates. The majority of our time-and-material contracts are subject to maximum contract values and, accordingly, revenues under these contracts are recognized under the percentage-of-completion method or as a revenue arrangement with multiple deliverables as described above. Revenues on contracts that are not subject to maximum contract values are recognized based on the actual number of hours we spend on the projects plus any actual out-of-pocket costs of materials and other direct incidental expenditures that we incur on the projects. Our time-and materials contracts also generally include annual billing rate adjustment provisions.
Service-related contracts. Service-related contracts, including operations and maintenance services and a variety of technical assistance services, are accounted for over the period of performance, in proportion to the costs of performance, evenly over the period, or over units of production.
Change Orders and Claims. Change orders are modifications of an original contract that effectively change the provisions of the contract without adding new provisions. Either we or our customer may initiate change orders. They may include changes in specifications or design, manner of performance, facilities, equipment, materials, sites and period of completion of the work. Claims are amounts in excess of agreed contract price that we seek to collect from our clients or others for customer-caused delays, errors in specifications and designs, contract terminations, change orders that are either in dispute or are unapproved as to both scope and price, or other causes of unanticipated additional contract costs.
Change orders and claims occur when changes are experienced once contract performance is underway. Change orders are sometimes documented and terms of such change orders agreed with the client before the work is performed. Sometimes circumstances require that work progresses without client agreement before the work is performed. Costs related to change orders and claims are recognized when they are incurred. Change orders are included in total estimated contract revenue when it is probable that the change order will result in a bona fide addition to contract value that can be reliably estimated. Claims are included in total estimated contract revenues to the extent that contract costs related to the claims have been incurred and when it is probable that the claim will result in a bona fide addition to contract value which can be reliably estimated. No profit is recognized on claims until final settlement occurs. This can lead to a situation where costs are recognized in one period and revenues are recognized when client agreement is obtained or claims resolution occurs, which can be in subsequent periods.
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Compliance Requirements. We have contracts with the U.S. government that contain provisions requiring compliance with the U.S. Federal Acquisition Regulation (“FAR”), and the U.S. Cost Accounting Standards (“CAS”). These regulations are generally applicable to all of our federal government contracts and are partially or fully incorporated in many local and state agency contracts. They limit the recovery of certain specified indirect costs on contracts subject to the FAR. Cost-plus contracts covered by the FAR provide for upward or downward adjustments if actual recoverable costs differ from the estimate billed under forward pricing arrangements. Most of our federal government contracts are subject to termination at the convenience of the client. Contracts typically provide for reimbursement of costs incurred and payment of fees earned through the date of such termination.
Federal government contracts subject to the FAR and some state and local governmental agencies require audits, which are performed for the most part by the Defense Contract Audit Agency (“DCAA”). The DCAA audits our overhead rates, cost proposals, incurred government contract costs, and internal control systems. During the course of its audits, the DCAA may question incurred costs if it believes we have accounted for such costs in a manner inconsistent with the requirements of the FAR or CAS and recommend that our U.S. government corporate administrative contracting officer disallow such costs. Historically, we have not experienced significant disallowed costs as a result of such audits. However, we can provide no assurance that the DCAA audits will not result in material disallowances of incurred costs in the future.
Costs and Accrued Earnings in Excess of Billings on Contracts in Process and Billings in Excess of Costs and Accrued Earnings on Contracts in Process
Costs and accrued earnings in excess of billings on contracts in process in the accompanying consolidated balance sheets represent unbilled amounts earned and reimbursable under contracts in progress. As of December 30, 2005 and December 31, 2004, costs and accrued earnings in excess of billings on contracts in progress were $513.9 million and $400.4 million, respectively. These amounts become billable according to the contract terms, which usually consider the passage of time, achievement of certain milestones or completion of the project. Generally, such unbilled amounts will be billed and collected over the next 12 months.
Billings in excess of costs and accrued earnings on contracts in process in the accompanying consolidated balance sheets represent cash collected from clients and advanced billings to clients on contracts in advance of work performed. As of December 30, 2005 and December 31, 2004, billings in excess of costs and accrued earnings on contracts in process were $108.6 million and $84.4 million, respectively. We anticipate that the majority of such amounts will be earned over the next 12 months.
Allowance for Uncollectible Accounts Receivable
We reduce our accounts receivable and costs and accrued earnings in excess of billings on contracts in process by estimating an allowance for amounts that may become uncollectible in the future. We determine our estimated allowance for uncollectible amounts based on management’s judgments regarding our operating performance related to the adequacy of the services performed or products delivered, the status of change orders and claims, our experience settling change orders and claims and the financial condition of our clients, which may be dependent on the type of client and current economic conditions that the client may be subject to.
Classification of Current Assets and Liabilities
We include in current assets and liabilities amounts realizable and payable under engineering and construction contracts that extend beyond one year. Accounts receivable, accounts receivable - retainage, costs and accrued earnings in excess of billings on contracts in process, subcontractors payable, subcontractor retainage, and billings in excess of costs and accrued earnings on contracts in process each contain amounts that, depending on contract performance, resolution of U.S. government contract audits, negotiations, change orders, claims or changes in facts and circumstances, may either be uncollectible or may not require payment within one year.
URS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Accounts receivable - retainage represents amounts billed to clients for services performed that, by the underlying contract terms, will not be paid until the projects are at or near completion. Correspondingly, subcontractors payable - retainage represents amounts billed to us by subcontractors for services performed that, by their underlying contract terms do not require payment by us until the projects are at or near completion.
Accounts payable and subcontractors payable include our estimate of incurred but unbilled subcontractor costs.
Concentrations of Credit Risk
Our accounts receivable and costs and accrued earnings in excess of billings on contracts in process are potentially subject to concentrations of credit risk. Our credit risk on accounts receivable is limited due to the large number of clients that comprise our customer base and their dispersion across different business and geographic areas. We estimate and maintain an allowance for potential uncollectible accounts and such estimates have historically been within management’s expectations. Our cash and cash equivalents balances are maintained in accounts held by major banks and financial institutions located primarily in the United States of America, Europe and Asia Pacific.
Cash and Cash Equivalents
We consider all highly liquid investments with acquisition date maturities of three months or less to be cash equivalents. At December 30, 2005 and December 31, 2004, 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 December 30, 2005 and December 31, 2004, cash and cash equivalents included $43.5 million and $13.5 million held by our consolidated joint ventures.
Fair Value of Financial Instruments
At December 30, 2005 and December 31, 2004, the carrying amounts of some of our financial instruments including cash, accounts receivable, accounts payable and other liabilities approximate fair values due to their short maturities. The fair values of our Credit Facility and other variable rate debt are based on current interest rates and approximate fair values. The fair values of our other long-term debt obligations exceed the carrying values as disclosed in Note 5, “Current and Long-Term Debt.”
Property and Equipment
Property and equipment are stated at cost. In the year assets are retired or otherwise disposed of, the costs and related accumulated depreciation are removed from the accounts, and any gain or loss on disposal is reflected in the Consolidated Statement of Operations and Comprehensive Income. Depreciation is provided on the straight-line and the double declining methods using estimated useful lives less residual value. Leasehold improvements are amortized over the length of the lease or estimated useful life, whichever is less. We capitalize our repairs and maintenance that extend the estimated useful lives of property and equipment; otherwise, repairs and maintenance are expensed. Whenever events or changes in circumstances indicate that the carrying amount of long-lived assets may not be recoverable, we compare the carrying value to the fair value and recognize the difference as an impairment loss.
Internal-Use Computer Software
We expense or capitalize charges associated with development of internal-use software as follows:
Preliminary project stage: Both internal and external costs incurred during this stage are expensed as incurred.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Application development stage: Both internal and external costs incurred to purchase and develop computer software are capitalized after the preliminary project stage is completed and management authorizes the computer software project. However, training costs and the process of data conversion from the old system to the new system, which includes purging or cleansing of existing data, reconciliation or balancing of old data to the converted data in the new system, are expensed as incurred.
