Amendment No. 1 to Form 10-Q for Period Ended March 31, 2005
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q/A

(Amendment No. 1)

 


 

(Mark One)

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

 

For the Quarterly Period Ended March 31, 2005

 

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  ¨    No  x

 

Indicated by checkmark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes  x    No  ¨

 

The number of shares outstanding as of May 10, 2005 of the issuer’s common stock was 36,601,438 and of the issuer’s restricted voting common stock was 2,605,709.

 


 

1


Table of Contents

EXPLANATORY NOTE

 

This Amendment No. 1 on Form 10-Q/A (the Amendment) amends the Quarterly Report on Form 10-Q for the quarter ended March 31, 2005 of Integrated Electrical Services, Inc. (the Company) to correct the number of shares outstanding as of May 10, 2005 of the issuer’s common stock and the issuer’s restricted voting common stock on the cover page. Additionally, this Amendment corrects the allocation between continuing operations and discontinued operations for tax effected valuation allowances released during the six months ended March 31, 2004. Other than as set forth in this Amendment No. 1, no information included in the initial Form 10-Q has been amended by this Form 10-Q/A. This Form 10-Q/A continues to speak as of the date that the initial 10-Q was filed with the SEC, and we have not updated the disclosure herein to reflect any information or events subsequent to the filing of the initial Form 10-Q.


Table of Contents

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

 

INDEX

 

          Page

PART I.

   FINANCIAL INFORMATION     

Item 1.

   Financial Statements     

Consolidated Balance Sheets as of September 30, 2004 and March 31, 2005

   3

Consolidated Statements of Operations for the six months ended March 31, 2004 and 2005

   4

Consolidated Statements of Operations for the three months ended March 31, 2004 and 2005

   5

Consolidated Statement of Stockholders’ Equity for the six months ended March 31, 2005

   6

Consolidated Statements of Cash Flows for the six months ended March 31, 2004 and 2005

   7

Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2005

   8

Notes to Condensed Consolidated Financial Statements

   9

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    20

Item 4.

   Controls and Procedures    36

PART II.

   OTHER INFORMATION     

Item 6.

   Exhibits    37

Signatures

        38

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

This quarterly report on Form 10-Q includes certain statements that may be deemed to be “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on the Company’s expectations and involve risks and uncertainties that could cause the Company’s 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 relating to estimating future operating results or our ability to generate sales, income, or cash flow, potential difficulty in addressing material weaknesses in the Company’s accounting systems that have been identified to the Company by its independent auditors, potential limitations on our ability to access the credit line under our credit facility, litigation risks and uncertainties, fluctuations in operating results because of downturns in levels of construction, inaccurate estimates used in entering into and executing contracts, difficulty in managing the operation of existing entities, the high level of competition in the construction industry, changes in interest rates, the general level of the economy, level of competition from other electrical contractors, increases in costs of labor, steel, copper and gasoline, limitations on the availability and the increased costs of surety bonds required for certain projects, inability to reach agreements with our surety or co-surety bonding company to provide sufficient bonding capacity, risk associated with failure to provide surety bonds on jobs where we have commenced work or are otherwise contractually obligated to provide surety bonds, loss of key personnel, business disruption and costs associated with the Securities and Exchange Commission investigation and class action litigation, inability to reach agreement for planned sales of assets, business disruption and transaction costs attributable to the sale of business units, costs associated with the closing of business units, unexpected liabilities associated with warranties or other liabilities attributable to the retention of the legal structure of business units where we have sold substantially all of the assets of the business unit, inability to fulfill the terms or meet the required financial covenants of the credit facility, inability to obtain a waiver of the existing Event of Default under the Credit Facility, cross defaults under the subordinated debt Senior Convertible Notes offering or agreement with the surety if the Event of Default is not waived or cured and an acceleration occurs difficulty in integrating new types of work into existing subsidiaries, inability of subsidiaries to incorporate new accounting, control and operating procedures, inaccuracies in estimating revenues and percentage of completion on contracts, and weather and seasonality. If the company is unable to file an S-1 in support of the Senior Convertible Notes, the penalty interest may apply under that agreement. You should understand that the foregoing important factors, in addition to those discussed in our other filings with the Securities and Exchange Commission (“SEC”), including those under the heading “Risk Factors” contained in our annual report on Form 10-K for the fiscal year ended September 30, 2004, could affect our future results and could cause results to differ materially from those expressed in such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this report.

