**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

 

| **ý** | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|------------|-----------------------------------------------------------------------------------------------|

 

**For thequarterly period ended December 31, 2004**

** **

**Commission File Number. 333-64745**

** **

**PENHALL INTERNATIONAL CORP.**

(ExactName of registrant as specified in its charter)

 

| **ARIZONA**                                                     | ** ** | **86-0634394**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State  or other jurisdiction of incorporation or organization) |       | (I.R.S.  Employer Identification Number) |

 

**1801PENHALL WAY, ANAHEIM, CA 92803**

(Addressof principal executive offices) (Zip Code)

 

**(714) 772-6450**

(Registrant’stelephone number, including area code)

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 
| **CLASS AND TITLE OF CAPITAL STOCK** | ** ** | **SHARES OUTSTANDING AS OF  FEBRUARY 14, 2005** |
|--------------------------------------|------------|-------------------------------------------------|
|                                 |       |                                            |
| Common Stock, $.01 Par  Value        |       | 986,552                                         |

 

Indicate by check mark whether the registrant (1) filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes  ý  No  o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  ý

 

 

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**PART I – FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **June 30, 2004** | ** ** | **December 31, 2004** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
|                                                                         |       |              |       |                  |       |
| ASSETS                                                                       |       |              |       |                  |       |
|                                                                         |       |              |       |                  |       |
| Current Assets:                                                              |       |              |       |                  |       |
| Cash  and cash equivalents                                                   |       | $                 | 1,076,000  |                  | $          | 44,000 |   |
| Receivables:                                                                 |       |              |       |                  |       |
| Contract and  trade receivables                                              |       | 30,386,000        |       | 29,511,000            |       |
| Contract  retentions due upon completion and acceptance of work              |       | 4,361,000         |       | 4,901,000             |       |
|                                                                         |       | 34,747,000        |       | 34,412,000            |       |
| Less allowance  for doubtful receivables                                     |       | 1,317,000         |       | 1,161,000             |       |
| Net receivables                                                              |       | 33,430,000        |       | 33,251,000            |       |
|                                                                         |       |              |       |                  |       |
| Costs and  estimated earnings in excess of billings on uncompleted contracts |       | 2,957,000         |       | 2,341,000             |       |
| Deferred tax  assets                                                         |       | 2,034,000         |       | 2,034,000             |       |
| Inventories                                                                  |       | 2,171,000         |       | 2,101,000             |       |
| Prepaid expenses  and other current assets                                   |       | 2,198,000         |       | 2,614,000             |       |
| Total current  assets                                                        |       | 43,866,000        |       | 42,385,000            |       |
|                                                                         |       |              |       |                  |       |
| Plant and  equipment, at cost:                                               |       |              |       |                  |       |
| Leasehold  improvements                                                      |       | 1,302,000         |       | 1,324,000             |       |
| Construction and  other equipment                                            |       | 115,998,000       |       | 120,082,000           |       |
|                                                                         |       | 117,300,000       |       | 121,406,000           |       |
| Less accumulated  depreciation                                               |       | 81,260,000        |       | 85,225,000            |       |
| Net plant and  equipment                                                     |       | 36,040,000        |       | 36,181,000            |       |
|                                                                         |       |              |       |                  |       |
| Goodwill                                                                     |       | 6,371,000         |       | 6,371,000             |       |
| Debt issuance  costs, net of accumulated amortization                        |       | 2,313,000         |       | 1,731,000             |       |
| Other assets,  net                                                           |       | 817,000           |       | 661,000               |       |
|                                                                         |       | $                 | 89,407,000 |                  | $          | 87,329,000 |   |
|                                                                              |            |                   |            |                       |            |  |  |  |

 

Seeaccompanying notes to the unaudited condensed consolidated financialstatements.

 

Continued

 

2

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**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| ** **                                                                                                                                                                                                               | ** ** | **June 30, 2004** | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
|                                                                                                                                                                                                                     |       |              |       |                  |       |
| LIABILITIES AND  STOCKHOLDERS’ DEFICIT                                                                                                                                                                              |       |              |       |                  |       |
|                                                                                                                                                                                                                     |       |              |       |                  |       |
| Current  liabilities:                                                                                                                                                                                                    |       |              |       |                  |       |
| Current  installments of long-term debt                                                                                                                                                                                  |       | $                 | 882,000    |                  | $          | 493,000 |   |
| Borrowings under  revolving credit facility                                                                                                                                                                              |       | —            |       | 3,000                 |       |
| Trade accounts  payable                                                                                                                                                                                                  |       | 5,664,000         |       | 4,240,000             |       |
| Accrued  liabilities and taxes payable                                                                                                                                                                                   |       | 12,857,000        |       | 12,108,000            |       |
| Current portion  of insurance reserves                                                                                                                                                                                   |       | 2,698,000         |       | 1,738,000             |       |
| Current portion  of deferred gain - sale-leaseback                                                                                                                                                                       |       | 109,000           |       | 109,000               |       |
| Billing in  excess of costs and estimated earnings on uncompleted contracts                                                                                                                                              |       | 1,526,000         |       | 1,386,000             |       |
| Total current  liabilities                                                                                                                                                                                               |       | 23,736,000        |       | 20,077,000            |       |
|                                                                                                                                                                                                                     |       |              |       |                  |       |
| Long-term debt,  excluding current installments                                                                                                                                                                          |       | 113,000           |       | 7,000                 |       |
| Long-term  portion of deferred gain - sale-leaseback                                                                                                                                                                     |       | 2,015,000         |       | 1,960,000             |       |
| Long-term  portion of insurance reserves                                                                                                                                                                                 |       | 4,878,000         |       | 5,903,000             |       |
| Senior notes                                                                                                                                                                                                             |       | 100,000,000       |       | 100,000,000           |       |
| Deferred tax  liabilities                                                                                                                                                                                                |       | 3,771,000         |       | 3,771,000             |       |
| Senior  Exchangeable Preferred stock, par value $.01 per share, redemption value  $18,602,000 and $19,613,000 at June 30, 2004 and December 31, 2004,  respectively. Authorized, issued and outstanding 10,000 shares    |       | 18,602,000        |       | 19,613,000            |       |
|                                                                                                                                                                                                                     |       |              |       |                  |       |
| Series A  Preferred stock, par value $.01 per share, redemption value $22,484,000 and  $24,007,000 at June 30, 2004 and December 31, 2004, respectively. Authorized  25,000 shares; issued and outstanding 10,428 shares |       | 22,484,000        |       | 24,007,000            |       |
|                                                                                                                                                                                                                     |       |              |       |                  |       |
| Series B  Preferred stock subject to put option, 7,688 shares outstanding at June 30,  2004 and December 31, 2004                                                                                                        |       | 7,688,000         |       | 7,688,000             |       |
|                                                                                                                                                                                                                     |       |              |       |                  |       |
| Common stock  subject to put option, 324,858 shares outstanding at June 30, 2004 and  December 31, 2004                                                                                                                  |       | 325,000           |       | 325,000               |       |
|                                                                                                                                                                                                                     |       |              |       |                  |       |
| Stockholders’  deficit:                                                                                                                                                                                             |       |              |       |                  |       |
| Series B  Preferred stock, par value $.01 per share. Authorized 50,000 shares; issued  and outstanding 11,110 shares at June 30, 2004 and December 31, 2004                                                              |       | 11,282,000        |       | 11,282,000            |       |
| Common stock,  par value $.01 per share. Authorized 5,000,000 shares; issued and outstanding  697,012 at June 30, 2004 and December 31, 2004                                                                             |       | 7,000             |       | 7,000                 |       |
| Additional  paid-in capital                                                                                                                                                                                              |       | 1,760,000         |       | 1,760,000             |       |
| Treasury stock,  at cost, 35,318 common shares at June 30, 2004 and December 31, 2004                                                                                                                                    |       | (336,000          | )          | (336,000              | )          |
| Accumulated  deficit                                                                                                                                                                                                     |       | (106,918,000      | )          | (108,735,000          | )          |
| Total  stockholders’ deficit                                                                                                                                                                                        |       | (94,205,000       | )          | (96,022,000           | )          |
| Commitments and  contingencies                                                                                                                                                                                           |       |              |       |                  |       |
|                                                                                                                                                                                                                     |       | $                 | 89,407,000 |                  | $          | 87,329,000 |   |

 

Seeaccompanying notes to the unaudited condensed consolidated financialstatements.

 

3

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**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                      | ** ** | **THREE MONTH PERIODS  ENDED DECEMBER 31,** | ** ** | **SIX MONTH PERIODS  ENDED DECEMBER 31,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                      | ** ** | **2003**                                    | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                                            |       |                                        |       |                                      |       |   |   |   |   |
| Revenues                                                        |       | $                                           | 37,875,000 |                                      | $          | 38,390,000 |   | $ | 85,399,000 |   | $ | 91,209,000 |   |
| Cost of revenues                                                |       | 27,966,000                                  |       | 29,671,000                                |       | 64,220,000 |   | 68,262,000 |   |
|                                                            |       |                                        |       |                                      |       |   |   |   |   |
| Gross profit                                                    |       | 9,909,000                                   |       | 8,719,000                                 |       | 21,179,000 |   | 22,947,000 |   |
| General and administrative expenses                             |       | 7,448,000                                   |       | 7,205,000                                 |       | 14,399,000 |   | 15,320,000 |   |
| Other operating income                                          |       | 334,000                                     |       | 262,000                                   |       | 398,000 |   | 319,000 |   |
|                                                            |       |                                        |       |                                      |       |   |   |   |   |
| Earnings from operations                                        |       | 2,795,000                                   |       | 1,776,000                                 |       | 7,178,000 |   | 7,946,000 |   |
| Interest expense                                                |       | 3,524,000                                   |       | 3,318,000                                 |       | 7,103,000 |   | 6,786,000 |   |
| Interest expense – preferred stock                         |       | —                                      |       | 1,286,000                                 |       | — |   | 2,534,000 |   |
| Other income                                                    |       | 806,000                                     |       | 28,000                                    |       | 806,000 |   | 55,000 |   |
|                                                            |       |                                        |       |                                      |       |   |   |   |   |
| Earnings (loss) before income taxes                        |       | 77,000                                      |       | (2,800,000                                | )          | 881,000 |   | (1,319,000 | ) |
| Income tax expense (benefit)                                    |       | 29,000                                      |       | (594,000                                  | )          | 335,000 |   | 498,000 |   |
|                                                            |       |                                        |       |                                      |       |   |   |   |   |
| Net earnings (loss)                                             |       | 48,000                                      |       | (2,206,000                                | )          | 546,000 |   | (1,817,000 | ) |
| Accretion of preferred stock to redemption value                |       | (1,140,000                                  | )          | —                                    |       | (2,246,000 | ) | — |   |
| Accrual of cumulative dividends on preferred stock              |       | (1,224,000                                  | )          | (1,394,000                                | )          | (2,403,000 | ) | (2,742,000 | ) |
|                                                            |       |                                        |       |                                      |       |   |   |   |   |
| Net loss applicable to common stockholders                      |       | $                                           | (2,316,000 | )                                         | $          | (3,600,000 | ) | $ | (4,103,000 | ) | $ | (4,559,000 | ) |
|                                                            |       |                                        |       |                                      |       |   |   |   |   |
| Loss per share basic and diluted                                |       | $                                           | (2.35      | )                                         | $          | (3.65 | ) | $ | (4.16 | ) | $ | (4.62 | ) |
| Weighted average number of shares outstanding basic and diluted |       | 986,552                                     |       | 986,552                                   |       | 986,552 |   | 986,552 |   |

** **

Seeaccompanying notes to the unaudited condensed consolidated financialstatements.