Post-Implementation/Operation Stage: All training costs and maintenance costs incurred during this stage are expensed as incurred.
Costs of upgrades and enhancements are capitalized if the expenditures will result in adding functionality to the software. Capitalized software costs are depreciated using the straight-line method over the estimated useful life of the related software, which may be up to ten years. Impairment is measured and recognized in accordance with the Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
Goodwill
Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) requires an assessment for impairment of goodwill and other intangible assets at least annually. In addition to our annual test, we regularly evaluate whether events or circumstances have occurred which may indicate a possible impairment of goodwill.
We believe the methodology we use in testing impairment of goodwill, which includes significant judgments and estimates, provides us with a reasonable basis in determining whether an impairment charge should be taken. Our methodology is as follows:
In evaluating whether there is an impairment of goodwill, we calculate the estimated fair value of our company by using a methodology that considers discounted projections of our cash flows and the estimated fair values of our debt and equity.
We first determine our estimated projected cash flows and estimated residual values of each of our reporting units and discount those cash flows and residual values based on a selected discount rate (a discounted cash flows approach) to arrive at an estimated fair value of each reporting unit. The determination of our discount rate considers our cost of capital and the cost of capital of some of our industry peers. We then consider the average closing sales price of our common stock and the fair market value of our interest-bearing obligations to arrive at an estimate of fair value (a market multiple approach). Our final estimate of fair value is established considering our market multiple and discounted cash flows approaches.
We allocate our final estimate of fair value to our reporting units based on the relative proportion of each reporting unit’s estimated discounted cash flows to the total. A reporting unit, as defined in SFAS 142, is an operating segment or a component of a segment where (a) the component constitutes a business for which discrete financial information is available, and (b) management regularly reviews the operating results of that component. Our reporting units consist of the EG&G Division, the domestic operations of the URS Division and the international operations of the URS Division.
We then compare the resulting fair values by reporting units to the respective net book values, including goodwill. If the net book value of a reporting unit exceeds its fair value, we measure the amount of the impairment loss by comparing the implied fair value (which is a reasonable estimate of the value of goodwill for the purpose of measuring an impairment loss) of the reporting unit’s goodwill to the carrying amount of that goodwill. To the extent that the carrying amount of a reporting unit’s goodwill exceeds its implied fair value, we recognize a goodwill impairment loss at that time. In evaluating whether there was an impairment of goodwill, we also take into consideration changes in our business mix and changes in our discounted cash flows, in addition to our average
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
closing stock price. Based on our annual review of goodwill by using the above described methodology at October 28, 2005, we concluded that we did not have any impairment of goodwill.
Purchased Intangible Assets
We amortize our purchased intangible assets using the straight-line method over their estimated period of benefit, ranging from three to fourteen years and include the amortization expense in the indirect, general and administrative expenses of our Consolidated Statements of Operations and Comprehensive Income.
Income Taxes
We account for income taxes in accordance with Financial Accounting Standards No. 109, “Accounting for Income Taxes.” Judgment is required in determining our consolidated income tax expense. In the normal course of our business, we may engage in numerous transactions every day for which the ultimate tax outcome (including the period in which the transaction will ultimately be included in taxable income or deducted as an expense) is uncertain. Additionally, we file income, franchise, gross receipts and similar tax returns in many jurisdictions. Our tax returns are subject to audit and investigation by the Internal Revenue Service, most states in the United States, and by various government agencies representing many jurisdictions outside the United States. We estimate and provide for additional income taxes that may be assessed by the various taxing authorities.
We use the asset and liability approach for financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Income tax expense is the amount of tax payable for the period plus or minus the change in deferred tax assets and liabilities during the period.
Valuation allowances based on our judgments and estimates are established when necessary to reduce deferred tax assets to the amount expected to be realized and based on expected future operating results and available tax alternatives. Our estimates are based on facts and circumstances in existence as well as interpretations of existing tax regulations and laws applied to the facts and circumstances, with the help of professional tax advisors. Management believes that realization of deferred tax assets in excess of the valuation allowance is more likely than not.
Pension Plans and Post-retirement Benefits
We account for our defined benefit pension plans and post-retirement benefits using actuarial valuations that are based on assumptions, including discount rates, long-term rates of return on plan assets, and rates of change in participant compensation levels. These assumptions are determined based upon the economic environment at the end of each annual reporting period. We evaluate the funded status of each of our defined benefit pension plans and post-retirement benefit plans using these assumptions, consider applicable regulatory requirements, tax deductibility, reporting considerations and other relevant factors, and thereby determine the appropriate funding level for each period.
The discount rate used to calculate the present value of the pension benefit obligation is assessed at least annually. The discount rate represents the rate inherent in the price at which the plans’ obligations could be settled at the measurement date.
The discount rate for our Chief Executive Officer’s Supplemental Executive Retirement Plan (the “Executive Plan”) is the annual rate of interest on 30-year Treasury securities for the month preceding the date benefit payments commence.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The discount rate for the EG&G defined benefit pension plan (“EG&G pension plan”) was derived using a “bond model” prepared by our external actuary. The model assumes that we purchase bonds with a credit rating of AA or better by Moody’s at prices based on a current bond yield and bond quality. The annual cash flows from the bonds are used to cover the projected benefits under the pension plan. The model develops the yield on this portfolio of bonds as of the measurement date. Sixty years of projected benefit payments are examined. Any residual benefit payments are deemed to be immaterial to the results. If cash flows from the bond portfolio exceed the benefit plans in early years, the initial value of the portfolio is adjusted to reflect the present value of the excess cash flow. The weighted average of the bond yields is determined based upon the estimated retirement payments in order to derive at the discount rate used in calculating the present value of the pension plan obligations. The discount rate derived is compared to the discount rates used by other publicly traded companies. The discount rate is deemed reasonable if it falls within the 25th to 75th percentile of all discount rates used.
The discount rate for Radian’s defined benefit plans, including a Supplemental Executive Retirement Plan (“SERP”) and a Salary Continuation Agreement (“SCA”), uses the EG&G pension plan bond model and is adjusted for the benefit duration of nine and six years for the Radian SERP and SCA, respectively. The Citigroup Pension Discount Spot Rate Curve is used to determine the yield differential for cash flow streams from appropriate quality bonds as of the measurement date. The yield differential is applied to the bond model rate of the EG&G pension plan to derive at the discount rate.
Earnings Per Share
Basic earnings per share 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 earnings per share 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 hypothetically used to repurchase treasury stock at the average market price for the period. Potentially dilutive shares of common stock outstanding include stock options, unvested restricted stock awards and units, and convertible preferred stock. Diluted income per common share is computed by dividing net income available for common stockholders plus preferred stock dividends by the weighted-average common share and potentially dilutive common shares that were outstanding during the period.
In March 2004, the Emerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board (“FASB”) issued EITF Consensus No. 03-06, “Participating Securities and the Two-class Method” (“EITF 03-06”). EITF 03-06 requires us to compute our basic earnings per share (“EPS”) by using the two-class method as we had outstanding shares of convertible participating preferred stock in prior years. In accordance with the disclosure requirements of Statement of Financial Accounting Standards No. 128, “Earnings per Share” (“SFAS 128”) and EITF 03-06, a reconciliation of the numerator and denominator of basic and diluted income per common share under the two-class method is provided as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In our computation of diluted earnings per share, we excluded the following potential shares of issued and unexercised stock options, with an exercise price greater than the average per share market value of our common stock, and unvested restricted stock awards and units, which have an anti-dilutive effect on earnings per share.
