**UNITED STATES**

**SECURITIES AND 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** |
|------------|------------|-----------------------------------------------------------------------------------------------|

 

**For thequarterly period ended March 31, 2005**

 

**CommissionFile Number. 333-64745**

 

**PENHALL INTERNATIONAL CORP.**

(Exact Name of registrant as specified in itscharter)

 

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

 

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

(Address of principal executive offices) (ZipCode)

 

**(714) 772-6450**

(Registrant’s telephone number, including areacode)

 

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

 
| **CLASS AND TITLE OF CAPITAL  STOCK** | ** ** | **SHARES OUTSTANDING AS OF  MAY 13, 2005** |
|--------------------------------------------|------------|-------------------------------------------------|
|                                       |       |                                            |
| Common  Stock, $.01 Par Value              |       | 986,552                                         |

 

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

 

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

 

 

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**PART I – FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED BALANCESHEETS**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **June 30, 2004** | ** ** | **March 31, 2005** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|-------------------------|------------|
|                                                                         |       |                   |       |                    |       |
| ASSETS                                                                       |       |                   |       |                    |       |
|                                                                         |       |                   |       |                    |       |
| Current Assets:                                                              |       |                   |       |                    |       |
| Cash and cash equivalents                                                    |       | $                      | 1,076,000  |                    | $          | 87,000 |   |
| Receivables:                                                                 |       |                   |       |                    |       |
| Contract and trade receivables                                               |       | 30,386,000             |       | 26,066,000              |       |
| Contract retentions due upon completion and  acceptance of work              |       | 4,361,000              |       | 4,426,000               |       |
|                                                                         |       | 34,747,000             |       | 30,492,000              |       |
| Less allowance for doubtful receivables                                      |       | 1,317,000              |       | 1,241,000               |       |
| Net receivables                                                              |       | 33,430,000             |       | 29,251,000              |       |
|                                                                         |       |                   |       |                    |       |
| Costs and estimated earnings in excess of  billings on uncompleted contracts |       | 2,957,000              |       | 3,056,000               |       |
| Deferred tax assets                                                          |       | 2,034,000              |       | 2,034,000               |       |
| Income taxes receivable                                                      |       | —                 |       | 1,544,000               |       |
| Inventories                                                                  |       | 2,171,000              |       | 2,238,000               |       |
| Prepaid expenses and other current assets                                    |       | 2,198,000              |       | 1,007,000               |       |
| Total current assets                                                         |       | 43,866,000             |       | 39,217,000              |       |
|                                                                         |       |                   |       |                    |       |
| Plant and equipment, at cost:                                                |       |                   |       |                    |       |
| Leasehold improvements                                                       |       | 1,302,000              |       | 1,322,000               |       |
| Construction and other equipment                                             |       | 115,998,000            |       | 121,923,000             |       |
|                                                                         |       | 117,300,000            |       | 123,245,000             |       |
| Less accumulated depreciation and  amortization                              |       | 81,260,000             |       | 87,192,000              |       |
| Net plant and equipment                                                      |       | 36,040,000             |       | 36,053,000              |       |
|                                                                         |       |                   |       |                    |       |
| Goodwill                                                                     |       | 6,371,000              |       | 6,371,000               |       |
| Debt issuance costs, net                                                     |       | 2,313,000              |       | 1,440,000               |       |
| Other assets, net                                                            |       | 817,000                |       | 582,000                 |       |
|                                                                         |       | $                      | 89,407,000 |                    | $          | 83,663,000 |   |

 

See accompanying notes to the unauditedcondensed consolidated financial statements.

 

2

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**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED BALANCESHEETS**

**(Unaudited)**

 
| ** **                                                                                                                                                                                                                           | ** ** | **June 30, 2004** | ** ** | **March 31, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-------------------------|------------|
|                                                                                                                                                                                                                                 |       |                   |       |                    |       |
| LIABILITIES AND STOCKHOLDERS’ DEFICIT                                                                                                                                                                                           |       |                   |       |                    |       |
|                                                                                                                                                                                                                                 |       |                   |       |                    |       |
| Current liabilities:                                                                                                                                                                                                                 |       |                   |       |                    |       |
| Current installments of long-term debt                                                                                                                                                                                               |       | $                      | 882,000    |                    | $          | 268,000 |   |
| Borrowings under revolving credit facility                                                                                                                                                                                           |       | —                 |       | 1,004,000               |       |
| Trade accounts payable                                                                                                                                                                                                               |       | 5,664,000              |       | 5,256,000               |       |
| Accrued liabilities and taxes payable                                                                                                                                                                                                |       | 12,857,000             |       | 9,421,000               |       |
| Current portion of insurance reserves                                                                                                                                                                                                |       | 2,698,000              |       | 1,873,000               |       |
| Current portion of deferred gain -  sale-leaseback                                                                                                                                                                                   |       | 109,000                |       | 109,000                 |       |
| Billing in excess of costs and estimated  earnings on uncompleted contracts                                                                                                                                                          |       | 1,526,000              |       | 974,000                 |       |
| Total current liabilities                                                                                                                                                                                                            |       | 23,736,000             |       | 18,905,000              |       |
|                                                                                                                                                                                                                                 |       |                   |       |                    |       |
| Long-term debt, excluding current  installments                                                                                                                                                                                      |       | 113,000                |       | —                  |       |
| Long-term portion of deferred gain -  sale-leaseback                                                                                                                                                                                 |       | 2,015,000              |       | 1,933,000               |       |
| Long-term portion of insurance reserves                                                                                                                                                                                              |       | 4,878,000              |       | 5,903,000               |       |
| Senior notes                                                                                                                                                                                                                         |       | 100,000,000            |       | 100,000,000             |       |
| Deferred tax liabilities                                                                                                                                                                                                             |       | 3,771,000              |       | 3,771,000               |       |
| Senior Exchangeable Preferred stock, par  value $.01 per share, redemption value $18,602,000 and $20,126,000 at  June 30, 2004 and March 31, 2005, respectively. Authorized, issued  and outstanding 10,000 shares         |       | 18,602,000             |       | 20,126,000              |       |
|                                                                                                                                                                                                                                 |       |                   |       |                    |       |
| Series A Preferred stock, par value  $.01 per share, redemption value $22,484,000 and $24,787,000 at June 30,  2004 and March 31, 2005, respectively. Authorized 25,000 shares; issued  and outstanding 10,428 shares |       | 22,484,000             |       | 24,787,000              |       |
|                                                                                                                                                                                                                                 |       |                   |       |                    |       |
| Series B Preferred stock subject to  put option, 7,688 shares outstanding at June 30, 2004 and March 31,  2005                                                                                                        |       | 7,688,000              |       | 7,688,000               |       |
|                                                                                                                                                                                                                                 |       |                   |       |                    |       |
| Common stock subject to put option, 324,858  shares outstanding at June 30, 2004 and March 31, 2005                                                                                                                        |       | 325,000                |       | 325,000                 |       |
|                                                                                                                                                                                                                                 |       |                   |       |                    |       |
| Stockholders’ deficit:                                                                                                                                                                                                          |       |                   |       |                    |       |
| Series B Preferred stock, par value  $.01 per share. Authorized 50,000 shares; issued and outstanding 11,110  shares at June 30, 2004 and March 31, 2005                                                              |       | 11,282,000             |       | 11,282,000              |       |
| Common stock, par value $.01 per share.  Authorized 5,000,000 shares; issued and outstanding 697,012 at June 30,  2004 and March 31, 2005                                                                                  |       | 7,000                  |       | 7,000                   |       |
| Additional paid-in capital                                                                                                                                                                                                           |       | 1,760,000              |       | 1,760,000               |       |
| Treasury stock, at cost, 35,318 common  shares at June 30, 2004 and March 31, 2005                                                                                                                                         |       | (336,000               | )          | (336,000                | )          |
| Accumulated deficit                                                                                                                                                                                                                  |       | (106,918,000           | )          | (112,488,000            | )          |
| Total stockholders’ deficit                                                                                                                                                                                                     |       | (94,205,000            | )          | (99,775,000             | )          |
| Commitments and contingencies                                                                                                                                                                                                        |       |                   |       |                    |       |
|                                                                                                                                                                                                                                 |       | $                      | 89,407,000 |                    | $          | 83,663,000 |   |

 

See accompanying notes to the unauditedcondensed consolidated financial statements.

 

3

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**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