 

4

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**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

** **
| ** **                                                                                 | ** ** | **SIX MONTH PERIODS ENDED  DECEMBER 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2003**                                  | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                                     |       |                                      |       |   |   |
| Net earnings  (loss)                                                                       |       | $                                         | 546,000    |   | $ | (1,817,000 | ) |
| Adjustments to  reconcile net earnings (loss) to net cash provided by operating activities |       |                                      |       |   |   |
| Depreciation and  amortization                                                             |       | 7,578,000                                 |       | 6,222,000 |   |
| Interest on  preferred stock                                                               |       | —                                    |       | 2,534,000 |   |
| Amortization of  debt issuance costs                                                       |       | 580,000                                   |       | 582,000 |   |
| Provision for  doubtful receivables                                                        |       | 84,000                                    |       | 239,000 |   |
| Gains on sale of  assets, net                                                              |       | (1,117,000                                | )          | (130,000 | ) |
| Amortization of  deferred gain on sale-leaseback                                           |       | —                                    |       | (55,000 | ) |
| Changes in  operating assets and liabilities:                                              |       |                                      |       |   |   |
| Receivables                                                                                |       | 1,440,000                                 |       | (60,000 | ) |
| Inventories,  prepaid expenses, other assets and income taxes receivable                   |       | 1,913,000                                 |       | (346,000 | ) |
| Costs and  estimated earnings in excess of billings on uncompleted contracts               |       | (417,000                                  | )          | 616,000 |   |
| Trade accounts  payable, accrued liabilities, insurance reserves and income taxes payable  |       | (3,468,000                                | )          | (2,538,000 | ) |
| Billings in  excess of costs and estimated earnings on uncompleted contracts               |       | 242,000                                   |       | (140,000 | ) |
| Net cash  provided by operating activities                                                 |       | 7,381,000                                 |       | 5,107,000 |   |
|                                                                                       |       |                                      |       |   |   |
| Cash flows from  investing activities:                                                     |       |                                      |       |   |   |
| Proceeds from  sale of assets                                                              |       | 12,880,000                                |       | 381,000 |   |
| Capital  expenditures                                                                      |       | (2,875,000                                | )          | (6,458,000 | ) |
| Net cash  provided by (used in) investing activities                                       |       | 10,005,000                                |       | (6,077,000 | ) |
|                                                                                       |       |                                      |       |   |   |
| Cash flows from  financing activities:                                                     |       |                                      |       |   |   |
| Borrowings under  long-term debt                                                           |       | 27,000                                    |       | 271,000 |   |
| Repayments of  long-term debt                                                              |       | (409,000                                  | )          | (766,000 | ) |
| Borrowings under  revolving credit facility                                                |       | 127,654,000                               |       | 99,254,000 |   |
| Repayments of  revolving credit facility                                                   |       | (142,139,000                              | )          | (99,251,000 | ) |
| Debt issuance  costs                                                                       |       | (161,000                                  | )          | — |   |
| Book overdraft                                                                             |       | (514,000                                  | )          | 430,000 |   |
| Net cash used in  financing activities                                                     |       | (15,542,000                               | )          | (62,000 | ) |
|                                                                                       |       |                                      |       |   |   |
| Net change in  cash and cash equivalents                                                   |       | 1,844,000                                 |       | (1,032,000 | ) |
| Cash and cash  equivalents at beginning of period                                          |       | 184,000                                   |       | 1,076,000 |   |
| Cash and cash  equivalents at end of period                                                |       | $                                         | 2,028,000  |   | $ | 44,000 |   |
| Supplemental  disclosures of cash flow information:                                        |       |                                      |       |   |   |
| Cash paid  (received) during the period for                                                |       |                                      |       |   |   |
| Income taxes                                                                               |       | $                                         | (2,466,000 | ) | $ | 750,000 |   |
| Interest                                                                                   |       | $                                         | 6,411,000  |   | $ | 6,126,000 |   |
| Supplemental  disclosures of non cash investing and financing information:                 |       |                                      |       |   |   |
| Accretion of  preferred stock to redemption value                                          |       | $                                         | 2,246,000  |   | $ | — |   |
| Accrual of  cumulative dividends on preferred stock                                        |       | $                                         | 2,403,000  |   | $ | 2,742,000 |   |

 

Seeaccompanying notes to the unaudited condensed consolidated financialstatements.

 

5

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**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004**

**(Unaudited)**

 

**(1)****        ****Basis of Presentation**

 

The accompanying condensed consolidated financial statements are unaudited and in the opinion of management include all adjustments necessary to present fairly the information set forth therein, which consist solely of normal recurring adjustments.  All significant intercompany transactions have been eliminated and certain reclassifications have been made to prior periods’ condensed consolidated financial statements to conform to the current period presentation.

 

The Company’s business is seasonal in nature and the results of operations for these interim periods are not necessarily indicative of results for the full year.  The consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included on Form 10-K/A of Penhall International Corp. (together with its subsidiaries, the “Company”) for the year ended June 30, 2004 as certain disclosures which would substantially duplicate those contained in such audited financial statements have been omitted from this report.

 

**(2)****        ****Stock-Based Compensation**

 

As permitted by SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS No. 123”) the Company continues to apply the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”).  The Company applies the intrinsic value method as outlined in APB No. 25 and related interpretations in accounting for stock options and share units granted to employees under these programs. Under the intrinsic value method, no compensation expense is recognized if the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of the grant. The Company has certain shares of Series B Preferred stock and common stock issued under the Securities Holders Agreement.  Certain compensation charges could result if triggering events (i.e. death, disability or termination) occur.  No compensation cost has been recognized on options granted to employees for the three and six month periods ended December 31, 2004. SFAS No. 123 requires that the Company provide pro forma information regarding net loss and net loss per common share as if compensation cost for the Company’s stock option programs had been determined in accordance with the fair value method prescribed therein. The Company adopted the disclosure portion of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” requiring quarterly SFAS No. 123 pro forma disclosure.

 

Had the Company determined compensation costbased on the fair value at the grant date for its stock options under SFASNo. 123, the Company’s basic and diluted net loss available to commonstockholders per share would have been adjusted to the pro forma amounts asindicated below:

 
| ** **                                                                                                                    | ** ** | **Three months ended** | ** ** | **Six months ended**  | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                    | ** ** | **December 31, 2003**  | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** | **December 31, 2004** | ** ** |
|                                                                                                                          |       |                   |       |                  |       |   |   |   |   |
| Net loss  available to common stockholders as reported                                                                        |       | $                      | (2,316,000 | )                     | $          | (3,600,000 | ) | (4,103,000 | ) | $ | (4,559,000 | ) |
| Add:                                                                                                                          |       |                   |       |                  |       |   |   |   |   |
| Stock-based  compensation expense included in reported net loss available to common  stockholders, net of related tax effects |       | $                      | —     |                  | $          | — |   | $ | — |   | $ | — |   |
| Deduct:                                                                                                                       |       |                   |       |                  |       |   |   |   |   |
| Total  stock-based compensation expense determined under the fair value method for  all awards, net of tax effects            |       | $                      | (2,000     | )                     | $          | (2,000 | ) | $ | (6,000 | ) | $ | (5,000 | ) |
| Pro forma net  loss available to common stockholders                                                                          |       | $                      | (2,318,000 | )                     | $          | (3,602,000 | ) | $ | (4,109,000 | ) | $ | (4,564,000 | ) |
| Basic and  diluted loss per share as reported                                                                                 |       | $                      | (2.35      | )                     | $          | (3.65 | ) | $ | (4.16 | ) | $ | (4.62 | ) |
| Pro forma basic  and diluted loss per share                                                                                   |       | $                      | (2.35      | )                     | $          | (3.65 | ) | $ | (4.17 | ) | $ | (4.63 | ) |

 

6

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**(3)****        ****Loss Per Share**

 

Basic loss per share iscomputed by dividing net loss available to common stockholders by theweighted average number of common shares outstanding during the period. Dilutedloss per share is calculated by dividing net loss available to commonstockholders by the weighted average number of common shares outstanding duringthe period plus the impact of assumed potentially dilutive securities. Thedilutive effect of outstanding options is reflected in diluted per share byapplication of the treasury stock method. For the three and six month periodsended December 31, 2003 and 2004 diluted loss per share is the same asbasic loss per share as options to purchase 8,585 and 7,910 shares ofcommon stock were not included in the computation of diluted loss pershare for the three-month and six-month periods ended December 31, 2003 and2004, respectively, as the effect would have been anti-dilutive.

 

**(4)****        ****Related Party**

 

The Company has a balance dueto Bruckmann, Rosser, Sherrill & Co., Inc. (BRS) of $525,000 as of December31, 2004 related to management services. The balance due at June 30, 2004 was $375,000.

