Ecology and Environment, Inc. FY07 2nd Qtr. Form 10-Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q


þ
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended January 27, 2007
 
 
o
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from __________ to __________

 
Commission File Number 1-9065


ECOLOGY AND ENVIRONMENT, INC.
(Exact name of registrant as specified in its charter)

New York
 
16-0971022
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification Number)
 
 
 
368 Pleasant View Drive
 
 
Lancaster, New York
 
14086-1397
(Address of principal executive offices)
 
(Zip code)


(716) 684-8060
(Registrant's telephone number, including area code)

NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report)


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, (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ   No o 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Exchange Act Rule 12b-2). (Check one):

Large accelerated filer   o 
Accelerated filer   o 
Non-accelerated filer  þ

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

At March 1, 2007, 2,482,262 shares of Registrant's Class A Common Stock (par value $.01) and 1,623,914 shares of Class B Common Stock (par value $.01) were outstanding.

 

PART 1
FINANCIAL INFORMATION

Item 1.
Financial Statements
 

 
Consolidated Balance Sheet
  
Unaudited
  
           
           
   
January 27,
  
July 31,
  
Assets
  
2007
  
2006
  
           
Current assets:
          
Cash and cash equivalents
  
$
13,656,959
  
$
13,094,499
  
Investment securities available for sale
    
99,431
   
97,560
 
Contract receivables, net
    
35,839,199
   
38,604,834
 
Deferred income taxes
    
3,917,859
   
5,630,832
 
Income tax receivable
    
575,192
   
-
 
Other current assets
    
1,777,594
   
1,041,751
 
           
Total current assets
    
55,866,234
   
58,469,476
 
               
Property, building and equipment, net
    
7,711,484
   
7,776,232
 
Deferred income taxes
    
1,316,040
   
1,316,040
 
Other assets
    
1,280,112
   
1,590,636
 
           
Total assets
  
$
66,173,870
  
$
69,152,384
  
               
               
Liabilities and Shareholders' Equity
              
               
Current liabilities:
              
Accounts payable
  
$
5,407,297
  
$
6,436,260
  
Accrued payroll costs
    
4,451,979
   
6,379,724
 
Income taxes payable
    
-
   
1,499,292
 
Deferred revenue
    
154,853
   
161,225
 
Current portion of long-term debt and capital lease obligations
    
248,353
   
403,182
 
Other accrued liabilities
    
11,851,884
   
13,690,742
 
           
Total current liabilities
    
22,114,366
   
28,570,425
 
               
Long-term debt and capital lease obligations
    
336,657
   
341,664
 
Minority interest
    
3,197,009
   
2,612,836
 
Commitments and contingencies (see note #9)
    
-
   
-
 
               
Shareholders' equity:
              
Preferred stock, par value $.01 per share;
              
authorized - 2,000,000 shares; no shares
              
issued
    
-
   
-
 
Class A common stock, par value $.01 per
              
share; authorized - 6,000,000 shares;
              
issued - 2,534,566 and 2,514,235 shares
    
25,346
   
25,346
 
Class B common stock, par value $.01 per
              
share; authorized - 10,000,000 shares;
              
issued - 1,650,173 and 1,650,173 shares
    
16,502
   
16,502
 
Capital in excess of par value
    
17,430,092
   
17,684,373
 
Retained earnings
    
24,365,815
   
23,163,716
 
Accumulated other comprehensive income
    
(665,748
)
  
(2,208,830
)
Treasury stock - Class A common, 52,304 and 102,204
              
shares; Class B common, 26,259 and 26,259 shares, at cost
    
(646,169
)
  
(1,053,648
)
           
Total shareholders' equity
    
40,525,838
   
37,627,459
 
               
Total liabilities and shareholders' equity
  
$
66,173,870
  
$
69,152,384
  
               
The accompanying notes are an integral part of these financial statements.
              


 
Consolidated Statement of Income
  
Unaudited
  
                   
   
Three months ended
  
Year to Date
  
   
January 27,
  
January 28,
  
January 27,
  
January 28,
  
   
2007
  
2006
  
2007
  
2006
  
                   
Gross revenues
  
$
24,131,179
  
$
24,028,549
  
$
48,324,846
  
$
47,553,889
  
Less: direct subcontract costs
    
4,342,666
   
4,175,450
   
7,632,648
   
7,425,931
 
                           
Net revenues
    
19,788,513
   
19,853,099
   
40,692,198
   
40,127,958
 
                           
Cost of professional services and
                          
other direct operating expenses
    
9,082,144
   
10,114,074
   
18,742,959
   
20,380,136
 
                           
Gross profit
    
10,706,369
   
9,739,025
   
21,949,239
   
19,747,822
 
Administrative and indirect operating
    
 
 
  
 
 
            
expenses
    
6,483,608
   
6,164,572
   
13,265,355
   
12,156,206
 
Marketing and related costs
    
2,425,491
   
1,991,074
   
4,904,050
   
4,176,994
 
Depreciation
    
332,444
   
283,832
   
646,381
   
534,847
 
                     
Income from operations
    
1,464,826
   
1,299,547
   
3,133,453
   
2,879,775
 
Interest expense
    
(12,095
)
  
(38,848
)
  
(67,255
)
  
(60,676
)
Interest income
    
118,272
   
55,042
   
246,245
   
97,404
 
Other expense
    
(76,083
)
  
(43,915
)
  
(68,180
)
  
(67,897
)
Net foreign currency exchange gain
    
50,187
   
8,759
   
47,834
   
11,380
 
                   
Income from continuing operations before income
                          
taxes and minority interest
    
1,545,107
   
1,280,585
   
3,292,097
   
2,859,986
 
Total income tax provision
    
576,988
   
554,376
   
996,285
   
1,082,408
 
                           
Net income from continuing operations
                          
before minority interest
    
968,119
   
726,209
   
2,295,812
   
1,777,578
 
Minority interest
    
(349,508
)
  
(69,558
)
  
(921,674
)
  
(337,832
)
                           
Net income from continuing operations
    
618,611
   
656,651
   
1,374,138
   
1,439,746
 
Income (loss) from discontinued operations
    
1,040,586
   
(50,953
)
  
985,797
   
(111,012
)
Income tax benefit (expense) on income from discontinued operations
    
(437,186
)
  
22,656
   
(417,243
)
  
45,959
 
                           
Net income
  
$
1,222,011
  
$
628,354
  
$
1,942,692
  
$
1,374,693
  
                   
Net income (loss) per common share: basic
                          
Continuing operations
  
$
0.15
  
$
0.16
  
$
0.34
  
$
0.36
  
Discontinued operations
    
0.15
   
(0.01
)
  
0.14
   
(0.02
)
Net income per common share: basic
  
$
0.30
  
$
0.15
  
$
0.48
  
$
0.34
  
                   
Net income (loss) per common share: diluted
                          
Continuing operations
  
$
0.15
  
$
0.16
  
$
0.34
  
$
0.36
  
Discontinued operations
    
0.15
   
(0.01
)
  
0.14
   
(0.02
)
Net income per common share: diluted
  
$
0.30
  
$
0.15
  
$
0.48
  
$
0.34
  
                           
Weighted average common shares outstanding: basic
    
4,015,682
   
3,982,433
   
4,016,830
   
3,982,711
 
                           
Weighted average common shares outstanding: diluted
    
4,053,681
   
3,986,591
   
4,054,261
   
3,984,255
 
                           
The accompanying notes are an integral part of these financial statements.
                          
