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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 2003
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from_______to_______.
Commission File No. 1-13783
INTEGRATED ELECTRICAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 76-0542208
(State or other jurisdiction of
incorporation or organization) (I.R.S. Employer Identification No.)
1800 West Loop South
Suite 500
Houston, Texas 77027-3233
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (713) 860-1500
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 [X] No [ ]
The number of shares outstanding as of January 26, 2004 of the issuer's common
stock was 35,787,721 and of the issuer's restricted voting common stock was
2,605,709.
INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2003 and
December 31, 2003.................................................................... 2
Consolidated Statements of Operations for the three months ended
December 31, 2002 and 2003........................................................... 3
Consolidated Statement of Stockholders' Equity for the three months ended
December 31, 2003.................................................................... 4
Consolidated Statements of Cash Flows for the three months ended
December 31, 2002 and 2003........................................................... 5
Condensed Notes to Consolidated Financial Statements...................................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................................. 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk....................... 25
Item 4. Controls and Procedures.......................................................... 25
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................. 26
Signatures ............................................................................. 27
INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
September 30, December 31,
2003 2003
------------- ------------
(Audited) (Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ................................................. $ 40,201 $ 44,153
Accounts receivable:
Trade, net of allowance of $5,425 and $4,238 respectively ............. 245,618 236,862
Retainage ............................................................. 68,789 68,829
Related party ......................................................... 67 36
Costs and estimated earnings in excess of billings on
uncompleted contracts ................................................. 48,256 49,226
Inventories ............................................................... 20,473 22,647
Prepaid expenses and other current assets ................................. 23,319 24,728
---------- ----------
Total current assets .................................................. 446,723 446,481
PROPERTY AND EQUIPMENT, net ............................................... 52,697 50,756
GOODWILL, net ............................................................. 197,884 197,884
OTHER NON-CURRENT ASSETS .................................................. 28,870 27,546
---------- ----------
Total assets ....................................................... $ 726,174 $ 722,667
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt ...................................... $ 256 $ 186
Accounts payable and accrued expenses ..................................... 138,143 126,905
Billings in excess of costs and estimated earnings on
uncompleted contracts ................................................. 41,913 42,067
---------- ----------
Total current liabilities ............................................. 180,312 169,158
OTHER LONG-TERM DEBT, net of current maturities ........................... 195 169
SENIOR SUBORDINATED NOTES, net of $3,198 and $3,048
unamortized discount, respectively .................................... 247,927 247,924
OTHER NON-CURRENT LIABILITIES ............................................. 30,183 32,002
---------- ----------
Total liabilities .................................................. 458,617 449,253
---------- ----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 10,000,000 shares authorized,
none issued and outstanding ........................................ -- --
Common stock, $.01 par value, 100,000,000 shares authorized,
38,439,984 shares issued ........................................... 385 385
Restricted voting common stock, $.01 par value, 2,605,709 shares
issued, authorized and outstanding ................................. 26 26
Treasury stock, at cost, 2,725,793 and 2,717,963 shares, respectively.. (16,361) (16,918)
Unearned restricted stock ............................................. -- (1,909)
Additional paid-in capital ............................................ 427,709 429,804
Retained deficit ...................................................... (144,202) (137,974)
---------- ----------
Total stockholders' equity ......................................... 267,557 273,414
---------- ----------
Total liabilities and stockholders' equity ......................... $ 726,174 $ 722,667
========== ==========
The accompanying condensed notes to consolidated financial statements are an
integral part of these financial statements.
2
INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
Three Months Ended December 31,
-------------------------------
2002 2003
------------- ------------
(Unaudited)
Revenues ..................................................... $ 348,577 $ 359,843
Cost of services ............................................. 297,221 309,232
------------ ------------
Gross profit ............................................ 51,356 50,611
Selling, general and administrative expenses ................. 38,619 36,279
------------ ------------
Income from operations .................................. 12,737 14,332
------------ ------------
Other (income)/expense:
Interest expense ........................................ 6,456 6,459
Loss on sale of assets .................................. 59 10
Other expense (income), net ............................. 31 (101)
------------ ------------
6,546 6,368
------------ ------------
Income before income taxes ................................... 6,191 7,964
Provision for income taxes ................................... 2,384 1,736
------------ ------------
Net income ................................................... $ 3,807 $ 6,228
============ ============
Basic earnings per share ..................................... $ 0.10 $ 0.16
============ ============
Diluted earnings per share ................................... $ 0.10 $ 0.16
============ ============
Shares used in the computation of earnings per share (Note 5):
Basic ................................................... 39,447,351 38,273,416
============ ============
Diluted ................................................. 39,472,309 38,835,737
============ ============
The accompanying condensed notes to consolidated financial statements are an
integral part of these financial statements.
3
INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
Restricted Voting
Common Stock Common Stock Treasury Stock
------------------- ------------------ -----------------------
Shares Amount Shares Amount Shares Amount
---------- ------ --------- ------ ---------- ---------
BALANCE, September 30,
2003 ................ 38,439,984 $ 385 2,605,709 $ 26 (2,725,793) $ (16,361)
Issuance of stock
(unaudited) ......... -- -- -- -- 2,781 17
Issuance of restricted
stock (unaudited) ... -- -- -- -- -- --
Purchase of treasury
stock (unaudited) ... -- -- -- -- (449,200) (3,350)
Exercise of stock
options (unaudited).. -- -- -- -- 454,249 2,776
Non-cash compensation
(unaudited) ......... -- -- -- -- -- --
Net income (unaudited).. -- -- -- -- -- --
---------- ------ --------- ------ ---------- ---------
BALANCE, December 31,
2003 (unaudited)..... 38,439,984 $ 385 2,605,709 $ 26 (2,717,963) $ (16,918)
========== ====== ========= ====== ========== =========
Unearned Additional Retained Total
Restricted Earnings Stockholders' Paid-In
Stock Capital (Deficit) Equity
---------- ---------- ----------- ---------
BALANCE, September 30,
2003 ................ $-- $ 427,709 $ (144,202) $ 267,557
Issuance of stock
(unaudited) ......... -- 3 -- 20
Issuance of restricted
stock (unaudited) ... (1,992) 1,992 -- --
Purchase of treasury
stock (unaudited) ... -- -- -- (3,350)
Exercise of stock
options (unaudited).. -- 100 -- 2,876
Non-cash compensation
(unaudited) ......... 83 -- -- 83
Net income (unaudited).. -- -- 6,228 6,228
---------- ---------- ----------- ---------
BALANCE, December 31,
2003 (unaudited)..... $ (1,909) $ 429,804 $ (137,974) $ 273,414
========== ========== =========== =========
The accompanying condensed notes to consolidated financial statements are an
integral part of these financial statements.
