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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(MARK ONE)
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 2003
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-7427
VERITAS DGC INC.
(Exact name of registrant as specified in its charter)
DELAWARE 76-0343152
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
10300 TOWN PARK
HOUSTON, TEXAS 77072
(Address of principal executive offices) (Zip Code)
(832) 351-8300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares of the Company's common stock, $.01 par value,
outstanding at November 30, 2003 was 33,727,077 (including 1,443,441 Veritas
Energy Services Inc. exchangeable shares which are identical to the Common Stock
in all material respects).
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TABLE OF CONTENTS
FORM 10-Q
Page Number
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Operations and Comprehensive Income (Loss) -
For the Three Months Ended October 31, 2003 and 2002 1
Consolidated Balance Sheets - October 31, 2003 and July 31, 2003 2
Consolidated Statements of Cash Flows -
For the Three Months Ended October 31, 2003 and 2002 3
Notes to Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures Regarding Market Risk 14
Item 4. Controls and Procedures 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 14
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 16
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VERITAS DGC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
THREE MONTHS ENDED
OCTOBER 31,
-------------------------------
2003 2002
--------- ---------
(In thousands, except per
share amounts)
Revenues ............................................................... $ 104,350 $ 137,507
Cost of services ....................................................... 116,835 118,712
Research and development ............................................... 3,445 3,008
General and administrative ............................................. 6,191 7,673
--------- ---------
Operating income (loss) ................................................ (22,121) 8,114
Interest expense ....................................................... 4,278 3,942
Other expense, net ..................................................... 35 1,234
--------- ---------
Income (loss) before provision for income taxes ........................ (26,434) 2,938
Income taxes (benefit) ................................................. (87) 1,375
--------- ---------
Net income (loss) ...................................................... $ (26,347) $ 1,563
========= =========
Net income (loss) per share:
Basic:
Net income (loss) per common share ................................ $ (.78) $ .05
Weighted average common shares (including exchangeable shares) .... 33,608 33,151
Diluted:
Net income (loss) per common share ................................ $ (.78) $ .05
Weighted average common shares (including exchangeable shares) .... 33,608 33,195
Comprehensive income (loss):
Net income (loss) ...................................................... $ (26,347) $ 1,563
Other comprehensive income (loss) (net of tax, $0 in all periods):
Foreign currency translation adjustments .......................... 5,365 225
Unrealized loss on investments available for sale ................. (247)
Unrealized gain on interest rate swap ............................. 462
Unrealized (loss) gain on foreign currency hedge .................. (128) 112
--------- ---------
Total other comprehensive income ....................................... 5,452 337
--------- ---------
Comprehensive income (loss) ............................................ $ (20,895) $ 1,900
========= =========
See Notes to Consolidated Financial Statements
1
VERITAS DGC INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except par value)
OCTOBER 31, 2003 JULY 31, 2003
---------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents .................................................... $ 56,346 $ 72,626
Restricted cash investments .................................................. 205 205
Accounts and notes receivable (net of allowance:
$3,419 at October; $7,953 at July) ....................................... 132,636 131,645
Materials and supplies inventory ............................................. 3,415 5,044
Prepayments and other ........................................................ 15,251 13,365
Income taxes receivable ...................................................... 13,748 11,335
--------- ---------
Total current assets ................................................... 221,601 234,220
Property and equipment ......................................................... 500,549 492,639
Less accumulated depreciation .................................................. 353,883 341,430
--------- ---------
Property and equipment, net ............................................ 146,666 151,209
Multi-client data library ...................................................... 364,963 371,949
Investment in and advances to joint ventures ................................... 4,153 4,657
Deferred tax asset ............................................................. 1,953 2,546
Other assets ................................................................... 22,214 23,781
--------- ---------
Total .............................................................. $ 761,550 $ 788,362
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current porting of long-term debt ............................................ $ 13,783 $ 13,908
Trade accounts payable ....................................................... 41,952 43,423
Accrued interest ............................................................. 515 551
Other accrued liabilities .................................................... 36,068 41,329
--------- ---------
Total current liabilities .............................................. 92,318 99,211
Non-current liabilities:
Long-term debt ............................................................... 180,055 180,317
Other non-current liabilities ................................................ 18,814 18,701
--------- ---------
Total non-current liabilities .......................................... 198,869 199,018
Stockholders' equity:
Common stock, $.01 par value; issued: 32,304,150 shares and 32,156,781 shares,
respectively (excluding common stock equivalent exchangeable shares of
subsidiary of 1,443,411 in both periods) .................................... 323 322
Additional paid-in capital ................................................... 429,418 428,402
Accumulated earnings (from August 1, 1991 with respect to Digicon Inc.) ....... 34,170 60,517
Accumulated other comprehensive income:
Cumulative foreign currency translation adjustment .......................... 8,883 3,518
Other comprehensive income (loss) ........................................... (691) (778)