 

**(5)****        ****Change in Accounting Principle**

 

In May 2003, the FASB issuedStatement 150, “*Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity.*” Statement 150establishes standards for classifying and measuring certain financialinstruments with characteristics of both liabilities and equity. Statement No.150 requires that an issuer classify a financial instrument that is within itsscope as a liability (or an asset in some circumstances) because that financialinstrument embodies an obligation of the issuer. Statement No. 150 is effectivefor financial instruments entered into or modified after May 31, 2003, andotherwise is effective for the first interim period beginning afterJune 15, 2003, except for mandatory redeemable financial instruments of certainentities, including the Company, for which this statement is effective forfiscal periods beginning after December 15, 2003 (the Company’s fiscal2005). The Company has adopted Statement 150 effective July 1, 2004.  As a result of the adoption of Statement 150,accretion related to the Senior Exchangeable Preferred Stock and the Series APreferred Stock is treated as interest expense in the Company’s consolidatedstatements of operations.  Prior to theadoption accretion was treated as part of the determination of net lossapplicable to common stockholders.

 

**(6)****        ****Commitments and Contingencies**

 

The Company has an employmentrelated legal matter which has been substantially settled.  The Company estimates that the remainingreserves of $29,000 are sufficient based on the settlement.  

 

There are various additional lawsuitsand claims pending and claims being pursued by the Company and its subsidiariesarising out of the normal course of business. It is management’s present opinion, based in part upon the advice oflegal counsel, that the outcome of these proceedings will not have a materialeffect on the Company’s consolidated financial statements taken as a whole.

 

7

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**(7)****         CondensedConsolidating Financial Information**

 

The following consolidating financial information ispresented for purposes of complying with the reporting requirements of theGuarantor Subsidiaries. The Guarantor Subsidiaries, (Penhall Company andsubsidiaries), guarantee certain obligations of the Company, including theSenior Notes.  Separate financial statementsand other disclosures with respect to each of the individual GuarantorSubsidiaries are not presented because the Company believes that such financialstatements and other information would not, in the opinion of management,provide additional information that is material to investors.

 

The condensed consolidating financial informationpresents condensed financial statements as of June 30, 2004 and December 31,2004 and for the three and six month periods ended December 31, 2003 and 2004of:

 

a.                                       PenhallInternational Corp. on a parent company only basis (“Parent”) (carrying itsinvestments in the subsidiaries under the equity method),

 

b.                                      theGuarantor Subsidiaries (Penhall Company and subsidiaries),

 

c.                                       eliminationentries necessary to consolidate the parent company and its subsidiaries,

 

d.                                      theCompany on a consolidated basis.

 

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**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004**

**(Unaudited)**

 

**CondensedConsolidating Balance Sheet**

 
| ** **                                                                   | ** ** | **JUNE 30, 2004**            | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                   | ** ** | **PENHALL  INTERNATIONAL  CORP.** | ** ** | **PENHALL  COMPANY** | ** ** | **ELIMINATIONS** | ** ** | **CONSOLIDATED** | ** ** |
| Assets                                                                       |       |                              |       |   |   |   |   |   |   |
| Current assets:                                                              |       |                              |       |   |   |   |   |   |   |
| Receivables, net                                                             |       | $                                 | —     |   | $ | 33,430,000 |   | $ | — |   | $ | 33,430,000 |   |
| Costs and  estimated earnings in excess of billings on uncompleted contracts |       | —                            |       | 2,957,000 |   | — |   | 2,957,000 |   |
| Inventories                                                                  |       | —                            |       | 2,171,000 |   | — |   | 2,171,000 |   |
| Other current  assets                                                        |       | 114,000                           |       | 5,194,000 |   | — |   | 5,308,000 |   |
| Total current  assets                                                        |       | 114,000                           |       | 43,752,000 |   | — |   | 43,866,000 |   |
| Net plant and  equipment                                                     |       | 23,000                            |       | 36,017,000 |   | — |   | 36,040,000 |   |
| Other assets,  net                                                           |       | 1,388,000                         |       | 8,113,000 |   | — |   | 9,501,000 |   |
| Investment in  subsidiaries                                                  |       | 60,171,000                        |       | — |   | (60,171,000 | ) | — |   |
|                                                                         |       | $                                 | 61,696,000 |   | $ | 87,882,000 |   | $ | (60,171,000 | ) | $ | 89,407,000 |   |
| Liabilities and  Stockholders’ Equity (Deficit):                        |       |                              |       |   |   |   |   |   |   |
| Current  installments of long-term debt                                      |       | $                                 | —     |   | $ | 882,000 |   | $ | — |   | $ | 882,000 |   |
| Trade accounts  payable                                                      |       | 3,000                             |       | 5,661,000 |   | — |   | 5,664,000 |   |
| Accrued  liabilities and taxes payable                                       |       | 5,725,000                         |       | 7,132,000 |   | — |   | 12,857,000 |   |
| Current portion  of insurance reserves                                       |       | —                            |       | 2,698,000 |   | — |   | 2,698,000 |   |
| Current portion  of deferred gain-sale-leaseback                             |       | 109,000                           |       | — |   | — |   | 109,000 |   |
| Billings in  excess of costs and estimated earnings on uncompleted contracts |       | —                            |       | 1,526,000 |   | — |   | 1,526,000 |   |
| Total current  liabilities                                                   |       | 5,837,000                         |       | 17,899,000 |   | — |   | 23,736,000 |   |
| Long-term debt,  excluding current installments                              |       | —                            |       | 113,000 |   | — |   | 113,000 |   |
| Long-term  portion of deferred gain – sale-leaseback                    |       | 2,015,000                         |       | — |   | — |   | 2,015,000 |   |
| Long-term  portion of insurance reserves                                     |       | —                            |       | 4,878,000 |   | — |   | 4,878,000 |   |
| Senior notes                                                                 |       | 100,000,000                       |       | — |   | — |   | 100,000,000 |   |
| Deferred tax  liabilities                                                    |       | (1,050,000                        | )          | 4,821,000 |   | — |   | 3,771,000 |   |
| Senior  Exchangeable Preferred stock                                         |       | 18,602,000                        |       | — |   | — |   | 18,602,000 |   |
| Series A  Preferred stock                                               |       | 22,484,000                        |       | — |   | — |   | 22,484,000 |   |
| Series B  Preferred stock subject to put option                         |       | 7,688,000                         |       | — |   | — |   | 7,688,000 |   |
| Common stock  subject to put option                                          |       | 325,000                           |       | — |   | — |   | 325,000 |   |
| Stockholders’  equity (deficit)                                         |       | (94,205,000                       | )          | 60,171,000 |   | (60,171,000 | ) | (94,205,000 | ) |
|                                                                         |       | $                                 | 61,696,000 |   | $ | 87,882,000 |   | $ | (60,171,000 | ) | $ |  89,407,000 |   |

 

9

----

 

**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004**

**(Unaudited)**

 

**CondensedConsolidating Balance Sheet**

 

 
| ** **                                                                   | ** ** | **DECEMBER 31, 2004**             | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                   | ** ** | **PENHALL  INTERNATIONAL  CORP.** | ** ** | **PENHALL  COMPANY** | ** ** | **ELIMINATIONS** | ** ** | **CONSOLIDATED** | ** ** |
| Assets                                                                       |       |                              |       |   |   |   |   |   |   |
| Current assets:                                                              |       |                              |       |   |   |   |   |   |   |
| Receivables, net                                                             |       | $                                 | —     |   | $ | 33,251,000 |   | $ | — |   | $ | 33,251,000 |   |
| Costs and  estimated earnings in excess of billings on uncompleted contracts |       | —                            |       | 2,341,000 |   | — |   | 2,341,000 |   |
| Inventories                                                                  |       | —                            |       | 2,101,000 |   | — |   | 2,101,000 |   |
| Other current  assets                                                        |       | 95,000                            |       | 4,597,000 |   | — |   | 4,692,000 |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
| Total current  assets                                                        |       | 95,000                            |       | 42,290,000 |   | — |   | 42,385,000 |   |
| Net plant and  equipment                                                     |       | 6,000                             |       | 36,175,000 |   | — |   | 36,181,000 |   |
| Other assets,  net                                                           |       | 1,056,000                         |       | 7,707,000 |   | — |   | 8,763,000 |   |
| Investment in  subsidiaries                                                  |       | 61,168,000                        |       | — |   | (61,168,000 | ) | — |   |
|                                                                         |       | $                                 | 62,325,000 |   | $ | 86,172,000 |   | $ | (61,168,000 | )  | $ | 87,329,000 |   |
| Liabilities and  Stockholders’ Equity (Deficit):                        |       |                              |       |   |   |   |   |   |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
| Current  installments of long-term debt                                      |       | $                                 | —     |   | $ | 493,000 |   | $ | — |   | $ | 493,000 |   |
| Borrowings under  revolving credit facility                                  |       | —                            |       | 3,000 |   | — |   | 3,000 |   |
| Trade accounts  payable                                                      |       | —                            |       | 4,240,000 |   | — |   | 4,240,000 |   |
| Accrued  liabilities and taxes payable                                       |       | 5,695,000                         |       | 6,413,000 |   | — |   | 12,108,000 |   |
| Current portion  of insurance reserves                                       |       | —                            |       | 1,738,000 |   | — |   | 1,738,000 |   |
| Current portion  of deferred gain- sale-leaseback                            |       | 109,000                           |       | — |   | — |   | 109,000 |   |
| Billings in  excess of costs and estimated earnings on uncompleted contracts |       | —                            |       | 1,386,000 |   | — |   | 1,386,000 |   |
| Total current  liabilities                                                   |       | 5,804,000                         |       | 14,273,000 |   | — |   | 20,077,000 |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
| Long-term debt,  excluding current installments                              |       | —                            |       | 7,000 |   | — |   | 7,000 |   |
| Long-term  portion of deferred gain – sale-leaseback                    |       | 1,960,000                         |       | — |   | — |   | 1,960,000 |   |
| Long-term  portion of insurance reserves                                     |       | —                            |       | 5,903,000 |   | — |   | 5,903,000 |   |
| Senior notes                                                                 |       | 100,000,000                       |       | — |   | — |   | 100,000,000 |   |
| Deferred tax  liabilities                                                    |       | (1,050,000                        | )          | 4,821,000 |   | — |   | 3,771,000 |   |
| Senior  Exchangeable Preferred stock                                         |       | 19,613,000                        |       | — |   | — |   | 19,613,000 |   |
| Series A  Preferred stock                                               |       | 24,007,000                        |       | — |   | — |   | 24,007,000 |   |
| Series B  Preferred stock subject to put option                         |       | 7,688,000                         |       | — |   | — |   | 7,688,000 |   |
| Common stock  subject to put option                                          |       | 325,000                           |       | — |   | — |   | 325,000 |   |
| Stockholders’  equity (deficit)                                         |       | (96,022,000                       | )          | 61,168,000 |   | (61,168,000 | ) | (96,022,000 | ) |
|                                                                         |       | $                                 | 62,325,000 |   | $ | 86,172,000 |   | $ | (61,168,000 | ) | $ | 87,329,000 |   |

