UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

TRC COMPANIES, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:  (860) 298-9692

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.   YES  ý    NO  o

On February 11, 2005 there were 14,208,747 shares of the registrant’s common stock, $.10 par value, outstanding.

TRC COMPANIES, INC.

CONTENTS OF QUARTERLY REPORT ON FORM 10-Q

QUARTER ENDED DECEMBER 31, 2004

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PART I:  FINANCIAL INFORMATION

TRC COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

The accompanying notes are an integral part of the condensed consolidated financial statements.

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TRC COMPANIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

The accompanying notes are an integral part of the condensed consolidated financial statements.

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TRC COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

The accompanying notes are an integral part of the condensed consolidated financial statements.

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TRC COMPANIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

December 31, 2004 and 2003

(in thousands, except per share data)

1.             Company Background and Basis of Presentation

TRC Companies, Inc. (the Company) is a customer-focused company that creates and implements sophisticated and innovative solutions to the challenges facing America’s environmental, energy and infrastructure markets.  The Company conducts its activities under one business segment which involves providing engineering and consulting services to commercial organizations and governmental agencies primarily in the United States of America.

The condensed consolidated financial statements include the Company and its subsidiaries after elimination of intercompany accounts and transactions.  Investments in which the Company has the ability to exercise significant influence, but not control, are accounted for by the equity method.  Investments in which the Company does not have the ability to exercise significant influence are accounted for by the cost method.  Certain contracts are executed jointly through alliances and joint ventures with unrelated third parties.  The Company recognizes its proportional share of such joint venture revenue, costs and operating profits in its Condensed Consolidated Statements of Income.

The Condensed Consolidated Balance Sheet at December 31, 2004 and the Condensed Consolidated Statements of Income for the three and six months ended December 31, 2004 and the Condensed Statements of Cash Flows for the six months ended December 31, 2004 and 2003 have been prepared pursuant to the interim period reporting requirements of Form 10-Q.  Consequently, the financial statements are unaudited, but, in the opinion of the Company, include all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of the results for the interim periods.  Also, certain information and footnote disclosures usually included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted.  These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K as of and for the year ended June 30, 2004.

2.             Change in Accounting for Investments

Effective July 1, 2004, the Company adopted the provisions of Emerging Issues Task Force (EITF) 03-16, “Accounting for Investments in Limited Liability Companies”, issued by the Financial Accounting Standards Board (FASB).  EITF 03-16 requires that investments in limited liability companies be accounted for similarly to a limited partnership investment.  As a result, investors are required to apply the equity method of accounting at a much lower ownership threshold than the 20% threshold applied under Accounting Principles Board (APB) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock”.  The new accounting guidance in EITF 03-16 required the Company to change its method of accounting for its 19.9% investment in a start-up energy

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savings company from the cost method to the equity method.  Accordingly, the Company recorded an adjustment in the three months ended September 30, 2004 for the cumulative effect of this change in accounting principle equal to its pro rata share of the energy savings company’s losses, up to the carrying amount, since making the investment in fiscal 2001.  The cumulative effect of the accounting change decreased net income for the six months ended December 31, 2004 by $589 (net of income taxes of $409) or $0.04 per diluted share.  Had the Company adopted EITF 03-16 as of July 1, 2003, it would have recorded no additional income or losses related to this investment, therefore application would have had no impact on net earnings of the Company.

3.             Recently Issued Accounting Standards

In December 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004) (SFAS 123R), “Share-Based Payment”, that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments.  SFAS 123R eliminates the ability to account for share-based compensation transactions using the intrinsic value method under APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and generally would require instead that such transactions be accounted for using a fair-value-based method. The Company is currently evaluating SFAS 123R to determine which fair-value-based model and transitional provision it will follow upon adoption. The options for transition methods as prescribed in SFAS 123R include either the modified prospective or the modified retrospective methods. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock as the requisite service is rendered beginning with the first quarter of adoption, while the modified retrospective method would record compensation expense for stock options and restricted stock beginning with the first period restated. Under the modified retrospective method, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented.  SFAS 123R will be effective for the Company beginning in its first quarter of fiscal 2006. Although the Company will continue to evaluate the application of SFAS 123R, management expects adoption to have a material impact on its results of operations in amounts not yet determinable.

