**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

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

 

**Forthe quarterly period ended September 30, 2005**

 

**CommissionFile Number. 333-64745**

 

**PENHALLINTERNATIONAL CORP.**

(Exact Name ofregistrant 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**

(Address ofprincipal executive offices) (Zip Code)

 

**(714)772-6450**

(Registrant’stelephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.   Yes ý No o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

    Yes o No ý

 

Indicateby check mark whether the registrant is shell company (as defined in Rule 12b-2of the Exchange Act).

    Yes o No ý

 

Indicateby the number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 
| **CLASS AND  TITLE OF CAPITAL STOCK** | ** ** | **SHARES  OUTSTANDING AS OF SEPTEMBER 28, 2005** |
|--------------------------------------------|------------|-------------------------------------------------------|
| Common Stock, $.01 Par Value               |       | 986,552                                               |

 

DOCUMENTS INCORPORATED BY REFERENCE:**None**

 

 

----

 

**PART I– FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

 

**PENHALLINTERNATIONAL CORP.**

**ANDSUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **June 30, 2005** | ** ** | **September 30, 2005** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| ASSETS                                                                       |       |                   |       |                        |       |
|                                                                         |       |                   |       |                        |       |
| Current  assets:                                                             |       |                   |       |                        |       |
| Cash  and cash equivalents                                                   |       | $                      | 98,000     |                        | $          | 103,000 |   |
| Receivables:                                                                 |       |                   |       |                        |       |
| Contract  and trade receivables                                              |       | 37,749,000             |       | 43,619,000                  |       |
| Contract  retentions due upon completion and acceptance of work              |       | 4,888,000              |       | 6,004,000                   |       |
|                                                                         |       | 42,637,000             |       | 49,623,000                  |       |
| Less  allowance for doubtful receivables                                     |       | 1,263,000              |       | 1,484,000                   |       |
| Net  receivables                                                             |       | 41,374,000             |       | 48,139,000                  |       |
|                                                                         |       |                   |       |                        |       |
| Costs  and estimated earnings in excess of billings on uncompleted contracts |       | 3,065,000              |       | 2,081,000                   |       |
| Deferred  tax assets                                                         |       | 1,624,000              |       | 1,624,000                   |       |
| Inventories                                                                  |       | 2,454,000              |       | 2,324,000                   |       |
| Prepaid  expenses and other current assets                                   |       | 1,019,000              |       | 2,843,000                   |       |
| Total  current assets                                                        |       | 49,634,000             |       | 57,114,000                  |       |
|                                                                         |       |                   |       |                        |       |
| Property,  plant and equipment, at cost:                                     |       |                   |       |                        |       |
| Land                                                                         |       | 152,000                |       | 152,000                     |       |
| Buildings  and leasehold improvements                                        |       | 1,551,000              |       | 1,551,000                   |       |
| Construction  and other equipment                                            |       | 123,059,000            |       | 126,401,000                 |       |
|                                                                         |       | 124,762,000            |       | 128,104,000                 |       |
| Less  accumulated depreciation and amortization                              |       | 87,499,000             |       | 89,004,000                  |       |
| Net  property, plant and equipment                                           |       | 37,263,000             |       | 39,100,000                  |       |
|                                                                         |       |                   |       |                        |       |
| Goodwill                                                                     |       | 6,682,000              |       | 6,682,000                   |       |
| Debt  issuance costs, net                                                    |       | 1,149,000              |       | 858,000                     |       |
| Other  assets, net                                                           |       | 503,000                |       | 424,000                     |       |
|                                                                         |       | $                      | 95,231,000 |                        | $          | 104,178,000 |   |
|                                                                              |            |                        |            |                             |            |  |  |  |  |

 

See accompanyingnotes to the unaudited condensed consolidated financial statements.

 

2

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| ** **                                                                                                                                                                                                                                                                                  | ** ** | **June 30, 2005** | ** ** | **September 30, 2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                  | ** ** | ** **             | ** ** | ** **                  | ** ** |
| LIABILITIES  AND STOCKHOLDERS’ DEFICIT                                                                                                                                                                                                                                                 |       |                   |       |                        |       |
|                                                                                                                                                                                                                                                                                        |       |                   |       |                        |       |
| Current  liabilities:                                                                                                                                                                                                                                                                       |       |                   |       |                        |       |
| Current  installments of long-term debt                                                                                                                                                                                                                                                     |       | $                      | 284,000    |                        | $          | 267,000 |   |
| Borrowings  under revolving credit facility                                                                                                                                                                                                                                                 |       | 468,000                |       | 5,368,000                   |       |
| Trade  accounts payable                                                                                                                                                                                                                                                                     |       | 10,385,000             |       | 10,620,000                  |       |
| Accrued  liabilities                                                                                                                                                                                                                                                                        |       | 14,222,000             |       | 11,815,000                  |       |
| Income  taxes payable                                                                                                                                                                                                                                                                       |       | 923,000                |       | 2,123,000                   |       |
| Current  portion of insurance reserves                                                                                                                                                                                                                                                      |       | 1,602,000              |       | 2,136,000                   |       |
| Current  portion of deferred gain - sale-leaseback                                                                                                                                                                                                                                          |       | 107,000                |       | 107,000                     |       |
| Billing  in excess of costs and estimated earnings on uncompleted contracts                                                                                                                                                                                                                 |       | 848,000                |       | 1,701,000                   |       |
| Total  current liabilities                                                                                                                                                                                                                                                                  |       | 28,839,000             |       | 34,137,000                  |       |
|                                                                                                                                                                                                                                                                                        |       |                   |       |                        |       |
| Long-term  debt, excluding current installments                                                                                                                                                                                                                                             |       | 100,000                |       | 200,000                     |       |
| Long-term  portion of deferred gain - sale-leaseback                                                                                                                                                                                                                                        |       | 1,861,000              |       | 1,834,000                   |       |
| Long-term  portion of insurance reserves                                                                                                                                                                                                                                                    |       | 6,333,000              |       | 6,333,000                   |       |
| Senior  notes                                                                                                                                                                                                                                                                               |       | 100,000,000            |       | 100,000,000                 |       |
| Deferred  tax liabilities                                                                                                                                                                                                                                                                   |       | 3,186,000              |       | 3,186,000                   |       |
| Senior  Exchangeable Preferred stock, par value $.01 per share, redemption value  $20,662,000 and $21,216,000 at June 30, 2005 and September 30,  2005, respectively. Authorized, issued and outstanding 10,000 shares                                                            |       | 20,662,000             |       | 21,216,000                  |       |
|                                                                                                                                                                                                                                                                                        |       |                   |       |                        |       |
| Series A  Preferred stock, par value $.01 per share, redemption value $25,604,000 and  $26,457,000 at June 30, 2005 and September 30, 2005, respectively.  Authorized 25,000 shares; issued and outstanding 10,428 shares at June 30,  2005 and September 30, 2005 |       | 25,604,000             |       | 26,457,000                  |       |
|                                                                                                                                                                                                                                                                                        |       |                   |       |                        |       |
| Series B  Preferred stock subject to put option, 7,688 shares outstanding at June 30,  2005 and September 30, 2005                                                                                                                                                           |       | 7,558,000              |       | 7,558,000                   |       |
|                                                                                                                                                                                                                                                                                        |       |                   |       |                        |       |
| Common  stock subject to put option, 324,858 shares outstanding at June 30, 2005  and September 30, 2005                                                                                                                                                                          |       | 321,000                |       | 321,000                     |       |
|                                                                                                                                                                                                                                                                                        |       |                   |       |                        |       |
| Stockholders’  deficit:                                                                                                                                                                                                                                                                |       |                   |       |                        |       |
| Series B  Preferred stock, par value $.01 per share. Authorized 50,000 shares; issued  and outstanding 11,110 shares at June 30, 2005 and September 30,  2005                                                                                                                |       | 11,412,000             |       | 11,412,000                  |       |
| Common  stock, par value $.01 per share. Authorized 5,000,000 shares; issued and  outstanding 697,012 at June 30, 2005 and September 30, 2005                                                                                                                                     |       | 7,000                  |       | 7,000                       |       |
| Additional  paid-in capital                                                                                                                                                                                                                                                                 |       | 1,764,000              |       | 1,764,000                   |       |
| Treasury  stock, at cost, 35,318 common shares at June 30, 2005 and September 30,  2005                                                                                                                                                                                           |       | (336,000               | )          | (336,000                    | )          |
| Accumulated  deficit                                                                                                                                                                                                                                                                        |       | (112,080,000           | )          | (109,911,000                | )          |
| Total  stockholders’ deficit                                                                                                                                                                                                                                                           |       | (99,233,000            | )          | (97,064,000                 | )          |
| Commitments  and contingencies                                                                                                                                                                                                                                                              |       |                   |       |                        |       |
|                                                                                                                                                                                                                                                                                        |       | $                      | 95,231,000 |                        | $          | 104,178,000 |   |

 

See accompanyingnotes to the unaudited condensed consolidated financial statements.

