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EEI > SEC Filings for EEI > Form 10-K on 14-Nov-2012All Recent SEC Filings

Show all filings for ECOLOGY & ENVIRONMENT INC

Form 10-K for ECOLOGY & ENVIRONMENT INC


14-Nov-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Liquidity and Capital Resources

Operating activities consumed cash flow of $.4 million during fiscal year 2012. Operating activities during fiscal year 2012 provided operating cash as a result of net income of $3.0 million, $2.2 million in depreciation and amortization expense and $.7 million in share based compensation expense. This was offset during the year by decreases in accounts payable, accrued payroll costs and accrued income taxes and an increase in accounts receivable. Accounts payable and accrued payroll costs consumed $3.3 million of cash during the period due to the payment of accrued bonuses and the timing of payments for operating costs and subcontracts. Accrued income taxes consumed $3.9 million of cash during the period due to the payment of tax estimates during the fiscal year 2012. Accounts receivable increased $2.3 million during fiscal year 2012 due primarily to increased receivables on foreign work.

Investment activities consumed $5.5 million of cash which was used mainly for the purchase of an enterprise wide planning and reporting system and to purchase additional interest in the majority owned subsidiaries Walsh Environmental Scientists and Engineers, LLC (Walsh) and E&E do Brasil (Brasil).

Financing activities provided $8.0 million of cash during fiscal year 2012 mainly from net debt proceeds of $11.5 million less dividend payments of $2.0 million, purchase of treasury stock for $.4 million and distributions to non-controlling interests of $1.1 million. Short term debt has increased this year due mainly to the delinquency of the receivables in the Middle East.

Ecology and Environment, Inc. (Company) maintains an unsecured line of credit available for working capital and letters of credit of $34 million at interest rates ranging from 2.5% to 5% at July 31, 2012. The Company guarantees the line of credit of Walsh. Its lenders have reaffirmed the Company's lines of credit within the past twelve months. At July 31, 2012 and 2011, the Company had letters of credit and loans outstanding totaling approximately $14.9 million and $4.1 million, respectively. After letters of credit and loans, there was $19.1 million of availability under the lines of credit at July 31, 2012. The Company maintained a cash balance of $10.4 million at July 31, 2012, however borrowings of $12.3 million against the Company's line of credit were necessary during the fiscal year due to the cash requirements at Ecology and Environment (Parent Company). The Company believes that cash flows from operations and borrowings against the lines of credit will be sufficient to cover all working capital requirements for at least the next twelve months and the foreseeable future.

Results of Operations

Revenue

Year to Date and Fourth Quarter 2012 vs 2011

Revenue for fiscal year 2012 was $155.4 million, a decrease of $13.8 million or 8% from the $169.2 million reported for fiscal year 2011. Revenue at the Parent Company was $80.9 million for fiscal year 2012, a decrease of $18.6 million or 19% from the $99.5 million reported in the prior year due to reduced revenues from the commercial and international markets. Revenues from the Parent Company's commercial market were $33.5 million for fiscal year 2012, down $15.0 million from the $48.5 million reported in fiscal

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year 2011 attributable to decreased activity in the domestic energy market due to the completion of a significant project. Revenues from the Parent Company's international market decreased $3.7 million over the prior year mainly attributable to decreased activity in the Middle East. This decrease was partially offset by increases in revenue at the Company's majority owned subsidiaries E&E do Brasil and Gestion Ambiental Consultores (GAC). E&E do Brasil reported revenue of $15.7 million for fiscal year 2012, an increase of $4.0 million from the $11.7 million reported in fiscal year 2011 due to modifications received on contracts in the transmission and energy markets. GAC reported revenue of $11.3 million for fiscal year 2012, an increase of $3.2 million from the $8.1 million reported in the prior year due to increased work in the mining market. Revenues for fiscal year 2012 included a favorable settlement of government contract rates covering the years 2002 through 2005 of approximately $.3 million.

E & E reported revenue of $36.9 million for the fourth quarter, a decrease of $7.3 million or 17% from the $44.2 million reported in the fourth quarter of fiscal year 2011. Revenue at the Parent Company was $20.1 million, a decrease of $6.6 million or 25% from the $26.7 million reported in fiscal year 2011 due mainly to decreases in the Company's domestic energy markets as a result of the completion of a significant project. The Company's majority owned subsidiary Walsh reported revenue of $7.8 million during the fourth quarter of fiscal year 2012, a decrease of $1.8 million from the $9.6 million reported in fiscal year 2011 due mainly to decreases in the domestic energy and state/local markets. This decrease was partially offset by increases in revenue at the Company's majority owned subsidiaries E&E do Brasil and GAC. E&E do Brasil reported revenue of $4.4 million during the fourth quarter of fiscal year 2012, an increase of $1.4 million over fiscal year 2011 due to work in the transmission and energy markets. GAC reported revenue of $3.4 million during the fourth quarter of fiscal year 2012, an increase of $1.0 million over fiscal year 2011 due to contracts in the mining market.