**(Unaudited)**

 
| ** **                                                       | ** ** | **THREE MONTH PERIODS  ENDED MARCH 31,** | ** ** | **NINE MONTH PERIODS  ENDED MARCH 31,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                       | ** ** | **2004**                                      | ** ** | **2005**                                     | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                             |       |                                          |       |                                         |       |   |   |   |   |
| Revenues                                                         |       | $                                             | 31,368,000 |                                         | $          | 30,860,000 |   | $ | 116,767,000 |   | $ | 122,069,000 |   |
| Cost of revenues                                                 |       | 26,083,000                                    |       | 24,703,000                                   |       | 90,303,000 |   | 92,965,000 |   |
|                                                             |       |                                          |       |                                         |       |   |   |   |   |
| Gross profit                                                     |       | 5,285,000                                     |       | 6,157,000                                    |       | 26,464,000 |   | 29,104,000 |   |
| General and administrative expenses                              |       | 7,281,000                                     |       | 7,042,000                                    |       | 21,680,000 |   | 22,362,000 |   |
| Goodwill impairment                                              |       | 353,000                                       |       | —                                       |       | 353,000 |   | — |   |
| Other operating income                                           |       | 122,000                                       |       | 23,000                                       |       | 520,000 |   | 342,000 |   |
|                                                             |       |                                          |       |                                         |       |   |   |   |   |
| Earnings (loss) from operations                                  |       | (2,227,000                                    | )          | (862,000                                     | )          | 4,951,000 |   | 7,084,000 |   |
| Interest expense                                                 |       | 3,344,000                                     |       | 3,285,000                                    |       | 10,447,000 |   | 10,071,000 |   |
| Interest expense – preferred stock                          |       | —                                        |       | 1,293,000                                    |       | — |   | 3,827,000 |   |
| Other income                                                     |       | 33,000                                        |       | 27,000                                       |       | 839,000 |   | 82,000 |   |
|                                                             |       |                                          |       |                                         |       |   |   |   |   |
| Loss before income taxes                                    |       | (5,538,000                                    | )          | (5,413,000                                   | )          | (4,657,000 | ) | (6,732,000 |   |
| Income tax benefit                                               |       | (2,082,000                                    | )          | (1,660,000                                   | )          | (1,747,000 | ) | (1,162,000 | ) |
|                                                             |       |                                          |       |                                         |       |   |   |   |   |
| Net loss                                                         |       | (3,456,000                                    | )          | (3,753,000                                   | )          | (2,910,000 | ) | (5,570,000 | ) |
| Accretion of preferred stock to redemption  value                |       | (1,162,000                                    | )          | —                                       |       | (3,408,000 | ) | — |   |
| Accrual of cumulative dividends on  preferred stock              |       | (1,249,000                                    | )          | (1,439,000                                   | )          | (3,653,000 | ) | (4,181,000 | ) |
|                                                             |       |                                          |       |                                         |       |   |   |   |   |
| Net loss applicable to common stockholders                       |       | $                                             | (5,867,000 | )                                            | $          | (5,192,000 | ) | $ | (9,971,000 | ) | $ | (9,751,000 | ) |
|                                                             |       |                                          |       |                                         |       |   |   |   |   |
| Loss per share - basic and diluted                               |       | $                                             | (5.95      | )                                            | $          | (5.26 | ) | $ | (10.11 | ) | $ | (9.88 | ) |
| Weighted average number of shares  outstanding basic and diluted |       | 986,552                                       |       | 986,552                                      |       | 986,552 |   | 986,552 |   |

 

See accompanying notes to the unauditedcondensed consolidated financial statements.

 

4

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**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                      | ** ** | **NINE MONTH PERIODS ENDED  MARCH 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                                     | ** ** | **2005** | ** ** |
| Cash flows from operating activities:                                           |       |                                         |       |   |   |
| Net earnings (loss)                                                             |       | $                                            | (2,910,000 | ) | $ | (5,570,000 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities |       |                                         |       |   |   |
| Depreciation and amortization                                                   |       | 10,996,000                                   |       | 9,170,000 |   |
| Interest on preferred stock                                                     |       | —                                       |       | 3,827,000 |   |
| Amortization of debt issuance costs                                             |       | 871,000                                      |       | 873,000 |   |
| Provision for doubtful receivables                                              |       | 437,000                                      |       | 498,000 |   |
| Gains on sale of assets, net                                                    |       | (1,204,000                                   | )          | (169,000 | ) |
| Goodwill impairment                                                             |       | 353,000                                      |       | — |   |
| Amortization of deferred gain on  sale-leaseback                                |       | (44,000                                      | )          | (82,000 | ) |
| Changes in operating assets and  liabilities:                                   |       |                                         |       |   |   |
| Receivables                                                                     |       | 1,425,000                                    |       | 3,681,000 |   |
| Inventories                                                                     |       | 99,000                                       |       | (67,000 | ) |
| Prepaid expenses and other assets                                               |       | 2,223,000                                    |       | 1,191,000 |   |
| Costs and estimated earnings in excess of  billings on uncompleted contracts    |       | (49,000                                      | )          | (99,000 | ) |
| Trade accounts payable                                                          |       | (3,512,000                                   | )          | (1,223,000 | ) |
| Accrued liabilities                                                             |       | (927,000                                     | )          | (2,850,000 | ) |
| Income taxes receivable/payable                                                 |       | 505,000                                      |       | (1,930,000 | ) |
| Billings in excess of costs and estimated  earnings on uncompleted contracts    |       | 318,000                                      |       | (552,000 | ) |
| Net cash provided by operating activities                                       |       | 8,581,000                                    |       | 6,698,000 |   |
|                                                                            |       |                                         |       |   |   |
| Cash flows from investing activities:                                           |       |                                         |       |   |   |
| Proceeds from sale of assets                                                    |       | 13,081,000                                   |       | 410,000 |   |
| Capital expenditures                                                            |       | (4,012,000                                   | )          | (9,189,000 | ) |
| Net cash provided by (used in) investing  activities                            |       | 9,069,000                                    |       | (8,779,000 | ) |
|                                                                            |       |                                         |       |   |   |
| Cash flows from financing activities:                                           |       |                                         |       |   |   |
| Borrowings under long-term debt                                                 |       | 96,000                                       |       | 271,000 |   |
| Repayments of long-term debt                                                    |       | (2,355,000                                   | )          | (998,000 | ) |
| Borrowings under revolving credit facility                                      |       | 164,198,000                                  |       | 135,967,000 |   |
| Repayments of revolving credit facility                                         |       | (178,683,000                                 | )          | (134,963,000 | ) |
| Debt issuance costs                                                             |       | (161,000                                     | )          | — |   |
| Book overdraft                                                                  |       | (514,000                                     | )          | 815,000 |   |
| Net cash (used in) provided by financing  activities                            |       | (17,419,000                                  | )          | 1,092,000 |   |
|                                                                            |       |                                         |       |   |   |
| Net change in cash and cash equivalents                                         |       | 231,000                                      |       | (989,000 | ) |
| Cash and cash equivalents at beginning of  period                               |       | 184,000                                      |       | 1,076,000 |   |
| Cash and cash equivalents at end of period                                      |       | $                                            | 415,000    |   | $ | 87,000 |   |
| Supplemental disclosures of cash flow  information:                             |       |                                         |       |   |   |
| Cash paid (received) during the period for                                      |       |                                         |       |   |   |
| Income taxes                                                                    |       | $                                            | (2,252,000 | ) | $ | 770,000 |   |
| Interest                                                                        |       | $                                            | 12,497,000 |   | $ | 12,149,000 |   |
| Supplemental disclosures of non cash  investing and financing information:      |       |                                         |       |   |   |
| Accretion of preferred stock to redemption  value                               |       | $                                            | 3,408,000  |   | $ | — |   |
| Accrual of cumulative dividends on  preferred stock                             |       | $                                            | 3,653,000  |   | $ | 4,181,000 |   |

 

See accompanying notes to the unauditedcondensed consolidated financial statements.

 

5

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**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTSMARCH 31, 2005**

**(Unaudited)**

 

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

 

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

 

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

 

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

 

As permitted by SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS No. 123”) the Company continues to apply the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”).  The Company applies the intrinsic value method as outlined in APB No. 25 and related interpretations in accounting for stock options and share units granted to employees under these programs. Under the intrinsic value method, no compensation expense is recognized if the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of the grant. The Company has certain shares of Series B Preferred stock and common stock issued under the Securities Holders Agreement.  Certain compensation charges could result if triggering events (i.e. death, disability or termination) occur.  No compensation cost has been recognized on options granted to employees for the three and nine month periods ended March 31, 2005. SFAS No. 123 requires that the Company provide pro forma information regarding net loss and net loss per common share as if compensation cost for the Company’s stock option programs had been determined in accordance with the fair value method prescribed therein. 

 

Had the Company determined compensation cost based onthe fair value at the grant date for its stock options under SFAS No. 123,the Company’s basic and diluted net loss available to common stockholders pershare would have been adjusted to the pro forma amounts as indicated below:

 
| ** **                                                                                                                     | ** ** | **Three months ended**  | ** ** | **Nine months ended**   | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                                                                     | ** ** | **March 31, 2004** | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** | **March 31, 2005** | ** ** |
| ** **                                                                                                                     | ** ** | ** **              | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss applicable to common stockholders  as reported                                                                        |       | $                       | (5,867,000 | )                       | $          | (5,192,000 | ) | (9,971,000 | ) | $ | (9,751,000 | ) |
| 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              |       | $                       | (1,000     | )                       | $          | (2,000 | ) | $ | (7,000 | ) | $ | (7,000 | ) |
|                                                                                                                           |       |                    |       |                    |       |   |   |   |   |
| Pro forma net loss applicable to common  stockholders                                                                          |       | $                       | (5,868,000 | )                       | $          | (5,194,000 | ) | $ | (9,978,000 | ) | $ | (9,758,000 | ) |
| Basic and diluted loss per share as  reported                                                                                  |       | $                       | (5.95      | )                       | $          | (5.26 | ) | $ | (10.11 | ) | $ | (9.88 | ) |
| Pro forma basic and diluted loss per share                                                                                     |       | $                       | (5.95      | )                       | $          | (5.26 | ) | $ | (10.11 | ) | $ | (9.89 | ) |

 

6

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

 

Basic loss per share is computed by dividing netloss applicable to common stockholders by the weighted average number ofcommon shares outstanding during the period. Diluted loss per share iscalculated by dividing net loss applicable to common stockholders by theweighted average number of common shares outstanding during the period plus theimpact of assumed potentially dilutive securities. The dilutive effect ofoutstanding options is reflected in diluted per share by application of thetreasury stock method. For the three and nine month periods endedMarch 31, 2004 and 2005 diluted loss per share is the same as basicloss per share as options to purchase 8,585 and 7,910 shares of commonstock were not included in the computation of diluted loss per share forthe three-month and nine-month periods ended March 31, 2004 and 2005,respectively, as the effect would have been anti-dilutive.

 

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

 

The Company has a balance due to Bruckmann, Rosser,Sherrill & Co., Inc. (BRS) of $600,000 as of March 31, 2005related to management services.  Thebalance due at June 30, 2004 was $375,000.