                           

 

 
Consolidated Statement of Cash Flows
  
Unaudited
  
           
   
Six months ended
  
   
January 27,
  
January 28,
  
   
2007
  
2006
  
   
 
      
Cash flows from operating activities:
          
Net income
  
$
1,942,692
  
$
1,374,693
  
Net income (loss) from discontinued operations, net of tax
    
568,554
   
(65,053
)
Income from continuing operations
    
1,374,138
   
1,439,746
 
Adjustments to reconcile net income to net cash
              
provided by (used in) operating activities:
              
Depreciation
    
646,381
   
534,847
 
Amortization, share based compensation expense
    
65,920
   
70,074
 
Gain on disposition of property and equipment
    
(1,039
)
  
5,554
 
Minority interest
    
921,674 
    
337,832 
  
Provision for contract adjustments
    
334,205
   
529,829
 
(Increase) decrease in:
              
- contracts receivable, net
    
2,415,541
   
(5,846,372
)
- other current assets
    
(718,516
)
  
650,543
 
- deferred income taxes
    
1,305,509
   
-
 
- income tax receivable
    
(575,192
)
  
-
 
- other non-current assets
    
502,524
   
(890,697
)
Increase (decrease) in:
              
- accounts payable
    
(1,028,963
)
  
(607,491
)
- accrued payroll costs
    
(1,927,745
)
  
1,467,721
 
- income taxes payable
    
(1,499,292
)
  
32,905
 
- deferred revenue
    
(6,372
)
  
(90,268
)
- other accrued liabilities
    
(1,554,859
)
  
2,859,728 
  
             
Net cash provided by operating activities
    
253,914 
    
493,951
 
           
Cash flows provided by (used in) investing activities:
              
Purchase of property, building and equipment
    
(580,594
)
  
(321,961
)
Proceeds from maturity of investments
    
-
   
24,750
 
Payment for the purchase of bond
    
(1,695
)
  
(1,671
)
           
Net cash used in investing activities
    
(582,289
)
  
(298,882
)
           
Cash flows provided by (used in) financing activities:
              
Dividends paid
    
(740,592
)
  
(690,423
)
Proceeds from debt
    
109,517
   
120,977
 
Repayment of debt
    
(269,353
)
  
(221,516
)
Distributions to minority partners
    
(424,940
)
  
(481,709
)
Net proceeds from issuance of common stock
    
-
   
8,700
 
Purchase of treasury stock
    
(49,465
)
  
(4,035
)
           
Net cash used in financing activities
    
(1,374,833
)
  
(1,268,006
)
           
Effect of exchange rate changes on cash and cash equivalents
    
3,107
   
41,670
 
               
Discontinued Operations
              
Net cash used in discontinued operating activities
    
(237,439
)
  
(93,703
)
Net cash provided by discontinued investing activities
    
2,500,000
   
-
 
               
Net cash provided by discontinued operations
    
2,262,561
   
(93,703
)
               
Net increase (decrease) in cash and cash equivalents
    
562,460
   
(1,124,970
)
Cash and cash equivalents at beginning of period
    
13,094,499
   
7,872,116
 
               
Cash and cash equivalents at end of period
  
$
13,656,959
  
$
6,747,146
  
               
The accompanying notes are an integral part of these financial statements.
              
 
 
 
Consolidated Statement of Changes in Shareholders' Equity
  
                                               
   
 
  
 
  
 
  
Accumulated
  
 
  
 
  
 
  
 
  
   
Common Stock
  
Capital in
  
 
  
Other
  
 
  
 
  
 
  
 
  
   
Class A
  
Class B
  
Excess of
  
Retained
  
Comprehensive
  
Unearned
  
Treasury Stock
  
Comprehensive
  
   
Shares
  
Amount
  
Shares
  
Amount
  
Par Value
  
earnings
  
Income
  
Compensation
  
Shares
  
Amount
  
Income
  
                                               
Balance at July 31, 2005
    
2,514,235
 
$
25,143
    
1,669,304
 
$
16,693
  
$
17,622,172
  
$
22,002,059
  
$
(2,236,051
)
$
(158,993
)
  
120,494
 
$
(987,199
)
$
-
  
                                                                     
Net income
    
-
 
$
-
    
-
 
$
-
  
$
-
  
$
2,582,587
  
$
-
  
$
-
    
-
 
$
-
    
2,582,587
 
Reclassification due to adoption of FAS 123R
    
-
   
-
   
-
   
-
   
(158,993
)
  
-
   
-
   
158,993
   
-
   
-
   
-
 
Foreign currency translation reserve
    
-
   
-
   
-
   
-
   
-
   
-
   
28,122
   
-
   
-
   
-
   
28,122
 
Cash dividends paid ($.35 per share)
    
-
   
-
   
-
   
-
   
-
   
(1,420,930
)
  
-
   
-
   
-
   
-
   
-
 
Unrealized investment gain, net
    
-
   
-
   
-
   
-
   
-
   
-
   
(901
)
  
-
   
-
   
-
   
(901
)
Conversion of common stock - B to A
    
19,131
   
191
   
(19,131
)
  
(191
)
  
-
   
-
   
-
   
-
   
-
   
-
   
-
 
Repurchase of Class A common stock
    
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
2,595
   
(25,077
)
  
-
 
Stock options exercised
    
1,200
   
12
   
-
   
-
   
8,688
   
-
   
-
   
-
   
-
   
-
   
-
 
Issuance of stock under stock award plan, net
    
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
 
Share-based compensation
    
-
   
-
   
-
   
-
   
130,277
   
-
   
-
   
-
   
-
   
-
   
-
 
Other
    
-
   
-
   
-
   
-
   
82,229
   
-
   
-
   
-
   
5,374
   
(41,372
)
  
-
 
                                                                     
Balance at July 31, 2006
    
2,534,566
 
$
25,346
    
1,650,173
 
$
16,502
  
$
17,684,373
  
$
23,163,716
  
$
(2,208,830
)
$
-
    
128,463
 
$
(1,053,648
)
$
2,609,808
  
                                                                     
Net income
    
-
   
-
   
-
   
-
   
-
   
1,942,692
   
-
   
-
   
-
   
-
   
1,942,692
 
Reclassification adjustment for realized foreign currency translation loss in net income
    
-
   
-
   
-
   
-
   
-
   
-
   
1,539,869
   
-
   
-
   
-
   
1,539,869
 
Foreign currency translation reserve
    
-
   
-
   
-
   
-
   
-
   
-
   
3,107
   
-
   
-
   
-
   
3,107
 
Cash dividends paid ($.18 per share)
    
-
   
-
   
-
   
-
   
-
   
(740,592
)
  
-
   
-
   
-
   
-
   
-
 
Unrealized investment gain, net
    
-
   
-
   
-
   
-
   
-
   
-
   
106
   
-
   
-
   
-
   
106
 
Repurchase of Class A common stock
    
-
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
5,799
   
(49,465
)
  
-
 
Issuance of stock under stock award plan
    
-
   
-
   
-
   
-
   
(325,985
)
  
-
   
-
   
-
   
(57,620
)
  
472,484
   
-
 
Share-based compensation
    
-
   
-
   
-
   
-
   
60,698
   
-
   
-
   
-
   
-
   
-
   
-
 
Tax impact of share based compensation
    
-
   
-
   
-
   
-
   
5,784
   
-
   
-
   
-
   
-
   
-
   
-
 
Other
    
-
   
-
   
-
   
-
   
5,222
   
-
   
-
   
-
   
1,921
   
(15,540
)
  
-
 
                                                                     
Balance at January 27, 2007
    
2,534,566
 
$
25,346
    
1,650,173
 
$
16,502
  
$
17,430,092
  
$
24,365,815
  
$
(665,748
)
$
-
    
78,563
 
$
(646,169
)
$
3,485,774
  
 

 
Ecology and Environment, Inc.
Notes to Consolidated Financial Statements


Summary of Operations and Basis of Presentation
 
The consolidated financial statements included herein have been prepared by Ecology and Environment, Inc., ("E & E" or the "Company"), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. The financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of such information. All such adjustments are of a normal recurring nature. Although E & E believes that the disclosures are adequate to make the information presented not misleading, certain information and footnote disclosures, including a description of significant accounting policies normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to such rules and regulations. Therefore, these financial statements should be read in conjunction with the financial statements and the notes thereto included in E & E's 2006 Annual Report on Form 10-K filed with the Securities and Exchange Commission. The results of operations for the six months ended January 27, 2007 are not necessarily indicative of the results for any subsequent period or the entire fiscal year ending July 31, 2007.