 

3

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**PENHALLINTERNATIONAL CORP.**

**ANDSUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                        | ** ** | **THREE MONTH PERIODS  ENDED SEPTEMBER 30,** | ** **       |
|-------------------------------------------------------------------|------------|---------------------------------------------------|------------------|
| ** **                                                        | ** ** | **2004**                                          | ** **       | **2005** | ** ** |
| ** **                                                        | ** ** | ** **                                        | ** **       | ** ** | ** ** |
| Revenues                                                          |       | $                                                 |  52,819,000 |   | $ |  58,627,000 |   |
| Cost of revenues                                                  |       | 38,591,000                                        |             | 40,517,000 |   |
|                                                              |       |                                              |             |   |   |
| Gross profit                                                      |       | 14,228,000                                        |             | 18,110,000 |   |
|                                                              |       |                                              |             |   |   |
| General and  administrative expenses                              |       | 8,115,000                                         |             | 8,970,000 |   |
| Other operating income,  net                                      |       | 57,000                                            |             | 376,000 |   |
| Earnings from  operations, net                                    |       | 6,170,000                                         |             | 9,516,000 |   |
|                                                              |       |                                              |             |   |   |
| Interest expense                                                  |       | 3,468,000                                         |             | 3,482,000 |   |
| Interest expense –  accretion on preferred stock             |       | 1,248,000                                         |             | 1,407,000 |   |
| Other income                                                      |       | 27,000                                            |             | 27,000 |   |
| Earnings before  income taxes                                |       | 1,481,000                                         |             | 4,654,000 |   |
|                                                              |       |                                              |             |   |   |
| Income tax expense                                                |       | 1,092,000                                         |             | 2,485,000 |   |
| Net earnings                                                      |       | 389,000                                           |             | 2,169,000 |   |
|                                                              |       |                                              |             |   |   |
| Accrual of cumulative  dividends on preferred stock               |       | (1,348,000                                        | )                | (1,536,000 | ) |
|                                                              |       |                                              |             |   |   |
| Net earnings (loss)  applicable to common stockholders            |       | $                                                 |  (959,000   | ) | $ |  633,000 |   |
|                                                              |       |                                              |             |   |   |
| Earnings (loss) per  share - basic and diluted                    |       | $                                                 |  (0.97      | ) | $ |  0.64 |   |
| Weighted average number  of shares outstanding: Basic and diluted |       | 986,552                                           |             | 986,552 |   |

 

See accompanyingnotes to the unaudited condensed consolidated financial statements.

 

4

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**PENHALLINTERNATIONAL CORP.**

**ANDSUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **THREE MONTH PERIODS ENDED  SEPTEMBER 30** | ** **      |
|------------------------------------------------------------------------------|------------|--------------------------------------------------|-----------------|
| ** **                                                                   | ** ** | **2004**                                         | ** **      | **2005** | ** ** |
| Cash  flows from operating activities:                                       |       |                                             |            |   |   |
| Net  earnings                                                                |       | $                                                | 389,000         |   | $ | 2,169,000 |   |
| Adjustments  to reconcile net loss to net cash used in operating activities  |       |                                             |            |   |   |
| Depreciation  and amortization                                               |       | 3,165,000                                        |            | 2,832,000 |   |
| Interest  expense – accretion on preferred stock                        |       | 1,248,000                                        |            | 1,407,000 |   |
| Amortization  of debt issuance costs                                         |       | 291,000                                          |            | 291,000 |   |
| Provision  for doubtful receivables                                          |       | 63,000                                           |            | 360,000 |   |
| Gains  on sale of assets, net                                                |       | (40,000                                          | )               | (370,000 | ) |
| Stock  compensation                                                          |       | —                                           |            | 4,000 |   |
| Amortization  of deferred gain on sale-leaseback                             |       | (28,000                                          | )               | (27,000 | ) |
| Changes  in operating assets and liabilities:                                |       |                                             |            |   |   |
| Receivables                                                                  |       | (7,543,000                                       | )               | (7,125,000 | ) |
| Inventories                                                                  |       | 311,000                                          |            | 130,000 |   |
| Prepaid  expenses and other assets                                           |       | (351,000                                         | )               | (1,824,000 | ) |
| Costs  and estimated earnings in excess of billings on uncompleted contracts |       | 426,000                                          |            | 984,000 |   |
| Trade  accounts payable                                                      |       | 867,000                                          |            | (770,000 | ) |
| Accrued  liabilities                                                         |       | (1,754,000                                       | )               | (2,411,000 | ) |
| Insurance  reserves                                                          |       | 100,000                                          |            | 534,000 |   |
| Income  taxes receivable/payable                                             |       | 1,088,000                                        |            | 1,200,000 |   |
| Billings  in excess of costs and estimated earnings on uncompleted contracts |       | (337,000                                         | )               | 853,000 |   |
| Net  cash used in operating activities                                       |       | (2,105,000                                       | )               | (1,763,000 | ) |
|                                                                         |       |                                             |            |   |   |
| Cash  flows from investing activities:                                       |       |                                             |            |   |   |
| Proceeds  from sale of assets                                                |       | 113,000                                          |            | 524,000 |   |
| Capital  expenditures                                                        |       | (2,328,000                                       | )               | (4,493,000 | ) |
| Net  cash used in investing activities                                       |       | (2,215,000                                       | )               | (3,969,000 | ) |
|                                                                         |       |                                             |            |   |   |
| Cash  flows from financing activities:                                       |       |                                             |            |   |   |
| Repayments  of long-term debt                                                |       | (475,000                                         | )               | (168,000 | ) |
| Borrowings  under revolving credit facility                                  |       | 50,534,000                                       |            | 61,671,000 |   |
| Repayments  of revolving credit facility                                     |       | (48,810,000                                      | )               | (56,771,000 | ) |
| Book  overdraft                                                              |       | 2,033,000                                        |            | 1,005,000 |   |
| Net  cash provided by financing activities                                   |       | 3,282,000                                        |            | 5,737,000 |   |
|                                                                         |       |                                             |            |   |   |
| Net  change in cash and cash equivalents                                     |       | (1,038,000                                       | )               | 5,000 |   |
| Cash  and cash equivalents at beginning of period                            |       | 1,076,000                                        |            | 98,000 |   |
| Cash  and cash equivalents at end of period                                  |       | $                                                |  38,000    |   | $ |  103,000 |   |
|                                                                         |       |                                             |            |   |   |
| Supplemental  disclosures of cash flow information:                          |       |                                             |            |   |   |
| Cash  paid during the period for:                                            |       |                                             |            |   |   |
| Income  taxes                                                                |       | $                                                |  5,000     |   | $ |  1,285,000 |   |
| Interest                                                                     |       | $                                                |  6,076,000 |   | $ |  6,153,000 |   |
| Noncash  investing and financing activities:                                 |       |                                             |            |   |   |
| Borrowings  related to purchase of assets                                    |       | $                                                |  —    |   | $ |  251,000 |   |
| Accrual  of cumulative dividends on preferred stock                          |       | $                                                |  1,348,000 |   | $ |  1,536,000 |   |

 

See accompanyingnotes to the unaudited condensed consolidated financial statements.

 

5

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**PENHALLINTERNATIONAL CORP.**

**ANDSUBSIDIARIES**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30,2005**

**(Unaudited)**

 

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

 

The accompanyingcondensed consolidated financial statements are unaudited and in the opinion ofmanagement include all adjustments necessary to present fairly the informationset forth therein, which consist solely of normal recurring adjustments. All significant intercompany transactions have been eliminated and certainreclassifications have been made to prior periods condensed consolidatedfinancial statements to conform to the current period presentation.

 

The Company’s business isseasonal in nature and the results of operations for these interim periods arenot necessarily indicative of results for the full year.  The consolidatedfinancial statements should be read in conjunction with the consolidatedfinancial statements and notes thereto included on Form 10-K of PenhallInternational Corp. (together with its subsidiaries, the “Company”) for theyear ended June 30, 2005, as certain disclosures which would substantiallyduplicate those contained in such audited financial statements have beenomitted from this report.

 

**(2)****         Change in AccountingPrinciples – Stock-Based Compensation**

 

On October 7, 1999,the Company’s Board of Directors approved a stock incentive plan (the “Plan”)under which employees, officers, directors or consultants (“EligibleParticipants”) may be granted stock options and restricted stock awards. TheBoard authorized the issuance of up to 50,000 shares of common stock and 2,500shares of Series B Preferred Stock under the Plan. The Plan isadministered by the Board of Directors or an appointed committee(Administrator). The exercise price for stock options or restricted stockawards shall not be less than the Fair Market Value (as defined) of the stockon the grant date subject to restrictions and conditions, including theCompany’s option to repurchase, as determined by the Administrator at the timeof the grant. The term of each stock option shall be fixed, and not exceeding10 years from the grant date of the stock option. In addition, stockoptions may be subject to specific vesting and acceleration provisions asdetermined by the Administrator at or after the grant date.

 

In December 2004, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards (SFAS) No. 123 (revised 2004), “Share-Based Payment,”which requires that compensation costs related to share-based paymenttransactions be recognized in financial statements. SFAS No. 123Reliminates the alternative to use the intrinsic method of accounting providedfor in Accounting Principles Board (APB) Opinion No. 25, “Accounting forStock Issued to Employees,” which generally resulted in no compensation expenserecorded in the financial statements related to the grant of stock options toemployees if certain conditions were met.

 

Effective July 1, 2005,the Company adopted SFAS No. 123R using the modified prospective method.Under this method, compensation costs for all awards granted after the date ofadoption and the unvested portion of previously granted awards outstanding atthe date of adoption will be measured at estimated fair value and included inoperating expenses over the vesting period during which an employee providesservice in exchange for the award. Accordingly, prior period amounts presentedherein have not been restated to reflect the adoption of SFAS No. 123R.

 

As a result of adopting SFASNo. 123R, the Company recorded $4,000 of stock-based compensation expensein its statement of operations for the three months ended September 30,2005. This stock-based compensation expense did not materially affect netearnings or basic or diluted earnings (loss) per share for the three monthsended September 30, 2005.

