**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**Form 10-Q**

**(Mark One)**

**ý**

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

 

**For the quarterly period endedJanuary 31, 2006**

 

**OR**

 

**o**

**TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from           to           **

 

**Commission file number 1-7427**

 

**Veritas DGC Inc.**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                                    | ** ** | **76-0343152**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer Identification  No.) |
|                                                            |       |                                  |
| **10300 Town Park**                                             |       |                                  |
| **Houston, Texas**                                              | ** ** | **77072**                             |
| (Address of principal executive  offices)                       |       | (Zip Code)                            |

 

**(832) 351-8300**

(Registrant’s telephone number,including area code)

 

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

 

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, or a non-acceleratedfiler.  See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 
| Large accelerated filer ý | Accelerated filer o | Non-accelerated filer o |
|-------------------------------------|--------------------------|------------------------------|

 

Indicate by check mark whether the registrantis a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý

 

The number of shares of the Company’s commonstock, $.01 par value, outstanding at February 28, 2006 was 35,558,617(including 89,828 Veritas Energy Services Inc. exchangeable shares which areidentical to the company’s common stock in all material respects).

 

 

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**TABLE OF CONTENTS**

 

**FORM 10-Q**

 
| **PART I. FINANCIAL INFORMATION**                                                                                            |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                         |   |
| ITEM 1. FINANCIAL STATEMENTS                                                                                                 |   |
| Consolidated Statements of Operations and Comprehensive Income for  the Three and Six Months Ended January 31, 2006 and 2005 |   |
| Consolidated Balance Sheets as of January 31, 2006 and July 31, 2005                                                         |   |
| Consolidated Statements of Cash Flows for the Six Months Ended  January 31, 2006 and 2005                                    |   |
| Notes to Consolidated Financial Statements                                                                                   |   |
| ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION  AND RESULTS OF OPERATIONS                          |   |
| ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET  RISK                                                      |   |
| ITEM 4. CONTROLS AND PROCEDURES                                                                                              |   |
|                                                                                                                         |   |
| **PART II. OTHER INFORMATION**                                                                                               |   |
|                                                                                                                         |   |
| ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                  |   |
| ITEM 6.  EXHIBITS                                                                                                            |   |
| SIGNATURES                                                                                                                   |   |

 

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**PART I. FINANCIAL INFORMATION**

 

## **Item1.**           Financial Statements

 

**VERITAS DGC INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTSOF OPERATIONS ANDCOMPREHENSIVE INCOME**

**(Unaudited)**

 
| ** **                                                      | ** ** | **Three Months Ended  January 31,**           | ** ** | **Six Months Ended****January 31,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                      | ** ** | **2006**                                      | ** ** | **2005**                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                      | ** ** | **(In thousands, except per share  amounts)** | ** ** |
|                                                            |       |                                          |       |                                |       |   |   |   |   |
| Revenues                                                        |       | $                                             | 238,860    |                                | $          | 192,228 |   | $ | 407,538 |   | $ | 321,809 |   |
| Cost of services                                                |       | 167,923                                       |       | 144,950                             |       | 304,589 |   | 260,952 |   |
| Research and development                                        |       | 5,815                                         |       | 5,020                               |       | 10,717 |   | 9,114 |   |
| General and administrative                                      |       | 11,544                                        |       | 8,595                               |       | 20,399 |   | 14,954 |   |
| Operating income                                                |       | 53,578                                        |       | 33,663                              |       | 71,833 |   | 36,789 |   |
| Interest expense                                                |       | 1,650                                         |       | 906                                 |       | 3,126 |   | 1,663 |   |
| Interest income                                                 |       | (2,426                                        | )          | (708                                | )          | (4,327 | ) | (1,527 | ) |
| Gain on involuntary conversion of assets                        |       | —                                        |       | —                              |       | (2,000 | ) | — |   |
| Other (income), net                                             |       | (520                                          | )          | (303                                | )          | (645 | ) | (62 | ) |
| Income before provision for  income taxes                       |       | 54,874                                        |       | 33,768                              |       | 75,679 |   | 36,715 |   |
| Provision for income taxes                                      |       | 23,792                                        |       | 16,400                              |       | 32,811 |   | 18,369 |   |
| Net income                                                      |       | $                                             | 31,082     |                                | $          | 17,368 |   | $ | 42,868 |   | $ | 18,346 |   |
|                                                            |       |                                          |       |                                |       |   |   |   |   |
| Net income per share:                                           |       |                                          |       |                                |       |   |   |   |   |
| Basic:                                                          |       |                                          |       |                                |       |   |   |   |   |
| Net income per common share                                     |       | $                                             | .89        |                                | $          | .51 |   | $ | 1.23 |   | $ | .54 |   |
| Weighted average common shares  (including exchangeable shares) |       | 35,045                                        |       | 33,783                              |       | 34,867 |   | 33,767 |   |
|                                                            |       |                                          |       |                                |       |   |   |   |   |
| Diluted:                                                        |       |                                          |       |                                |       |   |   |   |   |
| Net income per common share                                     |       | .81                                           |       | .51                                 |       | $ | 1.12 |   | $ | .53 |   |
| Weighted average common shares  (including exchangeable shares) |       | 38,494                                        |       | 34,318                              |       | 38,384 |   | 34,323 |   |
|                                                            |       |                                          |       |                                |       |   |   |   |   |
| Comprehensive income:                                           |       |                                          |       |                                |       |   |   |   |   |
| Net income                                                      |       | $                                             | 31,082     |                                | $          | 17,368 |   | $ | 42,868 |   | $ | 18,346 |   |
| Other comprehensive income (net  of tax, $0 in all periods):    |       |                                          |       |                                |       |   |   |   |   |
| Foreign currency translation  adjustments                       |       | 1,728                                         |       | (697                                | )          | 6,633 |   | 6,588 |   |
| Unrealized gain on investments  available for sale              |       | —                                        |       | 142                                 |       | — |   | 226 |   |
| Total other comprehensive income (loss)                         |       | 1,728                                         |       | (555                                | )          | 6,633 |   | 6,814 |   |
| Comprehensive income                                            |       | $                                             | 32,810     |                                | $          | 16,813 |   | $ | 49,501 |   | $ | 25,160 |   |

 

See Notes to ConsolidatedFinancial Statements

 

1

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**VERITAS DGC INC. ANDSUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(Dollars inthousands, except par value)**

 
| ** **                                                                                                                                                 | ** ** | **January 31,****2006** | ** ** | **July 31,****2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------|------------|
| ** **                                                                                                                                                 | ** ** | **(Unaudited)**         | ** ** | ** **           | ** ** |
| ASSETS                                                                                                                                                     |       |                    |       |                 |       |
| Current assets:                                                                                                                                            |       |                    |       |                 |       |
| Cash and cash equivalents                                                                                                                                  |       | $                       | 263,468    |                 | $          | 249,393 |   |
| Restricted cash investments                                                                                                                                |       | 696                     |       | 237                  |       |
| Accounts receivable (net of  allowance of $557 at January and $1,322 at July)                                                                              |       | 218,125                 |       | 165,989              |       |
| Materials and supplies  inventory                                                                                                                          |       | 5,975                   |       | 5,381                |       |
| Prepayments and other                                                                                                                                      |       | 21,540                  |       | 18,900               |       |
| Deferred tax asset and tax  receivables                                                                                                                    |       | 10,766                  |       | 12,486               |       |
| Total current assets                                                                                                                                       |       | 520,570                 |       | 452,386              |       |
|                                                                                                                                                       |       |                    |       |                 |       |
| Property and equipment                                                                                                                                     |       | 521,286                 |       | 495,090              |       |
| Less accumulated depreciation                                                                                                                              |       | 387,652                 |       | 367,173              |       |
| Property and equipment, net                                                                                                                                |       | 133,634                 |       | 127,917              |       |
|                                                                                                                                                       |       |                    |       |                 |       |
| Multi-client data library                                                                                                                                  |       | 292,720                 |       | 316,793              |       |
| Deferred tax asset, net                                                                                                                                    |       | 45,323                  |       | 45,963               |       |
| Other assets                                                                                                                                               |       | 23,957                  |       | 23,539               |       |
| Total                                                                                                                                                      |       | $                       | 1,016,204  |                 | $          | 966,598 |   |
|                                                                                                                                                       |       |                    |       |                 |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                  |       |                    |       |                 |       |
| Current liabilities:                                                                                                                                       |       |                    |       |                 |       |
| Notes payable                                                                                                                                              |       | $                       | 155,000    |                 | $          | — |   |
| Accounts payable, trade                                                                                                                                    |       | 57,032                  |       | 75,810               |       |
| Accrued and deferred income  taxes                                                                                                                         |       | 16,625                  |       | 9,402                |       |
| Deferred revenue                                                                                                                                           |       | 33,708                  |       | 42,043               |       |
| Other accrued liabilities                                                                                                                                  |       | 58,447                  |       | 65,193               |       |
| Total current liabilities                                                                                                                                  |       | 320,812                 |       | 192,448              |       |
| Non-current liabilities:                                                                                                                                   |       |                    |       |                 |       |
| Long-term debt                                                                                                                                             |       | —                  |       | 155,000              |       |
| Other non-current liabilities                                                                                                                              |       | 40,770                  |       | 36,602               |       |
| Total non-current liabilities                                                                                                                              |       | 40,770                  |       | 191,602              |       |
| Stockholders’ equity:                                                                                                                                 |       |                    |       |                 |       |
| Common stock, $.01 par value;  issued: 36,625,724 and 35,580,032 shares, respectively (excluding  Exchangeable Shares of 90,586 and 155,370, respectively) |       | 366                     |       | 355                  |       |
| Additional paid-in capital                                                                                                                                 |       | 474,649                 |       | 451,704              |       |
| Accumulated earnings                                                                                                                                       |       | 189,013                 |       | 146,145              |       |
| Accumulated other comprehensive  income:                                                                                                                   |       |                    |       |                 |       |
| Cumulative foreign currency  translation adjustment                                                                                                        |       | 20,879                  |       | 14,245               |       |
| Unrealized gain on investments  available for sale                                                                                                         |       | —                  |       | 197                  |       |
| Minimum pension liability                                                                                                                                  |       | (8,388                  | )          | (8,410               | )          |
| Treasury stock, at cost;  1,325,705 and 1,320,106 shares, respectively                                                                                     |       | (21,897                 | )          | (21,688              | )          |
| Total stockholders’ equity                                                                                                                            |       | 654,622                 |       | 582,548              |       |
| Total                                                                                                                                                      |       | $                       | 1,016,204  |                 | $          | 966,598 |   |

 

See Notes to ConsolidatedFinancial Statements

 