Unearned compensation .......................................................... (191) (340)
Treasury stock, at cost; 89,136 shares and 84,143 shares, respectively ......... (1,549) (1,508)
--------- ---------
Total stockholders' equity ............................................. 470,363 490,133
--------- ---------
Total .............................................................. $ 761,550 $ 788,362
========= =========
See Notes to Consolidated Financial Statements
2
VERITAS DGC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED OCTOBER 31,
-------------------------------
2003 2002
--------- ---------
(In thousands)
Cash flows from operating activities:
Net income (loss) ............................................................ $ (26,347) $ 1,563
Non-cash items included in net income (loss):
Depreciation and amortization, net (other than multi-client) .............. 9,359 12,752
Amortization of multi-client library ...................................... 56,213 32,026
Impairment of land acquisition equipment .................................. 1,780
Loss on disposition of property and equipment ............................. 182 224
Equity in loss of joint venture ........................................... 249 599
Deferred taxes ............................................................ 722
Amortization of unearned compensation ..................................... 149 180
Change in operating assets/liabilities:
Accounts and notes receivable ............................................. 276 (17,799)
Materials and supplies inventory .......................................... 1,634 11,850
Prepayments and other ..................................................... (2,102) (2,520)
Income tax receivable ..................................................... (2,181) 429
Accounts payable and other accrued liabilities ............................ (7,246) (19,462)
Other ..................................................................... (481) 508
--------- ---------
Net cash provided by operating activities ............................. 30,427 22,130
Cash flows from investing activities:
Investment in multi-client data library, net cash ............................ (40,507) (37,506)
Purchase of property and equipment ........................................... (8,581) (9,385)
Sale of property and equipment ............................................... 539 92
Sale of (RC)2 software operation ............................................. 2,000
Purchase of Hampson-Russell Software Services Ltd. ........................... (9,250)
--------- ---------
Net cash used by investing activities ................................. (46,549) (56,049)
Cash flows from financing activities:
Borrowing of long-term debt, net of debt issuance costs ...................... 120,500
Payments on long-term debt ................................................... (387) (49,950)
Net proceeds from sale of common stock ....................................... 497 643
--------- ---------
Net cash provided by financing activities ............................. 110 71,193
Currency (gain) loss on foreign cash ........................................... (268) 16
--------- ---------
Change in cash and cash equivalents ............................................ (16,280) 37,290
Beginning cash and cash equivalents balance .................................... 72,626 10,586
--------- ---------
Ending cash and cash equivalents balance ....................................... $ 56,346 $ 47,876
========= =========
SCHEDULE OF NON-CASH TRANSACTIONS:
Capitalization of depreciation and amortization resulting in an increase in
multi-client data library ........................................ $ 5,355 $ 6,034
CASH PAID FOR:
Interest ............................................................ $ 3,813 $ 6,771
Taxes ............................................................... 1,372 950
See Notes to Consolidated Financial Statements
3
VERITAS DGC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
VERITAS DGC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The accompanying consolidated financial statements include our accounts and
the accounts of majority-owned domestic and foreign subsidiaries. Investment in
an 80% owned joint venture is accounted for on the equity method due to
provisions in the joint venture agreement that give minority shareholders the
right to exercise control. All material intercompany balances and transactions
have been eliminated. All material adjustments consisting only of normal
recurring adjustments that, in the opinion of management are necessary for a
fair statement of the results for the interim periods, have been reflected.
These interim financial statements should be read in conjunction with our annual
audited consolidated financial statements.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions. These estimates and assumptions affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
RECLASSIFICATION OF PRIOR YEAR BALANCES
Certain prior year balances have been reclassified for consistent
presentation.
2. BUSINESS COMBINATION
On August 21, 2002, we acquired Hampson-Russell Software Services Ltd.
("Hampson-Russell"), a Canadian provider of software tools and consulting
services related to reservoir interpretation. Under the terms of the agreement,
we acquired substantially all of the assets of Hampson-Russell in exchange for
$9.2 million in cash, 589,623 shares of our common stock (valued at $12.30 per
share), and Hampson-Russell's right to receive a percentage of the revenues
generated by the purchased assets over the five years following the closing of
the transaction, provided that certain financial targets are obtained. The
common stock price of $12.30 was based on the average closing price for our
common stock for a short period up to the transaction close date. Our allocation
of the $16.8 million purchase price was based on fair value as follows: $0.3
million of fees and expenses, $13.2 million to software, $3.9 million to
goodwill, of which none is expected to be tax deductible, $1.1 million to
accrued liabilities, $0.3 million to fixed assets and $0.2 million to other
assets. The software will be amortized over no more than five years. David B.
Robson, Veritas DGC's Chairman and Chief Executive Officer, beneficially owns a
controlling interest in Vada Industries Ltd., which was a 25% shareholder of
Hampson-Russell at the time of the acquisition. The results of operations for
Hampson-Russell began to be included in our results of operations as of August
21, 2002.
4
3. SALE OF (RC)2 SOFTWARE OPERATION
In the fourth quarter of fiscal year 2003, we decided to sell the Reservoir
Characterization Research and Consulting, Inc., "(RC)2" software operation and
entered into a letter of intent to sell it to Seismic Micro-Technology, Inc
("SMT"). We closed the sale on September 16, 2003. We recorded a charge in the
fourth quarter of fiscal year 2003 of $7.6 million related to these operations.