In December 2004, the FASB issued Staff Position 109-1 (FSP 109-1), Application of FASB Statement No. 109 (FASB No. 109), “Accounting for Income Taxes”, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004. FSP 109-1 clarifies guidance that applies to the new deduction for qualified domestic production activities. When fully phased-in, the deduction will be up to 9% of the lesser of “qualified production activities income” or taxable income. FSP 109-1 clarifies that the deduction should be accounted for as a special deduction under FASB No. 109 and will reduce tax expense in the period or periods that the amounts are deductible on the tax return. Any tax benefits resulting from the new deduction will be effective for the Company’s fiscal year ending June 30, 2006.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is

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within its scope as a liability (or an asset in some circumstances), and is effective for instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.  The provisions regarding guidance for accounting for mandatorily redeemable non-controlling interests in subsidiaries that would not be liabilities under SFAS No. 150 have been deferred for an indefinite period.  The adoption of the currently effective provisions of this standard did not have a material impact on the Company’s results of operations or financial position.  The Company has specifically reviewed whether its redeemable preferred stock is within the scope of this standard, and, due to the redemption value being subject to a floor share price, the monetary amount at inception was not deemed to be fixed or known.  As a result, the Company’s redeemable preferred stock does not fall within the scope of this standard.  The Company is currently reviewing the deferred provisions and assessing their impact.

4.             Earnings per Share

Earnings per share (EPS) is computed in accordance with the provisions of SFAS No. 128, “Earnings per Share”.  Basic EPS is based upon net income available to common shareholders divided by the weighted average common shares outstanding during the period.  Diluted EPS reflects the potential dilutive effect of outstanding stock options and warrants and the conversion of the Company’s preferred stock.  For purposes of computing diluted EPS the Company uses the treasury stock method.  Additionally, when computing dilution related to the preferred stock, conversion is assumed as of the beginning of the period.

For the three months ended December 31, 2004 and 2003 and the six months ended December 31, 2004, assumed conversion of the preferred stock would have slightly increased rather than decreased EPS (would have been “anti-dilutive”). Therefore, conversion was not assumed for purposes of computing diluted EPS, and as a result, 932, 848 and 930 shares were excluded from the calculation of diluted EPS for the three months ended December 31, 2004 and 2003 and for the six months ended December 31, 2004, respectively.  For the six months ended December 31, 2003, assumed conversion of the preferred stock was dilutive, and therefore, conversion was assumed for purposes of computing diluted EPS. The number of outstanding stock options and warrants excluded from the diluted EPS calculations, as they were anti-dilutive, were 857 and 694 for the three months ended December 31, 2004 and 2003, respectively, and 871 and 899 for the six months ended December 31, 2004 and 2003, respectively.  The following table sets forth the computations of basic and diluted EPS:

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5.             Stock Options

The Company has a non-qualified stock option plan for employees and directors which is described more fully in Note 12 of the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2004.  The Company applies the provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations to account for stock options issued.  Accordingly, no compensation cost has been recognized for stock options issued as exercise prices were not less than the fair value of the common stock at the grant date.  If compensation costs for stock options issued had been determined based on the fair value at the grant date under SFAS No. 123, “Accounting for Stock-Based Compensation”, pro forma net income and EPS for the three and six months ended December 31, 2004 and 2003 would have been as follows:

6.             Acquisitions

During the six months ended December 31, 2004, the Company completed the acquisition of five companies.  The total purchase price for these acquisitions was $7,717 (before contingent consideration), consisting of a combination of cash and common stock of the Company.  As a result of these acquisitions, goodwill of $901 and other intangible assets of $4,929 were recorded in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”.  The goodwill and intangible assets recorded in connection with these transactions are deductible for income tax purposes.  The Company may make additional payments for these acquisitions if certain financial objectives, primarily operating income targets, are achieved, with such payments resulting in additional goodwill.  The acquisitions have been accounted for using the purchase method of accounting in accordance with SFAS No. 141, “Business Combinations”.  The impact of these acquisitions on operating results was not material; therefore, no pro forma information is presented.