4
INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Three Months Ended December 31,
-------------------------------
2002 2003
---------- ----------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .............................................................. $ 3,807 $ 6,228
Adjustments to reconcile net income to net cash
provided by operating activities
Provision for allowance for doubtful accounts ...................... 379 (389)
Deferred income taxes .............................................. -- (1,430)
Depreciation and amortization ...................................... 3,650 3,453
Loss on sale of property and equipment ............................. 59 10
Non-cash compensation expense ...................................... -- 83
Gain on divestiture ................................................ (26) --
Changes in operating assets and liabilities, net of acquisitions and
dispositions of businesses
(Increase) decrease in:
Accounts receivable ........................................... 8,401 8,962
Inventories ................................................... 873 (2,174)
Costs and estimated earnings in
excess of billings on uncompleted contracts .............. 105 (970)
Prepaid expenses and other current assets ..................... (27) 353
Other noncurrent assets ....................................... 429 673
Increase (decrease) in:
Accounts payable and accrued expenses ......................... (10,075) (8,330)
Billings in excess of costs and estimated
earnings on uncompleted contracts ........................ (6,101) 154
Other current liabilities ..................................... 167 --
Other noncurrent liabilities .................................. 1,612 34
---------- ----------
Net cash provided by operating activities ................ 3,253 6,427
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment ............................ 1,056 223
Purchases of property and equipment ..................................... (2,529) (1,745)
Investments in securities ............................................... -- (400)
Sale of business ........................................................ 1,084 --
---------- ----------
Net cash used in investing activities .................... (389) (1,922)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings .............................................................. 5 40
Repayments of debt ...................................................... (15,835) (139)
Purchase of treasury stock .............................................. (769) (3,350)
Proceeds from exercise of stock options ................................. -- 2,876
Proceeds from issuance of stock ......................................... 18 20
---------- ----------
Net cash used in financing activities .................... (16,581) (553)
---------- ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS .................................... (13,717) 3,952
CASH AND CASH EQUIVALENTS, beginning of period ............................... 32,779 40,201
---------- ----------
CASH AND CASH EQUIVALENTS, end of period ..................................... $ 19,062 $ 44,153
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid for
Interest ........................................................... $ 277 $ 210
Income taxes ....................................................... $ -- $ --
The accompanying condensed notes to consolidated financial statements are an
integral part of these financial statements.
5
INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. OVERVIEW
Integrated Electrical Services, Inc. (the "Company" or "IES"), a Delaware
corporation, was founded in June 1997 to create a leading national provider of
electrical services, focusing primarily on the commercial and industrial,
residential, low voltage and service and maintenance markets.
The accompanying unaudited condensed historical financial statements of the
Company have been prepared in accordance with accounting principles generally
accepted in the United States and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required for complete
financial statements, and therefore should be reviewed in conjunction with the
financial statements and related notes thereto contained in the Company's annual
report for the year ended September 30, 2003, filed on Form 10-K with the
Securities and Exchange Commission. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Actual operating results for the three
months ended December 31, 2003, are not necessarily indicative of the results
that may be expected for the fiscal year ended September 30, 2004.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
For a description of these policies, refer to Note 2 of the Notes to
Consolidated Financial Statements included in the Company's Annual Report on
Form 10-K for the year ended September 30, 2003.
SUBSIDIARY GUARANTIES
All of the Company's operating income and cash flows are generated by its wholly
owned subsidiaries, which are the subsidiary guarantors of the Company's
outstanding 9 3/8% senior subordinated notes due 2009 (the "Senior Subordinated
Notes"). The Company is structured as a holding company and substantially all of
its assets and operations are held by its subsidiaries. There are currently no
significant restrictions on the Company's ability to obtain funds from its
subsidiaries by dividend or loan. The parent holding company's independent
assets, revenues, income before taxes and operating cash flows are less than 3%
of the consolidated total. The separate financial statements of the subsidiary
guarantors are not included herein because (i) the subsidiary guarantors are all
of the direct and indirect subsidiaries of the Company; (ii) the subsidiary
guarantors have fully and unconditionally, jointly and severally guaranteed the
Senior Subordinated Notes; and (iii) the aggregate assets, liabilities, earnings
and equity of the subsidiary guarantors is substantially equivalent to the
assets, liabilities, earnings and equity of the Company on a consolidated basis.
As a result, the presentation of separate financial statements and other
disclosures concerning the subsidiary guarantors is not deemed material.
6
USE OF ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires the use of estimates and
assumptions by management in determining the reported amounts of assets and
liabilities, disclosures of contingent liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Estimates
are primarily used in the Company's revenue recognition of construction in
progress, fair value assumptions in analyzing goodwill impairment, allowance for
doubtful accounts receivable, realizability of deferred tax assets and
self-insured claims liability.
GOODWILL
The Company evaluates goodwill annually during its first fiscal quarter absent
any impairment indicators requiring more frequent impairment tests. Accordingly,
the Company performed its annual impairment test on October 1, 2003 and
determined that there was no impairment of recorded goodwill.
SEASONALITY AND QUARTERLY FLUCTUATIONS
The results of the Company's operations, particularly from residential
construction, are seasonal, dependant upon weather trends, with typically higher
revenues generated during the spring and summer and lower revenues during the
fall and winter. The commercial and industrial aspect of its business is less
subject to seasonal trends, as this work generally is performed inside
structures protected from the weather. The Company's service business is
generally not affected by seasonality. In addition, the construction industry
has historically been highly cyclical. The Company's volume of business may be
adversely affected by declines in construction projects resulting from adverse
regional or national economic conditions. Quarterly results may also be
materially affected by gross margins for both bid and negotiated projects, the
timing of new construction projects and any acquisitions. Accordingly, operating
results for any fiscal period are not necessarily indicative of results that may
be achieved for any subsequent fiscal period.
NEW ACCOUNTING PRONOUNCEMENT
In January 2003, the Financial Accounting Standards Board issued Interpretation
No. 46, "Consolidation of Variable Interest Entities," ("Interpretation 46").
The objective of Interpretation 46 is to improve the financial reporting by
companies involved with variable interest entities. Until now, one company
generally has included another entity in its consolidated financial statements
only if it controlled the entity through voting interest. Interpretation 46
changes that by requiring a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The consolidation requirements of
Interpretation 46 apply immediately to variable interest entities created after
January 31, 2003. The consolidation requirements apply to older entities in the
first fiscal year or interim period ending after March 31, 2004. Certain
disclosure requirements apply to all financial statements issued after January
31, 2003, regardless of when the variable interest entity was established. The
Company has minority interests in two firms, EnerTech Capital Partners II, L.P.
and Energy Photovoltaics, Inc., and a joint venture that may fall under this
7
interpretation. The Company does not believe the adoption of this statement will
have a material impact on its results of operations or financial position.
STOCK BASED COMPENSATION
The Company accounts for its stock-based compensation arrangements using the
intrinsic value method in accordance with the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25") and related interpretations. Under APB 25, if the exercise price of
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized. The Company's stock
options have all been granted with exercise prices at fair value, therefore no
compensation expense has been recognized under APB 25 (See Note 7).
The following table illustrates the effect on net income and earnings per share
assuming the compensation costs for IES' stock option and purchase plans had
been determined using the fair value method at the grant dates amortized on a
pro rata basis over the vesting period as required under SFAS No. 123,
"Accounting for Stock-Based Compensation" for the three months ended December
31, 2002 and 2003 (in thousands, except for per share data):
THREE MONTHS ENDED DECEMBER 30,
-------------------------------
2002 2003
------------ ----------
Net income, as reported.......................... $ 3,807 $ 6,228
Add: Stock-based employee compensation expense
included in reported net income, net of
related tax effects........................... -- 50
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax
effects....................................... 377 371
------------ -----------
Pro forma net income for SFAS
No.123....................................... $ 3,430 $ 5,907
============ ===========
Earnings per share:
Basic - as reported........................... $ 0.10 $ 0.16
Basic - pro forma for SFAS No. 123............ $ 0.09 $ 0.15
Earnings per share:
Diluted - as reported......................... $ 0.10 $ 0.16
Diluted - pro forma for SFAS No. 123.......... $ 0.09 $ 0.15
2. BUSINESS COMBINATIONS
Acquisition
On February 27, 2003, the Company purchased the assets of Riviera Electric LLC,
an electrical contractor located in the state of Colorado, out of a bankruptcy
auction of a prior competitor. The total consideration paid in this transaction
was approximately $2.7 million, comprised entirely of cash, net of cash
acquired. The fair value of the tangible net assets acquired exceeded
8
the total consideration paid. As a result, the long-term fixed assets of the
acquisition were reduced to zero. The accompanying balance sheet includes
allocations of the purchase price to the assets acquired and liabilities assumed
based on estimates of fair value and is subject to final adjustment during the
second fiscal quarter of the year ended September 30, 2004. The purchase price
was allocated as follows (amounts in thousands):
Accounts receivable, net.................................... $ 11,643
Retention................................................... 3,884
Costs and estimated earnings in excess of billings
on uncompleted projects and other...................... 922
Less: Accounts payable and accrued expenses................. (10,214)
Less: Billings in excess of costs and estimated
earnings on uncompleted projects and other............. (3,512)
---------
Cash paid, net of cash acquired............................. $ 2,723
=========
The unaudited pro forma data presented below reflect the results of operations
of IES and the acquisition of Riviera Electric LLC assuming the transaction was
completed on October 1, 2002 (in thousands):
Three Months
Ended
December 31,
------------
2002
------------
Revenues......................... $ 367,629
Net income....................... $ 4,010
Basic earnings per share......... $ 0.10
Diluted earnings per share....... $ 0.10
The unaudited pro forma data summarized above also reflects pro forma
adjustments primarily related to reductions in general and administrative
expenses for contractually agreed reductions in compensation programs and
additional income tax expense based on the Company's effective income tax rate.