Stock-Based Compensation
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (Revised), “Share-Based Payment” (“SFAS 123(R)”). This statement replaces Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). SFAS 123(R) also amends Statement of Financial Accounting Standards No. 95, “Statement of Cash Flows,” to require reporting of excess tax benefits from the exercises of stock-based compensation awards as a financing cash inflow rather than as an operating cash inflow. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 to provide implementation guidance on SFAS 123(R). The FASB has also issued interpretative guidance. In April 2005, the SEC adopted Rule 4-01(a) of Regulation S-X, which deferred the required effective date of SFAS 123(R) to our fiscal year 2006, which began on December 31, 2005 (the “Effective Date”). SFAS 123(R) requires that we record and expense for our stock-based compensation plans using a fair value method.
We adopted SFAS 123(R) on December 31, 2005, the beginning of our fiscal year 2006, rather than during the year ended December 30, 2005, and are currently in the process of implementing this new pronouncement by using the modified prospective transition method. As a result of this adoption, we are required to recognize the cost of all stock-based compensation awards granted, modified, settled or vested in interim or fiscal periods beginning in our fiscal year 2006. Since we accounted for our stock-based compensation in accordance with APB 25 through the year ended December 30, 2005, the adoption of SFAS 123(R) will have a material impact on our financial statements. In order to minimize the volatility of our stock-based compensation expense arising from the adoption of SFAS 123(R), we are currently issuing restricted stock awards and units rather than granting stock options to selected employees. We also modified our ESPP, effective January 1, 2006, to reduce the discount at which employees may purchase common stock from 15% to 5% of the fair market value and to apply the discount only at the end of each of the six-month offering periods.
Under APB 25, the compensation expense associated with employee stock awards was measured as the difference, if any, between the price to be paid by an employee and the fair value of the common stock on the grant date. Accordingly, we recognized no compensation expense for the stock-based option awards issued under our 1991 Stock Incentive Plan and 1999 Equity Incentive Plan (collectively, the “Stock Incentive Plans”). We also did not recognize any compensation expense for stock purchased through our Employee Stock Purchase Plan (“ESPP”) in accordance with a specific exception under APB 25.
Under APB 25, we recognized compensation expense for modifications of stock-based option grants. In addition, we continued to record compensation expense related to restricted stock awards and units over the applicable vesting period and such compensation expense was measured at the fair market value of the restricted stock awards and units at the date of the award.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Until the adoption of SFAS 123(R), we are required to disclose the pro forma results as if we had applied the fair value recognition provisions of SFAS 123. For the purpose of disclosure under Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” we use the Black-Scholes option pricing model to measure the estimated fair value of stock options and the ESPP. The following assumptions were used to estimate stock option and ESPP compensation expense using the fair value method of accounting:
If the compensation cost for awards under the Stock Incentive Plans and the ESPP had been determined in accordance with SFAS 123, our net income and earnings per share would have been reduced to the pro forma amounts indicated below:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
See further discussion on our stock options under Note 9. “Stockholders’ Equity”
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Adopted and Other Recently Issued Statements of Financial Accounting Standards
In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, “Inventory Costs, and Amendment of Accounting Research Bulletin No. 43 (“ARB No. 43”), Chapter 4” (“SFAS 151”). SFAS 151 amends the guidance in ARB No. 43 Chapter 4, “Inventory Pricing,” by clarifying that abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) be recognized as current period charges. The provisions of SFAS 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS 151 will not have a material effect on our consolidated financial statements.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143” (“FIN 47”). FIN 47 clarifies the term conditional asset retirement obligation as used in SFAS No. 143, “Accounting for Asset Retirement Obligations,” (“SFAS 143”) and provides further guidance as to when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 became effective for us in fiscal year 2005. The adoption of FIN 47 did not have a material effect on our consolidated financial statements.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), which replaces Accounting Principles Board Opinion No. 20, “Accounting Changes,” and Statement of Financial Accounting Standards No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS 154 requires retroactive application of a change in accounting principle to prior period financial statements unless it is impracticable or if another pronouncement mandates a different method. SFAS 154 also requires that a change in the method of depreciation, amortization or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate resulting from a change in accounting principle. It is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Depending on the type of accounting change, the adoption of SFAS 154 may have a material impact on our consolidated financial statements.
Reclassifications
We have made reclassifications to the two-month periods ended December 31, 2004 and 2003, and the years ended October 31, 2004 and 2003 financial statements to conform them to the fiscal year ended December 30, 2005 presentation. These reclassifications have no effect on consolidated net income, stockholders’ equity and net cash flows.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
(1)
Our capital leases consist primarily of equipment and furniture and fixtures.
As of December 30, 2005 and December 31, 2004, we capitalized internal-use software development costs of $61.0 million and $58.9 million, respectively. We amortize the capitalized software costs using the straight-line method over an estimated useful life of ten years.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Property and equipment is depreciated by using the following estimated useful lives:
Depreciation expense of property and equipment were as follows:
NOTE 3. PURCHASED INTANGIBLE ASSETS AND GOODWILL
Purchased Intangible Assets
Purchased intangible assets is comprised of customer backlog, software acquired, and favorable leases as a result of the EG&G acquisition. As of December 30, 2005 and December 31, 2004, the cost and accumulated amortization of our purchased intangible assets were as follows:
The Purchased intangible assets are amortized using the straight-line method based on the estimated useful life of the intangible assets. Amortization expenses of our purchased intangible assets were as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table presents the estimated future amortization expense of purchased intangible assets:
Goodwill
As of December 30, 2005 and December 31, 2004, our consolidated goodwill balances were $986.6 million and $1,004.7 million, respectively. The net change of $18.1 million for the 2005 fiscal year was due to:
NOTE 4. INCOME TAXES
The components of income tax expense are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The income (loss) before income taxes, by geographic area, is as follows:
As of December 30, 2005, for federal income tax purposes, we had available domestic net operating loss (“NOL”) of $3.0 million. Utilization of the NOL is limited pursuant to Section 1503 of the Internal Revenue Code and will be utilized against the income of our insurance company subsidiary. This NOL will be carried forward and will expire in fiscal year 2022. We also have $20.0 million of foreign NOLs available, which will expire at various dates. These foreign NOLs are available only to offset income earned in foreign jurisdictions.
While the domestic NOL partially offset income that would otherwise be taxable for federal income tax purposes, for state tax purposes, such amounts are only available to offset state tax in some jurisdictions.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The significant components of our deferred tax assets and liabilities are as follows:
Deferred tax assets/(liabilities) resulting from:
Our deferred tax assets arose from temporary differences in the recognition of accruals, primarily compensation and loss-related accruals, available NOLs and allowances for doubtful accounts. Our current deferred tax assets at December 30, 2005 increased slightly from the balance at October 31, 2004 due to an increase in various loss accruals, which was offset by a decrease in payroll-related accruals. Our current deferred tax liabilities primarily arose from temporary differences in the recognition of costs and accrued earnings in excess of billings on contracts in process, which increased as of December 30, 2005 compared to the balance as of October 31, 2004. Total tax deductible goodwill resulting from the Dames & Moore and EG&G acquisitions amounted to $350.1 million. As of December 30, 2005, $183.5 million of goodwill was unamortized for tax purposes. The difference between tax and
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
financial statement cumulative amortization on tax deductible goodwill gave rise to a long-term deferred tax liability. Our net non-current deferred tax liabilities as of December 30, 2005 decreased from the balance at October 31, 2004 due to increases in deferred tax assets related to pension liabilities and reserves. These increases were greater than the increases in deferred tax liabilities related to tax deductible goodwill. During 2005 we performed analysis related to recent audit activities and historic fluctuations in foreign currency translation. As a result, we reduced our reserves for tax contingencies in the areas of transfer pricing, state and local taxes, and foreign exchange gains and losses.
