EXHIBIT 13.1

 

SELECTED FINANCIAL DATA

 

The following table shows our selected consolidated financial information and has been derived from our audited financial statements. This financial information should be read in conjunction with, and is qualified by reference to, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the notes thereto included elsewhere in this exhibit.

 

(in thousands, except per share information)

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

 

The following discussion should be read in conjunction with our “Selected Financial Data” and our consolidated financial statements and related notes. The discussion in this section contains forward-looking statements that involve risks and uncertainties. These forward-looking statements are based on our current expectations about future events. These expectations are subject to risks and uncertainties, many of which are beyond our control. For a discussion of important risk factors that could cause actual results to differ materially from those described or implied by the forward-looking statements contained herein, see the “Note with Respect to Forward-Looking Statements” and “Risk Factors” sections included in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

Business Overview and Environment

 

We provide engineering expertise for public and private sector clients worldwide, with our Transportation and Federal business segments providing a variety of services to our markets. The Transportation segment provides services for Transportation, Aviation, and Rail & Transit markets and the Federal segment provides services for Defense, Environmental, Architecture, Geospatial Information Technology, Homeland Security, Municipal & Civil, Pipelines & Utilities and Water markets. Among the services we provide to clients in these markets are program management, design-build (for which we provide only the design portion of services), construction management, consulting, planning, surveying, mapping, geographic information systems, architectural and interior design, construction inspection, constructability reviews, site assessment and restoration, strategic regulatory analysis and regulatory compliance. We view our short and long-term liquidity as being dependent upon our results of operations, changes in working capital and our borrowing capacity. Our financial results are impacted by appropriations of public funds for infrastructure and other government-funded projects, capital spending levels in the private sector, and the demand for our services in the various engineering markets in which we compete.

 

On May 3, 2010, we acquired 100% of the outstanding shares of The LPA Group Incorporated and substantially all of its subsidiaries and affiliates (“LPA”), an engineering, architectural and planning firm specializing primarily in the planning and design of airports, highways, bridges and other transportation infrastructure, headquartered in Columbia, South Carolina. The majority of LPA’s clients are state and local governments as well as construction companies that serve those markets. Founded in 1981, LPA has a national reputation in the transportation consulting industry. With more than 35 offices across the United States (“U.S.”), LPA is consistently ranked in the Top 500 Design Firms by Engineering News-Record. The LPA acquisition has significantly expanded our presence in the southeastern U.S. Transportation market, and broadened our existing capabilities in planning, design, program management, and construction management in the Aviation, Highway, Bridge and Rail & Transit markets. LPA’s results are reflected in our Transportation segment for the period from May 3, 2010 through December 31, 2010.

 

We have significantly increased our revenues from U.S. federal government contracting in recent years and continue to view this as an important market, particularly the Department of Defense and the Department of Homeland Security. The Department of Homeland Security’s Federal Emergency Management Agency (“FEMA”), awarded BakerAECOM, LLC (“BakerAECOM”), a Delaware limited liability company of which we are the managing member, an Indefinite-Delivery/Indefinite-Quantity (“IDIQ”) contract for Production and Technical Services for FEMA’s Risk Mapping, Analysis and Planning Program (“Risk MAP Program”) on March 9, 2009. In February 2009, the U.S. Congress passed the American Recovery and Reinvestment Act of 2009, which contained approximately $130 billion for highways, buildings and other public works projects through December 31, 2010. We have benefited from work that the Federal government as well as state and local governments have procured as a result of this legislation, particularly in transportation design and construction phase services. In March 2010, the current legislation for transportation — the Safe, Accountable, Flexible, Efficient Transportation Equity Act — A Legacy for Users (“SAFETEA-LU”) was extended by Congress through March 31, 2011. Although this extension provides funding for transportation infrastructure projects through the first quarter of 2011, the level of funding, and whether further extensions of the program will occur based on the outcome of the Federal deficit debate in Congress, is uncertain. As a result, our key transportation clients are continuing to exercise a significant amount of caution in granting new infrastructure projects or entering into extensions of existing commitments. We presently expect that this trend will continue for the foreseeable future.

 

Our significant contracts awarded during 2010 and early 2011 include:

 

 

 

In addition, Baker is the lead architectural and engineering firm on a Kiewit-Mortenson joint venture. This Kiewit-Mortenson joint venture is one of seven companies to be awarded a multiple award construction contract (“MACC”) by the NAVFAC — Pacific to compete for design and construction projects on Guam and other areas in the NAVFAC Pacific area. The total capacity of the combined MACC contract for construction of facilities and infrastructure is $4.0 billion, with each of the seven contracts being for a twelve-month base period with four, one-year option periods.

 

Our five-year IDIQ contract with FEMA for up to $750 million to serve as the program manager to develop, plan, manage, implement and monitor the Multi-Hazard Flood Map Modernization Program (“FEMA Map Mod Program”) for flood hazard mitigation across the U.S. and its territories was scheduled to conclude on March 10, 2009. FEMA added a contract provision that extended the ordering period through September 2010. As of December 31, 2010, approximately $12 million is in our funded backlog related to this program. We expect work and revenue related to our current authorizations to continue through 2011.

 

Discontinued Operations — Energy

 

In our 2009 filings, we presented an Engineering and an Energy business segment. Our former Energy segment (“Baker Energy”) provided a full range of services for operating third-party oil and gas production facilities worldwide. On September 30, 2009, we divested substantially all of our subsidiaries that pertained to our former Energy segment (the “Energy sale”). Additionally, we sold our interest in B.E.S. Energy Resources Company, Ltd. (“B.E.S.”), an Energy company, on December 18, 2009 to J.S. Technical Services Co., LTD., which is owned by our former minority partner in B.E.S. As such, the Energy business has been reclassified into “discontinued operations” in our accompanying consolidated financial statements. The results for the years ended December 31, 2010, 2009 and 2008 give effect to the dispositions.

 

Executive Overview

 

Our earnings per diluted common share for continuing operations were $1.60 for the year ended December 31, 2010, compared to $2.75 per diluted common share reported for 2009. Our total earnings per diluted common share were $1.33 for the year ended December 31, 2010, compared to $3.01 per diluted common share reported for the same period in 2009.