2

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**VERITAS DGC INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(Unaudited)**

 
| ** **                                                                                             | ** ** | **Six Months Ended January 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                             | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                                                             | ** ** | **(In thousands)**               | ** ** |
| Cash flows from operating activities:                                                                  |       |                             |       |   |   |
| Net income                                                                                             |       | $                                | 42,868     |   | $ | 18,346 |   |
| Non-cash items included in net income:                                                                 |       |                             |       |   |   |
| Depreciation and amortization,  net (other than multi-client)                                          |       | 23,098                           |       | 22,195 |   |
| Amortization of multi-client  data library                                                             |       | 108,362                          |       | 84,403 |   |
| Stock based compensation                                                                               |       | 3,121                            |       | 178 |   |
| Deferred taxes                                                                                         |       | 1,296                            |       | (616 | ) |
| Change in operating  assets/liabilities:                                                               |       |                             |       |   |   |
| Accounts receivable                                                                                    |       | (62,670                          | )          | (7,333 | ) |
| Materials and supplies inventory                                                                       |       | (592                             | )          | (115 | ) |
| Prepayments and other                                                                                  |       | (2,803                           | )          | (2,151 | ) |
| Current income tax                                                                                     |       | 6,855                            |       | 18,827 |   |
| Accounts payable, deferred  revenue and other accrued liabilities                                      |       | (38,564                          | )          | 20,907 |   |
| Other                                                                                                  |       | 4,179                            |       | 7,021 |   |
| Net cash provided by operating  activities                                                             |       | 85,150                           |       | 161,662 |   |
|                                                                                                   |       |                             |       |   |   |
| Cash flows from investing activities:                                                                  |       |                             |       |   |   |
| Increase in restricted cash                                                                            |       | (457                             | )          | (124 | ) |
| Investment in multi-client data  library, net cash                                                     |       | (75,857                          | )          | (58,896 | ) |
| Purchase of property and  equipment                                                                    |       | (28,627                          | )          | (17,152 | ) |
| Proceeds from involuntary  conversion of assets                                                        |       | 13,600                           |       | — |   |
| Sale of property and equipment                                                                         |       | 133                              |       | 885 |   |
| Net cash used by investing  activities                                                                 |       | (91,208                          | )          | (75,287 | ) |
|                                                                                                   |       |                             |       |   |   |
| Cash flows from financing activities:                                                                  |       |                             |       |   |   |
| Excess tax benefit from stock  based compensation                                                      |       | 2,016                            |       | — |   |
| Principal repayments on capital  lease obligations                                                     |       | (919                             | )          | — |   |
| Net proceeds from sale of  common stock                                                                |       | 16,881                           |       | 1,918 |   |
| Net cash provided by financing  activities                                                             |       | 17,978                           |       | 1,918 |   |
| Currency gain on foreign cash                                                                          |       | 2,155                            |       | 638 |   |
| Increase in cash and cash equivalents                                                                  |       | 14,075                           |       | 88,931 |   |
| Beginning cash and cash equivalents balance                                                            |       | 249,393                          |       | 116,299 |   |
| Ending cash and cash equivalents balance                                                               |       | $                                | 263,468    |   | $ | 205,230 |   |
| ** **                                                                                             |       |                             |       |   |   |
| **Schedule of non-cash  transactions:**                                                                |       |                             |       |   |   |
| Capitalization of depreciation  and amortization resulting in an increase in multi-client data library |       | $                                | 6,603      |   | $ | 4,857 |   |
| Capital lease obligations  incurred for the purchase of property and equipment                         |       | $                                | 3,742      |   | $ | — |   |

 

See Notes to ConsolidatedFinancial Statements

 

3

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**VERITAS DGC INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

(Unaudited)

 

###### **1.**              Summary ofsignificant accounting policies

 

***Basis of presentation***

 

These consolidated financial statements are unaudited,but in the opinion of management, contain all appropriate adjustments, all ofwhich are normally recurring adjustments unless otherwise disclosed.  These financial statements, includingselected notes, have been prepared in accordance with the applicable rules ofthe Securities and Exchange Commission and do not include all of theinformation and disclosures required by accounting principles generallyaccepted in the United States of America for complete financial statements.  Certain reclassifications have been made tothe prior period amounts to conform to the current period classification.  These interim financial statements should beread in conjunction with the consolidated financial statements presented in theVeritas DGC Inc. Annual Report on Form 10-K for the year ended July 31, 2005.

*** ***

***Recent Accounting Pronouncements***

 

In December 2004, the Financial Accounting Standards Board (“FASB”)issued FASB Staff Position (“FSP”) No. 109-1, “Application of FASBStatement No. 109, Accounting for Income Taxes, to the Tax Deduction onQualified Production Activities Provided by the American Jobs Creation Act of2004,” which provides guidance on the recently enacted American Jobs CreationAct of 2004 (the “Act”). The Act provides a U.S. tax deduction for income fromqualified domestic production activities. FSP 109-1 provides for the treatmentof the deduction as a special deduction as described in SFAS No. 109.Accordingly, we will record the amount of any special deductions in the yearsthey are taken.

 

In December 2004, the FASB issued FASB Staff PositionNo. 109-2, “Accounting and Disclosure Guidance for the ForeignRepatriation Provision within the American Jobs Creation Act of 2004,” whichprovides guidance under SFAS No. 109 with respect to recording the potentialimpact of the repatriation provisions of the Act on a company’s income taxexpense and deferred tax liability. FSP 109-2 states that a company is allowedtime beyond the financial reporting period of enactment to evaluate the effectof the Act on its plan for reinvestment or repatriation of foreign earnings forpurposes of applying SFAS No. 109. The company has not yet decided onwhether, and to what extent, we might elect to repatriate foreign earningsunder the provisions in the Act. Any such repatriation under the Act must occurby July 31, 2006. Accordingly, Veritas’ consolidated financial statementsdo not reflect a provision for taxes related to this election.

 

In December 2004, the FASB issued Statement of FinancialAccounting Standards (“SFAS”) No. 153,**“Exchangesof Nonmonetary Assets — an amendment of APB Opinion No. 29,” to addressthe measurement of exchanges of nonmonetary assets.  SFAS No. 153eliminates the exception from fair value measurement for nonmonetary exchangesof similar productive assets and replaces it with a general exception forexchanges of nonmonetary assets that do not have commercial substance.  Anonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange.  This statement was adopted by the companybeginning August 1, 2005.  The adoption of this statement had no impact onthe company’s financial statements and is not expected to have a materialimpact on future financial statements.

 

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections—a replacement of APB Opinion No. 20 and FASBStatement No. 3.” SFAS No. 154 requires retrospective application to priorperiods’ financial statements for changes in accounting principle, unless it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change. SFAS 154 also requires that a change in depreciation,amortization, or depletion method for long-lived, non-financial assets beaccounted for as a change in accounting estimate effected by a change inaccounting principle. SFAS 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 15, 2005.The implementation of SFAS No. 154 is not expected to have a material impact onthe company’s financial statements.

 

4

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In February 2006, the FASB issued SFAS No. 155, “Accountingfor Certain Hybrid Financial Instruments – an amendment of FASB Statements No.133 and 150.”  SFAS No. 155 (a) permits fair value remeasurement for any hybridfinancial instrument that contains an embedded derivative that otherwise wouldrequire bifurcation, (b) clarifies that certain instruments are not subject tothe requirements of SFAS 133, (c) establishes a requirement to evaluateinterests in securitized financial assets to identify interests that maycontain an embedded derivative requiring bifurcation, (d) clarifies what may bean embedded derivative for certain concentrations of credit risk and (e) amendsSFAS 140 to eliminate certain prohibitions related to derivatives on aqualifying special-purpose entity.  SFAS155 is effective for us for the fiscal year beginning August 1, 2007.  We are currently evaluating the impact thatSFAS 155 may have on the company’s financial statements.

 

###### **2.**              Earnings per commonshare

 

Basic and diluted earnings per common share arecomputed as follows:

 
| ** **                                                      | ** ** | **Three Months Ended****January 31,**         | ** ** | **Six Months Ended****January 31,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                      | ** ** | **2006**                                      | ** ** | **2005**                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                      | ** ** | **(In thousands, except per share  amounts)** | ** ** |
|                                                            |       |                                          |       |                                |       |   |   |   |   |
| Net income                                                      |       | $                                             | 31,082     |                                | $          | 17,368 |   | $ | 42,868 |   | $ | 18,346 |   |
|                                                            |       |                                          |       |                                |       |   |   |   |   |
| **Basic:**                                                      |       |                                          |       |                                |       |   |   |   |   |
| Weighted average common shares  (including exchangeable shares) |       | 35,045                                        |       | 33,783                              |       | 34,867 |   | 33,767 |   |
| Net income per share                                            |       | $                                             | .89        |                                | $          | .51 |   | $ | 1.23 |   | $ | .54 |   |
|                                                            |       |                                          |       |                                |       |   |   |   |   |
| **Diluted:**                                                    |       |                                          |       |                                |       |   |   |   |   |
| Weighted average common shares  (including exchangeable shares) |       | 35,045                                        |       | 33,783                              |       | 34,867 |   | 33,767 |   |
| Shares issuable from assumed  conversion of notes               |       | 3,010                                         |       | —                              |       | 3,010 |   | — |   |
| Shares issuable from assumed  exercise of options               |       | 347                                           |       | 500                                 |       | 440 |   | 514 |   |
| Shares issuable from assumed  vesting of restricted stock       |       | 92                                            |       | 35                                  |       | 67 |   | 42 |   |
| Total                                                           |       | 38,494                                        |       | 34,318                              |       | 38,384 |   | 34,323 |   |
| Income (loss) per share                                         |       | $                                             | .81        |                                | $          | .51 |   | $ | 1.12 |   | $ | .53 |   |

 

The shares issuable from assumed conversion of notesfor both the three and six months ended January 31, 2006 are based upon a stockprice of $45.06, which was the closing price of Veritas DGC’s common stock atJanuary 31, 2006.

 

The following options to purchase common shares havebeen excluded from the computation assuming dilution because the exerciseprices of the options exceeded the average market price for the period of theunderlying common shares.

 
| ** **           | ** ** | **Three Months Ended****January 31,** | ** **  | **Six Months Ended****January 31,** | ** ** |
|----------------------|------------|---------------------------------------|-------------|-------------------------------------|------------|
| ** **           | ** ** | **2006**                              | ** **  | **2005**                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Number of options    |       | 30,455                                |        | 743,032                             |       | 31,386 |   | 743,032 |   |
| Exercise price range |       | $                                     | 38.13-55.13 |                                | $          | 22.84-55.13 |   | $ | 36.31-55.13 |   | $ | 22.84-55.13 |   |
| Expiring through     |       | October 2007                          |        | March 2012                          |       | October 2007 |   | March 2012 |   |
|                      |            |                                       |             |                                     |            |  |  |  |  |  |  |  |  |

 

5

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**3.**              Gain on involuntary conversion of assets

 

In January 2005, our seismic vessel Veritas Vikingexperienced an engine failure while acquiring data in the Gulf of Mexico andlost substantial amounts of overboard seismic equipment. This seismic equipmentwas insured at its replacement cost. As a result, insurance settlements forreimbursement of certain costs and to acquire replacement equipment in excessof the book value of the equipment lost less our deductible were recorded as again of $9.9 million during the fourth quarter of fiscal year 2005.  An additional $2.0 million gain was recordedin the first quarter of fiscal 2006 due to the timing of the insurancesettlements, which are substantially complete. The $2.0 million gain has been included as a change in accountsreceivable in the consolidated statement of cash flows.