The unaudited pro forma financial data does not purport to represent what the
Company's combined results of operations would actually have been if such
transactions had in fact occurred on October 1, 2002, and are not necessarily
representative of the Company's results of operations for any future period.
Divestiture
On October 8, 2002, the Company sold all of the stock of one of its operating
companies. The proceeds from the sale were $1.1 million in cash and 70,330
shares of the Company's common stock. The Company recorded a pre-tax gain of
less than $0.1 million associated with this sale that is recorded in other
income.
9
In connection with the disposition discussed above, the net pre-tax gain was
determined as follows for the quarter ended December 31, 2002 (in thousands):
Book value of assets divested................ $ 1,830
Liabilities divested......................... (502)
------------
Net assets divested...................... 1,328
------------
Cash received................................ 1,084
Common stock received........................ 270
------------
Total consideration received............. 1,354
------------
Pre-tax gain............................. $ 26
============
3. RESTRUCTURING CHARGES
In October 2001, the Company began implementation of a workforce reduction
program. The purpose of this program was to cut costs by reducing the number of
administrative staff both in the field and at the home office. The total number
of terminated employees was approximately 450. As a result of the program
implementation, the Company recorded pre-tax restructuring charges of $5.6
million associated with 45 employees during the year ended September 30, 2002
and presented these charges as a separate component of the Company's results of
operations for the period then ended. The charges were based on the costs of the
workforce reduction program and include severance and other special termination
benefits. The Company believes the reduction of these personnel resulted in
annual savings of approximately $4.1 million in salaries and benefits. During
the three months ended December 31, 2003, the Company reached agreements on the
remaining payments required under the restructuring agreements and reduced the
restructuring accrual by $0.4 million, which is included as a reduction in
selling, general and administrative expenses. At December 31, 2003,
approximately $0.5 million of these charges that relate to two individuals have
not been paid and were included in accounts payable and accrued expenses. The
Company anticipates making the remaining scheduled payments accrued under this
restructuring during the fiscal year ending September 30, 2004.
4. DEBT
Credit Facility
On May 27, 2003, the Company amended its $150.0 million revolving credit
facility to a $125.0 million revolving credit facility with a syndicate of
lending institutions to be used for working capital, capital expenditures,
acquisitions and other corporate purposes that matures May 22, 2006, as amended
(the "Credit Facility"). Amounts borrowed under the Credit Facility bear
interest at an annual rate equal to either (a) the London interbank offered rate
(LIBOR) plus 1.75 percent to 3.50 percent, as determined by the ratio of the
Company's total funded debt to EBITDA (as defined in the Credit Facility) or (b)
the higher of (i) the bank's prime rate or (ii) the Federal funds rate plus 0.50
percent plus an additional 0.25 percent to 2.00 percent, as determined by the
ratio of the Company's total funded debt to EBITDA. Commitment fees of 0.375
percent to 0.50 percent are assessed on any unused borrowing capacity under the
Credit Facility. The Company's existing and future subsidiaries guarantee the
repayment of all amounts due under the facility, and the facility is secured by
the capital stock of those subsidiaries and the
10
accounts receivable of the Company and those subsidiaries. Borrowings under the
Credit Facility are limited to 66 2/3% of outstanding receivables (as defined in
the agreement). The Credit Facility requires the consent of the lenders for
acquisitions exceeding a certain level of cash consideration, prohibits the
payment of cash dividends on the common stock, restricts the ability of the
Company to repurchase shares of common stock or to retire its Senior
Subordinated Notes, restricts the ability of the Company to incur other
indebtedness and requires the Company to comply with various affirmative and
negative covenants including certain financial covenants. Among other
restrictions, the financial covenants include a minimum net worth requirement, a
maximum total consolidated funded debt to EBITDA ratio, a maximum senior
consolidated debt to EBITDA ratio and a minimum interest coverage ratio. For
more information regarding the covenants to its Credit Facility, as amended, see
the Company's filing on Form 8-K dated May 28, 2003. The Company was in
compliance with the financial covenants of its Credit Facility, as amended, at
December 31, 2003. As of December 31, 2003, the Company had no borrowings
outstanding under its Credit Facility, letters of credit outstanding under its
Credit Facility of $30 million, $0.4 million of other borrowings and available
borrowing capacity under its Credit Facility of $95.0 million.
Senior Subordinated Notes
On January 25, 1999 and May 29, 2001, the Company completed offerings of $150.0
million and $125.0 million Senior Subordinated Notes, respectively. The offering
completed on May 29, 2001 yielded $117.0 million in proceeds to the Company, net
of a $4.2 million discount and $3.9 million in offering costs. The proceeds from
the May 29, 2001, offering were used primarily to repay amounts outstanding
under the Credit Facility. The Senior Subordinated Notes bear interest at 9 3/8%
and mature on February 1, 2009. The Company pays interest on the Senior
Subordinated Notes on February 1 and August 1 of each year. The Senior
Subordinated Notes are unsecured obligations and are subordinated to all
existing and future senior indebtedness. The Senior Subordinated Notes are
guaranteed on a senior subordinated basis by all of the Company's subsidiaries.
Under the terms of the Senior Subordinated Notes, the Company is required to
comply with various affirmative and negative covenants including: (i)
restrictions on additional indebtedness, and (ii) restrictions on liens,
guarantees and dividends. During the year ended September 30, 2002, the Company
retired approximately $27.1 million of these Senior Subordinated Notes.
Debt consists of the following (in thousands):
September December
30, 2003 31, 2003
-------- --------
Senior Subordinated Notes, due February 1, 2009, bearing 137,885 137,885
interest at 9.375% with an effective interest rate of 9.50%..............