1.
Summary of Significant Accounting Policies 

 
a.
Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned and majority owned subsidiaries. Also reflected in the financial statements is the 50% ownership in the Chinese operating joint venture, The Tianjin Green Engineering Company. This joint venture is accounted for under the equity method. All significant intercompany transactions and balances have been eliminated.

 
b.
Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results may differ from those estimates.

 
c.
Revenue Recognition

The majority of the Company's revenue is derived from environmental consulting work, with the balance derived from sample analysis (E & E Analytical Services Center, in operation through January 2005) and aquaculture. The consulting revenue is principally derived from the sale of labor hours. The consulting work is performed under a mix of fixed price, cost-type, and time and material contracts. Contracts are required from all customers. Revenue is recognized as follows:


Contract Type
 
Work Type
 
Revenue Recognition Policy
 
 
 
 
 
Fixed Price
 
Consulting
 
Percentage of completion, approximating the ratio of total costs incurred to date to total estimated costs.
 
 
 
 
 
Cost-type
 
Consulting
 
Costs as incurred. Fixed fee portion is recognized using percentage of completion determined by the percentage of level of effort (LOE) hours incurred to total LOE hours in the respective contracts.
 
 
 
 
 
Time and Materials
 
Consulting
 
As incurred at contract rates.
 
 
 
 
 
Unit Price
 
Laboratory/
Aquaculture
 
Upon completion of reports (laboratory) and upon delivery and payment from customers (aquaculture).

   
Change orders can occur when changes in scope are made after project work has begun, and can be initiated by either the Company or its clients. Claims are amounts in excess of the agreed contract price which the Company seeks to recover from a client for customer delays and / or errors or unapproved change orders that are in dispute. Costs related to change orders and claims are recognized as incurred. Revenues are recognized on change orders (including profit) when it is probable that the change order will be approved and the amount can be reasonably estimated. Revenue on claims is not recognized until the claim is approved by the customer.

   
All bid and proposal and other pre-contract costs are expensed as incurred. Out of pocket expenses such as travel, meals, field supplies, and other costs billed direct to contracts are included in both revenues and cost of professional services.

 
d.
Translation of Foreign Currencies

The financial statements of foreign subsidiaries where the local currency is the functional currency are translated into U.S. dollars using exchange rates in effect at period end for assets and liabilities and average exchange rates during each reporting period for results of operations. Translation adjustments are deferred in accumulated other comprehensive income.

The financial statements of foreign subsidiaries located in highly inflationary economies are remeasured as if the functional currency were the U.S. dollar. The remeasurement of local currencies into U.S. dollars creates translation adjustments which are included in net income. There were no highly inflationary economy translation adjustments for fiscal years 2006-2007.

 
e.
Income Taxes

The Company follows the asset and liability approach to account for income taxes. This approach requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Although realization is not assured, management believes it is more likely than not that the recorded net deferred tax assets will be realized. Since in some cases management has utilized estimates, the amount of the net deferred tax asset considered realizable could be reduced in the near term. No provision has been made for United States income taxes applicable to undistributed earnings of foreign subsidiaries as it is the intention of the Company to indefinitely reinvest those earnings in the operations of those entities.
 
The estimated effective tax rate for fiscal year 2007 was 30.2%, down from the 37.9% reported for fiscal year 2006. This is due mainly to reduced work overseas.  The effective rate differs from the statutory rate due to income from "pass through" entities allocable to minority partners that will be taxed only to the minority partners as well as foreign and state taxes. 

 
f.
Earnings Per Share

Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. See Footnote No. 8.

 
g.
Impairment of Long-Lived Assets

The Company accounts for impairment of long-lived assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 required that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the book value of the asset may not be recoverable. The Company assesses recoverability of the carrying value of the asset by estimating the future net cash flows (undiscounted) expected to result from the asset, including eventual disposition. If the future net cash flows are less than the carrying value of the asset, an impairment loss is recorded equal to the difference between the asset's carrying value and fair value. 
 
 
h.
Cash and Cash Equivalents

For purposes of the consolidated statement of cash flows, the Company considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents. Cash paid for interest was approximately $67,000 and $61,000 for the first six months of fiscal year 2007 and 2006, respectively. Cash paid for income taxes was approximately $1.3 million and $682,000 for the first six months of fiscal year 2007 and 2006, respectively. Additionally in 2007, the Company loaned its minority partners in Brazil $240,000 to invest in the subsidiary.
 
 
i.
Reclassifications

The Company had previously classified second-tier subsidiaries’ minority interest as “other expense” and “other accrued liabilities.” These amounts ($151,013 and $291,558 for three and six months as of January 28, 2006 on the income statement and $866,987 at July 31, 2006 on the balance sheet) have been reclassified to minority interest.
 
2.
Contract Receivables, net
 
 
January 27,
2007
 
July 31,
2006
 
 
 
 
 
 
United States government -
 
 
 
 
Billed
$
2,624,659
 
$
3,040,081
 
Unbilled
 
4,392,962
 
 
3,454,074
 
 
 
7,017,621
 
 
6,494,155
 
 
 
 
 
 
 
 
Industrial customers and state and municipal governments -
 
 
 
 
 
 
Billed
 
24,129,294
 
 
30,460,655
 
Unbilled
 
6,185,896
 
 
3,360,808
 
 
 
30,315,190
 
 
33,821,463
 
 
 
 
 
 
 
 
Less allowance for contract adjustments
 
(1,493,612
)
 
(1,710,784
)
 
 
 
 
 
 
 
 
$
35,839,199
 
$
38,604,834
 

United States government receivables arise from long-term U.S. government prime contracts and subcontracts. Unbilled receivables result from revenues which have been earned, but are not billed as of period-end. The above unbilled balances are comprised of incurred costs plus fees not yet processed and billed; and differences between year-to-date provisional billings and year-to-date actual contract costs incurred and fees earned of approximately $123,000 at January 27, 2007 and ($683,000) at July 31, 2006. Management anticipates that the January 27, 2007 unbilled receivables will be substantially billed and collected within one year. Included in the balance of receivables for industrial customers and state and municipal customers are receivables due under the contracts in Saudi Arabia and Kuwait of $8.2 million and $12.2 million at January 27, 2007 and July 31, 2006, respectively. These amounts include $2.6 million and $2.8 million respectively for amounts owed to subcontractors. Within the above billed balances are contractual retainages in the amount of approximately $833,000 at January 27, 2007 and $764,000 at July 31, 2006. Management anticipates that the January 27, 2007 retainage balance will be substantially collected within one year.

Included in other accrued liabilities is an additional allowance for contract adjustments relating to potential cost disallowances on amounts billed and collected in current and prior years' projects of approximately $3.7 million at January 27, 2007 and $3.4 million at July 31, 2006. Also included in other accrued liabilities is a reclassification of billings in excess of recognized revenues of approximately $2.9 million at January 27, 2007 and $4.0 million at July 31, 2006. An allowance for contract adjustments is recorded for contract disputes and government audits when the amounts are estimatable.