 

Our revenues from continuing operations were $499.4 million for the year ended December 31, 2010, a 12% increase from the $445.2 million reported for the same period in 2009. This increase in revenues was driven by $58.5 million of revenues from LPA, which was acquired in the second quarter of 2010, and increases in other key Transportation segment projects, offset by a decrease in revenues in our Federal segment.

 

Income from continuing operations for the year ended December 31, 2010 was $14.7 million, compared to $24.6 million for the same period in 2009. These results were driven by a decrease in our Federal segment’s work performed on the FEMA Map Mod Program contract and for our unconsolidated joint venture in Iraq, as well as an overall increase in our selling, general and administrative (“SG&A”) expenses driven primarily by the LPA acquisition. In addition, income from our unconsolidated subsidiary, Stanley Baker Hill, LLC (“SBH”), decreased by $5.9 million

year over year. These decreases were offset by an increase in revenues and margins in our Transportation segment, which includes the results of LPA, and a year-over-year decrease in our incentive compensation costs, partially offset by amortization expense for intangible assets related to the LPA acquisition.

 

We had a loss from discontinued operations related to our former Energy segment of $2.5 million for 2010, as compared to income of $2.3 million for the same period in 2009. The 2010 loss from discontinued operations was primarily attributable to the unfavorable development of legacy insurance claims and foreign tax accruals related to our former Energy business.

 

Results of Operations

 

Comparisons of the Year Ended December 31, 2010 and 2009

 

Revenues

 

Our revenues totaled $499.4 million for 2010 compared to $445.2 million for 2009, reflecting an increase of $54.2 million or 12%. This increase was driven by our Transportation segment, including $58.5 million of revenues from LPA which was acquired in the second quarter 2010, offset by a decrease in revenues in our Federal segment.

 

Transportation.  Revenues were $276.1 million for 2010 compared to $196.3 million for 2009, reflecting an increase of $79.8 million or 41%. The following table presents Transportation revenues by client type:

 

 

This increase was primarily driven by state and local government and domestic private industry revenues totaling $58.5 million from LPA, which was acquired in the second quarter of 2010. The increase was also driven by the period-over-period increase in services provided for Pennsylvania Department of Transportation projects of $7.5 million, revenues generated as a subcontractor for various projects related to the Utah Department of Transportation for design work on the expansion of the I-15 Corridor Reconstruction project totaling $6.8 million, and increases of services provided for the New Jersey Turnpike Commission of $4.3 million, the Arizona Department of Transportation of $3.3 million and for the Alamo Regional Mobility Authority of $2.8 million, partially offset by a decrease in work performed for the New Jersey Department of Transportation of $3.7 million.

 

Federal.  Revenues were $223.3 million for 2010 compared to $248.9 million for 2009, reflecting a decrease of $25.6 million or 10%. The following table presents Federal revenues by market:

 

 

The decrease in our Federal segment’s revenues for 2010 was driven by a decrease of $20.4 million in federal government work performed for our unconsolidated subsidiary operating in Iraq and the net decrease in work performed on our FEMA contracts of $13.2 million as compared to 2009, partially offset by an increase in services provide for the NAVFAC — Atlantic Division of $5.4 million, the Department of Public Works in Montgomery County, Maryland of $2.6 million and the Alaska Department of Natural Resources of $2.2 million.

 

Total revenues from FEMA were approximately $54 million and $67 million for 2010 and 2009, respectively. This decrease is primarily a result of the FEMA Map Mod Program being in its final stages, with this decrease partially offset with revenues from the Risk MAP Program, the intended successor to FEMA Map Mod Program. As a result of

achieving certain performance levels on the FEMA Risk Map Program and FEMA Map Mod Program, we recognized revenues from project incentive awards totaling $1.4 million in 2010 compared to $3.1 million for 2009.

 

Gross Profit

 

Our gross profit totaled $99.1 million for 2010 compared to $88.0 million for 2009, reflecting an increase of $11.1 million or 13%. Gross profit expressed as a percentage of revenues was 19.8% for both 2010 and 2009. The increase in gross profit for 2010 is primarily attributable to the addition of LPA’s margin of $12.2 million (net of amortization expense of $3.7 million for intangible assets related to the acquisition), decrease in incentive compensation costs of $3.7 million and increased revenue volume and margin improvement in our Transportation segment exclusive of LPA’s results, partially offset by a decrease in our Federal segment’s revenue volume. Included in total gross profit for 2010 and 2009 were Corporate-related costs for self-insured professional liability claims of $1.6 million and $1.1 million, respectively, which were not allocated to our segments.

 

Direct labor and subcontractor costs are major components in our cost of work performed due to the project-related nature of our service businesses. Direct labor costs expressed as a percentage of revenues were 26.5% for 2010 compared to 27.5% for 2009, while subcontractor costs expressed as a percentage of revenues were 21.7% for 2010 compared to 21.5% for 2009. Direct labor costs were primarily affected by a decrease in work performed for FEMA and SBH, while subcontractor costs as a percentage of revenue remain essentially unchanged. Expressed as a percentage of revenues, direct labor decreased in both segments while subcontractor costs increased in our Transportation segment and decreased in our Federal segment period over period.

 

Transportation.  Gross profit was $53.5 million for 2010 compared to $36.3 million for 2009, reflecting an increase of $17.2 million or 47%. The increase in gross profit for 2010 is primarily attributable to improved revenue volume compared to 2009 coupled with the addition of LPA’s margin and a decrease in incentive compensation costs, partially offset by increased amortization expense for intangible assets related to the LPA acquisition. Transportation’s gross profit expressed as a percentage of revenues was 19.3% in 2010 compared to 18.5% in 2009. Gross profit expressed as a percentage of revenues increased as a result of increased margin related to project mix, as well as a decrease in incentive compensation costs totaling $1.4 million, partially offset by the aforementioned amortization expense of $3.7 million.

 

Federal.  Gross profit was $47.2 million for 2010 compared to $52.8 million for 2009, reflecting a decrease of $5.6 million or 11%. The decrease in gross profit for 2010 is primarily attributable to a decrease in revenue volume, partially offset by the decrease in incentive compensation costs. Gross profit expressed as a percentage of revenues was 21.2% for both 2010 and 2009. Gross profit expressed as a percentage of revenues was unfavorably impacted by a decrease in margin related to project mix, which was offset by a decrease in incentive compensation costs totaling $2.3 million compared to 2009.