 

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

 

In May 2003, the FASB issued Statement 150, “*Accounting for Certain Financial Instruments with Characteristics ofboth Liabilities and Equity.*” Statement 150 establishes standardsfor classifying and measuring certain financial instruments with characteristicsof both liabilities and equity. Statement No. 150 requires that an issuerclassify a financial instrument that is within its scope as a liability (or anasset in some circumstances) because that financial instrument embodies anobligation of the issuer. Statement No. 150 is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective for the first interim period beginning after June 15, 2003,except for mandatory redeemable financial instruments of certain entities,including the Company, for which this statement is effective for fiscal periodsbeginning after December 15, 2003 (the Company’s fiscal 2005). The Companyhas adopted Statement 150 effective July 1, 2004.  As a result of the adoption of Statement 150,accretion related to the Senior Exchangeable Preferred Stock and theSeries A Preferred Stock is presented as interest expense in the Company’sconsolidated statements of operations. Prior to the adoption accretion was included as part of the determinationof net loss applicable to common stockholders.

 

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

 

The Company has an employment related legal matterwhich has been substantially settled. The Company estimates that the remaining reserves of $18,000 are sufficientbased on the settlement.  

 

There are various additional lawsuits and claimspending and claims being pursued by the Company and its subsidiaries arisingout of the normal course of business.  Itis management’s present opinion, based in part upon the advice of legalcounsel, that the outcome of these proceedings will not have a material effecton the Company’s consolidated financial statements taken as a whole.

 

7

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

 

The following consolidating financialinformation is presented for purposes of complying with the reportingrequirements of the Guarantor Subsidiaries. The Guarantor Subsidiaries,(Penhall Company and subsidiaries), guarantee jointly, severally,unconditionally and irrevocably certain obligations of the Company, includingthe Senior Notes.  Separate financialstatements and other disclosures with respect to each of the individualGuarantor Subsidiaries are not presented because the Company believes that suchfinancial statements and other information would not, in the opinion ofmanagement, provide additional information that is material to investors.

 

8

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**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTSMARCH 31, 2005**

**(Unaudited)**

 

**Condensed Consolidating BalanceSheet**

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

 

9

----

 

**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTSMARCH 31, 2005**

**(Unaudited)**

 

**Condensed Consolidating BalanceSheet**

 
| ** **                                                                   | ** ** | **MARCH 31, 2005**           | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                   | ** ** | **PENHALL  INTERNATIONAL  CORP.** | ** ** | **PENHALL  COMPANY** | ** ** | **ELIMINATIONS** | ** ** | **CONSOLIDATED** | ** ** |
| Assets                                                                       |       |                              |       |   |   |   |   |   |   |
| Current assets:                                                              |       |                              |       |   |   |   |   |   |   |
| Receivables, net                                                             |       | $                                 | —     |   | $ | 29,251,000 |   | $ | — |   | $ | 29,251,000 |   |
| Costs and estimated earnings in excess of  billings on uncompleted contracts |       | —                            |       | 3,056,000 |   | — |   | 3,056,000 |   |
| Income taxes receivable                                                      |       | 1,544,000                         |       | — |   | — |   | 1,544,000 |   |
| Inventories                                                                  |       | —                            |       | 2,238,000 |   | — |   | 2,238,000 |   |
| Other current assets                                                         |       | 94,000                            |       | 3,034,000 |   | — |   | 3,128,000 |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
| Total current assets                                                         |       | 1,638,000                         |       | 37,579,000 |   | — |   | 39,217,000 |   |
| Net plant and equipment                                                      |       | —                            |       | 36,053,000 |   | — |   | 36,053,000 |   |
| Other assets, net                                                            |       | 890,000                           |       | 7,503,000 |   | — |   | 8,393,000 |   |
| Investment in subsidiaries                                                   |       | 54,189,000                        |       | — |   | (54,189,000 | ) | — |   |
|                                                                         |       | $                                 | 56,717,000 |   | $ | 81,135,000 |   | $ | (54,189,000 | ) | $ | 83,663,000 |   |
| Liabilities and Stockholders’ Equity  (Deficit):                        |       |                              |       |   |   |   |   |   |   |
| Current installments of long-term debt                                       |       | $                                 | —     |   | $ | 268,000 |   | $ | — |   | $ | 268,000 |   |
| Borrowings under revolving credit facility                                   |       | —                            |       | 1,004,000 |   | — |   | 1,004,000 |   |
| Trade accounts payable                                                       |       | —                            |       | 5,256,000 |   | — |   | 5,256,000 |   |
| Accrued liabilities                                                          |       | 2,574,000                         |       | 6,847,000 |   | — |   | 9,421,000 |   |
| Current portion of insurance reserves                                        |       | —                            |       | 1,873,000 |   | — |   | 1,873,000 |   |
| Current portion of deferred gain-  sale-leaseback                            |       | 109,000                           |       | — |   | — |   | 109,000 |   |
| Billings in excess of costs and estimated  earnings on uncompleted contracts |       | —                            |       | 974,000 |   | — |   | 974,000 |   |
| Total current liabilities                                                    |       | 2,683,000                         |       | 16,222,000 |   | — |   | 18,905,000 |   |
|                                                                         |       |                              |       |   |   |   |   |   |   |
| Long-term debt, excluding current  installments                              |       | —                            |       | — |   | — |   | — |   |
| Long-term portion of deferred gain –  sale-leaseback                    |       | 1,933,000                         |       | — |   | — |   | 1,933,000 |   |
| Long-term portion of insurance reserves                                      |       | —                            |       | 5,903,000 |   | — |   | 5,903,000 |   |
| Senior notes                                                                 |       | 100,000,000                       |       | — |   | — |   | 100,000,000 |   |
| Deferred tax liabilities                                                     |       | (1,050,000                        | )          | 4,821,000 |   | — |   | 3,771,000 |   |
| Senior Exchangeable Preferred stock                                          |       | 20,126,000                        |       | — |   | — |   | 20,126,000 |   |
| Series A Preferred stock                                                |       | 24,787,000                        |       | — |   | — |   | 24,787,000 |   |
| Series B Preferred stock subject to  put option                         |       | 7,688,000                         |       | — |   | — |   | 7,688,000 |   |
| Common stock subject to put option                                           |       | 325,000                           |       | — |   | — |   | 325,000 |   |
| Stockholders’ equity (deficit)                                          |       | (99,775,000                       | )          | 54,189,000 |   | (54,189,000 | ) | (99,775,000 | ) |
|                                                                         |       | $                                 | 56,717,000 |   | $ | 81,135,000 |   | $ | (54,189,000 | ) | $ | 83,663,000 |   |

 

10

----

 

**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTSMARCH 31, 2005**

**(Unaudited)**

 

**CondensedConsolidating Statement of Operations**

 
| ** **                          | ** ** | **THREE MONTH PERIOD ENDED MARCH 31, 2004** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|
| ** **                          | ** ** | **Penhall  International  Corp.**                | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                            |       | $                                                | 1,100,000  |   | $ | 31,368,000 |   | $ | (1,100,000 | ) | $ | 31,368,000 |   |
| Cost of revenues                    |       | —                                           |       | 26,083,000 |   | — |   | 26,083,000 |   |
|                                |       |                                             |       |   |   |   |   |   |   |
| Gross profit                        |       | 1,100,000                                        |       | 5,285,000 |   | (1,100,000 | ) | 5,285,000 |   |
|                                |       |                                             |       |   |   |   |   |   |   |
| General and administrative expenses |       | 413,000                                          |       | 7,265,000 |   | (397,000 | ) | 7,281,000 |   |
| Royalties                           |       | —                                           |       | 703,000 |   | (703,000 | ) | — |   |
| Goodwill impairment                 |       | —                                           |       | 353,000 |   | — |   | 353,000 |   |
| Other operating income, net         |       | —                                           |       | 122,000 |   | — |   | 122,000 |   |
| Equity in loss of subsidiary        |       | (1,922,000                                       | )          | — |   | 1,922,000 |   | — |   |
|                                |       |                                             |       |   |   |   |   |   |   |
| Loss from operations                |       | (1,235,000                                       | )          | (2,914,000 | ) | 1,922,000 |   | (2,227,000 | ) |
|                                |       |                                             |       |   |   |   |   |   |   |
| Interest expense                    |       | 3,158,000                                        |       | 186,000 |   | — |   | 3,344,000 |   |
| Other income                        |       | 33,000                                           |       | — |   | — |   | 33,000 |   |
|                                |       |                                             |       |   |   |   |   |   |   |
| Loss before income taxes       |       | (4,360,000                                       | )          | (3,100,000 | ) | 1,922,000 |   | (5,538,000 | ) |
|                                |       |                                             |       |   |   |   |   |   |   |
| Income tax benefit                  |       | (904,000                                         | )          | (1,178,000 | ) | — |   | (2,082,000 | ) |
|                                |       |                                             |       |   |   |   |   |   |   |
| Net loss                            |       | $                                                | (3,456,000 | ) | $ | (1,922,000 | ) | $ | 1,922,000 |   | $ | (3,456,000 | ) |

 

11

----

 

**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTSMARCH 31, 2005**

**(Unaudited)**

 