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During the six months ended December 31, 2004, the Company recorded additional purchase price payments of $4,187 related to acquisitions completed in prior years, including 87 shares of the Company’s common stock valued at $1,431, resulting in additional goodwill.  The additional purchase price payments were earned as a result of the acquired entities achieving certain financial objectives, primarily operating income targets.  The Company also recorded an adjustment to purchase price allocation of $58 during the six months ended December 31, 2004 for an acquisition completed in prior years, with the amount of the adjustment decreasing goodwill.  At December 31, 2004 and June 30, 2004, the Company had liabilities for additional purchase price payments of $3,276 and $2,439, respectively.  These amounts are included in Other Accrued Liabilities on the Condensed Consolidated Balance Sheets.

7.             Goodwill and Intangible Assets

At December 31, 2004, the Company had $116,859 of goodwill, representing the cost of acquisitions in excess of values assigned to the underlying net assets of acquired companies.  In accordance with SFAS No. 142, goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to impairment testing at least annually.  The assessment of goodwill involves the estimation of the fair value of the Company’s one reporting unit as defined by SFAS No. 142.

In performing its goodwill assessment, the Company relies on a number of factors including the current market capitalization, operating results, business plans, economic projections, anticipated future cash flows and a discount rate reflecting the risk inherent in future cash flows.  There are inherent uncertainties related to these factors and management’s judgment in applying them to the analysis of goodwill impairment.  Management will complete the current fiscal year’s assessment during the third quarter of fiscal 2005 based on information as of the December 31, 2004 assessment date. There has been no indication of impairment. As part of the annual goodwill assessment, the Company will obtain an independent valuation of its reporting unit and assess such valuation relative to the carrying value.  There can be no assurance that future events will not result in impairment of goodwill or other assets.

The changes in the carrying amount of goodwill for the six months ended December 31, 2004 and the year ended June 30, 2004 are as follows:

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Identifiable intangible assets as of December 31, 2004 and June 30, 2004 are included in Other Assets on the Condensed Consolidated Balance Sheets and were comprised of:

Identifiable intangible assets are amortized over the weighted average periods of three to 24 months for contract backlog assets, 15 years for customer relationship assets and six years for other assets. The amortization of intangible assets during the three months ended December 31, 2004 and 2003 was $189 and $131, respectively.  The amortization of intangible assets during the six months ended December 31, 2004 and 2003 was $330 and $315, respectively.  Estimated amortization of intangible assets for future periods is as follows: remainder of fiscal 2005 - $469; fiscal 2006 - $508; fiscal 2007 - $508; fiscal 2008 - $490; fiscal 2009 - $486; fiscal 2010 and thereafter - $4,649.  These estimates do not reflect the impact of any future acquisitions.

8.             Changes in Contract Estimates

In the ordinary course of periodically updating the estimates to complete certain Exit Strategy contracts, the Company substantially decreased the estimated cost on one contract, and on another contract, the Company substantially increased the estimated cost.  Costs in excess of the original contract value, are recoverable from a finite risk cost cap insurance policy at a lower profit margin.  The net effect of these changes in estimates resulted in an increase in both net service revenue and operating income of approximately $1,003 for the three months ended September 30, 2004 and $1,005 for the six months ended December 31, 2004.

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9.             Accounts Receivable

The current portion of accounts receivable at December 31, 2004 and June 30, 2004 was comprised of the following:

A substantial portion of unbilled receivables represents billable amounts recognized as revenue, primarily in the last month of the fiscal period.  Management expects that substantially all unbilled amounts will be billed and collected within one year.  Retainage represents amounts billed but not paid by the customer which, pursuant to contract terms, are due at completion.

