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EEI > SEC Filings for EEI > Form 10-K on 14-Nov-2013All Recent SEC Filings

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Form 10-K for ECOLOGY & ENVIRONMENT INC


14-Nov-2013

Annual Report


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

Overview

Fiscal Year 2013 Operations Summary

Our income before income tax provision decreased $5.4 million (122%) to a loss of $1.0 million for fiscal year 2013. Revenue less subcontract costs, which is a key performance measurement for our business, decreased $13.2 million (11%) during fiscal year 2013, due mainly to:

lower project work volumes in energy and mining sectors within our domestic and certain of our foreign markets; and

higher net reserves for contract adjustments recorded as a reduction of revenue, which were required for projects in China and northern Africa.

During the fourth quarter of fiscal year 2013, we recorded a $0.8 million software impairment charge related to certain software modules that do not meet the needs of users that rely on the system and will not provide any future service potential. The software impairment charge is further described in Item 1 of this Annual Report.

Lower revenue less subcontract costs and the software impairment charge noted above were partially offset by:

lower professional service costs and other direct project expenses as a result of lower project work volumes and other managed reductions in technical staff levels; and

lower indirect expenses due primarily to managed reductions of staff levels in various administrative, marketing and other indirect departments.

Liquidity and Capital Resources

Despite an operating loss for the fiscal year ended July 31, 2013, we maintained a strong liquidity position during the year. Cash generated from operations was $11.9 million, which was adequate to fund investing and financing activities required to maintain our operations. Cash and cash equivalents decreased $1.0 million during fiscal year 2013 primarily due to $2.0 million in dividend payments paid to shareholders during the year, which were not required for operations, but which were approved on a discretionary basis by the Board of Directors.


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During fiscal years prior to 2013, we expended significant resources and working capital on contracts in the Middle East and China, which resulted in significant billed contract receivables that were not collected during those years, and which required additional borrowings from our existing lines of credit. During January 2013, we collected $7.1 million of cash related to contract receivables in the Middle East, which enabled us to reduce amounts outstanding under our lines of credit.

We believe that cash flows from U.S. operations, available cash and cash equivalent balances in our domestic subsidiaries and remaining amounts available under lines of credit will be sufficient to cover working capital requirements of our U.S. operations during the next twelve months and the foreseeable future.

Our foreign subsidiaries generate adequate cash flow to fund their operations.
We intend to reinvest foreign cash balances, net of any dividends paid from our foreign subsidiaries from time to time, into opportunities outside the U.S. If the foreign cash and cash equivalents were needed to fund domestic operations, we would be required to accrue and pay taxes on any amounts repatriated.

Cash and cash equivalents activity and balances are summarized in the following table.

                                                        Fiscal Year Ended July 31,
                                                  2013             2012             2011
Cash provided by (used in):
Operating activities                          $ 11,943,124     $   (360,288 )   $  1,010,791
Investing activities                            (2,557,656 )     (5,533,398 )     (2,822,924 )
Financing activities                            (9,950,867 )      7,988,123       (4,057,705 )
Effect of exchange rate changes on cash and
cash equivalents                                  (457,711 )       (156,509 )         52,486
Net (decrease) increase in cash and cash
equivalents                                   $ (1,023,110 )   $  1,937,928     $ (5,817,352 )

Cash and cash equivalents, by location:
U.S. operations                               $  6,244,053     $  4,398,921     $  5,602,946
Foreign operations                               3,200,607        6,068,849        2,926,896
Total cash and cash equivalents               $  9,244,660     $ 10,467,770     $  8,529,842

For the fiscal year ended July 31, 2013, cash provided by operations resulted primarily from the following net activity:
Net income (after adjustment for non-cash items) provided $4.8 million of operating cash;

Lower net contract receivables provided $7.2 million of operating cash, which resulted primarily from $7.1 million of cash received on aged outstanding receivables in the Middle East; and

Other working capital activity resulted in a net use of $0.4 million of operating cash, due primarily to lower work levels associated with lower revenue and to general reductions of current liabilities as a result of an improved liquidity position at the Parent Company.