**CondensedConsolidating Statement of Operations**

 
| ** **                          | ** ** | **THREE MONTH PERIOD ENDED MARCH 31, 2005** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|
| ** **                          | ** ** | **Penhall  International  Corp.**                | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                            |       | $                                                | 1,087,000  |   | $ | 30,860,000 |   | $ | (1,087,000 | ) | $ | 30,860,000 |   |
| Cost of revenues                    |       | —                                           |       | 24,703,000 |   | — |   | 24,703,000 |   |
|                                |       |                                             |       |   |   |   |   |   |   |
| Gross profit                        |       | 1,087,000                                        |       | 6,157,000 |   | (1,087,000 | ) | 6,157,000 |   |
|                                |       |                                             |       |   |   |   |   |   |   |
| General and administrative expenses |       | 432,000                                          |       | 7,006,000 |   | (396,000 | ) | 7,042,000 |   |
| Royalties                           |       | —                                           |       | 691,000 |   | (691,000 | ) | — |   |
| Other operating income, net         |       | 1,000                                            |       | 22,000 |   | — |   | 23,000 |   |
| Equity in loss of subsidiary        |       | (1,017,000                                       | )          | — |   | 1,017,000 |   | — |   |
|                                |       |                                             |       |   |   |   |   |   |   |
| Loss from operations                |       | (361,000                                         | )          | (1,518,000 | ) | 1,017,000 |   | (862,000 | ) |
|                                |       |                                             |       |   |   |   |   |   |   |
| Interest expense                    |       | 3,108,000                                        |       | 177,000 |   | — |   | 3,285,000 |   |
| Interest expense - preferred stock  |       | 1,293,000                                        |       | — |   | — |   | 1,293,000 |   |
| Other income                        |       | 27,000                                           |       | — |   | — |   | 27,000 |   |
|                                |       |                                             |       |   |   |   |   |   |   |
| Loss before income taxes            |       | (4,735,000                                       | )          | (1,695,000 | ) | 1,017,000 |   | (5,413,000 | ) |
|                                |       |                                             |       |   |   |   |   |   |   |
| Income tax benefit                  |       | (982,000                                         | )          | (678,000 | ) | — |   | (1,660,000 | ) |
|                                |       |                                             |       |   |   |   |   |   |   |
| Net loss                            |       | $                                                | (3,753,000 | ) | $ | (1,017,000 | ) | $ | 1,017,000 |   | $ | (3,753,000 | ) |

 

12

----

 

**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTSMARCH 31, 2005**

**(Unaudited)**

 

**CondensedConsolidating Statement of Operations**

 
| ** **                               | ** ** | **NINE MONTH PERIOD ENDED MARCH 31, 2004** | ** ** |
|------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                               | ** ** | **Penhall  International  Corp.**               | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                 |       | $                                               | 3,805,000  |   | $ | 116,767,000 |   | $ | (3,805,000 | ) | $ | 116,767,000 |   |
| Cost of revenues                         |       | —                                          |       | 90,303,000 |   | — |   | 90,303,000 |   |
|                                     |       |                                            |       |   |   |   |   |   |   |
| Gross profit                             |       | 3,805,000                                       |       | 26,464,000 |   | (3,805,000 | ) | 26,464,000 |   |
|                                     |       |                                            |       |   |   |   |   |   |   |
| General and administrative expenses      |       | 861,000                                         |       | 22,008,000 |   | (1,189,000 | ) | 21,680,000 |   |
| Royalties                                |       | —                                          |       | 2,616,000 |   | (2,616,000 | ) | — |   |
| Goodwill impairment                      |       | —                                          |       | 353,000 |   | — |   | 353,000 |   |
| Other operating income, net              |       | —                                          |       | 520,000 |   | — |   | 520,000 |   |
| Equity in earnings of subsidiary         |       | 1,199,000                                       |       | — |   | (1,199,000 | ) | — |   |
|                                     |       |                                            |       |   |   |   |   |   |   |
| Earnings from operations                 |       | 4,143,000                                       |       | 2,007,000 |   | (1,199,000 | ) | 4,951,000 |   |
|                                     |       |                                            |       |   |   |   |   |   |   |
| Interest expense                         |       | 9,579,000                                       |       | 868,000 |   | — |   | 10,447,000 |   |
| Other income                             |       | 44,000                                          |       | 795,000 |   | — |   | 839,000 |   |
|                                     |       |                                            |       |   |   |   |   |   |   |
| Earnings (loss) before income taxes |       | (5,392,000                                      | )          | 1,934,000 |   | (1,199,000 | ) | (4,657,000 | ) |
|                                     |       |                                            |       |   |   |   |   |   |   |
| Income tax expense (benefit)             |       | (2,482,000                                      | )          | 735,000 |   | — |   | (1,747,000 | ) |
|                                     |       |                                            |       |   |   |   |   |   |   |
| Net earnings (loss)                      |       | $                                               | (2,910,000 | ) | $ | 1,199,000 |   | $ | (1,199,000 | ) | $ | (2,910,000 | ) |

 

13

----

 

**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTSMARCH 31, 2005**

**(Unaudited)**

 

**CondensedConsolidating Statement of Operations**

 
| ** **                               | ** ** | **NINE MONTH PERIOD ENDED MARCH 31, 2005** | ** ** |
|------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                               | ** ** | **Penhall  International  Corp.**               | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Revenues                                 |       | $                                               | 3,922,000  |   | $ | 122,069,000 |   | $ | (3,922,000 | ) | $ | 122,069,000 |   |
| Cost of revenues                         |       | —                                          |       | 92,965,000 |   | — |   | 92,965,000 |   |
|                                     |       |                                            |       |   |   |   |   |   |   |
| Gross profit                             |       | 3,922,000                                       |       | 29,104,000 |   | (3,922,000 | ) | 29,104,000 |   |
|                                     |       |                                            |       |   |   |   |   |   |   |
| General and administrative expenses      |       | 1,303,000                                       |       | 22,247,000 |   | (1,188,000 | ) | 22,362,000 |   |
| Royalties                                |       | —                                          |       | 2,734,000 |   | (2,734,000 | ) | — |   |
| Other operating income, net              |       | 1,000                                           |       | 341,000 |   | — |   | 342,000 |   |
| Equity in earnings of subsidiary         |       | 2,339,000                                       |       | — |   | (2,339,000 | ) | — |   |
|                                     |       |                                            |       |   |   |   |   |   |   |
| Earnings from operations                 |       | 4,959,000                                       |       | 4,464,000 |   | (2,339,000 | ) | 7,084,000 |   |
|                                     |       |                                            |       |   |   |   |   |   |   |
| Interest expense                         |       | 9,506,000                                       |       | 565,000 |   | — |   | 10,071,000 |   |
| Interest expense - preferred stock       |       | 3,827,000                                       |       | — |   | — |   | 3,827,000 |   |
| Other income                             |       | 82,000                                          |       | — |   | — |   | 82,000 |   |
|                                     |       |                                            |       |   |   |   |   |   |   |
| Earnings (loss) before income taxes |       | (8,292,000                                      | )          | 3,899,000 |   | (2,339,000 | ) | (6,732,000 | ) |
| Income tax expense (benefit)             |       | (2,722,000                                      | )          | 1,560,000 |   | — |   | (1,162,000 | ) |
| Net earnings (loss)                      |       | $                                               | (5,570,000 | ) | $ | 2,339,000 |   | $ | (2,339,000 | ) | $ | (5,570,000 | ) |

 

14

----

 

**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTSMARCH 31, 2005**

**(Unaudited)**

 

**CondensedConsolidating Statement of Cash Flows**

 
| ** **                                           | ** ** | **NINE MONTH PERIOD ENDED MARCH 31, 2004** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | **Penhall  International  Corp.**               | ** ** | **Penhall  Company** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Net cash provided by (used in) operating  activities |       | $                                               | (5,911,000 | ) | $ | 14,492,000 |   | $ | — |   | $ | 8,581,000 |   |
|                                                 |       |                                            |       |   |   |   |   |   |   |
| Cash flows from investing activities:                |       |                                            |       |   |   |   |   |   |   |
| Proceeds from sale of assets                         |       | 11,312,000                                      |       | 1,769,000 |   | — |   | 13,081,000 |   |
| Capital expenditures                                 |       | —                                          |       | (4,012,000 | ) | — |   | (4,012,000 | ) |
|                                                 |       |                                            |       |   |   |   |   |   |   |
| Net cash provided by (used in) investing  activities |       | 11,312,000                                      |       | (2,243,000 | ) | — |   | 9,069,000 |   |
|                                                 |       |                                            |       |   |   |   |   |   |   |
| Cash flows from financing activities:                |       |                                            |       |   |   |   |   |   |   |
| Due to (from) affiliates                        |       | (5,208,000                                      | )          | 5,208,000 |   | — |   | — |   |
| Borrowings under long-term debt                      |       | —                                          |       | 96,000 |   | — |   | 96,000 |   |
| Repayments of long-term debt                         |       | (183,000                                        | )          | (2,172,000 | ) | — |   | (2,355,000 | ) |
| Borrowings under revolving credit facility           |       | —                                          |       | 164,198,000 |   | — |   | 164,198,000 |   |
| Repayments of revolving credit facility              |       | —                                          |       | (178,683,000 | ) | — |   | (178,683,000 | ) |
| Debt issuance costs                                  |       | —                                          |       | (161,000 | ) | — |   | (161,000 | ) |
| Book overdraft                                       |       | (152,000                                        | )          | (514,000 | ) | 152,000 |   | (514,000 | ) |
|                                                 |       |                                            |       |   |   |   |   |   |   |
| Net cash used in financing activities                |       | (5,543,000                                      | )          | (12,028,000 | ) | 152,000 |   | (17,419,000 | ) |
|                                                 |       |                                            |       |   |   |   |   |   |   |
| Net change in cash and cash equivalents              |       | (142,000                                        | )          | 221,000 |   | 152,000 |   | 231,000 |   |
| Cash and cash equivalents at beginning of  period    |       | 152,000                                         |       | 184,000 |   | (152,000 | ) | 184,000 |   |
|                                                 |       |                                            |       |   |   |   |   |   |   |
| Cash and cash equivalents at end of period           |       | $                                               | 10,000     |   | $ | 405,000 |   | $ | — |   | $ | 415,000 |   |

 

15

----

 

**PENHALL INTERNATIONAL CORP.AND SUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTSMARCH 31, 2005**

**(Unaudited)**

 