 

The fair value concepts usedin the Company’s presentation of proforma stock based compensation amounts werenot changed significantly in SFAS No. 123R; however, in adopting thisStandard, companies must choose among alternative valuation models andamortization assumptions. The Company has elected to continue to use both theBlack-Scholes option pricing model and straight-line amortization ofcompensation expense over the requisite service period of the grant. TheCompany will reconsider use of the Black-Scholes model if additionalinformation becomes available in the future that indicates another model wouldbe more appropriate, or if grants issued in future periods have characteristicsthat cannot be reasonably estimated using this model.

 

As of November 2001(grant date), the weighted average fair value of options granted was$21.72.  This was determined using theBlack-Scholes option pricing model with the following assumptions used forcalculation: risk-free interest rate of 4.7%, volatility of 3.01%, dividendrate of 0% and an expected life of 10 years.

 

As of September 30,2005, there was $103,000 of total unrecognized compensation cost related to non-vestedoptions.  This cost is expected to befully amortized in 6 years.  The fairmarket value of vested options utilizing the Black-Scholes option pricingmethod as of September 30, 2005 was $43,850.

 

6

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The following tablesummarizes stock option activity for the three months ended September 30,2005:

 
| ** **                                      | ** ** | **Number of shares** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Aggregate Intrinsic  Value** | ** ** | **Weighted –  Average  remaining  contractual  life** | ** ** |
|-------------------------------------------------|------------|----------------------|------------|--------------------------------------|------------|--------------------------------|------------|------------------------------------------------------------|------------|
| Shares  under option, July 1, 2005         |       |                 |       |                                 |       |                           |       |                                                       |       |
| Shares  under option, July 1, 2005         |       | 7,780                |       | $                                    | 58.51      |                           |       |                                                       | 6.1 years  |   |
| Options  granted                                |       | —               |       | $                                    | 58.51      |                           |       |                                                       | 6.1        |   |
| Options  exercised                              |       | —               |       | $                                    | 58.51      |                           |       |                                                       | 6.1        |   |
| Options  cancelled and expired                  |       | —               |       | $                                    | 58.51      |                           |       |                                                       | 6.1        |   |
| Shares  under option, September 30, 2005   |       | 7,780                |       | $                                    | 58.51      |                           | $          | —                                                     |       | 6.1 |   |
| Options  exercisable at September 30, 2005 |       | 3,045                |       | $                                    | 58.51      |                           | $          | —                                                     |       | 6.1 |   |

 

Under the modifiedprospective method, results for the three months ended September 30, 2004,were not restated to include stock option expense. The previously disclosed proforma effects of recognizing the estimated fair value of stock-based employeecompensation for the three months ended September 30, 2004, are presentedbelow:

 
| ** **                                                                                                                     | ** ** | **September 30,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                     | ** ** | ** **                   | ** ** |
| Net  loss applicable to common stockholders as reported                                                                        |       | $                            | (959,000   | ) |
| Add:                                                                                                                           |       |                         |       |
| Stock-based  compensation expense included in reported net loss applicable 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             |       | $                            | (3,000     | ) |
|                                                                                                                           |       |                         |       |
| Pro  forma net loss applicable to common stockholders                                                                          |       | $                            | (962,000   | ) |
| Basic  and diluted loss per share as reported                                                                                  |       | $                            | (0.97      | ) |
| Pro  forma basic and diluted loss per share                                                                                    |       | $                            | (0.98      | ) |

 

**(3)****         Earnings (loss) Per Share**

 

Basic earnings (loss) pershare is computed by dividing net loss applicable to common stockholdersby the weighted average number of common shares outstanding during the period.Diluted earnings (loss) per share is calculated by dividing net earnings (loss) applicableto common stockholders by the weighted average number of common sharesoutstanding during the period plus the impact of assumed potentially dilutivesecurities. The dilutive effect of outstanding options is reflected in dilutedper share by application of the treasury stock method. For the three monthperiods ended September 30, 2004 and 2005 diluted earnings (loss) pershare is the same as basic earnings (loss) per share as options topurchase 8,060 and 7,780 shares of common stock were not included in thecomputation of diluted earnings (loss) per share for the three-monthperiods ended September 30, 2004 and 2005, respectively, as the effectwould have been anti-dilutive.

 

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

 

The Company had nobalance due to Bruckmann, Rosser, Sherrill & Co., Inc. (BRS) asof September 30, 2005 related to management services.  The balancedue at June 30, 2005 was $675,000 and was paid to BRS during the quarterended September 30, 2005.

 

**(5)****         Commitments andContingencies**

 

There are variouslawsuits and claims pending and claims being pursued by the Company and itssubsidiaries arising out of the normal course of business.  It ismanagement’s present opinion, based in part upon the advice of legal counsel,that the outcome of these proceedings will not have a material effect on theCompany’s consolidated financial statements taken as a whole.

 

7

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**(6)****         Subsequent Events**

 

On November 1, 2005, Penhall International Corp.(the “Company”) entered into an amended and restated credit agreement (the “Amendedand Restated Credit Agreement”), by and among the Company, Penhall Company, aCalifornia corporation, Penhall Leasing, L.L.C., a California limited liabilitycompany, Penhall Investments, Inc., a California corporation, Bob Mack Co., Inc.,a California corporation, Capitol Drilling Supplies, Inc., an Indianacorporation, General Electric Capital Corporation, a Delaware corporation, as aSenior Lender, Letter of Credit Issuer and Agent, and the other financialinstitutions party thereto (collectively, the “Senior Lenders” and individuallyeach a “Senior Lender”).  On November 1,2005, the Company also entered into a second lien term loan agreement (the “LoanAgreement” and together with the Amended and Restated Credit Agreement, the “RefinancingAgreements”) by and among the Company, Deutsche Bank Trust Company Americas, asagent (“Agent”), Deutsche Bank Securities Inc., as Sole Lead Arranger and SoleBookrunner and the other financial institutions party thereto.  Approximately $109 million of the proceedsfrom the Refinancing Agreements will be used to redeem all of the Company’s$100 million aggregate principal amount of 12% Senior Notes due 2006(including the redemption premium and accrued interest through redemption) andto pay other costs and expenses incurred by the Company in connection with theexecution of the Refinancing Agreements.

 

*General*

The LoanAgreement consists of a term loan in the amount of $105 million, which will bedue and payable on November 1, 2010, if not sooner paid in full inaccordance with its terms.  The Amendedand Restated Credit Agreement consists of a revolving credit facility in anaggregate principal amount of $55 million, $35 million of which isavailable for the issuance of letters of credit.  The revolving credit facility matures on November 1,2010.  The Refinancing Agreements aresubject to certain mandatory prepayments upon the occurrence of certain events,including asset sales and issuances of stock (subject to certain exceptions setforth in the Refinancing Agreements). The Amended and Restated Credit Agreement and the Loan Agreement aresecured by a perfected first priority security interest and a perfected secondpriority security interest, respectively, in substantially all of the Company’stangible and intangible assets, subject to certain exceptions.

 

*Interest and Fees*

The interestrates per annum applicable to borrowings under the Amended and Restated CreditAgreement will be, at our option, the Index Rate or LIBOR Rate (each as definedin the Amended and Restated Credit Agreement) plus, in each case, an applicablemargin.  Borrowings under the LoanAgreement will bear interest at a rate per annum equal to the Company’s choiceof an alternate base rate (which is equal to the higher of (i) the rate ofinterest announced by Agent as its prime rate in effect and (ii) thefederal funds rate plus 0.50%) or the Adjusted Eurodollar Rate (as defined inthe Loan Agreement), plus, in each case an applicable margin.

 

Initially, theapplicable margin with respect to (i) the revolving credit facility underthe Amended and Restated Credit Agreement is (A) 1.50% per annum for IndexRate loans and (B) 2.50% per annum for LIBOR Rate loans and (ii) theterm loan under the Loan Agreement is (A) 5.75% per annum for alternatebase rate loans and (B) 6.75% per annum for Adjusted Eurodollar Rateloans.  After the Company’s fiscalquarter ending December 31, 2005, the margins applicable to the revolvingcredit facility under the Amended and Restated Credit Agreement will adjust (upor down) on a quarterly basis based on the monthly average borrowingavailability under the revolving credit facility.

 

In addition,the Company will be required to pay to the Senior Lenders under the Amended andRestated Credit Agreement a commitment fee in respect of the unused commitmentsthereunder at a per annum rate of one-half of one percent (0.50%).  The Company may voluntarily prepay anyborrowings under the revolving credit facility without premium or penalty,subject to LIBOR breakage fees, if any. The Company is required to pay a prepayment fee in respect of mostmandatory and voluntary prepayments under the Loan Agreement in an amount equalto:  (i) 2.0% of the principalamount prepaid if such prepayment is made on or before November 1, 2006;or (ii) 1.0% of the principal amount prepaid if such prepayment is madeafter November 1, 2006, but before November 1, 2007.

 

*Collateraland Guarantees*

The Company’s domesticsubsidiaries (including any future direct or indirect subsidiaries that may becreated or acquired by the Company), with certain exceptions as set forth inthe Refinancing Agreements, guarantee our obligations under each of the Amendedand Restated Credit Agreement and the Loan Agreement.  The guarantees in respect of the Amended andRestated Credit Agreement and the Loan Agreement will be secured by a perfectedfirst priority security interest, or by a second priority security interest, asapplicable, in substantially all of the guarantors’ tangible and intangibleassets (including, without limitation, intellectual property and all of thecapital stock of each of our direct and indirect domestic subsidiaries and 65%of the capital stock of certain of our first-tier foreign subsidiaries),subject to certain exceptions.