Net cash used in investment activities during the fiscal year ended July 31, 2013 primarily resulted from the following activity:
Purchases of property, building and equipment resulted in a use of $1.8 million of cash; and

Acquisitions of noncontrolling interests in two majority-owned subsidiaries, Walsh Environmental Scientists & Engineers, LLC ("Walsh") and Gustavson Associates, LLC ("Gustavson") resulted in a use of $0.6 million of cash.

Net cash used in financing activities during the fiscal year ended July 31, 2013 primarily resulted from the following activity:
Net repayment of borrowings against our lines of credit of $5.8 million, which was made possible by the receipt of $7.1 million of cash on aged outstanding receivables in the Middle East;

Repayments of debt and capital lease obligations of $0.9 million;

Dividend payments to common shareholders of $2.0 million; and

Distributions to non-controlling interests of $1.5 million.


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We maintain unsecured lines of credit available for working capital and letters of credit. Contractual interest rates ranged from 2.5% to 5% at July 31, 2013 and July 31, 2012. Our lenders have reaffirmed the lines of credit within the past twelve months. Our lines of credit are summarized in the following table.

                                                             Balance at July 31,
                                                            2013             2012
 Outstanding cash draws (recorded as lines of credit
 on the accompanying consolidated balance sheets)       $  6,528,691     $ 12,309,335
 Outstanding letters of credit to support operations       3,080,938        2,615,415
 Total amounts used under lines of credit                  9,609,629       14,924,750
 Remaining amounts available under lines of credit        24,759,371       19,444,250
 Total approved unsecured lines of credit               $ 34,369,000     $ 34,369,000

Balance Sheets

Contract Receivables, Net

Contract receivables, net are summarized in the following table.

                                                       Balance at July 31,
                                                      2013             2012

    Contract Receivables:
    Billed                                         $ 36,284,950     $  42,977,016
    Unbilled                                         16,441,857        28,829,818
                                                     52,726,807        71,806,834
    Allowance for doubtful accounts and contract
    adjustments                                      (5,592,800 )     (10,238,391 )
    Total contract receivables, net                $ 47,134,007     $  61,568,443

Activity within the allowance for doubtful accounts and contract adjustments is summarized in the following table.

                                                        Fiscal Year Ended July 31,
                                                  2013              2012            2011

Balance at beginning of period                $  10,238,391     $  6,755,087     $ 3,373,673
Net increase (decrease) due to adjustments
in the allowance for:
Contract adjustments (1)                          6,319,650        1,635,311       3,355,971
Doubtful accounts (2)                              (287,426 )        689,657         424,377
Transfer of reserves to (from) allowance
for doubtful accounts and contract
adjustments from (to) allowance for project
disallowances (3)                                    61,123        1,158,336        (398,934 )
Specific write-off of contract receivables
and reserves during the period                  (10,738,938 )            ---             ---
Balance at end of period                      $   5,592,800     $ 10,238,391     $ 6,755,087

(1) Increases (decreases) to the allowance for contract adjustments on the consolidated balance sheets are also recorded as (decreases) increases to revenue on the consolidated statements of operations.

(2) Increases (decreases) to the allowance for doubtful accounts on the consolidated balance sheets are also recorded as increases (decreases) to administrative and other indirect operating expenses on the consolidated statements of operations.

(3) The allowance for project disallowances is included in other accrued liabilities on the consolidated balance sheets.


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Significant concentrations of contract receivables and the allowance for doubtful accounts and contract adjustments are summarized in the following table.

                                        Balance at July 31, 2013              Balance at July 31, 2012
                                                       Allowance for                        Allowance for
                                                         Doubtful                             Doubtful
                                                       Accounts and                         Accounts and
                                      Contract           Contract           Contract          Contract
             Region                  Receivables        Adjustments       Receivables        Adjustments

United States, Canada and South
America                             $  41,302,180     $     1,576,746     $ 46,064,299     $     1,729,515
Middle East/Africa                     10,876,151           3,886,508       21,224,062           7,377,650
Asia                                      548,476             129,546        4,518,473           1,131,226
Totals                              $  52,726,807     $     5,592,800     $ 71,806,834     $    10,238,391

During the three months ended July 31, 2013, we recorded $10.7 million of specific write-offs of aged and uncollectible contract receivables related to projects in China, the Middle East and northern Africa, which resulted in equivalent reductions in contract receivables and the allowance for doubtful accounts and contract adjustments. The decision to write-off these contract receivable balances was based on management's assessment that cash collections are not likely.