$5.9 million of this charge was applied to reduce the carrying value of the
(RC)2 software to its value of $2.0 million. The remaining $1.7 million
primarily relates to employee severance and facility costs. As of October 31,
2003, we have $1.1 million remaining reserved for facility costs. Under the
terms of the agreement, SMT acquired the software developed and marketed by
(RC)2 and certain related trade names and trademarks. SMT paid us a cash payment
of $2.0 million plus a percentage of the revenues from the licensing of (RC)2
software over a four-year period. The cash payment was applied to the remaining
software value. SMT also assumed certain maintenance and support obligations for
the software and granted our subsidiaries and us a royalty-free license to
continue use of all SMT software including the software being sold.
4. MULTI-CLIENT LIBRARY ACCOUNTING CHANGE
As of August 1, 2003, we changed our multi-client amortization policy to
the greater of straight-line or sales forecast method. The impact of the change
will be to record a minimum amortization of surveys from their date of
completion instead of only in the last 24 months of a survey's book life. This
change resulted in a catch-up adjustment of $22.1 million recognized as
additional amortization expense during the current fiscal year and is included
in cost of services on the "Consolidated Statements of Operations and
Comprehensive Income (Loss) ". A minimum amortization schedule, excluding the
catch-up adjustment, is shown below. This table is based upon the recorded net
book value of all surveys, both complete and in-progress, as of July 31, 2003.
However, cost of sales attributed to any survey may be higher than that
resulting from the minimum amortization due to sales during the period.
FISCAL YEAR MINIMUM AMORTIZATION
--------------------
(IN THOUSANDS)
2004 ...................................................................................... $46,928
2005 ...................................................................................... 72,024
2006 ...................................................................................... 89,465
2007 ...................................................................................... 80,535
2008 and thereafter ....................................................................... 61,269
5. OTHER EXPENSE, NET
Other expense, net consists of the following:
THREE MONTHS ENDED OCTOBER 31,
------------------------------
2003 2002
--------- --------
(IN THOUSANDS)
Interest income ................................................................ $ (234) $ (74)
Net loss on disposition of property and equipment .............................. 182 224
Net foreign currency exchange loss ............................................. 32 283
Loss from unconsolidated joint venture ......................................... 249 599
Other .......................................................................... (194) 202
------- -------
------- -------
Total ................................................................. $ 35 $ 1,234
======= =======
5
6. EARNINGS PER COMMON SHARE
Basic and diluted earnings per common share are computed as follows:
THREE MONTHS ENDED
OCTOBER 31,
-----------------------------
2003 2002
-------- --------
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
Net income (loss) .............................................................. $(26,347) $ 1,563
Basic:
Weighted average common shares (including exchangeable shares) ............... 33,608 33,151
-------- --------
Net income (loss) per share .................................................. $ (.78) $ .05
======== ========
Diluted:
Weighted average common shares (including exchangeable shares) ............... 33,608 33,151
Shares issuable from assumed exercise of options ............................. 44
-------- --------
Total ................................................................ 33,608 33,195
-------- --------
Net income (loss) per share .................................................. $ (.78) $ .05
======== ========
The following options to purchase common shares have been excluded from the
computation assuming dilution because the options' exercise prices exceed the
average market price of the underlying common shares or the options are
anti-dilutive due to a net loss.
THREE MONTHS ENDED
OCTOBER 31,
-------------------------------------------
2003 2002
---------------- ----------------
Number of options ....... 3,985,002 3,363,216
Exercise price range .... $5.25 - $55.13 $10.71 - $55.125
Expiring through ........ March 2012 March 2012
7. LONG-TERM DEBT
Long-term debt is as follows:
OCTOBER 31, 2003 JULY 31, 2003
---------------- -------------
(IN THOUSANDS)
Term A loan due February 2006 .................................................. $ 29,775 $ 29,850
Term B loan due February 2007 .................................................. 124,063 124,375
Term C loan due February 2008 .................................................. 40,000 40,000
-------- --------
Total debt ................................................................ 193,838 194,225
Less: Current portion of long-term debt ........................................ 13,783 13,908
-------- --------
Total long-term debt ...................................................... $180,055 $180,317
======== ========
On February 14, 2003, we entered into a Credit Agreement (the "Credit
Agreement") with Deutsche Bank AG, New York Branch, as Administrative Agent,
Deutsche Bank AG, Canada Branch, as Canadian Administrative Agent, and certain
other lending institutions. The facility provides term financing of $195.0
million under term A, term B and term C tranches (the "Term Loans"), a revolving
loan facility aggregating $55.0 million, including a facility for swing line
loans of up to $10.0 million and the issuance of letters of credit in an
aggregate amount of up to $40.0 million. As of October 31, 2003, there were $4.4
million in letters of credit outstanding, leaving $50.6 million available for
borrowings. Among other restrictions, the Credit Agreement prohibits us from
paying cash dividends. Proceeds from the Term Loans were used to satisfy the
obligations under our previous credit agreement and our Senior Notes.
6
The term A loan was in the original principal amount of $30.0 million,
matures in February 2006, and requires quarterly interest payments at a rate, at
our election, of LIBOR plus a margin ranging from 3.5% to 4.0% or a base rate
plus a margin ranging from 2.25% to 2.75%. These margins are based on certain of
our financial ratios. The term B loan was in the original principal amount of
$125.0 million, matures in February 2007, and requires quarterly interest
payments at a rate, at our election, of LIBOR plus 5.0%, subject to a 2% LIBOR
floor or a base rate plus 3.75%. The term C loan was in the original principal
amount of $40.0 million, matures in February 2008, and requires quarterly
interest payments at a rate, at our election, of LIBOR plus 7.5%, subject to a
3% LIBOR floor or a base rate plus 6.25%.