Senior Subordinated Notes, due February 1, 2009, bearing
interest at 9.375% with an effective interest rate of 10.00%............. 110,000 110,000
Other.......................................................................... 451 355
----------------- --------------
Total debt............................................................... 248,336 248,240
Less - short-term debt and current maturities of long-term debt................ (256) (186)
Less - unamortized discount on Senior Subordinated Notes....................... (3,198) (3,048)
Add - fair value of terminated interest rate hedge............................. 3,240 3,087
----------------- --------------
Total long-term debt..................................................... $ 248,122 $ 248,093
================= ==============
11
5. EARNINGS PER SHARE
The following table reconciles the numerators and denominators of the basic and
diluted earnings per share for the three months ended December 31, 2002 and 2003
(in thousands, except share information):
Three Months Ended December 31,
-------------------------------
2002 2003
---------------- --------------
Numerator:
Net income............................................ $ 3,807 $ 6,228
================ ==============
Denominator:
Weighted average shares outstanding - basic........... 39,447,351 38,273,416
Effect of dilutive stock options...................... 24,958 562,321
---------------- --------------
Weighted average shares outstanding - diluted......... 39,472,309 38,835,737
================ ==============
Earnings per share:
Basic................................................. $ 0.10 $ 0.16
Diluted............................................... $ 0.10 $ 0.16
For the three months ended December 31, 2002 and 2003, stock options of 5.4
million and 2.3 million, respectively, were excluded from the computation of
diluted earnings per share because the options exercise prices were greater than
the average market price of the Company's common stock.
6. OPERATING SEGMENTS
The Company follows SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information." Certain information is disclosed, per SFAS No. 131,
based on the way management organizes financial information for making operating
decisions and assessing performance.
The Company's reportable segments are strategic business units that offer
products and services to two distinct customer groups. They are managed
separately because each business requires different operating and marketing
strategies. These segments, which contain different economic characteristics,
are managed through geographically-based regions.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance
based on income from operations of the respective business units prior to home
office expenses. Management allocates costs between segments for selling,
general and administrative expenses, goodwill impairment, depreciation expense,
capital expenditures and total assets.
12
Segment information for the three months ended December 31, 2002 and 2003 is as
follows (in thousands):
THREE MONTHS ENDED DECEMBER 31, 2002
----------------------------------------------------------
COMMERCIAL/
INDUSTRIAL RESIDENTIAL OTHER TOTAL
---------- ----------- ----- -----
Revenues..................................... $ 271,634 $ 76,943 $ - $ 348,577
Cost of services............................. 237,277 59,944 - 297,221
------------- ----------- --------- -----------
Gross profit................................. 34,357 16,999 - 51,356
Selling, general and administrative.......... 25,258 8,699 4,662 38,619
------------- ----------- --------- -----------
Operating income............................. $ 9,099 $ 8,300 $ (4,662) $ 12,737
============= =========== ========= ===========
Other data:
Depreciation expense......................... $ 2,920 $ 260 $ 470 $ 3,650
Capital expenditures......................... 1,280 252 997 2,529
Total assets................................. 492,839 104,853 96,005 693,697
THREE MONTHS ENDED DECEMBER 31, 2002
----------------------------------------------------------
COMMERCIAL/
INDUSTRIAL RESIDENTIAL OTHER TOTAL
---------- ----------- ----- -----
Revenues..................................... $ 288,195 $ 71,648 $ - $ 359,843
Cost of services............................. 252,571 56,661 - 309,232
------------- ----------- --------- -----------
Gross profit................................. 35,624 14,987 - 50,611
Selling, general and administrative.......... 22,719 8,332 5,228 36,279
------------- ----------- --------- -----------
Operating income............................. $ 12,905 $ 6,655 $ (5,228) $ 14,332
============= =========== ========= ===========
Other data:
Depreciation expense......................... $ 2,628 $ 278 $ 547 $ 3,453
Capital expenditures......................... 817 302 626 1,745
Total assets................................. 498,253 109,254 115,160 722,667
The Company does not have significant operations or long-lived assets in
countries outside of the United States.
7. 1999 INCENTIVE COMPENSATION PLAN
In November 1999, the Board of Directors adopted the 1999 Incentive Compensation
Plan (the "1999 Plan"). The 1999 Plan authorizes the Compensation Committee of
the Board of Directors or the Board of Directors to grant employees of the
Company awards in the form of options, stock appreciation rights, restricted
stock or other stock based awards. The Company has up to 5.5 million shares of
common stock authorized for issuance under the 1999 Plan.
In December 2003, the Company granted a restricted stock award of 242,295 shares
under its 1999 Plan to certain employees. This award will vest in equal
installments on December 1, 2004 and 2005, provided the recipient is still
employed by the Company. The market value of the stock on the date of grant for
this award was $2.0 million, which will be recognized as compensation expense
over the related two year vesting period. During the three months ended
13
December 31, 2003, the Company amortized $0.1 million to expense in connection
with this award.
8. COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries are involved in various legal proceedings that
have arisen in the ordinary course of business. While it is not possible to
predict the outcome of such proceedings with certainty and it is possible that
the results of legal proceedings may materially adversely affect the Company, in
the opinion of the Company, all such proceedings are either adequately covered
by insurance or, if not so covered, should not ultimately result in any
liability which would have a material adverse effect on the financial position,
liquidity or results of operations of the Company. The Company expenses routine
legal costs related to such proceedings as incurred.
Some of the Company's customers require the Company to post letters of credit as
a means of guaranteeing performance under its contracts and ensuring payment by
the Company to subcontractors and vendors. If the customer has reasonable cause
to effect payment under a letter of credit, the Company would be required to
reimburse its creditor for the letter of credit. Depending on the circumstances
surrounding a reimbursement to its creditor, the Company may have a charge to
earnings in that period. To date, the Company has not had a situation where a
customer has had reasonable cause to effect payment under a letter of credit. At
December 31, 2003, $1.6 million of the Company's outstanding letters of credit
were to collateralize its customers.
Some of the underwriters of the Company's casualty insurance program require it
to post letters of credit as collateral. This is common in the insurance
industry. To date the Company has not had a situation where an underwriter has
had reasonable cause to effect payment under a letter of credit. At December 31,
2003, $28.4 million of the Company's outstanding letters of credit were to
collateralize its insurance programs.
Many of the Company's customers require us to post performance and payment bonds
issued by a surety. Those bonds guarantee the customer that the Company will
perform under the terms of a contract and that it will pay its subcontractors
and vendors. In the event that the Company fails to perform under a contract or
pay subcontractors and vendors, the customer may demand the surety to pay or
perform under the Company's bond. The Company's relationship with its sureties
is such that it will indemnify the sureties for any expenses they incur in
connection with any of the bonds they issues on the Company's behalf. To date,
the Company has not incurred significant expenses to indemnify its sureties for
expenses they incurred on the Company's behalf. As of December 31, 2003, the
Company's cost to complete projects covered by surety bonds was approximately
$226 million.
The Company has committed to invest up to $5.0 million in EnerTech Capital
Partners II L.P. ("EnerTech"). EnerTech is a private equity firm specializing in
investment opportunities emerging from the deregulation and resulting
convergence of the energy, utility and telecommunications industries. Through
December 31, 2003, the Company had invested $3.1 million under its commitment to
EnerTech.
14
At December 31, 2003, the Company had reserves of $27.2 million recorded in
other noncurrent liabilities for tax positions adopted that a taxing authority
may view differently. The Company believes these reserves are adequate in the
event the positions are not ultimately upheld. The timing of the payments of
these reserves is not currently known and would be based on the outcome of a
possible review by a taxing authority.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The following should be read in conjunction with the response to Part I, Item 1
of this Report. Any capitalized terms used but not defined in this Item have the
same meaning given to them in Part I, Item 1.
This report on Form 10-Q includes certain statements that may be deemed to be
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as
amended. These statements are based on our expectations and involve risks and
uncertainties that could cause our actual results to differ materially from
those set forth in the statements. Such risks and uncertainties include, but are
not limited to, the inherent uncertainties related to estimating future results,
fluctuations in operating results because of downturns in levels of
construction, incorrect estimates used in entering into fixed price contracts,
difficulty in managing the operation and growth of existing and newly acquired
businesses, the high level of competition in the construction industry and the
effects of seasonality. The foregoing and other factors are discussed in our
filings with the SEC, including our Annual Report on Form 10-K for the year
ended September 30, 2003.