 

General information about us can be found at www.ies-co.com under “Investor Relations.” Our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any amendments to those reports, are available free of charge through our website as soon as reasonably practicable after we file them with, or furnish them to, the SEC.

 

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INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE INFORMATION)

 

    

September 30,

2004


   

March 31,

2005


 
     (Audited)     (Unaudited)  
ASSETS                 

CURRENT ASSETS:

                

Cash and cash equivalents

   $ 22,232     $ 32,384  

Accounts receivable:

                

Trade, net of allowance of $4,103 and $2,962 respectively

     211,279       195,416  

Retainage

     57,647       55,577  

Costs and estimated earnings in excess of billings on uncompleted contracts

     33,389       34,983  

Inventories

     17,888       19,509  

Prepaid expenses and other current assets

     12,989       22,064  

Assets held for sale associated with discontinued operations

     79,213       28,394  
    


 


Total current assets

     434,637       388,327  

PROPERTY AND EQUIPMENT, net

     40,991       37,405  

GOODWILL, net

     87,430       87,178  

OTHER NON-CURRENT ASSETS

     17,875       19,556  
    


 


Total assets

   $ 580,933     $ 532,466  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY                 

CURRENT LIABILITIES:

                

Current maturities of long-term debt

   $ 42,993     $ 2,382  

Accounts payable and accrued expenses

     136,213       129,845  

Billings in excess of costs and estimated earnings on uncompleted contracts

     32,515       36,016  

Liabilities related to assets held for sale associated with discontinued operations

     18,621       7,048  
    


 


Total current liabilities

     230,342       175,291  

LONG-TERM DEBT, net of current maturities

     15,061       126  

SENIOR CONVERTIBLE NOTES, net

     —         50,736  

SENIOR SUBORDINATED NOTES, net

     173,208       173,169  

OTHER NON-CURRENT LIABILITIES

     19,154       19,268  
    


 


Total liabilities

     437,765       418,590  
    


 


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 and 39,010,315 shares issued, respectively

     385       390  

Restricted voting common stock, $.01 par value, 2,655,709 shares authorized, 2,605,709 shares issued, and outstanding

     26       26  

Treasury stock, at cost, 2,172,313 and 2,416,377 shares, respectively

     (13,790 )     (13,022 )

Unearned restricted stock

     (1,113 )     (2,064 )

Additional paid-in capital

     429,376       431,096  

Retained deficit

     (271,716 )     (302,550 )
    


 


Total stockholders’ equity

     143,168       113,876  
    


 


Total liabilities and stockholders’ equity

   $ 580,933     $ 532,466  
    


 


 

The accompanying notes to condensed consolidated financial statements are an integral part of these financial statements.

 

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INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT SHARE INFORMATION)

 

    

Six Months Ended

March 31,


 
     2004

    2005

 
     (restated)        
     (Unaudited)  

Revenues

   $ 601,241       573,056  

Cost of services

     520,531       506,357  
    


 


Gross profit

     80,710       66,699  

Selling, general and administrative expenses

     63,448       71,508  
    


 


Income/(loss) from operations

     17,262       (4,809 )
    


 


Other (income)/expense:

                

Interest expense

     13,015       13,285  

Loss on sale of assets

     154       7  

Other expense, net

     5,319       548  
    


 


       18,488       13,840  
    


 


Loss from continuing operations before income taxes

     (1,226 )     (18,649 )

Provision/(benefit) for income taxes

     (6,720 )     896  
    


 


Net income/(loss) from continuing operations

     5,494       (19,545 )
    


 


Discontinued operations (Note 2)

                

Income/(loss) from discontinued operations (including loss on disposal of $0 and $236)

     5,356       (11,210 )

Provision for income taxes

     2,089       79  
    


 