**CondensedConsolidating Statement of Cash Flows**

 
| ** **                                           | ** ** | **NINE MONTH PERIOD ENDED MARCH 31, 2005** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | **PENHALL  INTERNATIONAL  CORP.**               | ** ** | **PENHALL  COMPANY** | ** ** | **ELIMINATIONS** | ** ** | **CONSOLIDATED** | ** ** |
|                                                 |       |                                            |       |   |   |   |   |   |   |
| Net cash provided by (used in) operating  activities |       | $                                               | (8,325,000 | ) | $ | 15,023,000 |   | $ | — |   | $ | 6,698,000 |   |
|                                                 |       |                                            |       |   |   |   |   |   |   |
| Cash flows from investing activities:                |       |                                            |       |   |   |   |   |   |   |
| Proceeds from sale of assets                         |       | —                                          |       | 410,000 |   | — |   | 410,000 |   |
| Capital expenditures                                 |       | —                                          |       | (9,189,000 | ) | — |   | (9,189,000 | ) |
| Net cash used in investing activities           |       | —                                          |       | (8,779,000 | ) | — |   | (8,779,000 | ) |
|                                                 |       |                                            |       |   |   |   |   |   |   |
| Cash flows from financing activities:                |       |                                            |       |   |   |   |   |   |   |
| Due to (from) affiliates                        |       | 8,321,000                                       |       | (8,321,000 | ) | — |   | — |   |
| Borrowings under long-term debt                      |       | —                                          |       | 271,000 |   | — |   | 271,000 |   |
| Repayments of long-term debt                         |       | —                                          |       | (998,000 | ) | — |   | (998,000 | ) |
| Borrowings under revolving credit facility           |       | —                                          |       | 135,967,000 |   | — |   | 135,967,000 |   |
| Repayments of revolving credit facility              |       | —                                          |       | (134,963,000 | ) | — |   | (134,963,000 | ) |
| Book overdraft                                       |       | —                                          |       | 815,000 |   | — |   | 815,000 |   |
| Net cash provided by (used in) financing  activities |       | 8,321,000                                       |       | (7,229,000 | ) | — |   | 1,092,000 |   |
|                                                 |       |                                            |       |   |   |   |   |   |   |
| Net change in cash and cash equivalents              |       | (4,000                                          | )          | (985,000 | ) | — |   | (989,000 | ) |
| Cash and cash equivalents at beginning of  period    |       | 8,000                                           |       | 1,068,000 |   | — |   | 1,076,000 |   |
| Cash and cash equivalents at end of period           |       | $                                               | 4,000      |   | $ | 83,000 |   | $ | — |   | $ | 87,000 |   |

 

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**ITEM 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations.**

 

The following discussion of the results ofoperations and financial condition of Penhall International Corp. andsubsidiaries (Penhall or the Company) should be read in conjunction with theunaudited condensed consolidated financial statements and footnotes theretoincluded in this quarterly report on Form 10-Q and the Company’saudited consolidated financial statements and footnotes thereto included in itsFiscal 2004 annual report on Form 10-K/A, filed with the Securitiesand Exchange Commission.

 

***GENERAL***

 

Penhall was founded in 1957 in Anaheim,California with one piece of equipment, and today is one of the largestoperated equipment rental services companies in the United States. Penhalldifferentiates itself from other equipment rental companies by providingspecialized services in connection with infrastructure projects through rentingequipment along with skilled operators to serve customers in the construction,industrial, manufacturing, governmental and residential markets. In addition,Penhall complements its Operated Equipment Rental Services with fixed-pricecontracts, which serve to market its Operated Equipment Rental Services businessand increase utilization of its operated equipment rental fleet. Penhallprovides its services from 37 locations in 16 states, with a presence in someof the fastest growing states in terms of construction spending and populationgrowth.

 

The operated equipment rental industry is aspecialized niche of the highly fragmented United States equipment rentalindustry, in which there are approximately 15,000 companies. Penhall has takenadvantage of consolidation opportunities by acquiring small companies intargeted markets as well as by establishing new offices in those markets. Since1998, Penhall has effected eight strategic acquisitions, including:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

During the same period, Penhall establishedoperations in six new markets by opening offices in Dallas, Richmond, Fresno,Buffalo, Reno, and Seattle. Penhall derives its revenues primarily fromservices provided for infrastructure related jobs. Penhall’s Operated EquipmentRental Services are provided primarily under hourly rentals, which are complemented byfixed-price contracts.

 

Fixed-price contracts are obtained primarily throughcompetitive bidding in response to advertisements by federal, state and localagencies and private parties and to a lesser extent through negotiation with privateparties. Our bidding activity is affected by such factors as backlog, currentutilization of equipment and other resources, our ability to obtain necessarysurety bonds and competitive considerations. Bidding activity, backlog andrevenue resulting from the award of new contracts may vary significantly fromperiod to period.

 

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The two primary economic drivers of our business are(1) federal, state and local public funding levels for transportation andother infrastructure projects and (2) the overall health of the economy,nationally and locally, particularly as it affects private non-residentialconstruction. The level of demand for our services will have a directcorrelation to these drivers. For example, a weak economy will generally resultin a reduced demand for construction in the private sector. This reduced demandincreases competition for fewer private sector projects and will ultimatelyalso increase competition in the public sector as companies migrate frombidding on scarce private sector work to projects in the public sector. Greatercompetition can reduce revenue growth and/or increase pressure on gross profitmargins. A weak economy also tends to produce less tax revenue, thereby decreasingthe funds available for spending on public infrastructure improvements. Thereare funding sources that have been specifically earmarked for infrastructurespending, such as gasoline taxes, which are not necessarily directly impactedby a weak economy. However, even these funds can be temporarily at risk asstate and local governments struggle to balance their budgets. Conversely,higher public funding and/or a robust economy will increase demand for ourservices and provide opportunities for revenue growth and margin improvement.

 

Revenue growth is also influenced byinfrastructure change, including new construction, modification, and regulatorychanges. Penhall’s revenues are also impacted positively after the occurrenceof natural disasters, such as the 1989 and 1994 earthquakes in Northern andSouthern California. Other factors that influence Penhall’s operations aredemand for operated rental equipment, the amount and quality of equipmentavailable for rent, rental rates and general economic conditions. Historically,revenues have been seasonal, as weather conditions in the spring and summermonths result in stronger performance in the first and fourth fiscal quartersthan in the second and third fiscal quarters.

 

The principal components of Penhall’s operatingcosts include the cost of labor, equipment rental fleet maintenance costsincluding parts and service, equipment rental fleet depreciation, insurance andother direct operating costs. Given the varied, and in some cases specialized,nature of its rental equipment, Penhall utilizes a range of periods over whichit depreciates its equipment on a straight-line basis. On average, Penhalldepreciates its equipment over an estimated useful life of three to eight yearswith a 10% residual value.

 

***CRITICAL ACCOUNTING POLICIES AND ESTIMATES***

 

The preparation of consolidated financialstatements requires the Company to make estimates and judgments that affect thereported amounts of assets, liabilities, revenues and expenses, and relateddisclosure of contingent assets and liabilities. On an on-going basis, theCompany evaluates its estimates, including those related to long-termconstruction contracts, accounts receivable, goodwill, long-lived assets,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-Term ConstructionContracts*

 

Income from construction operations isrecorded using the percentage-of-completion method of accounting. The majorityof our long-term fixed price contracts with our customers are either “fixedunit price” or “fixed price”. Under fixed unit price contracts, the Company iscommitted to provide materials or services required by a project at fixed unitprices.  The fixed unit price contractshifts the risk of estimating the quantity of units required for a particularproject to the customer, any increase in our unit cost over the expected unitcost in the bid, whether due to inflation, inefficiency, faulty estimates orother factors, is borne by the Company unless otherwise provided in thecontract. Fixed price contracts are priced on a lump-sum basis under which webear the risk that we may not be able to perform all the work profitably forthe specified contract amount.  All stateand federal government contracts and many of our other contracts provide fortermination of the contract for the convenience of the party contracting withus, with provisions to pay us for work performed through the date oftermination.

 

We use the percentage-of-completionaccounting method for construction contracts in accordance with the AmericanInstitute of Certified Public Accountants Statement of Position 81-1,“Accounting for Performance of Construction-Type and Certain Production-TypeContracts.” Revenue and earnings on construction contracts are recognized onthe percentage-of-completion method in the ratio of costs incurred to estimatedfinal costs.  Provisions are recognizedin the statement of operations for the full amount of estimated losses onuncompleted contracts whenever evidence indicates that the estimated total costof a contract exceeds its estimated total revenue.

 

Contract cost consists of direct costs oncontracts, including labor and materials, amounts payable to subcontractors,direct overhead costs and equipment expense (primarily depreciation, blades,fuel, maintenance and repairs). Contract cost is recorded as incurred andrevisions in contract revenue and cost estimates are reflected in the accountingperiod when known.  The accuracy of ourrevenue and profit recognition in a given period is dependent on the accuracyof our estimates of the cost

 

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to complete each project which are completed by our project managers.However, projects can be complex and in most cases the profit margin estimatesfor a project will either increase or decrease to some extent from the amountthat was originally estimated at the time of bid. Because we have many projectsof varying levels of complexity and size in process at any given time (during2004 we worked on over 1,000 projects) these changes in estimatestypically offset each other without materially impacting our overallprofitability. However, large changes in cost estimates in the larger projects,can have a more significant effect on profitability.

 

*Valuation of Long-Lived Assets*

 

Onan annual basis or sooner when triggering events occur, we will review thecarrying value of long-lived assets (excluding goodwill) for potentialimpairment.  Our review considers acombination of appraised value, anticipated future undiscounted cash flows andlocation of the asset for each line of equipment.  Deteriorating market conditions couldpotentially impact valuation of long-lived assets.  In markets where adverse market conditionsexist, the Company will consider reallocation of long-lived assets to marketswhere those assets will produce cash flow. Assets to be disposed of are reported at the lower of the carrying amountor fair value, less costs to sell. During the nine month period ended March 31, 2005, there were notriggering events.

 

*Income Taxes*

 

We account for income taxes under the asset and liability method ofSFAS No. 109, “Accounting for Income Taxes,” under which we recognizedeferred income taxes, net of valuation allowances, for the estimated futuretax effects of temporary differences between the financial statement carryingamounts of existing assets and liabilities and their tax bases and netoperating loss and tax credit carryforwards. Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to berecovered or settled. The effect on deferred tax assets and liabilities of achange in tax rates is recognized in income in the period that includes theenactment date.