In response to the SEC's Release No. 33-8040, "Cautionary Advice Regarding
Disclosure About Critical Accounting Policies," we have identified the
accounting principles which we believe are most critical to our reported
financial status by considering accounting policies that involve the most
complex or subjective decisions or assessments. We identified our most critical
accounting policies to be those related to revenue recognition, the assessment
of goodwill impairment, our allowance for doubtful accounts receivable, the
recording of our self-insurance liabilities and our estimation of the valuation
allowance for deferred tax assets. These accounting policies, as well as others,
are described in the Note 2 of "Notes to Consolidated Financial Statements" of
our Annual report on Form 10-K for the year ended September 30, 2003 and at
relevant sections in this discussion and analysis.
We enter into contracts principally on the basis of competitive bids. We
frequently negotiate the final terms and prices of those contracts with the
customer. Although the terms of our contracts vary considerably, most are made
on either a fixed price or unit price basis in which we agree to do the work for
a fixed amount for the entire project (fixed price) or for units of work
performed (unit price). We also perform services on a cost-plus or time and
materials basis. We are generally able to achieve higher margins on fixed price
and unit price than on cost-plus contracts. We currently generate, and expect to
continue to generate, more than half of our revenues under fixed price
contracts. Our most significant cost drivers are the cost of labor, the cost of
materials
15
and the cost of casualty and health insurance. These costs may vary from the
costs we originally estimated. Variations from estimated contract costs along
with other risks inherent in performing fixed price and unit price contracts may
result in actual revenue and gross profits for a project differing from those we
originally estimated and could result in losses on projects. Depending on the
size of a particular project, variations from estimated project costs could have
a significant impact on our operating results for any fiscal quarter or year. We
believe our exposure to losses on fixed price contracts is limited in aggregate
by the high volume and relatively short duration of the fixed price contracts we
undertake. Additionally, we derive a significant amount of our revenues from new
construction and from the southern part of the United States. Downturns in new
construction activity or in construction in the southern United States could
affect our results.
We complete most projects within one year. We frequently provide service and
maintenance work under open-ended, unit price master service agreements which
are renewable annually. We recognize revenue on service and time and material
work when services are performed. Work performed under a construction contract
generally provides that the customers accept completion of progress to date and
compensate us for services rendered measured in terms of units installed, hours
expended or some other measure of progress. Revenues from construction contracts
are recognized on the percentage-of-completion method in accordance with the
American Institute of Certified Public Accountants Statement of Position 81-1
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts." Percentage-of-completion for construction contracts is measured
principally by the percentage of costs incurred and accrued to date for each
contract to the estimated total costs for each contract at completion. We
generally consider contracts to be substantially complete upon departure from
the work site and acceptance by the customer. Contract costs include all direct
material and labor costs and those indirect costs related to contract
performance, such as indirect labor, supplies, tools, repairs and depreciation
costs. Changes in job performance, job conditions, estimated contract costs and
profitability and final contract settlements may result in revisions to costs
and income, and the effects of these revisions are recognized in the period in
which the revisions are determined. Provisions for total estimated losses on
uncompleted contracts are made in the period in which such losses are
determined.
We evaluate goodwill for potential impairment in accordance with Statement of
Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets." Included in this evaluation are certain assumptions and estimates to
determine the fair values of reporting units such as estimates of future cash
flows, discount rates, as well as assumptions and estimates related to the
valuation of other identified intangible assets. Changes in these assumptions
and estimates or significant changes to the market value of our common stock
could materially impact our results of operations or financial position.
We provide an allowance for doubtful accounts for unknown collection issues in
addition to reserves for specific accounts receivable where collection is
considered doubtful. Inherent in the assessment of the allowance for doubtful
accounts are certain judgments and estimates including, among others, our
customers' access to capital, our customers' willingness to pay, general
economic conditions and the ongoing relationships with our customers.
We are insured for workers' compensation, automobile liability, general
liability and employee-related health care claims, subject to large deductibles.
Our general liability program provides coverage for bodily injury and property
damage neither expected nor intended. Losses up to the
16
deductible amounts are accrued based upon our estimates of the liability for
claims incurred and an estimate of claims incurred but not reported. The
accruals are derived from actuarial studies, known facts, historical trends and
industry averages utilizing the assistance of an actuary to determine the best
estimate of the ultimate expected loss. We believe such accruals to be adequate.
However, insurance liabilities are difficult to assess and estimate due to
unknown factors, including the severity of an injury, the determination of our
liability in proportion to other parties, the number of incidents not reported
and the effectiveness of our safety program. Therefore, if actual experience
differs from the assumptions used in the actuarial valuation, adjustments to
the reserve may be required and would be recorded in the period that the
experience becomes known.
We regularly evaluate valuation allowances established for deferred tax assets
for which future realization is uncertain. We perform this evaluation at least
annually at the end of each fiscal year and at such time as events have occurred
or are anticipated to occur that may change our most recent assessment. The
estimation of required valuation allowances includes estimates of future taxable
income. In assessing the realizability of deferred tax assets at December 31,
2003, we considered whether it was more likely than not that some portion or all
of the deferred tax assets would not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable income
during the periods in which those temporary differences become deductible. We
consider the scheduled reversal of deferred tax liabilities, projected future
taxable income and tax planning strategies in making this assessment. If actual
future taxable income differs from our estimates, our results could be affected.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 COMPARED TO
THE THREE MONTHS ENDED DECEMBER 31, 2003
The following table presents selected unaudited historical financial information
for the three months ended December 31, 2002 and 2003.
Three Months Ended December 30,
--------------------------------------------
2002 % 2003 %
---- --- ---- ---
(dollars in millions)
Revenues................................................. $ 348.6 100% $ 359.8 100%
Cost of services (including depreciation)................ 297.2 85% 309.2 86%
------------ --- --------- ---
Gross profit..................................... 51.4 15% 50.6 14%
Selling, general & administrative expenses............... 38.6 11% 36.3 10%
------------ --- ---------- ---
Income from operations........................... 12.8 4% 14.3 4%
Interest and other expense, net.......................... 6.6 2% 6.4 2%
------------ --- ---------- ---
Income before income taxes............................... 6.2 2% 7.9 2%
Provision for income taxes............................... 2.4 1% 1.7 0%
------------ --- ---------- ---
Net income....................................... $ 3.8 1% $ 6.2 2%
============ === ========== ===
17
REVENUES
PERCENT OF TOTAL REVENUES
-------------------------------
THREE MONTHS ENDED DECEMBER 30,
-------------------------------
2002 2003
---- ----
Commercial and Industrial 78% 80%
Residential 22% 20%
-- --
Total Company 100% 100%
=== ===
Total revenues increased $11.2 million, or 3%, from $348.6 million for the three
months ended December 31, 2002, to $359.8 million for the three months ended
December 31, 2003. This increase in revenues is primarily the result of $12.4
million of revenues due to an acquisition that was included in the results of
operations for the three months ended December 31, 2003 but was not owned by
us during the three months ended December 31, 2002. Revenues were further
increased by a shift in the type of contract work performed from small service
and communications work to larger industrial project work. This shift in the
type of work performed decreased our service and communications revenues by
approximately $8.1 million, but increased industrial revenues by approximately
$11.0 million. These increases were countered by a $5.3 million decline in
residential work, particularly in the multi-family sector, due to market
contractions.