Year to Date and Fourth Quarter 2011 vs 2010

Revenue for fiscal year 2011 was $169.2 million, an increase of $25.1 million from the $144.1 million reported for fiscal year 2010 mainly attributable to increases at the Parent Company, ECSI and GAC. Revenue at the Parent Company was $99.5 million for fiscal year 2011, an increase of $15.3 million or 18% from the $84.2 million reported in the prior year. This increase was attributable to work performed on contracts in the Company's commercial and international markets offset by decreases in work in the federal government and state markets. Revenues from the Parent Company's commercial market were $48.5 million for fiscal year 2011, up $16.5 million from the $32.0 million reported in fiscal year 2010 attributable to increased activity in the domestic energy market. Revenues from the Parent Company's international market increased $5.2 million over the prior year mainly attributable to increased activity in the Middle East and Africa. Revenues from the Parent Company's federal government market were $26.6 million for fiscal year 2011, a decrease of $.6 million from the $27.2 million reported in the prior year mainly attributable to decreased activity in contracts with the United States Department of Defense (DOD). Revenues from the Parent Company's state market were $14.7 million for fiscal year 2011, down $5.8 million from the $20.5 million reported in fiscal year 2010. The decrease in state revenues was mainly attributable to decreased activity in Texas, Florida and California due to the state budgetary constraints. The inclusion of ECSI, formed in August 2010, contributed revenue of $5.2 million for fiscal year 2011. GAC, the Company's Chilean subsidiary, reported revenue of $8.1 million during fiscal year 2011, an increase of $4.3 million or 113% from the $3.8 million reported in fiscal year 2010 due to increased work in mining and extractive industries. E & E do Brasil reported revenue of $11.7 million for fiscal year 2011, an increase of $1.2 million or 11% from the $10.5 million reported in the prior year. The increase in revenue at E & E do Brasil was associated with increased work on contracts in the energy market. The Company's majority owned subsidiary Walsh Environmental reported revenues of $39.2 million for fiscal year 2011, a decrease of $2.9 million or 7% from the $42.1 million reported in fiscal year 2010 mainly attributable to the completion of work associated with a redevelopment project and a decrease in work in the energy market.

E & E reported revenue of $44.2 million for the fourth quarter, an increase of $3.5 million from the $40.7 million reported in the fourth quarter of the prior year. Revenue at the Parent Company was $26.7 million during the fourth quarter of fiscal year 2011, an increase of $1.4 million attributable to work performed on contracts in the Company's domestic energy market. Revenues from the Parent Company's commercial market were $13.3 million for the fourth quarter of fiscal year 2011, an increase of $1.4 million from the $11.9 million reported in the fourth quarter of fiscal year 2010 attributable to increased activity in the domestic energy market. The inclusion of ECSI contributed revenue of $1.2 million for the fourth quarter of fiscal year 2011. GAC reported revenue of $2.4 million during the fourth quarter of fiscal year 2011, an increase of $1.3 million or 118% from the $1.1 million reported in the prior year.

Income Before Income Taxes

Year to Date and Fourth Quarter 2012 vs 2011

The Company's income before income taxes was $4.4 million for fiscal year 2012, a decrease of $8.4 million or 66% from the $12.8 million reported in fiscal year 2011. Revenue less subcontract costs were $123.1 million, a decrease of $14.7 million or 11% from the $137.8 million reported in the prior year, mainly due to the decrease in revenue in the Parent Company's commercial energy and

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international markets. Gross profits (revenue less cost of professional services, other direct operating expenses and subcontract costs) decreased $4.5 million during fiscal year 2012. Indirect costs for fiscal year 2012 were $60.5 million, an increase of $2.7 million from $57.8 million reported in the prior year are mainly the result of lower staff utilization in the Parent Company and Walsh. Indirect costs for fiscal year 2012 included a reduction of $.8 million due to the Parent Company's decision to not award bonuses for fiscal year 2012 and a decrease in the Parent Company's discretionary contribution to the defined contribution retirement plan. Foreign exchange losses increased $.7 million in fiscal year 2012 mainly due to fluctuations in the exchange rates on receivables carried in Kuwaiti Dinar translated to US dollars.