 

We evaluate the realizability of our deferred tax assets on a regularbasis.  In making this assessment, management considers whether it is morelikely than not that some portion or all of its deferred tax assets will not berealized. The ultimate realization of deferred tax assets is dependent upon thegeneration of future taxable income during the periods in which those temporarydifferences become deductible. Management considers all available evidence,both positive and negative in making this assessment. Due to estimated futurereversals of existing taxable temporary differences, management believes it ismore likely than not that we will realize the benefits of these deductibledifferences.  In the future, if we determine that we no longer expect torealize a portion of our deferred tax assets, we would recognize a deferred taxasset valuation allowance, which would increase income tax expense in theperiod such determination is made.

 

*Goodwill*

 

We use estimates in order to determine ifgoodwill has been impaired. An impairment loss may be recognized if thecarrying amount of a reporting unit’s net book value exceeds the estimated fairvalue of the reporting unit.   As ofMarch 31, 2005, goodwill is assigned to five reporting units whichrepresent five individual acquisitions. We arrive at the estimated fair value of a reporting unit based on cashflow utilizing a multiple of earnings before interest, depreciation, taxes andamortization (EBIDTA).  This multiple isdetermined based on prior transactions conducted by the company and by othersin comparable market sectors to calculate the fair value.  We will perform our valuation analysis atleast annually or sooner if an event occurs or circumstances change that wouldindicate the carrying amount of goodwill may be impaired. If our estimates orassumptions change from those used in our current valuation, we may be requiredto recognize an impairment loss in future periods. The Company evaluatesgoodwill for impairment at June 30 of each year.

 

Factors weconsider important which could trigger an impairment review include:

 

•                  Significantunderperformance relative to expected historical or projected future operatingresults;

•                  Significantchanges in the manner of our use of the acquired assets or the strategy for ouroverall business;

•                  Significantnegative industry or economic trends;

•                  Unanticipatedcompetition; and

•                  EBITDArelative to net book value

 

A majority of the remaining goodwill resides in one reporting unit inwhich profit levels have sustained over time. We expect such profit levels to continue prospectively, however, ifprofit levels were to deteriorate the reporting units’ goodwill could becomeimpaired.

 

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***RESULTS OF OPERATIONS***

 

***Nine months EndedMarch 31, 2005 Compared to Nine months Ended March 31, 2004***

 

Revenues. Revenues for the nine months ended March 31, 2005  (“Interim 2005”) were $122.1 million anincrease of $5.3 million or 4.5% from the nine months ended March 31, 2004(“Interim 2004”).   In Interim 2005,service revenues increased $5.7 million or 7.0% and contract revenues decreased$0.4 million or 1.3% as compared to Interim 2004.  The increase in service revenues is primarilyattributable to increases in non-residential construction nationwide andparticularly in California as well as the increase in concrete restorationprojects undertaken by many states.  Thedecrease in contract revenues is primarily attributable to the impact of alarge project in Interim 2004 that was completed by Interim 2005.

 

Penhall operated through 37 locations in 16states at March 31, 2005, and through 38 locations in 17 states at March 31,2004.  At March 31, 2005, Penhall’soperated rental fleet consisted of 683 units compared to 700 units atMarch 31, 2004, a decrease of 2.4%. The smaller fleet of revenue units is attributable to the Company notreplacing all of the disposed units since overall revenue unit utilizationrates remain low for the nine-month period ended March 31, 2005.

 

Gross Profit. * *Gross profit totaled$29.1 million in Interim 2005, an increase of $2.6 million or 10.0% fromInterim 2004. Gross profit as a percentage of revenues increased from 22.7% inInterim 2004 to 23.8% in Interim 2005. The increase in gross profit fromInterim 2004 to Interim 2005 is primarily attributable to higher market demandfor operated equipment which increased demand for the Company’s services duringInterim 2005.  Another factor increasinggross profit was the $1.5 million decrease in depreciation expense, which isthe result of low capital expenditures during Fiscal 2003 and 2004.

 

General and Administrative Expenses.  General and administrative expenses were$22.4 million in Interim 2005 compared to $21.7 million in Interim 2004.As a percent of revenues, general and administrative expenses were 18.3% inInterim 2005 compared to 18.6% in Interim 2004. The increase in general andadministrative expenses during Interim 2005 is primarily attributable toincreases in rent expense of $0.7 million associated with the sale/leaseback ofCompany properties.

 

Interest Expense*.*Interest expense was $10.1 million in Interim 2005compared to interest expense of $10.4 million in Interim 2004. Thedecrease in interest expense is attributable to lower borrowings in Interim2005 primarily resulting from the proceeds on the sale-leaseback of the Companyowned properties, which was used to reduce the borrowings under the revolvingcredit facility, partially offset by higher costs for letters of credit.

 

Interest Expense - Preferred Stock.  In Interim2005, the Company adopted SFAS No. 150 which required the Company topresent separately as interest expense $3.8 million of accretion related tomandatorily redeemable instruments. Prior to Interim 2005, the Company recorded the accretion in thedetermination of net loss applicable to common stockholders which was $3.4 millionin Interim 2004.

 

OtherIncome.  Other income was $82,000 inInterim 2005 compared to $839,000 in Interim 2004.  The decrease is attributable to the sale ofan FCC license during Interim 2004.

 

Income Tax Benefit.  The Company recorded an income tax benefit of$1.2 million or 40% of earnings before income taxes excluding the impactof non-deductible interest expense on preferred stock, compared to an incometax benefit of $1.7 million, or 38.0% of earnings before income taxes inInterim 2004.   The change in theeffective tax rate adjusted for the non-deductible interest expense related topreferred stock for Interim 2005 is primarily attributable to changes in themix of earnings in differing tax jurisdictions.

 

***Three Months EndedMarch 31, 2005 Compared to Three Months Ended March 31, 2004***

 

Revenues. Revenues for the three months ended March 31, 2005  (“Quarter 2005”) were $30.9 million adecrease of $0.5 million or 1.6% from the three months ended March 31,2004 (“Quarter 2004”).  The decrease inrevenues is primarily attributable to unusually high levels of precipitation inthe southwest markets during Quarter 2005 which reduced our ability towork.  In Quarter 2005, service revenuesincreased $1.7 million or 7.4% and contract revenues decreased $2.2  million or 27.4% as compared to Quarter2004.  The increase in service revenuesis primarily attributable to increases in non residential construction.  The decrease in contract revenues in Quarter2005 is primarily related to a large project in Quarter 2004 which wascompleted prior to Quarter 2005.

 

Gross Profit. * *Gross profit totaled$6.2 million in Quarter 2005, an increase of $0.9 million or 16.5% fromQuarter 2004. Gross profit as a percentage of revenues increased to 19.9% inQuarter 2005 from 16.8% in Quarter 2004. The increase in gross profit fromQuarter 2004 to Quarter 2005 is primarily attributable to a $0.4 milliondecrease in depreciation expense, which is the result of low capitalexpenditures during fiscal 2003 and 2004, as well as higher utilization duringQuarter 2005.

 

General and Administrative Expenses.  General and administrative expenses were$7.0 million in Quarter 2005 compared to $7.3 million in Quarter 2004. Asa percent of revenues, general and administrative expenses were 22.8% inQuarter 2005 compared to 23.2% in Quarter 2004. The decrease in general andadministrative expenses as a percentage of revenues during Quarter 2005 isprimarily attributable to decreases in legal expense of $0.3 million duringQuarter 2005.

 

Interest Expense*.*Interest expense was $3.3 million in Quarter 2004 and2005. 

 

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Interest Expense - Preferred Stock.  In Quarter2005, the Company adopted SFAS No. 150 which required the Company topresent separately as interest expense $1.3 million of accretion related tomandatorily redeemable instruments. Prior to Quarter 2005, the Company recorded the accretion in thedetermination of net loss applicable to common stockholders which was $1.2million in Quarter 2004.

 

Income Tax Benefit*.*The Company recorded an income tax benefit of$1.7 million, or 40.3% of earnings before income taxes excluding theimpact of non-deductible interest expense on preferred stock, compared to anincome tax benefit of $2.1 million, or 37.6% of earnings before income taxes inQuarter 2004.    The change in theeffective tax rate adjusted for the non-deductible interest expense related topreferred stock for Quarter 2005 is primarily attributable to changes in themix of earnings in differing tax jurisdictions.

 

***LIQUIDITY AND CAPITAL RESOURCES***

 

Itis anticipated that the Company’s principal uses of liquidity will be to fundworking capital, meet debt service requirements and finance the Company’sstrategy of pursuing strategic acquisitions and expanding through internalgrowth. The Company’s principal sources of liquidity are expected to be cashflow from operations and borrowings under the Company’s new credit facility(“The New Credit”) secured in May 2003. The New Credit is a$50 million, three year asset-based borrowing facility consisting of arevolving credit facility (“New Revolver”) of up to $50 million, with a$25 million sub-facility for letters of credit. Availability under therevolver portion of The New Credit would be limited to a borrowing baseconsisting of (i) up to 85% of the net amount of the Company’s eligibletrade accounts receivable, (ii) up to the lesser of (a) 100% of thenet book value of the Company’s eligible inventory and eligible equipment or(b) 85% of the appraised net orderly liquidation value of Company’seligible inventory and equipment, and (iii) up to 50% of the appraisedforced liquidation value of the Company’s owned real estate.

 

The provisions of The New Credit include a lock-box agreement thatallows the lender, in its reasonable credit judgment, to assess additionalreserves against the borrowing base calculation.  Accordingly, borrowings under the agreementare classified as current.  Borrowingsunder The New Credit are also subject to certain key financialcovenants:

 

•                  Maintain a minimum interest coverage ratio(adjusted EBITDA divided by interest expense) of at least 1.25.  At March 31, 2005, the actual ratio was1.70.

 

•                  Maintain a maximum leverage ratio (debtsenior to the senior notes divided by adjusted EBITDA) of less than 2.30.  At March 31, 2005, the actual ratio was1.01.