3.
Line of Credit

The Company maintains an unsecured line of credit available for working capital and letters of credit of $20 million with a bank at 1/2% below the prevailing prime rate. A second line of credit is available at another bank for up to $13.5 million exclusively for letters of credit and is renewed annually. At January 27, 2007 and July 31, 2006, the Company had letters of credit outstanding totaling approximately $1.5 million. The Company had no outstanding borrowings for working capital at January 27, 2007 and July 31, 2006.

    The Company is in compliance with all bank loan covenants at January 27, 2007.

4.
Long-Term Debt and Capital Lease Obligations

Debt inclusive of capital lease obligations at January 27, 2007 and July 31, 2006 consists of the following:

 
January 27, 2007
 
July 31, 2006
 
 
 
 
 
 
Various bank loans and advances at interest rates ranging from 5% to 14½ %  
$
342,599
 
$
531,070
 
Capital lease obligations at varying interest rates averaging 12%
 
242,411
 
 
213,776
 
 
 
585,010
 
 
744,846
 
 
 
 
 
 
 
 
Less: current portion of debt and capital lease obligations
 
(248,353
)
 
(403,182
)
 
 
 
 
 
 
 
Long-term debt and capital lease obligations
$
336,657
 
$
341,664
 

The aggregate maturities of long-term debt and capital lease obligations at January 27, 2007 are as follows:

 
January 27, 2007
 
 
 
February 2007 - January 2008
$
248,353
February 2008 - January 2009
 
147,988
February 2009 - January 2010
 
55,489
February 2010 - January 2011
 
35,997
February 2011 - January 2012
 
27,148
Thereafter
 
70,035
 
$
585,010
 
5.
Stock Award Plan

Effective March 16, 1998, the Company adopted the Ecology and Environment, Inc. 1998 Stock Award Plan (the "1998 Plan"). To supplement the 1998 Plan, the 2003 Stock Award Plan (the "2003 Plan") was approved by the shareholders at the annual meeting held in January 2004 (the 1998 Plan and the 2003 Plan collectively referred to as the "Award Plan"). The 2003 Plan was approved retroactive to October 16, 2003 and will terminate on October 15, 2008. Under the Award Plan key employees (including officers) of the Company or any of its present or future subsidiaries may be designated to received awards of Class A Common stock of the Company as a bonus for services rendered to the Company or its subsidiaries, without payment therefore, based upon the fair market value of the Company stock at the time of the award. The Award Plan authorizes the Company's board of directors to determine for what period of time and under what circumstances awards can be forfeited.

The Company issued 57,620 shares valued at $585,995 in October 2006 pursuant to the Award Plan. These awards issued have a three year vesting period. The "pool" of excess tax benefits accumulated in Capital in Excess of Par Value at July 31, 2006 and January 27, 2007 was approximately $82,000 and $88,000, respectively.   Total gross compensation expense is recognized over the vesting period. Unrecognized compensation expense was approximately $412,000 and $42,000 at January 27, 2007 and July 31, 2006, respectively.

6.
Shareholders' Equity 

 
Class A and Class B common stock

 
The relative rights, preferences and limitations of the Company's Class A and Class B common stock can be summarized as follows: Holders of Class A shares are entitled to elect 25% of the Board of Directors so long as the number of outstanding Class A shares is at least 10% of the combined total number of outstanding Class A and Class B common shares. Holders of Class A common shares have one-tenth the voting power of Class B common shares with respect to most other matters.

 
In addition, Class A shares are eligible to receive dividends in excess of (and not less than) those paid to holders of Class B shares. Holders of Class B shares have the option to convert at any time, each share of Class B common stock into one share of Class A common stock. Upon sale or transfer, shares of Class B common stock will automatically convert into an equal number of shares of Class A common stock, except that sales or transfers of Class B common stock to an existing holder of Class B common stock or to an immediate family member will not cause such shares to automatically convert into Class A common stock.


7.
Shareholders' Equity - Restrictive Agreement

Messrs. Gerhard J. Neumaier, Frank B. Silvestro, Ronald L. Frank and Gerald A. Strobel entered into a Stockholders' Agreement in 1970 which governs the sale of certain shares of common stock owned by them, the former spouse of one of the individuals and some of their children. The agreement provides that prior to accepting a bona fide offer to purchase all or any part of their shares, each party must first allow the other members to the agreement the opportunity to acquire on a pro rata basis, with right of over-allotment, all of such shares covered by the offer on the same terms and conditions proposed by the offer.

8.
Earnings Per Share

The computation of basic earnings per share reconciled to diluted earnings per share follows:

   
Three Months Ended
  
Six Months Ended
  
   
1/27/07
  
1/28/06
  
1/27/07
  
1/28/06
  
                   
Income from continuing operations available to
common stockholders
  
$
618,611
  
$
656,651
  
$
1,374,138
  
$
1,439,746
  
Income (loss) from discontinued operations available
to common stockholders
    
603,400
    
(28,297
)
  
568,554
    
(65,053
)
Total income available to common stockholders
    
1,222,011
    
628,354
    
1,942,692
    
1,374,693
  
Weighted-average common shares outstanding (basic)
    
4,015,682
    
3,982,433
    
4,016,830
    
3,982,711
  
Basic earnings (loss) per share:
                          
Continuing operations
  
$
.15
  
$
.16
  
$
.34
  
$
.36
  
Discontinued operations
    
.15
    
(.01
)
  
.14
    
(.02
)
Total basic earnings per share
  
$
.30
  
$
.15
  
$
.48
  
$
.34
  
Incremental shares from assumed conversions of
stock options and restricted stock awards
    
37,999
    
4,158
    
37,431
    
1,544
  
Adjusted weighted-average common shares outstanding
    
4,053,681
    
3,986,591
    
4,054,261
    
3,984,255
  
Diluted earnings (loss) per share:
                          
Continuing operations
  
$
.15
  
$
.16
  
$
.34
  
$
.36
  
Discontinued operations
    
.15
    
(.01
)
  
.14
    
(.02
)
Total diluted earnings per share
  
$
.30
  
$
.15
  
$
.48
  
$
.34
  

After consideration of all the rights and privileges of the Class A and Class B stockholders discussed in Note 6, in particular the right of the holders of the Class B common stock to elect no less than 75% of the Board of Directors making it highly unlikely that the Company will pay a dividend on Class A common stock in excess of Class B common stock, the Company allocates undistributed earnings between the classes on a one-to-one basis when computing earnings per share. As a result, basic and fully diluted earnings per Class A and Class B share are equal amounts. 
 
9.
Segment Reporting

Ecology and Environment, Inc. has three reportable segments: consulting services, analytical laboratory services, and aquaculture. The consulting services segment provides broad based environmental services encompassing audits and impact assessments, surveys, air and water quality management, environmental engineering, environmental infrastructure planning, and industrial hygiene and occupational health studies to a world wide base of customers. The analytical laboratory provided analytical testing services to industrial and governmental clients for the analysis of waste, soil and sediment samples. The fish farm located in Jordan produces tilapia fish grown in a controlled environment for markets in the Middle East. The analytical laboratory was closed in fiscal year 2005.

The Company evaluates segment performance and allocates resources based on operating profit before interest income/expense and income taxes. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Intercompany sales from the analytical services segment to the consulting segment were recorded at market selling price, intercompany profits are eliminated. The Company's reportable segments are separate and distinct business units that offer different products. Consulting services are sold on the basis of time charges while analytical services and aquaculture products are sold on the basis of product unit prices.
 
