1 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 June 30, 2001 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 77027-3290 (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 August 10, 2001, of the issuer's common stock was 37,114,325 and of the issuer's restricted voting common stock was 2,605,709.
2 INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES INDEX PART I. FINANCIAL INFORMATION Page ---- Item 1. Financial Statements Consolidated Balance Sheets as of September 30, 2000 and June 30, 2001 ....................................................... 2 Consolidated Statements of Operations and Comprehensive Income for the nine months ended June 30, 2000 and 2001 ................... 3 Consolidated Statements of Operations and Comprehensive Income for the three months ended June 30, 2000 and 2001 ................... 4 Consolidated Statement of Stockholders' Equity for the nine months ended June 30, 2001 ....................................................... 5 Consolidated Statements of Cash Flows for the nine months ended June 30, 2000 and 2001 .............................................. 6 Consolidated Statements of Cash Flows for the three months ended June 30, 2000 and 2001 .............................................. 7 Condensed Notes to Consolidated Financial Statements ................... 8 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 PART II. OTHER INFORMATION Signatures ................................................................ 26 1
3 INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE INFORMATION) September 30, June 30, 2000 2001 ----------- ----------- (Audited) (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents ............................................... $ 770 $ 421 Accounts receivable: Trade, net of allowance of $7,121 and $5,463 respectively ............ 300,038 268,129 Retainage ............................................................ 67,851 65,405 Related parties ...................................................... 256 225 Costs and estimated earnings in excess of billings on uncompleted contracts ................................................ 51,119 55,610 Inventories, net ........................................................ 16,861 21,019 Prepaid expenses and other current assets ............................... 8,857 27,833 ----------- ----------- Total current assets ................................................. 445,752 438,642 PROPERTY AND EQUIPMENT, net ............................................. 61,367 68,774 GOODWILL, net ........................................................... 496,212 485,899 OTHER NON-CURRENT ASSETS ................................................ 16,659 24,572 ----------- ----------- Total assets ....................................................... $ 1,019,990 $ 1,017,887 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Short-term debt and current maturities of long-term debt ................ $ 93,903 $ 787 Accounts payable and accrued expenses ................................... 202,047 146,257 Income taxes payable .................................................... 1,166 7,150 Billings in excess of costs and estimated earnings on uncompleted contracts ................................................ 56,993 59,006 ----------- ----------- Total current liabilities ............................................ 354,109 213,200 LONG-TERM DEBT, net of current maturities ............................... 1,162 994 SENIOR SUBORDINATED NOTES, net of $1,073 and $5,117 unamortized discount, respectively ................................... 148,927 269,883 OTHER NON-CURRENT LIABILITIES ........................................... 8,043 8,412 ----------- ----------- Total liabilities .................................................. 512,241 492,489 ----------- ----------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value, 10,000,000 shares authorized, none issued or outstanding ............................ -- -- Common stock, $.01 par value, 100,000,000 shares authorized, 38,099,079 and 38,330,676 shares issued, respectively.............. 381 383 Restricted common stock, $.01 par value, 2,655,709 shares authorized, 2,655,709 and 2,605,709 shares outstanding, respectively........... 27 26 Treasury stock, at cost, none and 1,217,347 shares, respectively...... -- (8,909) Additional paid-in capital ........................................... 427,332 428,193 Retained earnings .................................................... 80,009 105,625 Accumulated other comprehensive income ............................... -- 80 ----------- ----------- Total stockholders' equity ......................................... 507,749 525,398 ----------- ----------- Total liabilities and stockholders' equity ......................... $ 1,019,990 $ 1,017,887 =========== =========== The accompanying condensed notes to financial statements are an integral part of these financial statements. 2
4 INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (IN THOUSANDS, EXCEPT SHARE INFORMATION) Nine Months Ended June 30, ------------------------------ 2000 2001 ------------ ------------ (Unaudited) Revenues ..................................... $ 1,157,667 $ 1,269,575 Cost of services (including depreciation) .... 957,139 1,036,530 ------------ ------------ Gross profit ............................ 200,528 233,045 Selling, general and administrative expenses . 150,864 156,744 Goodwill amortization ........................ 9,966 9,737 ------------ ------------ Income from operations .................. 39,698 66,564 ------------ ------------ Other (income)/expense: Interest expense ........................ 17,156 18,993 Gain on sales of assets ................. (92) (98) Other (income) expense, net ............. (935) 367 ------------ ------------ 16,129 19,262 ------------ ------------ Income before income taxes ................... 23,569 47,302 Provision for income taxes ................... 13,356 21,686 ------------ ------------ Net income ................................... $ 10,213 $ 25,616 ============ ============ Other comprehensive income, net of tax: Unrealized gains from available for sale securities .............................. -- 80 ============ ============ Comprehensive income ......................... $ 10,213 $ 25,696 ============ ============ Basic earnings per share ..................... $ 0.25 $ 0.63 ============ ============ Diluted earnings per share ................... $ 0.25 $ 0.62 ============ ============ Shares used in the computation of earnings per share (Note 4) Basic ................................... 40,066,403 40,637,478 ============ ============ Diluted ................................. 40,649,541 41,114,463 ============ ============ The accompanying condensed notes to financial statements are an integral part of these financial statements. 3