Commercial and industrial revenues increased $16.6 million, or 6%, from $271.6
million for the three months ended December 31, 2002, to $288.2 million for the
three months ended December 31, 2003. This increase in revenues is primarily the
result of $12.4 million of revenues due to an acquisition that was included in
the results of operations for the three months ended December 31, 2003 but was
not owned by us during the three months ended December 31, 2002. Commercial and
Industrial revenues were further increased by a $8.1 million increase in work
performed on industrial contracts, primarily for distribution, military and
airport work, offset by a decline in utility work. This increase was offset by a
decline in per-call service work telecom and line work on communications
projects.
Residential revenues decreased $5.3 million, or 7%, from $77.0 million for the
three months ended December 31, 2002, to $71.7 million for the three months
ended December 31, 2003, primarily as a result of a decline in single-family
residential work performed in Florida.
GROSS PROFIT
SEGMENT GROSS PROFIT MARGINS
AS A PERCENT OF SEGMENT REVENUES
---------------------------------
THREE MONTHS ENDED DECEMBER 30,
---------------------------------
2002 2003
---- ----
Commercial and Industrial 13% 12%
Residential 22% 21%
-- --
Total Company 15% 14%
== ==
18
Gross profit decreased $0.8 million, or 1%, from $51.4 million for the three
months ended December 31, 2002, to $50.6 million for the three months ended
December 31, 2003. Gross profit margin as a percentage of revenues decreased
from 15% for the three months ended December 31, 2002, to 14% for the three
months ended December 31, 2003. The decline in gross margin during the three
months ended December 31, 2003 was due to the shift in type of commercial and
industrial work performed and due to the increased competition for available
residential work.
Commercial and industrial gross profit increased $1.3 million, or 4%, from $34.3
million for the three months ended December 31, 2002, to $35.6 million for the
three months ended December 31, 2003. Commercial and industrial gross profit
margin as a percentage of revenues decreased from 13% for the three months ended
December 31, 2002, to 12% for the three months ended December 31, 2003. The
increase in commercial and industrial gross profit was due to higher revenues
earned year over year as discussed above and due to a shift in the type of
commercial and industrial work performed during the three months ended December
31, 2003. We were awarded $87.1 million in larger project work during the year
ended September 30, 2003, particularly industrial contracts in excess of $1.0
million. These larger projects, which were a source of revenues during the three
months ended December 31, 2003, produce gross profits but tend to earn lower
gross margins as a percentage of revenue due to the competitive bidding
procedures in place to be awarded this type of work. The shift of project work
from small projects such as the service and maintenance work to larger projects
in excess of $1.0 million impacted gross profits by approximately $0.8 million.
Residential gross profit decreased $2.0 million, or 12%, from $17.0 million for
the three months ended December 31, 2002, to $15.0 million for the three months
ended December 31, 2003. Residential gross profit margin as a percentage of
revenues decreased from 22% for the three months ended December 31, 2002, to 21%
for the three months ended December 31, 2003. This decrease in gross profit
margin as a percentage of revenues was primarily the result of increased costs
incurred due to the increased price of copperwire during the three months ended
December 31, 2003 and increased competition for available work. We believe
record low interest rates during recent years is driving demand for new homes.
The sustained high level of residential construction has increased the number of
service providers in the sector, resulting in increased pricing pressure for
available work, particularly affecting our operating units that perform limited
amounts of residential work in addition to their commercial and industrial
contract expertise.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased $2.3 million, or 6%, from
$38.6 million for the three months ended December 31, 2002, to $36.3 million for
the three months ended December 31, 2003. Selling, general and administrative
expenses as a percentage of revenues decreased one percentage point from 11% for
the three months ended December 31, 2002 to 10% for the three months ended
December 31, 2003. This decrease primarily results from an organizational
restructuring that occurred during the last two years where we streamlined our
administrative cost structure, yielding savings of approximately $3.6 million in
salaries and benefits. The decrease also reflects a $0.4 million release of
accrued restructuring charges for one individual that settled during the three
months ended December 31, 2003 and a $0.6 million decrease in bad debt expense
during the three months ended December 31, 2003 compared to the three months
ended December 31, 2002.
19
INCOME FROM OPERATIONS
Income from operations increased $1.5 million, or 12%, from $12.8 million for
the three months ended December 31, 2002, to $14.3 million for the three months
ended December 31, 2003. This increase in income from operations was primarily
attributed to a $11.2 million increase in revenues earned year over year, a $2.3
million decrease in selling, general and administrative expenses, offset by a
one percentage point decrease in gross profit earned on those revenues as
discussed.
NET INTEREST AND OTHER EXPENSE
Interest and other expense, net, decreased $0.2 million, or 3%, from $6.6
million for the three months ended December 31, 2002, to $6.4 million for the
three months ended December 31, 2003. This decrease in net interest and other
expense was primarily attributed to income generated by our captive insurance
subsidiary during the three months ended December 31, 2003.
PROVISION FOR INCOME TAXES
Our effective tax rate decreased from 38.5% for the three months ended December
31, 2002 to 21.8% for the three months ended December 31, 2003. This decrease is
attributable to the release of $1.4 million of tax effected valuation allowances
that were included in the tax provision during the three months ended December
31, 2003. We released these valuation allowances because we believe that we will
now realize a portion of the deferred tax assets for which they were
established. Without the impact of these valuation allowance releases, our
effective tax rate was 39.75% for the three months ended December 31, 2003. This
increase in our effective tax rate from 38.5% for the three months ended
December 31, 2002 to 39.75% for the three months ended December 31, 2003 is
attributable to an increase in state net operating loss valuation allowances and
additional reserves for potential tax liability related to tax return filing
positions taken by the Company.
20
WORKING CAPITAL
SEPTEMBER DECEMBER
30, 2003 31, 2003
------------------- -----------------
CURRENT ASSETS:
Cash and cash equivalents................................................. $ 40,201 $ 44,153
Accounts receivable:
Trade, net of allowance of $5,425 and $4,238 respectively............. 245,618 236,862
Retainage............................................................. 68,789 68,829
Related party......................................................... 67 36
Costs and estimated earnings in excess of billings on
uncompleted contracts.................................................... 48,256 49,226
Inventories............................................................... 20,473 22,647
Prepaid expenses and other current assets................................. 23,319 24,728
----------- ---------
Total current assets.............................................. $ 446,723 $ 446,481
----------- ---------
CURRENT LIABILITIES:
Current maturities of long-term debt...................................... $ 256 $ 186
Accounts payable and accrued expenses..................................... 138,143 126,905
Billings in excess of costs and estimated earnings on
uncompleted contracts.................................................... 41,913 42,067
----------- ---------
Total current liabilities......................................... $ 180,312 $ 169,158
----------- ---------
Working capital........................................................... $ 266,411 $ 277,323
=========== =========
Total current assets decreased $0.2 million, or 0%, from $446.7 million as of
September 30, 2003 to $446.5 million as of December 31, 2003. This decrease is
primarily the result of a $8.8 million decrease in trade accounts receivable,
net, due to a company-wide focus on collections and the timing of billings on
projects in progress. Working capital was increased by a $4.0 million increase
in cash and cash equivalents due to $6.4 million in cash provided by operations
during the three months ended December 31, 2003, offset by $1.9 million in cash
used in investing activities and $0.5 million used in financing activities. See
"Liquidity and Capital Resources" below for further information. Current assets
were further increased by a $2.2 million increase in inventories due to the
timing of installation of purchased materials for certain projects in progress
during the three months ended December 31, 2003.