The Long-Term Insurance Receivables at December 31, 2004 and June 30, 2004 of $8,317 and $2,879, respectively, relate to unbilled amounts on Exit Strategy contracts and represent amounts held by the insurance company which are released as work on a project is completed.

10.           Billings in Advance of Revenue Earned

Billings in Advance of Revenue Earned represents amounts billed or collected in accordance with contractual terms in advance of when the work is performed.  These advance payments primarily relate to the Company’s Exit Strategy program.

11.           Other Accrued Liabilities

At December 31, 2004 and June 30, 2004, Other Accrued Liabilities was comprised of the following:

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12.           Debt

The Company maintains a banking arrangement with Wachovia Bank, National Association in syndication with three additional banks that provides a $60,000 revolving credit facility to support operating and investing activities.  Borrowings under the agreement bear interest at Wachovia’s base rate or the Eurodollar rate plus or minus applicable margins and would be due and payable in March 2007 when the agreement expires, unless it is extended as management expects.  Borrowings under the agreement are collateralized by accounts receivable.  At December 31, 2004 borrowings pursuant to the agreement were $43,000 at an average interest rate of 3.9%, compared to $40,500 of borrowings at an average interest rate of 2.9% at June 30, 2004.

The credit facility provides for affirmative and negative covenants that limit, among other things, the Company’s ability to incur other indebtedness, dispose of assets, pay cash dividends on its common stock and make certain investments.  In addition, the agreement includes certain restrictive covenants, including, but not limited to, the minimum ratio of adjusted EBITDA to interest expense, income taxes and the current portion of long-term debt, and the minimum ratio of adjusted current assets to adjusted total liabilities.  The Company was in compliance with all covenants as of December 31, 2004.

13.           Convertible Redeemable Preferred Stock

In December 2001 the Company completed a private placement of $15,000 of a newly designated class of Preferred Stock with Fletcher International, Ltd., an affiliate of Fletcher Asset Management, Inc. (Fletcher) of New York City.  The Preferred Stock is convertible into 408 shares of the Company’s common stock at a conversion price of $36.72 per share. The Preferred Stock issued to Fletcher has a five-year term with a 4% annual dividend payable at the Company’s option in either cash or common stock.   The Preferred Stock was recorded net of issuance costs of $453.

The Company will have the right to redeem the Preferred Stock for cash if the price of its common stock exceeds 175% of the conversion price for any 15 business days in a 20 consecutive business day period.  Following 48 months of issuance, Fletcher may require the Company to redeem the Preferred Stock for common stock.  On the five-year expiration date, any shares of Preferred Stock still outstanding are to be redeemed, at the Company’s option, in either cash or shares of common stock.  If the Preferred Stock is redeemed for common shares the number of shares to be issued would equal the quotient of the par value of the Preferred Stock outstanding divided by the average market price of the Company’s common stock at the redemption date. The average market price is defined as the volume weighted average price of the Company’s common stock over forty business days ending on and including the third business day before the redemption date, but not greater than the average of the common stock for the first five or last five business days of such forty business day period.   The maximum number of common shares that can be issued upon redemption is 932.  The maximum number of shares applies when the average market price of the Company’s common stock is $16.09 per share or less.

For purposes of calculating diluted EPS the Company includes, if dilutive, the greater of (1) the potential number of common shares issued assuming conversion or (2) the potential number of common shares issued assuming redemption. See Note 4 beginning on page 8 of this report

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for the number of contingently issuable shares included in diluted EPS during the three and six months ended December 31, 2004 and 2003.

14.           Commitments and Contingencies

The Company has entered into several long-term contracts pursuant to its Exit Strategy program under which the Company is obligated to complete the remediation of environmental conditions at a site.  The Company assumes the risk for remediation costs for pre-existing site environmental conditions and believes that through in-depth technical analysis, comprehensive cost estimation and creative remedial approaches it is able to execute pricing strategies which protect the Company’s return on these projects.  The Company’s customer pays a fixed price and, as additional protection, a finite risk cost cap insurance policy is obtained from leading insurance companies with a minimum A.M. Best rating of A– Excellent (e.g. American International Group) which provides coverage for cost increases from unknown or changed conditions up to a specified maximum amount significantly in excess of the estimated cost of remediation.