5 INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (IN THOUSANDS, EXCEPT SHARE INFORMATION) Three Months Ended June 30, 2000 2001 ------------ ------------ (Unaudited) Revenues ..................................... $ 452,149 $ 423,988 Cost of services (including depreciation) .... 374,101 342,233 ------------ ------------ Gross profit ............................ 78,048 81,755 Selling, general and administrative expenses . 51,074 52,971 Goodwill amortization ........................ 3,246 3,244 ------------ ------------ Income from operations .................. 23,728 25,540 ------------ ------------ Other (income)/expense: Interest expense ........................ 5,761 6,499 (Gain)/loss on sale of assets ........... 97 (21) Other (income)/expense, net ............. (383) 54 ------------ ------------ 5,475 6,532 ------------ ------------ Income before income taxes ................... 18,253 19,008 Provision for income taxes ................... 8,169 8,475 ------------ ------------ Net income ................................... $ 10,084 $ 10,533 ============ ============ Other comprehensive income, net of tax: Unrealized losses from available for sale securities ................................... -- (27) ------------ ------------ Comprehensive income ......................... $ 10,084 $ 10,506 ============ ============ Basic earnings per share ..................... $ 0.25 $ 0.26 ============ ============ Diluted earnings per share ................... $ 0.25 $ 0.26 ============ ============ Shares used in the computation of earnings per share (Note 4) Basic ................................... 40,443,370 40,321,415 ============ ============ Diluted ................................. 40,791,970 40,956,004 ============ ============ The accompanying condensed notes to financial statements are an integral part of these financial statements. 4
6 INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE INFORMATION) Restricted Common Stock Common Stock Treasury Stock ------------ ------------ -------------- Shares Amount Shares Amount Shares Amount ------ ------ ------ ------ ------ ------ BALANCE, September 30, 2000 38,099,079 $ 381 2,655,709 $ 27 -- $ -- Issuance of stock (unaudited) ............... 224,428 2 (50,000) (1) -- -- Purchase of stock (unaudited) ............... -- -- -- -- (1,429,573) (10,104) Sale of stock (unaudited) . -- -- -- -- 207,642 1,173 Options exercised (unaudited) ............... 7,169 -- -- -- 4,584 22 Unrealized holding gain on securities (unaudited) . -- -- -- -- -- -- Net income (unaudited) .... -- -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- BALANCE, June 30, 2001 (unaudited) ............ 38,330,676 $ 383 2,605,709 $ 26 (1,217,347) $ (8,909) ========== ========== ========== ========== ========== ========== Accumulated Additional Other Total Paid In Retained Comprehensive Stockholders' Capital Earnings Income Equity ------- -------- ------ ------ BALANCE, September 30, 2000 $ 427,332 $ 80,009 $ -- $ 507,749 Issuance of stock (unaudited) ............... 1,028 -- -- 1,029 Purchase of stock (unaudited) ............... -- -- -- (10,104) Sale of stock (unaudited) . (193) -- -- 980 Options exercised (unaudited) ............... 26 -- -- 48 Unrealized holding gain on securities (unaudited) . -- -- 80 80 Net income (unaudited) .... -- 25,616 -- 25,616 ---------- ---------- ---------- ---------- BALANCE, June 30, 2001 (unaudited) ............ $ 428,193 $ 105,625 $ 80 $ 525,398 ========== ========== ========== ========== The accompanying condensed notes to financial statements are an integral part of these financial statements. 5
7 INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) Nine Months Ended June 30, 2000 2001 --------- --------- (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net income ................................................. $ 10,213 $ 25,616 Adjustments to reconcile net income to net cash provided by operating activities - Depreciation and amortization ......................... 24,508 21,354 Gain on sale of property and equipment ................ (92) (98) Non-cash compensation expense ......................... 4,147 426 Changes in operating assets and liabilities (Increase) decrease in: Accounts receivable, net ......................... (26,507) 34,393 Inventories ...................................... (5,637) (4,143) Costs and estimated earnings recognized in excess of billings on uncompleted contracts . (5,343) (4,146) Prepaid expenses and other current assets ........ (5,810) (18,827) Increase (decrease) in: Accounts payable and accrued expenses ............ 20,225 (55,704) Billings in excess of costs and estimated earnings recognized on uncompleted contracts ......... 22,624 2,358 Income taxes payable ............................. (407) 5,984 Other, net ....................................... 2,701 3,143 --------- --------- Net cash provided by operating activities ......... 40,622 10,356 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of businesses, net of cash acquired ............... (33,225) (233) Additions to property and equipment ........................ (21,062) (19,743) Investments in available for sale securities ............... -- (5,249) Proceeds from sale of property and equipment ............... 1,732 930 --------- --------- Net cash used by investing activities ............. (52,555) (24,295) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings ................................................. 50,434 212,565 Repayments of debt ......................................... (40,662) (185,570) Purchase of treasury stock ................................. -- (10,104) Payments for debt issuance costs ........................... -- (5,358) Proceeds from issuance of stock ............................ -- 1,029 Proceeds from sale of treasury stock ....................... -- 980 Proceeds from exercise of stock options .................... 3 48 --------- --------- Net cash provided by financing activities ......... 9,775 13,590 --------- --------- NET DECREASE IN CASH AND CASH EQUIVALENTS ....................... (2,158) (349) CASH AND CASH EQUIVALENTS, beginning of period .................. 2,931 770 --------- --------- CASH AND CASH EQUIVALENTS, end of period ........................ $ 773 $ 421 ========= ========= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for Interest .............................................. $ 17,415 $ 14,732 Income taxes .......................................... $ 17,615 $ 22,466 The accompanying condensed notes to financial statements are an integral part of these financial statements. 6
8 INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) Three Months Ended June 30, 2000 2001 --------- --------- (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net income ................................................. $ 10,084 $ 10,533 Adjustments to reconcile net income to net cash provided by operating activities - Depreciation and amortization ......................... 6,591 7,399 (Gain) loss on sale of property and equipment ......... 97 (21) Non-cash compensation expense ......................... 1,991 142 Changes in operating assets and liabilities (Increase) decrease in: Accounts receivable, net ......................... (27,054) (3,152) Inventories ...................................... (3,054) (3,618) Costs and estimated earnings recognized in excess of billings on uncompleted contracts . (1,154) (3,351) Prepaid expenses and other current assets ........ 186 (6,518) Increase (decrease) in: Accounts payable and accrued expenses ............ 11,425 242 Billings in excess of costs and estimated earnings recognized on uncompleted contracts ......... 17,957 512 Income taxes payable ............................. 781 5,088 Other, net ....................................... 5,318 2,053 --------- --------- Net cash provided by operating activities ......... 23,168 9,309 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of business, net of cash acquired ................. (1,044) -- Additions to property and equipment ........................ (5,652) (7,360) Investments in available for sale securities ............... -- (400) Proceeds from sale of property and equipment ............... 