 

8

----

 

*Covenantsand Other Matters*

The RefinancingAgreements include certain negative covenants restricting or limiting theCompany’s ability to, among other things: 

 
| **•** |   | incur any  indebtedness or contingent obligations except as expressly provided therein;                                                                                             |
|------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                |
| **•** |   | create liens;                                                                                                                                                                       |
|       |   |                                                                                                                                                                                |
| **•** |   | pay dividends,  distributions or make other specified restricted payments, and restrict the  ability of certain of our subsidiaries to pay dividends or make other  payments to us; |
|       |   |                                                                                                                                                                                |
| **•** |   | sell assets;                                                                                                                                                                        |
|       |   |                                                                                                                                                                                |
| **•** |   | make certain  capital expenditures, investments and acquisitions;                                                                                                                   |
|       |   |                                                                                                                                                                                |
| **•** |   | enter into  certain transactions with affiliates;                                                                                                                                   |
|       |   |                                                                                                                                                                                |
| **•** |   | enter into sale  and leaseback transactions; and                                                                                                                                    |
|       |   |                                                                                                                                                                                |
| **•** |   | merge or  consolidate with any other person or sell, assign, transfer, lease, convey or  otherwise dispose of all or substantially all of our assets.                               |

 

The Refinancing Agreements contain certain customary representationsand warranties, affirmative covenants and events of default, including failureto pay principal, interest or fees, material inaccuracy of representations andwarranties, violations of covenants, certain bankruptcy and insolvency events,failure to comply with the terms of the Intercreditor Agreement, change ofcontrol, cross-defaults to other debt and material judgments.

 

*IntercreditorAgreement*

In connectionwith entering the Refinancing Agreements, we entered into an IntercreditorAgreement which sets forth the relative rights of the respective lenders underthe Amended and Restated Credit Agreement and the Loan Agreement, including thesubordination of the liens under the Loan Agreement to the liens under theAmended and Restated Credit Agreement.

 

*Senior Notes*

On November 1, 2005,we called for redemption all of our outstanding $100 million aggregateprincipal amount of 12% Senior Notes due 2006. The Redemption Date is December 1,2005. On the Redemption Date, we will redeem $100,000,000 in aggregateprincipal amount of notes at a price of $1,020.00 per $1,000 in principalamount of notes redeemed, plus accrued interest through the Redemption Date.The aggregate redemption price of the notes (including redemption premium andaccrued interest) is approximately $106 million.  The Company expects to record a loss of approximately$2 million in the 2nd quarter of Fiscal 2006 relating to theredemption of the Senior Notes.  TheCompany has classified the Senior Notes as a long-term liability as of September 30,2005 consistent with the terms of the Loan Agreement in accordance with SFAS No. 6“Classification of Short-TermObligations Expected to Be Refinanced.” As a result of the redemption of the Senior Notes, the Company will nolonger be a public registrant and therefore will no longer be required fileinformation with the Securities and Exchange Commission (SEC).

 

*Senior Exchangeable PreferredStock*

On November 1, 2005,we also exercised our right to redeem all of our outstanding 10.5% SeniorExchangeable Preferred Stock (“Preferred Stock”) pursuant to the terms as setforth in (i) a letter agreement, dated December 14, 2004, by andbetween the Company and National Christian Foundation (“NCF”) and (ii) aletter agreement, dated September 8, 2005, by and between the Company andNCF.  The Redemption Date is December 1,2005.  Such letter agreements allow theCompany to redeem all of the Preferred Stock for an aggregate redemption priceof $7.5 million in cash on the Redemption Date.   The Company has not yetcompleted analysis of the accounting impact of the redemption of the SeniorExchangeable Preferred Stock.  We notethat the redemption could result in a gain to be recorded during the 2ndquarter of Fiscal 2006 and that redemption will positively impact earnings pershare as the interest expense – preferred stock will no longer include intereston the Senior Exchangeable Preferred Stock.

 

**(7)****         Condensed ConsolidatingFinancial Information**

 

The followingconsolidating financial information is presented for purposes of complying withthe reporting requirements of the Guarantor Subsidiaries. The GuarantorSubsidiaries, (Penhall Company and subsidiaries), fully guarantee jointly,severally, unconditionally and irrevocably certain obligations of the Company,including the Senior Notes.  Separate financial statements and otherdisclosures with respect to each of the individual Guarantor Subsidiaries arenot presented because the Company believes that such financial statements andother information would not, in the opinion of management, provide additionalinformation that is material to investors.

 

9

----

 

**PENHALLINTERNATIONAL CORP.**

**ANDSUBSIDIARIES**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30,2005**

**(Unaudited)**

 

**CondensedConsolidating Balance Sheet**

 
| ** **                                                                   | ** ** | **JUNE 30, 2005**            | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                   | ** ** | **PENHALL  INTERNATIONAL  CORP.** | ** ** | **PENHALL  COMPANY** | ** ** | **ELIMINATIONS** | ** ** | **CONSOLIDATED** | ** ** |
| Assets                                                                       |       |                              |       |   |   |   |   |   |   |
| Current  assets:                                                             |       |                              |       |   |   |   |   |   |   |
| Receivables,  net                                                            |       | $                                 | —     |   | $ | 41,374,000 |   | $ | — |   | $ | 41,374,000 |   |
| Costs  and estimated earnings in excess of billings on uncompleted contracts |       | —                            |       | 3,065,000 |   | — |   | 3,065,000 |   |
| Inventories                                                                  |       | —                            |       | 2,454,000 |   | — |   | 2,454,000 |   |
| Other  current assets                                                        |       | 16,000                            |       | 2,725,000 |   | — |   | 2,741,000 |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
| Total  current assets                                                        |       | 16,000                            |       | 49,618,000 |   | — |   | 49,634,000 |   |
| Net  property, plant and equipment                                           |       | —                            |       | 37,263,000 |   | — |   | 37,263,000 |   |
| Other  assets, net                                                           |       | 724,000                           |       | 7,610,000 |   | — |   | 8,334,000 |   |
| Investment  in subsidiaries                                                  |       | 61,859,000                        |       | — |   | (61,859,000 | ) | — |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
|                                                                         |       | $                                 | 62,599,000 |   | $ | 94,491,000 |   | $ | (61,859,000 | ) | $ | 95,231,000 |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
| Liabilities  and Stockholders’ Equity (Deficit):                        |       |                              |       |   |   |   |   |   |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
| Current  installments of long-term debt                                      |       | $                                 | —     |   | $ | 284,000 |   | $ | — |   | $ | 284,000 |   |
| Borrowings  under revolving credit facility                                  |       | —                            |       | 468,000 |   | — |   | 468,000 |   |
| Trade  accounts payable                                                      |       | —                            |       | 10,385,000 |   | — |   | 10,385,000 |   |
| Accrued  liabilities and taxes payable                                       |       | 6,567,000                         |       | 8,578,000 |   | — |   | 15,145,000 |   |
| Current  portion of insurance reserves                                       |       | —                            |       | 1,602,000 |   | — |   | 1,602,000 |   |
| Current  portion of deferred gain-sale-leaseback                             |       | 107,000                           |       | — |   | — |   | 107,000 |   |
| Billings  in excess of costs and estimated earnings on uncompleted contracts |       | —                            |       | 848,000 |   | — |   | 848,000 |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
| Total  current liabilities                                                   |       | 6,674,000                         |       | 22,165,000 |   | — |   | 28,839,000 |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
| Long-term  debt, excluding current installments                              |       | —                            |       | 100,000 |   | — |   | 100,000 |   |
| Long-term  portion of deferred gain-sale-leaseback                           |       | 1,861,000                         |       | — |   | — |   | 1,861,000 |   |
| Long-term  portion of insurance reserves                                     |       | —                            |       | 6,333,000 |   | — |   | 6,333,000 |   |
| Senior  notes                                                                |       | 100,000,000                       |       | — |   | — |   | 100,000,000 |   |
| Deferred  tax liabilities                                                    |       | (848,000                          | )          | 4,034,000 |   | — |   | 3,186,000 |   |
| Senior  Exchangeable Preferred stock                                         |       | 20,662,000                        |       | — |   | — |   | 20,662,000 |   |
| Series A  Preferred stock                                               |       | 25,604,000                        |       | — |   | — |   | 25,604,000 |   |
| Series B  Preferred stock subject to put option                         |       | 7,558,000                         |       | — |   | — |   | 7,558,000 |   |
| Common  stock subject to put option                                          |       | 321,000                           |       | — |   | — |   | 321,000 |   |
| Stockholders’  equity (deficit)                                         |       | (99,233,000                       | )          | 61,859,000 |   | (61,859,000 | ) | (99,233,000 | ) |
|                                                                         |       |                              |       |   |   |   |   |   |   |
|                                                                         |       | $                                 | 62,599,000 |   | $ | 94,491,000 |   | $ | (61,859,000 | ) | $ | 95,231,000 |   |

 