 

10

----

 

**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004**

**(Unaudited)**

 

**Condensed Consolidating Statement of Operations**

** **
| ** **                                | ** ** | **THREE MONTH PERIOD ENDED DECEMBER 31, 2003** | ** ** |
|-------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                | ** ** | **Penhall  International  Corp.**              | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                  |       | $                                              | 1,245,000  |   | $ | 37,875,000 |   | $ | (1,245,000 | ) | $ | 37,875,000 |   |
| Cost of revenues                          |       | —                                         |       | 27,966,000 |   | — |   | 27,966,000 |   |
|                                      |       |                                           |       |   |   |   |   |   |   |
| Gross profit                              |       | 1,245,000                                      |       | 9,909,000 |   | (1,245,000 | ) | 9,909,000 |   |
| General and  administrative expenses      |       | 256,000                                        |       | 7,589,000 |   | (397,000 | ) | 7,448,000 |   |
| Royalties                                 |       | —                                         |       | 848,000 |   | (848,000 | ) | — |   |
| Other operating  income, net              |       | —                                         |       | 334,000 |   | — |   | 334,000 |   |
| Equity in  earnings of subsidiary         |       | 1,374,000                                      |       | — |   | (1,374,000 | ) | — |   |
|                                      |       |                                           |       |   |   |   |   |   |   |
| Earnings from  operations                 |       | 2,363,000                                      |       | 1,806,000 |   | (1,374,000 | ) | 2,795,000 |   |
| Interest expense                          |       | 3,227,000                                      |       | 297,000 |   | — |   | 3,524,000 |   |
| Other income                              |       | 11,000                                         |       | 795,000 |   | — |   | 806,000 |   |
|                                      |       |                                           |       |   |   |   |   |   |   |
| Earnings  (loss) before income taxes |       | (853,000                                       | )          | 2,304,000 |   | (1,374,000 | ) | 77,000 |   |
| Income tax  expense (benefit)             |       | (901,000                                       | )          | 930,000 |   | — |   | 29,000 |   |
|                                      |       |                                           |       |   |   |   |   |   |   |
| Net earnings                              |       | $                                              | 48,000     |   | $ | 1,374,000 |   | $ | (1,374,000 | ) | $ | 48,000 |   |

** **

11

----

 

**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004**

**(Unaudited)**

 

**Condensed Consolidating Statement of Operations**

 
| ** **                                | ** ** | **THREE MONTH PERIOD ENDED DECEMBER 31, 2004** | ** ** |
|-------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                | ** ** | **Penhall  International  Corp.**              | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                  |       | $                                              | 1,256,000  |   | $ | 38,390,000 |   | $ | (1,256,000 | ) | $ | 38,390,000 |   |
| Cost of revenues                          |       | —                                         |       | 29,671,000 |   | — |   | 29,671,000 |   |
| Gross profit                              |       | 1,256,000                                      |       | 8,719,000 |   | (1,256,000 | ) | 8,719,000 |   |
| General and  administrative expenses      |       | 463,000                                        |       | 7,138,000 |   | (396,000 | ) | 7,205,000 |   |
| Royalties                                 |       | —                                         |       | 860,000 |   | (860,000 | ) | — |   |
| Other operating  income, net              |       | —                                         |       | 262,000 |   | — |   | 262,000 |   |
| Equity in  earnings of subsidiary         |       | 486,000                                        |       | — |   | (486,000 | ) | — |   |
| Earnings from  operations                 |       | 1,279,000                                      |       | 983,000 |   | (486,000 | ) | 1,776,000 |   |
| Interest expense                          |       | 3,146,000                                      |       | 172,000 |   | — |   | 3,318,000 |   |
| Interest expense  - preferred stock       |       | 1,286,000                                      |       | — |   | — |   | 1,286,000 |   |
| Other income                              |       | 28,000                                         |       | — |   | — |   | 28,000 |   |
| Earnings  (loss) before income taxes |       | (3,125,000                                     | )          | 811,000 |   | (486,000 | ) | (2,800,000 | ) |
| Income tax  expense (benefit)             |       | (919,000                                       | )          | 325,000 |   | — |   | (594,000 | ) |
| Net earnings  (loss)                      |       | $                                              | (2,206,000 | ) | $ | 486,000 |   | $ | (486,000 | ) | $ | (2,206,000 | ) |
|                                           |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

12

----

 

**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004**

**(Unaudited)**

 

**Condensed Consolidating Statement of Operations**

 
| ** **                                | ** ** | **SIX MONTH PERIOD ENDED DECEMBER 31, 2003** | ** ** |
|-------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                | ** ** | **Penhall  International  Corp.**            | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                  |       | $                                            | 2,705,000  |   | $ | 85,399,000 |   | $ | (2,705,000 | ) | $ | 85,399,000 |   |
| Cost of revenues                          |       | —                                       |       | 64,220,000 |   | — |   | 64,220,000 |   |
|                                      |       |                                         |       |   |   |   |   |   |   |
| Gross profit                              |       | 2,705,000                                    |       | 21,179,000 |   | (2,705,000 | ) | 21,179,000 |   |
| General and  administrative expenses      |       | 448,000                                      |       | 14,743,000 |   | (792,000 | ) | 14,399,000 |   |
| Royalties                                 |       | —                                       |       | 1,913,000 |   | (1,913,000 | ) | — |   |
| Other operating  income, net              |       | —                                       |       | 398,000 |   | — |   | 398,000 |   |
| Equity in  earnings of subsidiary         |       | 3,121,000                                    |       | — |   | (3,121,000 | ) | — |   |
|                                      |       |                                         |       |   |   |   |   |   |   |
| Earnings from  operations                 |       | 5,378,000                                    |       | 4,921,000 |   | (3,121,000 | ) | 7,178,000 |   |
| Interest expense                          |       | 6,421,000                                    |       | 682,000 |   | — |   | 7,103,000 |   |
| Other income                              |       | 11,000                                       |       | 795,000 |   | — |   | 806,000 |   |
|                                      |       |                                         |       |   |   |   |   |   |   |
| Earnings  (loss) before income taxes |       | (1,032,000                                   | )          | 5,034,000 |   | (3,121,000 | ) | 881,000 |   |
| Income tax  expense (benefit)             |       | (1,578,000                                   | )          | 1,913,000 |   | — |   | 335,000 |   |
|                                      |       |                                         |       |   |   |   |   |   |   |
| Net earnings                              |       | $                                            | 546,000    |   | $ | 3,121,000 |   | $ | (3,121,000 | ) | $ | 546,000 |   |
|                                           |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

13

----

 

**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004**

**(Unaudited)**

 

**Condensed Consolidating Statement of Operations**

 
| ** **                                | ** ** | **SIX MONTH PERIOD ENDED DECEMBER 31, 2004** | ** ** |
|-------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                | ** ** | **Penhall  International  Corp.**            | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                  |       | $                                            | 2,835,000  |   | $ | 91,209,000 |   | $ | (2,835,000 | ) | $ | 91,209,000 |   |
| Cost of revenues                          |       | —                                       |       | 68,262,000 |   | — |   | 68,262,000 |   |
| Gross profit                              |       | 2,835,000                                    |       | 22,947,000 |   | (2,835,000 | ) | 22,947,000 |   |
| General and  administrative expenses      |       | 871,000                                      |       | 15,241,000 |   | (792,000 | ) | 15,320,000 |   |
| Royalties                                 |       | —                                       |       | 2,043,000 |   | (2,043,000 | ) | — |   |
| Other operating  income, net              |       | —                                       |       | 319,000 |   | — |   | 319,000 |   |
| Equity in  earnings of subsidiary         |       | 3,356,000                                    |       | — |   | (3,356,000 | ) | — |   |
| Earnings from  operations                 |       | 5,320,000                                    |       | 5,982,000 |   | (3,356,000 | ) | 7,946,000 |   |
| Interest expense                          |       | 6,398,000                                    |       | 388,000 |   | — |   | 6,786,000 |   |
| Interest expense  - preferred stock       |       | 2,534,000                                    |       | — |   | — |   | 2,534,000 |   |
| Other income                              |       | 55,000                                       |       | — |   | — |   | 55,000 |   |
| Earnings  (loss) before income taxes |       |                                         |       |   |   |   |   |   |   |
|                                      |       | (3,557,000                                   | )          | 5,594,000 |   | (3,356,000 | ) | (1,319,000 | ) |
| Income tax  expense (benefit)             |       | (1,740,000                                   | )          | 2,238,000 |   | — |   | 498,000 |   |
| Net earnings  (loss)                      |       | $                                            | (1,817,000 | ) | $ | 3,356,000 |   | $ | (3,356,000 | ) | $ | (1,817,000 | ) |
|                                           |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

14

----

 

**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004**

**(Unaudited)**

 

