10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended December 31, 2006

OR

oTransition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     

Commission file number 1-9947

TRC COMPANIES, INC.

(Exact name of registrant as specified in its charter)

Delaware	06-0853807
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
21 Griffin Road North
Windsor, Connecticut	06095
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code:  (860) 298-9692

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. YES oNO x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer o Accelerated filer x Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES o   NO x

On May 21, 2007 there were 18,225,575 shares of the registrant’s common stock, $.10 par value, outstanding.

TRC COMPANIES, INC.

CONTENTS OF QUARTERLY REPORT ON FORM 10-Q

QUARTER ENDED DECEMBER 31, 2006

PART I—Financial Information

Item 1.	Condensed Consolidated Financial Statements (Unaudited)
	Condensed Consolidated Statements of Operations for the three and six months ended December 31, 2006 and 2005	3
	Condensed Consolidated Balance Sheets at December 31, 2006 and June 30, 2006	4
	Condensed Consolidated Statements of Cash Flows for the six months ended December 31, 2006 and 2005	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	28
Item 4.	Controls and Procedures	28
PART II—Other Information
Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	29
Item 3.	Defaults Upon Senior Securities	30
Item 4.	Submission of Matters to a Vote of Security Holders	30
Item 5.	Other Information	30
Item 6.	Exhibits	30
Signature		31
Certifications		32

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PART I: FINANCIAL INFORMATION

TRC COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

	Three Months Ended						Six Months Ended
	December 31,						December 31,
	2006			2005			2006			2005
Gross revenue	$	114,488		$	96,210		$	217,399		$	206,838
Less subcontractor costs and direct charges	48,671			37,680			87,631			89,879
Net service revenue	65,817			58,530			129,768			116,959
Interest income from contractual arrangements	1,250			962			2,451			1,847
Insurance recoverables	71			171			4,816			804
Operating costs and expenses:
Cost of services	56,340			57,444			114,303			112,101
General and administrative expenses	4,717			5,973			11,707			12,318
Provision for doubtful accounts	949			1,314			1,857			4,485
Depreciation and amortization	2,031			1,725			4,039			3,349
	64,037			66,456			131,906			132,253
Operating income (loss)	3,101			(6,793		)	5,129			(12,643		)
Interest expense	1,147			1,340			2,280			2,270
Income (loss) from continuing operations before taxes and equity earnings (losses)	1,954			(8,133		)	2,849			(14,913		)
Federal and state income tax provision (benefit)	981			(2,700		)	1,428			(4,951		)
Income (loss) from continuing operations before equity earnings (losses)	973			(5,433		)	1,421			(9,962		)
Equity in earnings (losses) from unconsolidated affiliates, net of taxes	18			(13		)	37			(3		)
Income (loss) from continuing operations	991			(5,446		)	1,458			(9,965		)
Discontinued operations, net of taxes	—			267			(123		)	166
Net income (loss)	991			(5,179		)	1,335			(9,799		)
Dividends, accretion charges, and benefit on redemption of preferred stock	(3,789		)	176			(3,642		)	391
Net income (loss) applicable to common shareholders	$	4,780		$	(5,355	)	$	4,977		$	(10,190	)
Basic earnings (losses) per common share:
Continuing operations	$	0.28		$	(0.39	)	$	0.30		$	(0.72	)
Discontinued operations	—			0.02			(0.01		)	0.01
	$	0.28		$	(0.37	)	$	0.29		$	(0.71	)
Diluted earnings (losses) per common share:
Continuing operations	$	0.27		$	(0.39	)	$	0.30		$	(0.72	)
Discontinued operations	—			0.02			(0.01		)	0.01
	$	0.27		$	(0.37	)	$	0.29		$	(0.71	)
Average shares outstanding:
Basic	17,117			14,456			16,923			14,426
Diluted	17,554			14,456			17,376			14,426

See accompanying notes to condensed consolidated financial statements.

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TRC COMPANIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

(Unaudited)

	December 31,		June 30,
	2006		2006
ASSETS
Current assets:
Cash	$	419	$	3,093
Accounts receivable, less allowances for doubtful accounts	129,113		120,829
Insurance recoverable - environmental remediation	7,881		3,546
Deferred income tax benefits	15,567		15,261
Income taxes refundable	4,761		5,429
Restricted investment	29,015		33,230
Prepaid expenses and other current assets	12,552		8,049
Total current assets	199,308		189,437
Property and equipment, at cost	54,969		54,063
Less accumulated depreciation and amortization	35,065		35,105
	19,904		18,958
Goodwill	129,953		126,325
Investments in and advances to unconsolidated affiliates and construction joint ventures	4,980		4,315
Long-term restricted investment	72,822		78,856
Long-term prepaid insurance	56,052		56,612
Assets held for sale	—		458
Other assets	10,189		10,442
Total assets	$	493,208	$	485,403
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	30,917	$	37,608
Accounts payable	40,451		41,450
Accrued compensation and benefits	20,477		20,930
Deferred revenue	36,585		39,726
Environmental remediation liability	3,416		2,504
Other accrued liabilities	30,782		22,214
Total current liabilities	162,628		164,432
Non-current liabilities:
Long-term debt, net of current portion	6,923		2,845
Deferred income tax liabilities	5,162		4,689
Long-term deferred revenue	142,684		143,979
Long-term environmental remediation liability	10,601		9,302
Total liabilities	327,998		325,247
Convertible redeemable preferred stock	—		15,000
Commitments and contingencies
Shareholders’ equity:
Capital stock:
Preferred, $.10 par value; 500,000 shares authorized, 0 and 15,000 issued and outstanding as convertible redeemable, liquidation preference of $0 and $15,000 at December 31, 2006 and June 30, 2006, respectively	—		—
Common, $.10 par value; 30,000,000 shares authorized, 18,112,057 and 18,108,575 issued and outstanding, respectively, at December 31, 2006, and 16,720,420 shares issued and outstanding at June 30, 2006	1,811		1,672
Additional paid-in capital	139,950		125,152
Retained earnings	23,297		18,320
Accumulated other comprehensive income	185		12
	165,243		145,156
Less treasury stock, at cost	33		—
Total shareholders’ equity	165,210		145,156
Total liabilities and shareholders’ equity	$	493,208	$	485,403

See accompanying notes to condensed consolidated financial statements.

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TRC COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	Six Months Ended
	December 31,
	2006			2005
Cash flows from operating activities:
Net income (loss)	$	1,335		$	(9,799	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Non-cash items:
Depreciation and amortization	4,039			3,810
Directors deferred compensation	83			70
Stock-based compensation expense	769			640
Provision for doubtful accounts	1,857			4,485
Non-cash interest (income) expense	(97		)	64
Deferred income taxes	151			(2,822		)
Equity in (earnings) losses from unconsolidated affiliates	(37		)	3
Equity earnings from construction joint ventures	(509		)	(91		)
Loss on disposal of assets	68			49
Other non-cash items	222			41
Changes in operating assets and liabilities:
Accounts receivable	(10,141		)	3,318
Restricted investments	9,997			19,848
Deferred revenue	(4,436		)	(21,296		)
Long-term prepaid insurance	560			876
Insurance recoverable - environmental remediation	(4,335		)	3,629
Prepaid expenses and other current assets	78			(1,239		)
Accounts payable	(481		)	4,716
Accrued compensation and benefits	(453		)	(290		)
Environmental remediation liability	2,211			1,126
Income taxes refundable	668			532
Other accrued liabilities	2,375			1,074
Excess tax benefit from option exercises	—			(59		)
Other assets	(261		)	(54		)
Net cash provided by operating activities	3,663			8,631
Cash flows from investing activities:
Additions to property and equipment	(5,152		)	(4,856		)
Restricted investment	522			220
Earnout payments for business acquisitions	(1,984		)	(3,636		)
Proceeds from sale of Bellatrix	400			—
Proceeds from sale of property and equipment	120			106
(Advances to) and proceeds from unconsolidated affiliates	(172		)	103
Net cash used in investing activities	(6,266		)	(8,063		)
Cash flows from financing activities:
Net payments under revolving credit facility	(6,820		)	(1,300		)
Payments of long-term debt	(285		)	(948		)
Borrowings of long-term debt	5,034			374
Proceeds from sale of common stock	2,000			—
Proceeds from exercise of stock options and warrants	—			231
Excess tax benefit from option exercises	—			59
Net cash used in financing activities	(71		)	(1,584		)
Decrease in cash	(2,674		)	(1,016		)
Cash, beginning of period	3,093			3,325
Cash, end of period	$	419		$	2,309

See accompanying notes to condensed consolidated financial statements.

5

TRC COMPANIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

December 31, 2006 and 2005

(in thousands, except per share data)

1.Company Background and Basis of Presentation

TRC Companies, Inc., through its subsidiaries (collectively, the “Company”), is an engineering, consulting, and construction management firm that provides integrated services to the environmental, energy, infrastructure, and real estate markets.  Its multidisciplinary project teams provide turnkey services to help its clients implement complex projects from initial concept to delivery and operation.  A broad range of commercial, industrial, and government clients depend on the Company for customized and complete solutions to their toughest business challenges.  The Company provides its services to commercial organizations and governmental agencies almost entirely in the United States of America.

The condensed consolidated financial statements include the Company and its wholly owned-subsidiaries after elimination of intercompany accounts and transactions.  Investments, in which the Company has the ability to exercise significant influence, but not control, are accounted for by the equity method.  Certain contracts are executed jointly through alliances and joint ventures with unrelated third parties.  The Company recognizes its proportional share of such joint venture revenue, costs and operating profits in its condensed consolidated statements of operations.

The Company incurred significant losses in fiscal 2006 and 2005. The Company is taking actions to return the Company to profitability and generate positive cash flows from operations.  Specifically, the Company has enhanced its controls over project acceptance, which it believes will reduce the level of contract losses; has increased the level of experience of its accounting personnel in order to improve internal controls and reduce compliance costs; has improved the timeliness of customer invoicing, and enhanced its collection efforts, which the Company believes will result in fewer write-offs of project revenue and in lower levels of bad debt expense and reduce the Company’s reliance on its revolving credit agreement; and improved project management, which it believes will result in higher levels of project profitability.  Management believes that existing cash resources, cash forecasted to be generated from operations and availability under the new credit facility are adequate to meet the Company’s requirements.

As discussed in Note 6, in the fourth quarter of fiscal 2006, the Company sold the assets of the Pacific Land Design, Inc. and Pacific Land Design Roseville, Inc. entities (together “PacLand”), as well as committed to sell the assets of its Bellatrix business in Phoenix, Arizona (“Bellatrix”). Bellatrix was sold in August 2006. The operations of these entities have been segregated and are shown as discontinued operations in the condensed consolidated statements of operations, and the assets of Bellatrix held by the Company at June 30, 2006 have been shown as assets held for sale in the condensed consolidated balance sheet.