442 411 --------- --------- Net cash used in investing activities ............. (6,254) (7,349) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings ................................................. 2,030 155,565 Repayments of debt ......................................... (25,173) (143,813) Purchase of treasury stock ................................. -- (8,648) Payments for debt issuance costs ........................... -- (5,358) Proceeds from exercise of stock options .................... -- 48 Proceeds from issuance of stock ............................ -- 34 --------- --------- Net cash used in financing activities ............. (23,143) (2,172) --------- --------- NET DECREASE IN CASH AND CASH EQUIVALENTS ....................... (6,229) (212) CASH AND CASH EQUIVALENTS, beginning of period .................. 7,002 633 --------- --------- CASH AND CASH EQUIVALENTS, end of period ........................ $ 773 $ 421 ========= ========= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for Interest .............................................. $ 5,908 $ 2,657 Income taxes .......................................... $ 1,242 $ 3,376 The accompanying condensed notes to financial statements are an integral part of these financial statements. 7
9 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, communications solutions 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, 2000 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 nine months ended June 30, 2001, are not necessarily indicative of the results that may be expected for the fiscal year ended September 30, 2001. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES There were no significant changes in the accounting policies of the Company during the periods presented. For a description of these policies, refer to Note 2 of the Notes to Financial Statements included in the Company's Annual Report on Form 10-K for the year ended September 30, 2000. 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 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. 8
10 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, allowance for doubtful accounts and self insured claims liability. NEW ACCOUNTING PRONOUNCEMENTS In December 1999, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 101 (SAB 101). SAB 101 reflects the basic principles of revenue recognition in existing accounting principles generally accepted in the United States, and does not supersede any existing authoritative literature. The Company recognizes revenue from construction contracts 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," and as a result SAB 101 requires no change to the Company's revenue recognition policies. Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133, as amended, is required to be adopted for fiscal years beginning after June 15, 2000. The Company adopted SFAS No. 133, as amended, on October 1, 2000. Adoption of this statement did not have a material impact on the financial position or results of operations of the Company, as it has not engaged or entered into any arrangements usually associated with derivative instruments. On June 30, 2001 the Financial Accounting Standards Board ("FASB") adopted SFAS Nos. 141 "Business Combinations" and 142 "Goodwill and Other Intangible Assets." SFAS Nos. 141 and 142 are effective for fiscal years beginning after December 15, 2001. The Company plans to adopt these standards effective October 1, 2001. SFAS No. 141 requires that all business combinations initiated after June 30, 2001, to be accounted for using the purchase method. The Company does not believe that the effect on financial statements of the adoption of SFAS No. 141 will be material. SFAS No.142 requires that goodwill no longer be amortized but be subject to an annual assessment for impairment based on a fair value test. In addition, acquired intangible assets are required to be separately recognized if the benefit of the asset is based on contractual or legal rights. The Company is currently assessing the Statement and believes it could have a material impact on its consolidated financial statements. 2. WRITE-OFF OF CAPITALIZED SOFTWARE In accordance with its ongoing review of capitalized software, in March 2000, the Company curtailed the development of a complex and proprietary information system. This comprehensive information system had been under development for approximately one year. After a period of field testing, the Company determined that it was necessary to significantly alter the technological architecture of the system in order to reduce ongoing support, maintenance and communications costs. Accordingly, the Company recorded a pretax charge of approximately $6.8 million, of which $5.7 million was included in depreciation expense for the nine months ended June 30, 2000 to write-off the carrying value of the software costs, development costs and certain hardware and network infrastructure costs. 9
11 3. DEBT Credit Facility On May 22, 2001, the Company replaced its $175.0 million credit facility with a new $150.0 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, 2004 (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 2.75 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 up to an additional 1.25 percent, as determined by the ratio of the Company's total funded debt to EBITDA. Commitment fees of 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 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, 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 minimum net worth requirements, a maximum total consolidated funded debt to EBITDA ratio, a maximum senior consolidated debt to EBITDA ratio, and a minimum interest coverage ratio. The Company was in compliance with the financial covenants at June 30, 2001. As of June 30, 2001, the Company had no outstanding indebtedness under its Credit Facility, letters of credit outstanding under its Credit Facility of $5.3 million, $1.8 million of other borrowings and available borrowing capacity under its Credit Facility of $144.7 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 $117.2 million in proceeds to the Company, net of a $4.2 million discount and $3.6 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. 10
12 4. PER SHARE INFORMATION The following table reconciles the numerators and denominators of the basic and diluted earnings per share for the nine months ended June 30, 2000 and 2001 (in thousands, except share information): Nine Months Ended June 30, 2000 2001 ----------- ----------- Numerator: Net income .......................... $ 10,213 $ 25,616 =========== =========== Denominator: Weighted average shares outstanding - basic .................................. 40,066,403 40,637,478 Effect of dilutive stock options .... 583,138 476,985 ----------- ----------- Weighted average shares outstanding - diluted ................................ 40,649,541 41,114,463 =========== =========== Earnings per share: Basic ............................... $ 0.25 $ 0.63 Diluted ............................. $ 0.25 $ 0.62 For the nine months ended June 30, 2000 and 2001, stock options of 4.4 million and 5.1 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. The following table reconciles the numerators and denominators of the basic and diluted earnings per share for the three months ended June 30, 2000 and 2001 (in thousands, except share information): Three Months Ended June 30, 2000 2001 ----------- ----------- Numerator: Net income .......................... $ 10,084 $ 10,533 =========== =========== Denominator: Weighted average shares outstanding - 40,443,370 40,321,415 basic Effect of dilutive stock options .... 348,600 634,589 ----------- ----------- Weighted average shares outstanding - diluted ................................ 40,791,970 40,956,004 =========== =========== Earnings per share: Basic ............................... $ 0.25 $ 0.26 Diluted ............................. $ 0.25 $ 0.26 For the three months ended June 30, 2000 and 2001, stock options of 5.1 million and 4.4 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. 11