**Condensed Consolidating Statement of Cash Flows**

 
| ** **                                           | ** ** | **SIX MONTH PERIOD ENDED DECEMBER 31, 2003** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                           | ** ** | **Penhall  International  Corp.**            | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Net cash  provided by operating activities           |       | $                                            | 1,203,000  |   | $ | 6,178,000 |   | $ | — |   | $ | 7,381,000 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Cash flows from  investing activities:               |       |                                         |       |   |   |   |   |   |   |
| Proceeds from  sale of assets                        |       | 11,312,000                                   |       | 1,568,000 |   | — |   | 12,880,000 |   |
| Capital  expenditures                                |       | —                                       |       | (2,875,000 | ) | — |   | (2,875,000 | ) |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Net cash  provided by (used in) investing activities |       | 11,312,000                                   |       | (1,307,000 | ) | — |   | 10,005,000 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Cash flows from  financing activities:               |       |                                         |       |   |   |   |   |   |   |
| Due to  (from) affiliates                       |       | (12,317,000                                  | )          | 12,317,000 |   | — |   | — |   |
| Borrowings under  long-term debt                     |       | —                                       |       | 27,000 |   | — |   | 27,000 |   |
| Repayments of  long-term debt                        |       | (183,000                                     | )          | (226,000 | ) | — |   | (409,000 | ) |
| Borrowings under  revolving credit facility          |       | —                                       |       | 127,654,000 |   | — |   | 127,654,000 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Repayments of  revolving credit facility             |       | —                                       |       | (142,139,000 | ) | — |   | (142,139,000 | ) |
| Debt issuance  costs                                 |       | —                                       |       | (161,000 | ) | — |   | (161,000 | ) |
| Book overdraft                                       |       | (152,000                                     | )          | (514,000 | ) | 152,000 |   | (514,000 | ) |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Net cash used in  financing activities               |       | (12,652,000                                  | )          | (3,042,000 | ) | 152,000 |   | (15,542,000 | ) |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Net change in  cash and cash equivalents             |       | (137,000                                     | )          | 1,829,000 |   | 152,000 |   | 1,844,000 |   |
| Cash and cash  equivalents at beginning of period    |       | 152,000                                      |       | 184,000 |   | (152,000 | ) | 184,000 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Cash and cash  equivalents at end of period          |       | $                                            | 15,000     |   | $ | 2,013,000 |   | $ | — |   | $ | 2,028,000 |   |
|                                                      |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

15

----

 

**PENHALLINTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2004**

**(Unaudited)**

 

**Condensed Consolidating Statement of Cash Flows**

 
| ** **                                            | ** ** | **SIX MONTH PERIOD ENDED DECEMBER 31, 2004** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                            | ** ** | **PENHALL  INTERNATIONAL  CORP.**            | ** ** | **PENHALL  COMPANY** | ** ** | **ELIMINATIONS** | ** ** | **CONSOLIDATED** | ** ** |
|                                                  |       |                                         |       |   |   |   |   |   |   |
| Net cash  provided by (used in) operating activities  |       | $                                            | (2,363,000 | ) | $ | 7,470,000 |   | $ | — |   | $ | 5,107,000 |   |
|                                                  |       |                                         |       |   |   |   |   |   |   |
| Cash flows from  investing activities:                |       |                                         |       |   |   |   |   |   |   |
| Proceeds from  sale of assets                         |       | —                                       |       | 381,000 |   | — |   | 381,000 |   |
| Capital  expenditures                                 |       | —                                       |       | (6,458,000 | ) | — |   | (6,458,000 | ) |
| Net cash  used in investing activities           |       | —                                       |       | (6,077,000 | ) | — |   | (6,077,000 | ) |
|                                                  |       |                                         |       |   |   |   |   |   |   |
| Cash flows from  financing activities:                |       |                                         |       |   |   |   |   |   |   |
| Due to  (from) affiliates                        |       | 2,359,000                                    |       | (2,359,000 | ) | — |   | — |   |
| Borrowings under  long-term debt                      |       | —                                       |       | 270,000 |   | — |   | 270,000 |   |
| Repayments of  long-term debt                         |       | —                                       |       | (765,000 | ) | — |   | (765,000 | ) |
| Borrowings under  revolving credit facility           |       | —                                       |       | 99,254,000 |   | — |   | 99,254,000 |   |
| Repayments of  revolving credit facility              |       | —                                       |       | (99,251,000 | ) | — |   | (99,251,000 | ) |
| Book overdraft                                        |       | —                                       |       | 430,000 |   | — |   | 430,000 |   |
| Net cash  provided by (used in)  financing activities |       | 2,359,000                                    |       | (2,421,000 | ) | — |   | (62,000 | ) |
|                                                  |       |                                         |       |   |   |   |   |   |   |
| Net change in  cash and cash equivalents              |       | (4,000                                       | )          | (1,028,000 | ) | — |   | (1,032,000 | ) |
| Cash and cash  equivalents at beginning of period     |       | 8,000                                        |       | 1,068,000 |   | — |   | 1,076,000 |   |
| Cash and cash  equivalents at end of period           |       | $                                            | 4,000      |   | $ | 40,000 |   | $ | — |   | $ | 44,000 |   |
|                                                       |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 2.****  Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

 

The following discussionof the results of operations and financial condition of Penhall InternationalCorp. and subsidiaries (Penhall or the Company) should be read in conjunctionwith the unaudited condensed consolidated financial statements and footnotesthereto included in this quarterly report on Form 10-Q and the Company’saudited consolidated financial statements and footnotes thereto included in itsannual report on Form 10-K, filed with the Securities and Exchange Commission.

 

***GENERAL***

 

Penhall was founded in1957 in Anaheim, California with one piece of equipment, and today is one ofthe largest operated equipment rental services companies in the United States.Penhall differentiates itself from other equipment rental companies by providingspecialized services in connection with infrastructure projects through rentingequipment along with skilled operators to serve customers in the construction,industrial, manufacturing, governmental and residential markets. In addition,Penhall complements its Operated Equipment Rental Services with fixed-pricecontracts, which serve to market its Operated Equipment Rental Servicesbusiness and increase utilization of its operated equipment rental fleet.Penhall provides its services from 37 locations in 17 states, with a presencein some of the fastest growing states in terms of construction spending andpopulation growth.

 

The operated equipment rental industry is a specialized niche of thehighly fragmented United States equipment rental industry, in which there areapproximately 17,000 companies. Penhall has taken advantage of consolidationopportunities by acquiring small companies in targeted markets as well as byestablishing new offices in those markets. Since 1998, Penhall has effectedeight strategic acquisitions, including:

 

1.                                       HSI, a Minnesota-based firm acquired inApril 1998,

 

2.                                       Daley Concrete Cutting, a South Carolina-baseddivision of U.S. Rentals acquired in October 1998,

 

3.                                       Lipscomb Concrete Cutting, a NorthCarolina-based company acquired in November 1998,

 

4.                                       Prospect Drilling and Sawing, aMinnesota-based company acquired in June 1999,

 

5.                                       Advance Concrete Sawing and Drilling, Inc., aCalifornia-based company acquired in September 2000,

 

6.                                       H&P Sawing and Drilling, a Kansas City,Missouri-based company acquired in March 2002.  Effective October 1, 2004, the Kansas Citylocation was closed.  The assets havebeen transferred to other locations,

 

7.                                       Bob Mack Company, California-based company acquired in March 2002,

 

8.                                       Arizona Curb Cut Company, an Arizona-basedcompany acquired in April 2002.

 

During the same period,Penhall established operations in six new markets by opening offices in Dallas,Richmond, Fresno, Buffalo, Reno, and Seattle. Penhall derives its revenuesprimarily from services provided for infrastructure related jobs. Penhall’sOperated Equipment Rental Services are provided primarily under hourly rentals, which are complemented byfixed-price contracts.

 

Fixed-pricecontracts are obtained primarily through competitive bidding in response toadvertisements by federal, state and local agencies and private parties and toa lesser extent through negotiation with private parties. Our bidding activityis affected by such factors as backlog, current utilization of equipment and otherresources, our ability to obtain necessary surety bonds and competitiveconsiderations. Bidding activity, backlog and revenue resulting from the awardof new contracts may vary significantly from period to period.

 

The two primary economic drivers of ourbusiness are (1) federal, state and local public funding levels fortransportation and other infrastructure projects and (2) the overallhealth of the economy, nationally and locally, particularly as it affectsprivate non-residential construction. The level of demand for our services willhave a direct correlation to these drivers. For example, a weak economy willgenerally result in a reduced demand for construction in the private sector.This reduced demand increases competition for fewer private sector projects andwill ultimately also increase competition in the public sector as companiesmigrate from bidding on scarce private sector work to projects in the publicsector. Greater competition can reduce revenue growth and/or increase pressureon gross profit margins. A weak economy also tends to produce less tax revenue,thereby decreasing the funds available for spending on public infrastructureimprovements. There are funding sources that have been specifically earmarkedfor infrastructure

 

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spending, such as gasoline taxes, which are notnecessarily directly impacted by a weak economy. However, even these funds canbe temporarily at risk as state and local governments struggle to balance theirbudgets. Conversely, higher public funding and/or a robust economy willincrease demand for our services and provide opportunities for revenue growthand margin improvement.

 

Revenue growth is alsoinfluenced by infrastructure change, including new construction, modification,and regulatory changes. Penhall’s revenues are also impacted positively afterthe occurrence of natural disasters, such as the 1989 and 1994 earthquakes inNorthern and Southern California. Other factors that influence Penhall’soperations are demand for operated rental equipment, the amount and quality ofequipment available for rent, rental rates and general economic conditions.Historically, revenues have been seasonal, as weather conditions in the springand summer months result in stronger performance in the first and fourth fiscalquarters than in the second and third fiscal quarters.

 

The principal componentsof Penhall’s operating costs include the cost of labor, equipment rental fleetmaintenance costs including parts and service, equipment rental fleetdepreciation, insurance and other direct operating costs. Given the varied, andin some cases specialized, nature of its rental equipment, Penhall utilizes arange of periods over which it depreciates its equipment on a straight-line basis.On average, Penhall depreciates its equipment over an estimated useful life ofthree to eight years with a 10% residual value.