The condensed consolidated balance sheet at December 31, 2006 and the condensed consolidated statements of operations for the three and six months ended December 31, 2006 and 2005 and the condensed consolidated statement of cash flows for the six months ended December 31, 2006 and 2005 have been prepared pursuant to the interim period reporting requirements of Form 10-Q and in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). Consequently, the financial statements are unaudited but, in the opinion of the Company’s management, include all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of the results for the interim periods.  Also, certain information and footnote disclosures usually included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K/A as of and for the fiscal year ended June 30, 2006.

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2.Recently Issued Accounting Standards

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”).  This interpretation of Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes,” prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  In order to minimize the diversity in practice existing in the accounting for income taxes, FIN 48 also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  As this interpretation is effective for fiscal years beginning after December 15, 2006, the Company will adopt FIN 48 on July 1, 2007. The cumulative effect of applying the provisions of FIN 48 will be reported as an adjustment to the opening balance of retained earnings for that fiscal year, presented separately.  The Company has not completed its evaluation of the effect of adoption of FIN 48.  However, due to the fact that the Company has established tax positions in previously filed tax returns, and is expected to take tax positions in future tax returns to be reflected in the financial statements, the adoption of FIN 48 may have a significant impact on the Company’s financial position or results of operations.

In October 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). This standard establishes a framework for measuring fair value and expands disclosures about fair value measurement of a company’s assets and liabilities. This standard also requires that the fair value measurement be determined based on the assumptions that market participants would use in pricing an asset or liability. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and, generally, must be applied prospectively. The Company will adopt SFAS 157 on July 1, 2008 and is currently evaluating the effect, if any, that the adoption will have on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115,” (“SFAS 159”).  This standard permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is expected to expand the use of fair value measurement, which is consistent with the Board’s long-term measurement objectives for accounting for financial instruments. The Company will adopt SFAS 159 on July 1, 2008 and is currently evaluating the effect, if any, that the adoption will have on its consolidated financial statements.

3.Earnings per Share

Basic earnings per share (“EPS”) is determined as net income (loss) applicable to common shareholders divided by the weighted average common shares outstanding during the period.  Diluted EPS reflects the potential dilutive effect of outstanding stock options and warrants and the conversion of the Company’s preferred stock.  For purposes of computing diluted EPS the Company uses the treasury stock method.

The number of outstanding stock options and warrants excluded from the diluted EPS calculations (as they were anti-dilutive) was 1,970 and 1,708 for the three and six months ended December 31, 2006, and 2,761 for the three and six months ended December 31, 2005, respectively.  For the three months and six months ended December 31, 2005, the Company incurred a net loss.  As a result, the assumed conversion of the preferred stock into 932 shares of common stock was excluded from the calculation of diluted EPS for the three and six months ended December 31, 2005. The following table sets forth the computations of basic and diluted EPS:

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	Three Months Ended					Six Months Ended
	December 31,					December 31,
	2006		2005			2006			2005
Income (loss) from continuing operations	$	991	$	(5,446	)	$	1,458		$	(9,965	)
Discontinued operations, net of taxes	—		267			(123		)	166
Net income (loss)	991		(5,179		)	1,335			(9,799		)
Dividends, accretion charges and benefit on redemption of preferred stock	3,789		(176		)	3,642			(391		)
Net income (loss) applicable to common shareholders	$	4,780	$	(5,355	)	$	4,977		$	(10,190	)
Weighted average common shares outstanding — basic	17,117		14,456			16,923			14,426
Potentially dilutive common shares:
Stock options and warrants	428		—			444			—
Contingently issuable shares	9		—			9			—
Total diluted shares	17,554		14,456			17,376			14,426
Basic earnings (loss) per share:
Continuing operations	$	0.28	$	(0.39	)	$	0.30		$	(0.72	)
Discontinued operations	—		0.02			(0.01		)	0.01
Basic earnings (loss) per common share	$	0.28	$	(0.37	)	$	0.29		$	(0.71	)
Diluted earnings (loss) per share:
Continuing operations	0.27		(0.39		)	0.30			(0.72		)
Discontinued operations	—		0.02			(0.01		)	0.01
Diluted earnings (loss) per common share	$	0.27	$	(0.37	)	$	0.29		$	(0.71	)

4.Accounts Receivable

The current portion of accounts receivable at December 31, 2006 and June 30, 2006 was comprised of the following:

	December 31,		June 30,
	2006		2006
Billed	$	96,430	$	72,602
Unbilled	42,871		56,058
Retainage	3,354		5,056
	142,655		133,716
Less allowances for doubtful accounts	13,542		12,887
	$	129,113	$	120,829

A substantial portion of unbilled receivables represents billable amounts recognized as revenue, primarily in the last month of the fiscal period.  Management expects that almost all unbilled amounts will be billed and collected within one year.  Retainage represents amounts billed but not paid by the client which, pursuant to contract terms, are due at completion.

Claims are amounts in excess of the agreed contract price (or amounts not included in the original contract price) that a contractor seeks to collect for delays, errors in specifications and designs, contract terminations, change orders in dispute or unapproved as to both scope and price or other causes.  Costs attributable to claims are treated as costs of contract performance as incurred.  As of December 31, 2006 and June 30, 2006, respectively, the Company had recorded a claim receivable of $1,026 and $989 equal to the contract costs incurred for the claim.  The claim relates to a design-build infrastructure project in which the Company was a subcontractor.  The ultimate client for the project is a state government entity.  The Company is currently processing the claim with the prime contractor and the state government entity.

5.Other Accrued Liabilities

At December 31, 2006 and June 30, 2006, other accrued liabilities were comprised of the following:

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	December 31,		June 30,
	2006		2006
Additional purchase price payments	$	4,291	$	2,774
Contract costs	3,996		3,295
Contract loss reserves	5,602		5,140
Audit and legal costs	11,280		6,105
Lease obligations	1,758		1,869
Other	3,855		3,031
	$	30,782	$	22,214

6.Acquisitions and Divestitures

(a) Acquisitions

During the six months ended December 31, 2006 and 2005, the Company made additional purchase price cash payments of $1,984 and $3,636, respectively, related to acquisitions completed in prior years.  In addition during the six months ended December 31, 2006 and 2005, the Company issued 16 and 55 shares of common stock valued at $161 and $681, respectively, related to acquisitions completed in prior years.  The additional purchase price payments were earned as a result of the acquired entities achieving certain financial objectives, primarily operating income targets.

(b) Discontinued Operations

The Company sold the assets of PacLand, as well as committed to sell the assets of its Bellatrix business in the fourth quarter of fiscal 2006. Bellatrix was sold in August 2006. The operations of these entities have been segregated and are shown as discontinued operations in the condensed consolidated statements of operations, and the assets of Bellatrix held by the Company at June 30, 2006 were shown as assets held for sale in the condensed consolidated balance sheet.

The summarized combined statements of operations for discontinued operations were as follows:

	Three Months Ended					Six Months Ended
	December 31,					December 31,
	2006		2005			2006			2005
Gross revenue	$	—	$	3,672		$	419		$	6,721
Net service revenue	$	—	$	2,527		$	21		$	4,522
Operating income (loss)	—		402			(196		)	251
Interest expense	—		(2		)	—			(4		)
	—		400			(196		)	247
Income tax benefit (expense)	—		(133		)	73			(81		)
Income (loss) from discontinued operations	$	—	$	267		$	(123	)	$	166

7.Goodwill and Intangible Assets

The changes in the carrying amount of goodwill for the six months ended December 31, 2006 are as follows:

Goodwill, July 1, 2006	$	126,325
Additional purchase price payments accrued	3,628
Goodwill, December 31, 2006	$	129,953

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The Company completed its required annual assessment of the recoverability of goodwill as of December 31, 2006 and concluded that no impairment existed.  In performing the goodwill assessment we used current market capitalization and other factors as the best evidence of fair value.  There can be no assurance that future events will not result in an impairment of goodwill or other assets.

During the first quarter of fiscal 2007, the Company amended the earnout agreement with the principals of the Company’s Environomics LLC subsidiary.  The agreement resulted in a change to the earnout payment from a calculated multiple based on operating income to a predetermined amount.  As a result, the Company recorded additional goodwill of $3,015. The earnout is payable in quarterly payments of $503 each, through January 2008.

Identifiable intangible assets as of December 31, 2006 and June 30, 2006 are included in other assets on the condensed consolidated balance sheets and were comprised of:

	December 31, 2006				June 30, 2006
	Gross				Gross
	Carrying		Accumulated		Carrying		Accumulated
	Amount		Amortization		Amount		Amortization
Identifiable intangible assets with determinable lives:
Contract backlog	$	456	$	363	$	616	$	399
Customer relationships	7,166		1,473		7,166		1,214
Trade names	139		139		139		—
Other	190		125		190		108
	7,951		2,100		8,111		1,721
Identifiable intangible assets with indefinite lives:
Other	726		300		726		300
	$	8,677	$	2,400	$	8,837	$	2,021

Identifiable intangible assets with determinable lives are amortized over the weighted average period of approximately thirteen years.  The weighted average periods of amortization by intangible asset class is approximately three years for contract backlog assets, fourteen years for customer relationship assets and six years for other assets.  The amortization of intangible assets during the three months ended December 31, 2006 and 2005 was $266 and $357, respectively. The amortization of intangible assets during the six months ended December 31, 2006 and 2005 was $539 and $718, respectively.   Estimated amortization of intangible assets for future periods is as follows: remainder of fiscal 2007 - $325; fiscal 2008 - - $587; fiscal 2009 - $537; fiscal 2010 - $520; fiscal 2011 - $493; fiscal 2012 and thereafter - $3,389.

8.Debt

On July 17, 2006, the Company and certain of its subsidiaries, together (the “Borrower”), entered into a secured credit agreement (the “Credit Agreement”) and related security documentation with Wells Fargo Foothill, Inc., as lender and administrative agent.  The Credit Agreement provides the Borrower with a five-year senior revolving credit facility of up to $50,000 based upon a borrowing base formula on accounts receivable. Amounts outstanding under the new credit facility bear interest at the greater of 7.75% and prime rate plus a margin of 1.25% to 2.25%, or the greater of 5.0% and LIBOR plus a margin of 2.25% to 3.25%, based on average excess availability.  The Credit Agreement contains covenants which, among other things, require the Company to maintain a minimum EBITDA of $3,112, $5,783, $8,644 and $12,278 for the quarter, two quarter, three quarter and four quarter periods ended or ending September 30, 2006, December 31, 2006, March 31, 2007 and June 30, 2007, respectively. As of December 31, 2006, the Company was in compliance with this covenant. Thereafter, the minimum EBITDA covenant increases in

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approximately equal annual increments to $24,000 for the fiscal year ended June 30, 2010.  The Company must maintain average monthly backlog of $190,000. Capital expenditures are limited to $9,619, $10,099 and $10,604 for the fiscal years ended June 30, 2007, 2008, and 2009 and thereafter, respectively. The Borrower’s obligations under the Credit Agreement are secured by a pledge of substantially all of the assets of the Borrower and guaranteed by substantially all of the Company’s subsidiaries that are not borrowers.  The Credit Agreement also contains cross-default provisions which become effective if the Company defaults on other indebtedness.  The proceeds of the Credit Agreement were utilized to repay the then existing credit facility in full.