The Company's income before income taxes was $.1 million for the fourth quarter of fiscal year 2012, a decrease of $2.9 million or 97% from the $3.0 million reported in the fourth quarter of fiscal year 2011. Revenue less subcontract costs were $29.3 million, a decrease of $6.0 million from the $35.3 million reported in the fourth quarter of the prior year, mainly due to the decrease in revenue in the Parent Company's domestic energy market. Gross profits decreased $2.6 million during the fourth quarter of fiscal year 2012. Indirect costs for the fourth quarter of fiscal year 2012 were $14.6 million, consistent with the fourth quarter of fiscal year 2011. Indirect costs for the fourth quarter of fiscal year 2012 included a reduction of $.8 million due to the Parent Company's decision to not award bonuses for fiscal year 2012 and a decrease in the Parent Company's discretionary contribution to the defined contribution retirement plan. Foreign exchange losses increased $.3 million for the quarter mainly due to fluctuations in the exchange rates on receivables carried in Kuwaiti Dinar translated to US dollars.

Year to Date and Fourth Quarter 2011 vs 2010

The Company's income before income taxes was $12.8 million for fiscal year 2011, an increase of $2.3 million from the $10.5 million reported in fiscal year 2010. Revenue less subcontract costs were $137.8 million, an increase of $24.0 million or 21% from the $113.8 million reported in the prior year. Gross profits increased $7.7 million during fiscal year 2011. The gross margin percentage for fiscal year 2011 was 42%, down from the 44% reported for fiscal year 2010 due mainly to increased field work on large projects in the energy markets. Income from operations for fiscal year 2011 was $12.4 million, up 25% from the $9.9 million reported in fiscal year 2010. These increases were mainly attributable to the increased energy market work. Indirect costs fell as a percent of revenue from 36% in fiscal year 2010 to 34% in fiscal year 2011. The Company recorded a sale of land during the first quarter of fiscal year 2010 for a gain of $809,000 ($453,000 after tax) which positively impacted earnings by $.11 per share compared to a $290,000 ($94,000 after tax and noncontrolling interest) gain on the sale of the assets of the Jordanian Fish Farm (AMARACO) in current fiscal year which impacted earnings by $.02 per share. The Company recognized a net foreign exchange gain of $.3 million for fiscal year 2011.

The Company's income before income taxes was $3.0 million for the fourth quarter of fiscal year 2011, a decrease of $1.2 million from the $4.2 million reported in the fourth quarter of fiscal year 2010. Revenue less subcontract costs for the fourth quarter of fiscal year 2011 were $35.3 million, an increase of $2.5 million from the $32.8 million reported in the prior year. Gross profits decreased slightly during the fourth quarter of fiscal year 2011. Income from operations for the fourth quarter of fiscal year 2011 was $3.0 million, down 29% from the $4.2 million reported in fourth quarter of fiscal year 2010. Consolidated indirect costs for the fourth quarter of fiscal year 2011 were $14.7 million, an increase of $1.0 million from the $13.7 million reported in the fourth quarter of fiscal year 2010 attributable to the formation of ECSI and excess staffing and other indirect operating expenses at E & E do Brasil. The Company recognized a net foreign exchange gain of $.1 million for the fourth quarter of fiscal year 2011.

Income Taxes

The effective tax rate for the fiscal year ended July 31, 2012, is 30.9%, as compared to the tax rate of 36.3% reported for the fiscal year ended July 31, 2011. The reduction in the effective tax rate is mainly a result of increased income in the corporate partnerships as well as increased income from foreign entities in countries with a lower effective tax rate than in the U.S, along with a decrease in income in the U.S. with a higher effective tax rate. In addition, during the fiscal year ended July 31, 2012, an income tax benefit of $.3 million and $.1 million, was recognized as result of favorable Kuwait and state related tax settlements, net of federal benefit, respectively.

Critical Accounting Policies and Use of Estimates

Management's discussion and analysis of financial condition and results of operations discuss the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, allowance for doubtful accounts, income taxes, impairment of long-lived assets and contingencies. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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Recent Accounting Pronouncements

An accounting standard related to the presentation of other comprehensive income was issued to increase the prominence of items reported in other comprehensive income. The amended standard requires the components of net income and the components of other comprehensive income to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements, and other disclosures. Among the new provisions of this standard was a requirement for entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented (for both interim and annual financial statements); however, a subsequent accounting standard update was issued, which indefinitely deferred the reclassification requirement. Further deliberations on this topic by the FASB are expected at a future date. Excluding the deferred reclassification requirement, the remaining portion of the standard was effective for us beginning with our first quarter of fiscal year 2012; however, we have historically presented the components of net income and the components of other comprehensive income in two separate, but consecutive, statements.