Net income/(loss) from discontinued operations

     3,267       (11,289 )
    


 


Net income (loss)

   $ 8,761     $ (30,834 )
    


 


Basic earnings/(loss) per share from continuing operations

   $ 0.14     $ (0.50 )
    


 


Basic earnings/(loss) per share from discontinued operations

   $ 0.09     $ (0.29 )
    


 


Basic earnings/(loss) per share

   $ 0.23     $ (0.79 )
    


 


Diluted earnings/(loss) per share from continuing operations

   $ 0.14     $ (0.50 )
    


 


Diluted earnings/(loss) per share from discontinued operations

   $ 0.08     $ (0.29 )
    


 


Diluted earnings/(loss) per share

   $ 0.22     $ (0.79 )
    


 


Shares used in the computation of earnings/(loss) per share (Note 4):

                

Basic

     38,408,067       39,033,601  
    


 


Diluted

     39,013,887       39,033,601  
    


 


 

The accompanying notes to condensed consolidated financial statements are an integral part of these financial statements.

 

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INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT SHARE INFORMATION)

 

    

Three Months Ended

March 31,


 
     2004

    2005

 
     (restated)        
     (Unaudited)  

Revenues

   $ 290,284       287,521  

Cost of services

     254,402       254,466  
    


 


Gross profit

     35,882       33,055  

Selling, general and administrative expenses

     31,377       35,904  
    


 


Income/(loss) from operations

     4,505       (2,849 )
    


 


Other (income)/expense:

                

Interest expense

     6,556       4,441  

Loss on sale of assets

     139       188  

Other expense, net

     5,195       292  
    


 


       11,890       4,921  
    


 


Loss from continuing operations before income taxes

     (7,385 )     (7,770 )

Provision/(benefit) for income taxes

     (7,766 )     636  
    


 


Net income (loss) from continuing operations

     381       (8,406 )
    


 


Discontinued operations (Note 2)

                

Income/(loss) from discontinued operations (including loss on disposal of $0 and $103)

     3,451       (4,785 )

Provision for income taxes

     1,360       35  
    


 


Net income/(loss) from discontinued operations

     2,091       (4,820 )
    


 


Net income (loss)

   $ 2,472     $ (13,226 )
    


 


Basic earnings/(loss) per share from continuing operations

   $ 0.01     $ (0.21 )
    


 


Basic earnings/(loss) per share from discontinued operations

   $ 0.05     $ (0.12 )
    


 


Basic earnings/(loss) per share

   $ 0.06     $ (0.34 )
    


 


Diluted earnings/(loss) per share from continuing operations

   $ 0.01     $ (0.21 )
    


 


Diluted earnings/(loss) per share from discontinued operations

   $ 0.05     $ (0.12 )
    


 


Diluted earnings/(loss) per share

   $ 0.06     $ (0.34 )
    


 


Shares used in the computation of earnings/(loss) per share (Note 4):

                

Basic

     38,544,198       39,149,769  
    


 


Diluted

     39,242,461       39,149,769  
    


 


 

The accompanying notes to condensed consolidated financial statements are an integral part of these financial statements.

 

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INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(IN THOUSANDS, EXCEPT SHARE INFORMATION)

 

     Common Stock

   Restricted Voting
Common Stock


   Treasury Stock

   

Unearned

Restricted

Stock


   

Additional

Paid-In

Capital


   

Retained

(Deficit)


   

Total

Stockholders’

Equity


 
     Shares

   Amount

   Shares

   Amount

   Shares

    Amount

         

BALANCE, September 30, 2004

   38,439,984    $ 385    2,605,709    $ 26    (2,172,313 )   $ (13,790 )   $ (1,113 )   $ 429,376     $ (271,716 )   $ 143,168  

Issuance of stock (unaudited)

   7,310      —      —        —      8,252       52       —         (12 )     —         40  

Issuance of restricted stock (unaudited)

   365,564      3    —        —      (365,564 )     (3 )     (1,711 )     1,711       —         —    

Vesting of restricted stock (unaudited)

   —        —      —        —      113,248       719       —         (719 )     —         —    