The term A and term B loans required quarterly combined principal payments
of $387,500 representing 0.25% of the initial principal balances. Should there
be an event of default or if an unmatured event of default exists, or the credit
rating of any of the debt is below Moody's Ba2 or S&P's BB, or our leverage
ratio as of the last day of the most recent excess cash flow calculation period
rises above certain levels, the term A and B loans also require principal
payments of 50% of the prior fiscal year's cash flow, calculated as per the loan
agreement. This payment is due 100 days after the end of the fiscal year and
results in a ratable reduction of the future required quarterly principal
payments. As our lowest debt rating by Moody's is below the minimum level, we
paid $12.4 million of principal in November 2003 related to the company's cash
flow from January 1, 2003 through July 31, 2003. Based upon this payment, our
required quarterly combined principal payments will be reduced to $356,371.
Future excess cash flow payments of this type, if any, will be based on cash
flow for full fiscal years.
Loans made under the revolving loan facility, including swing line loans,
bear interest at a variable rate determined on the date of borrowing that is
related to various base rates and margins depending upon our leverage ratio and
the location of the borrowing. The revolving loan facility expires in February
2006.
Borrowings under the Credit Agreement are secured by assets, including
equipment, vehicles, multi-client data library, intellectual property, and stock
of certain material subsidiaries, owned by us and certain of our subsidiaries.
At October 31, 2003, the carrying value of the secured assets, including
intercompany receivables, was $1.1 billion. The Credit Agreement and related
documents contain a number of covenants, including financial covenants relating
to interest coverage, leverage and net worth.
8. HEDGE TRANSACTIONS
In March 2001, we entered into a contract requiring payments in Norwegian
kroner to charter the seismic vessel M/V Seisquest. The contract requires 36
monthly payments commencing on June 1, 2001. To protect against exposure to
exchange rate risk, we entered into multiple forward contracts as cash flow
hedges effectively locking our exchange rate for Norwegian kroner to the U.S.
dollar.
On February 25, 2003, we entered into interest rate swaps in order to
reduce our exposure to the variable interest rates of the Credit Agreement
described above. These swaps, with notional amounts totaling $80.0 million,
effectively hedge 41% of our exposure to interest rate changes for the two-year
term of the swaps and had no value at inception.
Details of the interest rate swaps are summarized in the following table:
Tranche Hedged Amount Term Pay % Receive Libor Floor
-------------- ------- -------- ----- ------- -----------
(in thousands)
Term A ............. $25,000 24 months 1.86 LIBOR None
Term B ............. $55,000 24 months 2.49 LIBOR 2%
7
The values of the forward contracts and the interest rate swaps are as
follows:
OCTOBER 31, 2003 JULY 31, 2003
----------------------------------------- -----------------------------------------
FORWARD UNREALIZED FORWARD UNREALIZED
VALUE GAIN/(LOSS) FAIR VALUE VALUE GAIN FAIR VALUE
------- ----------- ---------- ------- ---------- ----------
(IN THOUSANDS)
Forward contracts .... $ 1,941 $ 504 $ 2,445 $ 2,780 $ 632 $ 3,412
Interest rate swaps ... (315) (315) (777) (777)
9. SEGMENT INFORMATION
We have two segments, land and marine operations, both of which provide
geophysical products and services to the petroleum industry. The two segments
have been aggregated as they are similar in their economic characteristics and
the nature of their products, production processes and customers. A
reconciliation of the reportable segments' results to those of the total
enterprise is given below:
THREE MONTHS ENDED
OCTOBER 31,
2003 2002
----------------------------------- ----------------------------------
SEGMENTS CORPORATE TOTAL SEGMENTS CORPORATE TOTAL
--------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
Revenues ......................................... $ 104,350 $ 104,350 $ 137,507 $ 137,507
Operating income (loss) .......................... (13,723) $ (8,398) (22,121) 16,781 $ (8,667) 8,114
Income (loss) before provision for income taxes .. (14,460) (11,974) (26,434) 15,677 (12,739) 2,938
10. STOCK BASED COMPENSATION
We account for stock based employee compensation using the intrinsic method
prescribed in Accounting Principles Board Opinion No. 25 and have adopted the
disclosure only provisions of Statement of Financial Accounting Standards No.