 

###### **4.**              Notes payable anddebt structure

 

As of January 31, 2006, our notes payable consisted of$155.0 million of Convertible Senior Notes due 2024. These notes are classifiedas a current liability as of January 31, 2006 because the conversion featurediscussed below results in the notes being convertible at the option of theholders.

 

The Convertible Senior Notes bear interest at a perannum rate which equals the three-month LIBOR rate, adjusted quarterly, minus aspread of 0.75%.  The interest rate ofthe notes, from December 15, 2005 through March 14, 2006, is 3.74%, based on aLIBOR rate of 4.49%.  For the secondquarter of fiscal 2006, the weighted average interest rate on the notes was3.44%. The notes will mature on March 15, 2024 and may not be redeemed by usprior to March 20, 2009. Holders of the notes may require us to repurchasesome, or all, of the notes on March 15, 2009, 2014 and 2019. They could alsorequire repurchase upon a change of control (as defined in the indenture underwhich the Convertible Senior Notes were issued).

 

Under certaincircumstances and at the option of the holder, the Convertible Senior Notes are convertible prior to thematurity date into cash and shares of our common stock.  Certain of these circumstances may result inclassification of the ConvertibleSenior Notes as current on our balance sheet. These circumstances include:

 

1.                                       the closing saleprice of our common stock is over 120% of the conversion price, which iscurrently $24.03 (with 120% being $28.84) for 20 trading days in the period of30 consecutive trading days ending on the last trading day of the fiscalquarter preceding the quarter in which the conversion occurs;

 

2.                                       if we called thenotes for redemption and the redemption has not occurred;

 

3.                                       the occurrenceof a five consecutive trading day period in which the trading price of thenotes was less than 95% of the closing sale price of our common stock on suchday multiplied by the conversion ratio; or

 

4.                                       the occurrenceof specified corporate transactions.

 

Should any of these circumstances occur, theConvertible Senior Notes would be convertible at the then current stock pricetimes the conversion ratio of 41.6146. This amount would be payable in cashequal to the principal amount of the notes, the par value adjusted fordividends or other equity transactions, and the additional amount payable inshares of our common stock.  Currently,the maximum amount payable by us on conversion is $155 million in cash plusapproximately 6.5 million shares. This settlement method is prescribed in theindenture and is not at the discretion of any party.  The shares issuable from such conversion areconsidered in the calculation of diluted earnings per share.

 

As of the beginning of the second fiscal quarter of2006, the Convertible Senior Notes were convertible as the stock price remainedgreater than 120% of the Conversion Price for at least 20 trading days in theperiod of 30 consecutive trading days ending on October 31, 2005.  The notes continued to be convertible as ofJanuary 31, 2006.  Because of theconvertibility, the notes have been classified as a current liability on ourconsolidated balance sheet as of January 31, 2006.  The determination of the convertibility ofthe notes occurs quarterly.  Dependingupon the common stock price in the future, the notes may not be convertible infuture quarters and therefore would not be

 

6

----

 

classified as current onour consolidated balance sheet.  Assuminga stock price of $45.06 (which was the closing stock price at January 31,2006), conversion of all the notes would result in our payment of $155 millionin cash and 3.0 million shares of common stock.

 

In connectionwith our issuance of the Convertible Senior Notes, we entered into aregistration rights agreement pursuant to which we agreed to register theresale of the notes and underlying common stock by the holders thereof.  If we fail to keep the shelf registrationstatement related to this debt effective or usable in accordance with theregistration rights agreement, then we may be required to pay liquidateddamages to all holders of notes and all holders of our common stock issued uponconversion of the notes.  The liquidateddamages to be paid are equal to an annual rate of 0.50% of the principalamount.  In November 2005, the shelfregistration statement became no longer effective and, accordingly, we beganaccruing liquidated damages at approximately $2,100 per day.  For the six months ended January 31, 2006, wehave recorded approximately $220,000 of expense related to these liquidateddamages.  In the process of making thisregistration effective, on November 4, 2005, we filed a post-effectiveamendment to the registration statement; however, until the registrationstatement is declared effective, liquidated damages will be paid each quarterto the record holders.  Because we arenot required to register the resale of the notes and underlying common stockafter March 10, 2006, our liability for the payment of liquidated damages endson that date.

 

In addition to the notes, through the end of thesecond fiscal quarter, we had a Credit Facility consisting primarily of arevolving loan facility permitting borrowings of up to $55.0 million, includinga facility for swing line loans of up to $10.0 million, the issuance of lettersof credit in an aggregate amount of up to $48.0 million.  Loans made under the revolving loan facility,including swing-line loans, bore interest at a variable rate determined on thedate of borrowing that is related to various base rates and margins dependingupon our leverage ratio and the location of the borrowing. The revolving loanfacility was terminated on February 6, 2006 and replaced by another facilitywhich is described in Note 9, Subsequent Event. Until its termination, the Credit Facility prohibited us from, amongother things, paying cash dividends. As of January 31, 2006, there were noborrowings and $5.2 million in letters of credit outstanding under therevolving loan facility, leaving $49.8 million available.

 

We also have various unsecured lines of credit, withlending institutions that operate in geographic areas not covered by thelending institutions in our Credit Facility, totaling $8.5 million that may beused exclusively for the issuance of letters of credit and bank guarantees. Asof January 31, 2006, $1.7 million in letters of credit were outstanding underthese lines.

 

Borrowings under the Credit Facility, prior to itstermination on February 6, 2006, were secured by assets, including accountsreceivable, equipment, vehicles, multi-client data library, intellectualproperty, and stock of certain material subsidiaries, owned by us and certainof our subsidiaries. At January 31, 2006, the carrying value of the securedassets, including intercompany receivables, which are eliminated inconsolidation, was $1.3 billion. The Credit Facility and related documentscontained a number of covenants, including financial covenants relating tointerest coverage, leverage and net worth. These covenants related tomeasurements as of quarter ending dates, and, as of our last fiscal quarterended January 31, 2006, we were in compliance with these covenants.

 

See Note 9, Subsequent Event for the discussion of thenew credit facility that we entered into in February 2006.

 

7

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###### **5.**              Pension plan

 

We maintain a contributory defined benefit pensionplan for eligible participating employees in the United Kingdom.  The following is the net periodic benefitcost by component:

 
| ** **                                       | ** ** | **Three Months Ended****January 31,** | ** ** | **Six Months Ended****January 31,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                       | ** ** | **2006**                              | ** ** | **2005**                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                    | ** ** |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| Service cost (benefits earned during the period) |       | $                                     | 323        |                                | $          | 153 |   | $ | 654 |   | $ | 304 |   |
| Interest cost on projected benefit obligation    |       | 468                                   |       | 311                                 |       | 948 |   | 619 |   |
| Expected return on plan assets                   |       | (316                                  | )          | (222                                | )          | (640 | ) | (441 | ) |
| Amortization of prior service cost               |       | (35                                   | )          | (37                                 | )          | (71 | ) | (74 | ) |
| Amortization of net gain (loss)                  |       | 255                                   |       | 78                                  |       | 516 |   | 156 |   |
| Amortization of transition obligation            |       | 2                                     |       | 2                                   |       | 4 |   | 4 |   |
| Net periodic benefit costs                       |       | $                                     | 697        |                                | $          | 285 |   | $ | 1,411 |   | $ | 568 |   |

 

We have made contributions to this plan based on theschedule of contributions on which the above service cost was based and expectto complete these contributions, totaling approximately $1.3 million for theyear, during fiscal 2006.

 

8

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###### **6.**              Segment information

 

We have organized the company into four reportablesegments: North and South America (NASA); Europe, Africa, Middle East andCommonwealth of Independent States (EAME); Asia Pacific (APAC); and VeritasHampson Russell (VHR).  In NASA, EAME andAPAC, we conduct geophysical surveys on both a contract and a multi-clientbasis. When we conduct surveys on a contract basis, we acquire and process datafor a single client who pays us to conduct the survey and owns the data weacquire. When we conduct surveys on a multi-client basis, we acquire andprocess data for our own account and license that data and associated productsto multiple clients.  NASA, EAME and APACoffer a common suite of these products and services to their customers,although each product or service may be adapted to meet the needs of the localmarkets.  VHR licenses geophysicalsoftware and provides geophysical reservoir consulting services.  The results of VHR’s operations werepreviously included in those of the NASA region; however, beginning in fiscal2006, senior management began to review the results of VHR separately.  This segmentation of our company isrepresentative of the manner in which it is viewed and managed by our seniormanagers and our Board of Directors.  Theinformation related to the three and six months ended January 31, 2005 has beenrestated to reflect the new segment structure. A reconciliation of the reportable segments’ results to those of thetotal enterprise is given below:

 
| ** **                                                    | ** ** | **For the Three Months Ended  January 31, 2006** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                    | ** ** | **NASA**                                         | ** ** | **EAME** | ** ** | **APAC** | ** ** | **VHR** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
| ** **                                                    | ** ** | **(In thousands)**                               | ** ** |
| Revenue                                                       |       | $                                                | 170,142    |   | $ | 33,690 |   | $ | 29,733 |   | $ | 5,295 |   | $ | — |   | $ | 238,860 |   |
| Depreciation and amortization,  net (other than multi-client) |       | 9,501                                            |       | 2,265 |   | 1,070 |   | 993 |   | 224 |   | 14,053 |   |
| Amortization of multi-client library                          |       | 51,926                                           |       | 3,596 |   | — |   | — |   | — |   | 55,522 |   |
| Operating income (loss)                                       |       | 53,169                                           |       | 6,681 |   | 5,438 |   | (766 | ) | (10,944 | ) | 53,578 |   |
| Assets                                                        |       | 522,539                                          |       | 156,300 |   | 64,595 |   | 16,230 |   | 256,540 |   | 1,016,204 |   |
|                                                               |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                    | ** ** | **For the Three Months Ended  January 31, 2005** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                    | ** ** | **NASA**                                         | ** ** | **EAME** | ** ** | **APAC** | ** ** | **VHR** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
| ** **                                                    | ** ** | **(In thousands)**                               | ** ** |
| Revenue                                                       |       | $                                                | 130,827    |   | $ | 33,076 |   | $ | 24,045 |   | $ | 4,280 |   | $ | — |   | $ | 192,228 |   |
| Depreciation and amortization,  net (other than multi-client) |       | 9,059                                            |       | 1,042 |   | 1,083 |   | 981 |   | 266 |   | 12,431 |   |
| Amortization of multi-client library                          |       | 32,484                                           |       | 13,730 |   | 1,917 |   | — |   | — |   | 48,131 |   |
| Operating income (loss)                                       |       | 37,503                                           |       | 4,402 |   | 2,251 |   | (2,078 | ) | (8,415 | ) | 33,663 |   |
| Assets                                                        |       | 479,209                                          |       | 105,945 |   | 48,700 |   | 15,124 |   | 187,396 |   | 836,374 |   |
|                                                               |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