Prior to these write-off adjustments, combined contract receivables related to projects in the Middle East, Africa and Asia represented 35% and 36% of total contract receivables at July 31, 2013 and 2012, while the combined allowance for doubtful accounts and contract adjustments related to these projects represented 90% and 83%, respectively, of the total allowance for doubtful accounts and contract adjustments at those same period end dates. These allowance percentages highlight our experience of the heightened operating risks (i.e., political, regulatory and cultural risks) within these foreign regions in comparison with similar risks in the United States, Canada and South America.
These heightened operating risks have ultimately resulted in higher counterparty, credit and liquidity risks as we expend resources that may not be recovered for several months, or at all.

Middle East/Africa

As of July 31, 2012, we recorded $14.8 million of contract receivables and $3.9 million of allowance for doubtful accounts and contract adjustments related to specific projects in the Middle East. During the quarter ended January 31, 2013, we received $7.1 million of cash related to one of these projects, which resulted in reductions in contract receivables and the allowance for doubtful accounts and contract adjustments of $7.1 million and $1.7 million, respectively. This reduction in the allowance for doubtful accounts and contract adjustments was partially offset by $0.4 million of contract adjustments recorded in response to continued aging of contract receivables related to other projects in the Middle East.

During fiscal year 2013, we recorded $0.9 million of contract adjustments related to work completed for a project in northern Africa, for which the client has not yet approved the project tasks as of July 31, 2013.

During the three months ended July 31, 2013, we recorded $3.4 million of specific write-offs of aged, uncollectible and fully reserved contract receivables related to projects in the Middle East and Africa, which resulted in equivalent reductions in contract receivables and the allowance for doubtful accounts and contract adjustments.

Asia

In January 2013, we announced that we had entered into contracts to provide environmental consulting services to a client in China. The contracts replaced a previous agreement from fiscal year 2011. Through July 31, 2013, we recorded $6.8 million of contract receivables related to these agreements in China.
Since inception of these agreements, we encountered significant operational project issues and delays in collecting required contractual advance payments due to us.


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After considering the age of the related contract receivables, non-payment of required contractual advance payments owed to us and the lack of any other cash collections to date, management concluded during the fourth quarter of fiscal year 2013 that the contract receivables from the client in China were uncollectible, and we recorded $4.8 million of contract adjustments during the quarter, of which $3.8 million related to revenue and contract receivables recorded during fiscal year 2013. For all of fiscal year 2013, we recorded $6.3 million of contract adjustments related to these contract receivables. The total allowance for doubtful accounts and contract adjustments related to these contracts, prior to write-off of the fully reserved contract receivable balance during the fourth quarter of fiscal year 2013, was $6.8 million. During the fourth quarter of fiscal year 2013, management suspended all project activity related to these contracts.

During the three months ended July 31, 2013, the Company recorded $7.3 million of specific write-offs of aged, uncollectible and fully reserved contract receivables related to projects in China, which resulted in equivalent reductions in contract receivables and the allowance for doubtful accounts and contract adjustments.

Property, Plant and Equipment, Net

During fiscal years 2012 and 2013, the Company acquired and developed a new operating and financial software system for use by EEI and its U.S. and foreign subsidiaries. Through July 31, 2013, the Company capitalized $4.1 million of expenditures for the acquisition and development of this system, which was being amortized over a 10 year useful life. During the quarter ended July 31, 2013, management assessed the utility and effectiveness of various modules included in the software package, and determined that certain software modules do not meet the needs of users that rely on the system and will not provide any future service potential. As a result, the Company recorded a software impairment charge of $0.8 million during the three months ended July 31, 2013, which is included in administrative and indirect operating expenses on the consolidated statements of operations.

Results of Operations

Revenue, net

Revenue, net and revenue, net less subcontract costs, by business entity, are
summarized in the following table.