148. The effect on net income and earnings per share that would have been
recorded using the fair value based method for stock options is as follows:
THREE MONTHS ENDED
OCTOBER 31,
---------------------------------
2003 2002
---------- ----------
(IN THOUSANDS)
Net income (loss), as reported ................................................. $ (26,347) $ 1,563
Deduct: Total stock-based employee compensation expense determined under fair
value based method for all awards, net of related tax effects ............. 1,633 4,636
---------- ----------
Pro forma net income (loss) .................................................... $ (27,980) $ (3,073)
========== ==========
Earnings (loss) per share:
Basic - as reported ......................................................... $ (.78) $ .05
Basic - pro forma ........................................................... (.83) (.09)
Diluted - as reported ....................................................... $ (.78) $ .05
Diluted - pro forma ......................................................... (.83) (.09)
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report on Form 10-Q and the documents incorporated by reference
contain forward-looking statements, within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
These statements include statements incorporated by reference to other documents
we file with the SEC. Forward-looking statements include, among other things,
business strategy and expectations concerning industry conditions, market
position, future operations, margins, profitability, liquidity and capital
resources. Forward-looking statements generally can be identified by the use of
terminology such as "may," "will," "expect," "intend," "estimate," "anticipate"
or "believe" or similar expressions or the negatives thereof. These expectations
are based on management's assumptions and current beliefs based on currently
available information. Although we believe that the expectations reflected in
such statements are reasonable, we can give no assurance that such expectation
will be correct. You are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date of this report on
Form 10-Q. Our operations are subject to a number of uncertainties, risks and
other influences, many of which are outside our control, and any one of which,
or a combination of which, could cause our actual results of operations to
differ materially from the forward-looking statements. Important factors that
could cause actual results to differ materially from our expectations are
disclosed in "Risk Factors" and elsewhere in our Annual Report on Form 10-K.
OVERVIEW
The first quarter was a difficult start to the fiscal year. However, the
disappointing first quarter results have not materially changed our outlook for
fiscal 2004. We continue to project overall flat activity as compared to fiscal
2003, and believe the sluggish spending by our major customers could improve
beginning as early as the second quarter. We are optimistic that sales of our
data library in key areas, such as the Gulf of Mexico, will show substantial
improvement in coming months and that increased contract work will yield good
utilization of our acquisition and processing assets.
We were not alone in having difficulties over the past several quarters.
The entire seismic industry has experienced reduced sales of multi-client data,
causing several of our competitors to record large impairments to their
libraries and to move more of their acquisition assets into the contract market.
This shift has exacerbated already low pricing in that arena.
Seismic spending by the major oil companies and large independents has been
very slow, although partially offset by increased spending by some of the
national oil companies. However, the national oil companies tend to package much
of their work into large programs that encourage very aggressive bidding, as
evidenced by the extremely low pricing on recent contract awards. As a result,
our future profitability will continue to be heavily reliant on the sales of
existing multi-client data, most significantly in the Gulf of Mexico.
We are currently forecasting both multi-client and contract revenue for the
remaining quarters of the fiscal year to be substantially higher than in the
first quarter and higher than in the corresponding quarters of the prior fiscal
year. With our expectations of reduced investment in multi-client library in the
current fiscal year and lower funding levels, achievement of these higher
revenues will require higher shelf sales than we have experienced in recent
quarters. Recently, we have seen stronger interest in our library from various
customers and expect that, once calendar 2004 budgets are in place, we will be
able to close substantial deals that are in the discussion phase at this time.
Additionally, a few of our customers have commented that they may have some
"year-end money" to spend on data library in December.
9
RESULTS OF OPERATIONS
THREE MONTHS ENDED OCTOBER 31, 2003 COMPARED WITH THREE MONTHS ENDED OCTOBER 31,
2002
Revenues. Revenues decreased by 24% overall. Multi-client revenue declined
for the third consecutive quarter, down 29% primarily due to decreased sales in
the Gulf of Mexico and offshore Brazil, partially offset by increased onshore
sales in Canada and the U.S. Revenue from ongoing surveys was lower in the
current quarter, despite our higher multi-client spending, due to lower funding
of the current projects. Contract revenue decreased by 21% due to a large land
acquisition project in Peru last year as well as fewer contract marine
acquisition projects in the current quarter.
Revenues break down as follows:
Three Months Ended
October 31,
----------------------------
2003 2002
-------- --------
(In thousands)
Multi-client:
Land ............................................................ $ 13,902 $ 11,021
Marine .......................................................... 25,884 45,258
-------- --------
Subtotal .................................................. 39,786 56,279
Contract:
Land ............................................................ 36,747 48,363
Marine .......................................................... 27,817 32,865
Subtotal ................................................ 64,564 81,228
-------- --------
Total Revenues ................................................... $104,350 $137,507
======== ========
Operating income (loss). Operating income (loss) decreased from income of
$8.1 million to a loss of $22.1 million. The poor results for the quarter were
due mostly to a change in accounting for our multi-client library, which
resulted in a charge of $22.1 million (included in cost of services on the
"Consolidated Statements of Operations and Comprehensive Income (Loss)"). This
charge represents the adjustment necessary to reduce each of our surveys as of
August 1, 2003 to a balance no greater than that which would have been recorded
had the company been previously using the new method. While the sales forecast
method remains our primary means of expensing multi-client surveys, we have now
established a minimum cumulative amortization for each survey based upon
straight-line amortization over five years. The monthly expense recognized for
each survey is the greater of the amount derived by the sales forecast method or
the amount of minimum amortization. This is a change from the prior method that
provided for a minimum amortization only during the last two years of the
surveys' book lives.
Disregarding the charge for the change in accounting method, our operating
results were significantly below those of the prior comparable period. The
biggest contributor to the poor results was the fact that our multi-client
revenue was the lowest we have seen in many years, with sales of completed
surveys (shelf sales) being particularly low. However, over the past two years
our shelf sales have been lowest during the first quarter and then peaked in the
second quarter. We are projecting a similar trend for this year.