 

•                  The Company is limited to $1.75 million ofcapital expenditures annually for parts and property.  This includes any fixed assets (other thanequipment), parts, tools, supplies or improvements that have a useful lifegreater than one year.  At March 31,2005, the Company had spent $244,000 for parts and property.

 

•                  The Company is required to maintain a dollarutilization rate above 48% over the prior 4 quarters.  Dollar utilization is total revenue forequipment divided by total standard available revenue during the period.   At March 31, 2005, the Company’s dollarutilization was 64.2%. 

 

At March 31, 2005, theCompany was in compliance with all covenants. There are no anticipated trends that we are aware of that would indicatenon-compliance with such covenants, however, significant deterioration in ourfinancial performance could impact our ability to comply with such covenants.

 

The indebtedness of the Company under The NewCredit is secured by a first priority perfected security interest in all of theinventory, accounts receivable, equipment, fixtures, cash, and other assets ofthe Company.  As of March 31, 2005,the Company had outstanding borrowings of $1.0 million, $20.7 million ofoutstanding letters of credit, borrowing base limitations of $11.4 million, andborrowings unused and available under The New Credit of $16.9 million.

 
| **Summary Cash Flow Data (000’s)  for the nine months  ended March 31,** | ** ** | **2004** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash and cash equivalents                                                          |       | $        | 415        |     | $          | 87 |   |
|                                                                               |       |     |       |     |       |
| Net cash provided by (used in):                                                    |       |     |       |     |       |
| Operating activities                                                               |       | $        | 8,581      |     | $          | 6,698 |   |
| Investing activities                                                               |       | $        | 9,069      |     | $          | (8,779 | ) |
| Financing activities                                                               |       | $        | (17,419    | )        | $          | 1,092 |   |
| Capital expenditures                                                               |       | $        | (4,012     | )        | $          | (9,189 | ) |

 

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 12months.

 

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Cash Flows from Operating Activities. Net cash provided by operating activitiesdecreased by $1.9 million, to $6.7 million in Interim 2005 compared to$8.6 million of net cash provided by operating activities during Interim2004. The decrease in net cash provided by operating activities was primarilydue to Federal tax refunds received during Interim 2004 totaling $2.5 millionwhich are partially offset by the reduction in accounts receivable duringInterim 2005 which provided $3.7 million in cash compared to $1.4 million incash provided by the change in accounts receivable during Interim 2004.  Cash provided by the reduction in accounts receivableis due primarily to several large projects that were billed as ofJune 2004 and collected during interim 2005.  Billings in excess of costs and estimatedearnings on uncompleted contracts used $0.6 million in net cash during Interim2005 compared to $0.3 million in net cash provided during Interim 2004.  The change of $0.9 million is attributable tomultiple projects and primarily the result of milestone billing arrangementswith our customers.  Prepaid expenses andother current assets provided $1.2 million in cash during Interim 2005 comparedto $2.2 million in Interim 2004.  Thisdecrease is primarily related to the timing of the Company’s insurance premiumpayments.  Trade accounts payable used$1.2 million in cash during Interim 2005 compared to $3.5 million in cash inInterim 2004.  This change was primarilydue to the type of contract work being performed at June 2003 which hadhigher levels of subcontract and materials elements than the contract work atJune 2004.  Accrued liabilities used$2.9 million in cash during Interim 2005 compared to $0.9 million in Interim2004.  This change is due to timing ofpayroll and related tax payments in addition to timing of insurance paymentsresulting from a change in the Company’s insurance year which was effectiveJuly 2004.  

 

Cash Flows from Investing Activities. Net cash used in investing activitiestotaled $8.8 million for Interim 2005 compared to $9.1 million of net cashprovided by investing activities during Interim 2004, a change of $17.9 million.In Interim 2005 proceeds from the sale of assets totaled $0.4 million wereoffset by capital expenditures of $9.2 million. In Interim 2004, combined proceeds of $13.1 million from asale-leaseback of all of the Company’s owned properties, the sale of one of ourthree FCC licenses and the proceeds from the sales of assets were offset bycapital expenditures of $4.0 million.  Asall of our owned properties were subject to the sale-leaseback transactionduring Interim 2004 we don’t expect to generate additional liquidity throughsale-leaseback transactions.  

 

Cash Flows from Financing Activities. Net cash provided by financing activitieschanged by $18.5 million to $1.1 million in Interim 2005 compared to net cashused by financing activities totaling $17.4 million in Interim 2004.  This change in net cash from financingactivities resulted primarily from a net increase in repayments of debt due inpart to the sale-leaseback of the Company’s properties that occurred duringInterim 2004.  Additionally, in Interim2005 there was cash provided by book overdraft of $0.8 million compared to cashused by book overdraft of $0.5 million during Interim 2004.  

 

The Company had standby letters of credit totaling$20.7 million at March 31, 2005, all of which are automatically renewableunless the Company or the participating party cancels  the letter of credit thirty days prior toexpiration.  The letters of credit areprovided as collateral 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 has budgeted approximately $12.0million for fiscal 2005 capital expenditures, including replacement andmaintenance of equipment, purchases of new equipment, and purchases of realproperty improvements.

 

Historically, Penhall funded its workingcapital requirements, capital expenditures and other needs principally fromoperating cash flows. However, in 1998, a series of transactions occurredsimilar to a leveraged buyout.  As a resultof these transactions the Company has substantial indebtedness and debt serviceobligations. As of March 31, 2005, the Company and its subsidiaries had$101.3 million of indebtedness related to borrowings, $44.9 million ofindebtedness related to mandatorily redeemable preferred stock and astockholders’ deficit of $99.8 million.  As of March 31, 2005 approximately $16.9million of additional borrowing was available under The New Credit.

 

Asof March 31, 2005, the Company has the following obligations subject toredemption or maturity in fiscal 2007 and 2008:

 
| ** **                          | ** ** | **Due date** | ** ** | **Balance at  March 31,  2005** | ** **  |
|-------------------------------------|------------|--------------|------------|--------------------------------------|-------------|
| Senior Notes                        |       | 08/01/06     |       | $                                    | 100,000,000 |   |
| Senior Exchangeable Preferred Stock |       | 02/01/07     |       | $                                    | 20,126,000  |   |
| Preferred Series A             |       | 08/01/07     |       | $                                    | 24,787,000  |   |

 

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Theaccretion of preferred stock will increase the total obligation through thedates of redemption.  The Companyis exploring various strategies to extend the maturity of

its existing senior notes.  Suchstrategies could take the form of a bank financing or capital marketstransaction. Noassurance can be given that such financing will be available to the Company or,if available that it may be obtained on terms and conditions that aresatisfactory to the Company.

 

As long as the uncertainty associated withthe resolution of these obligations remains, the Company could be subject toadverse consequences including:

 

•                  Makingit more difficult to obtain surety support;

•                  Increasingour vulnerability to general adverse economic and industry conditions;

•                  Limitingour ability to extend or replace the Company’s existing credit facility;

•                  Limitingour ability to extend or replace the Company’s existing Senior Notes:

•                  Limitingour flexibility in planning for, or reacting to, changes in our business andthe industry in which we operate.

 

The Company also has certain common stock andSeries B Preferred stock that are subject to the terms and conditions of aSecurities Holders Agreement.  TheCompany may be required to repurchase these shares if certain conditions aremet.  As of June 30, 2004 andMarch 31, 2005, the Company has recorded these shares at historical costof $8,013,000, as temporary equity in the condensed consolidated balancesheet.  The Series B Preferred stocksubject to the terms and conditions of the Securities Holders Agreement and theremaining Series B Preferred stock include provisions for cumulativedividends of 13% which have not been recorded as the dividends have not beendeclared.  Such dividends approximate$25,669,000 as of March 31, 2005. The Company believes that the likelihood of the conditions allowingredemption by the stockholder occurring is remote.

 

From August 1, 2002 throughOctober 25, 2002, the Company repurchased capital stock of the Companyfrom four former employees for aggregate consideration of $35,000.  The Company’s Indenture dated as ofAugust 1, 1998 (the “Indenture”) with United States Trust Company, asTrustee (the “Trustee”), permits repurchases of capital stock from formeremployees in annual amounts up to $1,000,000 and up to $5,000,000 in aggregateover the life of the Indenture; provided that, at the time of any suchrepurchase, the Company must be able to incur additional indebtedness under theIndenture’s fixed charge coverage ratio. At the time of the repurchases described above, the Company was not ableto incur additional indebtedness under the Indenture’s fixed charge coverageratio, and accordingly such repurchases were not permitted by theIndenture.  The Company has informed theTrustee of such repurchases.  The Trusteehas indicated that it considers the infraction minor and will not pursuewritten notice of default to the Company. In the event that the Company receives written notice specifying thedefault and demanding that such default be remedied from either the Trustee orfrom Holders of at least 25% of the outstanding principal amount of the Notes,then the Company will arrange for a third party to repurchase Company stock inthe aggregate consideration of $35,000 to remedy the default.

 

In connection with our business, the Companyis often required to provide surety bonds that provide an additional measure ofsecurity for our performance under certain public and private sector contracts.Our ability to obtain surety bonds depends upon our capitalization, workingcapital, past performance, management expertise and external factors, includingthe capacity of the overall surety market. Surety companies consider suchfactors in light of the amount of our backlog that we have currently bonded andtheir current underwriting standards, which may change from time to time. Inthe last few years we have seen a steady decrease in the capacity of the suretymarket, driven primarily by substantial increases in surety industry losses andconsolidation in the surety market through acquisition. Due to the Company’soperating results for the past three years and the shrinking capacity of thesurety market, the Company has seen higher premiums and increased difficulty obtainingbonding, in particular for larger and long-term projects.  In order to provide more flexibility andadditional capacity to our surety program, we have retained a secondsurety.  As of March 31, 2005, over26% of the Company’s backlog is bonded. The Company’s inability to obtain surety bonds in the future wouldsignificantly impact our ability to obtain new contracts, which could have amaterial adverse effect on our business.