Total current liabilities decreased $11.1 million, or 6%, from $180.3 million as
of September 30, 2003 to $169.2 million as of December 31, 2003. This decrease
is primarily the result of a $11.2 million decrease in accounts payable and
accrued expenses due to the timing of payments made.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2003, we had cash and cash equivalents of $44.2 million,
working capital of $277.3 million, no outstanding borrowings under our credit
facility, $30.0 million of letters of credit outstanding, and available capacity
under our credit facility of $95.0 million. The amount outstanding under our
senior subordinated notes was $247.9 million. All debt obligations are on our
balance sheet.
21
During the three months ended December 31, 2003, we generated $6.4 million of
net cash from operating activities. This net cash provided by operating
activities was comprised of net income of $6.2 million, increased by $1.7
million of non-cash charges related primarily to depreciation expense,offset by
the reversal of deferred income taxes and further increased by changes in
working capital. Working capital changes consisted of an $9.0 million decrease
in trade accounts receivable, net, due to the timing of collections. Working
capital changes also included a $2.2 million increase in inventory and an $8.3
million decrease in accounts payable and accrued expenses as a result of the
timing of payments made, with the balance of the change due to other working
capital changes. Net cash used in investing activities was $1.9 million,
consisting primarily of $1.7 million used for capital expenditures and $0.4
million invested in securities, offset by $0.2 million in proceeds from the
sale of fixed assets. Net cash used in financing activities was $0.5 million,
resulting primarily from $3.4 million used in the acquisition of treasury
stock, offset by $2.9 million received from the exercise of stock options.
On May 27, 2003, we amended our $150.0 million revolving credit facility to a
$125.0 million revolving credit facility with a syndicate of lending
institutions to be used for working capital, capital expenditure, acquisitions
and other corporate purposes that matures May 22, 2006, as amended. Amounts
borrowed under the credit facility bear interest at an annual rate equal to
either (a) the London interbank offered rate (LIBOR) plus 1.75 percent to 3.50
percent, as determined by the ratio of our total funded debt to EBITDA (as
defined in the credit facility) or (b) the higher of (i) the bank's prime rate
or (ii) the Federal funds rate plus 0.50 percent plus an additional 0.25 percent
to 2.00 percent, as determined by the ratio of our total funded debt to EBITDA.
Commitment fees of 0.375 percent to 0.50 percent are assessed on any unused
borrowing capacity under the credit facility. Our existing and future
subsidiaries guarantee the repayment of all amounts due under the facility, and
the facility is secured by the capital stock of those subsidiaries and the
accounts receivable of the company and those subsidiaries. Borrowings under the
credit facility are limited to 66 2/3% of outstanding receivables (as defined in
the agreement). The credit facility requires the consent of the lenders for
acquisitions exceeding a certain level of cash consideration, prohibits the
payment of cash dividends on the common stock, restricts our ability to
repurchase shares of common stock or to retire senior subordinated notes,
restricts our ability to incur other indebtedness and requires us to comply with
various affirmative and negative covenants including certain financial
covenants. Among other restrictions, the financial covenants include a minimum
net worth requirement, a maximum total consolidated funded debt to EBITDA ratio,
a maximum senior consolidated debt to EBITDA ratio and a minimum interest
coverage ratio. For more information regarding the covenants to our credit
facility, as amended, see our filing on Form 8-K dated May 28, 2003. We were in
compliance with the financial covenants of our credit facility, as amended, at
December 31, 2003. As of January 27, 2004, we had no outstanding borrowings on
our credit facility.
On January 25, 1999 and May 29, 2001, we completed our offerings of $150.0
million and $125.0 million senior subordinated notes, respectively. The offering
completed on May 29, 2001 yielded $117.0 million in proceeds, net of a $4.2
million discount and $3.9 million in offering costs. The proceeds from the May
29, 2001 offering were used primarily to repay amounts outstanding under our
credit facility. The notes bear interest at 9 3/8% and will mature on February
1, 2009. We pay interest on the notes on February 1 and August 1 of each year.
The
22
notes are unsecured senior subordinated obligations and are subordinated to all
of our existing and future senior indebtedness. The notes are guaranteed on a
senior subordinated basis by all of our subsidiaries. Under the terms of the
notes, we are required to comply with various affirmative and negative covenants
including (1) restrictions on additional indebtedness, and (2) restrictions on
liens, guarantees and dividends. During the year ended September 30, 2002, we
retired approximately $27.1 million of these senior subordinated notes. At
December 31, 2003, we had $247.9 million in outstanding senior subordinated
notes.
We utilized approximately $2.7 million cash, net of cash acquired, to purchase
Riviera Electric LLC in Denver, Colorado on February 27, 2003.
All of our operating income and cash flows are generated by our wholly owned
subsidiaries, which are the subsidiary guarantors of our outstanding senior
subordinated notes. We are structured as a holding company and substantially all
of our assets and operations are held by our subsidiaries. There are currently
no significant restrictions on our ability to obtain funds from our subsidiaries
by dividend or loan. Our parent holding company's independent assets, revenues,
income before taxes and operating cash flows are less than 3% of the
consolidated total. The separate financial statements of the subsidiary
guarantors are not included herein because (i) the subsidiary guarantors are all
of the direct and indirect subsidiaries of the company; (ii) the subsidiary
guarantors have fully and unconditionally, jointly and severally guaranteed the
senior subordinated notes; and (iii) the aggregate assets, liabilities, earnings
and equity of the subsidiary guarantors is substantially equivalent to the
assets, liabilities, earnings and equity of the company on a consolidated basis.
As a result, the presentation of separate financial statements and other
disclosures concerning the subsidiary guarantors is not deemed material.
Other Commitments. As is common in our industry, we have entered into certain
off balance sheet arrangements that expose us to increased risk. Our significant
off balance sheet transactions include liabilities associated with noncancelable
operating leases, letter of credit obligations and surety guarantees.
We enter into noncancelable operating leases for many of our vehicle and
equipment needs. These leases allow us to retain our cash when we do not own the
vehicles or equipment and we pay a monthly lease rental fee. At the end of the
lease, we have no further obligation to the lessor. We may determine to cancel
or terminate a lease before the end of its term. Typically, we are liable to the
lessor for various lease cancellation or termination costs and the difference
between the then fair market value of the leased asset and the implied book
value of the leased asset as calculated in accordance with the lease agreement.
Some of our customers require us to post letters of credit as a means of
guaranteeing performance under our contracts and ensuring payment by us to
subcontractors and vendors. If our customer has reasonable cause to effect
payment under a letter of credit, we would be required to reimburse our creditor
for the letter of credit. Depending on the circumstances surrounding a
reimbursement to our creditor, we may have a charge to earnings in that period.
To date, we have not had a situation where a customer has had reasonable cause
to effect payment under a letter of credit. At December 31, 2003, $1.6 million
of our outstanding letters of credit were to collateralize our customers.
23
Some of the underwriters of our casualty insurance programs require us to post
letters of credit as collateral. This is common in the insurance industry. To
date we have not had a situation where an underwriter has had reasonable cause
to effect payment under a letter of credit. At December 31, 2003, $28.4 million
of our outstanding letters of credit were to collateralize our insurance
programs.
Many of our customers require us to post performance and payment bonds issued by
a surety. Those bonds guarantee the customer that we will perform under the
terms of a contract and that we will pay subcontractors and vendors. In the
event that we fail to perform under a contract or pay subcontractors and
vendors, the customer may demand the surety to pay or perform under our bond.
Our relationship with our surety is such that we will indemnify the surety for
any expenses it incurs in connection with any of the bonds it issues on our
behalf. To date, we have not incurred significant expenses to indemnify our
surety for expenses it incurred on our behalf. As of December 31, 2003, our cost
to complete projects covered by surety bonds was approximately $226 million.