Reportable segments for the six months ended January 27, 2007 are as follows:

 
 
 
 
 
Aquaculture
 
 
 
 
 
 
Consulting
 
Analytical
 
Continued
 
Discontinued
 
Elimination
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total consolidated net revenues
$
40,601,940
 
$
---
 
$
90,258
 
$
---
 
$
---
 
$
40,692,198
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation expense
$
639,478
 
$
---
 
$
6,903
 
$
---
 
$
---
 
$
646,381
 
Segment profit (loss) before income
taxes and minority interest
$
3,311,178
 
$
---
 
$
(19,081
)
$
985,797
 
$
---
 
$
4,277,894
 
Segment assets
$
63,894,870
 
$
2,100,000
 
$
179,000
 
$
---
 
$
---
 
$
66,173,870
 
Expenditures for long-lived assets
$
580,594
 
$
---
 
$
---
 
$
---
 
$
---
 
$
580,594
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Geographic Information:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net
Revenues (1)
 
 
Long-Lived Assets-Gross
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
United States
$
33,476,198
 
$
22,666,019
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign Countries
 
7,216,000
 
 
1,899,000
 
 
 
 
 
 
 
 
 
 
 
 
 

(1) Net revenues are attributed to countries based on the location of the customers.

Reportable segments for the six months ended January 28, 2006 are as follows:

 
 
 
 
 
Aquaculture
 
 
 
 
 
 
Consulting
 
Analytical
 
Continued
 
Discontinued
 
Elimination
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total consolidated net revenues
$
40,093,110
 
$
---
 
$
34,848
 
$
---
 
$
---
 
$
40,127,958
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation expense
$
528,519
 
$
---
 
$
6,328
 
$
---
 
$
---
 
$
534,847
 
Segment profit (loss) before income taxes and minority interest
$
2,899,369
 
$
---
 
$
(39,383
)
 
(111,012
)
$
---
 
$
2,748,974
 
Segment assets
$
57,970,485
 
$
2,100,000
 
$
275,000
 
$
42,000
 
$
---
 
$
60,387,485
 
Expenditures for long-lived assets
 
321,961
 
$
---
 
$
---
 
$
---
 
$
---
 
$
321,961
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Geographic Information:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net
Revenues (1)
 
 
Long-Lived Assets-Gross
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
United States
$
34,968,958
 
$
21,769,808
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign Countries
 
5,159,000
 
 
1,770,000
 
 
 
 
 
 
 
 
 
 
 
 
 

 
(1)
Net revenues are attributed to countries based on the location of the customers. Net revenues in foreign countries includes $1.2 million in Kuwait.

10.
Commitments and Contingencies

From time to time, the Company is named defendant in legal actions arising out of the normal course of business. The Company is not a party to any pending legal proceedings the resolution of which the management of the Company believes will have a material adverse effect on the Company’s results of operations, financial condition, cash flows, or to any other pending legal proceedings other than ordinary, routine litigation incidental to its business. The Company maintains liability insurance against risks arising out of the normal course of business.

Certain contracts contain termination provisions under which the customer may, without penalty, terminate the contracts upon written notice to the Company. In the event of termination, the Company would be paid only termination costs in accordance with the particular contract. Generally, termination costs include unpaid costs incurred to date, earned fees and any additional costs directly allocable to the termination.

On or about October 28, 2005 several Plaintiffs filed an action in District Court in the City and County of Boulder, Colorado, Case No. 05 CV 1008, against three named Defendants, one of which is Walsh Environmental Scientists & Engineers, LLC (Walsh). Walsh is a majority-owned subsidiary of the Company. The Company is not named as a Defendant. The Plaintiff’s Complaint alleges claims of negligence, breach of contract and trespass for unspecified damages against the Defendants resulting from a forest fire that ignited from a fallen power line during a wind storm that took place in Boulder County, Colorado in October 2003. Walsh’s legal counsel has received other communication from the Plaintiff’s attorneys, which indicates that Plaintiffs may be seeking damages, in the aggregate, in excess of $17,000,000. The Company’s liability insurance extends to its subsidiaries. Walsh believes the claims asserted against it are without merit and intends to vigorously defend this lawsuit.

The Company’s three contracts in the State of Kuwait, funded by the United Nations Compensation Commission (UNCC), began in fiscal year 2002 and extend into fiscal year 2007. The Environmental Services Agreements (ESAs) between the client, the Public Authority for Assessment of Compensation for Damages Resulting from Iraqi Aggression (PAAC), and the Company were signed in January 2002. These ESAs contemplated the receipt of a tax order from the Ministry of Finance declaring that the income generated by the Company in performance of the services would be exempt from Kuwait income tax. The ESAs also stated that the Company would be entitled to be reimbursed by PAAC for Kuwait income tax costs, if any, as finally determined. The Company was notified in May 2002 by PAAC that the tax exemption contemplated in the ESAs had been officially granted. In fiscal year 2007, E&E received notification from PAAC that it should declare its taxes to the Ministry of Finance in order to facilitate the closure and final payments under the contracts. The Company believes that it holds a tax exemption, or at a minimum, an obligation for reimbursement from its client PAAC for any income taxes. Accordingly, the Company has not provided for Kuwait income taxes on these contracts. Total receivables net of subcontractors and allowance for doubtful accounts due to the Company under these contracts at January 27, 2007 is approximately $1.9 million. The Company believes the potential impact on its operations and cash flows may be zero but will not exceed $1.9 million.

The Company is involved in other litigation arising in the normal course of business. In the opinion of management, any adverse outcome to other litigation arising in the normal course of business would not have a material impact on the financial results of the Company 

11.
Recent Accounting Pronouncements

In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements.

Traditionally, there have been two widely-recognized methods for quantifying the effects of financial statement misstatements: the “roll-over” method and the “iron curtain” method. The roll-over method focuses primarily on the impact of a misstatement of the income statement--including the reversing effect of prior year misstatements--but its use can lead to the accumulation of misstatements in the balance sheet. The iron curtain method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. Prior to August 1, 2006, the Company utilized the roll-over method for quantifying identified financial statement misstatements.

In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron curtain and the roll-over methods.

SAB 108 permits public companies to initially apply its provisions either by (i) restating prior financial statements as if the “dual approach” had always been used or (ii) recording the cumulative effect of initially applying the “dual approach” as adjustments to the carrying values of assets and liabilities as of August 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings.

The Company elected to record the effects of applying SAB 108 using the “cumulative effect” transition method and recorded an adjustment to reduce retained earnings by $302,000 in the first quarter of fiscal year 2007. However, upon subsequent review, the Company concluded that $326,357 of this entry could have been corrected by recording other balance sheet only adjustments, not affecting retained earnings. This correction would result in a net increase in retained earnings of $24,357 and can no longer be deemed material enough to be recorded as a cumulative effect adjustment. Therefore, the Company has reversed the cumulative effect adjustment recorded in the first quarter and reflected the remaining $24,357 as corrections to the year to date figures in “other expense” for the six months ended January 27, 2007. The accompanying Statement of Changes in Shareholders’ Equity reflects the removal of the cumulative effect adjustment previously recorded in the first quarter of fiscal year 2007.

In June 2006, the FASB issued FIN 48, an interpretation of SFAS 109. FIN 48 clarifies the accounting for uncertainty in income taxes and reduces the diversity in current practice associated with the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return by defining a “more-likely-than-not” threshold regarding the sustainability of the position. The Company is required to adopt FIN 48 in the fiscal year ending July 31, 2008 and is currently evaluating the impact on its financial statements.