Issuance of stock under employee stock purchase plan (unaudited)

   61,541      1    —        —      —         —         —         253       —         254  

Exercise of stock options (unaudited)

   135,916      1    —        —      —         —         —         624       —         625  

Non-cash compensation (unaudited)

   —        —      —        —      —         —         760       (137 )     —         623  

Net loss (unaudited)

   —        —      —        —      —         —         —         —         (30,834 )     (30,834 )
    
  

  
  

  

 


 


 


 


 


BALANCE, March 31, 2005 (unaudited)

   39,010,315    $ 390    2,605,709    $ 26    (2,416,377 )   $ (13,022 )   $ (2,064 )   $ 431,096     $ (302,550 )   $ 113,876  
    
  

  
  

  

 


 


 


 


 


 

The accompanying notes to condensed consolidated financial statements are an integral part of these financial statements.

 

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INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

 

     Six Months Ended
March 31,


 
     2004

    2005

 
     (restated)        
     (Unaudited)  

CASH FLOWS FROM OPERATING ACTIVITIES:

                

Net income/(loss)

   $ 8,761     $ (30,834 )

Adjustments to reconcile net income to net cash provided by operating activities:

                

Net loss/(income) from discontinued operations

     (3,267 )     11,289  

Bad debt expense

     (245 )     1,291  

Deferred financing cost amortization

     748       1,691  

Other depreciation and amortization

     5,864       5,990  

Loss on sale of property and equipment

     154       88  

Non-cash compensation expense

     332       623  

Equity in losses of investment

     432       571  

Impairment to goodwill

     —         596  

Impairment of companies

     —         70  

Mark to market loss for embedded conversion option

     —         734  

Deferred income tax expense/(benefit)

     (8,230 )     680  

Changes in operating assets and liabilities, net of the effect of discontinued operations:

                

Accounts receivable

     16,513       18,543  

Inventories

     (2,972 )     (1,621 )

Costs and estimated earnings in excess of billings on uncompleted contracts

     787       (1,096 )

Prepaid expenses and other current assets

     (1,723 )     (9,487 )

Other noncurrent assets

     1,843       286  

Accounts payable and accrued expenses

     (10,125 )     (5,670 )

Billings in excess of costs and estimated earnings on uncompleted contracts

     (3,657 )     3,518  

Other current liabilities

     52       (299 )

Other noncurrent liabilities

     1,433       (499 )
    


 


Net cash provided by (used in) continuing operations

     6,700       (3,536 )

Net cash provided by discontinued operations

     324       431  
    


 


Net cash provided by (used in) operating activities

     7,024       (3,105 )
    


 


CASH FLOWS FROM INVESTING ACTIVITIES:

                

Proceeds from sales of property and equipment

     318       299  

Investments in securities

     (400 )     (400 )

Purchases of property and equipment

     (2,837 )     (2,187 )

Net investing activities from discontinued operations

     (222 )     24,091  
    


 


Net cash provided by (used in) investing activities

     (3,141 )     21,803  
    


 


CASH FLOWS FROM FINANCING ACTIVITIES:

                

Borrowings of debt

     50,040       10,000  

Borrowings on Senior Convertible Notes

     —         50,000  

Repayments of debt

     (75,241 )     (65,589 )

Issuance of common stock

     39       40  

Proceeds from issuance of stock under employee stock purchase plan

     652       254  

Payments for debt issuance costs

     (1,245 )     (3,876 )

Purchase of treasury stock

     (4,340 )     —    

Proceeds from exercise of stock options

     5,054       625  
    


 


Net cash used in financing activities

     (25,041 )     (8,546 )
    


 


NET INCREASE IN CASH AND CASH EQUIVALENTS

     (21,158 )     10,152  

CASH AND CASH EQUIVALENTS, beginning of period

     40,201       22,232  
    


 


CASH AND CASH EQUIVALENTS, end of period

   $ 19,043     $ 32,384  
    


 


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

                

Cash paid for

                

Interest

   $ 13,480       9,811  

Income taxes

   $ 700       644  

 

The accompanying notes to condensed consolidated financial statements are an integral part of these financial statements.