13 5. 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 four distinct customer groups. They are managed separately because each business requires different operating and marketing strategies. During fiscal 2000, the Company aligned its operations among two complementary core businesses: electrical contracting and communications solutions. Within the electrical contracting business, the Company has three reportable segments: commercial/industrial, residential and service and maintenance. The commercial/industrial segment provides design, installation, renovation and upgrades and replacement services in facilities such as office buildings, high-rise apartments and condominiums, theaters, restaurants, hotels, hospitals and critical-care facilities, school districts, manufacturing and processing facilities, military installations, airports, refineries and petrochemical and power plants. The residential segment consists of installation, replacement and renovation services in single family and low-rise multifamily housing units. The service and maintenance segment provides maintenance and replacement services from service calls and routine maintenance contracts. The communications solutions business provides installation service and maintenance, design, engineering and support services to outside plant, network enterprise and switch network customers. Other includes expenses associated with the Company's home office and regional infrastructure. 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 unallocated home office expenses. Management allocates costs between segments for selling, general and administrative expenses, goodwill amortization, depreciation expense, capital expenditures and total assets. Those methods used for allocation may change in the future. Segment information for the nine months ended June 30, 2000 and 2001 is as follows (in thousands): NINE MONTHS ENDED JUNE 30, 2000 ---------------------------------------------------------------------------------------------------- ELECTRICAL CONTRACTING ------------------------------------------------------- COMMERCIAL/ SERVICE AND COMMUNICATIONS INDUSTRIAL RESIDENTIAL MAINTENANCE SUBTOTAL SOLUTIONS OTHER TOTAL ---------- ---------- ---------- ---------- ---------- ---------- ---------- Revenues .................. $ 776,759 $ 177,852 $ 92,418 $1,047,029 $ 110,638 $ -- $1,157,667 Cost of services (including depreciation) ............. 666,652 135,877 72,298 874,827 82,312 -- 957,139 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Gross profit .............. 110,107 41,975 20,120 172,202 28,326 -- 200,528 Selling, general and administrative ............ 73,095 20,276 9,243 102,614 14,372 33,878 150,864 Goodwill amortization ..... 7,124 1,389 765 9,278 688 -- 9,966 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Operating income .......... $ 29,888 $ 20,310 $ 10,112 $ 60,310 $ 13,266 $(33,878) $ 39,698 ========== ========== ========== ========== ========== ========== ========== Other data: Depreciation expense ...... $ 5,135 $ 804 $ 572 $ 6,511 $ 1,965 $ 6,066 $ 14,542 Capital expenditures ...... 8,475 1,737 2,831 13,043 2,080 5,939 21,062 Total assets .............. 671,957 110,415 79,949 862,321 73,401 22,491 958,213 12
14 NINE MONTHS ENDED JUNE 30, 2001 ---------------------------------------------------------------------------------------------------- ELECTRICAL CONTRACTING ------------------------------------------------------- COMMERCIAL/ SERVICE AND COMMUNICATIONS INDUSTRIAL RESIDENTIAL MAINTENANCE SUBTOTAL SOLUTIONS OTHER TOTAL ---------- ---------- ---------- ---------- ---------- ---------- ---------- Revenues .................. $ 845,771 $ 193,903 $ 101,436 $1,141,110 $ 128,465 $ -- $1,269,575 Cost of services (including depreciation) ........... 705,825 148,461 78,059 932,345 104,185 -- 1,036,530 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Gross profit .............. 139,946 45,442 23,377 208,765 24,280 -- 233,045 Selling, general and administrative .......... 80,104 23,035 9,773 112,912 13,707 30,125 156,744 Goodwill amortization ..... 6,895 1,389 765 9,049 688 -- 9,737 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Operating income .......... $ 52,947 $ 21,018 $ 12,839 $ 86,804 $ 9,885 $ (30,125) $ 66,564 ========== ========== ========== ========== ========== ========== ========== Other data: Depreciation expense ...... $ 6,279 $ 1,288 $ 722 $ 8,289 $ 2,673 $ 655 $ 11,617 Capital expenditures ...... 6,600 1,533 2,586 10,719 3,737 5,287 19,743 Total assets .............. 666,236 114,221 79,904 860,361 93,581 63,945 1,017,887 Segment information for the three months ended June 30, 2000 and 2001 is as follows (in thousands): THREE MONTHS ENDED JUNE 30, 2000 ---------------------------------------------------------------------------------------------------- ELECTRICAL CONTRACTING ------------------------------------------------------- COMMERCIAL/ SERVICE AND COMMUNICATIONS INDUSTRIAL RESIDENTIAL MAINTENANCE SUBTOTAL SOLUTIONS OTHER TOTAL ---------- ---------- ---------- ---------- ---------- ---------- ---------- Revenues .................. $308,516 $ 61,618 $ 32,234 $402,368 $ 49,781 $ -- $452,149 Cost of services (including depreciation) ............. 266,634 45,127 25,149 336,910 37,191 -- 374,101 -------- -------- -------- -------- -------- -------- -------- Gross profit .............. 41,882 16,491 7,085 65,458 12,590 -- 78,048 Selling, general and administrative ............ 24,496 8,195 2,996 35,687 6,272 9,115 51,074 Goodwill amortization ..... 2,299 463 255 3,017 229 -- 3,246 -------- -------- -------- -------- -------- -------- -------- Operating income .......... $ 15,087 $ 7,833 $ 3,834 $ 26,754 $ 6,089 $ (9,115) $ 23,728 ======== ======== ======== ======== ======== ======== ======== Other data: Depreciation expense ...... $ 1,972 $ 276 $ 199 $ 2,447 $ 745 $ 153 $ 3,345 Capital expenditures ...... 3,239 658 611 4,508 916 228 5,652 Total assets .............. 671,957 110,415 79,949 862,321 73,401 22,491 958,213 THREE MONTHS ENDED JUNE 30, 2001 ---------------------------------------------------------------------------------------------------- ELECTRICAL CONTRACTING ------------------------------------------------------- COMMERCIAL/ SERVICE AND COMMUNICATIONS INDUSTRIAL RESIDENTIAL MAINTENANCE SUBTOTAL SOLUTIONS OTHER TOTAL ---------- ---------- ---------- ---------- ---------- ---------- ---------- Revenues .................. $ 275,349 $ 71,785 $ 32,202 $ 379,336 $ 44,652 $ -- $ 423,988 Cost of services (including depreciation) ............. 224,629 54,291 24,734 303,654 38,579 -- 342,233 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Gross profit .............. 50,720 17,494 7,468 75,682 6,073 -- 81,755 Selling, general and administrative............. 25,163 8,686 3,105 36,954 4,644 11,373 52,971 Goodwill amortization ..... 2,297 463 255 3,015 229 -- 3,244 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Operating income .......... $ 23,260 $ 8,345 $ 4,108 $ 35,713 $ 1,200 $ (11,373) $ 25,540 ========== ========== ========== ========== ========== ========== ========== Other data: Depreciation expense ...... $ 2,189 $ 460 $ 274 $ 2,923 $ 986 $ 246 $ 4,155 Capital expenditures ...... 2,311 498 1,237 4,046 1,308 2,006 7,360 Total assets .............. 666,236 114,221 79,904 860,361 93,581 63,945 1,017,887 The Company does not have significant operations or long-lived assets in countries outside of the United States. 13