 

***CRITICALACCOUNTING POLICIES AND ESTIMATES***

 

The preparation ofconsolidated financial statements requires the Company to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. On anon-going basis, the Company evaluates its estimates, including those related tolong-term construction contracts, accounts receivable, goodwill, long-livedassets, self-insurance, contingencies and litigation. The Company bases itsestimates on current information, historical experience and on various otherassumptions that are believed to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities and the recognition of revenue that are not readilyapparent from other sources. Actual results may differ from these estimatesunder different assumptions or conditions. The Company believes the followingcritical accounting policies affect its more significant judgments andestimates used in the preparation of its consolidated financial statements:

 

*Revenue Recognition on Long-TermConstruction Contracts*

 

Income from constructionoperations is recorded using the percentage-of-completion method of accounting.The majority of our long-term fixed price contracts with our customers areeither “fixed unit price” or “fixed price”. Under fixed unit price contracts,the Company is committed to provide materials or services required by a projectat fixed unit prices.  The fixed unitprice contract shifts the risk of estimating the quantity of units required fora particular project to the customer, any increase in our unit cost over theexpected unit cost in the bid, whether due to inflation, inefficiency, faultyestimates or other factors, is borne by the Company unless otherwise providedin the contract. Fixed price contracts are priced on a lump-sum basis underwhich we bear the risk that we may not be able to perform all the workprofitably for the specified contract amount. All state and federal government contracts and many of our othercontracts provide for termination of the contract for the convenience of theparty contracting with us, with provisions to pay us for work performed throughthe date of termination.

 

We use thepercentage-of-completion accounting method for construction contracts inaccordance with the American Institute of Certified Public AccountantsStatement of Position 81-1, “Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts.” Revenue and earningson construction contracts are recognized on the percentage-of-completion methodin the ratio of costs incurred to estimated final costs.  Provisions are recognized in the statement ofoperations for the full amount of estimated losses on uncompleted contractswhenever evidence indicates that the estimated total cost of a contract exceedsits estimated total revenue.

 

Contract cost consists ofdirect costs on contracts, including labor and materials, amounts payable tosubcontractors, direct overhead costs and equipment expense (primarilydepreciation, blades, fuel, maintenance and repairs). Contract cost is recordedas incurred and revisions in contract revenue and cost estimates are reflectedin the accounting period when known.

 

The accuracy of ourrevenue and profit recognition in a given period is dependent on the accuracyof our estimates of the cost to complete each project which are completed byour project managers. However, projects can be complex and in most cases theprofit margin estimates for a project will either increase or decrease to someextent from the amount that was originally estimated at the time of bid.Because we have many projects of varying levels of complexity and size inprocess at any given time (during 2004 we worked on over 1,000 projects)these changes in estimates typically offset each other without materiallyimpacting our overall profitability. However, large changes in cost estimatesin the larger projects, can have a more significanteffect on profitability.

 

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*Valuation of Long-Lived Assets*

 

Whentriggering events occur, we will review the carrying value of long-lived assets(excluding goodwill) for potential impairment. Our review considers a combination of appraised value, anticipatedfuture undiscounted cash flows and location of the asset for each line ofequipment.  Deteriorating marketconditions could potentially impact valuation of long-lived assets.  In markets where adverse market conditionsexist, the Company will consider reallocation of long-lived assets to marketswhere those assets will produce cash flow. Assets to be disposed of are reported at the lower of the carryingamount or fair value, less costs to sell.

 

*Goodwill*

 

Weuse estimates in order to determine if goodwill has been impaired. Animpairment loss may be recognized if the carrying amount of a reporting unit’snet book value exceeds the estimated fair value of the reporting unit. Wearrive at the estimated fair value of a reporting unit based on cash flowutilizing a multiple of earnings before interest, depreciation, taxes andamortization (EBIDTA).  This multiple isdetermined based on prior transactions conducted by the company and by othersin comparable market sectors to calculate the fair value.  We will perform our valuation analysis atleast annually or sooner if an event occurs or circumstances change that wouldindicate the carrying amount of goodwill may be impaired. If our estimates orassumptions change from those used in our current valuation, we may be requiredto recognize an impairment loss in future periods. The Company evaluatesgoodwill for impairment at June 30 of each year.

 

Factors we consider important which couldtrigger an impairment review include:

 

•                    Significant underperformance relative toexpected historical or projected future operating results;

 

•                    Significant changes in the manner of our useof the acquired assets or the strategy for our overall business;

 

•                    Significant negative industry or economictrends;

 

•                    Unanticipated competition; and

 

•                    EBITDA relative to net book value

 

***RESULTS OF OPERATIONS***

 

***Six months EndedDecember 31, 2004 Compared to Six months Ended December 31, 2003***

 

Revenues.  Revenues for the six months ended December31, 2004  (“Interim 2005”) were $91.2 million an increase of $5.8 million or6.8% from the six months ended December 31, 2003 (“Interim 2004”).   InInterim 2005, service revenues increased $4.0 million or 6.8% and contractrevenues increased $1.8 million or 6.8% as compared to Interim 2004.  The increase in revenues is primarily attributableto increases in non-residential construction nationwide and particularly inCalifornia as well as the increase in concrete restoration projects undertakenby many of the states.

 

Penhall operated through37 locations in 16 states at December 31, 2004, and through 38 locations in 17states at December 31, 2003.  At December31, 2004, Penhall’s operated rental fleet consisted of 686 units compared to701 units at December 31, 2003, a decrease of 2.1%.  The smaller fleet of revenue units isattributable to the Company not replacing all of the disposed units sincerevenue unit utilization rates remain below 72% for the six-month period.

 

GrossProfit.* *Gross profit totaled$22.9 million in Interim 2005, an increase of  $1.8 million or 8.3% from Interim2004. Gross profit as a percentage of revenues increased from 24.8% in Interim2004 to 25.2% in Interim 2005. The increase in gross profit from Interim 2004to Interim 2005 is primarily attributable to higher market demand for operatedequipment which increased demand for the Company’s services during Interim2005.  Another factor increasing grossprofit was the $1.1 million decrease in depreciation expense, which is theresult of low capital expenditures during 2003 and 2004.

 

Generaland Administrative Expenses.  General and administrative expenses were$15.3 million in Interim 2005 compared to $14.4 million in Interim 2004.As a percent of revenues, general and administrative expenses were 16.8% inInterim 2005 compared to 16.9% in Interim 2004. The increase in general and administrativeexpenses during Interim 2005 is primarily attributable to increases in rentexpense of $0.6 million associated with the sale/leaseback of Companyproperties and increases in incentive compensation of $0.4 million.

 

InterestExpense*.***Interest expense was $6.8 million inInterim 2005 compared to interest expense of $7.1 million in Interim 2004.The decrease in interest expense is attributable to lower borrowings in Interim2005 primarily resulting from the proceeds on the sale-leaseback of the Companyowned properties, which was used to reduce the borrowings under the revolvingcredit facility, partially offset by higher costs for letters of credit.

 

InterestExpense - Preferred Stock.  InInterim 2005, the Company adopted SFAS No. 150 which required the Company topresent separately as interest expense $2.5 million of accretion related tomandatorily redeemable instruments. Prior to Interim 2005, the Company recorded the accretion in the determinationof net loss applicable to common stockholders which was $2.2 million in Interim2004.

 

Other Income. Other income was $55,000 in Interim 2005 compared to $0.8 million inInterim 2004.  The decrease isattributable to the sale of an FCC license during Interim 2004.

 

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Income Tax Expense.  The Company recorded an income tax expense of$0.5 million or 41% of earnings before income taxes excluding the impactof non-deductible interest expense on preferred stock, compared to an incometax expense of $0.3 million, or 38.0% of earnings before income taxes inInterim 2004.   The change in theeffective tax rate adjusted for the non-deductible interest for Interim 2005 isprimarily attributable to a change in estimated deductible depreciation for2005.

 

***Three MonthsEnded December 31, 2004 Compared to Three Months Ended December 31, 2003***

 

Revenues.  Revenues for the three months ended December31, 2004  (“Interim 2005”) were $38.4 million an increase of $0.5 million or1.4% from the three months ended December 31, 2003 (“Interim 2004”).   InInterim 2005, service revenues increased $2.2 million or 8.3% and contractrevenues decreased $1.7 million or 15.6% as compared to Interim 2004.  The increase in service revenues is primarilyattributable to increases in non residential construction nationwide andparticularly in California as well as the increase in concrete restorationprojects undertaken by many of the states.  The decrease in contract revenues in Interim2005 is primarily related to a large project in Interim 2004 which wassubstantially completed prior to Interim 2005.

 

GrossProfit.* *Gross profit totaled$8.7 million in Interim 2005, a decrease of $1.2 million or 12.0% fromInterim 2004. Gross profit as a percentage of revenues decreased from 26.2% inInterim 2004 to 22.7% in Interim 2005. The decrease in gross profit fromInterim 2004 to Interim 2005 is primarily attributable to the significant grossprofit of a large project in Interim 2004 partially offset by a $0.5 milliondecrease in depreciation expense, which is the result of lower capital expendituresduring 2003 and 2004, compared with previous periods.

 

Generaland Administrative Expenses.  General and administrative expenses were$7.2 million in Interim 2005 compared to $7.4 million in Interim 2004. Asa percent of revenues, general and administrative expenses were 18.8% inInterim 2005 compared to 19.7% in Interim 2004. The decrease in general andadministrative expenses as a percentage of revenues during Interim 2005 isprimarily to decreases in bonus expense of $0.3 million and depreciation of$0.1 million partially offset by increases in rent expense of $0.3 millionassociated with the sale/leaseback of Company properties.

 

InterestExpense*.***Interest expense was $3.3 million inInterim 2005 compared to interest expense of $3.5 million in Interim 2004.The decrease in interest expense is attributable to lower borrowings in Interim2005 primarily resulting from the proceeds on the sale-leaseback of the Companyowned properties, which was used to reduce the borrowings under the revolvingcredit facility, partially offset by higher costs for letters of credit.

 

InterestExpense - Preferred Stock.  InInterim 2005, the Company adopted SFAS No. 150 which required the Company topresent separately as interest expense $1.3 million of accretion related tomandatorily redeemable instruments. Prior to Interim 2005, the Company recorded the accretion in thedetermination of net loss applicable to common stockholders which was $1.1million in Interim 2004.

 

Other Income. Other income was $28,000 in Interim 2005 compared to $0.8 million inInterim 2004.  The decrease isattributable to the sale of an FCC license during Interim 2004.