In addition to the accounting adjustment, the results of the quarter
reflect additional minimum amortization expense of $7.2 million, compared with
$0.2 million during the prior fiscal year's first quarter. The extremely low
levels of Gulf of Mexico shelf sales also detrimentally affected our
multi-client margin. Many of our surveys in the Gulf of Mexico are fully
amortized and, historically, sales of these surveys have contributed
substantially to our profitability. Contract margins were higher than in last
year's comparable quarter, although the prior fiscal period's margins reflect
several operational disruptions and low margins on the large land acquisition
job in Peru.
10
General and administrative expense declined by $1.5 million as the prior
year's first fiscal quarter includes $1.0 million of severance costs and $0.8
million of other non-recurring costs. Absent these costs, general and
administrative expense increased by $0.3 million.
Other expense, net. Other expense, net, decreased from $1.2 million to
$35,000. No single item accounts for a significant portion of the change. A
combination of increased interest income due to a higher cash balance, declining
losses from our unconsolidated Indonesian joint venture and declining foreign
currency exchange losses account for the largest portion of the change.
Income taxes. Despite the significant operating loss for the current
quarter, a tax benefit of only $87,000 was provided due to limitations on the
establishment of deferred tax assets in the U.S. and several international
jurisdictions. Similarly, profitability generated in these jurisdictions will
not result in a corresponding tax provision in the short term. As a result, our
effective tax rate for fiscal 2004 is expected to be well below the U.S.
statutory rate, assuming taxable profit is generated.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW AND LIQUIDITY
Our internal sources of liquidity are cash, cash equivalents and cash flow
from operations. External sources include public financing, equity sales,
equipment financing, our revolving loan facility, and trade credit. We believe
that our current cash balance and cash flow from operations will be adequate to
meet our liquidity needs for fiscal 2004. However, key elements of our
forecasted cash flow are increasing shelf sales of multi-client surveys and
higher contract acquisition work. Should these not occur at forecasted levels,
which are substantially higher than experienced during the first quarter, we
would need to curtail discretionary spending.
Net cash provided by operating activities increased from $22.1 million in
the first quarter of fiscal 2003 to $30.4 million in the first quarter of the
current fiscal year primarily due to less cash being used in working capital in
the current quarter. The large net loss in the current quarter was predominantly
due to the $22.1 million non-cash charge for the change in accounting for our
multi-client library and is offset in amortization of multi-client library. Net
cash used by investing activities decreased from $56.0 million in the first
quarter of 2003 to $46.5 million in the first quarter of fiscal 2004, with the
main reason being the $9.3 million used for the purchase of Hampson-Russell in
fiscal 2003. Our cash investment in multi-client library was $3.0 million higher
in the current quarter which was partially offset by $2.0 million from the sale
of (RC)2. Our capital expenditure estimate for fiscal 2004 is approximately $48
million and will be spent on replacement and upgrading of existing equipment.
For fiscal 2004, we are forecasting an approximately $120 million to $130
million cash investment in our data library. We expect to fund these investments
from our current cash balance and from internally generated cash flows. Net cash
provided by financing activities decreased from $71.2 million in the first
quarter of fiscal 2003 to $0.1 million in the first quarter of fiscal 2004. We
borrowed from our revolver in the prior fiscal year's first quarter to enhance
our cash position prior to restructuring our debt.
Free cash flow from operations is an important measure of liquidity for us.
We define free cash flow as cash from operating activities less cash
multi-client spending and capital expenditures. This non-GAAP liquidity measure
is useful as an addition to the most directly comparable GAAP measure of "net
cash provided by operating activities" because free cash flow includes
investments in operational assets and therefore presents a more complete picture
of net cash flow from ongoing operations. This measure excludes items such as
proceeds from the disposal of assets, cash paid for acquisitions and all
financing activities. Some portion of projected positive free cash flow would be
committed to items such as debt repayment obligations.
Our free cash flow for the first quarter of fiscal 2004 was negative due
primarily to investment in our multi-client library. We are forecasting lower
quarterly multi-client investment during the rest of the fiscal year. We intend
to manage our business to achieve positive free cash flow for fiscal 2004 by
maintaining flexibility in our capital and multi-client investments and
generally spending within the constraints established by our operational cash
flow.
11
A reconciliation of free cash flow to net cash provided by operating
activities is presented in the following table:
THREE MONTHS ENDED
OCTOBER 31,
-----------------------------
2003 2002
-------- --------
(In thousands)
Net cash provided by operating activities ...................................... $ 30,427 $ 22,130
Multi-client expenditures, net cash ............................................ (40,507) (37,506)
Capital expenditures ........................................................... (8,581) (9,385)
-------- --------
Free cash flow (deficit) ....................................................... $(18,661) $(24,761)
======== ========
The following represents our financial contractual obligations and
commitments as of October 31, 2003 for the specified periods:
PAYMENTS DUE
-------------------------------------------------------------------------
GREATER
CONTRACTUAL CASH OBLIGATIONS TOTAL LESS THAN 1 YEAR 1 - 3 YEARS 3 - 5 YEARS THAN 5 YEARS
---------------------------- -------- ---------------- ----------- ----------- ------------
(In thousands)
Payments due for operating lease obligations ......... $140,004 $ 37,026 $ 50,572 $ 21,111 $ 31,295
Scheduled principal payments under debt obligations .. 193,838 13,427 29,476 110,935 40,000
Forward exchange contracts ........................... 1,659 1,659
Potential payments under letters of
credit ........................................... 4,405 3,312 1,093
While we believe that we have adequate sources of funds to meet our
liquidity needs, our ability to meet our obligations depends on our future
performance, which, in turn, is subject to many factors beyond our control. Key
internal factors affecting future results include utilization levels of
acquisition and processing assets and the level of multi-client data library
licensing, all of which are driven by the external factors of exploration
spending and, ultimately, underlying commodity prices.