15 6. 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 1999 and March 2000, the Company granted restricted stock awards of 609,306 and 400,000, respectively, under its stock plans to certain of its employees. The December 1999 awards vested in equal installments on May 31, 2000, and August 31, 2000, provided that the recipient was still employed by the Company. The March 2000 award vests in equal installments on March 20th of each year through 2004, provided the recipient is still employed by the Company. The market value of the underlying stock on the date of grant for the December 1999 and March 2000 awards was $5.2 million and $2.3 million, respectively, which is being recognized as compensation expense over the related vesting periods. During the nine months ended June 30, 2000 and 2001, the Company amortized $4.1 million and $0.4 million, respectively, to expense in connection with these awards. During the three months ended June 30, 2000 and 2001, the Company amortized $2.0 million and $0.1 million, respectively. 7. COMMITMENTS AND CONTINGENCIES The Company is 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, 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. The Company has committed to invest an additional $3.9 million in certain investment opportunities. 14
16 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, and 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, 2000. RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED JUNE 30, 2000 COMPARED TO THE NINE MONTHS ENDED JUNE 30, 2001 The following table presents selected unaudited historical financial information for the nine months ended June 30, 2000 and 2001. The historical results of operations presented below include the results of operations of our acquired companies beginning on their respective dates of acquisition. Nine Months Ended June 30, -------------------------------------- 2000 % 2001 % -------- --- -------- --- (dollars in millions) Revenues ................................. $1,157.7 100% $1,269.6 100% Cost of services (including depreciation) 957.2 83% 1,036.6 82% -------- --- -------- --- Gross profit ..................... 200.5 17% 233.0 18% Selling, general & administrative expenses 150.8 13% 156.7 12% Goodwill amortization .................... 10.0 1% 9.7 1% -------- --- -------- --- Income from operations ........... 39.7 3% 66.6 5% Interest and other expense, net .......... 16.1 1% 19.3 1% -------- --- -------- --- Income before income taxes ....... 23.6 2% 47.3 4% Provision for income taxes ............... 13.4 1% 21.7 2% -------- --- -------- --- Net income ....................... $ 10.2 1% $ 25.6 2% ======== === ======== === 15
17 REVENUES PERCENT OF TOTAL REVENUES NINE MONTHS ENDED JUNE 30, -------------------------- 2000 2001 ---- ---- Commercial and Industrial 67% 67% Residential 15% 15% Service and Maintenance 8% 8% Communications Solutions 10% 10% ---- ---- Total Company 100% 100% ==== ==== Total revenues increased $111.9 million, or 10%, from $1,157.7 million for the nine months ended June 30, 2000, to $1,269.6 million for the nine months ended June 30, 2001. Total same store revenues increased approximately $88.5 million, or 8%, from $1,157.7 million for the nine months ended June 30, 2000, to $1,246.2 million for the nine months ended June 30, 2001. The increase in revenues is primarily the result of acquisitions made during the three months ended December 31, 1999, and increased awards of construction contracts in the markets we serve. Commercial and industrial revenues increased $69.0 million, or 9%, from $776.8 million for the nine months ended June 30, 2000, to $845.8 million for the nine months ended June 30, 2001. This increase is primarily the result of acquisitions and increased awards of construction contracts in the markets we serve. Residential revenues increased $16.0 million, or 9%, from $177.9 million for the nine months ended June 30, 2000, to $193.9 million for the nine months ended June 30, 2001. This increase primarily results from an acquisition made during the three months ended December 31, 1999, and increased awards of construction contracts in the markets we serve. Service and maintenance revenues increased $9.0 million, or 10%, from $92.4 million for the nine months ended June 30, 2000, to $101.4 million for the nine months ended June 30, 2001. This increase in revenues is primarily the result of company-wide efforts to expand our service and maintenance business. Communications solutions revenues increased $17.9 million, or 16%, from $110.6 million for the nine months ended June 30, 2000, to $128.5 million for the nine months ended June 30, 2001. This increase is primarily the result of company-wide efforts to grow our communications solutions business and increased awards of communications solutions contracts during the six months ended March 31, 2001, and partially offset by decreased awards from telecommunication companies on communication solutions contracts and increased competition for available work during the three months ended June 30, 2001. 16
18 GROSS PROFIT SEGMENT GROSS PROFIT MARGINS AS A PERCENT OF SEGMENT REVENUES -------------------------- NINE MONTHS ENDED JUNE 30, -------------------------- 2000 2001 --------- --------- Commercial and Industrial 14% 17% Residential 24% 23% Service and Maintenance 22% 23% Communications Solutions 26% 19% --------- --------- Total Company 17% 18% ========= ========= Gross profit increased $32.5 million, or 16%, from $200.5 million for the nine months ended June 30, 2000, to $233.0 million for the nine months ended June 30, 2001. Gross profit margin as a percentage of revenues increased approximately 1% from 17% for the nine months ended June 30, 2000 to 18% for the nine months ended June 30, 2001. This increase in gross profit margin as a percentage of revenues was primarily the result of losses recorded on fixed-price contracts at one subsidiary and the completion of certain contracts at lower than planned gross margins during the nine months ended June 30, 2000, and further increased by our focus on safety resulting in decreased workers compensation claims during the nine months ended June 30, 2001. Commercial and industrial gross profit increased $29.8 million, or 27%, from $110.1 million for the nine months ended June 30, 2000, to $139.9 million for the nine months ended June 30, 2001. Commercial and industrial gross profit margin as a percentage of revenues increased approximately 3% from 14% for the nine months ended June 30, 2000, to 17% for the nine months ended June 30, 2001. This increase in gross profit margin as a percentage of revenues was primarily due to the completion of several contracts at higher than anticipated margins, the impact of losses recorded on fixed-price contracts at one subsidiary during the nine months ended June 30, 2000, and further increased by our focus on safety resulting in decreased workers compensation claims during the nine months ended June 30, 2001. Residential gross profit increased $3.4 million, or 