On July 19, 2006, the Company and substantially all of its subsidiaries entered into a three-year subordinated loan agreement with Federal Partners, L.P. (“Federal Partners”), a stockholder of the Company, pursuant to which the Company borrowed $5,000 from Federal Partners.  The loan bears interest at a fixed rate of 9% per annum.  The loan is stated to mature on July 19, 2009 upon which the full principal amount of the loan then outstanding shall be due and payable.  In addition, the Company issued a ten-year warrant to purchase up to 66 shares of its common stock to Federal Partners at an exercise price equal to $0.10 per share, pursuant to the terms and conditions of a Warrant Agreement, dated July 19, 2006. The estimated fair value of the warrants of $659 was determined using the Black-Scholes option pricing model and the following assumptions: term of 10 years, a risk free interest rate of 4.94%, a dividend yield of 0% and volatility of 50%. The face amount of the note payable of $5,000 was proportionately allocated to the note payable and the warrant in the amount of $4,418 and $582, respectively. The amount allocated to the warrants of $582 was recorded as a discount on the note payable and is being amortized over the three year life of the note payable. For the three and six months ended December 31, 2006, $49 and $88, respectively, was amortized as interest expense.

On October 31, 2006, the Credit Agreement was amended (the “First Amendment”) to modify certain terms which, among other things, waived certain schedule requirements related to post-closing deliverables, changed the definition of “Eligible Unbilled Accounts” under the Credit Agreement, and changed the schedule for delivery of certain reports.

On November 29, 2006, the Credit Agreement was amended (the “Second Amendment”) to modify certain terms which changed the delivery date for the Company’s Fiscal 2006 Annual Report on Form 10-K to on or before December 31, 2006 and increased the letter of credit usage limit from $5,000 to $7,500.

On December 29, 2006, the Credit Agreement was further amended (the “Third Amendment”) to modify certain terms which changed the delivery date for the Company’s Fiscal 2006 Annual Report on Form 10-K to on or before January 31, 2007.

At December 31, 2006, the Company had borrowings outstanding pursuant to its revolving credit facility of $30,280 at an average interest rate of 10.0% compared to $37,100 of borrowings outstanding at an average interest rate of 10.5% (including the 2% default rate of interest) at June 30, 2006.

9.Convertible Preferred Stock

On December 1, 2006, the Company entered into a Purchase and Exchange Agreement (the “Exchange Agreement”) with Fletcher International, Ltd. (“Fletcher”) pursuant to which the 15 shares of Series A-1 Cumulative Convertible Preferred Stock held by Fletcher which were redeemable in common stock as of December 14, 2006, were exchanged for 1,132 shares of common stock, thereby retiring the Preferred Stock.  The difference between the carrying value of the preferred stock of $15,000 and the fair value of the common stock issued of $11,083 at the redemption date was recorded as a benefit on redemption of preferred stock and increased net income applicable to common shareholders for the three and six months ended December 31, 2006.

As part of the Exchange Agreement, Fletcher also agreed to purchase an additional 204 shares of common stock at $9.79 per share, the closing price of the common stock on the New York Stock Exchange on December 1, 2006.  The closing of the transactions under the Exchange Agreement occurred on December 7, 2006.

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10.Restructuring Costs

The following table summarizes accrued restructuring obligations and related activity for the period July 1, 2006 to December 31, 2006:

	Employee Severance			Facility Closures			Total
Liability balance at July 1, 2006	$	103		$	287		$	390
Total charge to operating costs and expenses	2			1			3
Payments	(105		)	(96		)	(201		)
Adjustments	—			49			49
Liability balance at December 31, 2006	$	—		$	241		$	241

Severance and benefits costs

Severance and benefits costs primarily include involuntary termination and health benefits, outplacement costs and payroll taxes for terminated personnel.

Facility closure and asset impairment costs

Total facility closure costs include lease liabilities offset by estimated sublease income and were based on market trend information analyses. In December 2006, the Company entered into a sub-lease of its Dallas facility, resulting in a $49 adjustment to the previous estimated accrual amount.  As of December 31, 2006, $241 of facility closure costs remain accrued and are expected to be paid by fiscal year 2013. The Company’s lease abandonment accrual is net of $581 of actual sublease payments due under non-cancelable subleases at December 31, 2006.

11.Commitments and Contingencies

Exit Strategy Contracts

The Company has entered into several long-term contracts pursuant to its Exit Strategy program under which the Company is obligated to complete the remediation of environmental conditions at a site.  The Company assumes the risk for remediation costs for pre-existing site environmental conditions and believes that through in-depth technical analysis, comprehensive cost estimation and creative remedial approaches it is able to execute pricing strategies which protect the Company’s return on these projects.  The Company’s client pays a fixed price and, as additional protection, a finite risk cost cap insurance policy is obtained from leading insurance companies with a minimum A.M. Best rating of A- Excellent (e.g., American International Group) which provides coverage for cost increases from unknown or changed conditions up to a specified maximum amount significantly in excess of the estimated cost of remediation.

The contract proceeds are paid by the client at inception.  A portion of these proceeds, generally five to ten percent, are remitted to the Company, and these amounts are included as deferred revenue under current or long-term liabilities on the Company’s condensed consolidated balance sheets.  This balance is reduced as the Company performs work under the contract and recognizes revenue.  The balance of contract proceeds, less any insurance premiums and fees for a policy to cover potential cost overruns and other factors, are deposited into a restricted investment account with an insurer and is used to pay the Company as work is performed.  The Company believes that it is adequately protected from risks on these projects and that adverse developments, if any, will not likely have a material impact on its operating results, financial position and cash flows.

Five Exit Strategy contracts entered into by the Company involved the Company entering into consent decrees with government authorities and assuming the obligation for the settling responsible parties’ statutory environmental remediation liability at the sites.  The Company’s expected remediation costs for the aforementioned contracts (included within current and long-term deferred revenue items in the condensed consolidated balance sheets) are fully funded by the contract price and are fully insured by an environmental remediation cost cap policy (current and long-term restricted investment items in the

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condensed consolidated balance sheets).  At December 31, 2006, the remediation for one of the projects was complete, and the Company had begun long-term maintenance and monitoring at that site.

The Company’s indirect cost rates applied to contracts with the U.S. Government and various state agencies are subject to examination and renegotiation.  Contracts and other records of the Company have been examined through June 30, 1999.  The Company believes that adjustments resulting from such examination or renegotiation proceedings, if any, will not likely have a material impact on the Company’s operating results, financial position and cash flows.

During fiscal 2006 the Company and another contractor jointly and severally entered into a $3,500 contract to provide demolition and abatement services. The Company and the contractor entered into a teaming arrangement which stated that the Company would be entitled to 8% of the $3,500 contract proceeds for providing working capital, procurement assistance and bonding for the project.  The other contractor was responsible for insurance, supervision, labor, equipment and materials for the project. Initially, the work was proceeding and progress payments were received from the customer, however, as the contract encountered delays and issues arose regarding the scope of work, there was insufficient cash flow to fund the cost overruns on the project.  In the fourth quarter of fiscal 2006, the Company was required to provide funding to project subcontractors. Through June 30, 2006, the Company received approximately $200 of cash and incurred expenses of approximately $3,600. As a result, the Company recognized a $3,400 loss on the project in the fourth quarter of fiscal 2006. The Company is in the process of evaluating a claim for the project.  The Company accounts for gain contingencies in accordance with the provisions of SFAS No. 5, “Accounting for Contingencies,” and therefore does not record gain contingencies and recognize revenue until it is earned and realized.  At December 31, 2006, the Company had not recorded any potential recoveries related to this project.

Legal Matters

The Company and its subsidiaries are subject to claims and lawsuits typical of those filed against engineering and consulting companies.  The Company carries liability insurance, including professional liability insurance, against such claims, subject to certain deductibles and policy limits.  Except as described herein, management is of the opinion that the resolution of these claims and lawsuits will not likely have a material adverse effect on the Company’s operating results, financial position and cash flows.

In re: Tropicana Garage Collapse Litigation - Superior Court New Jersey, Atlantic County, 2004.  A subsidiary of the Company was named as a defendant, along with a number of other companies, in litigation brought on behalf of individuals claiming damages for alleged injuries, including death, related to a collapse of several floors of a parking garage under construction in Atlantic City, New Jersey.  That subsidiary was also named a defendant in other actions for business claims related to the parking garage.  The subsidiary (along with other contractors) is covered under an insurance program specific to this project (the “wrap-up program”).  In addition, the subsidiary was covered under the Company’s insurance program.  The subsidiary had a limited inspection role in connection with the construction.  A global settlement of all claims between all parties in this case was reached in April 2007. The subsidiary will have no uninsured exposure.

Godosis v. Cal-Tran Associates, et al, New York Supreme Court, New York County, 2004, and Cal-Tran Associates v. City of New York, et al, New York Supreme Court, Queens County, 2005.  A subsidiary of the Company was engaged by the New York City Department of Transportation (“NYCDOT”) to provide construction support services with respect to the replacement of an overpass bridge in Queens, New York.  A motorist and his wife commenced litigation alleging that, during demolition of a portion of the existing bridge, two sections fell onto the roadway beneath and that the motorist was injured.  The subsidiary (along with other project contractors) was named in the suit. The suit was settled in May 2007.  The subsidiary will have no uninsured exposure beyond the applicable deductible. In a separate action, the general contractor on that project has sued the City of New York as well as the subsidiary and other contractors on the project alleging, among other things, that it was wrongfully defaulted by the City of New York in connection with the project.  The subsidiary had no significant on-site role.  Although the ultimate outcome of this matter cannot be predicted with certainty at this time and could have a material adverse effect, management believes the subsidiary has meritorious defenses.  In a separate but related matter, the subsidiary entered into an agreement in September 2005 with NYCDOT

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under which the subsidiary assigned its subcontract for the project to an unrelated entity, paid that entity $300 and NYCDOT $500 and agreed for a limited period of time not to bid on engagements with New York City agencies. These settlement amounts, which were accrued as of June 30, 2005, were paid in fiscal 2006.