DEBT STRUCTURE
On February 14, 2003, we entered into a Credit Agreement (the "Credit
Agreement") with Deutsche Bank AG, New York Branch, as Administrative Agent,
Deutsche Bank AG, Canada Branch, as Canadian Administrative Agent, and certain
other lending institutions. The Credit Agreement provides term financing of
$195.0 million under term A, term B and term C tranches (the "Term Loans"), a
revolving loan facility aggregating $55.0 million, including a facility for
swing line loans of up to $10.0 million and the issuance of letters of credit in
an aggregate amount of up to $40.0 million. As of October 31, 2003, there were
$4.4 million in letters of credit outstanding, leaving $50.6 million available
for borrowings. Among other restrictions, the Credit Agreement prohibits us from
paying cash dividends. Proceeds from the Term Loans were used to satisfy the
obligations under our previous credit agreement and our Senior Notes.
The term A loan was in the original principal amount of $30.0 million,
matures in February 2006, and requires quarterly interest payments at a rate, at
our election, of LIBOR plus a margin ranging from 3.5% to 4.0% or a base rate
plus a margin ranging from 2.25% to 2.75%. These margins are based on certain of
our financial ratios. The term B loan was in the original principal amount of
$125.0 million, matures in February 2007, and requires quarterly interest
payments at a rate, at our election, of LIBOR plus 5.0%, subject to a 2% LIBOR
floor or a base rate plus 3.75%. The term C loan was in the original principal
amount of $40.0 million, matures in February 2008, and requires quarterly
interest payments at a rate, at our election, of LIBOR plus 7.5%, subject to a
3% LIBOR floor or a base rate plus 6.25%.
12
The term A and term B loans required quarterly combined principal payments
of $387,500 representing 0.25% of the initial principal balances. Should there
be an event of default or if an unmatured event of default exists, or the credit
rating of any of the debt is below Moody's Ba2 or S&P's BB, or our leverage
ratio as of the last day of the most recent excess cash flow calculation period
rises above certain levels, the term A and B loans also require principal
payments of 50% of the prior fiscal year's cash flow, calculated as per the loan
agreement. This payment is due 100 days after the end of the fiscal year and
results in a ratable reduction of the future required quarterly principal
payments. As our lowest debt rating by Moody's is below the minimum level, we
paid $12.4 million of principal in November 2003 related to the company's cash
flow from January 1, 2003 through July 31, 2003. Based upon this payment, our
required quarterly combined principal payments will be reduced to $356,371.
Future excess cash flow payments of this type, if any, will be based on cash
flow for full fiscal years.
Loans made under the revolving loan facility, including swing-line loans,
bear interest at a variable rate determined on the date of borrowing that is
related to various base rates and margins depending upon our leverage ratio and
the location of the borrowing. The revolving loan facility expires in February
2006.
Borrowings under the Credit Agreement are secured by assets, including
equipment, vehicles, multi-client data library, intellectual property, and stock
of certain material subsidiaries, owned by us and certain of our subsidiaries.
At October 31, 2003, the carrying value of the secured assets, including
intercompany receivables, was $1.1 billion. The Credit Agreement and related
documents contain a number of covenants, including financial covenants relating
to interest coverage, leverage and net worth. Proceeds from the Term Loans were
used to satisfy the obligations under the previous credit agreement and the
Senior Notes.
OFF-BALANCE SHEET INSTRUMENTS
Our limited hedging program consists of off-balance sheet instruments to
fix the U.S. dollar value of foreign currency payments to be made under a
Norwegian vessel charter and interest rate swap contracts that effectively fix
the interest rate on $80.0 million of our variable rate long - term debt. None
of these hedges are critical to our operations but they reduce our exposure to
currency and interest rate fluctuations and allow us to better plan our future
cash flows. These instruments are described in detail in Item 3, Quantitative
and Qualitative Disclosures Regarding Market Risk, as well as in Note 8 of Notes
to Consolidated Financial Statements.
CRITICAL ACCOUNTING POLICIES
While all of our accounting policies are important in assuring that we
adhere to current accounting standards, certain policies are particularly
important due to their impact on our financial statements. These are described
in detail in Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations - Significant Accounting Policies included in our
Annual Report on Form 10-K for the fiscal year ended July 31, 2003 which
description is incorporated herein by reference. Since our last annual filing we
have changed our accounting policy regarding the amortization of our
multi-client data library. This new policy is described below.
MULTI-CLIENT DATA LIBRARY
In the portion of our business known as multi-client data library, we
collect and process geophysical data for our own account and retain all
ownership rights. We license the data to multiple clients on a non-transferable
basis. We capitalize the costs associated with acquiring and processing the
multi-client data on a survey-by-survey basis (versus a pooled basis). As of
August 1, 2003, we changed our method of amortizing these cost to the greater of
straight-line over a five-year period or the sales forecast method. The sales
forecast method amortizes the capitalized cost of multi-client data in the
period revenue is recognized in an amount equal to the period revenue multiplied
by the percentage of total estimated costs to total estimated revenue.