 

Income Tax Benefit*.***The Company recorded an income taxbenefit of $0.6 million, or 39.2% of earnings before income taxesexcluding the impact of non-deductible interest expense on preferred stock,compared to an income tax expense of $29,000, or 37.7% of earnings beforeincome taxes in Interim 2004.    Thechange in the effective tax rate adjusted for the non-deductible interest forInterim 2005 is primarily attributable to a change in estimated deductibledepreciation for 2005.

 

***LIQUIDITYAND CAPITAL RESOURCES***

 

Itis anticipated that the Company’s principal uses of liquidity will be to fundworking capital, meet debt service requirements and finance the Company’sstrategy of pursuing strategic acquisitions and expanding through internalgrowth. The Company’s principal sources of liquidity are expected to be cashflow from operations and borrowings under the Company’s new credit facility (“TheNew Credit”) secured in May 2003. The New Credit is a $50 million; threeyear asset-based borrowing facility consisting of a revolving credit facility (“NewRevolver”) of up to $50 million, with a $25 million sub-facility forletters of credit. Availability under the revolver portion of The New Creditwould be limited to a borrowing base consisting of (i) up to 85% of thenet amount of the Company’s eligible trade accounts receivable, (ii) up tothe lesser of (a) 100% of the net book value of the Company’s eligibleinventory and eligible equipment or (b) 85% of the appraised net orderlyliquidation value of Company’s eligible inventory and equipment, and(iii) up to 50% of the appraised forced liquidation value of the Company’sowned real estate.

 

Theprovisions of The New Credit include a lock-box agreement and also allow thelender, in its reasonable credit judgment, to assess additional reservesagainst the borrowing base calculation. Accordingly, borrowings under the agreement are classified as current.  Borrowings under The New Credit are subjectto certain financial covenants that include capital expenditure limits,utilization rate ratio, minimum interest coverage ratio, maximum leverage ratioand a minimum borrowing availability limit. The indebtedness of the Companyunder The New Credit is secured by a first priority perfected security interestin all of the inventory, accounts receivable, equipment, fixtures, cash, andother assets of the Company.  As ofDecember 31, 2004, the Company had outstanding borrowings of $3,000, $17.9million of outstanding letters of credit, borrowing base limitations of $10.1million, and borrowings unused and available under The New Credit of $22.0million.

 

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| **Summary  Cash Flow Data (000’s) for the six months  ended December 31,** | ** ** | **2003** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash and cash  equivalents                                                      |       | $        | 2,028      |     | $          | 44 |   |
|                                                                            |       |     |       |     |       |
| Net cash  provided by (used in):                                                |       |     |       |     |       |
| Operating  activities                                                           |       | $        | 7,381      |     | $          | 5,107 |   |
| Investing  activities                                                           |       | $        | 10,005     |     | $          | (6,077 | ) |
| Financing  activities                                                           |       | $        | (15,542    | )        | $          | (62 | ) |
| Capital  expenditures                                                           |       | $        | (2,875     | )        | $          | (6,458 | ) |

 

Webelieve that our current cash and cash equivalents, cash generated fromoperations, and the amount available under our existing credit facility will besufficient to meet our expected working capital needs, capital expenditures,financial commitments and other liquidity requirements associated with ourexisting operations through the next 12 months.

 

Cashprovided by operating activities decreased from $7.4 million in Interim 2004 to$5.1 million in Interim 2005.  In Interim2005, the net cash was provided by net loss adjusted by non-cash expensespartially offset by increases in inventories, prepaid expenses and other assetsand decreases in accounts payable, accrued liabilities and income taxespayable.  In Interim 2004, the net cashwas provided by net earnings adjusted by non-cash expenses plus decreases inreceivables and inventories, prepaid expenses and other asset partially offsetby increases in costs and estimated earnings in excess of billings onuncompleted contracts and accounts payable, accrued liabilities and incometaxes payable.

 

Cashused by investing activities in Interim 2005 of $6.1 million was a $16.1million change from the $10.0 million provided by investing activities inInterim 2004.  The change was due to thehigher level of capital expenditures in Interim 2005 compared to the $12.9million received from the proceeds from the sale-leaseback of properties, thesale of the FCC license and the normal sales of assets in Interim 2004.  The Company had no acquisitions in Interim2004 or 2005.

 

Cashused by financing activities were $62,000 and $15.5 million in Interim 2005 and2004, respectively.  In Interim 2004 cashfrom the sale-leaseback was used primarily to reduce debt under the revolvingcredit facility.

 

TheCompany had standby letters of credit totaling $17.9 million at December 31,2004, all of which are automatically renewable unless participating partiesnotify the other party thirty days prior to cancellation.  The letters of credit are provided ascollateral for our surety and for our insurance programs.  In addition, we are generally required toprovide surety bonds that provide an additional measure of security undercertain public and private sector contracts. Most of the Company’s surety bondsare performance bonds which do not have a stated expiration date; instead thebonds are generally released when each contract is accepted by our customer.

 

Management estimates thatPenhall’s annual capital expenditures will be approximately $12.0 million forfiscal 2005, including replacement and maintenance of equipment, purchases ofnew equipment, and purchases of real property improvements.

 

Historically, Penhallfunded its working capital requirements, capital expenditures and other needsprincipally from operating cash flows. However, in 1998, a series oftransactions occurred similar to a leveraged buyout.  As a result of these transactions the Companyhas substantial indebtedness and debt service obligations. As of December 31,2004, the Company and its subsidiaries had $100.5 million of indebtednessrelated to borrowings, $43.6 million of indebtedness related to mandatorilyredeemable preferred stock and a stockholders’ deficit of $96.0 million.  As of December 31, 2004 approximately $22.0 million of additionalborrowing was available under The New Credit.

 

Asof December 31, 2004, the Company has the following obligations subject toredemption or maturity in fiscal 2007 and 2008:

 
| ** **                           | ** ** | **Due date** | ** ** | **Balance at  December 31,  2004** | ** **  |
|--------------------------------------|------------|--------------|------------|------------------------------------|-------------|
| Senior Notes                         |       | 08/01/06     |       | $                                  | 100,000,000 |   |
| Senior  Exchangeable Preferred Stock |       | 02/01/07     |       | $                                  | 19,613,000  |   |
| Preferred Series  A                  |       | 08/01/07     |       | $                                  | 24,007,000  |   |

 

Theaccretion of preferred stock will increase the total obligation through thedates of redemption.  The Companyanticipates extending or refinancing these obligations.  No assurance can be given that such financingwill be available to the Company or, if available that it may be obtained onterms and conditions that are satisfactory to the Company.

 

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Aslong as the uncertainty associated with the resolution of these obligationsremains, the Company could be subject to adverse consequences including:

 

•                    Making it more difficult to obtain surety support;

 

•                    Increasing our vulnerability to general adverse economic and industryconditions;

 

•                    Limiting our ability to extend or replace the Company’s existing creditfacility;

 

•                    Limiting our ability to extend or replace the Company’s existing SeniorNotes:

 

•                    Limiting our flexibility in planning for, or reacting to, changes in ourbusiness and the industry in which we operate.

 

TheCompany also has certain common stock and Series B Preferred stock that aresubject to the terms and conditions of a Securities Holders Agreement.  The Company may be required to repurchasethese shares if certain conditions are met. As of June 30, 2004 and December 31, 2004, the Company has recordedthese shares at historical cost of $8,013,000, as temporary equity in thecondensed consolidated balance sheet. The Series B Preferred stock subject to the terms and conditions of the SecuritiesHolders Agreement and the remaining Series B Preferred stock include provisionsfor cumulative dividends of 13% which have not been recorded as the dividendshave not been declared.  Such dividendsapproximate $24,261,000 as of December 31, 2004.  The Company believes that the likelihood ofthe conditions allowing redemption by the stockholder occurring is remote.

 

FromAugust 1, 2002 through October 25, 2002, the Company repurchasedcapital stock of the Company from four former employees for aggregateconsideration of $35,000.  The Company’sIndenture dated as of August 1, 1998 (the “Indenture”) with United StatesTrust Company, as Trustee (the “Trustee”), permits repurchases of capital stockfrom former employees in annual amounts up to $1,000,000 and up to $5,000,000in aggregate over the life of the Indenture; provided that, at the time of anysuch repurchase, the Company must be able to incur additional indebtednessunder the Indenture’s fixed charge coverage ratio.  At the time of the repurchases describedabove, the Company was not able to incur additional indebtedness under theIndenture’s fixed charge coverage ratio, and accordingly such repurchases werenot permitted by the Indenture.  TheCompany has informed the Trustee of such repurchases.  The Trustee has indicated that it considersthe infraction minor and will not pursue written notice of default to theCompany.  In the event that the Companyreceives written notice specifying the default and demanding that such defaultbe remedied from either the Trustee or from Holders of at least 25% of the outstandingprincipal amount of the Notes, then the Company will arrange for a third partyto repurchase Company stock in the aggregate consideration of $35,000 to remedythe default.

 

The Company’s bondingcapacity has been restricted due to both Penhall’s poor operating results overthe past three fiscal years, as well as the reduced bonding capacity in themarket.  Further, one of the Company’scurrent surety has indicated that another year ofoperating losses could result in the discontinuation of their suretysupport.  The Company has obtainedadditional surety support from a secondary source.  Our inability to obtain surety bonds in thefuture would significantly impact our ability to obtain new contracts, whichcould have a material adverse effect on our business.

 

***CHANGE IN ACCOUNTING PRINCIPLE***

 

InMay 2003, the FASB issued Statement 150, “*Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity.*”Statement 150 establishes standards for classifying and measuring certainfinancial instruments with characteristics of both liabilities and equity.Statement No. 150 requires that an issuer classify a financial instrument thatis within its scope as a liability (or an asset in some circumstances) becausethat financial instrument embodies an obligation of the issuer. Statement No.150 is effective for financial instruments entered into or modified after May31, 2003, and otherwise is effective for the first interim period beginningafter June 15, 2003, except for mandatory redeemable financial instrumentsof certain entities, including the Company, for which this statement iseffective for fiscal periods beginning after December 15, 2003 (theCompany’s fiscal 2005). The Company has adopted Statement 150 effective July 1,2004.  As a result of the adoption ofStatement 150, accretion related to the Senior Exchangeable Preferred Stock andthe Series A Preferred Stock is treated as interestexpense in the Company’s consolidated statements of operations.  Prior to the adoption accretion was treatedas part of the determination of net loss applicable to common stockholders.