10

----

 
| ** **                                                                   | ** ** | **SEPTEMBER 30, 2005**       | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                   | ** ** | **PENHALL  INTERNATIONAL  CORP.** | ** ** | **PENHALL  COMPANY** | ** ** | **ELIMINATIONS** | ** ** | **CONSOLIDATED** | ** ** |
| Assets                                                                       |       |                              |       |   |   |   |   |   |   |
| Current  assets:                                                             |       |                              |       |   |   |   |   |   |   |
| Receivables,  net                                                            |       | $                                 | —     |   | $ | 48,139,000 |   | $ | — |   | $ | 48,139,000 |   |
| Costs  and estimated earnings in excess of billings on uncompleted contracts |       | —                            |       | 2,081,000 |   | — |   | 2,081,000 |   |
| Inventories                                                                  |       | —                            |       | 2,324,000 |   | — |   | 2,324,000 |   |
| Other  current assets                                                        |       | 510,000                           |       | 4,060,000 |   | — |   | 4,570,000 |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
| Total  current assets                                                        |       | 510,000                           |       | 56,604,000 |   | — |   | 57,114,000 |   |
| Net  plant and equipment                                                     |       | —                            |       | 39,100,000 |   | — |   | 39,100,000 |   |
| Other  assets, net                                                           |       | 558,000                           |       | 7,406,000 |   | — |   | 7,964,000 |   |
| Investment  in subsidiaries                                                  |       | 62,633,000                        |       | — |   | (62,633,000 | ) | — |   |
|                                                                         |       | $                                 | 63,701,000 |   | $ | 103,110,000 |   | $ | (62,633,000 | ) | $ | 104,178,000 |   |
| Liabilities  and Stockholders’ Equity (Deficit):                        |       |                              |       |   |   |   |   |   |   |
| Current  installments of long-term debt                                      |       | $                                 | —     |   | $ | 267,000 |   | $ | — |   | $ | 267,000 |   |
| Borrowings  under revolving credit facility                                  |       | —                            |       | 5,368,000 |   | — |   | 5,368,000 |   |
| Trade  accounts payable                                                      |       | —                            |       | 10,620,000 |   | — |   | 10,620,000 |   |
| Accrued  liabilities                                                         |       | 1,997,000                         |       | 9,818,000 |   | — |   | 11,815,000 |   |
| Income  taxes payable                                                        |       | 2,123,000                         |       |   |   |   |   | 2,123,000 |   |
| Current  portion of insurance reserves                                       |       | —                            |       | 2,136,000 |   | — |   | 2,136,000 |   |
| Current  portion of deferred gain- sale-leaseback                            |       | 107,000                           |       | — |   | — |   | 107,000 |   |
| Billings  in excess of costs and estimated earnings on uncompleted contracts |       | —                            |       | 1,701,000 |   | — |   | 1,701,000 |   |
| Total  current liabilities                                                   |       | 4,227,000                         |       | 29,910,000 |   | — |   | 34,137,000 |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
| Long-term  debt, excluding current installments                              |       | —                            |       | 200,000 |   | — |   | 200,000 |   |
| Long-term  portion of deferred gain - sale-leaseback                         |       | 1,834,000                         |       | — |   | — |   | 1,834,000 |   |
| Long-term  portion of insurance reserves                                     |       | —                            |       | 6,333,000 |   | — |   | 6,333,000 |   |
| Senior  notes                                                                |       | 100,000,000                       |       | — |   | — |   | 100,000,000 |   |
| Deferred  tax liabilities                                                    |       | (848,000                          | )          | 4,034,000 |   | — |   | 3,186,000 |   |
| Senior  Exchangeable Preferred stock                                         |       | 21,216,000                        |       | — |   | — |   | 21,216,000 |   |
| Series A  Preferred stock                                               |       | 26,458,000                        |       | — |   | — |   | 26,457,000 |   |
| Series B  Preferred stock subject to put option                         |       | 7,558,000                         |       | — |   | — |   | 7,558,000 |   |
| Common  stock subject to put option                                          |       | 321,000                           |       | — |   | — |   | 321,000 |   |
| Stockholders’  equity (deficit)                                         |       | (97,064,000                       | )          | 62,633,000 |   | (62,633,000 | ) | (97,064,000 | ) |
|                                                                         |       | $                                 | 63,701,000 |   | $ | 103,110,000 |   | $ | (62,633,000 | ) | $ | 104,178,000 |   |

 

11

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**PENHALLINTERNATIONAL CORP.**

**ANDSUBSIDIARIES**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30,2005**

**(Unaudited)**

 

**CondensedConsolidating Statement of Operations**

 
| ** **                                            | ** ** | **THREE MONTH PERIOD ENDED SEPTEMBER 30, 2004** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                            | ** ** | **Penhall  International  Corp.**                    | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                              |       | $                                                    | 1,579,000  |   | $ | 52,819,000 |   | $ | (1,579,000 | ) | $ | 52,819,000 |   |
| Cost  of revenues                                     |       | —                                               |       | 38,591,000 |   | — |   | 38,591,000 |   |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| Gross  profit                                         |       | 1,579,000                                            |       | 14,228,000 |   | (1,579,000 | ) | 14,228,000 |   |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| General  and administrative expenses                  |       | 408,000                                              |       | 8,103,000 |   | (396,000 | ) | 8,115,000 |   |
| Royalties                                             |       | —                                               |       | 1,183,000 |   | (1,183,000 | ) | — |   |
| Other  operating income, net                          |       | —                                               |       | 57,000 |   | — |   | 57,000 |   |
| Equity  in earnings of subsidiary                     |       | 2,870,000                                            |       | — |   | (2,870,000 | ) | — |   |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| Earnings  from operations, net                        |       | 4,041,000                                            |       | 4,999,000 |   | (2,870,000 | ) | 6,170,000 |   |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| Interest  expense                                     |       | 3,252,000                                            |       | 216,000 |   | — |   | 3,468,000 |   |
| Interest  expense – accretion on preferred stock |       | 1,248,000                                            |       | — |   | — |   | 1,248,000 |   |
| Other  income                                         |       | 27,000                                               |       | — |   | — |   | 27,000 |   |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| Earnings  (loss) before income taxes                  |       | (432,000                                             | )          | 4,783,000 |   | (2,870,000 | ) | 1,481,000 |   |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| Income  tax expense (benefit)                         |       | (821,000                                             | )          | 1,913,000 |   | — |   | 1,092,000 |   |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| Net  earnings                                         |       | $                                                    | 389,000    |   | $ | 2,870,000 |   | $ | (2,870,000 | ) | $ | 389,000 |   |

 

12

----

 
| ** **                           | ** ** | **THREE MONTH PERIOD ENDED SEPTEMBER 30, 2005** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|
| ** **                           | ** ** | **Penhall  International  Corp.**                    | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                             |       | $                                                    | 1,709,000  |   | $ | 58,627,000 |   | $ | (1,709,000 | ) | $ | 58,627,000 |   |
| Cost  of revenues                    |       | —                                               |       | 41,830,000 |   | (1,313,000 | ) | 40,517,000 |   |
|                                 |       |                                                 |       |   |   |   |   |   |   |
| Gross  profit                        |       | 1,709,000                                            |       | 16,797,000 |   | (396,000 | ) | 18,110,000 |   |
|                                 |       |                                                 |       |   |   |   |   |   |   |
| General  and administrative expenses |       | 416,000                                              |       | 8,950,000 |   | (396,000 | ) | 8,970,000 |   |
| Other  operating income, net         |       | —                                               |       | 376,000 |   | — |   | 376,000 |   |
| Equity  in earnings of subsidiary    |       | 4,716,000                                            |       | — |   | (4,716,000 | ) | — |   |
|                                 |       |                                                 |       |   |   |   |   |   |   |
| Earnings  from operations            |       | 6,009,000                                            |       | 8,223,000 |   | (4,716,000 | ) | 9,516,000 |   |
|                                 |       |                                                 |       |   |   |   |   |   |   |
| Interest  expense                    |       | 3,252,000                                            |       | 230,000 |   | — |   | 3,482,000 |   |
| Interest  expense - preferred stock  |       | 1,407,000                                            |       | — |   | — |   | 1,407,000 |   |
| Other  income                        |       | 27,000                                               |       | — |   | — |   | 27,000 |   |
|                                 |       |                                                 |       |   |   |   |   |   |   |
| Income  before income taxes          |       | 1,377,000                                            |       | 7,993,000 |   | (4,716,000 | ) | 4,654,000 |   |
|                                 |       |                                                 |       |   |   |   |   |   |   |
| Income  tax expense (benefit)        |       | (792,000                                             | )          | 3,277,000 |   | — |   | 2,485,000 |   |
|                                 |       |                                                 |       |   |   |   |   |   |   |
| Net  earnings                        |       | $                                                    | 2,169,000  |   | $ | 4,716,000 |   | $ | (4,716,000 | ) | $ | 2,169,000 |   |
|                                      |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

13

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**PENHALLINTERNATIONAL CORP.**

**ANDSUBSIDIARIES**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30,2005**

**(Unaudited)**

 