                                                                Fiscal Year Ended July 31,
                                                         2013              2012              2011

Gross revenue by entity:
EEI and all of its wholly owned subsidiaries         $  82,358,140     $  85,150,365     $ 108,596,221
EEI's majority-owned subsidiaries:
Walsh Environmental Scientists & Engineers, LLC
("Walsh")                                               28,263,579        39,295,981        39,230,040
Ecology & Environment do Brasil, Ltda ("E&E
Brasil")                                                15,125,046        15,702,130        11,740,335
Gestion Ambiental Consultores S.A. ("GAC")              10,640,382        11,298,271         8,112,753
ECSI, LLC ("ECSI")                                       4,869,394         5,539,993         5,299,482
Total                                                  141,256,541       156,986,740       172,978,831
Less: Net reserves for contract adjustments
recorded during the period                              (6,319,650 )      (1,576,641 )     (3,805,9711 )
Revenue, net per consolidated statements of income   $ 134,936,891     $ 155,410,099     $ 169,172,860

Revenue, net less subcontract costs, by entity:
EEI and all of its wholly owned subsidiaries         $  69,691,641     $  72,290,708     $  97,255,198
EEI's majority-owned subsidiaries:
Walsh                                                   20,796,180        26,003,190        23,739,544
E&E Brasil                                              13,778,136        14,433,459         9,967,276
GAC                                                      7,327,335         6,620,988         6,112,245
ECSI                                                     4,621,818         5,323,216         4,578,631
Total                                                $ 116,215,110     $ 124,671,561     $ 141,652,894

Fiscal Year 2013 Versus 2012

The overall decrease in consolidated revenue less subcontract costs for the fiscal year ended July 31, 2013, as compared with the prior fiscal year, resulted from the net impact of the following entity activity:

Lower Parent Company and wholly-owned subsidiary revenue resulted from lower sales volume, particularly within domestic state and federal government markets.

Lower Walsh revenue primarily resulted from lower sales volume, particularly within the energy and mining sectors in its U.S. and foreign markets.

Lower E&E Brasil revenue was primarily due to weakening of the local currency (Reais) against the U.S. dollar. In the local currency, revenue for E&E Brasil increased 9% during the fiscal year ended July 31, 2013, primarily due to higher revenues in the energy transmission sector.

Higher GAC revenue less subcontract costs was primarily due to a significant decrease in subcontract costs, which was partially offset by lower sales volume in the mining sector, as a mining project completed during fiscal year 2012 was not renewed or replaced during fiscal year 2013.

Lower ECSI revenue primarily resulted from lower sales volume in the mining sector, as a mining project completed during fiscal year 2012 were not renewed or replaced during fiscal year 2013.


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Net reserves for contract adjustments recorded as an offset to revenue are summarized by region in the following table.

                                                    Fiscal Year Ended July 31,
                  Region                       2013            2012            2011

  United States, Canada and South America   $    73,534     $  (355,643 )   $  (326,678 )
  Middle East/Africa                            (72,024 )     1,314,058       3,669,649
  Asia                                        6,318,140         618,226         463,000
  Totals                                    $ 6,319,650     $ 1,576,641     $ 3,805,971

Commentary regarding net reserves for contract adjustments recorded as an offset to revenue during the fiscal year ended July 31, 2013 is included within Balance Sheet commentary above.

Fiscal Year 2012 Versus 2011

The overall decrease in consolidated revenue less subcontract costs for the fiscal year ended July 31, 2012, as compared with the prior fiscal year, resulted from the following entity activity:

Lower Parent Company and wholly-owned subsidiary revenue resulted from lower sales volume, particularly within the domestic energy market as a significant project ended during fiscal year 2011.

Higher Walsh revenue was primarily due to significantly higher volume of energy market project activity in Walsh's subsidiary in Peru.

Higher E&E Brasil revenue was primarily due to significant modifications received on transmission and energy market projects.

Higher GAC and ECSI revenue primarily resulted from higher sales volume in the mining sector.

Operating Expenses

Overview

The cost of professional services and other direct operating expenses represent
labor and other direct costs of providing services to our clients under our
project agreements.  These costs, and fluctuations in these costs, generally
correlate directly with related project revenues.  The cost of professional
services and other direct operating expenses, by business entity, are summarized
in the following table.