 

Selling, General and Administrative Expenses

 

Our SG&A expenses totaled $76.8 million for 2010 compared to $57.4 million for 2009, reflecting an increase of $19.4 million or 34%. SG&A expenses for the Transportation segment were $45.1 million for 2010 compared to $28.3 million for 2009, reflecting an increase of $16.8 million or 59%. SG&A expenses for the Transportation segment expressed as a percentage of revenues increased to 16.3% for 2010 from 14.4% for 2009 driven primarily by an increase in costs related to the addition of LPA. SG&A expenses for the Federal segment were $31.6 million for 2010 compared to $28.8 million for 2009, reflecting an increase of $2.8 million or 9.7%. SG&A expenses for the Federal segment expressed as a percentage of revenues increased to 14.2% for 2010 from 11.6% for 2009 driven in part by the Federal segment’s decreased revenue volume.

 

Overhead costs are primarily allocated between the Transportation and Federal segments based on that segment’s percentage of total direct labor. As a result of the allocation, SG&A expenses by segment directly fluctuated in relation to the increases or decreases in the Transportation and Federal segment’s direct labor percentage of total direct labor. Also included in total SG&A expenses for 2010 and 2009 were Corporate-related costs of $0.1 million and $0.3 million, respectively, which were not allocated to our segments.

 

SG&A expenses increased period-over-period primarily due to additional SG&A expenses of $14.2 million from LPA, which includes amortization expense of $1.0 million for intangible assets related to the LPA acquisition. Also contributing to the increase in SG&A expenses was an increase in acquisition and integration-related costs, increased occupancy-related costs associated with significant renewal activity and the addition of new locations during the year, a favorable, non-recurring insurance settlement that was recognized in 2009, a nonrecurring indirect tax charge, and increased professional fees, partially offset by a decrease in incentive compensation costs. SG&A

expenses expressed as a percentage of revenues increased to 15.4% for 2010 from 12.9% for 2009. This overall increase in SG&A expenses expressed as a percentage of revenues is primarily driven by the aforementioned increased acquisition and integration-related costs of $2.3 million, increased occupancy-related costs of $1.1 million, favorable non-recurring insurance settlements totaling approximately $1.0 million that was recognized in 2009, a nonrecurring indirect tax charge of $0.6 million and an increase in professional fees of $0.5 million. This was offset by a reduction of incentive compensation costs of $1.6 million.

 

Other Income/(Expense)

 

“Other income/(expense)” aggregated to income of $2.4 million for 2010 compared to $7.4 million for 2009. “Other income/(expense)” is comprised primarily of equity income from our unconsolidated subsidiaries of $2.6 million for 2010 compared to $7.1 million for 2009. The decrease in equity income from our unconsolidated subsidiaries was primarily due to SBH’s current Iraq IDIQ contract ending in September 2009 and the associated decrease in work performed as existing task orders were completed. It is not anticipated that further contract funding will be added to this contract vehicle. A modest amount of currently funded task order work was extended beyond September 30, 2010 but the contract was materially complete by September 2010. SBH will be dissolved in 2011 and we anticipate any activity for this entity until dissolution will be nominal. The decrease in SBH from $7.1 million for 2009 to $1.2 million for 2010 was partially offset by an increase of $1.4 million related to the addition of LPA’s joint venture, Louisiana TIMED Managers (“LTM”), during the period. We do not anticipate LTM to maintain this level of income in future periods. Interest income increased from $0.2 million in 2009 to $0.4 million in 2010, primarily due to the increased interest earned on available for sale securities Also included in “Other income/(expense)” is a minimal amount of interest expense and currency-related gains and losses.

 

Income Taxes

 

Our provisions for income taxes from continuing operations resulted in effective income tax rates of approximately 39% and 35% for the years ended December 31, 2010 and 2009, respectively. The variance between the U.S. federal statutory rate of 35% and our effective income tax rates for these periods is primarily due to state income taxes and permanent items that are not deductible for U.S. tax purposes. In 2009, the impact of state income taxes and permanent differences was fully offset by our ability to utilize $1.4 million of foreign tax credits.

 

Loss/Income from Discontinued Operations

 

As a result of the sale of our Energy business, we have presented those results on a discontinued operations basis. The net loss from discontinued operations was $2.5 million for 2010 as compared to net income from discontinued operations of $2.3 million in 2009. As part of the Energy sale we have indemnified the buyer for certain legacy costs related to our former Energy segment in excess of amounts accrued as of the transaction date. These costs include, but are not limited to, insurance and taxes. The 2010 net loss from discontinued operations primarily related to the unfavorable development of legacy insurance claims and adjustment of foreign tax accruals related to the Energy business. Reflected in our December 31, 2010 Consolidated Balance Sheet are both liabilities and assets related to Baker Energy’s workers’ compensation, automobile and health insurances through September 30, 2009. As part of the sale of Baker Energy, the buyer agreed to assume the liabilities associated with those insurances, subject to certain indemnifications, as of September 30, 2009. However, corresponding liabilities representing the reserves associated with these insurances, including reserves for incurred but not reported claims, are included in our Consolidated Balance Sheet as those insurances are written to us, rather than to a Baker Energy entity. As such, we are required to maintain reserves for these insurances in our Consolidated Balance Sheet. As the buyer assumed the liabilities associated with these insurances as of the closing balance sheet, we have also recorded a corresponding receivable from the buyer representing the amount of the aggregate insurance liabilities as of September 30, 2009 for the Energy Business, less reimbursements made to us through December 31, 2010. We have also indemnified the buyer for any taxes in excess of the amounts accrued as of September 30, 2009.

 

The income tax benefit attributable to discontinued operations was approximately $0.2 million in 2010, as compared to a benefit for income taxes of approximately $5.5 million in 2009. During 2010, the Company incurred additional non-deductible expenses related to its discontinued operations totaling $2.5 million and paid insurance liabilities totaling $1.8 million. This had the effect of increasing the capital loss carryforward and related valuation allowance to $23.3 million and $8.2 million, respectively. Additionally, the Company’s valuation allowance against its deferred tax asset for insurance liabilities was reduced to $1.4 million as of December 31, 2010 from $2.0 million as of December 31 2009. The 2009 income tax benefit was primarily attributable to utilizing credits for taxes paid in foreign jurisdictions as

a result of generating sufficient foreign source income to offset our overall foreign loss. These benefits were partially offset by the normal course provisions for income tax during 2009 for our former Energy operations.