9

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| ** **                                                    | ** ** | **For the Six Months Ended  January 31, 2006** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                    | ** ** | **NASA**                                       | ** ** | **EAME** | ** ** | **APAC** | ** ** | **VHR** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
| ** **                                                    | ** ** | **(In thousands)**                             | ** ** |
| Revenue                                                       |       | $                                              | 272,984    |   | $ | 68,459 |   | $ | 56,516 |   | $ | 9,579 |   | $ | — |   | $ | 407,538 |   |
| Depreciation and amortization,  net (other than multi-client) |       | 14,340                                         |       | 3,473 |   | 2,889 |   | 1,954 |   | 442 |   | 23,098 |   |
| Amortization of multi-client library                          |       | 88,671                                         |       | 19,691 |   | — |   | — |   | — |   | 108,362 |   |
| Operating income (loss)                                       |       | 72,205                                         |       | 10,209 |   | 11,242 |   | (1,428 | ) | (20,395 | ) | 71,833 |   |
| Assets                                                        |       | 522,539                                        |       | 156,300 |   | 64,595 |   | 16,230 |   | 256,540 |   | 1,016,204 |   |
|                                                               |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                    | ** ** | **For the Six Months Ended  January 31, 2005** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                    | ** ** | **NASA**                                       | ** ** | **EAME** | ** ** | **APAC** | ** ** | **VHR** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
| ** **                                                    | ** ** | **(In thousands)**                             | ** ** |
| Revenue                                                       |       | $                                              | 207,520    |   | $ | 64,850 |   | $ | 42,101 |   | $ | 7,338 |   | $ | — |   | $ | 321,809 |   |
| Depreciation and amortization,  net (other than multi-client) |       | 15,041                                         |       | 2,510 |   | 2,170 |   | 1,901 |   | 573 |   | 22,195 |   |
| Amortization of multi-client library                          |       | 57,656                                         |       | 24,166 |   | 2,581 |   | — |   | — |   | 84,403 |   |
| Operating income (loss)                                       |       | 46,536                                         |       | 7,500 |   | 1,116 |   | (3,480 | ) | (14,883 | ) | 36,789 |   |
| Assets                                                        |       | 479,209                                        |       | 105,945 |   | 48,700 |   | 15,124 |   | 187,396 |   | 836,374 |   |
|                                                               |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Corporate operating income (loss) includes certaingeneral and administrative and research and development expenses not allocatedto the segments.  Corporate assetsconsist primarily of cash and cash equivalents.

 

###### **7.**              Stock basedcompensation

 

As of August 1, 2005, we adopted the FinancialAccounting Standard Board Statement No. 123(R) (SFAS 123R) to account for stockbased employee compensation.  SFAS 123Rrequires us to record the cost of stock options and other equity-basedcompensation in our income statement based upon the estimated fair value ofthose awards.  We elected to use themodified prospective method for adoption, which requires compensation expenseto be recorded for all unvested stock options and other equity-basedcompensation beginning in the first quarter of adoption.  Accordingly, prior periods have not beenrestated to reflect stock based compensation. For all unvested options outstanding as of August 1, 2005, the previouslymeasured but unrecognized compensation expense, based on the fair value at theoriginal grant date, will be recognized in the statement of operations over theremaining vesting period. For equity-based compensation granted subsequent toAugust 1, 2005, compensation expense, based on the fair value on the date ofgrant, will be recognized in the statement of operations over the vestingperiod.  For deferred share units, it isour policy to determine the fair value of the units based on our common stockprice at the date of grant which is then expensed over the applicable serviceperiod.

 

Prior to December 11, 2002, we had two employeenonqualified stock option plans under which options were granted to officersand select employees. Options generally vested over three years and wereexercisable over a five to ten-year period from the date of grant. The exerciseprice for each option was the fair market value of the common stock on thegrant date. Our Board of Directors authorized 5,954,550 shares of common stockto be issued under these option plans.

 

Prior to December 11, 2002, we also maintained a stockoption plan for non-employee directors (the “Director Plan”) under which optionswere granted to our non-employee directors. The Director Plan provided thatevery year each eligible director was granted options to purchase 5,000 sharesof our common stock which vest over a period of three years from the date ofgrant and are exercisable over five to ten years from the date of grant. Theexercise price for each option granted was the fair market value at the date ofgrant. The Board of Directors authorized 600,000 shares of common stock to beissued under the Director Plan.

 

10

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On December 11, 2002, we adopted our current ShareIncentive Plan that provides for the issuance to directors, officers and selectemployees of: (1) nonqualified options to purchase our common stock, (2)incentive options to purchase our common stock, (3) share appreciation rights,(4) deferred share units, (5) restricted shares and (6) performance shares.Options issued to employees under the Share Incentive Plan have exercise pricesequal to the fair market value at the date of grant; have five-year lives andvest over three years. Options issued to continuing non-employee directorsunder the Share Incentive Plan have exercise prices equal to the fair marketvalue at the date of grant, have five-year lives and vest immediately.  As of January 31, 2006, 1.3 million shareswere reserved for issuance under this plan, with no more than 0.3 million ofthose shares issuable in any form other than stock options.

 

Information related to stock based compensationfollows:

 
| ** **                                                                            | ** ** | **Three Months Ended**                               | ** ** | **Six Months Ended**    | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                            | ** ** | **January 31, 2006**                                 | ** ** | **January 31,****2006** | ** ** |
| ** **                                                                            | ** ** | **(in millions of dollars, expect  per share data)** | ** ** |
| Compensation costs recorded for all plans                                             |       | $                                                    | 1.7        |                    | $          | 3.1 |   |
| Tax benefit recognized in  income statement for share-based compensation arrangements |       | 0.5                                                  |       | 0.9                     |       |
| Impact of adopting SFAS 123R to:                                                      |       |                                                 |       |                    |       |
| Net income                                                                            |       | 1.2                                                  |       | 2.2                     |       |
| Basic earnings per share                                                              |       | 0.03                                                 |       | 0.06                    |       |
| Diluted earnings per share                                                            |       | 0.03                                                 |       | 0.06                    |       |
|                                                                                       |            |                                                      |            |                         |            |  |  |

 

SFAS 123R requires tax benefits relating to excessstock based compensation deductions to be prospectively presented in ourstatement of cash flows as financing cash inflows.  Accordingly, for the six months ended January31, 2006, we reported approximately $2.0 million of excess tax benefits fromstock based compensation as cash provided by financing activities on ourstatement of cash flows.

 

Our policy of meeting the requirements upon exerciseof stock options is to issue new shares.

 

As of January 31, 2006, there was approximately $10.2million of total unrecognized compensation cost related to nonvestedshare-based compensation arrangements.  Thatcost is expected to be recognized on a straight line basis over the vestingperiod, generally 3 years.

 

Stock options

 

The fair value of each option award granted afterAugust 1, 2005 is estimated on the date of grant using a lattice-based optionvaluation model that uses the assumptions noted in the following table.Expected volatilities are based on implied volatilities from traded options onour stock and historical volatility of our stock.  We use historical datato estimate option exercise and employee termination within the valuationmodel; separate groups of employees were reviewed and shown to have similarhistorical exercise behavior and are considered together for valuationpurposes.  The expected term of options granted is derived from the outputof the option valuation model and represents the period of time that optionsgranted are expected to be outstanding.  The risk-free rate for periodswithin the contractual life of the option is based on the U.S. Treasury yieldcurve at the time of grant.

 
| ** **               | ** ** | **Six Months Ended  January 31, 2006** | ** ** |
|--------------------------|------------|----------------------------------------|------------|
| Expected volatility      |       | 50.8                                   | %          |
| Expected dividends       |       | 0                                      | %          |
| Expected term (in years) |       | 4.0                                    |       |
| Risk free rate           |       | 4.0                                    | %          |

 

11

----

 

The following table provides additional information relatedto this stock option plan:

 
| ** **                     | ** ** | **For the Six Months Ended January 31, 2006** | ** ** |
|--------------------------------|------------|-----------------------------------------------|------------|
| ** **                     | ** ** | **Number of****Shares**                       | ** ** | **Weighted****Average  Exercise  Price** | ** ** | **Weighted****Average  Grant Date  Fair Value** | ** ** | **Weighted****Average  Contractual  Life  In Years** | ** ** | **Aggregate****Intrinsic  Value (000’s)** | ** ** |
| Beginning balance              |       | 2,422,790                                     |       | $ | 17.52 |   |   |   |   |   |   |   |
| Options granted                |       | 209,750                                       |       | 31.94 |   | $ | 13.29 |   | 4.6 |   |   |   |
| Options exercised              |       | (948,874                                      | )          | 17.00 |   |   |   |   |   |   |   |
| Options forfeited              |       | (24,155                                       | )          | 25.19 |   |   |   |   |   |   |   |
| Total outstanding              |       | 1,659,511                                     |       | 19.58 |   |   |   | 3.1 |   | $ | 42,290 |   |
| Options exercisable and vested |       | 1,121,811                                     |       | 20.26 |   |   |   | 3.0 |   | $ | 27,821 |   |
|                                |            |                                               |            |  |  |  |  |  |  |  |  |  |  |  |

 

The total intrinsic value of options exercised duringthe six months ended January 31, 2006 and 2005 was $19.1 million and $1.5million, respectively.  Cash receivedfrom option exercises under all share-based payment arrangements for the sixmonths ended January 31, 2006 was approximately $16.9 million.  The taxbenefit realized for the tax deductions resulting from option exercises ofshare-based payment arrangements was approximately $3.0 million for the sixmonths ended January 31, 2006.

 

Performance shares

 

During October 2005, certain participants were awardedrights to receive restricted shares of the company in October 2006.  Restricted shares will be granted, if earned,in October 2006.  The number of shares isbased upon established performance targets that will be assessed at the end ofthe fiscal year.  The vesting of theissued restricted shares will be two years after the performance targets areassessed and therefore the service period is from the date of grant throughJuly 31, 2008.  These shares were valuedinitially at $31.94 per share for a total value of $2.5 million based upon themarket price of the shares at the award date and the expected outcome of theperformance targets.  Based on theresults for the six months ended January 31, 2006 and the increased potentialthat the fiscal 2006 performance targets will be exceeded, we accruedadditional stock based compensation related to the performance shares during thethree months ended January 31, 2006.  Theshares are currently valued at $4.9 million, which will be recorded ascompensation expense over the remaining service period.  The compensation expense related to this planmay continue to fluctuate based upon the expected outcome of the performancetargets.