8%, from $42.0 million for the nine months ended June 30, 2000, to $45.4 million for the nine months ended June 30, 2001. Residential gross profit margin as a percentage of revenues decreased approximately 1% from 24% for the nine months ended June 30, 2000, to 23% for the nine months ended June 30, 2001. This decrease in gross profit margin as a percent of revenues primarily resulted from project selection and the initial increased costs associated with the designation of the residential business as a separate segment and managing it separately from our other electrical work. Service and maintenance gross profit increased $3.3 million, or 16%, from $20.1 million from the nine months ended June 30, 2000, to $23.4 million for the nine months ended June 30, 2001. Service and maintenance gross profit margin as a percentage of revenues increased to 23% for the nine months ended June 30, 2001, from 22% for the nine months ended June 30, 2000. This increase resulted from increased efficiencies in the delivery of service and maintenance to our customers. Communication solutions gross profit decreased $4.0 million, or 14%, from $28.3 million for the nine months ended June 30, 2000, to $24.3 million for the nine months ended June 30, 2001. Communication solutions gross profit margin as a percentage of revenues decreased to 19% for the nine months ended June 30, 2001 from 26% for the nine months ended June 30, 2000. These 17
19 decreases are the result of what we believe to be a temporary decrease in spending by telecommunications companies and significant competition for available work. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses increased $5.9 million, or 4%, from $150.8 million for the nine months ended June 30, 2000, to $156.7 million for the nine months ended June 30, 2001. Selling, general and administrative expenses as a percentage of revenues decreased approximately 1%, from 13% for the nine months ended June 30, 2000 to 12% for the nine months ended June 30, 2001. This decrease primarily resulted from $9.8 million of expenses incurred during the nine months ended June 30, 2000, related to restricted stock awards and our decision to curtail the development of an information system in March 2000. INCOME FROM OPERATIONS Income from operations increased $26.9 million, from $39.7 million for the nine months ended June 30, 2000, to $66.6 million for the nine months ended June 30, 2001. This increase in income from operations was primarily attributed to the revenue growth due to increased construction activity in the markets we serve and improvements in overall gross margins resulting from the impact of losses recorded on fixed-price contracts at one subsidiary and the completion of certain contracts at lower than planned gross margins during the nine months ended June 30, 2000. Income from operations was further increased by our focus on safety resulting in decreased workers compensation claims during the nine months ended June 30, 2001. NET INTEREST AND OTHER EXPENSE Interest and other expense, net increased from $16.1 million for the nine months ended June 30, 2000, to $19.3 million for the nine months ended June 30, 2001, primarily as a result of increased interest expense on borrowings. PROVISION FOR INCOME TAXES Our effective tax rate decreased from 56.6% for the nine months ended June 30, 2000, to 45.9% for the nine months ended June 30, 2001. The lower effective tax rate in the current nine months period was the result of a non-deductible goodwill amortization and non-cash compensation expense related to restricted stock awards representing a smaller percentage of our pre-tax income in such period. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2001 The following table presents selected unaudited historical financial information for the three months ended June 30, 2000 and 2001. 18
20 Three Months Ended June 30, ----------------------------------- 2000 % 2001 % ------- --- -------- ---- (dollars in millions) Revenues ......................................... $ 452.1 100% $ 424.0 100% Cost of services (including depreciation) 374.1 83% 342.2 81% -------- ---- -------- ---- Gross profit ............................. 78.0 17% 81.8 19% Selling, general & administrative expenses ....... 51.1 11% 53.0 12% Goodwill amortization ............................ 3.2 1% 3.2 1% -------- ---- -------- ---- Income from operations ................... 23.7 5% 25.6 6% Interest and other expense, net .................. 5.4 1% 6.6 1% -------- ---- -------- ---- Income before income taxes ............... 18.3 4% 19.0 5% Provision for income taxes ....................... 8.2 2% 8.5 2% -------- ---- -------- ---- Net income ............................... $ 10.1 2% $ 10.5 3% ======== ==== ======== ==== REVENUES PERCENT OF TOTAL REVENUES THREE MONTHS ENDED JUNE 30, --------------------------- 2000 2001 ---- ---- Commercial and Industrial 68% 65% Residential 14% 17% Service and Maintenance 7% 7% Communications Solutions 11% 11% ---- ---- Total Company 100% 100% ==== ==== Total revenues decreased $28.1 million, or 6%, from $452.1 million for the three months ended June 30, 2000, to $424.0 million for the three months ended June 30, 2001. This decrease in revenues is primarily the result of non-recurring work performed for one customer during the three months ended June 30, 2000. Commercial and industrial revenues decreased $33.2 million, or 11%, from $308.5 million for the three months ended June 30, 2000, to $275.3 million for the three months ended June 30, 2001. This decrease is primarily the result of non-recurring work performed for one customer during the three months ended June 30, 2000. Residential revenues increased $10.2 million, or 17%, from $61.6 million for the three months ended June 30, 2000, to $71.8 million for the three months ended June 30, 2001, primarily results from increased awards of construction contracts in markets we serve. Service and maintenance revenues remained constant at $32.2 million for the three months ended June 30, 2000 and for the three months ended June 30, 2001. We continue to focus on growing this segment. Communications solutions revenues decreased $5.1 million, or 10%, from $49.8 million for the three months ended June 30, 2000, to $44.7 million for the three months ended June 30, 2001. This decrease is the result of decreased awards from telecommunications companies on communications solutions contracts and increased competition for available work during the three months ended June 30, 2001. 19