 

Comparisons of the Year Ended December 31, 2009 and 2008

 

Revenues

 

Our revenues totaled $445.2 million for 2009 compared to $455.9 million for 2008, reflecting a decrease of $10.7 million or 2%. This decrease was driven by our Federal segment, partially offset by an increase in revenues in our Transportation segment.

 

Transportation.  Revenues were $196.3 million for 2009 compared to $180.8 million for 2008, reflecting an increase of $15.5 million or 9%. The following table presents Transportation revenues by client type:

 

 

This increase was primarily driven by increases in work performed for the Pennsylvania Department of Transportation of $7.5 million, North Texas Tollway Authority of $2.7 million, the Ohio Department of Transportation of $2.6 million, as well as increases on several other existing projects.

 

Federal.  Revenues were $248.9 million for 2009 compared to $275.1 million for 2008, reflecting a decrease of $26.2 million or 10%. The following table presents Federal revenues by market:

 

 

The decrease in our Federal segment’s revenues for 2009 was driven by a decrease in work performed on our FEMA contracts of $26.3 million as compared to 2008, partially offset by an increase of $2.4 million in federal government work performed for our unconsolidated subsidiary operating in Iraq.

 

Total revenues from FEMA were approximately $67 million and $93 million for 2009 and 2008, respectively. This decrease is primarily a result of approaching the contract close out date for the FEMA Map Mod Program. As a result of achieving certain performance levels on the FEMA Map Mod Program, we recognized revenues from project incentive awards totaling $3.1 million and $4.1 million for 2009 and 2008, respectively.

 

Gross Profit

 

Our gross profit totaled $88.0 million for 2009 compared to $84.5 million for 2008, reflecting an increase of $3.5 million or 4%. Gross profit expressed as a percentage of revenues was 19.8% for 2009 compared to 18.5% for 2008. This increase in gross profit and gross profit expressed as a percentage of revenues was driven by margin improvement related to project mix, partially offset by a reduction in FEMA project incentive awards of $1.0 million. Total gross profit included Corporate expense of $1.1 million for 2009 versus $1.1 million of income for 2008 that was not allocated to our segments. We experienced a reduction in costs of $1.7 million related to our self-insured professional liability claims during 2008 as compared to unfavorable claims development related to our self-insured professional liability in 2009 which drove this year-over-year change in Corporate expense.

 

Direct labor and subcontractor costs are major components in our cost of work performed due to the project-related nature of our service businesses. Direct labor costs expressed as a percentage of revenues were 27.5% for 2009 compared to 25.1% for 2008, while subcontractor costs expressed as a percentage of revenues were 21.5% and

26.9% for 2009 and 2008, respectively. Expressed as a percentage of revenues, direct labor increased due to work performed for our unconsolidated subsidiary operating in Iraq, while the decrease in work related to FEMA drove the decrease in subcontractor costs period over period.

 

Transportation.  Gross profit was $36.3 million for 2009 compared to $28.7 million for 2008, reflecting an increase of $7.6 million or 26%. The increase in gross profit for 2009 is primarily attributable to an increased revenue volume and margin improvements compared to 2008. Transportation’s gross profit expressed as a percentage of revenues was 18.5% in 2009 compared to 15.9% in 2008. The increase in gross profit expressed as a percentage of revenue was driven by margin improvement related to project mix.

 

Federal.  Gross profit was $52.8 million for 2009 compared to $54.7 million for 2008, reflecting a decrease of $1.9 million or 3%. The decrease in gross profit for 2009 is primarily attributable to a decreased revenue volume and a reduction in project incentive awards of $1.0 million. Gross profit expressed as a percentage of revenues was 21.2% in 2009 compared to 19.9% in 2008. The increase in gross profit expressed as a percentage of revenue was driven by margin improvement related to project mix, offset by a decrease in project incentive awards of $1.0 million compared to 2008.

 

Selling, General and Administrative Expenses

 

Our SG&A expenses totaled $57.4 million for 2009 compared to $51.2 million for 2008, reflecting an increase of $6.2 million or 12%. SG&A expenses for the Transportation segment were $28.3 million for 2009 compared to $24.8 million for 2008, reflecting an increase of $3.5 million or 14%. SG&A expenses for the Transportation segment expressed as a percentage of revenues increased to 14.4% for 2009 from 13.8% for 2008. SG&A expenses for the Federal segment were $28.8 million for 2009 compared to $26.3 million for 2008, reflecting an increase of $2.5 million or 10%. SG&A expenses for the Federal segment expressed as a percentage of revenues increased to 11.6% for 2009 from 9.6% for 2008.

 

SG&A expenses increased year-over-year due to an increase in corporate overhead costs and an increase of $0.5 million for organic growth initiatives, partially offset by favorable insurance settlements totaling approximately $1.0 million. SG&A expenses expressed as a percentage of revenues increased to 12.9% in 2009 compared to 11.2% for 2008. This overall increase in SG&A expenses expressed as a percentage of revenues is primarily driven by the aforementioned increase for organic growth initiatives and the increase in corporate overhead costs of $3.5 million, primarily related to incentive compensation accruals, stock-based compensation, and retention costs.

 

Overhead costs are primarily allocated between the Transportation and Federal segments based on that segment’s percentage of total direct labor. As a result of the allocation, SG&A expenses by segment directly fluctuated in relation to the increases or decreases in the Transportation and Federal segment’s direct labor percentage of total direct labor. Also included in total SG&A expenses for 2009 and 2008 were Corporate-related costs of $0.3 million and $0.1 million, respectively, which were not allocated to our segments.

 

Other Income/(Expense)

 

“Other income/(expense)” aggregated to income of $7.4 million for 2009 compared to income of $3.7 million for 2008. “Other income/(expense)” primarily included equity income from our unconsolidated subsidiary of $7.1 million for 2009 compared to $3.1 million for 2008. The increase in equity income from our unconsolidated subsidiary was primarily related to improved margins on extensions of work orders being performed by our unconsolidated subsidiary operating in Iraq. Also included in “Other income/(expense)” is a minimal amount of interest income, interest expense and currency-related gains and losses.