Upon signing of the contract, a majority of the contract price is deposited in a restricted account held by the insurance company, and the Company is paid by the insurance company from such proceeds.  Any portion of the initial contract price not retained by the insurance company is transferred to the Company and is included under Current Liabilities on the Company’s Condensed Consolidated Balance Sheets under the item termed Billings in Advance of Revenue Earned.  This amount is reduced as the Company performs under the contract and recognizes revenue.  The Company believes that it is adequately protected from risks on these projects and that adverse developments, if any, will not have a material impact on its operating results, financial position or cash flows.

Four Exit Strategy contracts entered into by the Company involved the Company entering into consent decrees with government authorities and assuming the obligation for the settling responsible parties’ environmental remediation liability for the sites.  The Company’s expected remediation costs (Current and Long-Term Environmental Remediation Liability items in the Condensed Consolidated Balance Sheets) are fully funded by the contract price received and are fully insured by an environmental remediation cost cap policy (Current and Long-Term Insurance Recoverable items in the Condensed Consolidated Balance Sheets).  At December 31, 2004, the remediation for one of the projects was complete and the Company had begun long-term maintenance and monitoring at that site.  During the six months ended December 31, 2004, the Company recorded, as non-cash transactions, environmental remediation liabilities of approximately $24 million and corresponding insurance recoverables related to two new Exit Strategy contracts where the Company entered into additional consent decrees related to the assumption of environmental liabilities.

The Company and its subsidiaries are subject to claims and lawsuits typical of those filed against engineering and consulting companies.  The Company carries liability insurance, including professional liability insurance, against such claims subject to certain deductibles and policy limits.  Management is of the opinion that the resolution of these claims and lawsuits (including the ones described immediately below) will not have a material adverse effect on the Company’s operating results, financial position or cash flows.

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A subsidiary of the Company has been named as a defendant, along with a number of other companies, in litigation in New Jersey Superior Court brought on behalf of individuals claiming damages for alleged injuries related to a collapse of several floors of a parking garage under construction in Atlantic City, New Jersey.  The litigation is in early stages of discovery.  The Company’s subsidiary had a limited inspection role in connection with the construction, and management believes that it has meritorious defenses, is adequately insured and that this matter will not have a material adverse effect on the Company’s operating results, financial position or cash flows.

The Company’s indirect cost rates applied to contracts with the U.S. Government and various state agencies are subject to examination and renegotiation.  The Company believes that adjustments resulting from such examination or renegotiation proceedings, if any, will not have a material impact on the Company’s operating results, financial position or cash flows.

The Company indemnifies its directors and officers to the maximum extent permitted under the laws of the State of Delaware.

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TRC COMPANIES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Three and Six Months Ended December 31, 2004 and 2003

Management’s Discussion and Analysis contains statements that are forward-looking.  These statements are based upon current expectations and assumptions that are subject to risks and uncertainties.  Actual results could differ materially due to a number of factors.  See the discussion in “Forward-Looking Statements” below.

Critical Accounting Policies

The Company’s financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.  These principles require the use of estimates and assumptions that affect amounts reported and disclosed in the financial statements and related notes.  Actual results could differ from these estimates and assumptions.  Management uses its best judgment in the assumptions used to value these estimates, which are based on current facts and circumstances, prior experience and other assumptions that are believed to be reasonable.  The Company’s accounting policies are described in Note 2 to the Notes to Consolidated Financial Statements of the Annual Report on Form 10-K for the year ended June 30, 2004.  Management believes the following critical accounting policies reflect the more significant judgments and estimates used in preparation of the Company’s consolidated financial statements and are the policies which are most critical in the portrayal of the Company’s financial position and results of operations:

Long-Term Contracts:  The Company recognizes contract revenue in accordance with American Institute of Certified Public Accountants Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts”.  The Company records revenue on its cost-type and time and material contracts based upon direct labor costs and other direct contract costs incurred.  The Company has fixed price Exit Strategy contracts to remediate environmental conditions at contaminated sites under which the Company and its customers are protected against cost overruns by insurance policies.  Revenue (and related costs) from these fixed price contracts is recognized using the efforts-expended, percentage-of-completion method of accounting based on total costs incurred to date as compared to total costs estimated at completion.  Contract costs include direct labor costs, subcontractor costs, other direct costs and indirect costs.  The Company’s method of revenue recognition requires the Company to prepare estimates of costs to complete for contracts in progress.  In making such estimates, judgments are required to evaluate contingencies, such as potential variances in schedule and labor and other contract costs, liability claims, contract disputes or achievement of contractual performance standards.  Changes in total estimated contract costs and losses, if any, are recognized in the period they are determined.

Allowances for doubtful accounts:  Allowances for doubtful accounts are maintained for estimated losses resulting from the failure of our customers to make required payments.  Allowances for doubtful accounts have been determined through reviews of specific amounts deemed to be uncollectible, potential write-offs as a result of customers who have filed for bankruptcy protection, plus an allowance for other amounts for which some loss is determined to be probable based on

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current circumstances.  If the financial condition of customers or the Company’s assessment as to collectibility were to change, adjustments to the allowances may be required.

Income taxes:  At December 31, 2004, the Company had approximately $6.2 million of gross deferred income tax benefits.  The realization of a portion of these benefits is dependent on the Company’s estimates of future taxable income and its tax planning strategies.  A $0.5 million valuation allowance has been recorded in relation to certain state loss carryforwards, which will more likely than not expire unused.  Management believes that sufficient taxable income will be earned in the future to realize the remaining deferred income tax benefits. However, the realization of these deferred income tax benefits can be impacted by changes to tax codes, statutory tax rates and future taxable income levels.

Acquisitions:  Assets and liabilities acquired in business combinations are recorded at their estimated fair values at the acquisition date.  At December 31, 2004, the Company had approximately $116.9 million of goodwill, representing the cost of acquisitions in excess of fair values assigned to the underlying net assets of acquired companies.  In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets”, goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment testing.  Additionally, goodwill is tested between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value.

In performing its goodwill assessment, the Company relies on a number of factors including the current market capitalization, operating results, business plans, economic projections, anticipated future cash flows and a discount rate reflecting the risk inherent in future cash flows.  There are inherent uncertainties related to these factors and management’s judgment in applying them to the analysis of goodwill impairment. Since management’s judgment is involved in performing goodwill valuation analyses, there is risk that the carrying value of goodwill may be overstated or understated.  Management will complete the current fiscal year’s assessment during the third quarter of fiscal 2005 based on information as of the December 31, 2004 assessment date. There has been no indication of impairment. As part of the annual goodwill assessment, the Company will obtain an independent valuation of its reporting unit and assess such valuation relative to the carrying value.  There can be no assurance that future events will not result in impairment of goodwill or other assets.

Results of Operations

Results for the first half of fiscal 2005 reflect a continuation of the economic and industry trends we have seen over the last several quarters. State and local government budgets remain somewhat soft, and these constraints appear to be limiting project expenditures. Ongoing delays in the passage of the successor bill to the Transportation Equity Act for the 21^st Century are exacerbating state reluctance to initiate the planning, design and construction of new transportation projects. We anticipate the passage of a new transportation bill in fiscal 2005, and a ramping-up of state transportation expenditures in the wake of passage of this bill.  Although we are seeing indications of the recovery in spending by our industrial clients, many remain cautious regarding spending on new  capital projects. Continued low interest rates are driving demand for our commercial land development and redevelopment services, including brownfields development. We see ongoing strength in this market, in part driven by our geographic focus in areas where demand is growing but supply of land and housing is constrained and in areas where there is significant population growth.  High energy prices and favorable energy legislation are supporting the continued interest in various energy production and distribution projects, including wind energy projects and evaluation of various options for importing LNG into the U.S.