 
12.
Sale of Frutas Marinas Del Mar S.R.L.

 
On January 9, 2007 the Company sold its interest in the shrimp farm in Costa Rica to the Roozen Group for $2,500,000 in cash. When the farm was closed in fiscal year 2003, the Company recorded an impairment charge. The previously unrecognized foreign translation loss in the amount of approximately $1.5 million has been accounted for in the computation of the current year gain on sale. There was a pretax gain on the sale of the farm of $960,131 after deducting costs of the sale.  This gain is included in the accompanying financial statements under discontinued operations.

 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations

Liquidity and Capital Resources

Operating activities contributed $254,000 and $494,000 of cash during the first six months or fiscal year 2007 and 2006, respectively. Minority interest increased $922,000 during fiscal year 2007 due mainly to an increase in profits from Walsh Environmental and its subsidiaries located in Peru and Ecuador. Contract receivables provided $2.4 million of cash during the first six months of fiscal year 2007 due mainly to collections on outstanding invoices from the Company’s contracts in the Middle East. Accrued payroll costs decreased $1.9 million during fiscal year 2007 due to the issuance of corporate bonuses to eligible employees as well as an increase in paid time off taken during the holidays. Other accrued liabilities decreased $1.6 million during the first six months of fiscal year 2007 due mainly to reductions in amounts owed to subcontractors on the Company’s Kuwait contract as collections on billings were received. The Company purchased $581,000 of new capital equipment compared to depreciation charges of $646,000 during the first six months of fiscal year 2007.

Financing activities consumed $1.4 million of cash during the first six months of fiscal year 2007. The Board of Directors paid dividends in the amount of $741,000 or $.18 per share during the second quarter of fiscal year 2007.  The Company reported $425,000 in distributions to minority partners during the first six months of fiscal year 2007. Long-term debt and capital lease obligations decreased $160,000 mainly due to repayments of debt held by GAC and the Walsh Environmental subsidiary, Walsh Peru.

The Company maintains an unsecured line of credit of $20.0 million with a bank at ½% below the prevailing prime rate. A second line of credit is available at another bank for up to $13.5 million, exclusively for letters of credit. The Company has outstanding letters of credit (LOC’s) at January 27, 2007 in the amount of $1.5 million. These LOC’s were obtained to secure advance payments and performance guarantees for contracts in the Middle East. After LOC’s, there are no outstanding borrowings under the lines of credit and there is $32.0 million of line still available at January 27, 2007. There are no significant additional working capital requirements pending at January 27, 2007. The Company believes that cash flows from operations and borrowings against the line of credit will be sufficient to cover all working capital requirements for at least the next twelve months and the foreseeable future.

Results of Operations

Net Revenue

Fiscal Year 2007 vs 2006

The Company had a solid second quarter of fiscal year 2007 as it reported net revenues of $19.8 million, consistent with the $19.9 million reported in the second quarter of fiscal year 2006. Net revenues were held steady despite the strong comparables in the prior year which included $3.5 million of hurricane work in the Gulf Coast, $.9 million of work on the Region 9 START contract which ended in fiscal year 2006 and $.5 million of work on the Company’s contract in Kuwait as it neared completion. Although the relief efforts on hurricane Katrina and Rita are complete, the Company continues to work in the Gulf Coast region on projects to restore the wetlands that were damaged by the hurricanes. Walsh Environmental reported net revenues of $4.5 million during the second quarter of fiscal year 2007, up 32% from the $3.4 million reported in the prior year as a result of higher revenues from its energy, mining and transportation sectors. During the second quarter of fiscal year 2007, net revenues from state clients increased $384,000 from the $4.0 million reported during the second quarter of the prior year. The increase in state net revenues was mainly attributable to increased work levels on contracts in New York and Illinois.
 
Fiscal Year 2006 vs 2005

Net revenues for the second quarter of fiscal year 2006 were $19.9 million, up 14% from the $17.4 million reported in fiscal year 2005. The increase in net revenues was attributable to increased work on projects in the Gulf Coast associated with the relief efforts for hurricanes Katrina and Rita as well as an increase in work at two of the Company’s subsidiaries, Walsh Environmental and E&E do Brasil. The Company reported net revenues from these Gulf Coast contracts of $3.5 million during the second quarter of fiscal year 2006. Walsh Environmental reported net revenues of $3.3 million during the second quarter of fiscal year 2006, up 27% from the $2.6 million reported in the prior year. The increase in Walsh was due to higher revenues from its subsidiaries in Peru and Ecuador as well as Gustavson Associates. E&E do Brasil reported net revenues of $721,000 during the second quarter of fiscal year 2006, up 88% from the $383,000 reported in the prior year. Offsetting these increases were decreases in net revenues from the contracts in Saudi Arabia and Kuwait. These contracts in the Middle East decreased $1.2 million or 57%. The contracts in Saudi Arabia are 100% complete and the contracts in Kuwait are approaching completion. Net revenues decreased $642,000 during the second quarter of fiscal year 2006 due to the completion of both the Company’s Superfund Technical Assessment and Response Team (START) contract in EPA Region III in June 2005 and EPA Region X in December 2005. The remaining START contract in EPA Region IX was scheduled to end in December 2005, however an extension was exercised extending work through the middle of April 2006. New START contracts in EPA Regions IX and X were rebid in September 2005. The Company was awarded the new START contract in EPA Region X in December 2005. However, the Company was notified in February 2006 that it was unsuccessful in winning the new START contract in EPA Region IX. The START Region IX contract contributed net revenues of $1.8 million during the first six months of fiscal year 2005 and $4.4 million in fiscal year 2005. The Company closed its Analytical Services Center in Lancaster, N.Y. during the second quarter of the fiscal year 2005. As a result, ASC net revenues decreased $867,000 during the second quarter of fiscal year 2006.


Income From Continuing Operations Before Income Taxes and Minority Interest

Fiscal Year 2007 vs 2006

The Company’s income from continuing operations before income taxes and minority interest was $1.5 million for the second quarter of fiscal year 2007, up 15% from the $1.3 million reported in the second quarter of fiscal year 2006. Gross margins increased in fiscal year 2007 due to higher margin work and increased revenues from the Walsh Environmental subsidiary. The increase in gross margins was offset by an overall increase in indirect, administrative, marketing and proposal costs throughout the Company.
Administrative and indirect operating expenses were $6.5 million during the second quarter of fiscal year 2007, up from the $6.2 million reported during the prior year. Marketing and proposal costs were $2.4 million during the fiscal year 2007, an increase of 20% from the $2.0 million reported during the second quarter of fiscal year 2006. The increase in indirect costs was attributable to increased proposal work brought about by significant opportunities in the energy sector relating to alternative energy and clean technologies. The Company has also increased business development costs worldwide to capitalize on global energy opportunities. Interest income increased $63,000 from the $55,000 reported during the second quarter of fiscal year 2006, consistent with the doubling of the Company’s cash balances. The Company reported a net foreign currency exchange gain of $50,000 during the second quarter of fiscal year 2007 due to payments received on billings from the contract in Kuwait.
 
On January 9, 2007 the Company sold its interest in the shrimp farm in Costa Rica to the Roozen Group for $2,500,000 in cash. When the farm was closed in fiscal year 2003, the Company recorded an impairment charge. The previously unrecognized foreign translation loss in the amount of approximately $1.5 million has been accounted for in the computation of the current year gain on sale. After deducting costs of the sale, there was a pretax gain recorded on the sale of the farm of approximately $960,000 which was included in discontinued operations.