Historically, we have reported some deferred tax assets and liabilities in categories which may not have been adequately descriptive as to the nature of the book and tax difference, and some of these deferred tax assets and liabilities were previously reported on a net basis. We have now presented our deferred tax assets and liabilities on a gross basis and in categories that we believe provide improved visibility. The impact on prior years’ financial statements was not material; however, we elected to conform the presentation of all prior years’ deferred taxes to the current year’s presentation. This change also resulted in balance sheet reclassifications of deferred tax assets and liabilities. Our Current Deferred Tax Assets and Non-Current Deferred Tax Liabilities each increased by $4.1 million, $5.6 million, and $5.3 million at December 31, 2004, October 31, 2004, and October 31, 2003, respectively. These adjustments had no impact on our consolidated operating income, net income, earnings per share, or cash flows for any previous periods.
Earnings from our foreign subsidiaries are indefinitely reinvested outside of our home tax jurisdiction and thus pursuant to Accounting Principles Board Opinion No. 23, “Accounting for Income Taxes - Special Areas,” we do not recognize a deferred tax liability for the tax effect of the excess of the book over tax basis of our investments in foreign subsidiaries and it is not practicable to calculate the amount of taxes that would be due upon remittance.
The difference between total tax expense and the amount computed by applying the statutory federal income tax rate to income before taxes is as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. CURRENT AND LONG-TERM DEBT
Current and long-term debt consists of the following:
Credit Facilities
New Credit Facility
On June 28, 2005, we entered into a new credit facility (“New Credit Facility”) consisting of a 6-year term loan of $350.0 million and a 5-year Revolving Line of Credit of $300.0 million, against which up to $200.0 million can be used to issue letters of credit. As of December 30, 2005, we had $270.0 million outstanding under the term loan, $68.9 million in letters of credit, and no amount outstanding under the Revolving Line of Credit.
Our Revolving Line of Credit is used to fund daily operating cash needs and to support our standby letters of credit. During the ordinary course of business, the use of our Revolving Line of Credit is a function of collection and disbursement activities. Our daily cash needs generally follow a predictable pattern that parallels our payroll cycles, which dictate, as necessary, our short term borrowing requirements.
Principal amounts under the term loan will become due and payable on a quarterly basis: 15% of the principal will be payable in four equal quarterly payments beginning in the third quarter of 2008, 20% of the principal will be due during the next four quarters, and 65% will be due in the final four quarters ending on June 28, 2011. Our Revolving Line of Credit expires and is payable in full on June 28, 2010. At our option, we may repay the loans under our New Credit Facility without premium or penalty.
All loans outstanding under our New Credit Facility bear interest at either LIBOR or the 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 (“Moody’s”) 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 December 30, 2005, the LIBOR margin was 1.00% for both the term loan and Revolving Line of Credit. As of December 30, 2005, the interest rate on our term loan was 5.53%.
A substantial number of our domestic subsidiaries are guarantors of the New Credit Facility on a joint and several basis. Initially, the obligations are collateralized by our guarantors’ capital stock. The collateralized
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
obligations will be eliminated if we reach an investment grade credit rating of “Baa3” from Moody’s and “BBB-” from Standard & Poor’s. If our credit rating were to fall to or below “Ba2” from Moody’s or “BB” from Standard & Poor’s, we would be required to provide a secured interest in substantially all of our existing and subsequently acquired personal and real property, in addition to the collateralized guarantors’ capital stock. Although the capital stock of the non-guarantor subsidiaries are not required to be pledged as collateral, the terms of the New Credit Facility restrict the non-guarantors’ assets, with some exceptions, from being used as a pledge for future liens (a “negative pledge”). Moody’s upgraded our credit rating from “Ba2” to “Ba1” on June 20, 2005. On July 26, 2005, Standard & Poor’s upgraded our credit rating from “BB” to “BB+.” As of December 30, 2005, our credit rating remained the same.
Our New Credit Facility contains financial covenants. We are required to maintain: (a) a maximum ratio of total funded debt to total capital of 40% or less and (b) a minimum interest coverage ratio of not less than 3 to 1. The interest coverage ratio is calculated by dividing consolidated Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”), as defined in our New Credit Facility agreement, by consolidated cash interest expense.
The New Credit Facility also contains customary events of default and customary affirmative and negative covenants, some of which are dependent upon our credit ratings and include, but are not limited to, limitations on mergers, consolidations, acquisitions, asset sales, stock redemptions or repurchases, transactions with stockholders and affiliates, liens, capital leases, negative pledges, sale-leaseback transactions, indebtedness, contingent obligations and investments, and restrictions against dividend payments.
Our obligations under our New Credit Facility and our 111/2% notes have been substantially guaranteed by all of our domestic subsidiaries. See further discussion at Note 14, “Supplemental Guarantor Information” to our “Consolidated Financial Statements and Supplementary Data” included under Item 8 of this report.
As of December 30, 2005, we were in compliance with all the covenants of the New Credit Facility.
Old Credit Facility
The old senior secured credit facility (“Old Credit Facility”) consisted of two term loans, term loan A and term loan B, and a revolving line of credit. The Old Credit Facility was terminated and repaid in full on June 28, 2005. As of December 31, 2004, we had $353.8 million in principal amounts outstanding under the term loan facilities with an interest rate of 4.42%. We had also drawn $18.0 million against the revolving line of credit and had outstanding standby letters of credit aggregating to $55.3 million, reducing the amount available to us under the revolving credit facility to $151.7 million.
Revolving Line of Credit
Our revolving line of credit information is summarized as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Other Indebtedness
111/2% Senior Notes (“111/2% notes”). As of December 30, 2005 and December 31, 2004, we had outstanding amounts of $2.8 million and $130.0 million, respectively, of the original outstanding principal, due 2009. On June 15, 2005, we accepted tenders for and retired $127.2 million of the 111/2% notes. Interest is payable semi-annually in arrears on March 15 and September 15 of each year. These notes are effectively subordinate to our New Credit Facility, capital leases and notes payable.
The indenture governing our 111/2% notes was amended on June 30, 2005 to substantially eliminate all covenants and default provisions. As such, we were compliant with the remaining covenants as of December 30, 2005.
Substantially all of our domestic subsidiaries fully and unconditionally guarantee our 111/2% notes on a joint and several basis. We have classified our 111/2% notes as current portion of long-term debt of our Consolidated Balance Sheets as we intend to redeem the remaining outstanding balance of our 111/2% notes on September 15, 2006 at the redemption price of 105.75% (expressed as a percentage of the principal amount of our 111/2% notes so redeemed), plus accrued and unpaid interest, if any, to the date of redemption. If redemption of our 111/2% occurred after September 15, 2006, the redemption price would be as follows:
On May 14, 2004, we exercised the equity redemption clause of our 111/2% notes and redeemed $70.0 million of the original principal amount at a price of 111.50%.
121/4% Senior Subordinated Notes (“121/4% notes”). On February 14, 2005, we retired the entire outstanding balance of $10 million of our 121/4% notes. As of December 31, 2004, we owed $10 million.
61/2% Convertible Subordinated Debentures (“61/2% debentures”). On August 15, 2005, we retired the entire outstanding balance of $1.8 million of our 61/2% debentures. As of December 31, 2004, we owed $1.8 million.
Notes payable, foreign credit lines and other indebtedness. As of December 30, 2005 and December 31, 2004, we had outstanding amounts of $9.6 million and $13.4 million, respectively, in notes payable and foreign lines of credit. Notes payable primarily include notes used to finance the purchase of office equipment, computer equipment and furniture. The weighted average interest rates of the notes were approximately 5.6% and 5.8% as of December 30, 2005 and December 31, 2004, respectively.