The Company derives its revenue from fees for providing engineering and consulting services.  The types of contracts with our customers and the approximate percentage of Net Service Revenue (NSR) for the six months ended December 31, 2004 from each contract type are as follows:

In the course of providing its services, the Company routinely subcontracts drilling, laboratory analyses, construction equipment and other services.  These costs are passed directly through to customers and, in accordance with industry practice, are included in gross revenue.  Because subcontractor costs and direct charges can vary significantly from project to project, the Company

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considers NSR, which is gross revenue less subcontractor costs and direct charges, as its primary measure of revenue growth.

The following table presents the percentage relationships of items in the Condensed Consolidated Statements of Income to NSR:

Gross revenue decreased $1.5 million, or 1.5%, to $95.8 million during the three months ended December 31, 2004, from $97.3 million in the same period last year.  Gross revenue decreased $2.2 million, or 1.2%, to $185.4 million during the six months ended December 31, 2004, from $187.6 million in the same period last year.  The decreases were primarily related to delays in certain business activities discussed below.

NSR decreased $1.7 million, or 2.8%, to $58.6 million during the three months ended December 31, 2004, from $60.3 million during the same period last year.  NSR increased $2.1 million, or 1.8%, to $119.0 million during the six months ended December 31, 2004, from $116.9 million during the same period last year.  Organic activities (existing business) provided $0.3 million or 13% of NSR growth for the six months ended December 31, 2004, and acquisitions provided the remaining $1.8 million or 87% of the NSR growth for the period.  Management continues to have an objective to balance organic and acquisition growth over the long-term.  For example, during the three months ended September 30, 2004, organic activities provided $3.3 million or 88% of NSR growth and acquisitions provided the remaining $0.5 million or 12% of the NSR growth.  Acquisition growth was purposely limited in the six months ended December 31, 2003 because during that fiscal year management focused on improving efficiencies in the overall core business as opposed to evaluating and implementing acquisitions.  NSR from acquired companies is considered part of acquisition growth during the twelve months following the date acquired.

NSR from organic activities decreased during the three months ended December 31, 2004 compared to the same period last year, primarily due to the temporary postponement of several large government-related emissions tests and the unexpected softness in the transportation market which resulted in an estimated NSR and operating income decrease of approximately $1.8 million.  The impact of these delays was partially offset by adjustments to the

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estimates at completion on certain Exit Strategy contracts which contributed approximately $1.0 million to NSR and operating income during the six months ended December 31, 2004.

Costs of services decreased $0.4 million, or 0.7%, to $49.7 million for the three months ended December 31, 2004, from $50.1 million during the same period last year.  Costs of services increased $2.4 million, or 2.5%, to $99.9 million for the six months ended December 31, 2004, from $97.5 million during the same period last year.  As a percentage of NSR, cost of services increased to 84.8% from 83.0% and to 84.0% from 83.5% for the three and six month periods ended December 31, 2004, respectively, when compared to the same periods last year.  The increase in the percentage for the three months ended December 31, 2004 was primarily attributed to the decrease in NSR from organic activities, which is discussed above, and the resulting increase in non-billable labor costs.

General and administrative expenses (G&A) increased $0.5 million, or 24.1%, to $2.7 million for the three months ended December 31, 2004, from $2.2 million during the same period last year.  G&A increased $0.5 million, or 11.3%, to $4.9 million for the six months ended December 31, 2004, from $4.4 million during the same period last year.  G&A for the three months ended December 31, 2004, includes approximately $0.4 million of costs associated with compliance with Section 404 of the Sarbanes-Oxley Act of 2002.  As a percentage of NSR, G&A increased to 4.6% from 3.6% and to 4.2% from 3.8% for the three and six month periods ended December 31, 2004, respectively, when compared to the same periods last year.