 

Restricted Stock

 

Restricted shares awarded generally vest ratably over3 years.  The status of the restrictedstock as of July 31, 2005 and the changes during the fiscal year throughJanuary 31, 2006 are presented below:

 
| ** **                    | ** ** | **Number of****Shares** | ** ** |
|-------------------------------|------------|-------------------------|------------|
| Nonvested at July 31, 2005    |       | 54,134                  |       |
|                          |       |                    |       |
| Granted                       |       | 97,500                  |       |
| Vested                        |       | 7,167                   |       |
| Forfeited                     |       | 1,888                   |       |
| Nonvested at October 31, 2005 |       | 142,579                 |       |
|                          |       |                    |       |
| Granted                       |       | 3,100                   |       |
| Vested                        |       | 14,540                  |       |
| Forfeited                     |       | —                  |       |
| Nonvested at January 31, 2006 |       | 131,139                 |       |

 

The weighted average grant date fair value for thegranted restricted stock was $30.35 and $31.89 per share for the three and sixmonths ended January 31, 2006, respectively. The total fair value of shares vested during the three

 

12

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and six months endedJanuary 31, 2006 and 2005 was as follows (in thousands of dollars):

 
| ** **                  | ** ** | **Three Months Ended****January 31,** | ** ** | **Six Months Ended****January 31,** | ** ** |
|-----------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                  | ** ** | **2006**                              | ** ** | **2005**                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                  | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value of shares vested |       | $                                     | 584        |                                | $          | 317 |   | $ | 822 |   | $ | 490 |   |
|                             |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |

 

Employee Stock Purchase Plan

 

We also have an employee stock purchase plan which wasapproved by our stockholders. Originally 1,000,000 shares were authorized forissuance under this plan. Participation is voluntary and substantially allfull-time employees meeting limited eligibility requirements may participate.Contributions are made through payroll deductions and may not be less than 1%or more than 15% of the participant’s base pay as defined. The participant’soption to purchase common stock is deemed to be granted on the first day andexercised on the last day of the fiscal quarter at a price that is the lower of85% of the market price on the first or last day of the fiscal quarter.  Information related to the shares grantedduring the first and second quarters of fiscal 2006 is below.  The fair value was determined using theBlack-Scholes option valuation method using the assumptions shown below.

 
| ** **                 | ** ** | ** **          | ** ** | ** **                     | ** ** | ** **                 | ** ** | **Assumptions used in valuation model** | ** ** |
|----------------------------|------------|---------------------|------------|--------------------------------|------------|----------------------------|------------|-----------------------------------------|------------|
| **For the quarter ending** | ** ** | **Shares  granted** | ** ** | **Quarter when  to be issued** | ** ** | **Grant date  fair value** | ** ** | **Risk free  rate**                     | ** ** | **Volatility** | ** ** | **Expected  life** | ** ** | **Expected  dividends** | ** ** |
| October 31,  2005          |       | 23,144              |       | Second                         |       | $                          | 7.52       |                                    | 3.5        | % | 47 | % | 90 days |   | — |   |
| January 31,  2006          |       | 21,878              |       | Third                          |       | $                          | 7.50       |                                    | 3.9        | % | 40 | % | 90 days |   | — |   |

 

Prior to August 1, 2005

 

Prior to August 1, 2005, we accounted for equity-basedcompensation using the intrinsic method prescribed in Accounting PrinciplesBoard Opinion No. 25.  As required bySFAS 123R, we have disclosed below the effect on net income and earnings pershare of equity-based employee compensation, including stock options, thatwould have been recorded using the fair value based method for the three andsix months ended January 31, 2005.

 
| ** **                                                                                                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**    | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                  | ** ** | **January 31, 2005**   | ** ** | **January 31,****2005** | ** ** |
|                                                                                                                                        |       |                   |       |                    |       |
| Net income as reported                                                                                                                      |       | $                      | 17,368     |                    | $          | 18,346 |   |
| Add: Compensation expense,  net of related tax effects                                                                                 |       | 96                     |       | 179                     |       |
| Less: Total stock-based  employee compensation expense determined under fair value based method for  all awards, net of related tax effects |       | (675                   | )          | (1,354                  | )          |
| Pro forma net income                                                                                                                        |       | $                      | 16,789     |                    | $          | 17,171 |   |
|                                                                                                                                        |       |                   |       |                    |       |
| Earnings per share:                                                                                                                         |       |                   |       |                    |       |
| Basic:                                                                                                                                      |       |                   |       |                    |       |
| As reported                                                                                                                                 |       | $                      | .51        |                    | $          | .54 |   |
| Pro-forma                                                                                                                                   |       | .50                    |       | .51                     |       |
|                                                                                                                                        |       |                   |       |                    |       |
| Diluted:                                                                                                                                    |       |                   |       |                    |       |
| As reported                                                                                                                                 |       | $                      | .51        |                    | $          | .53 |   |
| Pro-forma                                                                                                                                   |       | .49                    |       | .50                     |       |

 

13

----

 

The weighted average fair values of options grantedduring fiscal year 2005 were determined using the Black-Scholes optionvaluation method assuming no expected dividends. Other assumptions used are asfollows:

 

| ** **              | ** ** | **For the Three and Six Months  Ended January 31, 2005** | ** ** |
|-------------------------|------------|----------------------------------------------------------|------------|
| Risk-free interest rate |       | 3.7                                                      | %          |
| Expected volatility     |       | 46.8                                                     | %          |
| Expected life in years  |       | 4.0                                                      |       |

 

###### **8.**              Exchangeable Shares

 

Two shares of special voting stock of Veritas DGC Inc.are authorized and outstanding, each as a series of common shares. One specialvoting share was issued in connection with the combination of Digicon Inc.(Veritas DGC Inc.’s former name) and Veritas Energy Services Inc. in August of1996. The other special voting share was issued in connection with thecombination of Veritas DGC Inc., Veritas Energy Services and Enertec ResourcesInc. in September 1999.

 

These special voting shares possess a number of votesequal to the number of outstanding Veritas Energy Services exchangeable sharesand Veritas Energy Services Class A exchangeable shares, Series 1 that are notowned by Veritas DGC Inc. or any of its subsidiaries.  Such exchangeable shares were issued to theformer stockholders of Veritas Energy Services and Enertec Resources inbusiness combinations with Veritas DGC Inc. In any matter submitted to VeritasDGC Inc. stockholders for a vote, each holder of a Veritas Energy Servicesexchangeable share has the right to instruct a trustee as to the manner ofvoting for one of the votes comprising the Veritas Energy Services specialvoting share for each Veritas Energy Services exchangeable share owned by theholder. Likewise, each holder of a Veritas Energy Services class A exchangeableshare, series 1 has the right to instruct a trustee as to the manner of votingfor one of the votes comprising the Enertec special voting share for eachVeritas Energy Services Class A exchangeable shares, Series 1 owned by theholder. The Veritas Energy Services exchangeable shares and the Veritas EnergyServices Class A exchangeable shares, Series 1 are convertible on a one-for-onebasis into shares of the common stock and, when coupled with the voting rightsafforded by the special voting shares, have rights virtually identical toVeritas DGC Inc. common stock. As a result, we treat the exchangeable shares asshares of our common stock for all purposes including the calculation ofearnings per share information.

 

In January 2006, it was announced that Veritas EnergyServices has accelerated the automatic redemption date of its exchangeableshares and its class A exchangeable shares, series 1 to May 16, 2006, and thatVeritas DGC has exercised its right to redeem both classes of Veritas EnergyServices exchangeable shares. On May 16, 2006, the closing date, eachexchangeable share of both classes then outstanding will be exchanged for oneshare of Veritas DGC common stock. Following the redemption on May 16, VeritasDGC will own all of the issued and outstanding shares of Veritas EnergyServices.  Therefore, after May 16, 2006,we expect to have only one class of stock outstanding.

 

###### **9.**              Subsequent Event

 

In February 2006, we entered into anew five-year $85 million revolving loan agreement with a syndicate ofbanks.  The new facility provides forrevolving loans and the issuance of letters of credit to Veritas DGC Inc. andcertain of its subsidiaries of up to $45 million in the United States, $15million in Canada, $15 million in Singapore and $10 million in the UnitedKingdom.  Certainclosing conditions are yet to be met with regard to the Singapore portion ofthe facility, but are currently expected to be satisfied in March 2006.  Until those conditions are met, the Singaporeportion of the facility will not be available for borrowing or letters ofcredit.  The previousCredit Facility entered into in February 2003 was terminated.

 

The new facility is secured by pledgesof accounts receivable, certain intercompany notes, stock in certain Veritassubsidiaries, and the U.S. land data library. Veritas and certain of itssubsidiaries have also issued loan guarantees with respect to certainborrowings. Interest rates on borrowings under the facility are selected by theborrower at the time of any advance and, prior to April 30, 2006, the rates soselected may be either at LIBOR plus

 

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1.00% or the Base Rate (defined as the lesser of theapplicable prime rate or the federal funds rate). On and after April 30, 2006,these rates may be adjusted upward depending upon our leverage ratio(calculated as a ratio of funded debt versus EBITDA for the previous fourquarters) to a maximum of LIBOR plus 1.50% or the base rate plus 0.50%. Theloan agreement and related documents contain customary financial covenants anddefault provisions.

 

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## **Item 2.**    Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

 

*This report on Form 10-Q and thedocuments incorporated by reference contain forward-looking statements, withinthe meaning of Section 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934. These statements include statementsincorporated by reference to other documents we file with the SEC.Forward-looking statements include, among other things, business strategy andexpectations concerning industry conditions, market position, futureoperations, margins, profitability, liquidity and capital resources. Forward-lookingstatements generally can be identified by the use of terminology such as “may,”“will,” “expect,” “intend,” “estimate,” “anticipate” or “believe” or similarexpressions or the negatives thereof. These expectations are based onmanagement’s assumptions and current beliefs based on currently availableinformation.  Although we believe thatthe expectations reflected in such statements are reasonable, we can give noassurance that such expectation will be correct. You are cautioned not to placeundue reliance on these*forward*-looking statements, which speak only as of the date of this report onForm 10-Q. Our operations are subject to a number of uncertainties, risks andother influences, many of which are outside our control, and any one of which,or a combination of which, could cause our actual results of operations todiffer materially from the forward-looking statements. Important factors thatcould cause actual results to differ materially from our expectations aredisclosed in “Risk Factors” and elsewhere in our Annual Report on Form 10-K.*

 

#### **Overview**

 

We believe that globalexploration for oil and gas is increasing worldwide in key basins ofinterest.  While seismic hastraditionally been used purely as an exploration tool, we are seeing growinginterest in new seismic reservoir imaging techniques, such as multi- orwide-azimuth acquisition, which offer better delineation of complex structuresand may advance the use of seismic in hydrocarbon production.  We believe all of this is promising for ourbusiness, although seismic spending will undoubtedly continue to fluctuate.