 

***CHANGE IN ACCOUNTING PRINCIPLE***

 

In May 2003, the FASB issued Statement150, “*Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.*” Statement 150establishes standards for classifying and measuring certain financialinstruments with characteristics of both liabilities and equity. StatementNo. 150 requires that an issuer classify a financial instrument that iswithin its scope as a liability (or an asset in some circumstances) becausethat financial instrument embodies an obligation of the issuer. StatementNo. 150 is effective for financial instruments entered into or modifiedafter May 31, 2003, and otherwise is effective for the first interimperiod beginning after June 15, 2003, except for mandatory redeemablefinancial instruments of certain entities, including the Company, for whichthis statement is effective for fiscal periods beginning afterDecember 15, 2003 (the Company’s fiscal 2005). The Company has adoptedStatement 150 effective July 1, 2004. As a

 

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result of the adoption of Statement 150, accretion related to theSenior Exchangeable Preferred Stock and the Series A Preferred Stock ispresented as interest expense in the Company’s consolidated statements ofoperations.  Prior to the adoptionaccretion was included as part of the determination of net loss applicable tocommon stockholders.

 

***NEW ACCOUNTING PRINCIPLES***

 

In December 2004, the FASB issued FASBStaff Position No. 109-1, “*Application of FASBStatement No. 109, Accounting for Income Taxes, to the Tax Deduction on QualifiedProduction Activities Provided by the American Jobs Creation Act of 2004*”(“FSP No. 109-1”) and FASB Staff Position No. 109-2, “*Accounting and Disclosure Guidance for the Foreign EarningsRepatriation Provision within the American Jobs Creation Act of 2004*”(“FSP No. 109-2”). These staff positions provide accounting guidance onhow companies should account for the effects of the American Jobs Creation Actof 2004 (“AJCA”) that was signed into law on October 22, 2004. FSPNo. 109-1 states that the tax relief (special tax deduction for domesticmanufacturing) from this legislation should be accounted for as a “specialdeduction” instead of a tax rate reduction. FSP No. 109-2 gives a companyadditional time to evaluate the effects of the legislation on any plan forreinvestment or repatriation of foreign earnings for purposes of applying FASBStatement No. 109. We do not expect adoption of FSP No 109-1 or FSP No 109-2to have a material effect on our consolidated results of operations andearnings per share.

 

In December 2004, the FASB StatementNo. 123R (revised 2004), “*Share-Based Payment*”which replaces Statement No. 123, “*Accounting for Stock-BasedCompensation”* and supersedes APB Opinion No. 25, “*Accounting for Stock Issued to Employees*.” Statement No. 123Rrequires all share-based payments to employees, including grants of employeestock options, to be recognized in the financial statements based on their fairvalues, beginning with the first interim or annual period after June 15,2005, with early adoption encouraged. The pro forma disclosures previouslypermitted under Statement No. 123, will no longer will be an alternativeto financial statement recognition. We are required to adopt StatementNo. 123R in our first quarter of fiscal 2006. Under StatementNo. 123R, we must determine the appropriate fair value model to be usedfor valuing share-based payments, the amortization method for compensation costand the transition method to be used at date of adoption. The transitionmethods include prospective and retroactive adoption options. Under theretroactive option, prior periods may be restated either as of the beginning ofthe year of adoption or for all periods presented. The prospective methodrequires that compensation expense be recorded for all unvested stock optionsand restricted stock at the beginning of the first quarter of adoption ofStatement No.123R, while the retroactive method would record compensationexpense for all unvested stock options and restricted stock beginning with thefirst period restated. We are evaluating the requirements of StatementNo. 123R, and we do not expect that the adoption of Statement No.123R tohave a material impact on our consolidated results of operations and earningsper share unless we were to issue additional options under our stock incentiveplan.

 

In November 2004, the FASB issuedStatement No. 151, “*Inventory Costs - AnAmendment of ARB No. 43, Chapter**4.*”  Statement No. 151 amends the guidance inARB No. 43, Chapter 4, “*Inventory Pricing*,”to clarify the accounting for abnormal amounts of idle facility expense,freight, handling costs, and wasted material (spoilage). Among otherprovisions, the new rule requires that items such as idle facilityexpense, excessive spoilage, double freight, and rehandling costs be recognizedas current period charges regardless of whether they meet the criterion of “soabnormal” as stated in ARB No. 43. Statement No. 151 is effective forfiscal periods beginning after June 15, 2005 and is required to be adoptedby the Company in the first quarter of fiscal 2006. The adoption of StatementNo. 151 is not expected to have a material impact on our consolidatedfinancial condition, results of operations, or cash flows.

 

In December 2004, the FASB issuedStatement No. 153, “*Exchanges of NonmonetaryAssets - An Amendment of APB Opinion No. 29, Accounting for NonmonetaryTransactions*”.  StatementNo. 153 eliminates the exception from fair value measurement fornonmonetary exchanges of similar productive assets in paragraph 21(b) ofAPB Opinion No. 29, “*Accounting for NonmonetaryTransactions*,” and replaces it with an exception for exchanges thatdo not have commercial substance. Statement No. 153 specifies that anonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange.Statement No. 153 is effective for the fiscal periods beginning afterJune 15, 2005, and is required to be adopted by the Company in the firstquarter of fiscal 2006. The adoption of Statement No. 153 is not expectedto have a material impact on our consolidated financial condition, results ofoperations, or cash flows.

 

In March 2005, the FASB issued FASBInterpretation (“FIN”) No. 47, *“Accounting forConditional Asset Retirement Obligations,”* which clarifies the termconditional asset retirement obligation as used in Statement No. 143, *“Accounting for Asset Retirement Obligations,”* as a legalobligation to perform an asset retirement activity in which the timing and/ormethod of settlement are conditional on a future event that may or may not bewithin the control of the Company. FIN No. 47 is effective no later thanthe end of fiscal years ending after December 15, 2005. The Company iscurrently evaluating the impact of adopting this interpretation. 

 

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**Item 3.  Quantitative and Qualitative Disclosures about Market Risk**

 

The Company is exposed to interest ratechanges primarily as a result of its notes payable, including New Revolver andSenior Notes which are used to maintain liquidity and fund capital expendituresand expansion of the Company’s operations. The Company’s interest rate riskmanagement objective is to limit the impact of interest rate changes onearnings and cash flows and to lower its overall borrowing costs. To achieveits objectives the Company borrows primarily at fixed rates and has the abilityto choose interest rates under the Company’s credit facility.  The Company does not enter into derivative orinterest rate transactions for speculative purposes.

 

The table below presents the principalamounts of debt, weighted average interest rates, fair values and other itemsrequired by the year of expected maturity to evaluate the expected cash flowsand sensitivity to interest rate changes as of March 31, 2005.

 
| ** **                                 | ** ** | **YEARS ENDING JUNE 30,** | ** ** |
|--------------------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **THERE-  AFTER** | ** ** | **TOTAL** | ** ** | **FAIR  VALUE** | ** ** |
| ** **                                 | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | **(IN THOUSANDS)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                       |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Fixed rate debt                            |       | $                              | 138        |   | $ | 130 |   | $ | 100,000 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   | $ | 100,268 |   | $ | 100,648 | (3) |
| Average interest rate                      |       |                           |       |   |   |   |   |   |   |   |   |   |   | 11.95 | % |   |   |
| Variable rate LIBOR debt (1) (2)      |       | 1,004                          |       | 0 |   | 0 |   | 0 |   | 0 |   | 0 |   | 1,004 |   | 1,004 |   |
| Weighted average current interest rate (1) |       |                           |       |   |   |   |   |   |   |   |   |   |   | 7.75 | % |   |   |
|                                            |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          Therevolving credit facility is classified as a short-term obligation in theconsolidated balance sheet; however, the credit facility matures in 2006.  This is a $50 million revolving creditfacility with the interest based upon LIBOR plus 350 basis points and an optionalloan with the interest based on prime plus 200 basis points.  The total borrowing unused and availableunder the facility was $16.9 million at March 31, 2005.

 

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

 

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

 

**Item 4. Controls and Procedures**

 

Evaluationof Disclosure Controls and Procedures. As required by Rule 13a-15(b) under the Exchange Act, ourmanagement, including our Chief Executive Officer and Chief Financial Officer,carried out an evaluation of the effectiveness of the design and operation ofour “disclosure controls and procedures” as of the end of the period covered bythis report.  As defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, disclosure controls and procedures arecontrols and other procedures of our company that are designed to ensure thatinformation required to be disclosed by our company in the reports we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms.  Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by our company in the reports we file or submit underthe Exchange Act is accumulated and communicated to our company’s management,including our Chief Executive Officer and Chief Financial Officer, asappropriate to allow timely decisions regarding required disclosure.

 

Basedon this evaluation, our Chief Executive Officer and Chief Financial Officerhave concluded that our disclosure controls and procedures were effective as ofthe end of the period covered by this report in that they were reasonablydesigned to ensure that information required to be disclosed by our company inthe reports we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the rules andforms of the SEC.  It should be notedthat any system of controls, however well designed and operated, is based inpart upon certain assumptions and can provide only reasonable, and notabsolute, assurance that the objectives of the system are met.

 

Changes in Internal Control over Financial Reporting. As required byRule 13a-15(d) under the Exchange Act, our management, including ourChief 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 II Other Information**

 

Items 1 – 5 are not applicable

 

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 May 13, 2005*                                                      |
|             |       |                                                                                                                                                                                   |
| 31.2             |       | Certification of Chief Financial Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 dated May 13, 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 May 13, 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 May 13, 2005* |

 

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*               Filedherewith.

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

Date: May 13, 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 May 13, 2005*                                                      |
|             |       |                                                                                                                                                                                   |
| 31.2             |       | Certification of Chief Financial Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 dated May 13, 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 May 13, 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 May 13, 2005* |

 

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*                      Filedherewith.

 

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