21 GROSS PROFIT SEGMENT GROSS PROFIT MARGINS AS A PERCENT OF SEGMENT REVENUES --------------------------- THREE MONTHS ENDED JUNE 30, --------------------------- 2000 2001 ---- ---- Commercial and Industrial 14% 18% Residential 27% 24% Service and Maintenance 22% 23% Communications Solutions 25% 14% --- --- Total Company 17% 19% === === Gross profit increased $3.8 million, or 5%, from $78.0 million for the three months ended June 30, 2000, to $81.8 million for the three months ended June 30, 2001. Gross profit margin as a percentage of revenues increased approximately 2% from 17% for the three months ended June 30, 2000 to 19% for the three months ended June 30, 2001. This increase in gross profit margin as a percentage of revenues was primarily the result of losses recorded on fixed-price contracts at one subsidiary and the completion of certain contracts at lower than planned gross margins during the three months ended June 30, 2000, and further increased by our focus on safety resulting in decreased workers compensation claims during the three months ended June 30, 2001. Commercial and industrial gross profit increased $8.8 million, or 21%, from $41.9 million for the three months ended June 30, 2000, to $50.7 million for the three months ended June 30, 2001. Commercial and industrial gross profit margin as a percentage of revenues increased 4% from 14% for the three months ended June 30, 2000, to 18% for the three months ended June 30, 2001. This increase in gross profit margin as a percentage of revenues was primarily due to the completion of several contracts at higher than anticipated margins, the impact of losses recorded on fixed-price contracts at one subsidiary during the three months ended June 30, 2000, and further increased by our focus on safety resulting in decreased workers compensation claims during the three months ended June 30, 2001. Residential gross profit increased $1.0 million, or 6%, from $16.5 million for the three months ended June 30, 2000, to $17.5 million for the three months ended June 30, 2001. Residential gross profit margin as a percentage of revenues decreased 3% from 27% for the three months ended June 30, 2000, to 24% for the three months ended June 30, 2001. This decrease in gross profit margin as a percent of revenues primarily resulted from project selection and the initial increased costs associated with the designation of the residential business as a separate segment and managing it separately from our other electrical work. Service and maintenance gross profit increased $0.4 million, or 6%, from $7.1 million from the three months ended June 30, 2000, to $7.5 million for the three months ended June 30, 2001. Service and maintenance gross profit margin as a percent of revenues increased slightly from 22% for the three months ended June 30, 2000, to 23% for the three months ended June 30, 2001. We continue to focus on growing this segment of our business. Communication solutions gross profit decreased $6.5 million, or 52%, from $12.6 million for the three months ended June 30, 2000, to $6.1 million for the three months ended June 30, 2001. Communication solutions gross profit margin as a percentage of revenues decreased to 14% for the three months ended June 30, 2001, from 25% for the three months ended June 30, 2000. 20
22 These decreases are the result of what we believe to be a temporary decrease in spending by telecommunications companies and significant competition for available work. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses increased $1.9 million, or 4%, from $51.1 million for the three months ended June 30, 2000, to $53.0 million for the three months ended June 30, 2001. Selling, general and administrative expenses as a percentage of revenues increased from 11% for the three months ended June 30, 2000 to 12% for the three months ended June 30, 2001. This increase primarily resulted from increased infrastructure cost incurred to manage our business. INCOME FROM OPERATIONS Income from operations increased $1.9 million, from $23.7 million for the three months ended June 30, 2000, to $25.6 million for the three months ended June 30, 2001. This increase in income from operations was primarily attributed to improvements in overall gross margins resulting from the impact of losses recorded on fixed-price contracts at one subsidiary and the completion of certain contracts at lower than planned gross margins during the nine months ended June 30, 2000. Income from operations further increased by our focus on safety resulting in decreased workers compensation claims during the nine months ended June 30, 2001. NET INTEREST AND OTHER EXPENSE Interest and other expense, net increased from $5.4 million for the three months ended June 30, 2000, to $6.6 million for the three months ended June 30, 2001, primarily as a result of increased interest expense on borrowings. PROVISION FOR INCOME TAXES Our effective tax rate decreased from 44.8% for the three months ended June 30, 2000 to 44.7% for the three months ended June 30, 2001. The lower effective tax rate in the current three month period is the result of non-deductible goodwill amortization and non-cash compensation expense related to restricted stock awards representing a smaller percentage of our pre-tax income in such period. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2001, we had cash and cash equivalents of $0.4 million, working capital of $225.4 million, no outstanding borrowings under our credit facility, $5.3 million of letters of credit outstanding, and available capacity under our credit facility of $144.7 million. The amount outstanding under our senior subordinated notes was $275.0 million. During the nine months ended June 30, 2001, we generated $10.4 million of net cash from operating activities. This net cash provided by operating activities is comprised of net income of $25.6 million, increased by $21.4 million of non-cash charges related primarily to depreciation and amortization expense and decreased by changes in working capital. Working capital changes consisted of a $34.4 million decrease in accounts receivable as a result of the timing of collections, offset by $55.7 million decrease in accounts payable and accrued expenses as a result of the timing of payments, including taxes and accrued interest. Working capital changes also included a $18.8 million increase in prepaid and other current assets, with the balance of the change due to other working capital changes. Net cash used in investing activities was $24.2 21
23 million, consisting primarily of $19.7 million used for capital expenditures and $5.3 million for the purchase of available for sale securities. Net cash provided by financing activities was $13.6 million, resulting primarily from borrowings, net of repayments under our credit facility. During the three months ended June 30, 2001, we generated $9.3 million of net cash from operating activities. This net cash provided by operating activities is comprised of net income of $10.5 million, increased by $7.4 million of non-cash charges related primarily to depreciation and amortization expense and increased by changes in working capital. Working capital changes consisted of a $3.1 million decrease in accounts receivable as a result of the timing of collections, increased by $0.2 million increase in accounts payable and accrued expenses as a result of the timing of payments, including taxes and accrued interest. Working capital changes also included a $0.5 million decrease in billings in excess of costs and estimated earnings on uncompleted contracts, an increase in prepaid expenses and other current assets of $6.5 million, with the balance of the change due to other working capital changes. Net cash used in investing activities was $7.4 million, consisting primarily of $7.3 million used for capital expenditures. Net cash used by financing activities was $2.2 million, resulting primarily from repayments, net of borrowings under our credit facility. On May 22, 2001, We replaced our $175.0 million credit facility with a new $150.0 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, 2004. Amounts borrowed under our credit facility bear interest at an annual rate equal to either (a) the London interbank offered rate (LIBOR) plus 1.75 percent to 2.75 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 0.5 percent plus up to an additional 1.25 percent, as determined by the ratio of our total funded debt to EBITDA. Commitment fees of 0.50 percent, as determined by the ratio of