 

Our overall performance forthe six months ended January 31, 2006 is the result of being well positioned totake advantage of the increased exploration and reservoir delineationspending.  This positioning includeshaving quality multi-client data in areas of current customer interest, dataprocessing abilities that enable us to produce the highest quality seismicimages, and field operations that are capable of providing technical as well ashealth, safety and environmental excellence.

 

The particularly strongperformance of our land multi-client business in North America provides a solidindicator of our customers’ renewed interest and increased exploration activityin the Canadian and US markets.

 

Due to our sales andoperational efforts and the robust seismic market, we have seen our backlogincrease to $474 million at January 31, 2006 from $459 million at October 31,2005 and $300 million at January 31, 2005. We expect that approximately 80% of the backlog at January 31, 2006 willbe completed during the next twelve months.

 

We have organized the company into four reportablesegments: North and South America (NASA); Europe, Africa, Middle East andCommonwealth of Independent States (EAME); Asia Pacific (APAC); and VeritasHampson Russell (VHR).  In NASA, EAME andAPAC, we conduct geophysical surveys on both a contract and a multi-clientbasis. When we conduct surveys on a contract basis, we acquire and process datafor a single client who pays us to conduct the survey and owns the data weacquire. When we conduct surveys on a multi-client basis, we acquire andprocess data for our own account and license that data and associated productsto multiple clients.  NASA, EAME and APACoffer a common suite of these products and services to their customers,although each product or service may be adapted to meet the needs of the localmarkets.  VHR licenses geophysicalsoftware and provides geophysical reservoir consulting services.  The results of VHR’s operations werepreviously included in those of the NASA region; however, beginning in fiscal2006, senior management began to review the results of VHR separately.  This segmentation of our company isrepresentative of the manner in which it is viewed and managed by our seniormanagers and our Board of Directors.  Theinformation related to the three and six months ended January 31, 2005 has beenrestated to reflect the new segment structure.

 

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#### **Results of operations**

 

#### ***Three months ended January 31,2006 compared with three months ended January 31, 2005***

 

*Revenues*.  Ourrevenues increased by 24% from $192.2 million in the second quarter offiscal 2005 to $238.9 million in the second quarter of fiscal 2006.

 

Multi-client revenue in the second quarter of fiscal2006 increased $35.4 million, or 40%, compared to the prior year’s second fiscalquarter. Both land and marine multi-client revenue improved based onstrengthening worldwide exploration spending resulting in increased seismicsurvey sales.  Land multi-client revenueincreased by $31.9 million or 210% and marine multi-client increased $3.5million or 5%.

 

Contract revenue in the second quarter of fiscal 2006increased by $11.2 million, or 11%, from the prior year’s second fiscal quarteras a result of robust marine activity in the North Sea and Asia Pacific.  Revenue growth was partially offset by lowerland contract revenue due to project delays as a result of unusually mildwinter weather conditions in Canada.

 

All of our segments contributed to higher revenue,which was driven primarily by increased multi-client work.  NASA generated a $39.3 million revenueincrease primarily through multi-client land work in Canada.  Asia Pacific region continued to experienceincreases in its marine contract work.

 

Revenues by contract type were as follows:

 
| ** **         | ** ** | **Three Months Ended January 31,** | ** ** |
|--------------------|------------|------------------------------------|------------|
| ** **         | ** ** | ** **                         | ** ** | ** ** | ** ** | **Change** | ** ** |
| ** **         | ** ** | **2006**                           | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **         | ** ** | **(Dollars in thousands)**         | ** ** |
| Multi-Client:      |       |                               |       |   |   |   |   |   |   |
| Land               |       | $                                  | 47,081     |   | $ | 15,197 |   | $ | 31,884 |   | 210 | % |
| Marine             |       | 76,001                             |       | 72,470 |   | 3,531 |   | 5 | % |
| Total Multi-Client |       | 123,082                            |       | 87,667 |   | 35,415 |   | 40 | % |
| Contract:          |       |                               |       |   |   |   |   |   |   |
| Land               |       | 33,545                             |       | 40,465 |   | (6,920 | ) | (17 | )% |
| Marine             |       | 82,233                             |       | 64,096 |   | 18,137 |   | 28 | % |
| Total Contract     |       | 115,778                            |       | 104,561 |   | 11,217 |   | 11 | % |
| Total Revenue      |       | $                                  | 238,860    |   | $ | 192,228 |   | $ | 46,632 |   | 24 | % |

 

Revenues from our operating segments were as follows:

 
| ** **    | ** ** | **For the Three Months Ended  January 31,** | ** ** |
|---------------|------------|---------------------------------------------|------------|
| ** **    | ** ** | ** **                                  | ** ** | ** ** | ** ** | **Change** | ** ** |
| ** **    | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **    | ** ** | **(Dollars in thousands)**                  | ** ** |
|          |       |                                        |       |   |   |   |   |   |   |
| NASA          |       | $                                           | 170,142    |   | $ | 130,827 |   | $ | 39,315 |   | 30 | % |
| EAME          |       | 33,690                                      |       | 33,076 |   | 614 |   | 2 | % |
| APAC          |       | 29,733                                      |       | 24,045 |   | 5,688 |   | 24 | % |
| VHR           |       | 5,295                                       |       | 4,280 |   | 1,015 |   | 24 | % |
| Total Revenue |       | $                                           | 238,860    |   | $ | 192,228 |   | $ | 46,632 |   | 24 | % |

 

*Operating income. *Operating income increased $19.9 million, or 59%,compared to the prior year’s second fiscal quarter due to increased revenue inboth multi-client and contract work, combined with higher margins in themulti-client business.  This performancewas driven by a favorable sales mix of multi-client revenue especially inCanada and the Gulf of Mexico.

 

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General and administrative expenses increased $2.9million from the prior year’s second fiscal quarter primarily due toshare-based employee compensation expense resulting from the adoption of SFAS123R, severance costs and increased provision for performance-based incentivecompensation.

 

*Interest expense.*  Interest expense increased by $0.7 millionfrom the prior year’s second fiscal quarter due to the increase in the LIBORrate applicable to the $155 million convertible debt.

 

*Interest income*.  Interest income increased approximately $1.7million compared to the prior year’s second fiscal quarter due to higherinterest rates and a higher cash balance.

 

*Other income (expense), net. *Other income and expense,net primarily consists of foreign exchange gains of $0.5 million in the secondquarter of fiscal 2006.  For secondquarter of fiscal 2005, other income and expense, net consists of $0.1 millionof foreign exchange gains and other miscellaneous gains of $0.2 million.

 

*Income taxes. * The company’s effective tax ratefor the quarter ended January 31, 2006 was 43%, which is higher than the 35%U.S. statutory rate.  Substantially allof this higher tax rate was attributable to non-U.S. activities.  The prior year’s second quarter tax rate of49% is higher than the current quarter tax rate due to the company’s inabilityto record in the prior year the benefit of certain deferred tax assets.  However, during the fourth fiscal quarter of2005, we concluded that valuation allowances recorded against deferred taxassets in certain jurisdictions were no longer necessary, resulting in a nettax benefit in fiscal 2005.

 

#### ***Six months ended January 31, 2006compared with six months ended January 31, 2005***

 

*Revenues*.  Ourrevenues increased by 27% from $321.8 million in the first six months offiscal 2005 to $407.5 million in the first six months of fiscal 2006.

 

Multi-client revenue in the first six months of fiscal2006 of $197.5 million increased $64.8 million, or 49%, compared to the priorfiscal year’s first six months.  Bothland and marine revenue improved as a result of increased sales of surveys inprocess in the Gulf of Mexico, Canada and the North Sea.

 

Contract revenue in the first six months of fiscal2006 of $210.0 million increased $21.0 million, or 11%, compared to the priorfiscal year’s first six months.  Marinerevenue increased significantly in the APAC region.  The EAME region also had increases in marineactivity, while in the NASA region we chose to allocate our vessels tomulti-client library projects resulting in higher multi-client revenue.

 

NASA and APAC regions contributed the largest revenueincreases on a segment basis.  Growth in NASAwas due to increased multi-client activity in the Gulf of Mexico andCanada.  APAC continued to benefit fromhigher activity in the marine contract business.

 

Revenues by contract type were as follows:

 
| ** **         | ** ** | **Six Months Ended January 31,** | ** ** |
|--------------------|------------|----------------------------------|------------|
| ** **         | ** ** | ** **                       | ** ** | ** ** | ** ** | **Change** | ** ** |
| ** **         | ** ** | **2006**                         | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **         | ** ** | **(Dollars in thousands)**       | ** ** |
| Multi-Client:      |       |                             |       |   |   |   |   |   |   |
| Land               |       | $                                | 72,980     |   | $ | 26,013 |   | $ | 46,967 |   | 181 | % |
| Marine             |       | 124,559                          |       | 106,751 |   | 17,808 |   | 17 | % |
| Total Multi-Client |       | 197,539                          |       | 132,764 |   | 64,775 |   | 49 | % |
| Contract:          |       |                             |       |   |   |   |   |   |   |
| Land               |       | 81,192                           |       | 76,962 |   | 4,230 |   | 5 | % |
| Marine             |       | 128,807                          |       | 112,083 |   | 16,724 |   | 15 | % |
| Total Contract     |       | 209,999                          |       | 189,045 |   | 20,954 |   | 11 | % |
| Total Revenue      |       | $                                | 407,538    |   | $ | 321,809 |   | $ | 85,729 |   | 27 | % |

 

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Revenues from our operating segments were as follows:

 
| ** **    | ** ** | **For the Six Months Ended  January 31,** | ** ** |
|---------------|------------|-------------------------------------------|------------|
| ** **    | ** ** | ** **                                | ** ** | ** ** | ** ** | **Change** | ** ** |
| ** **    | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **    | ** ** | **(Dollars in thousands)**                | ** ** |
|          |       |                                      |       |   |   |   |   |   |   |
| NASA          |       | $                                         | 272,984    |   | $ | 207,520 |   | $ | 65,464 |   | 32 | % |
| EAME          |       | 68,459                                    |       | 64,850 |   | 3,609 |   | 6 | % |
| APAC          |       | 56,516                                    |       | 42,101 |   | 14,415 |   | 34 | % |
| VHR           |       | 9,579                                     |       | 7,338 |   | 2,241 |   | 31 | % |
| Total Revenue |       | $                                         | 407,538    |   | $ | 321,809 |   | $ | 85,729 |   | 27 | % |

 

*Operating income. *Operating income increased $35.0 million from $36.8million in the first six months of fiscal 2005 to $71.8 million in the firstsix months of fiscal 2006.  This increaseis due to increases in both revenues and margins in both multi-client andcontract work.  The margin increases areprimarily from the multi-client work in NASA both in Canada and the Gulf ofMexico as well as an increase in marine contract work in the APAC region.