We maintain foreign lines of credit, which are collateralized by the assets of our foreign subsidiaries and letters of credit. As of December 30, 2005, we had $10.0 million in lines of credit available under these facilities, with no amounts outstanding. As of December 31, 2004, we had $16.4 million in lines of credit available under these facilities, with $8.5 million outstanding. The interest rates were 6.6% and 8.6% as of December 30, 2005 and December 31, 2004, respectively.
Fair Value of Financial Instruments
The fair values of the 111/2% notes and the 121/4% notes fluctuate depending on market conditions and our performance and at times may differ from their carrying values. On February 14, 2005, we retired the entire outstanding balance of $10.0 million on the 121/4% notes. On June 15, 2005, we retired 97.8% of the $130.0 million of
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
the 111/2% notes, leaving $2.8 million outstanding. We believe that the fair value of our remaining 111/2% notes approximate their carrying value as of December 30, 2005. As of December 31, 2004, the total fair values of the 111/2% notes and the 121/4% notes were approximately $161.5 million.
Maturities
As of December 30, 2005, the amounts of our long-term debt outstanding (excluding capital leases) that mature in the next five years and thereafter are as follows:
Costs Incurred for Extinguishment of Debt
We incurred the following costs to extinguish the Old Credit Facility, 61/2% debentures, 111/2% notes, and 121/4% notes during the years ended December 30, 2005 and October 31, 2004. During the two months ended December 31, 2004 and 2003 and the year ended October 31, 2003, we did not extinguish any debt.
The write-off of the pre-paid financing fees, debt issuance costs and discounts and the amounts paid for tender/call premiums and expenses are included in the indirect, general and administrative expenses of our Consolidated Statements of Operations and Comprehensive Income.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 6. OBLIGATIONS UNDER LEASES
Total rental expense included in operations for operating leases for the years ended December 30, 2005, October 31, 2004 and October 31, 2003, totaled $96.1 million, $91.9 million and $92.0 million, respectively. For the two months ended December 31, 2004 and 2003, total rental expense included in operations for operating leases were $16.5 million and $14.6 million, respectively. Some of the operating leases are subject to renewal options and escalation based upon property taxes and operating expenses. These operating lease agreements expire at varying dates through 2022. Obligations under operating leases include building, office, and other equipment rentals. Obligations under capital leases include leases on vehicles, office equipment and other equipment.
Obligations under non-cancelable lease agreements are as follows:
NOTE 7. 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. Their operating results also are reviewed separately by management. 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.
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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.
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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.
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Geographic areas
Our revenues and net property and equipment at cost by geographic area are shown below.
No individual foreign country contributed more than 10% of our consolidated revenues for the year ended December 30, 2005, the two months ended December 31, 2004 and 2003, and the years ended October 31, 2004 and 2003.
Major Customers
We have multiple contracts with the U.S. Army, which 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.
(1)
The U.S. Army includes U.S. Army Corps of Engineers
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NOTE 8. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, we are subject to certain contractual guarantees and governmental audits or investigations and we are 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: Prior to our acquisition of Lear Seigler Services, Inc. (“LSI”) in August 2002, LSI provided aircraft maintenance support services on aircraft under contracts (the “F-5 Contract”) with a Saudi Arabian government ministry (the “Ministry”). LSI’s operational performance under the Contract was completed in November 2000 and the Ministry has yet to pay a $12.2 million account receivable owed to LSI. The following legal proceedings ensued:
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. The $7.9 million judgment remains unpaid and LSI is currently pursuing a countersuit in Saudi Arabia against the Al Bilad landlord. Another landlord has obtained a judgment in Saudi Arabia against LSI for $1.2 million. The $1.2 million judgment also remains unpaid and LSI successfully appealed the decision in June 2005 in Saudi Arabia, which was remanded for future proceedings. LSI intends to continue to vigorously defend these matters.
LSI is involved in a dispute relating to a tax assessment issued by the Saudi Arabian taxing authority against LSI of approximately $5.1 million for the years 1999 through 2002. LSI disagrees with the Saudi Arabian taxing authority’s assessment and is providing responses, additional information and documentation to the taxing authority. Despite LSI’s position on the taxing authority’s assessment, the Ministry inappropriately directed payment of a performance bond outstanding under the Contract in the amount of approximately $5.6 million. Banque Saudi Fransi paid the bond to the Ministry and thereafter filed a reimbursement claim against LSI in December 2004 in the United Kingdom’s High Court of Justice, Queen’s Bench Division, Commercial Court. LSI believes Banque Saudi Fransi’s payment of the performance bond amount was inappropriate and constituted a contractual violation of our performance bond agreement. In April 2005, LSI responded to the Banque Saudi Fransi’s claim and the Commercial Court granted Banque Saudi Fransi an application for summary judgment of approximately $5.6 million, plus attorney fees and interest. On October 25, 2005, LSI appealed this judgment to the Court of Appeal of England & Wales (Civil Division), which was granted on December 6, 2005, on the condition that LSI secured the judgment. LSI has satisfied this condition by providing Banque Saudi Fransi with a letter of credit covering the amount of the judgment. We accrued a charge of $7.0 million related to this matter during the year ended December 30, 2005. LSI intends to continue to vigorously defend this matter.
In November 2004, LSI filed a complaint against the Ministry in the United States District Court for the Western District of Texas for intentional interference with commercial relations caused by the Ministry’s wrongful demand of the performance bond. In addition, LSI’s complaint also asserts a breach of the Contract, unjust enrichment and promissory estoppel, and seeks payment of the $12.2 million account receivable owed to LSI under the Contract, as well as other damages. In March 2005, the Ministry responded to LSI’s complaint by filing a motion to dismiss, which the District Court denied. In November 2005, the Ministry filed another motion to dismiss, in which the District Court responded to by ordering the parties to conduct further discovery. LSI intends to continue to vigorously pursue this matter.
•
Lebanon: Prior to our acquisition of Dames and Moore Group, Inc. in 1999, which included Radian International, LLC, a wholly-owned subsidiary (“Radian”), Radian entered into a contract to provide environmental remediation to a Lebanese company (“Solidere”) involved in the development and reconstruction of the central district of Beirut. Various disputes have arisen under this contract, including
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an allegation by Solidere that Radian defectively performed the contract resulting in the production of chemical and biological constituents, including methane gas, at the project site. The parties initially sought to resolve their disputes in an arbitration proceeding filed with the International Chamber of Commerce (“ICC”). During July 2004, an ICC arbitration panel ruled against Radian and ordered Radian to prepare a plan to, among other things, reduce the level of methane gas at the project site to the contract level, to pay approximately $2.4 million in attorney fees and other expenses to Solidere, and authorized Solidere to withhold project payments. As of December 30, 2005, Solidere had withheld project payments for which we have recorded accounts receivable and retainage amounting to $10.1 million included in our consolidated accounts receivable. In addition, Radian has deferred other costs amounting to $5.6 million included in our consolidated costs and accrued earnings in excess of billings on contracts in process and $3.2 million included in our consolidated other assets. Additional disputes have arisen regarding Radian’s compliance with the ICC arbitration panel’s July 2004 ruling. On January 20, 2006 Radian initiated a new ICC arbitration proceeding against Solidere due to Solidere’s non-cooperation that prevented Radian from complying with the ICC arbitration panel’s July 2004 ruling. Thereafter, on February 10, 2006, 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, seeking to recover the cost to remediate the project site, damages resulting from delays to remediate the project site, as well as past and future legal costs. On February 20, 2006, Radian amended its January 20, 2006 arbitration proceeding request to include Solidere’s unwarranted termination of Radian’s contract. Radian intends to continue to vigorously defend this matter.