 

***NEW ACCOUNTING PRINCIPLES***

 

In December 2004, theFASB issued FASB Staff Position No. 109-1, “*Application of FASBStatement No. 109, Accounting for Income Taxes, to the Tax Deduction onQualified Production Activities Provided by the American Jobs Creation Act of2004*” (“FSP No. 109-1”), and FASB Staff Position No. 109-2, “ (“FSPNo. 109-2”). These staff positions provide accounting guidance on how companiesshould account for the effects of the American Jobs Creation Act of 2004 (“AJCA”)that was signed into law on October 22, 2004. FSP No. 109-1 states that the taxrelief (special tax deduction for domestic manufacturing) from this legislationshould be accounted for as a “special deduction” instead of a tax ratereduction. FSP No. 109-2 gives a company additional time to evaluate theeffects of the legislation on any plan for reinvestment or repatriation offoreign earnings for purposes of applying FASB Statement No. 109. We are currentlyinvestigating the effects of both FSP No’s 109-1 and 109-2 on the Company.

 

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InDecember 2004, the FASB Statement No. 123R (revised 2004), “*Share-Based Payment*” which replaces Statement No. 123, “*Accounting for Stock-Based Compensation”* and supersedes APBOpinion No. 25, “*Accounting for Stock Issued to Employees*.”Statement No. 123R requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the financial statementsbased on their fair values, beginning with the first interim or annual periodafter June 15, 2005, with early adoption encouraged. The pro forma disclosurespreviously permitted under Statement No. 123, will no longerwill be an alternative to financial statement recognition. We arerequired to adopt Statement No. 123R in our first quarter of fiscal 2006. UnderStatement No. 123R, we must determine the appropriate fair value model to beused for valuing share-based payments, the amortization method for compensationcost and the transition method to be used at date of adoption. The transitionmethods include prospective and retroactive adoption options. Under theretroactive option, prior periods may be restated either as of the beginning ofthe year of adoption or for all periods presented. The prospective methodrequires that compensation expense be recorded for all unvested stock optionsand restricted stock at the beginning of the first quarter of adoption of StatementNo.123R, while the retroactive method would record compensation expense for allunvested stock options and restricted stock beginning with the first periodrestated. We are evaluating the requirements of Statement No. 123R, and we donot expect that the adoption of Statement No.123R to have a material impact onour consolidated results of operations and earnings per share. We have not yetdetermined the method of adoption or the effect of adopting Statement No. 123R,and we have not determined whether the adoption will result in amounts that aredifferent than the current pro forma disclosures under Statement No. 123.

 

In November 2004, theFASB issued Statement No. 151, “*Inventory Costs - AnAmendment of ARB No. 43, Chapter**4*”.  Statement No. 151 amends the guidance in ARBNo. 43, Chapter 4, “*Inventory Pricing*,”to clarify the accounting for abnormal amounts of idle facility expense,freight, handling costs, and wasted material (spoilage). Among otherprovisions, the new rule requires that items such as idle facility expense,excessive spoilage, double freight, and rehandling costs be recognized ascurrent period charges regardless of whether they meet the criterion of “soabnormal” as stated in ARB No. 43. Statement No. 151 is effective for fiscalperiods beginning after June 15, 2005 and is required to be adopted by theCompany in the first quarter of fiscal 2006. The adoption of Statement No. 151is not expected to have a material impact on our consolidated financialcondition, results of operations, or cash flows.

 

In December 2004, theFASB issued Statement No. 153, “*Exchanges of NonmonetaryAssets - An Amendment of APB Opinion No. 29, Accounting for NonmonetaryTransactions*”.  Statement No. 153eliminates the exception from fair value measurement for nonmonetary exchangesof similar productive assets in paragraph 21(b) of APB Opinion No. 29, “*Accounting for Nonmonetary Transactions*,” and replaces itwith an exception for exchanges that do not have commercial substance. StatementNo. 153 specifies that a nonmonetary exchange has commercial substance if thefuture cash flows of the entity are expected to change significantly as aresult of the exchange. Statement No. 153 is effective for the fiscal periodsbeginning after June 15, 2005 and is required to be adopted by the Company inthe first quarter of fiscal 2006. The adoption of Statement No. 153 is notexpected to have a material impact on our consolidated financial condition,results of operations, or cash flows.

 

**Item 3.****   Quantitative and Qualitative Disclosuresabout Market Risk**

 

The Company is exposed tointerest rate changes primarily as a result of its notes payable, including NewRevolver and Senior Notes which are used to maintain liquidity and fund capitalexpenditures and expansion of the Company’s operations. The Company’s interestrate risk management objective is to limit the impact of interest rate changeson earnings and cash flows and to lower its overall borrowing costs. To achieveits objectives the Company borrows primarily at fixed rates and has the abilityto choose interest rates under the Company’s credit facility.  The Company does not enter into derivative orinterest rate transactions for speculative purposes.

 

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The table below presentsthe principal amounts of debt, weighted average interest rates, fair values andother items required by the year of expected maturity to evaluate the expectedcash flows and sensitivity to interest rate changes as of December 31, 2004.

 
| ** **                                  | ** ** | **YEARS ENDING JUNE 30,** | ** ** |
|---------------------------------------------|------------|--------------------------------|------------|
| ** **                                  | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **THERE-  AFTER** | ** ** | **TOTAL** | ** ** | **FAIR  VALUE** | ** ** |
| ** **                                  | ** ** | **(IN THOUSANDS)**             | ** ** |
|                                        |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Fixed rate debt                             |       | $                              | 379        |   | $ | 124 |   | $ | 100,000 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   | $ | 100,500 |   | $ | 100,810 | (3) |
| Average interest  rate                      |       |                           |       |   |   |   |   |   |   |   |   |   |   | 11.94 | % |   |   |
| Variable rate  LIBOR debt (1) (2)           |       | 3                              |       | 0 |   | 0 |   | 0 |   | 0 |   | 0 |   | 3 |   | 0 |   |
| Weighted average  current interest rate (1) |       |                           |       |   |   |   |   |   |   |   |   |   |   | 7.25 | % |   |   |
|                                             |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          Therevolving credit facility is classified as a short-term obligation in theconsolidated balance sheet; however, the credit facility matures in 2006.  This is a $50 million revolving creditfacility with the interest based upon LIBOR plus 350 basis points.  The total borrowing unused and availableunder the facility was $22.0 million at December 31, 2004.

 

(2)          The Company has different interest rateoptions for its variable rate debt.

 

(3)          The fair value of fixed rate debt wasdetermined based on quoted market price for the debt instrument.

 

**Item 4.****Controls and Procedures**

 

*Evaluation of DisclosureControls and Procedures*.  Wecarried out an evaluation, under the supervision and with the participation ofour management, including our president and chief executive officer and ourchief financial officer, of the effectiveness of our disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of theend of the period covered by this report. Based on this evaluation, ourpresident and chief executive officer and chief financial officer haveconcluded that our disclosure controls and procedures were effective as of theend of the period covered by this report in that they were reasonably designedto ensure that information required to be disclosed by our company in thereports we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the rules andforms of the SEC. It should be noted that any system of controls, however welldesigned and operated, is based in part upon certain assumptions and canprovide only reasonable, and not absolute, assurance that the objectives of thesystem are met.

 

*Changes in Internal Control Over Financial Reporting*.  Therewas no change in our internal control over financial reporting that occurredduring the period covered by this report that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

During the period, senior management implemented certain enhancementsincluding enhanced analysis and support for the financial presentation of ourredeemable securities and securities subject to shareholder agreements.

 

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**Part IIOther Information**

 

Items 1 – 5 are notapplicable

 

Item6. Exhibits

 
| **EXHIBIT  NO.** | ** ** | **DESCRIPTION**                                                                                                                                                                         |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1             |       | Certification of Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 dated February 14, 2005*                                                      |
|             |       |                                                                                                                                                                                    |
| 31.2             |       | Certification of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 dated February 14, 2005*                                                      |
|             |       |                                                                                                                                                                                    |
| 32.1             |       | Certification of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 dated February  14, 2005* |
|             |       |                                                                                                                                                                                    |
| 32.2             |       | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 dated February  14, 2005* |

 

----

| * |   | Filed herewith. |
|---|--------|-----------------|

 

25

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**SIGNATURES**

 

Pursuant to the requirements of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.

 

Date: February 14, 2005

 
| **SIGNATURE** | ** **           | **TITLE** |
|---------------|----------------------|-----------|
|          |                 |      |
|          | /s/ JOHN T. SAWYER   |      |   | Chairman of the Board, President and Chief Executive  Officer |
|          | John T. Sawyer       |      |   | (Principal Executive  Officer) |
|          |                 |      |
|          | /s/ JEFFREY E. PLATT |      |   | Vice President-Finance and Chief Financial Officer  (Principal |
|          | Jeffrey E. Platt     |      |   | Accounting Officer) |
|          |                 |      |
|          | /s/ PAUL N. ARNOLD   |      |   | Director |
|          | Paul N. Arnold       |      |   |   |
|          |                 |      |
|          | /s/ HAROLD O. ROSSER |      |   | Director |
|          | Harold O. Rosser     |      |   |   |
|          |                 |      |
|          | /s/ J. RICE EDMONDS  |      |   | Director |
|          | J. Rice Edmonds      |      |   |   |
|               |                      |           |  |  |  |  |  |

 

26

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| **EXHIBIT  NO.** | ** ** | **DESCRIPTION**                                                                                                                                                                         |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1             |       | Certification of Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 dated February 14, 2005*                                                      |
|             |       |                                                                                                                                                                                    |
| 31.2             |       | Certification of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 dated February 14, 2005*                                                      |
|             |       |                                                                                                                                                                                    |
| 32.1             |       | Certification of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 dated February  14, 2005* |
|             |       |                                                                                                                                                                                    |
| 32.2             |       | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 dated February  14, 2005* |

 

----

| * |   | Filed herewith. |
|---|--------|-----------------|

 

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