 

Income Taxes

 

Our provisions for income taxes from continuing operations resulted in effective income tax rates of approximately 35% and 39% for the years ended December 31, 2009 and 2008, respectively.

 

The variance between the U.S. federal statutory rate of 35% and our effective income tax rates for these periods is primarily due to state income taxes and permanent items that are not deductible for U.S. tax purposes. Additionally, in 2009, the impact of state income taxes and permanent differences was fully offset by our ability to utilize $1.4 million of foreign tax credits.

Income from Discontinued Operations

 

As a result of the sale of our Energy business, we have presented those results on a discontinued operations basis. Income from discontinued operations was $2.3 million for 2009 as compared to $6.6 million in 2008, which represented a decrease of $4.3 million. These amounts are comprised as follows:

 

 

Income from Discontinued Operations Attributable to Michael Baker Corporation

 

We recorded income from discontinued operations before income taxes of approximately $2.3 million for 2009 as compared to $13.5 million for 2008. This represents a decrease as compared to the corresponding period of $11.2 million. The results of Baker Energy and B.E.S. are representative of their results through their respective sale dates, while other legacy discontinued operations costs related to the Energy business were still being incurred though the end of the 2009. The primary drivers for the year-over-year change resulted from the write-off of a bankrupt customer’s receivable balance totaling $6.0 million, accruals recorded related to an assessment received for payroll taxes of $1.9 million in one of our former international subsidiaries in 2009 and increased workers compensation expense of $1.0 million, partially offset by the favorable impact of the reversal of a $2.5 million reserve due to the settlement of a contract-related claim. The 2008 income amount benefited by the recognition of a non-recurring project incentive award of $1.1 million from a former onshore managed services client in 2008, coupled with the favorable impacts of tax penalty and interest reductions of $1.6 million and $1.6 million, respectively.

 

The income tax benefit attributable to discontinued operations was approximately $4.9 million in 2009, as compared to a provision for income taxes of approximately $6.8 million in 2008. Prior to the quarter ended September 30, 2009, we were in an overall foreign loss position for U.S. Federal income tax purposes, which precluded us from utilizing credits for taxes paid in foreign jurisdictions. However, as a result of generating sufficient foreign source income to offset our overall foreign loss, we have now concluded that we can utilize those tax credits. This resulted in the reversal of deferred tax liabilities for a net impact of $5.9 million related to unremitted foreign source earnings, which are taxable for U.S. federal tax purposes, but can be offset if there are sufficient foreign tax credits that can be utilized. Additionally, we recorded a deferred tax asset of approximately $2.0 million related to foreign tax credits. A valuation allowance totaling $1.5 million was placed against those foreign tax credits as we have concluded we will not be able to utilize those credits in future periods based on our forecasted foreign source income in future periods. In 2008 the provision for income taxes includes the normal course provisions for income taxes during the year for our former Energy operations, including income taxes in our former international operations, some of which are based on a deemed profits tax which are assessed based on revenues.

 

Loss on Sale of Energy

 

In conjunction with the sale of Baker Energy on September 30, 2009, we recorded a loss of $5.1 million. The loss for Baker Energy was the result of the recognition of transaction fees of approximately $2.2 million, the recognition of cumulative currency translation adjustments of approximately $2.2 million, and the deficiency between the net assets conveyed and the consideration received of approximately $0.6 million. The transaction fees were primarily comprised of investment banker fees of approximately $0.6 million, legal fees of approximately $0.3 million, and payments of approximately $1.3 million for an Energy management retention plan with the proceeds payable upon the sale of the business.

The loss on the sale of Baker Energy was offset by a tax benefit of approximately $0.6 million. The majority of the loss resulted in a capital loss carryforward of approximately $19.0 million for tax purposes, for which a deferred tax asset and related valuation allowance totaling $6.7 million was recorded due to our expected inability to utilize it. The Company also recorded a full valuation allowance against $2.0 million in net deferred tax assets related to Legacy Baker Energy insurance liabilities. These liabilities are reimbursable from the buyer but the related accounts receivable has already been included within the previously mentioned capital loss. Should we be able to generate capital gains within the five-year carryforward period, the reserved portion of these deferred tax assets may also be utilized; however, our current projections do not forecast sufficient capital gains necessary to utilize that asset.

 

In conjunction with the sale of B.E.S. on December 18, 2009, we recorded a loss of $0.2 million. The loss for B.E.S. included nominal fees associated with the sale of this entity.

 

Contract Backlog

 

Funded backlog consists of that portion of uncompleted work represented by signed contracts and/or approved task orders, and for which the procuring agency has appropriated and allocated the funds to pay for the work. Total backlog incrementally includes that portion of contract value for which options have not yet been exercised or task orders have not been approved. We refer to this incremental contract value as unfunded backlog. U.S. government agencies and many state and local governmental agencies operate under annual fiscal appropriations and fund various contracts only on an incremental basis. In addition, our clients may terminate contracts at will or not exercise option years. Our ability to realize revenues from our backlog depends on the availability of funding for various federal, state and local government agencies; therefore, no assurance can be given that all backlog will be realized.

 

The following table presents our contract backlog:

 

 

As of December 31, 2010, our funded backlog consisted of approximately $400 million for our Transportation segment and approximately $170 million for the Federal segment. Included in total backlog as of December 31, 2010 was $104 million of funded backlog related to LPA. Of our total funded backlog as of December 31, 2010, approximately $279 million is expected to be recognized as revenue within the next year. Additionally, we expect our sources of revenue within the next year to include recognized unfunded backlog and new work added. Due to the nature of unfunded backlog, consisting of options that have not yet been exercised or task orders that have not yet been approved, we are unable to reasonably estimate what, if any, portion of our unfunded backlog will be realized within the next year.

 

In March 2009, BakerAECOM was informed by FEMA that it has been awarded an IDIQ contract for the Risk MAP Program, which is the successor to the FEMA Map Mod Program. The resultant performance-based contract has a five-year term with a maximum contract value of up to $600 million. As of December 31, 2010, approximately $50 million is in our funded backlog and $504 million is in our unfunded backlog related to this program.