Solidere is also seeking damages for delays of up to $8.5 million and drew upon an $8.5 million bank guarantee at Saradar Bank, Sh.M.L. (“Saradar”). In July 2004, Saradar filed a reimbursement claim in the First Court in Beirut, Lebanon to recover the $8.5 million bank guarantee from Radian and co-defendant Wells Fargo Bank, N.A. In February 2005, Radian responded to Saradar’s claim by filing a Statement of Defense in the First Court of Beirut. In April 2005, Saradar also filed a reimbursement claim against Solidere in the First Court of Beirut. Radian believes that the bank guarantee has expired and as a result, it was not obligated under the guarantee. Radian intends to continue to vigorously defend this matter.
Prior to entering into the Solidere contract, Radian obtained a project-specific, $50 million insurance policy from Alpina Insurance Company (“Alpina”) with a $1 million deductible, which Radian believes is available to support the claims in excess of the deductible. The Solidere contract contains a $20 million limitation on damages which Solidere disputes. 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 was granted by the District Court. 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 is involved in settlement discussions with Alpina and its other insurance carriers to resolve the matter and intends to continue to vigorously pursue this matter.
•
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 support services in connection with the construction of the Lee Roy Selmon Elevated Expressway structure in Tampa, Florida. 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 were reported at the time of the incident. The Authority has completed and is implementing a plan to remediate the damage to the Expressway. In October 2005, the Authority filed a lawsuit in the Thirteenth Judicial Circuit of Florida against URS Corporation Southern and an unrelated third party, alleging breach of contract and professional negligence resulting in damages to the Authority exceeding
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$120 million. Sufficient information is not currently available to assess liabilities associated with a remediation plan. URS Corporation Southern intends to continue to vigorously defend this matter.
Currently, we have limits of $125.0 million per loss and $125.0 million in the aggregate annually for general liability, professional errors and omissions liability and contractor’s pollution liability insurance (in addition to other policies for some specific projects). These policies include self-insured claim retention amounts of $4.0 million, $7.5 million and $7.5 million, respectively. In some actions, parties may seek punitive and treble damages that substantially exceed our insurance coverage.
Excess limits provided for these coverages are 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. We intend to maintain these policies; however, 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 any of our contingencies described above, 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 contingencies is subject to inherent uncertainty and it is reasonably possible that such resolution could have an adverse effect on us.
As of December 30, 2005, 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 $6.5 million; however, it was temporarily increased to $11.5 million from December 19, 2005 through January 31, 2006, to address temporary working capital needs of the joint venture. It reverted back to the original amount of $6.5 million on February 1, 2006.
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 9. STOCKHOLDERS’ EQUITY
Authorized Common and Preferred Stock
On July 23, 2003, we filed a Certificate of Elimination with the State of Delaware so that none of our authorized shares of our Series A Preferred Stock, Series B Exchangeable Convertible Preferred Stock (the “Series B Preferred Stock”), Series C Preferred Stock, Series D Senior Convertible Participating Preferred Stock (the “Series D
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Preferred Stock”), and Series E Cumulative Convertible Participating Preferred Stock (the “Series E Preferred Stock”) would be outstanding or issuable. In addition, on March 24, 2004, we filed a Certificate of Amendment of Certificate of Incorporation with the State of Delaware to increase the total authorized number of shares of all classes of our stock to one hundred million shares of common stock and three million shares of preferred stock. As of December 30, 2005 and December 31, 2004, we do not have any outstanding shares of preferred stock.
On October 12, 1999, our stockholders approved the 1999 Equity Incentive Plan (“1999 Plan”). An aggregate of 1,500,000 shares of common stock initially were reserved for issuance under the 1999 Plan, and the 1999 Plan provides an automatic reload of shares every July 1 through 2009 equal to the lesser of 5% of the outstanding common stock or 1.5 million shares. As of December 30, 2005, we had reserved approximately 9.6 million shares and had issued options and restricted stock awards and units in the aggregate amount of approximately 7.1 million shares under the 1999 Plan.
On March 26, 1991, the stockholders approved the 1991 Stock Incentive Plan (“1991 Plan”). The 1991 Plan provided for the grant of up to 3,310,000 restricted shares, stock units and options. When the 1999 Plan was approved, the remaining shares available for grant under the 1991 Plan were added to the 1999 Plan.
Common Shares
On June 8, 2005, we sold 4,000,393 shares of our common stock through a public offering. The offering price of our common shares was $34.50 per share and the total offering proceeds to us were $130.3 million, net of underwriting discounts and commissions and other offering-related expenses of $7.8 million. We used the net proceeds from this common stock offering and cash available on hand to pay $127.2 million of the 111/2% notes and $18.8 million of tender premiums and expenses.
During April 2004, we sold 8.1 million shares of our common stock through a public offering. The offering price of our common stock was $26.50 per share and the total offering proceeds to us were $204.3 million, net of underwriting discounts and commissions and other offering-related expenses of $10.5 million. We used the net proceeds from this common stock offering to pay down our 111/2% notes and our 121/4% notes.
Employee Stock Purchase Plan
Our ESPP allowed eligible employees to purchase shares of common stock through payroll deductions of up to 10% of their compensation, subject to Internal Revenue Code limitations, at a price of 85% of the lower of the fair market value as of the beginning or the end of each of the six-month offering periods, which commences on January 1 and July 1 of each year. If the first or last day of the offering period ended on the non-trading day, the fair market value of the preceding day would be used as the purchase price of each share of common stock. Contributions are credited to each participant’s account on the last day of each offering period. Effective January 1, 2006, we modified our ESPP to allow employees to purchase common stock at a price of 95% of the fair market value as of the end of each of the six-month offering periods.
For the years ended December 30, 2005, October 31, 2004, and October 31, 2003, employees purchased 549,967 shares, 637,570 shares and 787,483 shares under our ESPP, respectively. There were no ESPP shares recorded during the two months ended December 31, 2004 and 2003.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Restricted Stock Awards and Units
Due to the impacts associated with the adoption of SFAS 123(R), we have decided currently to issue restricted stock awards and units rather than stock options to selected employees in order to minimize the volatility of our stock-based compensation expense. Our restricted stock awards and units, net of cancellations, are summarized as follows:
We had 314 thousand shares of unvested restricted stock awards and units granted during the year ended December 30, 2005 and the weighted-average grant-date fair value of unvested restricted stock awards and units was $39.65.
Stock Incentive Plans
Stock options expire in ten years from the date of grant and vest over service periods that range from three to five years.
A summary of the status of the stock options granted under our Stock Incentive Plans for the fiscal year ended December 30, 2005, two months ended December 31, 2004, and the years ended October 31, 2004 and 2003, is presented below:
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The following table summarizes information about stock options outstanding at December 30, 2005, under our Stock Incentive Plans:
Comprehensive Income (Loss)
The accumulated balances and reporting period activities related to each component of other comprehensive income (loss) are summarized as follows:
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NOTE 10. EMPLOYEE RETIREMENT PLANS
Effective January 1, 2005, we have a single domestic defined contribution retirement plan, the URS Corporation 401(k) Plan (“401(k) Plan”). This 401(k) Plan covers all full-time employees who are at least 18 years of age. Employer contributions to this 401(k) Plan are made at the discretion of the Board of Directors. We made contributions of $15.9 million, $13.0 million, and $11.0 million to the 401(k) Plan during the years ended December 31, 2005, October 31, 2004 and October 31, 2003, respectively. For the two months ended December 31, 2004 and 2003, we did not make any contributions to the 401(k) Plan.
Some of our foreign subsidiaries have contributory trustee retirement plans covering substantially all of their employees. We made contributions in the amounts of approximately $6.0 million, $4.4 million and $5.1 million for the fiscal years ended December 30, 2005, October 31, 2004 and October 31, 2003, respectively. For the two months ended December 31, 2004 and 2003, we make contributions of $0.9 million and $1.2 million, respectively, to the contributory trustee retirement plans.