McConnell v. Dominguez, New Mexico First Judicial District Court, Santa Fe County, 2005.  A subsidiary of the Company was named as a defendant, along with a number of other defendants, in litigation brought by the personal representative of a pilot killed in a helicopter crash.  It is alleged that in the course of conducting an aerial inspection of a power transmission line in New Mexico, the helicopter collided with the line.  The subsidiary had a design role with respect to modifications to a portion of the transmission line several years before the alleged accident.  A settlement was reached in this case in February 2007. The subsidiary will have no uninsured exposure beyond the applicable deductible.

Willis v. TRC, U.S. District Court, Central District of Louisiana, 2005.  The Company is a defendant in litigation brought by the seller of a small civil engineering firm which it acquired in September 2004.  The seller, an individual, is alleging that the Company breached certain provisions of the stock purchase agreement related to the acquisition.  The Company has counterclaimed alleging breach of contract and fraud, including securities fraud, on the part of the seller.  Although the ultimate outcome cannot be predicted at this time, an adverse resolution of this matter could have a material adverse effect on the Company’s business, operating results, financial position and cash flows.

City of Rowlett v. Hunter Associates, Inc., et. al. in the 101st District Court of Dallas County, Texas, 2006.  A subsidiary of the Company was named as a defendant in a lawsuit brought by the City of Rowlett, Texas.  The City is alleging that the design of a sewer line did not adequately address potential corrosion issues.  The outcome of this case cannot be predicted at this time; however, damages alleged are substantial, and an ultimate adverse determination of the case could have a material adverse effect on the Company’s business, operating results, financial position and cash flows.

East Palo Alto Hotel Development, LLC v. Lowney Associates, et. al., California Superior Court, San Francisco County, 2006.  A subsidiary of the Company was named as a defendant in a lawsuit brought by East Palo Alto Hotel Development, LLC, the developer of a hotel complex in East Palo Alto, California that the subsidiary contracted with to provide geotechnical investigation and related services.  The developer claims costs for delay and extra work alleging that the subsidiary was negligent in characterizing the extent of settlement to be encountered in construction of the project.  The Company believes the subsidiary has meritorious defenses and is adequately insured.

Fagin et. al. v. TRC Companies, Inc. et. al., in the 44th District Court of Dallas County, Texas, 2005.  Sellers of a business acquired by the Company in 2000 allege that the purchase price was not accurately calculated based on the net worth of the acquired business and allege that certain earnout payments to be made pursuant to the purchase agreement for the business were not properly calculated.  The case is in the discovery phase, and the ultimate outcome of this matter cannot be predicted at this time.  The Company believes it has meritorious defenses, but an adverse determination in this matter could have a material adverse effect on the Company’s business, operating results, financial position and cash flows.

East River Realty Company LLC v. TRC Companies, Inc. et. al., United States District Court for the Southern District of New York, 2006.  The owner of sites on which the Company is performing demolition and environmental remediation services pursuant to an Exit Strategy contract brought an action for injunctive relief and damages alleging that the Company was obligated to enroll the sites into an alternate New York state voluntary regulatory cleanup program.  Although the Company believed it had meritorious defenses, it entered into a settlement agreement with the plaintiff which stayed the proceedings and any damage claims and under which the Company consented to enrolling certain of the sites into the alternate program subject to the plaintiff obtaining certain required consents.  In addition, the plaintiff agreed to pay certain costs of the Company and indemnify it from future costs related to the program.  In April 2007, this matter was dismissed with prejudice.

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Miguel Zanabria and Monica Arce v. The Bank of New York Company, Inc. et. al.; Monica Arce and Miguel Zanabria v. the Bank of New York Company, Inc., et. al.; Jose Vaca v. The Bank of New York Company, Inc., United States District Court for the Southern District of New York, 2006.  In November 2006, a subsidiary of the Company was named as a defendant (along with a number of other defendants) in these three cases which are pending in the United States District Court for the Southern District of New York and are styled under the caption “In Re World Trade Center Lower Manhattan Disaster Site Litigation.”  The Complaints allege that the plaintiffs were workers involved in construction, demolition, excavation, debris removal and clean-up in the buildings surrounding the World Trade Center site, and that plaintiffs were injured.  There is insufficient information to assess the subsidiary’s involvement in these matters.

Iva Petersen v. V-Tech et. al., Court of Common Pleas, Philadelphia County, Pennsylvania, 2006.  A subsidiary of the Company was named as a defendant in a lawsuit brought by Ms. Petersen, who is alleging she was injured when a tree limb fell on a bus in which she was a passenger.  In a related action, the driver of the bus has also brought claims related to the same incident.  The subsidiary was engaged by the Pennsylvania Department of Transportation to provide certain inspection services on the median and roadside in the vicinity of the alleged accident site.  There is insufficient information to assess the subsidiary’s involvement in this matter.

Raymond Millich Sr. v. Eugene Chavez and TRC Companies, Inc., District Court La Plata County, Colorado, 2007.  Two employees of a subsidiary of the Company were involved in a serious motor vehicle accident in southern Colorado.  Although the Company’s employees were not seriously injured, three individuals were killed and another two seriously injured.  A suit has been filed against the Company and the driver of the truck by the father of one of the deceased.  There is insufficient information at this time to fully assess this matter.

The Company’s accrual for litigation-related losses that were probable and estimable, primarily those discussed above, was $7,894 at December 31, 2006 and $3,543 at June 30, 2006. The Company has also insurance recovery receivables related to these accruals of $6,498 at December 31, 2006 and $1,819 at June 30, 2006.  The increase in the accrual and recovery is due to the settlements noted above during fiscal 2007.  As additional information about current or future litigation or other contingencies becomes available, management will assess whether such information warrants the recording of additional accruals relating to those contingencies.  Such additional accruals could potentially have a material impact on the Company’s business, results of operations, financial position and cash flows.

The Company indemnifies its directors and officers to the maximum extent permitted under the laws of the State of Delaware.

12.Subsequent Events

On January 31, 2007, the Credit Agreement was amended (the “Fourth Amendment”) to modify certain terms to change the delivery date for the Company’s Fiscal 2006 Annual Report on Form 10-K to on or before February 28, 2007, to permit an investment by the Company in certain real estate located in New Jersey through a joint venture in Center Avenue Holdings, LLC, to permit the Company to receive a loan from the City of Lowell, Massachusetts in connection with the relocation of its Lowell, Massachusetts office and to permit the divestiture of Omni Environmental, Inc. (“Omni”).  Omni was sold in March 2007.

On May 18, 2007, the Company announced that Chief Operating Officer Timothy D. Belton was leaving the Company to pursue other opportunities effective May 18, 2007.  In accordance with Mr. Belton’s employment agreement, he will receive one year’s compensation and other benefits totaling approximately $350,000, which will be accrued as of May 18, 2007.  The Company will also incur a stock-based compensation charge due to the accelerated vesting of Mr. Belton’s stock options on May 18, 2007.

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TRC COMPANIES, INC.

Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Three and Six Months Ended December 31, 2006 and 2005

You should read the following discussion of our results of operations and financial condition in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q and with our Annual Report on Form 10-K/A filed for the fiscal year ended June 30, 2006.  This discussion contains forward-looking statements that are based upon current expectations and assumptions that are subject to risks and uncertainties.  By their nature, such forward-looking statements involve risks and uncertainties.  We have attempted to identify such statements using words such as “may”, “expects”, “plans”, “anticipates”, “believes”, “estimates”, or other words of similar import.  We caution the reader that there may be events in the future that management is not able to accurately predict or control which may cause actual results to differ materially from the expectations described in the forward-looking statements.  The factors in the sections captioned “Critical Accounting Policies” and “Risk Factors” in our Annual Report on Form 10-K/A filed for the fiscal year ended June 30, 2006 and below in this Form 10-Q provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations described in the forward-looking statements.

OVERVIEW

We are a client-focused company that creates and implements innovative solutions to the challenges facing America’s real estate, energy, environmental and infrastructure markets, and we are a leading provider of technical, financial, risk management and construction services to industry and government clients across the country.

We derive our revenue from fees for professional and technical services.  As a service company, we are labor-intensive rather than capital-intensive.  Our revenue is driven by our ability to attract and retain qualified and productive employees, identify business opportunities, secure new and renew existing client contracts, provide outstanding services to our clients and execute projects successfully.  Our income (loss) from operations is derived from our ability to generate revenue and collect cash under our contracts in excess of our direct costs, subcontractor costs, other contract costs, and general and administrative (“G&A”) expenses.

In the course of providing our services we routinely subcontract services.  Generally, these subcontractor costs are passed through to our clients and, in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”), and consistent with industry practice, are included in gross revenue.  Because subcontractor services can change significantly from project to project, changes in gross revenue may not be indicative of business trends.  Accordingly, we also report net service revenue (“NSR”), net of subcontractor costs and other direct reimbursable costs, which is gross revenue less the cost of subcontractor services and other direct reimbursable costs, and our discussion and analysis of financial condition and results of operations uses NSR as a point of reference.

For analytical purposes only, we categorize our revenue into two types: acquisition and organic.  Acquisition revenue consists of revenue derived from newly acquired companies during the first year following their respective acquisition dates.  Organic revenue consists of our total revenue less any acquisition revenue.

Our cost of services (“COS”) includes professional compensation and related benefits, together with certain direct and indirect overhead costs such as rents, utilities and travel.  Professional compensation represents the majority of these costs.  Our G&A expenses are comprised primarily of our corporate headquarters’ costs related to corporate executive management, finance, accounting, administration and legal.  These costs are generally unrelated to specific client projects and can vary as expenses are incurred to support corporate activities and initiatives.

Our revenue, expenses and operating results may fluctuate significantly from year to year as a result of numerous factors, including:

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·unanticipated changes in contract performance that may affect profitability, particularly with contracts that are fixed-price or have funding limits;

·seasonality of the spending cycle of our public sector clients, notably state and local government entities, and the spending patterns of our commercial sector clients;

·budget constraints experienced by our federal, state and local government clients;

·acquisitions or the integration of acquired companies;

·divestitures or discontinuance of operating units;

·employee hiring, utilization and turnover rates;

·the number and significance of client contracts commenced and completed during the period;

·creditworthiness and solvency of clients;

·the ability of our clients to terminate contracts without penalties;

·delays incurred in connection with contracts;

·the size, scope and payment terms of contracts;

·contract negotiations on change orders and collections of related accounts receivable;

·the timing of expenses incurred for corporate initiatives;

·reductions in the prices of services offered by our competitors;

·litigation;

·changes in accounting rules; and

·general economic or political conditions.