Depreciation and amortization expense increased $0.1 million, or 5.9%, to $1.5 million for the three months ended December 31, 2004, from $1.4 million during the same period last year.    Depreciation and amortization expense increased $0.1 million, or 3.9%, to $3.0 million for the six months ended December 31, 2004, from $2.9 million during the same period last year.  As a percentage of NSR, depreciation and amortization expense increased to 2.6% from 2.4% and to 2.5% from 2.4% for the three and six month periods ended December 31, 2004, respectively, when compared to the same periods last year.

As a result of the above factors, income from operations decreased by $1.9 million to $4.7 million during the three months ended December 31, 2004, from $6.6 million in the same period last year.  Income from operations decreased by $0.9 million to $11.1 million during the six months ended December 31, 2004, from $12.0 million in the same period last year.  For the six months ended December 31, 2004, operating income from organic activities decreased $1.0 million, while operating income from acquisitions was $0.1 million.

In October 2004, the Company exercised an option to redeem its investment in an environmental liability management company formed by a customer.  As a result, the Company will receive $0.9 million and expects to recognize a gain of $0.8 million, net of its initial investment, in the quarter ending March 31, 2005 as non-operating income.  The amount earned was related to cost savings generated on an environmental remediation program.

The provision for federal and state income taxes reflects an effective rate of 41.0% for the three and six months ended December 31, 2004 compared to an effective rate of 41.0% and 40.5%, respectively, for the same period last year.  This increase was primarily due to higher state income taxes.  The Company believes that there will be sufficient taxable income in future periods to enable utilization of available deferred income tax benefits.

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The Company changed its method of accounting for its 19.9% investment in a start-up energy savings company from the cost method to the equity method, effective July 1, 2004.  The cumulative effect of the accounting change decreased net income for the six months ended December 31, 2004 by $589 (net of income taxes of $409) or $0.04 per diluted share.  Had the Company adopted Emerging Issues Task Force 03-16 as of July 1, 2003, it would have recorded no additional income or losses related to this investment, therefore application would have had no impact on net earnings of the Company.  See Note 2 to the Notes to the Condensed Consolidated Financial Statements on page 6 of this report for a further discussion of this item.

Impact of Inflation

The Company’s operations have not been materially affected by inflation or changing prices because of the short-term nature of many of its contracts and the fact that most contracts of a longer term are subject to adjustment or have been priced to cover anticipated increases in labor and other costs.

Liquidity and Capital Resources

The Company primarily relies on cash from operations and financing activities, including borrowings based upon the strength of its balance sheet, to fund operations.  The Company’s liquidity is assessed in terms of its overall ability to generate cash to fund its operating and investing activities and to reduce debt.  Of particular importance in the management of liquidity are cash flows generated from operating activities, acquisitions, capital expenditure levels and an adequate bank line of credit.

Cash flows provided by operating activities for the six months ended December 31, 2004 were $7.3 million, compared to $3.6 million during the same period last year.  During the six months ended December 31, 2004, the cash provided by: (1) the $5.4 million of net income; (2) the $3.0 million of non-cash charges for depreciation and amortization; (3) the $5.2 million increase in billings in advance of revenue earned; and (4) the $5.7 million increase in accounts payable was primarily offset by the $13.3 million increase in total accounts receivable resulting from the Company’s revenue growth and, to a lesser extent, the $2.2 million decrease in accrued compensation and benefits.  Accounts receivable increased at a slightly faster pace than gross revenue primarily due to the timing of gross revenue resulting from the recording of subcontractor efforts on Exit Strategy and other construction contracts.

Investing activities used cash of approximately $11.1 million during the six months ended December 31, 2004, compared to $5.3 million during the same period last year, primarily because of the Company’s planned, temporary reduction in acquisitions in the prior period.  The investments in the current period consisted of $8.1 million for acquisitions (approximately $6.1 million for current year acquisitions and approximately $2.0 million for additional purchase price payments related to acquisitions completed in prior years) and approximately $2.2 million of capital expenditures for additional information technology and other equipment to support business growth.  Also, the Company expects to make capital expenditures of approximately $2.5 million during the remainder of fiscal 2005.

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