**CondensedConsolidating Statement of Cash Flows**

 
| ** **                                           | ** ** | **THREE MONTH PERIOD ENDED SEPTEMBER 30, 2004** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                           | ** ** | **Penhall  International  Corp.**                    | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Net  cash provided by (used in) operating activities |       | $                                                    | (2,817,000 | ) | $ | 712,000 |   | $ | — |   | $ | (2,105,000 | ) |
|                                                 |       |                                                 |       |   |   |   |   |   |   |
| Cash  flows from investing activities:               |       |                                                 |       |   |   |   |   |   |   |
| Proceeds  from sale of assets                        |       | —                                               |       | 113,000 |   | — |   | 113,000 |   |
| Capital  expenditures                                |       | —                                               |       | (2,328,000 | ) | — |   | (2,328,000 | ) |
| Net  cash used in investing activities               |       | —                                               |       | (2,215,000 | ) | — |   | (2,215,000 | ) |
|                                                 |       |                                                 |       |   |   |   |   |   |   |
| Cash  flows from financing activities:               |       |                                                 |       |   |   |   |   |   |   |
| Due  to (from) affiliates                       |       | 2,815,000                                            |       | (2,815,000 | ) | — |   | — |   |
| Repayments  of long-term debt                        |       | —                                               |       | (475,000 | ) | — |   | (475,000 | ) |
| Borrowings  under revolving credit facility          |       | —                                               |       | 50,534,000 |   | — |   | 50,534,000 |   |
| Repayments  of revolving credit facility             |       | —                                               |       | (48,810,000 | ) | — |   | (48,810,000 | ) |
| Book  overdraft                                      |       | —                                               |       | 2,033,000 |   | — |   | 2,033,000 |   |
| Net  cash provided by financing activities           |       | 2,815,000                                            |       | 467,000 |   | — |   | 3,282,000 |   |
|                                                 |       |                                                 |       |   |   |   |   |   |   |
| Net  change in cash and cash equivalents             |       | (2,000                                               | )          | (1,036,000 | ) | — |   | (1,038,000 | ) |
| Cash  and cash equivalents at beginning of period    |       | 8,000                                                |       | 1,068,000 |   | — |   | 1,076,000 |   |
|                                                 |       |                                                 |       |   |   |   |   |   |   |
| Cash  and cash equivalents at end of period          |       | $                                                    | 6,000      |   | $ | 32,000 |   | $ | — |   | $ | 38,000 |   |

 

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| ** **                                           | ** ** | **THREE MONTH PERIOD ENDED SEPTEMBER 30, 2005** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                           | ** ** | **PENHALL  INTERNATIONAL  CORP.**                    | ** ** | **PENHALL  COMPANY** | ** ** | **ELIMINATIONS** | ** ** | **CONSOLIDATED** | ** ** |
| ** **                                           | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net  cash provided by (used in) operating activities |       | $                                                    | (3,942,000 | ) | $ | 2,179,000 |   | $ | — |   | $ | (1,763,000 | ) |
|                                                 |       |                                                 |       |   |   |   |   |   |   |
| Cash  flows from investing activities:               |       |                                                 |       |   |   |   |   |   |   |
| Proceeds  from sale of assets                        |       | —                                               |       | 524,000 |   | — |   | 524,000 |   |
| Capital  expenditures                                |       | —                                               |       | (4,493,000 | ) | — |   | (4,493,000 | ) |
| Net  cash used in investing activities          |       | —                                               |       | (3,969,000 | ) | — |   | (3,969,000 | ) |
|                                                 |       |                                                 |       |   |   |   |   |   |   |
| Cash  flows from financing activities:               |       |                                                 |       |   |   |   |   |   |   |
| Due  to (from) affiliates                       |       | 3,942,000                                            |       | (3,942,000 | ) | — |   | — |   |
| Repayments  of long-term debt                        |       | —                                               |       | (168,000 | ) | — |   | (168,000 | ) |
| Borrowings  under revolving credit facility          |       | —                                               |       | 61,671,000 |   | — |   | 61,671,000 |   |
| Repayments  of revolving credit facility             |       | —                                               |       | (56,771,000 | ) | — |   | (56,771,000 | ) |
| Book  overdraft                                      |       | —                                               |       | 1,005,000 |   | — |   | 1,005,000 |   |
| Net  cash provided by financing activities           |       | 3,942,000                                            |       | 1,795,000 |   | — |   | 5,737,000 |   |
|                                                 |       |                                                 |       |   |   |   |   |   |   |
| Net  change in cash and cash equivalents             |       | —                                               |       | 5,000 |   | — |   | 5,000 |   |
| Cash  and cash equivalents at beginning of period    |       | 5,000                                                |       | 93,000 |   | — |   | 98,000 |   |
| Cash  and cash equivalents at end of period          |       | $                                                    | 5,000      |   | $ | 98,000 |   | $ | — |   | $ | 103,000 |   |
|                                                      |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM2.  Management’s Discussion and Analysis of Financial Condition andResults 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 itsFiscal 2005 annual report on Form 10-K, filed with the Securities andExchange 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 byproviding specialized services in connection with infrastructure projectsthrough renting equipment along with skilled operators to serve customers inthe construction, industrial, manufacturing, governmental and residentialmarkets. In addition, Penhall complements its Operated Equipment RentalServices with fixed-price contracts, which serve to market its OperatedEquipment Rental Services business and increase utilization of its operatedequipment rental fleet. Penhall provides its services from 39 locations in 18states, with a presence in some of the fastest growing states in terms ofconstruction spending and population growth.

 

The operated equipmentrental industry is a specialized niche of the highly fragmented United Statesequipment rental industry in which there are approximately 17,000 companies.Penhall has taken advantage of consolidation opportunities by acquiring small companiesin targeted markets as well as by establishing new offices in those markets.Since 1998, Penhall has effected nine strategic acquisitions, including:

 

1.                                       HSI, a Minnesota-based firm acquired in April 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.,a California-based company acquired in September 2000,

 

6.                                       H&P Sawing and Drilling, a Kansas City,Missouri-based Company acquired in March 2002,

 

7.                                       Bob Mack Company, California based companyacquired in March 2002,

 

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

 

9.                                       Capitol Drilling Supplies, Inc, an Indianabased company acquired in June 2005.

 

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 bylong-term fixed-price contracts.

 

Fixed-price contracts areobtained primarily through competitive bidding in response to advertisements byfederal, state and local agencies and private parties and to a lesser extentthrough negotiation with private parties. Our bidding activity is affected bysuch factors as backlog, current utilization of equipment and other resources,our ability to obtain necessary surety bonds and competitive considerations.Bidding activity, backlog and revenue resulting from the award of new contractsmay vary significantly from period to period.

 

The two primary economicdrivers of our business are (1) federal, state and local public fundinglevels for transportation and other infrastructure projects and (2) theoverall health of the economy, nationally and locally, particularly as itaffects private non-residential construction. The level of demand for ourservices will have a direct correlation to these drivers. For example, a weakeconomy will generally result in a reduced demand for construction in theprivate sector. This reduced demand increases competition for fewer privatesector projects and will ultimately also increase competition in the publicsector as companies migrate from bidding on scarce private sector work to projectsin the public sector. Greater competition can reduce revenue growth and/orincrease pressure on gross

 

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profit margins. A weakeconomy also tends to produce less tax revenue, thereby decreasing the fundsavailable for spending on public infrastructure improvements. There are fundingsources that have been specifically earmarked for infrastructure spending, suchas gasoline taxes, which are not necessarily directly impacted by a weakeconomy. However, even these funds can be temporarily at risk as state andlocal governments struggle to balance their budgets. Conversely, higher publicfunding and/or a robust economy will increase demand for our services andprovide opportunities for revenue growth and 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-linebasis. On average, Penhall depreciates its equipment over an estimated usefullife of three to eight years with a 10% residual value.

 

**CRITICAL ACCOUNTING POLICIES ANDESTIMATES**

 

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 its estimateson current information, historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities and the recognition of revenue that are not readily apparentfrom other sources. Actual results may differ from these estimates underdifferent 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*

 

The majority of ourlong-term fixed price contracts with our customers are either “fixed unit price”or “fixed price.”  Under fixed unit pricecontracts, the Company is committed to provide materials or services requiredby a project at fixed unit prices.  Thefixed unit price contract shifts the risk of estimating the quantity of unitsrequired for a particular project to the customer, any increase in our unitcost over the expected unit cost in the bid, whether due to inflation,inefficiency, faulty estimates or other factors, is borne by the Company unlessotherwise provided in the contract. Fixed price contracts are priced on alump-sum basis under which we bear the risk that we may not be able to performall the work profitably for the specified contract amount.  All state and federal government contractsand many of our other contracts provide for termination of the contract for theconvenience of the party contracting with us, with provisions to pay us forwork performed through the 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.  Revenue from contract claims is recognizedwhen we have a signed settlement agreement and payment is reasonably assured.  Revenue from contract change orders, whichoccur on most large projects, is recognized at an amount which approximatescosts when it is probable that the costs will be recovered through a change inthe contract price.  Revenue is notrecognized on unapproved contract change orders until such time we believe thatrecovery is probable.  Provisions arerecognized in the statement of operations for the full amount of estimatedlosses on uncompleted contracts whenever evidence indicates that the estimatedtotal cost of a contract exceeds its estimated total revenue.

 

Contract cost consists ofdirect costs on contracts, including labor and materials, amounts payable tosubcontractors, direct overhead costs and equipment expense.  Contract costs are recorded as incurred andrevisions in contract revenue and cost estimates are reflected in theaccounting 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 2005 we worked

 

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on over1,000 projects) these changes in estimates typically offset each otherwithout materially impacting our overall profitability. However, large changesin cost estimates in the larger projects can have a more significant effect onprofitability.

 

On certain projects andconsistent within the construction industry, the Company is subject tomilestone and/or contractual billing arrangements.  These billing arrangements can result in anincrease to Costs and Estimated Earnings in Excess of Billings on UncompletedContracts.  Due to the volume of projectsthat the Company usually has at any one time, material fluctuations resultingfrom billing arrangements are not typical.

 

*Valuation of Long-LivedAssets*

 

In accordance with SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets” the Companyreviews its assets for impairment.  SFAS No. 144addresses financial accounting and reporting for the impairment or disposal oflong-lived assets.  This Statementrequires that long-lived assets be reviewed for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable.  If the carrying amountof an asset exceeds its estimated future cash flows, an impairment charge isrecognized by the amount by which the carrying amount of the asset exceeds thefair value of the asset.  Deterioratingmarket conditions 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. Further, technological improvements in equipment or processes couldrender certain long-lived assets as impaired, as could competitivepressures.  We are not aware of anytechnological improvements or competitive pressures that could potentiallyresult in impairment of long-lived assets; however such factors could occur inthe future.  SFAS No. 144 requirescompanies to separately report discontinued operations and extends thatreporting to a component of an entity that either has been disposed of or isclassified as held for sale.  Assets tobe disposed of are reported at the lower of the carrying amount or fair value,less costs to sell.