Recent Events

Financing Arrangements

On July 17, 2006, we and certain of our subsidiaries, together (the “Borrower”), entered into a secured credit agreement (the “Credit Agreement”) and related security documentation with Wells Fargo Foothill, Inc., as lender and administrative agent.  The Credit Agreement provides the Borrower with a five-year senior revolving credit facility of up to $50.0 million based upon a borrowing base formula on accounts receivable. Amounts outstanding under the new credit facility bear interest at the greater of 7.75% and prime rate plus a margin of 1.25% to 2.25%, or the greater of 5.0% and LIBOR plus a margin of 2.25% to 3.25%, based on average excess availability.  The Credit Agreement contains covenants which, among other things, require us to maintain a minimum EBITDA (in thousands) of $3,112, $5,783, $8,644 and $12,278 for the quarter, two quarter, three quarter and four quarter periods ended or ending September 30, 2006, December 31, 2006, March 31, 2007 and June 30, 2007, respectively. Thereafter, the minimum EBITDA covenant increases in approximately equal annual increments to $24.0 million for the fiscal year ended June 30, 2010.  We must maintain average monthly backlog of $190.0 million. Capital expenditures (in thousands) are limited to $9,619, $10,099 and $10,604 for the fiscal years ended June 30, 2007, 2008, and 2009 and thereafter, respectively.  The Borrower’s obligations under the Credit Agreement are secured by a pledge of substantially all of the assets of the Borrower and guaranteed by substantially all of our subsidiaries

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that are not borrowers.  The Credit Agreement also contains cross-default provisions which become effective if the Company defaults on other indebtedness. The proceeds of the Credit Agreement were utilized to repay the then existing credit facility in full.

On July 19, 2006, we and substantially all of our subsidiaries entered into a three-year subordinated loan agreement (the “Subordinated Loan Agreement”) with Federal Partners, L.P. (“Federal Partners”), a stockholder of ours, pursuant to which we borrowed $5.0 million from Federal Partners.  The loan bears interest at a fixed rate of 9% per annum.  The loan is stated to mature on July 19, 2009 upon which the full principal amount of the loan then outstanding shall be due and payable.In addition, we issued a ten-year warrant to purchase up to 66 thousand shares of our common stock to Federal Partners at an exercise price equal to $0.10 per share, pursuant to the terms and conditions of a Warrant Agreement, dated July 19, 2006, between us and Federal Partners.

On October 31, 2006, the Credit Agreement was amended (the “First Amendment”) to modify certain of the terms under the Credit Agreement which among other things, waived certain schedule requirements related to post-closing deliverables, changed the definition of “Eligible Unbilled Accounts” under the Credit Agreement, and changed the schedule for delivery of certain reports.

On November 29, 2006, the Credit Agreement was amended (the “Second Amendment”) to modify certain of the terms under the Credit Agreement which changed the delivery date for our Fiscal 2006 Annual Report on Form 10-K to on or before December 31, 2006 and increased the letter of credit usage limit from $5.0 million to $7.5 million.

On December 29, 2006, the Credit Agreement was amended (the “Third Amendment”) to modify certain of the terms under the Credit Agreement which changed the delivery date for our Fiscal 2006 Annual Report on Form 10-K to on or before January 31, 2007.

On January 31, 2007, the Credit Agreement was amended (the “Fourth Amendment”) to modify certain of the terms under the Credit Agreement to change the delivery date for our Fiscal 2006 Annual Report on Form 10-K to on or before February 28, 2007, to permit an investment by us in certain real estate located in New Jersey through a joint venture in Center Avenue Holdings, LLC, to permit us to receive a loan from the City of Lowell, Massachusetts in connection with the relocation of our Lowell, Massachusetts office and to permit the divestiture of Omni Environmental, Inc. (“Omni”).  Omni was sold in March 2007.

On December 1, 2006, we entered into a Purchase and Exchange Agreement (the “Exchange Agreement”) with Fletcher International, Ltd. (“Fletcher”) pursuant to which the 15,000 shares of Series A-1 Cumulative Convertible Preferred Stock held by Fletcher which were redeemable in common stock as of December 14, 2006, were exchanged for 1,132,000 shares of common stock, thereby retiring the Preferred Stock.  The difference between the carrying value of the preferred stock of $15,000 and the fair value of the common stock issued of $11,083 at the redemption date was recorded as a benefit on redemption of preferred stock and increased net income applicable to common shareholders for the three and six months ended December 31, 2006. As part of the Exchange Agreement, Fletcher agreed to purchase an additional 204,000 shares of common stock at $9.79 per share, the closing price of the common stock on the New York Stock Exchange on December 1, 2006.  The closing of the transactions under the Exchange Agreement occurred on December 7, 2006.

Discontinued Operations

We sold the assets of PacLand and Bellatrix.  Bellatrix was sold in August 2006. The operations of these entities have been segregated and are shown as discontinued operations in the condensed consolidated statements of operations and the assets of Bellatrix held by us at June 30, 2006 have been shown as assets held for sale in the condensed consolidated balance sheet.

Other

On May 18, 2007, we announced that Chief Operating Officer Timothy D. Belton was leaving the Company to pursue other opportunities effective May 18, 2007.  In accordance with Mr. Belton’s employment agreement, he will receive one year’s compensation and other benefits totaling approximately $350,000, which will be accrued as

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of May 18, 2007.  We will also incur a stock-based compensation charge due to the accelerated vesting of Mr. Belton’s stock options on May 18, 2007.

Critical Accounting Policies

Our financial statements have been prepared in accordance with U.S. GAAP.  These principles require the use of estimates and assumptions that affect amounts reported and disclosed in the financial statements and related notes.  Actual results could differ from these estimates and assumptions.  We use our best judgment in the assumptions used to value these estimates, which are based on current facts and circumstances, prior experience and other assumptions that are believed to be reasonable.  Our accounting policies are described in Note 2 of the Notes to consolidated financial statements contained in Item 8 of the Annual Report on Form 10-K/A.  We believe the following critical accounting policies reflect the more significant judgments and estimates used in preparation of our consolidated financial statements and are the policies which are most critical in the portrayal of our financial position and results of operations:

Revenue Recognition:We recognize contract revenue in accordance with American Institute of Certified Public Accountants Statement of No. Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”).  Pursuant to SOP 81-1, certain Exit Strategy contracts are segmented into two profit centers: (1) remediation and (2) operation, maintenance and monitoring.  We earn our revenue from fixed-price, time-and-materials and cost-plus contracts as described below.

Fixed-Price

We recognize revenue on fixed-price contracts using the percentage-of-completion method. Under this method for revenue recognition, we estimate the progress towards completion to determine the amount of revenue and profit to recognize on all significant contracts.  We generally utilize an efforts-expended cost-to-cost approach in applying the percentage-of-completion method under which revenue is earned in proportion to total costs incurred divided by total costs expected to be incurred.

Under the percentage-of-completion method, recognition of profit is dependent upon the accuracy of a variety of estimates including engineering progress, materials quantities, achievement of milestones and other incentives, penalty provisions, labor productivity and cost estimates.  Such estimates are based on various judgments we make with respect to those factors and can be difficult to accurately determine until the project is significantly underway.  Due to uncertainties inherent in the estimation process, actual completion costs often vary from estimates.  Pursuant to SOP 81-1, if estimated total costs on any contract indicate a loss, we charge the entire estimated loss to operations in the period the loss first becomes known.

If actual costs exceed the original contract price, payment of additional costs will be pursuant to a change order, contract modification, or claim.

Unit price contracts are a subset of fixed-price contracts.  Under unit price contracts, our clients pay a set fee for each service or unit of production.  We recognize revenue under unit price contracts as we complete the related service transaction for our clients.  If our costs per service transaction exceed original estimates, our profit margins will decrease and we may realize a loss on the project unless we can receive payment for the additional costs.

Time-and-Materials

Under time-and-materials contracts, we negotiate hourly billing rates and charge our clients based on the actual time that we expend on a project.  In addition, clients reimburse us for actual out-of-pocket costs of materials and other direct reimbursable expenses that we incur in connection with our performance under the contract.  Our profit margins on time-and-materials contracts fluctuate based on actual labor and overhead costs that we directly charge or allocate to contracts compared to negotiated billing rates.  Revenue on time-and-materials contracts is recognized based on the actual number of hours we spend on the projects plus any actual out-of-pocket costs of materials and other direct reimbursable expenses that we incur on the projects.

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Cost-Plus

Cost-Plus Fixed Fee.  Under cost-plus fixed fee contracts, we charge clients for our costs, including both direct and indirect costs, plus a fixed negotiated fee.  In negotiating a cost-plus fixed fee contract, we estimate all recoverable direct and indirect costs and then add a fixed profit component.  The total estimated cost plus the negotiated fee represents the total contract value.  We recognize revenue based on the actual labor costs, plus non-labor costs we incur, plus the portion of the fixed fee we have earned to date.  We invoice for our services as revenue is recognized or in accordance with agreed upon billing schedules.

Cost-Plus Fixed Rate.  Under our cost-plus fixed rate contracts, we charge clients for our costs plus negotiated rates based on our indirect costs.  In negotiating a cost-plus fixed rate contract, we estimate all recoverable direct and indirect costs and then add a profit component, which is a percentage of total recoverable costs, to arrive at a total dollar estimate for the project.  We recognize revenue based on the actual total costs we have expended plus the applicable fixed rate.  If the actual total costs are lower than the total costs we have estimated, our revenue from that project will be lower than originally estimated.

Change Orders/Claims

Change orders are modifications of an original contract that effectively change the provisions of the contract.  Change orders typically result from changes in scope, specifications or design, manner of performance, facilities, equipment, materials, sites, or period of completion of the work.  Claims are amounts in excess of the agreed contract price that we seek to collect from our clients or others for client-caused delays, errors in specifications and designs, contract terminations, change orders that are either in dispute or are unapproved as to both scope and price, or other causes.

Costs related to change orders and claims are recognized when they are incurred.  Change orders are included in total estimated contract revenue when it is probable that the change order will result in a bona fide addition to contract value and can be reliably estimated.  Claims are included in total estimated contract revenues only to the extent that contract costs related to the claims have been incurred and when it is probable that the claim will result in a bona fide addition to contract value which can be reliably estimated.  No profit is recognized on claims until final settlement occurs.

Other Contract Matters

We have fixed-price Exit Strategy contracts to remediate environmental conditions at contaminated sites.  Under most Exit Strategy contracts, the majority of the contract price is deposited into a restricted account with an insurer.  These proceeds, less any insurance premiums and fees for a policy to cover potential cost overruns and other factors, are held by the insurer and used to pay us as work is performed.  The arrangement with the insurer provides for the deposited funds to earn interest at the one-year constant maturity U.S. Treasury Bill rate. The interest is recorded when earned and reported as “interest income from contractual arrangements” on the condensed consolidated statement of operations.