 

General and administrative expenses increased $5.4million from the prior fiscal year’s first six months due to share-basedemployee compensation expense of approximately $1.6 million resulting from theadoption of SFAS 123R as well as severance costs, higher professional fees andincreased provision for performance-based incentive compensation.

 

*Interest expense*.Interest expense increased by $1.4 million from the prior fiscal year’s firstsix months as a result of the increase in the LIBOR applicable to the $155million convertible debt.

 

*Interest income*.  Interest income increased $2.8 million compared to the prior year’s firstsix months primarily due to a higherinterest rates and a higher cash balance.

 

*Gain on involuntary conversion ofassets*.  The companyrecognized a pre-tax insurance gain of $2.0 million in the first quarter offiscal 2006 related to insurance settlements for the equipment loss on theVeritas Viking experienced in the second quarter of fiscal year 2005.

 

*Other income (expense), net. *Other income and expense,net consists of foreign exchange losses of $0.4 million and other miscellaneousgains of $1.0 million for the six months ended January 31, 2006.  For the six months ended January 31, 2005,other income and expense, net consisted of $0.2 million of foreign exchangelosses and other miscellaneous gains of $0.3 million.

 

*Income taxes. *The company’s effective tax rate for the six months ended January 31,2006 was 43%, which is higher than the 35% U.S. statutory rate.  Substantially all of this higher tax rate wasattributable to non-U.S. activities.  Theeffective tax rate for the prior year’s first six months of 50% is higher thanthe current year tax rate due to the company’s inability to record in the prioryear the benefit of certain deferred tax assets.  However, during the fourth fiscal quarter of2005, we concluded that valuation allowances recorded against deferred taxassets in certain jurisdictions were no longer necessary, resulting in a nettax benefit in fiscal 2005.

 

#### **Liquidity and capital resources**

 

#### ***Cash flow and liquidity***

 

Our internal sources of liquidity are cash on hand andcash flow from operations.  Externalsources include public financing, equity sales, equipment financing, existingcredit facilities, and trade credit.  Webelieve that our current cash balance and cash flow from operations will beadequate to meet our liquidity needs over the next twelve months. We expect tocontinue to increase our cash balance during the remainder of fiscal 2006.

 

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Net cash provided by operating activities decreased to$85 million for the first six months of fiscal 2006 from $162 million for thefirst six months of fiscal 2005 primarily due to the timing of various workingcapital accounts partially offset by increased net income.  Net cash used by investing activitiesincreased to $91 million in the first six months of fiscal 2006 from $75 millionin the first six months of fiscal 2005 primarily due to increased multi-clientlibrary expenditures.  Our currentlyprojected cash investments for fiscal 2006 include capital expenditures toreplace and upgrade existing equipment of approximately $68 to $73 million andinvestment in our data library of approximately $155 to $165 million.  We expect to fund the remainder of theseinvestments from our current cash on hand and from internally generated funds.

 

As of the beginning of the second fiscal quarter, theConvertible Senior Notes were convertible as the stock price remained greaterthan 120% of the Conversion Price for at least 20 trading days in the period of30 consecutive trading days ending on October 31, 2005 which is the last day ofour first fiscal quarter.  As such, thedebt is classified as current as of January 31, 2006.  However, we do not expect any of the debt tobe converted during fiscal 2006.  As ofJanuary 31, 2006, we had an adequate amount of cash to fund the conversion ofthe notes which would require a payment of the entire principal amount had allof the notes been converted on that date.

 

While we believe that we have adequate sources offunds to meet our liquidity needs even if we were required to fund theconversion of the notes, our ability to meet our obligations depends on ourfuture performance, which is subject to many factors beyond our control. Keyfactors affecting future results include utilization levels of acquisition andprocessing assets and demand for multi-client library surveys, all of which aredriven by exploration spending and, ultimately, the underlying commodityprices.

 

In March 2006, we entered into an agreement with another company tocharter a seismic vessel which is to be newly constructed.  The timecharter is for a period of 8 years fixed, with options of up to 10 moreyears.  When delivered in February 2007, the vessel will be theseventh seismic vessel in our fleet.  Inaddition to the charter, we expect to invest approximately $55 million to equipthe vessel for seismic operations.  Of the expected $55 million total,approximately $1.3 million will be spent during the fiscal year endingJuly 31, 2006 and the remaining is expected to be spent during the fiscalyear ending July 31, 2007.

 

#### ***Debt structure***

 

As of January 31, 2006, our notes payable consisted of$155.0 million of Convertible Senior Notes due 2024. These notes are classifiedas a current liability as of January 31, 2006 because the conversion featurediscussed below results in the notes being convertible at the option of the holders.

 

The Convertible Senior Notes bear interest at a perannum rate which equals the three-month LIBOR rate, adjusted quarterly, minus aspread of 0.75%.  The interest rate ofthe notes, from December 15, 2005 through March 14, 2006, is 3.74%, based on a LIBORrate of 4.49%.  For the second quarter offiscal 2006, the weighted average interest rate on the notes was 3.44%. Thenotes will mature on March 15, 2024 and may not be redeemed by us prior toMarch 20, 2009. Holders of the notes may require us to repurchase some, or all,of the notes on March 15, 2009, 2014 and 2019. They could also requirerepurchase upon a change of control (as defined in the indenture under whichthe Convertible Senior Notes were issued).

 

Under certaincircumstances and at the option of the holder, the Convertible Senior Notes are convertible prior to thematurity date into cash and shares of our common stock.  Certain of these circumstances may result inclassification of the ConvertibleSenior Notes as current on our balance sheet. These circumstances include:

 

1.                                       the closing saleprice of our common stock is over 120% of the conversion price, which iscurrently $24.03 (with 120% being $28.84) for 20 trading days in the period of30 consecutive trading days ending on the last trading day of the fiscalquarter preceding the quarter in which the conversion occurs;

 

2.                                       if we called thenotes for redemption and the redemption has not occurred;

 

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3.                                       the occurrenceof a five consecutive trading day period in which the trading price of thenotes was less than 95% of the closing sale price of our common stock on suchday multiplied by the conversion ratio; or

 

4.                                       the occurrenceof specified corporate transactions.

 

Should any of these circumstances occur, theConvertible Senior Notes would be convertible at the then current stock pricetimes the conversion ratio of 41.6146. This amount would be payable in cashequal to the principal amount of the notes, the par value adjusted for dividendsor other equity transactions, and the additional amount payable in shares ofour common stock.  Currently, the maximumamount payable by us on conversion is $155 million in cash plus approximately6.5 million shares. This settlement method is prescribed in the indenture andis not at the discretion of any party. The shares issuable from such conversion are considered in thecalculation of diluted earnings per share.

 

As of the beginning of the second fiscal quarter of2006, the Convertible Senior Notes were convertible as the stock price remainedgreater than 120% of the Conversion Price for at least 20 trading days in theperiod of 30 consecutive trading days ending on October 31, 2005.  The notes continued to be convertible as ofJanuary 31, 2006.  Because of theconvertibility, the notes have been classified as a current liability on ourconsolidated balance sheet as of January 31, 2006.  The determination of the convertibility ofthe notes occurs quarterly.  Dependingupon the common stock price in the future, the notes may not be convertible infuture quarters and therefore would not be classified as current on ourconsolidated balance sheet.  Assuming astock price of $45.06 (which was the closing stock price at January 31, 2006),conversion of all the notes would result in our payment of $155 million in cashand 3.0 million shares of common stock.

 

In connectionwith our issuance of the Convertible Senior Notes, we entered into aregistration rights agreement pursuant to which we agreed to register theresale of the notes and underlying common stock by the holders thereof.  If we fail to keep the shelf registrationstatement related to this debt effective or usable in accordance with theregistration rights agreement, then we may be required to pay liquidateddamages to all holders of notes and all holders of our common stock issued uponconversion of the notes.  The liquidateddamages to be paid are equal to an annual rate of 0.50% of the principalamount.  In November 2005, the shelfregistration statement became no longer effective and, accordingly, we beganaccruing liquidated damages at approximately $2,100 per day.  For the six months ended January 31, 2006, wehave recorded approximately $220,000 of expense related to these liquidateddamages.  In the process of making thisregistration effective, on November 4, 2005, we filed a post-effectiveamendment to the registration statement; however, until the registrationstatement is declared effective, liquidated damages will be paid each quarterto the record holders.  Because we arenot required to register the resale of the notes and underlying common stockafter March 10, 2006, our liability for the payment of liquidated damages endson that date.

 

In addition to the notes, through the end of the secondfiscal quarter, we had a Credit Facility consisting primarily of a revolvingloan facility permitting borrowings of up to $55.0 million, including afacility for swing line loans of up to $10.0 million, the issuance of lettersof credit in an aggregate amount of up to $48.0 million.  Loans made under the revolving loan facility,including swing-line loans, bore interest at a variable rate determined on thedate of borrowing that is related to various base rates and margins dependingupon our leverage ratio and the location of the borrowing. The revolving loanfacility was terminated on February 6, 2006 and replaced by another facilitywhich is described in Note 9, Subsequent Event. Until its termination, the Credit Facility prohibited us from, amongother things, paying cash dividends. As of January 31, 2006, there were noborrowings and $5.2 million in letters of credit outstanding under therevolving loan facility, leaving $49.8 million available.

 

We also have various unsecured lines of credit, withlending institutions that operate in geographic areas not covered by thelending institutions in our Credit Facility, totaling $8.5 million that may beused exclusively for the issuance of letters of credit and bank guarantees. Asof January 31, 2006, $1.7 million in letters of credit were outstanding underthese lines.

 

Borrowings under the Credit Facility, prior to itstermination on February 6, 2006, were secured by assets, including accountsreceivable, equipment, vehicles, multi-client data library, intellectualproperty, and stock of certain material subsidiaries, owned by us and certainof our subsidiaries. At January 31, 2006, the carrying value of the securedassets, including intercompany receivables, which are eliminated inconsolidation, was $1.3 billion. The

 

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Credit Facility andrelated documents contained a number of covenants, including financialcovenants relating to interest coverage, leverage and net worth. Thesecovenants related to measurements as of quarter ending dates, and, as of ourlast fiscal quarter ended January 31, 2006, we were in compliance with thesecovenants.

 

In February 2006, we entered into anew five-year $85 million revolving loan agreement with a syndicate ofbanks.  The new facility provides forrevolving loans and the issuance of letters of credit to Veritas DGC Inc. andcertain of its subsidiaries of up to $45 million in the United States, $15million in Canada, $15 million in Singapore and $10 million in the United Kingdom.  Certain closingconditions are yet to be met with regard to the Singapore portion of thefacility, but are currently expected to be satisfied in March 2006.  Until those conditions are met, the Singaporeportion of the facility will not be available for borrowing or letters ofcredit.  The previousCredit Facility entered into in February 2003 was terminated.