 

As of December 31, 2010 and 2009, approximately $12 million and $40 million of our funded backlog, respectively, related to the $750 million FEMA Map Mod Program contract to assist FEMA in conducting a large-scale overhaul of the nation’s flood hazard maps, which commenced late in the first quarter of 2004. This contract includes data collection and analysis, map production, product delivery, and effective program management; and seeks to produce digital flood hazard data, provide access to flood hazard data and maps via the Internet, and implement a nationwide state-of-the-art infrastructure that enables all-hazard mapping. This contract was scheduled to conclude on March 10, 2009; however, FEMA added a contract provision that extended the ordering through September 2010. We do not anticipate realizing most of the remaining contract balance ($191 million as of December 31, 2010); as such this was removed from our unfunded backlog in the first quarter of 2009. We expect modest work and revenue related to our current authorizations to continue through 2011.

Liquidity and Capital Resources

 

We have three principal sources of liquidity to fund our operations: our existing cash, cash equivalents, and investments; cash generated by operations; and our available capacity under our Unsecured Credit Agreement (“Credit Agreement”), which is with a consortium of financial institutions and provides for a commitment of $125 million through September 30, 2015.

 

The following table reflects our available funding capacity as of December 31, 2010:

 

 

Our cash flows are primarily impacted from period to period by fluctuations in working capital. Factors such as our contract mix, commercial terms, days sales outstanding (“DSO”) and delays in the start of projects may impact our working capital. In line with industry practice, we accumulate costs during a given month and then bill those costs in the following month for many of our contracts. While salary costs associated with the contracts are paid on a bi-weekly basis, certain subcontractor costs are generally not paid until we receive payment from our customers. As of December 31, 2010 and 2009, $20.6 million and $19.5 million, respectively, of our accounts payable balance is comprised of invoices with “pay-when-paid” terms. As a substantial portion of our customer base is with public sector clients, such as agencies of the U.S. Federal Government as well as Departments of Transportation for various states, we have not historically experienced a large volume of write-offs related to our receivables and our unbilled revenues on contracts in progress. We regularly assess our receivables and costs in excess of billings for collectability, and provide allowances for doubtful accounts where appropriate. We believe our reserves for doubtful accounts are appropriate as of December 31, 2010, but adverse changes in the economic environment may impact certain of our customers’ ability to access capital and compensate us for our services, as well as impact project activity for 2011. The following table represents our summarized working capital information:

 

 

 

The decrease in our working capital and current ratio in 2010 is driven by the acquisition of the LPA Group. We utilized approximately $52.4 million of our existing cash and cash equivalents for this transaction, and the acquisition generated approximately $43.8 million of goodwill, which is a non-current asset.

 

Cash Provided by Operating Activities

 

Cash provided by operating activities was $27.1 million, $36.4 million and $32.2 million for years ended December 31, 2010, 2009 and 2008, respectively. Non-cash charges for depreciation and amortization increased to $9.5 million in 2010 from $5.6 million and $5.0 million in 2009 and 2008, respectively, due to the amortization of intangible assets acquired as part of the acquisition of LPA in 2010.

Our cash provided by operating activities for 2010 resulted primarily from the net income of $12.9 million, a decrease in receivables of $10.6 million and the dividends received from our unconsolidated subsidiary of $2.6 million. Unfavorably impacting our cash provided by operating activities was an increase in our prepaid taxes as of December 31, 2010 as compared to the prior year.

 

Our total days sales outstanding in receivables and unbilled revenues, net of billings in excess, increased from 81 days at year-end 2009 to 82 days as of December 31, 2010. This slight 2010 increase in DSO was primarily driven by the decrease in revenues during in the fourth quarter of 2010 and the year over year increase in unbilled revenues, net of billings in excess.

 

Our cash provided by operating activities for 2009 resulted primarily from net income of $27.2 million and the dividends received from our unconsolidated subsidiary of $7.3 million. Also favorably impacting our cash provided by operating activities was a decrease in our prepaid balance as of December 31, 2009.

 

Cash (Used in)/Provided by Investing Activities

 

Cash used in investing activities was $53.8 million in 2010, primarily as a result of our acquisition of LPA. We disbursed $52.4 million related to the LPA acquisition in the second quarter of 2010, which is reflected as an outflow for the year ended December 31, 2010. Conversely, $10.0 million related to a net asset adjustment provision in the terms of the Energy Sale was received in 2010, and is reflected as an inflow for the year ended December 31, 2010. Cash used in investing activities for 2010 reflects $7.7 million related to the net purchases of available-for-sale securities partially offset by net cash inflows of $2.5 million related to the maturity of short-term investments.

 

Cash provided by investing activities for 2009 included approximately $37.9 million of cash conveyed to us from the buyer upon the sale of Baker Energy. This cash receipt was partially offset by existing cash of approximately $7.8 million conveyed to the buyer upon the sale of Baker Energy. This cash, which related to our former Energy business’ international operations, was reimbursed through the sale agreement net asset adjustment; however, the proceeds of the net asset adjustment were not received prior to December 31, 2009 and were reflected as an inflow of cash in 2010 as noted above. Cash provided by investing activities for 2009 also included approximately $0.9 million of net cash conveyed to us upon the sale of B.E.S. Partially offsetting the cash inflows from the sale of these businesses in 2009 was $2.5 million and $2.2 million related to the purchase of short-term investments and available-for-sale securities, respectively.

 

In addition, our cash used in investing activities for all periods presented also related to capital expenditures. The majority of our 2010 capital additions pertain to computer software purchases, office equipment and leasehold improvements related to office openings or relocations. We also acquired various assets through operating leases, which reduced the level of capital expenditures that would have otherwise been necessary to operate our business.

 

Cash (Used in)/Provided by Financing Activities

 

In 2010, in conjunction with the refinancing of our Credit Agreement, we incurred $0.6 million of costs, which are reflected as an outflow of cash from financing activities. Our other financing activities primarily related to noncontrolling interest distributions and capital contributions related to our BakerAECOM partners, excess tax expense from stock based compensation and payments on capital lease obligations partially offset by the proceeds received from the exercise of stock options for the periods presented.