The net proceeds held by the insurer, and interest growth thereon, are recorded as an asset (current and long-term restricted investment) on our condensed consolidated balance sheet, with a corresponding liability related to the net proceeds (current and long-term deferred revenue).  Consistent with our other fixed price contracts, we recognize revenue on Exit Strategy contracts using the percentage-of-completion method. Under this method for revenue recognition, we estimate the progress towards completion to determine the amount of revenue and profit to recognize on all significant contracts. We utilize an efforts-expended cost-to-cost approach in applying the percentage-of-completion method under which revenue is earned in proportion to total costs incurred, divided by total costs expected to be incurred.  When determining the extent of progress towards completion on Exit Strategy contracts, prepaid insurance premiums and fees are amortized, on a straight-line basis, to cost incurred over the life of the related insurance policy.  Pursuant to SOP 81-1, certain Exit Strategy contracts are classified as pertaining to either remediation or operation, maintenance and monitoring.

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In instances where we establish that: (1) costs exceed the contract value and interest growth thereon and (2) such costs are covered by insurance, we record an insurance recovery up to the amount of our insured costs. An insurance gain, that is, an amount to be recovered in excess of our recorded costs, is not recognized until the receipt of insurance proceeds. Insurance recoveries are reported as “insurance recoverable” on our condensed consolidated statement of operations. Pursuant to SOP 81-1, if estimated total costs on any contract indicate a loss, we charge the entire estimated loss to operations in the period the loss first becomes known.

Federal Acquisition Regulations (“FAR”), which are applicable to our federal government contracts and may be incorporated in many local and state agency contracts, limit the recovery of certain specified indirect costs on contracts.  Cost-plus contracts covered by FAR or with certain state and local agencies also require an audit of actual costs and provide for upward or downward adjustments if actual recoverable costs differ from billed recoverable costs.  Most of our federal government contracts are subject to termination at the discretion of the client.  Contracts typically provide for reimbursement of costs incurred and payment of fees earned through the date of such termination.

These contracts are subject to audit by the government, primarily the Defense Contract Audit Agency (“DCAA”), which reviews our overhead rates, operating systems and cost proposals.  During the course of its audits, the DCAA may disallow costs if it determines that we have improperly accounted for such costs in a manner inconsistent with Cost Accounting Standards. Our last audit was for fiscal 2001 and resulted in a $127 thousand adjustment.  Historically, we have not had any material cost disallowances by the DCAA as a result of audit; however, there can be no assurance that DCAA audits will not result in material cost disallowances in the future.

Allowances for Doubtful Accounts:  Allowances for doubtful accounts are maintained for estimated losses resulting from the failure of our clients to make required payments.  Allowances for doubtful accounts have been determined through reviews of specific amounts deemed to be uncollectible and estimated write-offs as a result of clients who have filed for bankruptcy protection, plus an allowance for other amounts for which some loss is determined to be probable based on current circumstances.  If the financial condition of clients or our assessment as to collectibility were to change, adjustments to the allowances may be required.

Income Taxes:  At December 31, 2006 and June 30, 2006, we had approximately $25.8 million and $25.3 million, respectively, of gross deferred income tax benefits.  The realization of a portion of these benefits is dependent on our estimates of future taxable income and our tax planning strategies.  A $1.4 million valuation allowance has been recorded as of December 31, 2006 and June 30, 2006 in relation to certain state loss carryforwards which will more likely than not expire unused and state deferred tax assets from which a benefit is not likely to be realized.  We believe that sufficient taxable income will be earned in the future to realize the remaining deferred income tax benefits.  However, the realization of these deferred income tax benefits can be impacted by changes to tax codes, statutory tax rates and future taxable income levels.  At December 31, 2006 and June 30, 2006, we had approximately $13.9 million and $13.3 million, respectively, of gross deferred income tax liabilities which related primarily to depreciation and amortization.

Business Acquisitions:  Assets and liabilities acquired in business combinations are recorded at their estimated fair values on the acquisition date.  At December 31, 2006 and June 30, 2006, we had approximately $130.0 million and $126.3 million of goodwill, respectively, representing the cost of acquisitions in excess of fair values assigned to the underlying net assets of acquired companies.  In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to annual impairment testing.  Additionally, goodwill is tested between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the unit below its carrying value.  The assessment of goodwill involves the estimation of the fair value of our units as defined by SFAS 142.

We completed our required annual assessment of the recoverability of goodwill as of December 31, 2006 and concluded that no impairment existed.  In performing our goodwill assessment we used current market

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capitalization and other factors as the best evidence of fair value.  There can be no assurance that future events will not result in an impairment of goodwill or other assets.

Long-Lived Assets:  We periodically assess the recoverability of the unamortized balance of our long-lived assets, including intangible assets, based on expected future profitability and undiscounted expected cash flows and their contribution to our overall operations. Should the review indicate that the carrying value is not fully recoverable, the excess of the carrying value over the fair value of the other intangible assets would be recognized as an impairment loss.

Consolidation:  We determine whether we have a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity (“VIE”) under generally accepted accounting principles.

Voting Interest Entities.  Voting interest entities are entities in which: (i) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the obligation to absorb losses, the right to receive residual returns and the right to make decisions about the entity’s activities.  Voting interest entities are consolidated in accordance with Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” (“ARB 51”) as amended.  ARB 51 states that the usual condition for a controlling financial interest in an entity is ownership of a majority voting interest.  Accordingly, we consolidate voting interest entities in which we have a majority voting interest.

Variable Interest Entities.  VIEs are entities that lack one or more of the characteristics of a voting interest entity.  A controlling financial interest in a VIE is present when an enterprise has a variable interest, or a combination of variable interests, that will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both.  The enterprise with a controlling financial interest, known as the primary beneficiary, consolidates the VIE.  In accordance with the Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 46(R), “Consolidation of Variable Interest Entities,” we consolidate all VIEs of which we are the primary beneficiary.

We determine whether we are the primary beneficiary of a VIE by first performing a qualitative analysis of the VIE that includes a review of, among other factors, its capital structure, contractual terms, which interests create or absorb variability, related party relationships and the design of the VIE.

Equity-Method Investments. When we do not have a controlling financial interest in an entity but exert significant influence over the entity’s operating and financial policies (generally defined as owning a voting interest of 20% to 50% for a corporation or 3% - 5% to 50% for a partnership or Limited Liability Company) and have an investment in common stock or in-substance common stock, we account for our investment in accordance with the equity method of accounting prescribed by APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.”

Insurance Matters, Litigation and Contingencies:  In the normal course of business, we are subject to certain contractual guarantees and litigation. Generally, such guarantees relate to project schedules and performance.  Most of the litigation involves us as a defendant in contractual disputes, professional liability, personal injury and other similar lawsuits. We maintain insurance coverage for various aspects of our business and operations.  However, we have elected to retain a portion of losses that may occur through the use of various deductibles, limits and retentions under our insurance programs.  This practice may subject us to some future liability for which we are only partially insured or are completely uninsured.  In accordance with SFAS No. 5, “Accounting for Contingencies,” we record in our condensed consolidated balance sheets amounts representing our estimated losses from claims and settlements when such losses are deemed probable and estimable.  Otherwise, these losses are expensed as incurred.  Costs of defense are expensed as incurred.  If the estimate of a probable loss is a range, and no amount within the range is more likely, we accrue the lower limit of the range.  As additional information about current or future litigation or other contingencies becomes available, management will assess whether such information warrants the recording of additional expenses relating to those contingencies.  Such additional expenses could potentially have a material impact on our results of operations and financial position.

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Results of Operations

We were profitable during the three months ended December 31, 2006, as we began to see the benefits of various initiatives including our ongoing cost reduction efforts, increased operational efficiencies and focus on margin improvement which helped overcome some of the challenges that negatively affected our performance in fiscal 2006 and continued into fiscal 2007.  While operating results were favorable compared to the same period last year, we were impacted by certain under performing operations and by charges related to the completion of and audit of our fiscal 2006 financial statements, the refinancing of our credit agreement and consulting fees related to our restructuring effort.

Our results of operations and financial condition throughout the remainder of fiscal 2007 will be adversely affected by continued higher-than-expected operating costs, including costs associated with the launch of our branding campaign, costs associated with the installation of a new enterprise-wide IT platform and costs related to the finalization of our fiscal 2006 and 2007 financial statements.  The majority of these costs will be incurred in the second half of fiscal 2007. We expect that other changes will help offset these higher-than-expected costs.  We have enhanced our controls over project acceptance, which should reduce the level of contract losses.  We have increased the level of experience of our accounting personnel in order to improve our internal controls and reduce compliance costs. We have improved the timeliness of customer invoicing, and enhanced our collection efforts, which we believe will result in fewer write-offs of project revenue and in lower levels of bad debt expense.  Lastly, we have improved project management, which we believe will result in higher levels of project profitability.

Business activity remains strong across all of our markets:

Real Estate: Industry activity has remained strong in key markets.  Backlog for Exit Strategy projects remains strong, and we continue to evaluate real estate redevelopment and investment projects.

Energy: The United States is in the early stages of a multi-year build-out of the electric transmission grid. Years of underinvestment coupled with an increasingly favorable regulatory environment has provided an extraordinary business climate for those serving this market. According to a Department of Energy (DOE) study, $50 billion to $100 billion of investment is needed to modernize the grid. These needs and financial incentives of increased returns on equity with large investments in energy assets provide excellent opportunities to sell services including: permitting/licensing, engineering and construction for the electric transmission system, and development of renewable energy projects. We are well established in the geographic regions where demand for services is the highest.

Environmental:  Market demand for environmental services remains solid, driven by a combination of regulatory requirements and economic factors.  Regulatory focus on new emissions of concern (e.g. mercury, small particulates) is increasing short to mid-term demand for air quality consulting and air measurement services.  Climate change initiatives at the state level, and ultimately the federal level, will sustain market growth for air services.  By contrast, the demand for remediation services is being driven less by regulatory requirements and more by the economics of the real estate market.  The remediation of Brownfield sites in certain urban areas now makes financial sense as governments provide incentives to convert these sites into productive use.  Real estate developers and owners are also increasing their demand for building science services (e.g. mold, water intrusion, indoor air quality) as insurers demand that they better manage risks associated with issues of construction quality.

Infrastructure: With the passage by Congress of the TEA-21 successor highway and transit bill, SAFETEA-LU, we anticipate a gradual ramping up of transportation activity in the states where we operate.  With improving conditions in many states and certainty regarding federal funding, we anticipate increased activity in our transportation business.