 

The new facility is secured by pledgesof accounts receivable, certain intercompany notes, stock in certain Veritassubsidiaries, and the U.S. land data library. Veritas and certain of itssubsidiaries have also issued loan guarantees with respect to certainborrowings. Interest rates on borrowings under the facility are selected by theborrower at the time of any advance and, prior to April 30, 2006, the rates soselected may be either at LIBOR plus 1.00% or the Base Rate (defined as thelesser of the applicable prime rate or the federal funds rate). On and afterApril 30, 2006, these rates may be adjusted upward depending upon our leverageratio (calculated as a ratio of funded debt versus EBITDA for the previous fourquarters) to a maximum of LIBOR plus 1.50% or the base rate plus 0.50%. Theloan agreement and related documents contain customary financial covenants anddefault provisions.

 

***Recent Accounting Pronouncements***

 

In December 2004, the FASB issued FASB Staff PositionNo. 109-1, “Application of FASB Statement No. 109, Accounting forIncome Taxes, to the Tax Deduction on Qualified Production Activities Providedby the American Jobs Creation Act of 2004,” which provides guidance on therecently enacted American Jobs Creation Act of 2004 (the “Act”). The Actprovides a tax deduction for income from qualified domestic productionactivities. FSP 109-1 provides for the treatment of the deduction as a specialdeduction as described in SFAS No. 109. Accordingly, we will record theamount of any special deductions in the years they are taken.

 

In December 2004, the FASB issued FASB StaffPosition No. 109-2, “Accounting and Disclosure Guidance for the ForeignRepatriation Provision within the American Jobs Creation Act of 2004,” whichprovides guidance under SFAS No. 109 with respect to recording thepotential impact of the repatriation provisions of the Act on a company’sincome tax expense and deferred tax liability. FSP 109-2 states that a companyis allowed time beyond the financial reporting period of enactment to evaluatethe effect of the Act on its plan for reinvestment or repatriation of foreignearnings for purposes of applying SFAS No. 109. The company has not yetdecided on whether, and to what extent, we might elect to repatriate foreignearnings under the provisions in the Act. Any such repatriation under the Actmust occur by July 31, 2006. Accordingly, Veritas’ consolidated financialstatements do not reflect a provision for taxes related to this election.

 

In December 2004, the FASB issued SFAS No. 153,**“Exchanges of Nonmonetary Assets — anamendment of APB Opinion No. 29,” to address the measurement of exchangesof nonmonetary assets.  SFAS No. 153 eliminates the exception fromfair value measurement for nonmonetary exchanges of similar productive assetsand replaces it with a general exception for exchanges of nonmonetary assetsthat do not have commercial substance.  A nonmonetary exchange hascommercial substance if the future cash flows of the entity are expected tochange significantly as a result of the exchange.  This statement was adopted by the companybeginning August 1, 2005.  The adoption of this statement had no impact onthe company’s financial statements and is not expected to have a materialimpact on future financial statements.

 

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections—a replacement of APB Opinion No. 20 and FASBStatement No. 3.” SFAS No. 154 requires retrospective application to priorperiods’ financial statements for changes in accounting principle, unless it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change. SFAS 154 also requires that a change in depreciation,amortization, or depletion method for long-lived, non-financial assets beaccounted for as a change in accounting estimate effected by a change inaccounting principle. SFAS 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 15, 2005.The implementation of SFAS No. 154 is not

 

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expected to have amaterial impact on the company’s financial statements.

 

In February 2006, the FASB issued SFAS No. 155, “Accountingfor Certain Hybrid Financial Instruments – an amendment of FASB Statements No.133 and 150.”  SFAS No. 155 (a) permits fair value remeasurement for any hybridfinancial instrument that contains an embedded derivative that otherwise wouldrequire bifurcation, (b) clarifies that certain instruments are not subject tothe requirements of SFAS 133, (c) establishes a requirement to evaluateinterests in securitized financial assets to identify interests that maycontain an embedded derivative requiring bifurcation, (d) clarifies what may bean embedded derivative for certain concentrations of credit risk and (e) amendsSFAS 140 to eliminate certain prohibitions related to derivatives on aqualifying special-purpose entity.  SFAS155 is effective for us for the fiscal year beginning August 1, 2007.  We are currently evaluating the impact thatSFAS 155 may have on the company’s financial statements.

 

#### ***Critical accounting policies***

 

As of August 1, 2005, we adopted the FinancialAccounting Standard Board Statement No. 123(R) (SFAS 123R) to account for stockbased employee compensation.  SFAS 123Rrequires us to record the cost of stock options and other equity-basedcompensation in our income statement based upon the estimated fair value ofthose awards.  We elected to use themodified prospective method for adoption, which requires compensation expenseto be recorded for all unvested stock options and other equity-based compensationbeginning in the first quarter of adoption. For all unvested options outstanding as of August 1, 2005, thepreviously measured but unrecognized compensation expense, based on the fairvalue at the original grant date, will be recognized in the statement ofoperations over the remaining vesting period. For equity-based compensationgranted subsequent to August 1, 2005, compensation expense, based on the fairvalue on the date of grant, will be recognized in the statement of operationsover the vesting period.  Determining thefair value of stock based awards at the grant date requires judgment, includingestimating the expected term of stock options, the expected volatility of ourstock and the amount of stock options to be forfeited.  If actual results differ significantly fromthese estimates, stock based compensation expense and the results of operationscould be materially impacted.

 

While all of our accounting policies are important inassuring that we adhere to current accounting standards, certain policies areparticularly important due to their impact on our financial statements.  In addition to the accounting policy relatedto stock based compensation discussed above, the remaining critical accountingpolicies are described in detail in Item 7. Management’s Discussion andAnalysis of Financial Condition and Results of Operations - SignificantAccounting Policies included in our Annual Report on Form 10-K for the fiscalyear ended July 31, 2005, which description is incorporated herein byreference.

 

## **Item 3.**    Quantitative and Qualitative DisclosuresRegarding Market Risk

 

As of January 31, 2006, wehad $155.0 million Convertible Senior Notes bearing interest at LIBOR less0.75% with a fair value of $305 million, based upon the bid price of 196.63 onJanuary 31, 2006.  These notes are nothedged and represent our total exposure to interest rate risk. Each 100 basispoint increase in the LIBOR rate will increase our interest expense by $1.6million per year.

 

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

 

**Evaluation ofDisclosure Controls and Procedures**

 

 We carried out an evaluation, under the supervision of and withthe participation of our management, including our Chief Executive Officer andChief Financial Officer, as to the effectiveness, design and operation of ourdisclosure controls and procedures (as defined in Rule 13a-15(e) under theSecurities and Exchange Act of 1934) as of January 31, 2006. The evaluationconsidered the procedures designed to ensure that information required to bedisclosed by us in reports that we file or submit under the Securities andExchange Act of 1934 is recorded, processed, summarized and reported in thetime periods specified in the rules and forms of the Securities and ExchangeCommission and communicated to our management as appropriate to allow timelydecisions regarding required disclosure. Our Chief Executive Officer and ChiefFinancial Officer concluded that the design and operation of our disclosurecontrols and procedures were effective as of January 31, 2006.

 

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**Changesin Internal Control over Financial Reporting**

 

During the second quarter of fiscal 2006, we did notmake any change to our internal control over financial reporting thatmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

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# **PART II.  OTHERINFORMATION**

 

## **Item 4. Submission of Matters to a Vote of SecurityHolders**

## ** **

On December 15, 2005, at the Annual Meeting of Stockholders, thestockholders voted, as follows, to elect eight directors of Veritas DGC Inc.and ratify PricewaterhouseCoopers LLP as the company’s independent accountants.

 

The results of the election of the directors by the stockholders wereas follows:

 
| **Name**            | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|---------------------|------------|---------------|------------|--------------------|------------|
|                |       |          |       |               |       |
| Loren K.  Carroll   |       | 30,008,074    |       | 305,615            |       |
| Clayton P.  Cormier |       | 29,884,249    |       | 429,440            |       |
| James R.  Gibbs     |       | 29,922,924    |       | 390,765            |       |
| Thierry  Pilenko    |       | 29,905,712    |       | 407,977            |       |
| Jan Rask            |       | 17,793,019    |       | 12,520,670         |       |
| Yoram Shoham        |       | 30,005,577    |       | 308,112            |       |
| David F.  Work      |       | 30,008,074    |       | 305,615            |       |
| Terence K.  Young   |       | 29,678,692    |       | 634,997            |       |

 

The results of the vote by the holders of Shares on theproposal to ratify the selection of PricewaterhouseCoopers LLP as the company’sindependent accountants were as follows:

 
| Votes For: 30,008,074 | Votes Against: 305,615 | Abstentions: | 0 |
|-----------------------|------------------------|--------------|---|

 

## **Item6.**    Exhibits

 

***Exhibits filed with this report:***

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.36            |       | —    Loan Agreement ($45,000,000  U.S. Revolving Loan Facility, $15,000,000 Canadian Revolving Loan Facility,  $15,000,000 Singapore Revolving Loan Facility, and $10,000,000 U.K. Revolving  Loan Facility) dated as of February 6, 2006, among Veritas DGC Inc., as  U.S. Borrower, Veritas Energy Services Inc. and Veritas Energy Services  Partnership, as Canadian Borrowers, Veritas Geophysical (Asia Pacific) Pte.  Ltd., as Singapore Borrower, Veritas DGC Limited, as U.K. Borrower, Wells  Fargo Bank, National Association, as U.S. Agent and Lead Arranger, HSBC  Canada, as Canadian Agent, The Hongkong and Shanghai Banking Corporation  Limited, Singapore Branch, as Singapore Agent, HSBC Bank plc, as U.K. Agent,  and the other lenders now or hereafter parties thereto (Exhibit 10.1 to  Veritas DGC Inc.’s Form 8-K dated February 6, 2006 is incorporated herein by  reference.) |
| *31.1            |       | —    Certification  pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 by Chief Executive  Officer.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| *31.2            |       | —    Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by Chief Financial  Officer.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| *32.1            |       | —    Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Chief Executive  Officer.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| *32.2            |       | —    Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Chief Financial  Officer.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |

 

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***  filed herewith**

 

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## **SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized, on the 8th day of March 2006.

 
| ** ** | **Veritas DGC Inc.** |
|------------|----------------------|
|       |                 |
|       | By:                  | /s/ Mark E. Baldwin |   |
|       |                 | Mark  E. Baldwin |
|       |                 | Executive Vice President, Chief Financial Officer and Treasurer  (Principal Financial Officer) |
|       |                 |   |
|       |                 |   |
|       |                 | /s/ Dennis S. Baldwin |   |
|       |                 | Dennis  S. Baldwin |
|       |                 | Vice President, Corporate Controller  (Chief Accounting Officer) |

 

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