 

*Goodwill*

 

We use estimates in order todetermine if goodwill has been impaired. An impairment loss may be recognized if the carrying amount of areporting unit’s net book value exceeds the estimated fair value of thereporting unit.  As of June 30,2005, goodwill is assigned to five reporting units derived from individualacquisitions.     We arrive at theestimated fair value of a reporting unit using a discounted cash flowapproach.  We will perform our valuationanalysis at least annually or sooner if an event occurs or circumstances changethat would indicate the carrying amount of goodwill may be impaired.  If our estimates or assumptions change fromthose used in our current valuation, we may be required to recognize animpairment loss to future periods.  TheCompany evaluates goodwill for impairment at June 30 of each year.

 

Factorswe consider important which could trigger an impairment review include, but arenot limited to:

 

•                  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

•                  Adjusted EBITDA relative to net book value

 

We allocatedgoodwill to the reporting units that benefited from the relatedacquisitions.  As of September 30,2005, $6.0 million of the remaining goodwill of $6.7 million resides in onereporting unit in which profit levels have been sustained over time since theacquisition and have been consistent with the Company’s estimates.  We expect such profit levels tocontinue.  However, if profit levels wereto decline, the reporting units’ goodwill could become impaired.

 

***Three months Ended September 30, 2005 Compared to Threemonths Ended September 30, 2004***

 

Revenues.  Revenuesfor the three months ended September 30, 2005 (“Interim 2006”) were $58.6million an increase of $5.8 million or 11.0% from the three months ended September 30,2004 (“Interim 2005”).   In Interim 2006, service revenues increased$5.5 million or 16.2% and contract revenues increased $0.3 million or 1.8% ascompared to Interim 2005.  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 states.  The minor increase in contractrevenues is primarily attributable to timing of projects and not indicative ofany known trend.

 

Penhall operated through39 locations in 18 states at September 30, 2005, and through 37 locationsin 17 states at September 30, 2004.  At September 30, 2005,Penhall’s operated rental fleet consisted of 698 units compared to 693 units atSeptember 30, 2004, an increase of 0.7%.  The increase in revenueunits is attributable to a slight increase in equipment utilization.

 

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Gross Profit.* *Gross profit totaled $18.1 millionin Interim 2006, an increase of $3.9 million or 27.3% from Interim 2005. Grossprofit as a percentage of revenues increased from 26.9% in Interim 2005 to 30.9%in Interim 2006. The increase in gross profit from Interim 2005 to Interim 2006is primarily attributable to higher market demand for operated equipment whichincreased demand for the Company’s services during Interim 2006.

 

General andAdministrative Expenses.  General and administrative expenses were $9.0 millionin Interim 2006 compared to $8.1 million in Interim 2005. As a percent ofrevenues, general and administrative expenses were 15.3% in Interim 2006compared to 15.4% in Interim 2005. The increase in general and administrativeexpenses during Interim 2006 is primarily attributable to increases in bonusexpense, salaries and bad debt expense offset by a decrease in insurancepremiums.

 

Other Operating Income,net.  Other operating income was $0.4million in Interim 2006, an increase of $0.3 million as compared to $0.1million in Interim 2005.  This increaseis comprised primarily of gains on sales of equipment of which $0.2 million isattributable to the sale of one piece of equipment.

 

Interest Expense*.* Interest expense was $3.5 millionin Interim 2006 and Interim 2005.  Interestexpense in consistent during both periods due to consistent borrowing duringboth three month periods.

 

Interest Expense -Preferred Stock.  The Company presents separately as interest expense the accretionrelated to mandatorily redeemable instruments.  Interest expense –Preferred stock totaled $1.4 million in Interim 2006 an increase of $0.2million compared to Interim 2005.

 

Other Income.  Otherincome was $27,000 in Interim 2006 and in Interim 2005.  Other income isattributable to the amortization of deferred profit related to thesale-leaseback which occurred in December 2003.

 

Income Tax Expense. The Company recorded income tax expense of $2.5 million or 41% of earningsbefore income taxes excluding the impact of non-deductible interest expense onpreferred stock in Interim 2006, compared to income tax benefit of $1.1 million,or 40.0% of earnings before income taxes in Interim 2005.   Thechange in the effective tax rate adjusted for the non-deductible interestexpense related to preferred stock for Interim 2006 is primarily attributableto changes in the mix of earnings in differing tax jurisdictions.

 

LIQUIDITY AND CAPITALRESOURCES

 

It is anticipated that theCompany’s principal uses of liquidity will be to fund working capital, meetdebt service requirements and finance the Company’s strategy of pursuingstrategic acquisitions and expanding through internal growth.  We believe that our current cash and cashequivalents, cash generated from operations, and the amount available under ourexisting credit facility will be sufficient to meet our expected workingcapital needs, capital expenditures, financial commitments and other liquidityrequirements associated with our existing operations through the next twelvemonths.

 

The Company’s principalsources of liquidity are expected to be cash flow from operations andborrowings under the New Credit Facility (“New Credit”) secured in May 2003which was replaced on November 1, 2005 by the Amended and Restated CreditAgreement.   The Amended and Restated CreditAgreement consists of a revolving credit facility in an aggregate principalamount of $55 million, $35 million of which is available for the issuanceof letters of credit.  The revolvingcredit facility matures on November 1, 2010.  SeeNote 6 to the condensed consolidated financial statements.  At September 30, 2005, theCompany was in compliance with all covenants under the then existing creditfacility which was secured in May 2003.

 

As of November 14, 2005,the Company had outstanding borrowings of $9.5 million, $20.0 million ofoutstanding letters of credit, borrowing base limitations of $5.0 million andborrowings unused and available under the Amended and Restated Credit Agreementof $20.4 million.

 

**Summary Cash Flow Data (000’s) for the periods ending September 30.**

 
| ** **                       | ** ** | **2004** | ** ** | **2005** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Cash and cash  equivalents       |       | $        | 38         |     | $          | 103 |   |
|                             |       |     |       |     |       |
| Net cash provided by  (used in): |       |     |       |     |       |
| Operating  activities            |       | $        | (2,105     | )        | $          | (1,763 | ) |
| Investing  activities            |       | $        | (2,215     | )        | $          | (3,969 | ) |
| Financing  activities            |       | $        | 3,282      |     | $          | 5,737 |   |
| Capital expenditures             |       | $        | 2,328      |     | $          | 4,493 |   |
|                                  |            |          |            |          |            |  |  |  |  |  |  |

 

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Cashused in operating activities decreased from $2.1 million in Interim 2005 to $1.8million in Interim 2006.  Thedecrease in net cash used in operating activities was primarily due to theincrease in net earnings which increased from $0.4 million in Interim 2005 to$2.2 million in Interim 2006.  Thisincrease was offset by the following: Prepaid expenses and other assets used $0.4 million in cash duringInterim 2005 compared to $1.8 million in Interim 2006.  This increase was due to the timing ofinsurance premium prepayments during Interim 2006.  The payments related to Interim 2005 werepaid prior to June 2004.  Accountspayable provided $0.9 million in cash during Interim 2005 compared to using$0.8 million during Interim 2006.   Thisincrease in use of cash is primarily related to payments made against accountspayable during Interim 2006 which were related to materials and subcontractcosts.  Accrued liabilities used $1.8million during Interim 2005 compared to $2.4 million during Interim 2006.  This increase was primarily attributable tothe payment of $0.8 million to BRS related to management fees.  Annual management fees of $0.3 million wereheld until the Company met a certain EBITDA minimum according to the IndentureAgreement.

 

Cashused by investing activities in Interim 2006 was $4.0 million compared to $2.2million during Interim 2005.  This changeis due primarily to an increase in capital expenditures from $2.3 millionduring Interim 2005 to $4.5 million during Interim 2006.  The increase in capital expenditures isrelated to a slight increase in equipment utilization and replacement of agingequipment.

 

Cashprovided by financing activities in Interim 2006 was $5.7 million compared to $3.3million in Interim 2005.  The increase isprimarily related to an increase in borrowing against our revolving credit lineduring Interim 2006.

 

TheCompany had standby letters of credit totaling $20.0 million at June 30,2005, 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 $14.0 million forfiscal 2006, including replacement and maintenance of equipment, purchases ofnew equipment, and purchases of real property improvements.

 

Historically, Penhall hasfunded its working capital requirements, capital expenditures and other needsprincipally from operating cash flows. As a result of the Transactions,however, the Company has substantial indebtedness and debt service obligations.As of September 30, 2005, the Company and its subsidiaries had $153.5million of total indebtedness outstanding (including the Senior Notes andmandatorily redeemable stock) and a stockholders’ deficit of $97.1million.  As of September 30, 2005 approximately $23.9million of additional borrowing was available under the New Credit which wasreplaced by the Amended and Restated Credit Agreement on November 1, 2005.