The following table presents the percentage relationships of items in the condensed consolidated statements of operations to NSR:

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	Three Months Ended				Six Months Ended
	December 31,				December 31,
	2006		2005		2006		2005
Net service revenue	100.0	%	100.0	%	100.0	%	100.0	%
Interest income from contractual arrangements	1.9		1.6		1.9		1.6
Insurance recoverables	0.1		0.3		3.7		0.7
Operating costs and expenses:
Cost of services	85.6		98.1		88.1		95.8
General and administrative expenses	7.2		10.2		9.0		10.5
Provision for doubtful accounts	1.4		2.2		1.4		3.8
Depreciation and amortization	3.1		2.9		3.1		2.9
	97.3		113.4		101.6		113.0
Operating income (loss)	4.7		(11.5	)	4.0		(10.7	)
Interest expense	1.7		2.3		1.8		1.9
Income (loss) from continuing operations before taxes and equity earnings (losses)	3.0		(13.8	)	2.2		(12.6	)
Federal and state income tax provision (benefit)	1.5		(4.6	)	1.1		(4.2	)
Income (loss) from continuing operations before equity earnings (losses)	1.5		(9.2	)	1.1		(8.4	)
Equity in earnings (losses) from unconsolidated affiliates, net of taxes	—		—		—		—
Income (loss) from continuing operations	1.5		(9.2	)	1.1		(8.4	)
Discontinued operations, net of taxes	—		0.5		(0.1	)	0.1
Net income (loss)	1.5		(8.7	)	1.0		(8.3	)
Dividends, accretion charges, and benefit on redemption of preferred stock	(5.8	)	0.3		(2.8	)	0.3
Net income (loss) applicable to common shareholders	7.3	%	(9.0	)%	3.8	%	(8.6	)%

Gross revenue increased $18.3 million, or 19.0%, to $114.5 million for the three months ended December 31, 2006 from $96.2 million for the same period of the prior year. Approximately $17.8 million of the increase was related to increased demand for our energy related engineering services.

Gross revenue increased $10.6 million, or 5.1%, to $217.4 million for the six months ended December 31, 2006 from $206.8 million for the same period of the prior year.  Approximately $27.3 million of the increase was related to increased demand for our energy related engineering services.  This increase was partially offset by lower subcontractor activity on certain projects which resulted in lower gross revenue.  Specifically, gross revenue in 2005 included approximately $12.5 million related to a project under which we were engaged to engineer, procure and construct a collection system and electrical substation for a wind farm.  The remaining decrease in gross revenue primarily relates to lower levels of project activity on a large Exit Strategy contract that had substantial demolition costs in the first half of fiscal 2006 when compared to fiscal 2007.

NSR increased $7.3 million, or 12.5%, to $65.8 million for the three months ended December 31, 2006 compared to $58.5 million for the same period of the prior year.  Approximately $3.5 million of the increase relates to increased demand for our energy related engineering services principally related to power generation projects.  The remaining increase in NSR resulted from increases in demand for our air emission services.

NSR increased $12.8 million, or 10.9%, to $129.8 million for the six months ended December 31, 2006 compared to $117.0 million for the same period of the prior year.  Approximately $6.8 million of the increase relates to increased demand for our energy related engineering services.  The remaining increase in NSR primarily resulted from increases in demand for our air emission services which resulted in an NSR increase of $2.5M for the six months ended December 31, 2006 and our ability to increase margins in the current year.

Interest income from contractual arrangements increased $0.3 million, or 30.0%, to $1.3 million for the three months ended December 31, 2006 from $1.0 million for the same period of the prior year primarily due to higher one-year constant maturity T-Bill rates.

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Interest income from contractual arrangements increased $0.6 million, or 33.3%, to $2.5 million for the six months ended December 31, 2006 from $1.8 million for the same period of the prior year primarily due to higher one-year constant maturity T-Bill rates.

Insurance recoverables decreased $0.1 million, to $0.1 million for the three months ended December 31, 2006 compared to $0.2 million for the same period of the prior year due to changes in recoverables on Exit Strategy contracts.

Insurance recoverables increased $4.0 million, or 500.0%, to $4.8 million for the six months ended December 31, 2006 from $0.8 million for the same period of the prior year primarily related to two Exit Strategy contracts which went into insurance coverage in the six months ended December 31, 2006.  This resulted in the contracts requiring contract reserves, and as the additional costs will be funded from an insurance policy, insurance recoverables were recorded.

Cost of services decreased $1.1 million, or 1.9%, to $56.3 million for the three months ended December 31, 2006 from $57.4 million for the same period of the prior year.  Costs in 2005 include a restructuring accrual of approximately $0.9 million.

Cost of services increased $2.2 million, or 2.0%, to $114.3 million for the six months ended December 31, 2006 from $112.1 million for the same period of the prior year.  The increase in costs of services was primarily due to increases in billable headcount to support the increased demand for our energy and air emission services. As a percentage of net service revenue, cost of services was 88.1% and 95.8% in the six months ended December 2006 and 2005, respectively. Cost of services, as a percentage of net service revenue, decreased as the amount of work without profit on previously recognized loss contracts was substantially less than in the six months ended December 31, 2005.

General and administrative expenses decreased $1.3 million, or 21.7%, to $4.7 million for the three months ended December 31, 2006 compared to $6.0 million for the same period of the prior year.  The prior year period included $0.9 million incurred for restructuring services as well as $0.2 million in forbearance fees that were not incurred this year.

General and administrative expenses decreased $0.6 million, or 5.0%, to $11.7 million for the six months ended December 31, 2006 compared to $12.3 million for the same period of the prior year.  The prior year period included $0.9 million incurred for restructuring services as well as $0.2 million in forbearance fees that were not incurred in this year.  The decreases are partially offset by an increase in other professional services incurred of approximately $0.1 million, for legal and accounting services.

The provision for doubtful accounts decreased $0.4 million, or 27.8%, to $0.9 million for the three months ended December 31, 2006 from $1.3 million for the same period of the prior year. The decrease was primarily due to better contract management and cash collection efforts.

The provision for doubtful accounts decreased $2.6 million, or 58.6%, to $1.9 million for the six months ended December 31, 2006 from $4.5 million for the same period of the prior year. The prior year period included $2.0 million of charges related to several large projects balances that were deemed uncollectible and no similar large charges were incurred in fiscal 2007.

Depreciation and amortization increased $0.3 million, or 17.7%, to $2.0 million for the three months ended December 31, 2006 from $1.7 million for the same period of the prior year.  The increase in depreciation and amortization expense for the second quarter of fiscal 2007 is primarily due to additional depreciation expense resulting from capital expenditures in fiscal years 2007 and 2006.

Depreciation and amortization increased $0.7 million, or 20.6%, to $4.0 million for the six months ended December 31, 2006 from $3.3 million for the same period of the prior year.  The increase in depreciation and amortization expense for the first six months of fiscal 2007 is primarily due to additional depreciation expense resulting from capital expenditures in fiscal years 2007 and 2006.

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As a result of the above factors, operating income increased by $9.9 million, to $3.1 million for the three months ended December 31, 2006 from a $6.8 million loss for the same period of the prior year.

As a result of the above factors, operating income increased by $17.8 million, to $5.1 million for the six months ended December 31, 2006 from a $12.6 million loss for the same period of the prior year.

Interest expense decreased $0.2 million, or 15.4%, to $1.1 million for the three months ended December 31, 2006 from $1.3 million for the same period in the prior year.  The decrease was primarily due to a decrease in the average outstanding balance on our credit facility from $57.3 million in the second quarter of fiscal 2006 to $32.5 million in the second quarter of fiscal 2007.  The decreased average line of credit balance is being offset by higher average interest rates being charged on the line in fiscal 2007, 10.0% versus 8.4% in fiscal 2006.  In addition in fiscal 2007 the Company also began incurring interest expense at 9.0% annually on the Federal Partners $5.0 million subordinated note issued in July 2006.

Interest expense remained flat for the six months ended December 31, 2006 versus the same period last year at $2.3 million each period.  The average outstanding line of credit balance decreased significantly from $56.5 million to $34.0 million for the six months ended December 31, 2005 and 2006, respectively, however the average interest rate incurred increased from 7.0% in the six months ended December 31, 2005 to 10.3% in the six months ended December 31, 2006.  In addition in fiscal 2007 the Company also began incurring interest expense at 9.0% annually on the Federal Partners $5.0 million subordinated note issued in July 2006.

The federal and state income tax provision (benefit) represents an effective rate of 50.1% for the first six months of fiscal 2007 and a benefit rate of 33.2% for the same period of fiscal 2006.  The increase was primarily due to losses incurred in the first half of fiscal 2007 by certain entities for which no associated state tax benefit was available.  We believe that there will be sufficient taxable income in future periods to enable utilization of available deferred income tax benefits.

Impact of Inflation

Our operations have not been materially affected by inflation or changing prices because most contracts of a longer term are subject to adjustment or have been priced to cover anticipated increases in labor and other costs, and the remaining contracts are short term in nature.

Liquidity and Capital Resources

We primarily rely on cash from operations and financing activities, including borrowings under our revolving credit facility, to fund operations.  Our liquidity is assessed in terms of our overall ability to generate cash to fund our operating and investing activities and to reduce debt.

Cash flows provided by operating activities was $3.7 million for the six months ended December 31, 2006, compared to $8.6 million provided for the same period last year. Uses of cash by operating assets and liabilities for the three months ended September 30, 2006 totaled $24.7 million and consisted primarily of the following: (1) a $10.1 million increase in our receivables due primarily to increased business at our E-Pro subsidiary; (2) a $4.4 million decrease in our gross deferred revenue balance, due primarily to new contract awards in our Exit Strategy program; (3) a $4.3 million increase in insurance recoverables due to Exit Strategy contracts which are estimated to incur costs beyond the projected commutation account balance; and (4) a $4.6 million increase in prepaid and other current assets due primarily to insurance recoveries related to legal matters. Cash used was offset by sources of cash from operating assets and liabilities totaling $20.5 million consisting primarily of the following: (1) a $10.0 million decrease in restricted investments due to invoice collections on Exit Strategy projects, (2) a $7.1 million increase in other accrued liabilities primarily attributable accrued earnouts and legal matters, and (3) a $2.2 million increase in environmental liabilities incurred.

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Accounts receivable include both: (1) billed receivables associated with invoices submitted for work previously completed and (2) unbilled receivables (work in progress).  The unbilled receivables are primarily related to work performed in the last month of the fiscal period.  The magnitude of accounts receivable for a professional services company is typically evaluated as days sales outstanding (“DSO”), which is calculated by dividing both current and long-term receivables by the most recent four-month average of daily gross revenue after adjusting for acquisitions.  DSO, which measures the collections turnover of both billed and unbilled receivables, decreased to 104 days at December 31, 2006 from 110 at June 30, 2006.  Our goal is to reduce DSO to less than 90 days.

Under Exit Strategy contracts, the majority of the contract price is deposited into a restricted account with an insurer.  These proceeds, less any insurance premiums for a policy to cover potential cost overruns and other factors, are held by the insurer and used to pay us as work is performed.  The arrangement with the insurer provides for deposited funds to earn interest at the one-year constant maturity T-Bill rate.  If the deposited funds do not grow at the rate anticipated when the contract was executed, over time the deposit balance may be less than originally expected.  However, an insurance policy provides coverage for cost increases from unknown or changed conditions up to a specified maximum amount significantly in excess of the estimated cost of remediation.