Executive Plan
In July 1999, as amended and restated in September 2003, we entered into a Supplemental Executive Retirement Agreement with our Chief Executive Officer (the “Executive”) to provide an annual lifetime retirement benefit, which was fully earned as of December 30, 2005. Benefits are based on the Executive’s final average annual compensation and his age at the time of his employment termination. “Final average compensation” means the higher of (1) the sum of the Executive’s base salary plus target bonus established for him under our incentive compensation program during the selected consecutive 36 months in his final 60 months of employment in which that average was the highest and (2) $1,600,000. As there is no funding requirement for the Executive Plan, the benefit payable is “unfunded,” as that term is used in Sections 201(2), 301(a)(3), 401(a)(10) and 4021(a)(6) of the Employee Retirement Income Securities Act (“ERISA”). However, we are obligated to fund the benefit payable into a rabbi trust upon receiving a 15-day notice, his death or the termination of his employment for any reason. As of December 30, 2005 and December 31, 2004, there were no plan assets under the Executive Plan. We measure pension costs according to actuarial valuations and the projected unit credit cost method is used to determine pension cost for financial accounting purposes.
Our estimates of benefit obligations and assumptions used to measure those obligations for the Executive Plan as of December 30, 2005 and December 31, 2004, are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Components of net periodic pension costs for the year ended December 30, 2005, two months ended December 31, 2004, and the years ended October 31, 2004, and October 31, 2003 are as follows:
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At December 30, 2005, the estimated future benefit payments to be paid out in the next ten years are as follows:
Radian SERP and SCA
In fiscal year 1999, we acquired and assumed some of the defined benefit pension plans and post-retirement benefit plans of Radian International, L.L.C. (“Radian”), which were transferred to our subsidiary, URS Corporation, a Nevada company. These benefit plans cover a selected group of Radian employees and former employees who will continue to be eligible to participate in these benefit plans.
The Radian defined benefit plans include a Supplemental Executive Retirement Plan (“SERP”) and a Salary Continuation Agreement (“SCA”), which are intended to supplement the retirement benefits provided by other benefit plans upon the participants attaining minimum age and years of service requirements. The SERP and SCA provide benefits based on fixed amounts of historical compensation and therefore, increases in compensation do not need to be considered in our calculation of the projected benefit obligation or periodic pension cost related to these plans. As there is no funding requirement for the SERP and SCA, the benefit payable is “unfunded,” as that term is used in Sections 201(2), 301(a)(3), 401(a)(10) and 4021(a)(6) of ERISA. As of December 30, 2005 and December 31, 2004, there were no plan assets under the SERP and SCA and these plans are unfunded. However, at December 30, 2005 and 2004, we had designated and deposited $1.5 million and $2.3 million, respectively, in a grantor trust account for the SERP. Such trust does not cause the plan to cease to be “unfunded” for ERISA purposes, because the assets of the trust may be reached by creditors in the event of insolvency or bankruptcy of the plan sponsor. The decrease in our designated deposit balance from December 31, 2004 to December 30, 2005 was due to benefit payments made. Radian also has a post-retirement benefit program that provides certain medical insurance benefits to participants upon meeting minimum age and years of service requirements. This post-retirement benefit program is also unfunded and the historical costs, accumulated benefit obligation and projected benefit obligation for this post-retirement benefit program are not significant. We measure pension costs according to actuarial valuations and the projected unit credit cost method is used to determine pension cost for financial accounting purposes.
Our estimates of benefit obligations and assumptions used to measure those obligations for the SERP and SCA as of December 30, 2005 and December 31, 2004 are as follows:
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Components of net periodic pension costs for the year ended December 30, 2005, two months ended December 31, 2004, and the years ended October 31, 2004, and October 31, 2003 are as follows:
At December 30, 2005, the estimated future benefit payments to be paid out in the next ten years are as follows:
EG&G Pension Plan
In fiscal year 2002, we acquired EG&G and assumed the obligations of the EG&G pension plan and post-retirement medical plan (“EG&G post-retirement medical plan”) of EG&G Technical Services, Inc. These plans cover some of our hourly and salaried employees of the EG&G Division and a joint venture in which the EG&G Division participates.
The EG&G pension plan provides retirement benefit payments for the life of participating retired employees. The EG&G post-retirement medical plan provides certain medical benefits to employees that meet certain eligibility requirements. All of these benefits may be subject to deductibles, co-payment provisions, and other limitations. Based on an analysis of the Medicare Act, FSP 106-2, and facts available to us, we formed a conclusion that the majority of the health care benefits we provide to retirees is not actuarially equivalent to Medicare Part D and therefore, our measures of the accumulated post-retirement benefit obligation and net periodic pension costs of our post-retirement plans do not reflect any amount associated with the subsidy. We measure our pension costs according to actuarial
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valuations and the projected unit credit cost method is used to determine pension costs for financial accounting purposes.
Our estimates of benefit obligations and assumptions used to measure those obligations for the EG&G pension plan at December 30, 2005 and December 31, 2004 are as follows:
Net periodic pension costs for the EG&G pension plan include the following components for the year ended December 30, 2005, two months ended December 31, 2004, and the years ended October 31, 2004 and October 31, 2003.
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(1)
Our assumption used in determining the expected long-term rate of return on plan assets was based on an actuarial analysis. This analysis includes a review of anticipated future long-term performance of individual asset classes and consideration of the appropriate asset allocation strategy given the anticipated requirements of the plan to determine the average rate of earnings expected on the funds invested to provide for the pension plan benefits. While the study gives appropriate consideration to recent fund performance and historical returns, the assumption is primarily a long-term, prospective rate. Based on our most recent analysis, our expected long-term rate of return assumption for our EG&G pension plan will remain at 8.5%.
(2)
We re-measured our EG&G pension plan at December 31, 2003 due to the plan amendment included above.
The EG&G pension plan asset allocations at December 30, 2005 and December 31, 2004 by asset category are as follows:
We maintain our target allocation percentages based on our investment policy established for the EG&G pension plan, which is designed to achieve long term objectives of return, while mitigating against downside risk and considering expected cash flows. Our investment policy is reviewed from time to time to ensure consistency with our long term objective of funding at or near to the projected benefit obligation. The current target asset allocation is as follows:
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We made cash contributions of approximately $7.5 million during fiscal year 2005 and we expect to make cash contributions during fiscal year 2006 of approximately $7.0 million to the EG&G pension plan.
At December 30, 2005, the estimated future benefit payments for the EG&G pension plan to be paid out in the next ten years are as follows:
EG&G post-retirement medical plan
Our estimates of benefit obligations and assumptions used to measure those obligations of the EG&G post-retirement medical plan at December 30, 2005 and December 31, 2004 are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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Net periodic pension and other post-retirement benefit costs include the following components for the year ended December 30, 2005, two months ended December 31, 2004, and the years ended October 31, 2004 and October 31, 2003.
(1)
Our assumption used in determining the expected long-term rate of return on plan assets was based on an actuarial analysis. This analysis includes a review of anticipated future long-term performance of individual asset classes and consideration of the appropriate asset allocation strategy given the anticipated requirements of the plan to determine the average rate of earnings expected on the funds invested to provide for the pension plan benefits. While the study gives appropriate consideration to recent fund performance and historical returns, the assumption is primarily a long-term, prospective rate. Based on our most recent analysis, our expected long-term rate of return assumption for our EG&G post-retirement medical plan will remain at 8.5%.