our total funded debt to EBITDA, are assessed on any unused borrowing capacity under our credit facility. Our existing and future subsidiaries guarantee the repayment of all amounts due under our facility, and our facility is secured by the capital stock of those subsidiaries, our accounts receivable and accounts receivable of those subsidiaries. Borrowings under our credit facility are limited to 66 2/3% of outstanding receivables (as defined in the agreement). Our credit facility requires the consent of the lenders for acquisitions exceeding a certain level of cash consideration, prohibits the payment of cash dividends on our common stock, restricts our ability to repurchase shares of common stock, 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 minimum net worth requirements, a maximum total consolidated funded debt to EBITDA ratio, a maximum senior consolidated debt to EBITDA ratio, and a minimum interest coverage ratio. We were in compliance with the financial covenants at June 30, 2001. As of June 30, 2001, we did not have outstanding indebtedness under our credit facility, letters of credit outstanding under our credit facility of $5.3 million, $1.8 million of other borrowings and available borrowing capacity under our credit facility of $144.7 million. 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 $117.2 million in proceeds, net of a $4.2 million discount and $3.6 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, commencing August 1, 1999. The notes are unsecured senior subordinated obligations and are subordinated to all 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. 22
24 We anticipate that our cash flow from operations and proceeds from our credit facility will provide sufficient cash to enable us to meet our working capital needs, debt service requirements and planned capital expenditures for property and equipment through the next twelve months. We intend to continue to pursue selected acquisition opportunities. We may be in various stages of negotiation, due diligence and documentation of potential acquisitions at any time. The timing, size or success of any acquisition effort and the associated potential capital commitments cannot be predicted. We expect to fund future acquisitions primarily with working capital, cash flow from operations and borrowings, including any unborrowed portion of the credit facility, as well as issuances of additional equity or debt. To the extent we fund a significant portion of the consideration for future acquisitions with cash, we may have to increase the amount available for borrowing under our credit facility or obtain other sources of financing through the public or private sale of debt or equity securities. There can be no assurance that we will be able to secure this financing if and when it is needed or on terms we consider acceptable. We expect capital expenditures for equipment and expansion of facilities to be funded from cash flow from operations and supplemented as necessary by borrowings under our credit facility. We do not utilize financial instruments for trading purposes and hold no derivative financial instruments which could expose us to significant market risk. We may, however, decide to hold derivative financial instruments in the future, which would effectively convert a portion of our fixed interest rate debt into a floating rate. Our current exposure to market risk for changes in interest rates relates primarily to obligations under our credit facility and our long-term obligations under the existing senior subordinated notes. The credit facility matures on May 22, 2004 and the existing senior subordinated notes mature on February 1, 2009. 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. 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; (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; and (iv) the presentation of separate financial statements and other disclosures concerning the subsidiary guarantors is not deemed material. SEASONALITY AND QUARTERLY FLUCTUATIONS Our results of operations, particularly from residential construction, are seasonal, depending on 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 our business is less subject to seasonal trends, as this work generally is performed inside structures protected from the weather. Our service 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 gross margins in 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. 23
25 ACCOUNTING PRONOUNCEMENTS In December 1999, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 101 (SAB 101). SAB 101 reflects the basic principles of revenue recognition in existing accounting principles generally accepted in the United States, and does not supersede any existing authoritative literature. We recognize revenue from construction contracts 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," and as a result, SAB 101 requires no changes to our existing revenue recognition policies. Statement of Financial Account Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, is required to be adopted for fiscal years beginning after June 15, 2000. We adopted SFAS No. 133, as amended, on October 1, 2000. Adoption of this statement did not have a material impact on the financial position or results of our operations, as we have not engaged or entered into any arrangements usually associated with derivative instruments. On June 30, 2001 the Financial Accounting Standards Board ("FASB") adopted SFAS Nos. 141 "Business Combinations" and 142 "Goodwill and Other Intangible Assets." SFAS Nos. 141 and 142 are effective for fiscal years beginning after December 15, 2001. We plan to adopt these standards effective October 1, 2001. SFAS No. 141 requires that all business combinations initiated after June 30, 2001, to be accounted for using the purchase method. We do not believe that the effect on financial statements of the adoption of SFAS No. 141 will be material. SFAS No.142 requires that goodwill no longer be amortized but be subject to an annual assessment for impairment based on a fair value test. In addition, acquired intangible assets are required to be separately recognized if the benefit of the asset is based on contractual or legal rights. We are currently assessing the Statement and believe it could have a material impact on our consolidated financial statements. 24
26 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 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, including commodity price risk, foreign currency exchange risk or interest rate risks from the use of derivative financial instruments. Further, management does not use derivative financial instruments for trading or to speculate on changes in interest rates or commodity prices. As a result, our exposure to changes in interest rates results from fixed rate debt. 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 June 30, 2001. 2001 2002 2003 2004 2005 Thereafter Total ----- ----- ----- ----- ------------ ------------ ------------ Liabilities-Debt: Fixed Rate (Senior Subordinated Notes)............... -- -- -- -- -- $ 275,000 $ 275,000 Average Interest Rate . 9.375% 9.375% 9.375% 9.375% 9.375% 9.375% 9.375% Fair Value of Debt: Fixed Rate .................................................................................................... $ 269,500 25
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: August 13, 2001 By: /s/ William W. Reynolds ------------------------------- William W. Reynolds Executive Vice President and Chief Financial Officer 26