Investing activities used cash of approximately $6.3 million during the six months ended December 31, 2006, compared to $8.1 million used for the same period last year.  The current period uses were primarily: (1) $5.2 million for property and equipment additions, and (2) $2.0 million for earnout payments, being offset by (1) $0.5 million from restricted investment activity and (2) $0.4 million received as consideration on the sale of Bellatrix.

During the six months ended December 31, 2006, financing activities used cash of $0.1 million, consisting primarily of $6.8 million of net payments on our credit facilities, being offset by $4.7 million of net long term borrowing on the Federal Partners subordinated loan, as well as $2.0 million received for the issuance of 1.1 million additional shares of common stock to Fletcher.

On July 17, 2006, we and certain of our subsidiaries, together, entered into a secured credit agreement (the “Credit Agreement”) and related security documentation with Wells Fargo Foothill, Inc., as lender and administrative agent.  The Credit Agreement provides us with a five-year senior revolving credit facility of up to $50,000 based upon a borrowing base formula on accounts receivable.  Amounts outstanding under the new credit facility bear interest at the greater of 7.75% and prime rate plus a margin of 1.25% to 2.25%, or the greater of 5.0% and LIBOR plus a margin of 2.25% to 3.25%, based on average excess availability.  The Credit Agreement contains covenants which, among other things, require us to maintain a minimum EBITDA of $3,112, $5,783, $8,644 and $12,278 for the quarter, two quarter, three quarter and four quarter periods ended or ending September 30, 2006, December 31, 2006, March 31, 2007 and June 30, 2007, respectively.  As of September 30, 2006, we are in compliance with this covenant. Thereafter, the minimum EBITDA covenant increases in approximately equal annual increments to $24,000 for the fiscal year ended June 30, 2010.  We must maintain average monthly backlog of $190,000.  Capital expenditures are limited to $9,619, $10,099 and $10,604 for the fiscal years ended June 30, 2007, 2008, and 2009 and thereafter, respectively.  Our obligations under the Credit Agreement are secured by a pledge of substantially all of our assets and guaranteed by substantially all of our subsidiaries that are not borrowers.  The Credit Agreement also contains cross-default provisions which become effective if we default on other indebtedness.  The proceeds of the credit Agreement were utilized to repay the then existing credit facility in full.

On July 19, 2006, we and substantially all of our subsidiaries entered into a three-year subordinated loan agreement with Federal Partners, L.P. (“Federal Partners”), a stockholder of ours, pursuant to which we borrowed $5,000 from Federal Partners.  The loan bears interest at a fixed rate of 9% per annum.  The loan is stated to mature on July 19, 2009 upon which the full principal amount of the loan then outstanding shall be due and payable.  In addition, we issued a ten-year warrant to purchase up to 66 shares of its common stock to Federal Partners at an exercise price equal to $0.10 per share, pursuant to the terms and conditions of a Warrant Agreement, dated July 19, 2006, between us and Federal Partners.

Based on our current operating plans, we believe that the existing cash resources, cash forecasted to be generated by operations, and availability on our existing line of credit will be sufficient to meet working capital and capital requirements.

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Item 3.  Quantitative and Qualitative Disclosures about Market Risk

We currently do not utilize derivative financial instruments that expose us to significant market risk.  We are exposed to interest rate risk under our credit agreement.  Our credit facility provides for borrowings bearing interest at the greater of 7.75% and prime rate plus a margin of 1.25% to 2.25%, or the greater of 5.0% and LIBOR plus a margin of 2.25% to 3.25%, based on average excess availability.

Borrowings at the base rate have no designated term and may be repaid without penalty any time prior to the facility’s maturity date.  Under its term, the facility matures on July 17, 2011 or earlier at our discretion, upon payment in full of loans and other obligations.

Item 4.  Controls and Procedures

Disclosure Controls and Procedures.

We have carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) as of the end of the period covered by this Report on Form 10-Q. Based upon this evaluation, and in light of the previously identified material weakness in our internal control over financial reporting described below, the Chief Executive Officer and the Chief Financial Officer have concluded that, as of December 31, 2006, our disclosure controls and procedures were not effective in alerting them in a timely manner to material information required to be included in our periodic filings. Notwithstanding such ineffectiveness, however, we believe that all necessary steps have been taken at the time of this filing to ensure the accuracy and completeness of the information contained in this report.

Internal Control over Financial Reporting.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

In connection with the audit of our financial statements for the year ended June 30, 2006, our management identified a number of material weaknesses in our internal controls. A material weakness as defined in the Public Company Accounting Oversight Board’s Auditing Standard No. 2 is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of our annual or interim financials statements will not be prevented or detected on a timely basis.

Material Weakness in Internal Control.

Our management identified material weaknesses related to policies and procedures to ensure accurate and reliable interim and annual consolidated financial statements. Specifically, we lacked (i) effective controls at the entity level; (ii) adequate segregation of duties; (iii) adequate controls related to the financial reporting and closing process; (iv) adequate controls related to estimating, job costing and revenue recognition (which material weakness resulted in a restatement of our fiscal 2006 consolidated financial statements); (v) adequate controls related to processing and valuation of accounts receivable; (vi) adequate controls related to the expenditures cycle; (vii) adequate controls related to the payroll cycle; (viii) adequate general computer controls; and (ix) adequate controls related to the income tax cycle. As a result, we concluded that there was a material weakness in our internal control over financial reporting.

Remediation of Material Weakness in Internal Control over Financial Reporting.

28

Prior to June 30, 2006, and since, we implemented and have continued to implement measures to address the material weaknesses in our internal control over financial reporting and to improve the integrity of our reporting processes.

It is management’s objective to remediate the material weaknesses described above. The following describes the measures we have undertaken to improve overall internal control over financial reporting prior and subsequent to June 30, 2006, and which should materially affect our internal control over financial reporting:

·We are investing over $3.0 million in the development and implementation of a new fully integrated accounting and operations internal control and management information system.

·We are significantly enhancing our corporate infrastructure in order to upgrade and improve all internal accounting procedures and processes supporting our business.

·We have initiated a program to develop and improve policies and procedures in connection with the operational performance of our internal finance and accounting processes and underlying information and reporting systems; establish greater organizational accountability and lines of responsibility and approval; and better support our operations.

·We are improving our organizational structure to help achieve the proper number of, and quality of our, accounting, finance and information technology functions, including the proper segregation of duties among accounting personnel.

·We are refining our period-end financial reporting processes to improve the quality and timeliness of our financial information.

Changes in Internal Control over Financial Reporting.

Except as described above, there was no change in the our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) nor any changes in other factors which occurred during the fiscal quarter ended December 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II:  OTHER INFORMATION

Item 1.Legal Proceedings

See Note 11 under Part I, Item 1, Financial Information.

Item 1A.Risk Factors

No material changes.

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

During the quarter ended December 31, 2006, the Company issued an aggregate of 8,654 shares of unregistered common stock with a market value of approximately $75,000 as additional consideration earned in the current period on acquisitions completed in prior years.  In addition, the Company issued 13,365 shares of unregistered common stock with a market value of approximately $128,000 in lieu of the quarterly cash dividend on its Convertible Redeemable Preferred Stock.  In conjunction with the redemption of the Company’s outstanding redeemable convertible preferred stock, the Company issued 1,132,075 shares of common stock with a market value of approximately $11,083,000 as well as issued an additional 204,290 shares of common stock with an approximate market value of $2,000,000. All such shares were issued to accredited investors pursuant to the exemption afforded by Section 4(2) of the Securities Act of 1933, as amended.

29

Item 3.Defaults Upon Senior Securities

None.

Item 4.Submission of Matters to a Vote of Security Holders

None

Item 5.Other Informationa

None

Item 6.Exhibits

3.1Restated Certificate of Incorporation, dated November 18, 1994, incorporated by reference from the Company’s Form 10-K for the fiscal year ended June 30, 1995.

3.2Bylaws of the Company, as amended, incorporated by reference from the Company’s Form S-1 as filed on April 16, 1986, Registration No. 33-4896.

3.3Certificate of Rights and Preferences of Series A-1 Cumulative Convertible Preferred Stock filed with the Secretary of the State of Delaware, incorporated by reference from the Company’s Form 8-K filed on December 26, 2001.

10.3Amended and Restated Revolving Credit Agreement, dated March 31, 2004, by and among TRC Companies, Inc. and subsidiaries and Wachovia Bank, National Association, as Sole Lead Arranger and Administrative Agent, incorporated by reference to the Company’s Form 10-Q for the quarterly period ended March 31, 2004.

10.3.1Amendment No. 1 dated March 29, 2005 to Amended and Restated Revolving Credit Agreement, by and among TRC Companies, Inc. and subsidiaries and Wachovia Bank, National Association, as Sole Lead Arranger and Administrative Agent.

10.7Employment Agreement by and between TRC Companies, Inc. and Christopher P. Vincze, dated March 18, 2005, incorporated by reference to the Company’s Form 8-K filed on  March 24, 2005.

10.7.1Employment Agreement by and between TRC Companies, Inc. and Timothy D. Belton, dated March 6, 2006, incorporated by reference to the Company’s Form 8-K filed on March 30, 2006.

31.1Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32Certification Pursuant to Rule 13a-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code).

30

Signature

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 the undersigned thereunto duly authorized.

	TRC COMPANIES, INC.
May 25, 2007	by:	/s/ Carl d. Paschetag, Jr.
		Carl d. Paschetag, Jr.
		Senior Vice President and Chief Financial Officer
		(Chief Accounting Officer)

31

EX-31.1

Exhibit 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT 2002

I, Christopher P. Vincze, certify that:

1. I have reviewed this quarterly report on Form 10-Q of TRC Companies, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 25, 2007

/s/ Christopher P. Vincze

Christopher P. Vincze

Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT 2002

I, Carl d. Paschetag, Jr., certify that:

1. I have reviewed this quarterly report on Form 10-Q of TRC Companies, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 25, 2007

/s/ Carl d. Paschetag, Jr.

Carl d. Paschetag, Jr.

Chief Financial Officer

EX-32

Exhibit 32

TRC COMPANIES, INC.

Certification
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code)

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code), each of the undersigned officers of TRC Companies, Inc., a Delaware corporation (the Company), does hereby certify, to such officer’s knowledge, that:

The Quarterly Report on Form 10-Q for the quarter ended December 31, 2006 (the Form 10-Q) of the Company fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: May 25, 2007	/s/ Christopher P. Vincze
	Christopher P. Vincze
	Chief Executive Officer
Date: May 25, 2007	/s/ Carl d. Paschetag, Jr.
	Carl d. Paschetag, Jr.
	Chief Financial Officer