Fiscal Year 2006 vs 2005

The Company’s income from continuing operations before income taxes and minority interest for the second quarter of fiscal year 2006 was $1.3 million, compared to the $2.4 million loss reported in the second quarter of the prior year. This increase was due mainly to increased utilization and the closing and impairment of the Analytical Services Center (ASC) in January 2005. The increase in utilization is mainly attributable to an increase in work performed on contracts associated with the relief efforts for hurricanes Katrina and Rita. Work on these contracts was scheduled to continue at a reduced rate through the end of April 2006. The company was aggressively marketing other opportunities and was optimistic future work in the region would materialize. With net revenues and utilization increasing during the quarter, management continued to control indirect costs and maintain them at a level consistent with the second quarter of fiscal year 2005. The Company’s decision to close the ASC resulted in a total net loss of $1.6 million or $.39 per share in the second quarter of fiscal year 2005.

American Jobs Creation Act of 2004

In October 2004, Congress passed, and the President signed into law, the American Jobs Creation Act of 2004 (the “Act”). Some key provisions of the act affecting the Company were the repeal of the United States export tax incentive known as the extraterritorial income exclusion (EIE) and the implementation of a domestic manufacturing deduction. The EIE is phased out over the calendar years 2005 and 2006 with an exemption for binding contracts with unrelated persons entered into before September 18, 2003. These phase-out provisions will allow the Company to maintain an EIE deduction at a reduced amount through fiscal year 2007. The Company will accrue some benefits from the domestic manufacturing deduction, although such benefits are not material. Under the Act’s repatriation provisions, the Company repatriated approximately $77,000 during the fourth quarter of fiscal year 2006.

Recent Accounting Pronouncements

The Company adopted FAS 123(R), Share-Based Payment, effective August 1, 2005.  The Statement requires companies to expense the value of employee stock options and similar awards. Under FAS 123(R), SBP awards result in a cost that will be measured at fair value on the awards' grant date, based on the estimated number of awards that are expected to vest. Compensation cost for awards that vest would not be reversed if the awards expire without being exercised.  The unearned stock compensation balance of $158,993 as of July 31, 2005, which was accounted for under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), was reclassified into additional paid-in-capital upon adoption of SFAS 123(R). The impact on the Company’s financial statements was not material.

In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements.

Traditionally, there have been two widely-recognized methods for quantifying the effects of financial statement misstatements: the “roll-over” method and the “iron curtain” method. The roll-over method focuses primarily on the impact of a misstatement of the income statement--including the reversing effect of prior year misstatements--but its use can lead to the accumulation of misstatements in the balance sheet. The iron curtain method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. Prior to August 1, 2006, the Company utilized the roll-over method for quantifying identified financial statement misstatements.

In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron curtain and the roll-over methods.

SAB 108 permits public companies to initially apply its provisions either by (i) restating prior financial statements as if the “dual approach” had always been used or (ii) recording the cumulative effect of initially applying the “dual approach” as adjustments to the carrying values of assets and liabilities as of August 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings.

The Company elected to record the effects of applying SAB 108 using the “cumulative effect” transition method and recorded an adjustment to reduce retained earnings by $302,000 in the first quarter of fiscal year 2007. However, upon subsequent review of this entry, the Company concluded that $326,357 of this entry could have been corrected by recording other balance sheet only adjustments, not affecting retained earnings. This correction would result in a net increase in retained earnings of $24,357 and can no longer be deemed material enough to be recorded as a cumulative effect adjustment. Therefore, the Company has reversed the cumulative effect adjustment recorded in the first quarter and reflected the remaining $24,357 as corrections to the year to date figures in “other expense” for the six months ended January 27, 2007. The accompanying Statement of Changes in Shareholders’ Equity reflects the removal of the cumulative effect adjustment previously recorded in the first quarter of fiscal year 2007.

In June 2006, the FASB issued FIN 48, and interpretation of SFAS 109. FIN 48 clarifies the accounting for uncertainty in income taxes and reduces the diversity in current practice associated with the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return by defining a “more-likely-than-not” threshold regarding the sustainability of the position. The Company is required to adopt FIN 48 in the fiscal year ended July 31, 2008 and is currently evaluating the impact on its financial statements.

Critical Accounting Policies and Use of Estimates

Management's discussion and analysis of financial condition and results of operations discuss the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, allowance for doubtful accounts, income taxes, impairment of long-lived assets and contingencies.  Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.

Revenue Recognition

The Company’s revenues are derived primarily from the professional and technical services performed by its employees or, in certain cases, by subcontractors engaged to perform on under contracts we enter into with our clients. The revenues recognized, therefore, are derived from our ability to charge clients for those services under the contracts.

The Company employs three major types of contracts: “cost-plus contracts,” “fixed-price contracts” and “time-and-materials contracts.” Within each of the major contract types are variations on the basic contract mechanism. Fixed-price contracts generally present the highest level of financial and performance risk, but often also provide the highest potential financial returns. Cost-plus contracts present a lower risk, but generally provide lower returns and often include more onerous terms and conditions. Time-and-materials contracts generally represent the time spent by our professional staff at stated or negotiated billing rates.

Fixed price contracts are accounted for on the “percentage-of-completion” method, wherein revenue is recognized as project progress occurs. Time and material contracts are accounted for over the period of performance, in proportion to the costs of performance, predominately based on labor hours incurred. If an estimate of costs at completion on any contract indicates that a loss will be incurred, the entire estimated loss is charged to operations in the period the loss becomes evident.

The use of the percentage of completion revenue recognition method requires the use of estimates and judgment regarding the project’s expected revenues, costs and the extent of progress towards completion. The Company has a history of making reasonably dependable estimates of the extent of progress towards completion, contract revenue and contract completion costs. However, due to uncertainties inherent in the estimation process, it is possible that completion costs may vary from estimates.

Most of our percentage-of-completion projects follow a method which approximates the “cost-to-cost” method of determining the percentage of completion. Under the cost-to-cost method, we make periodic estimates of our progress towards project completion by analyzing costs incurred to date, plus an estimate of the amount of costs that we expect to incur until the completion of the project. Revenue is then calculated on a cumulative basis (project-to-date) as the total contract value multiplied by the current percentage-of-completion. The revenue for the current period is calculated as cumulative revenues less project revenues already recognized. The recognition of revenues and profit is dependent upon the accuracy of a variety of estimates. Such estimates are based on various judgments we make with respect to those factors and are difficult to accurately determine until the project is significantly underway.

For some contracts, using the cost-to-cost method in estimating percentage-of-completion may overstate the progress on the project. For projects where the cost-to-cost method does not appropriately reflect the progress on the projects, we use alternative methods such as actual labor hours, for measuring progress on the project and recognize revenue accordingly. For instance, in a project where a large amount of equipment is purchased or an extensive amount of mobilization is involved, including these costs in calculating the percentage-of-completion may overstate the actual progress on the project. For these types of projects, actual labor hours spent on the project may be a more appropriate measure of the progress on the project.
 
The Company’s contracts with the U.S. government contain provisions requiring compliance with the FAR, and the CAS. These regulations are generally applicable to all of the Company’s federal government contracts and are partially or fully incorporated in many local and state agency contracts. They limit the recovery of certain specified indirect costs on contracts subject to the FAR. Cost-plus contracts covered by the FAR provide for upward or downward adjustments if actual recoverable costs differ from the estimate billed. Most of our federal government contracts are subject to termination at the convenience of the client. Contracts typically provide for reimbursement of costs incurred and payment of fees earned through the date of such termination.

Federal government contracts are subject to the FAR and some state and local governmental agencies require audits, which are performed for the most part by the EPA Office of Inspector General (EPAOIG). The EPAOIG audits overhead rates, cost proposals, incurred government contract costs, and internal control systems. During the course of its audits, the EPAOIG may question incurred costs if it believes we have accounted for such costs in a manner inconsistent with the requirements of the FAR or CAS and recommend that our U.S. government financial administrative contracting officer disallow such costs. Historically, we have not experienced significant disallowed costs as a result of such audits. However, we can provide no assurance that the EPAOIG audits will not result in material disallowances of incurred costs in the future.