 

Credit Agreement

 

On September 30, 2010, we entered into a new Credit Agreement. Our new Credit Agreement is with a consortium of financial institutions and provides for an aggregate commitment of $125.0 million revolving credit facility with a $50 million accordion option through September 30, 2015. The new arrangement increased our credit capacity by $65 million. The Credit Agreement includes a $5.0 million swing line facility and $20.0 million sub-facility for the issuance of letters of credit (“LOCs”). As of December 31, 2010 and 2009, there were no borrowings outstanding under our respective Credit Agreements and outstanding LOCs were $7.7 million and $9.4 million, respectively.

 

The Credit Agreement provides pricing options for us to borrow at the bank’s prime interest rate or at LIBOR plus an applicable margin determined by our leverage ratio based on a measure of indebtedness to earnings before interest, taxes, depreciation, and amortization (“EBITDA”). Our Credit Agreement also contains usual and customary negative covenants for a credit facility, requires us to meet minimum leverage and interest and rent coverage ratio covenants and places certain limitations on dividend payments. Our Credit Agreement also contains usual and customary

provisions regarding acceleration. In the event of certain defaults by us under the credit facility, the lenders will have no further obligation to extend credit and, in some cases, any amounts owed by us under the credit facility will automatically become immediately due and payable.

 

Although only $7.7 million of our credit capacity was utilized under this facility as of December 31, 2010, in future periods we may leverage our Credit Agreement to facilitate our growth strategy, specifically utilizing our available credit to fund strategic acquisitions. The inability of one or more financial institutions in the consortium to meet its commitment under our Credit Agreement could impact our growth strategy. Currently, we believe that we will be able to readily access our Credit Agreement as necessary.

 

Financial Condition & Liquidity

 

As of December 31, 2010, we had $77.4 million of cash & cash equivalents, as well as approximately $9.8 million in available for sale securities. Since our long-term plan is to grow both organically and through acquisitions, our management team determined that capital preservation is a critical factor in executing on this strategy. As such, the determination was made to maintain the majority of our cash balances in highly rated bonds and money market funds. We believe that this strategy to preserve our current cash position with sufficient liquidity to deploy those funds rapidly is the prudent course of action in light of our acquisition and organic growth initiatives. We principally maintain our cash & cash equivalents and bonds in accounts held by major banks and financial institutions. The majority of our funds are held in accounts in which the amounts on deposit are not covered by or exceed available insurance by the Federal Deposit Insurance Corporation. Although there is no assurance that one or more institutions in which we hold our cash & cash equivalents and bonds will not fail, we currently believe that we will be able to readily access our funds when needed.

 

We plan to utilize our cash, investments and borrowing capacity under the Credit Agreement for, among other things, short-term working capital needs, including the satisfaction of contractual obligations and payment of taxes, to fund capital expenditures, and to support strategic opportunities that management identifies. We continue to pursue growth in our core businesses and are specifically seeking to expand our engineering operations through organic growth and strategic acquisitions that align with our core competencies. We consider acquisitions, or related investments, for the purposes of geographic expansion and/or improving our market share as key components of our growth strategy and intend to use existing cash, investments and the Credit Agreement to fund such endeavors. Additionally, in February 2011, we filed a shelf registration with the Securities & Exchange Commission (“SEC”). Under the shelf registration, if and when declared effective by the SEC, we may sell, from time to time, up to $125 million of our common stock or debt securities, either individually or in units, in one or more offerings. While we have no specific plans to offer the securities covered by the registration statement, and are not required to offer the securities in the future, we believe the shelf registration will provide us with financial flexibility to fund our growth objectives, if necessary. We also periodically review our business, and our service offerings within our business, for financial performance and growth potential. As such, we may also consider realigning our current organizational structure if we conclude that such actions would further increase our operating efficiency and strengthen our competitive position over the long term.

 

On May 3, 2010, we entered into a Stock Purchase Agreement (“SPA”) to acquire 100% of the outstanding shares of LPA for $59.5 million. This transaction was funded with approximately $51.4 million of cash on hand and approximately $8.1 million of our stock. The transaction was subject to a working capital adjustment provision resulting in an additional payment of approximately $1.1 million to the former shareholders in June 2010. LPA is an engineering, architectural and planning firm specializing in the construction of airports, highways, bridges and other transportation infrastructure primarily in the southeastern United States. The majority of their clients are state and local governments, as well as construction companies that serve those markets. The acquisition was consummated because it contributes to our long-term strategic plan by enabling us to expand geographically into the southeastern United States. Additionally, this transaction strengthens our expertise in aviation, design-build and construction management services in state and local transportation markets. We anticipate continuing to utilize our cash, investments, equity and borrowing capacity for strategic acquisitions of firms that would enhance our current service offerings or allow us to expand our operations geographically, most likely domestically, in order to continue to grow our business.

 

If we commit to funding future acquisitions, we may need to issue debt or equity securities (including raising capital via our shelf registration, if and when declared effective by the SEC), add a temporary credit facility, and/or pursue other financing vehicles in order to execute such transactions. We believe that the combination of our cash and cash equivalents, investments, cash generated from operations and our existing Credit Agreement will be sufficient to meet our operating and capital expenditure requirements for the next twelve months and beyond.

Contractual Obligations and Off-Balance Sheet Arrangements

 

A summary of our contractual obligations and off-balance sheet arrangements as of December 31, 2010 are as follows:

 

 

 

Liabilities totaling $2.6 million as of December 31, 2010 recorded for uncertainty in income taxes are excluded from the above table due to the inability to make a reliable estimate of the period of any future cash settlement.

 

 

Our banks issue standby letters of credit on our behalf under the aforementioned Credit Agreement. As of December 31, 2010, the majority of our outstanding LOCs were issued to insurance companies to serve as collateral for payments the insurers are required to make under certain of our self-insurance programs. These LOCs may be drawn upon in the event that we do not reimburse the insurance companies for claims payments made on our behalf. Such LOCs renew automatically on an annual basis unless either the LOC is returned to the bank by the beneficiaries or our banks elect not to renew them.