An accounting standard update regarding fair value measurement was issued to conform the definition of fair value and common requirements for measurement of and disclosure about fair value under U.S. GAAP and International Financial Reporting Standards. The amended standard also clarifies the application of existing fair value measurement requirements and expands the disclosure requirements for fair value measurements that are estimated using significant unobservable Level 3 inputs. The standard update was effective for us beginning with our first interim period of fiscal year 2012. The adoption of the standard did not have a material impact on our consolidated financial statements.

An accounting standard update related to new disclosures about balance sheet offsetting and related arrangements was issued. For derivatives and financial assets and liabilities, the amendments require the disclosure of gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the balance sheet. The standard update is effective for us beginning with our first interim period in fiscal year 2013. This standard does not amend the existing guidance on when it is appropriate to offset. As a result, we do not expect the adoption of this standard to have a material impact on our consolidated financial statements.

Revenue Recognition

The Company's revenues are derived primarily from the professional and technical services performed by its employees or, in certain cases, by subcontractors engaged to perform on under contracts entered into with our clients. The revenues recognized, therefore, are derived from our ability to charge clients for those services under the contracts. Sales and cost of sales at the Company's South American subsidiaries exclude tax assessments by governmental authorities, which are collected by the Company from its customers and then remitted to governmental authorities.

The Company employs 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 the highest level of financial and performance risk, but often also provide the highest potential financial returns. Cost-plus contracts present a 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.

Fixed price contracts are accounted for on the "percentage-of-completion" method, wherein revenue is recognized as project progress occurs. Time and material contracts are accounted for over the period of performance, in proportion to the costs of performance, predominately based on labor hours incurred. If an estimate of costs at completion on any contract indicates that a loss will be incurred, the entire estimated loss is charged to operations in the period the loss becomes evident.

The use of the percentage of completion revenue recognition method requires the use of estimates and judgment regarding the project's expected revenues, costs and the extent of progress towards completion. The Company has a history of making reasonably dependable estimates of the extent of progress towards completion, contract revenue and contract completion costs.
However, due to uncertainties inherent in the estimation process, it is possible that completion costs may vary from estimates.

Most of our percentage-of-completion projects follow a method which approximates 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 recognition of revenues and profit is dependent upon the accuracy of a variety of 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.

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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 equipment is purchased or an extensive amount of mobilization is involved, including these costs 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.

The Company's contracts with the U.S. government contain provisions requiring compliance with the Federal Acquisition Regulation (FAR), and the Cost Accounting Standards (CAS). These regulations are generally applicable to all of the Company's 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. 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 Defense Contract Audit Agency (DCAA). The DCAA audits 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 financial 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 such audits will not result in material disallowances of incurred costs in the future.

The Company maintains reserves for cost disallowances on its cost based contracts as a result of government audits. Government audits have been completed and final rates have been negotiated through fiscal year 2005. The Company has estimated its exposure based on completed audits, historical experience and discussions with the government auditors. If these estimates or their related assumptions change, the Company may be required to record additional charges for disallowed costs on its government contracts.

Allowance for Doubtful Accounts and Contract Adjustments

We reduce our contract receivables and costs and estimated 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 and allowance for contract adjustments based on management's judgments regarding our operating performance related to the adequacy of the services performed, 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.

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.

Uncertain Tax Positions

A tax position is a position in a previously filed tax return or a position expected to be taken in a future tax filing that is reflected in measuring current or deferred income tax assets and liabilities. Tax positions shall be recognized only when it is more likely than not (likelihood of greater than 50%), based on technical merits, that the position will be sustained. Tax positions that meet the more likely than not threshold should be measured using a probability weighted approach as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement. Whether the more-likely-than-not recognition threshold is met for a tax position, is a matter of judgment based on the individual facts and circumstances of that position evaluated in light of all available evidence. The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in administrative and indirect operating expenses.

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Changes in Corporate Entities

On January 4, 2012, the Company purchased an additional 1.3% of Walsh from noncontrolling shareholders for approximately $254,000. Two thirds of the purchase price was paid in cash while the remaining one third was paid for with E&E stock. With this purchase E&E's ownership share in Walsh increased to approximately 86% of that company.

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