The Company maintains reserves for cost disallowances on its cost based contracts as a result of government audits.  The Company recently settled fiscal years 1996 thru 2000 for amounts within the anticipated range.  However, final rates have not been negotiated under these audits since 2001.  The Company has estimated its exposure based on completed audits, historical experience and discussions with the government auditors.  If these estimates or their related assumptions change, the Company may be required to record additional charges for disallowed costs on its government contracts.
 
Allowance for Uncollectible Accounts
 
We reduce our accounts receivable and costs and accrued earnings in excess of billings on contracts in process by establishing an allowance for amounts that, in the future, may become uncollectible or unrealizable, respectively. We determine our estimated allowance for uncollectible amounts based on management’s judgments regarding our operating performance related to the adequacy of the services performed, the status of change orders and claims, our experience settling change orders and claims and the financial condition of our clients, which may be dependent on the type of client and current economic conditions that the client may be subject to.

Deferred Income Taxes

We use the asset and liability approach for financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances based on our judgments and estimates are established when necessary to reduce deferred tax assets to the amount expected to be realized in future operating results. Management believes that realization of deferred tax assets in excess of the valuation allowance is more likely than not. Our estimates are based on facts and circumstances in existence as well as interpretations of existing tax regulations and laws applied to the facts and circumstances, with the help of professional tax advisors. Therefore, we estimate and provide for amounts of additional income taxes that may be assessed by the various taxing authorities.

Changes in Corporate Entities

On January 9, 2007 the Company sold its interest in the shrimp farm in Costa Rica to the Roozen Group for $2,500,000 in cash. When the farm was closed in fiscal year 2003, the Company recorded an impairment charge. The previously unrecognized foreign translation loss in the amount of approximately $1.5 million has been accounted for in the computation of the current year gain on sale.  After deducting costs of sale, there was a pretax gain recorded on the sale of the farm of approximately $960,000 which was included in discontinued operations. 

On December 29, 2006 a capital infusion of $500,000 was made to E&E do Brasil, Ltda. order to fund working capital requirements resulting from the Company's significant growth. On the same date the Company entered into a loan agreement for $120,000 each with its two Brazilian partners. The loans were granted to allow them to maintain their ownership percentage in E&E do Brasil, Ltda. (a limited partnership). The loans made to the partners are payable to Ecology and Environment, Inc., and are five year loans with annual principal repayments, and twelve per cent interest costs due on the outstanding balance. The loans are secured by the partners' shares.

Inflation

Inflation has not had a material impact on the Company’s business because a significant amount of the Company’s contracts are either cost based or contain commercial rates for services that are adjusted annually.


Item 3.  Quantitative and Qualitative Disclosures About Market Risk

The Company may have exposure to market risk for change in interest rates, primarily related to its investments. The Company does not have any derivative financial instruments included in its investments. The Company invests only in instruments that meet high credit quality standards. The Company is averse to principal loss and ensures the safety and preservation of its invested funds by limited default risk, market risk and reinvestment risk. As of January 27, 2007, the Company’s investments consisted of short-term commercial paper and mutual funds. The Company does not expect any material loss with respect to its investments.

The Company is currently documenting, evaluating, and testing its internal controls in order to allow management to report on and attest to, and its' independent public accounting firm to attest to, the Company's internal controls as of July 31, 2008 and 2009 respectively, as required by Section 404 of the Sarbanes-Oxley Act. Management continues to invest time on this endeavor and expects to continue its efforts through 2008. If weaknesses in our existing information and control systems are discovered that impede our ability to satisfy Sarbanes-Oxley reporting requirements, the Company must successfully and timely implement improvements to those systems. There is no assurance that the Company will be able to meet these requirements.
 
 
Item 4.  Controls and Procedures

Company management, with the participation of the chief executive officer and chief financial officer, evaluated the effectiveness of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of July 31, 2005. In designing and evaluating the Company’s disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, the Company’s chief executive officer and chief financial officer concluded that, as of July 31, 2006, the Company’s disclosure controls and procedures were (1) designed to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to its chief executive officer and chief financial officer by others within those entities, particularly during the period in which this report was being prepared and (2) effective, to ensure that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to Company’s management, including its principal executive and principal financial officers, or persons providing similar functions, as appropriate to allow timely decisions regarding required disclosures. There have been no significant changes in internal controls over financial reporting during the period covered by this report.


PART II
OTHER INFORMATION


Item 1.
Legal Proceedings

From time to time, the Company is named a defendant in legal actions arising out of the normal course of business. The Company is not a party to any pending legal proceeding the resolution of which the management of the Company believes will have a material adverse effect on the Company's results of operations, financial condition, cash flows, or to any other pending legal proceedings other than ordinary, routine litigation incidental to its business. The Company maintains liability insurance against risks arising out of the normal course of business.

On or about October 28, 2005 several Plaintiffs filed an action in District Court in the City and County of Boulder, Colorado, Case No. 05 CV 1008, against three named Defendants, one of which is Walsh Environmental Scientists & Engineers, LLC (Walsh). Walsh is a majority-owned subsidiary of the Company. The Company is not named as a Defendant. The Plaintiff’s Complaint alleges claims of negligence, breach of contract and trespass for unspecified damages against the Defendants resulting from a forest fire that ignited from a fallen power line during a wind storm that took place in Boulder County, Colorado in October 2003. Walsh’s legal counsel has received other communication from the Plaintiff’s attorneys, which indicates that Plaintiffs may be seeking damages, in the aggregate, in excess of $17,000,000. The Company’s liability insurance extends to its subsidiaries. Walsh believes the claims asserted against it are without merit and intends to vigorously defend this lawsuit.

The Company is involved in other litigation arising in the normal course of business. In the opinion of management, any adverse outcome to other litigation arising in the normal course of business would not have a material impact on the financial results of the Company.


Item 2.
Changes in Securities and Use of Proceeds

(e)  Purchased Equity Securities. The following table summarizes the Company's purchases of its common stock during the quarter ended January 27, 2007:

Period 
Total Number of
Shares Purchased
Average Price
Paid Per Share
Total Number of Shares
Purchased as Part of Publicly Announced Plans or Programs (1)
Maximum Number of Shares
that May Yet Be Purchased
Under the Plans or Programs
 
August 1, 2006 -
 January 27, 2007
5,799
$10.06
5,799
208,640

(1)
The Company purchased 5,799 shares of its Class A common stock during the first six months of its fiscal year ended July 31, 2007, pursuant to a 200,000 share repurchase program approved at the Board of Directors meeting held in January 2004. The purchases were made in open-market transactions. In February 2006, the Board of Directors authorized the repurchase of an additional 200,000 shares.


Item 3.
Defaults Upon Senior Securities

The Registrant has no information for Item 3 that is required to be presented.


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

The Registrant has no information for Item 4 that is required to be presented.


Item 5.
Other Information

The Registrant has no information for Item 5 that is required to be presented.


Item 6.
Exhibits and Reports on Form 8-K

 
(a)
- 31.1 Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
- 31.2 Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
- 32.1 Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- 32.2 Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 
(b)
Registrant filed a Form 8-K report on January 10, 2007 to report the sale of its shrimp farm operation in Costa Rica.


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.

 
 
ECOLOGY AND ENVIRONMENT, INC.
 
 
 
Date:
March 13, 2007
/s/ Ronald L. Frank
 
 
 
Ronald L. Frank
Executive Vice President, Secretary, Treasurer and Chief Financial Officer - Principal Financial Officer