 

Bonds are provided on our behalf by certain insurance carriers. The beneficiaries under these performance and payment bonds may request payment from our insurance carriers in the event that we do not perform under the project or if subcontractors are not paid. We do not expect any amounts to be paid under our outstanding bonds as of December 31, 2010. In addition, we believe that our bonding lines will be sufficient to meet our bid and performance bonding needs for at least the next year.

 

Critical Accounting Estimates

 

We have identified the following critical accounting estimates as those that are most important to the portrayal of our results of operations and financial condition, and which require management’s most difficult, subjective or complex judgments and estimates.

Project Cost Estimates to Complete.  We utilize the percentage-of-completion method of accounting for the majority of our contracts. Revenues for the current period on these contracts are determined by multiplying the estimated margin at completion for each contract by the project’s percentage of completion to date, adding labor costs, subcontractor costs and other direct costs incurred to date, and subtracting revenues recognized in prior periods. In applying the percentage-of-completion method, a project’s percent complete as of any balance sheet date is computed as the ratio of labor costs incurred to date divided by the total estimated labor costs at completion. Estimated labor costs at completion reflect labor costs incurred to date plus an estimate of the labor costs to complete the project. As changes in estimates of total labor costs at completion and/or estimated total losses on projects are identified, appropriate earnings adjustments are recorded during the period that the change or loss is identified. Due to the volume and varying degrees of complexity of our active projects, as well as the many factors that can affect estimated costs at completion, the computations of these estimates require the use of complex and subjective judgments. Accordingly, labor cost estimates to complete require regular review and revision to ensure that project earnings are not misstated. We have a history of making reasonably dependable estimates of costs at completion on our contracts that follow the percentage-of-completion method; however, due to uncertainties inherent in the estimation process, it is possible that estimated project costs at completion could vary from our estimates. As of December 31, 2010, we do not believe that material changes to project cost estimates at completion for any of our open projects are reasonably likely to occur.

 

Revenue Recognition.  As referenced above, we recognize revenue under the percentage-of-completion method for the majority of our contracts. Under certain circumstances, we may agree to provide new or additional services to a client without a fully executed contract or change order. In these instances, although the costs of providing these services are expensed as incurred, the recognition of related contract revenues are delayed until the contracts and/or change orders have been fully executed by the clients, other suitable written project approvals are received from the clients, or until management determines that revenue recognition is appropriate based on the probability of client acceptance. The probability of client acceptance is assessed based on such factors as our historical relationship with the client, the nature and scope of the services to be provided, and management’s ability to accurately estimate the realizable value of the services to be provided. Under this policy, we had not recognized potential future revenues estimated at $4.2 million and $3.5 million as of December 31, 2010 and 2009, respectively, for which the related costs had already been expensed as of these dates. The consistent application of this policy may result in revenues being recognized in a period subsequent to the period in which the related costs were incurred and expensed. Profit incentives and/or award fees are recorded as revenues when the amounts are both probable and reasonably estimable.

 

Income and Other Taxes.  We record our annual current tax provision based upon our book income plus or minus any permanent and temporary differences multiplied by the statutory rate in the appropriate jurisdictions where we operate. In certain foreign jurisdictions where we previously operated, income tax is based on a deemed profit methodology. The calculation of our annual tax provision may require interpreting tax laws and regulations and could result in the use of judgments or estimates which could cause our recorded tax liability to differ from the actual amount due.

 

We recognize current tax assets and liabilities for estimated taxes refundable or payable on tax returns for the current year. We also recognize deferred tax assets or liabilities for the estimated future tax effects attributable to temporary differences, net operating losses, undistributed foreign earnings, and various other credits and carryforwards. Our current and deferred tax assets and liabilities are measured based on provisions in enacted tax laws in each jurisdiction where we operate. We do not consider the effects of future changes in tax laws or rates in the current period. We analyze our deferred tax assets and place a valuation allowance on those assets if we do not expect the realization of these assets to be more likely than not.

 

Goodwill and Intangible Assets.  We account for acquired businesses using the acquisition method of accounting, which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective estimated fair values. The cost to acquire a business has been allocated to the underlying net assets of the acquired business based on estimates of their respective fair values. Intangible assets are amortized over the expected life of the asset. Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill.

 

The judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially impact our results of operations. Fair values and useful lives are determined based on, among other factors, the expected future period of benefit of the asset, the various

characteristics of the asset and projected cash flows. Because this process involves management making estimates with respect to future revenues and market conditions and because these estimates form the basis for the determination of whether or not an impairment charge should be recorded, these estimates are considered to be critical accounting estimates.

 

During the second quarter of each year and in certain other circumstances, we perform a valuation of the goodwill associated with our business. To the extent that the fair value of the business, including the goodwill, is less than the recorded value, we would write down the value of the goodwill. The valuation of the goodwill is affected by, among other things, our business plans for the future and estimated results of future operations. Changes in our business plans and/or in future operating results may have an impact on the valuation of the assets and therefore could result in our recording a related impairment charge.

 

Contingencies.  The preparation of financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, and also affect the amounts of revenues and expenses reported for each period. Specifically, management estimates are inherent in the assessment of our exposure to insurance claims that fall below policy deductibles or within self-insured retention levels and to litigation and other legal claims and contingencies, as well as in determining our liabilities for incurred but not reported insurance claims. Significant judgments by us and advice provided by third-party experts are utilized in determining probable and/or reasonably estimable amounts to be recorded or disclosed in our financial statements. The results of any changes in accounting estimates are reflected in the financial statements of the period in which the changes are determined. Based on the information that is currently available, we do not believe that material changes to these estimates are reasonably likely to occur.

 

Recent Accounting Pronouncements

 

In June 2009, the FASB issued authoritative guidance amending the timing and considerations of analyses performed to determine if our variable interests give it a controlling financial interest in a variable interest entity, as well as requiring additional disclosures. We adopted the provisions of this guidance on January 1, 2010. The adoption of this authoritative guidance did not have a material impact on our consolidated financial statements.

MICHAEL BAKER CORPORATION

 

CONSOLIDATED STATEMENTS OF INCOME

 

 

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

MICHAEL BAKER CORPORATION

 

CONSOLIDATED BALANCE SHEETS

 

 

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

MICHAEL BAKER CORPORATION

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

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

MICHAEL BAKER CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ INVESTMENT