Assumed health care costs trend rates have a significant effect on the health care plan. A one percentage point change in assumed health care costs trend rates would have the following effects on net periodic cost for the fiscal year ended December 30, 2005 and the accumulated post-retirement benefit obligation as of December 30, 2005:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EG&G post-retirement medical plan asset allocations at December 30, 2005 and December 31, 2004 by asset category are as follows:
We maintain our target allocation percentages based on our investment policy established for the EG&G post-retirement medical plan, which is designed to achieve long term objectives of return, while mitigating against downside risk and considering expected cash flows. Our investment policy is reviewed from time to time to ensure consistency with our long term objective of funding at or near to the accumulated post-retirement benefit obligation. The current target asset allocation is as follows:
We currently expect to make approximately $0.2 million cash contributions to the EG&G post-retirement medical plan for fiscal year 2006. As of December 30, 2005, the estimated future benefit payments for EG&G post-retirement medical plan to be paid out in the next ten years are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 11. VALUATION AND ALLOWANCE ACCOUNTS
Receivable allowances is comprised of an allowance for losses and an allowance for doubtful accounts. We determine these amounts based on historical experience and other currently available information. The following table summarizes the activities in the allowance for losses and doubtful accounts from the beginning of the periods to the end of the periods.
NOTE 12. SELECTED QUARTERLY FINANCIAL DATA (Unaudited)
The following table sets forth selected quarterly financial data for the years ended December 30, 2005 and October 31, 2004 that is derived from audited consolidated financial statements. We also included the selected financial data for the two months ended December 31, 2004 and 2003. The selected quarterly financial data presented below should be read in conjunction with the rest of the information in this report.
(1)
Revenues, direct operating expenses and gross profit for the full year of 2005 include, out-of-period adjustments of $55.9 million, $52.3 million, and $3.7 million, respectively, related to an enhanced methodology used to quantify period end accrued expenses, including related sub-contractor accruals for reimbursable or re-billable items.
(2)
Refer to Note 3, “Purchased Intangible Assets and Goodwill” for discussion of an adjustment, which we believe to be immaterial, to goodwill and deferred income taxes related to an August 2002 acquisition, which increased our income tax expense by $3.6 million in the fourth quarter of 2005.
(3)
The net out-of-period items recorded in the fourth quarter of 2005 relating to the matters noted above and other individually immaterial adjustments was $0.9 million. The effect of these adjustments, in our opinion, is immaterial to our financial position, results of operations and cash flows for any interim or annual period presented in these financial statements.
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Operating income is defined as income before income taxes and interest expense.
NOTE 13. RELATED PARTY TRANSACTIONS
On January 19, 2005, affiliates of Blum Capital Partners, L.P. (collectively, “Blum Affiliates”) sold 2,000,000 shares of our common stock in an underwritten secondary offering, pursuant to a registration statement that we previously filed in accordance with the terms of an existing registration rights agreement. The general partner of Blum Capital Partners, L.P. was a member of our Board of Directors.
On October 21, 2005, according to the terms of the registration rights agreement, Blum Affiliates requested that we register their remaining 3,580,907 shares of our common stock, which they sold on December 6, 2005.
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NOTE 14. SUPPLEMENTAL GUARANTOR INFORMATION
We are required to provide supplemental guarantor information because substantially all of our domestic operating subsidiaries have guaranteed our obligations under our 111/2% notes. Each of the subsidiary guarantors has fully and unconditionally guaranteed our obligations on a joint and several basis.
Substantially all of our income and cash flows are generated by our subsidiaries. We have no operating assets or operations other than our investments in our subsidiaries. As a result, the funds necessary to meet our debt service obligations are provided in large part by distributions or advances from our subsidiaries. Financial conditions and operating requirements of the subsidiary guarantors may limit our ability to obtain cash from our subsidiaries for the purposes of meeting our debt service obligations, including the payment of principal and interest on our 111/2% notes. In addition, legal restrictions (including local regulations), and contractual obligations associated with secured loans (such as equipment financings at the subsidiary level) may preclude the subsidiary guarantors’ ability to pay dividends or make loans or other distributions to us.
The following information sets forth our condensed consolidating balance sheets as of December 30, 2005 and December 31, 2004; our condensed consolidating statements of operations and comprehensive income for the fiscal year ended December 30, 2005, the two months ended December 31, 2004 and 2003, and the years ended October 31, 2004 and 2003; and our condensed consolidating statements of cash flows for the fiscal year ended December 30, 2005, two months ended December 31, 2004 and December 31, 2003, and the years ended October 31, 2004 and 2003. Entries necessary to consolidate our subsidiaries are reflected in the eliminations column. Separate complete financial statements of our subsidiaries that guarantee our 111/2% notes would not provide additional material information that would be useful in assessing the financial composition of such subsidiaries.
URS CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEET
(In thousands)
URS CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEET
(In thousands)
URS CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME
(In thousands)
URS CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME
(In thousands)
URS CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME
(In thousands)
URS CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(In thousands)
URS CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(In thousands)
URS CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(In thousands)
URS CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(In thousands)
URS CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
(In thousands)
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Attached as exhibits to this Form 10-K 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. Item 8, “Consolidated Financial Statements and Supplementary Data,” of this report sets forth the report of PricewaterhouseCoopers LLP, our independent registered public accounting firm, regarding its audit of our internal control over financial reporting and of management’s assessment of internal control over financial reporting. This section should be read in conjunction with the certifications and the PricewaterhouseCoopers report for a more complete understanding of the topics presented.
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 Annual Report on Form 10-K was (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and (ii) 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 December 30, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Management assessed our internal control over financial reporting as of December 30, 2005, the end of our fiscal year. Management based its assessment on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included evaluation and testing of the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment.
Based on our assessment, management has concluded that our internal control over financial reporting was effective as of December 30, 2005. We communicated the results of management’s assessment to the Audit Committee of our Board of Directors.
Our independent registered public accounting firm, PricewaterhouseCoopers LLP, audited management’s assessment of the effectiveness of the company’s internal control over financial reporting at December 30, 2005 as stated in their report appearing under Item 8.
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.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference from the information under the captions “Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Information about the Board of Directors” in our definitive proxy statement for the Annual Meeting of Stockholders to be held on May 25, 2006 and from Item 4A - “Executive Officers of the Registrant” in Part I above.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference from the information under the captions “Executive Compensation,” “Employment Agreement,” “Compensation Committee Interlocks and Insider Participations,” “Report of the Compensation Committee on Executive Compensation for Fiscal Year 2005,” “Performance Measurement Comparison” and “Information about the Board of Directors” in our definitive proxy statement for the Annual Meeting of Stockholders to be held on May 25, 2006.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Incorporated by reference from the information under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” in our definitive proxy statement for the Annual Meeting of Stockholders to be held on May 25, 2006.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Some of our officers, directors and employees may have disposed of shares of our common stock, both in cashless transactions with us and in market transactions, in connection with exercises of stock options, the vesting of restricted and deferred stock and the payment of withholding taxes due with respect to such exercises and vesting. These officers, directors and employees may continue to dispose of shares of our common stock in this manner and for similar purposes. In addition, please see the information contained under the caption “Certain Relationships and Related Transactions,” in our definitive proxy statement for the Annual Meeting of Stockholders to be held on May 25, 2006.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Incorporated by reference from the information under the captions “Information about Our Independent Registered Public Accounting Firm,” and “Report of the Audit Committee for Fiscal Year 2005” in our definitive proxy statement for the Annual Meeting of Stockholders to be held on May 25, 2006.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)
Documents Filed as Part of this Report.
(1)
Financial Statements and Supplementary Data
(2)
Schedules are omitted because they are not applicable, not required or because the required information is included in the Consolidated Financial Statements or Notes thereto.
(3)
Exhibits
4.61
Specimen Common Stock Certificate, filed as an exhibit to our registration statement on Form S-1 or amendments thereto.
10.11*
Amendment to the EG&G Technical Services, Inc. Employees Retirement Plan. FILED HEREWITH.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, URS Corporation, the Registrant, has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 15, 2006
URS Corporation
(Registrant)
/s/ Reed N. Brimhall
Reed N. Brimhall
Vice President, Controller
and Chief Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the date indicated.
EXHIBIT INDEX