We have committed to invest up to $5.0 million in EnerTech Capital Partners II,
L.P. ("EnerTech"). EnerTech is a private equity firm specializing in investment
opportunities emerging from the deregulation and resulting convergence of the
energy, utility and telecommunications industries. Through December 31, 2003, we
had invested $3.1 million under our commitment to EnerTech.
Our future contractual obligations include (in thousands):
LESS THAN
ONE YEAR 2004 2005 2006 2007 THEREAFTER TOTAL
---------- ---------- ---------- ---------- ---------- -------------- -----------
Debt and capital lease obligations... $ 186 $ 127 $ 20 $ 8 $ 14 $ 247,885 $ 248,240
Operating lease obligations.......... $ 11,679 $ 10,903 $ 6,967 $ 4,531 $ 3,026 $ 1,751 $ 38,857
Our other commercial commitments expire as follows (in thousands):
LESS THAN
ONE YEAR 2004 2005 2006 2007 THEREAFTER TOTAL
---------- ---------- ---------- ---------- ---------- -------------- -----------
Standby letters of credit............ $ 30,004 $ -- $ -- $ -- $ -- $ -- $ 30,004
Other commercial commitments......... $ -- $ -- $ -- $ -- $ -- $ 1,900 (1) $ 1,900
(1) Balance of investment commitment in EnerTech.
Outlook. The following statements are based on current expectations. These
statements are forward-looking and actual results may differ materially.
Economic conditions across the country are challenging. We continue to focus on
collecting receivables and reducing days sales outstanding. To improve our
position for continued success, we continue to take steps to reduce costs. We
have made significant cuts in administrative overhead at the home office and in
the field. Although we have seen signs of improvement in our quarter ended
December 30, 2003, the economic outlook for the remainder of fiscal 2004 is
still somewhat uncertain. We expect earnings per share in the second quarter of
fiscal 2004 to range between $0.10 and $0.15 per share. For the year ended
September 30, 2004, we expect earnings to range between $0.55 and $0.75 per
share.
24
We expect to generate cash flow from operations. Our cash flows from operations
tend to track with the seasonality of our business and historically have
improved in the latter part of our fiscal year. We anticipate that our cash flow
from operations will provide sufficient cash to enable us to meet our working
capital needs, debt service requirements and capital expenditures for property
and equipment through the next twelve months. We expect capital expenditures of
approximately $12 million for the fiscal year ended September 30, 2004. Our
ability to generate cash flow from operations is dependent on many factors,
including demand for our products and services, the availability of work at
margins acceptable to us and the ultimate collectibility of our receivables. See
"Disclosure Regarding Forward-Looking Statements" contained in our annual report
for the year ended September 30, 2003, filed on Form 10-K with the Securities
and Exchange Commission.
SEASONALITY AND QUARTERLY FLUCTUATIONS
Our results of operations from residential construction are seasonal, depending
on weather trends, with typically higher revenues generated during spring and
summer and lower revenues during fall and winter. The commercial and industrial
aspect of our business is less subject to seasonal trends, as this work
generally is performed inside structures protected from the weather. Our service
and maintenance business is generally not affected by seasonality. In addition,
the construction industry has historically been highly cyclical. Our volume of
business may be adversely affected by declines in construction projects
resulting from adverse regional or national economic conditions. Quarterly
results may also be materially affected by the timing of new construction
projects, acquisitions and the timing and magnitude of acquisition assimilation
costs. Accordingly, operating results for any fiscal period are not necessarily
indicative of results that may be achieved for any subsequent fiscal period.
NEW ACCOUNTING PRONOUNCEMENT
In January 2003, the Financial Accounting Standards Board issued Interpretation
No. 46, "Consolidation of Variable Interest Entities," ("Interpretation 46").
The objective of Interpretation 46 is to improve the financial reporting by
companies involved with variable interest entities. Until now, one company
generally has included another entity in its consolidated financial statements
only if it controlled the entity through voting interest. Interpretation 46
changes that by requiring a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The consolidation requirements of
Interpretation 46 apply immediately to variable interest entities created after
January 31, 2003. The consolidation requirements apply to older entities in the
first fiscal year or interim period ending after March 31, 2004. Certain
disclosure requirements apply to all financial statements issued after January
31, 2003, regardless of when the variable interest entity was established. We
have minority interests in two firms, EnerTech Capital Partners II, L.P. and
Energy Photovoltaics, Inc., and a joint venture that may fall under this
interpretation. The adoption of this statement does not have a material impact
on our results of operations or financial position.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
25
Management is actively involved in monitoring exposure to market risk and
continues to develop and utilize appropriate risk management techniques. We are
not exposed to any significant market risks from commodity price risk or foreign
currency exchange risk. Our exposure to significant market risks includes
outstanding borrowings under our floating rate credit facility. Management does
not use derivative financial instruments for trading purposes or to speculate on
changes in interest rates or commodity prices.
As a result, our exposure to changes in interest rates results from our
short-term and long-term debt with both fixed and floating interest rates. The
following table presents principal or notional amounts (stated in thousands) and
related interest rates by year of maturity for our debt obligations and their
indicated fair market value at December 31, 2003:
2004 2005 2006 2007 2008 THEREAFTER TOTAL
---------- ---------- ---------- ---------- ---------- ----------- -----------
Liabilities-Debt:
Fixed Rate (senior subordinated notes).. $ -- $ -- $ -- $ -- $ -- $247,885 $ 247,885
Interest Rate .......................... 9.375% 9.375% 9.375% 9.375% 9.375% 9.375% 9.375%
Fair Value of Debt:
Fixed Rate $ 260,279
ITEM 4. CONTROLS AND PROCEDURES
As of December 31, 2003, an evaluation was performed under the supervision and
with the participation of the Company's management, including the CEO and CFO,
of the effectiveness of the design and operation of the Company's disclosure
controls and procedures. Based on that evaluation, the Company's management,
including the CEO and CFO, concluded that the Company's disclosure controls and
procedures were effective as of December 31, 2003 in providing reasonable
assurances that material information required to be disclosed is included on a
timely basis in the reports it files with the Securities and Exchange
Commission.
Since the date of the evaluation, there have been no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls.
26
INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS
31.1 Certification of Herbert R. Allen, Chief Executive Officer,
pursuant to Section 302 of The Sarbanes-Oxley Act of 2002.
31.2 Certification of William W. Reynolds, Chief Financial Officer,
pursuant to Section 302 of The Sarbanes-Oxley Act of 2002.
32.1 Certification of Herbert R. Allen, Chief Executive Officer,
pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
32.2 Certification of William W. Reynolds, Chief Financial Officer,
pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
B. REPORTS ON FORM 8-K
On October 24, 2003, the Company filed an amendment to its 8-K filed
May 12, 2003 on Form 8-K/A.
27
INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, who has signed this report on behalf of
the Registrant and as the principal financial officer of the Registrant.
INTEGRATED ELECTRICAL SERVICES, INC.
Date: January 29, 2004 By: /s/ William W. Reynolds
----------------------------------
William W. Reynolds
Executive Vice President and
Chief Financial Officer
28
EXHIBIT INDEX
EXHIBITS DESCRIPTION OF EXHIBITS
31.1 Certification of Herbert R. Allen, Chief Executive Officer,
pursuant to Section 302 of The Sarbanes-Oxley Act of 2002.
31.2 Certification of William W. Reynolds, Chief Financial Officer,
pursuant to Section 302 of The Sarbanes-Oxley Act of 2002.
32.1 Certification of Herbert R. Allen, Chief Executive Officer,
pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
32.2 Certification of William W. Reynolds, Chief Financial Officer,
pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.