Therefore, multi-client margins recognized in any given period are the product
of estimated costs and estimated sales and may not reflect the ultimate cash
margins recognized from a survey. The change in policy resulted in a charge of
$22.1 million to the current year as a catch-up adjustment to multi-client
amortization and is included in cost of services on the "Consolidated Statements
of Operations and Comprehensive Income (Loss)". We periodically review the
carrying value of the multi-client data library to assess whether there has been
a permanent impairment of value and then record losses when it is determined
that estimated sales will not be sufficient to cover the carrying value of the
asset.
13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK
At October 31, 2003, we had limited market risk related to foreign
currencies. In March 2001, we entered into a contract requiring payments in
Norwegian kroner to charter the seismic vessel M/V Seisquest. The contract
requires 36 monthly payments commencing on June 1, 2001. To protect against
exposure to exchange rate risk, we entered into multiple forward contracts as
cash flow hedges fixing our exchange rates for Norwegian kroner to the U.S.
dollar. The total fair value of the open forward contracts at October 31, 2003
in U.S. dollars was $2.4 million.
As of February 14, 2003, with the signing of the new Credit Agreement, we
are exposed to interest rate risk based upon fluctuations in the Libor rate. To
partially mitigate this risk, on February 25, 2003, we entered into interest
rate swaps in the notional amount of $80.0 million, effectively hedging 41% of
our exposure to interest rate fluctuations for the two-year term of the swaps.
These swaps had no value at inception.
Details of the interest rate swaps are summarized in the following table:
Tranche Hedged Amount Term Pay % Receive Libor Floor
-------------- ------- --------- ----- ------- -----------
(in thousands)
Term A ..... $25,000 24 months 1.86 Libor None
Term B ..... $55,000 24 months 2.49 Libor 2%
The fair value of the swaps on October 31, 2003 was a negative $315,000 and
is included in other accrued liabilities on the "Consolidated Balance Sheets".
ITEM 4. CONTROLS AND PROCEDURES
Our management, including the Chief Executive Officer and Chief Financial
Officer, has conducted an evaluation of the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this report
pursuant to Exchange Act Rule 13a-15. Based on that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that the disclosure
controls and procedures are effective in ensuring that information required to
be disclosed in the reports we file or submit under the Exchange Act is
recorded, processed, summarized, and reported within the time periods specified
in Securities and Exchange Commission rules and forms. There have been no
changes in our internal controls over financial reporting (as defined in Rule
13a-15(f) under the Exchange Act) identified in connection with the evaluation
described above that has materially affected, or is reasonably likely to
materially affect, our internal controls over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On September 28, 2002, we filed suit in Federal Court against one of our
customers seeking $6.8 million in damages for its failure to pay past due
invoices and for other damages. The customer, in turn, filed a counterclaim
against us alleging that the services were not properly performed, although the
counterclaim did not specify the amount of damages claimed. At the time, we
believed the facts in the matter were in our favor, however, during the third
quarter of fiscal 2003, we reserved $2.9 million of the related receivable in
response to a "going concern" qualification to the audit opinion in the
customer's Form 10-K filing. In the first quarter of fiscal 2004, this matter
was settled resulting in our recording of a $0.6 million gain, which is included
in operating profit.
On occasion, we are named as a defendant in litigation relating to our
normal business operations. Although we are insured against various business
risks to the extent we believe prudent, there is no assurance that the nature
and amount of such insurance will be adequate in every case.
14
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBITS FILED WITH THIS REPORT:
EXHIBIT
NO. DESCRIPTION
------- -----------
*31.1 -- Certification pursuant to Section 302 of the Sarbanes- Oxley Act
of 2002 by Chief Executive Officer.
*31.2 -- Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 by Chief Financial Officer.
*32.1 -- Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 by Chief Executive Officer.
*32.2 -- Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 by Chief Financial Officer.
----------
* FILED HEREWITH
b) REPORTS ON FORM 8-K
We filed three Current Reports on Form 8-K during the period covered
by this report which were dated July 31, 2003, September 3, 2003 and
October 14, 2003. All three Current Reports on Form 8-K reported
information under Item 12, Results of Operations and Financial Condition.
15
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on the 10th day of December 2003.
VERITAS DGC INC.
By: /s/ Matthew D. Fitzgerald
-------------------------------------------
MATTHEW D. FITZGERALD
Executive Vice President, Chief Financial
Officer and Treasurer
(Principal Financial Officer)
/s/ Vincent M. Thielen
-------------------------------------------
VINCENT M. THIELEN
Vice President, Corporate Controller
(Chief Accounting Officer)
16
INDEX TO EXHIBITS
EXHIBIT
NO. DESCRIPTION
------- -----------
*31.1 -- Certification pursuant to Section 302 of the Sarbanes- Oxley Act
of 2002 by Chief Executive Officer.
*31.2 -- Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 by Chief Financial Officer.
*32.1 -- Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 by Chief Executive Officer.
*32.2 -- Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 by Chief Financial Officer.
----------
* FILED HEREWITH