                                                        Fiscal Year Ended July 31,
                                                  2013             2012             2011

EEI and all of its wholly owned
subsidiaries                                  $ 29,408,179     $ 33,152,707     $ 46,194,644
EEI's majority-owned subsidiaries:
Walsh                                            6,034,926        7,709,299        7,887,484
E&E Brasil                                       7,524,216        8,413,975        5,909,552
GAC                                              5,258,000        4,499,132        4,332,206
ECSI                                             1,529,296        1,857,168        1,591,101
Total cost of professional services and
other direct operating expenses               $ 49,754,617     $ 55,632,281     $ 65,914,987


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Indirect operating expenses include administrative and indirect operating expenses, as well as marketing and related costs. Combined indirect operating expenses, by business entity, are summarized in the following table.

                                                   Fiscal Year Ended July 31,
                                             2013             2012             2011

   EEI and all of its wholly owned
   subsidiaries                          $ 36,239,243     $ 38,957,028     $ 37,081,202
   EEI's majority-owned subsidiaries:
   Walsh                                   12,707,123       12,953,357       11,677,740
   E&E Brasil                               5,480,397        4,847,879        5,765,816
   GAC                                      1,161,575          923,723          790,257
   ECSI                                     3,021,712        2,836,756        2,470,453
   Total indirect operating expenses     $ 58,610,050     $ 60,518,743     $ 57,785,468

Fiscal Year 2013 Versus 2012

During fiscal year 2013, management at EEI and our U.S. subsidiaries critically reviewed technical and indirect staffing levels, other expenses necessary to support current project work levels and key administrative processes, particularly in our domestic subsidiaries and operations. As a result of this review, the number of full time employees in various technical and indirect departments at EEI and its U.S. subsidiaries decreased by a combined 10% in fiscal year 2013. Utilization of contracted services was also reviewed and reduced. Management continues to critically evaluate its organizational and cost structure to identify ways to operate more efficiently and cost effectively.

Consolidated expenses directly associated with services provided under contracts decreased $5.9 million (11%) during fiscal year 2013. This net decrease was primarily due to lower consolidated revenues at EEI and its U.S. subsidiaries, which resulted from lower service levels provided during the year and to managed reductions in technical staff levels. Expense reductions in the U.S. were partially offset by a higher volume of project activity and related expenses in South American subsidiaries.

Consolidated administrative, marketing and other indirect expenses decreased $1.9 million (3%) during fiscal year 2013. During the year, management at EEI and its U.S. subsidiaries critically reviewed indirect staffing levels and key administrative processes, and reduced staff counts and utilization of contracted services in certain indirect departments. These cost reductions in the U.S. were partially offset by higher indirect expenses to support growth in South American subsidiaries and by a $0.8 million software impairment charge recorded by EEI during the fourth quarter of fiscal year 2013 (refer to Item 1 of this Annual Report).

Depreciation and amortization expense increased $0.3 million (12%) during fiscal year 2013, which resulted from acquisitions of depreciable assets of $1.8 million and $4.4 million during fiscal years 2013 and 2012, respectively.

Fiscal Year 2012 Versus 2011

Expenses directly associated with services provided under contracts decreased $10.3 million (16%) during fiscal year 2012. This decrease was directly related to lower revenues resulting from lower service levels provided during the year.

Administrative, marketing and other indirect expenses increased a combined $2.7 million (5%) during fiscal year 2012, which represented the net impact of several factors:
Lower sales volumes resulted in lower technical staff utilization on specific projects, and higher allocation of the cost of those resources to indirect expenses.

EEI's decisions to not award bonuses for fiscal year 2012 and to decrease EEI's discretionary contribution to its defined contribution retirement plan resulted in a combined $0.8 million reduction in indirect expenses during fiscal year 2012.

Foreign exchange losses increased $0.7 million in fiscal year 2012 mainly due to fluctuations in the exchange rates on receivables carried in local currency (Kuwaiti Dinars) and translated to U.S. dollars.


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Depreciation and amortization expense increased $0.4 million (23%) during fiscal year 2012, which resulted from acquisitions of depreciable assets of $4.4 million and $2.5 million during fiscal years 2012 and 2011, respectively.

Income Taxes

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