 

Debt servicerequirements include $100,000,000 of Senior Notes issued August 4,1998.  The Senior Notes are guaranteed bythe wholly owned subsidiaries of Penhall International Corp.  The Senior Notes bear interest at 12% perannum and interest is payable semiannually in arrears; all unpaid principal andinterest is due August 1, 2006.  Inaddition, the Senior Notes are redeemable at the Company’s option, in whole atany time or in part from time-to-time, on or after August 1, 2003, atcertain redemption rates ranging from 106% to 102%.  The Company’s Indenture dated August 1,1998 (the “Indenture”) with United States Trust Company, as Trustee (the “Trustee”)contains certain financial and non-financial limitations.  Some of these limitations are based upon theCompany’s Adjusted EBIDTA, as defined, including the calculation of theConsolidated Fixed Charge Coverage Ratio (the “Coverage Ratio”), asdefined.  The Indenture permitsrepurchase of capital stock from former employees in annual amounts up to$1,000,000 and up to $5,000,000 in aggregate over the life of the Indenture;provided that, at the time of any such repurchase, the Company must be able toincur additional indebtedness as defined by the Coverage Ratio.

 

On November 1, 2005,we called for redemption all of our outstanding $100 million aggregateprincipal amount of 12% Senior Notes due 2006. The Redemption Date is December 1,2005. On the Redemption Date, we will redeem $100,000,000 in aggregateprincipal amount of notes at a price of $1,020.00 per $1,000 in principalamount of notes redeemed, plus accrued interest through the Redemption Date.The aggregate redemption price of the notes (including redemption premium andaccrued interest) is approximately $106 million.

 

From August 1, 2002through October 25, 2002, the Company repurchased capital stock of theCompany from four former employees for aggregate consideration of $35,000.  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 theoutstanding principal amount of the Notes, then the Company will arrange for athird party to repurchase Company stock in the aggregate consideration of$35,000 

 

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to remedy the default.

 

As of September 30,2005, the Company has the following obligations subject to redemption ormaturity in fiscal 2007 and 2008:

 
| ** **                           | ** ** | **Due date** | ** ** | **Balance at  September 30, 2005** | ** **  |
|--------------------------------------|------------|--------------|------------|-----------------------------------------|-------------|
| Senior Notes                         |       | 08/01/06     |       | $                                       | 100,000,000 |   |
| Senior Exchangeable  Preferred Stock |       | 02/01/07     |       | $                                       | 21,216,000  |   |
| Preferred Series A              |       | 08/01/07     |       | $                                       | 26,458,000  |   |
|                                      |            |              |            |                                         |             |  |  |

 

On November 1, 2005,we exercised our right to redeem all of our outstanding 10.5% SeniorExchangeable Preferred Stock (“Preferred Stock”) pursuant to the terms as setforth in (i) a letter agreement, dated December 14, 2004, by andbetween the Company and National Christian Foundation (“NCF”) and (ii) aletter agreement, dated September 8, 2005, by and between the Company andNCF.  The Redemption Date is December 1,2005.  Such letter agreements allow theCompany to redeem all of the Preferred Stock for an aggregate redemption priceof $7.5 million in cash on the Redemption Date.

 

The Company also has certaincommon stock and Series B Preferred stock that are subject to the termsand conditions of a Securities Holders Agreement.  The Company may be required to repurchasethese shares if certain conditions are met. As of June 30, 2005 and September 30, 2005, the Company hasrecorded these shares at historical cost of $7,558,000, as temporary equity in theconsolidated balance sheet.  The Series BPreferred stock subject to the terms and conditions of the StockholdersAgreement 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 $28,675,000 as of September 30, 2005.  The Company believes that the likelihood ofthe conditions requiring redemption by the stockholder occurring is remote.

 

In connectionwith our business, the Company is often required to provide surety bonds thatprovide an additional measure of security for our performance under certainpublic and private sector contracts. Our ability to obtain surety bonds dependsupon our capitalization, working capital, past performance, managementexpertise and external factors, including the capacity of the overall suretymarket. Surety companies consider such factors in light of the amount of ourbacklog that we have currently bonded and their current underwriting standards,which may change from time to time. In the last few years we have seen a steadydecrease in the capacity of the surety market, driven primarily by substantialincreases in surety industry losses and consolidation in the surety marketthrough acquisition.  At September 30, 2005, approximately $13million of the Company’s backlog is bonded.  The Company’s inability toobtain surety bonds in the future would significantly impact our ability toobtain new contracts, which could have a material adverse effect on ourbusiness.    Effective November 2005, we successfullyreplaced one of our sureties.

 

***NEW ACCOUNTING PRINCIPLES***

 

In December 2004,the FASB issued Statement No. 123R (revised 2004), “*Share-Based Payment*” which replacesStatement No. 123, “*Accounting forStock-Based Compensation”* and supersedes APB Opinion No. 25, “*Accounting for Stock Issued to Employees*.”Statement No. 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the financialstatements based on their fair values, beginning with the first interim orannual period after June 15, 2005, with early adoption encouraged. The proforma disclosures previously permitted under Statement No. 123, are nolonger an alternative to financial statement recognition. Under Statement No. 123R,we determined that the appropriate fair value model to be used for valuingshare-based payments is the Black-Scholes option pricing model.  We are using the straight-line method for amortizationof compensation cost and elected to use the modified prospective method at July 1,2005 for the transition.  The modified prospectivemethod requires that compensation expense be recorded for all unvested stockoptions and restricted stock at the beginning of the first quarter of adoptionof Statement No.123R.  Adoption ofStatement 123R has not had a material impact on our consolidated results of operationsand earnings per share.  See note 2 tothe condensed consolidated financial statements.

 

**Item3.   Quantitative and Qualitative Disclosures about 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 Companydoes not enter into derivative or interest rate transactions for speculativepurposes.

 

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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 September 30,2005.

 
| ** **                                       | ** ** | **YEARS ENDING JUNE 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------|------------|
| ** **                                       | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **THERE-  AFTER** | ** ** | **TOTAL** | ** ** | **FAIR  VALUE** | ** ** |
| ** **                                       | ** ** | **(IN THOUSANDS)**             | ** ** |
|                                             |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Fixed  rate debt (5)                             |       | $                              | 221        |   | $ | 100,182 |   | $ | 64,000 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   | $ | 100,467 |   | $ | 99,967 | (3) |
| Average  interest rate                           |       |                           |       |   |   |   |   |   |   |   |   |   |   | 11.94 | % |   |   |
| Variable  rate LIBOR  debt (1) (2) (4) |       | 5,368                          |       | 0 |   | 0 |   | 0 |   | 0 |   | 0 |   | 5,368 |   | 5,368 |   |
| Weighted  average current interest rate (1)      |       |                           |       |   |   |   |   |   |   |   |   |   |   | 8.25 | % |   |   |
|                                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)             The revolving creditfacility is classified as a short-term obligation in the consolidated balancesheet; however, the credit facility matures in 2006.  This is a $50million revolving credit facility with the interest based upon LIBOR plus 350basis points and an optional loan with the interest based on prime plus 200basis points.  The total borrowing unused and available under the facilitywas $23.9 million at September 30, 2005.

 

(2)             TheCompany has different interest rate options for its variable rate debt.

 

(3)             The fair value offixed rate debt was determined based on quoted market price for the debtinstrument.

 

(4)             As of November 1,2005 the Company replaced the revolving credit facility. See Note 6 to thecondensed consolidated financial statements.

 

(5)             Asof November 1, 2005 the Company entered into a second lien term loanagreement (“Loan Agreement”).  Theproceeds will be used to redeem all of the Company’s $100 million 12% SeniorNotes.  The Loan Agreement consists of aterm loan in the amount of $105 million, which will be due and payable on November 1,2010, if not sooner paid in full in accordance with its terms.  See note 6 to the condensed consolidatedfinancial statements.

 

**Item 4.Controls and Procedures**

 

We,under the supervision and with the participation of our management, includingour Chief Executive Officer and Chief Financial Officer, evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rule13a-15(e) under the Securities Exchange Act of 1934) as of the end of theperiod covered by this Form 10-Q. Based on that evaluation, our ChiefExecutive Officer and our Chief Financial Officer concluded that our disclosurecontrols and procedures were effective in that they provide reasonableassurance that information relating to our Company required to be disclosed inour reports filed or submitted under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported within the time periods specifiedin the relevant SEC rules and formsand that information required to be disclosed by our Company in the reportsthat it files or submits under the Securities Exchange Act of 1934 isaccumulated and communicated to its management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate to allow timely decisionsregarding disclosure.

 

Ourmanagement, including our Chief Executive Officer and Chief Financial Officer,does not expect that our disclosure controls or internal controls will preventall errors or fraud. A control system, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the control system are met. Because of the inherent limitationsin all control systems, no evaluation of control can provide absolute assurancethat all control issues and instances of fraud, if any, within the Company havebeen detected.

 

Our management, includingour Chief Executive Officer and Chief Financial Officer, also conducted anevaluation of our internal control over financial reporting to determinewhether any change occurred during our most recent fiscal quarter that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting. Based on that evaluation, during our mostrecent fiscal quarter, there were no changes in our internal control overfinancial reporting that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

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**Part IIOther Information**

 

Items 1 – 5 are notapplicable

 

Item 6. Exhibits

 
| **EXHIBIT NO.** | ** ** | **DESCRIPTION**                                                                                                                                                                              |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1                 |       | Certification of Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 dated November 14, 2005*                                                      |
|                 |       |                                                                                                                                                                                         |
| 31.2                 |       | Certification of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 dated November 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 November 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 November 14,  2005* |

 

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*                                         Filedherewith.

 

23

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

Date: November 14,2005

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

 

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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 November 14, 2005*                                                      |
|             |       |                                                                                                                                                                                         |
| 31.2             |       | Certification of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 dated November 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 November 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 November 14,  2005* |

 

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*                                         Filedherewith.

 

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