 

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Table of Contents

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

 

     Three Months Ended
March 31,


 
     2004

    2005

 
     (restated)        
     (Unaudited)  

CASH FLOWS FROM OPERATING ACTIVITIES:

                

Net income/(loss)

   $ 2,533     $ (13,226 )

Adjustments to reconcile net income to net cash provided by operating activities:

                

Net loss/(income) from discontinued operations

     (2,091 )     4,820  

Bad debt expense

     (781 )     567  

Deferred financing cost amortization

     374       884  

Other depreciation and amortization

     2,949       3,296  

Loss on sale of property and equipment

     140       124  

Non-cash compensation expense

     249       413  

Equity in losses of investment

     432       307  

Mark to market gain for embedded conversion option

     —         (1,942 )

Deferred income tax expense/(benefit)

     (6,800 )     497  

Changes in operating assets and liabilities, net of the effect of discontinued operations:

                

Accounts receivable

     10,340       5,640  

Inventories

     (913 )     (425 )

Costs and estimated earnings in excess of billings on uncompleted contracts

     203       (2,781 )

Prepaid expenses and other current assets

     (1,754 )     520  

Other noncurrent assets

     1,544       37  

Accounts payable and accrued expenses

     (5,507 )     11,277  

Billings in excess of costs and estimated earnings on uncompleted contracts

     (3,922 )     (4,921 )

Other current liabilities

     51       (344 )

Other noncurrent liabilities

     1,399       161  
    


 


Net cash provided by (used in) continuing operations

     (1,554 )     4,904  

Net cash provided by discontinued operations

     2,151       1,033  
    


 


Net cash provided by operating activities

     597       5,937  
    


 


CASH FLOWS FROM INVESTING ACTIVITIES:

                

Proceeds from sales of property and equipment

     165       243  

Investments in securities

     —         (400 )

Purchases of property and equipment

     (1,267 )     (988 )

Net investing activities from discontinued operations

     (117 )     12,358  
    


 


Net cash provided by (used in) investing activities

     (1,219 )     11,213  
    


 


CASH FLOWS FROM FINANCING ACTIVITIES:

                

Borrowings of debt

     50,000       —    

Borrowings on Senior Convertible Notes

     —         14,000  

Repayments of debt

     (75,102 )     (29,888 )

Issuance of common stock

     19       —    

Proceeds from issuance of stock under employee stock purchase plan

     652       254  

Payments for debt issuance costs

     (1,245 )     (1,196 )

Purchase of treasury stock

     (990 )     —    

Proceeds from exercise of stock options

     2,178       392  
    


 


Net cash used in financing activities

     (24,488 )     (16,438 )
    


 


NET INCREASE IN CASH AND CASH EQUIVALENTS

     (25,110 )     712  

CASH AND CASH EQUIVALENTS, beginning of period

     44,153       31,672  
    


 


CASH AND CASH EQUIVALENTS, end of period

   $ 19,043     $ 32,384  
    


 


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

                

Cash paid for

                

Interest

   $ 13,270       8,692  

Income taxes

   $ 326       367  

 

The accompanying notes to condensed consolidated financial statements are an integral part of these financial statements.

 

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Table of Contents

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2005

(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 Consolidated Financial Statements (the “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, 2004, filed on Form 10-K with the Securities and Exchange Commission. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Actual operating results for the six months ended March 31, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ended September 30, 2005.

 

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

For a description of these policies, refer to Note 2 of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2004.

 

RESTATEMENT OF FINANCIAL STATEMENTS

 

Effective for the fiscal year ended September 30, 2004, the Company restated its reported results for the six months ended March 31, 2004 and the years ended September 30, 2002 and 2003 pursuant to having determined that the timing of the recognition of revenue and costs on certain of its long-term construction contracts accounted for under the percentage-of-completion method of accounting and that the accounting for one of its investments warranted such restatement. For a complete description of the restatement, refer to Note 3 of the Company’s 2004 Annual Report on Form 10-K. As a result of the restatement, the following reported results as of and for the six and three months ended March 31, 2004 have been restated to reflect the revisions indicated:

 

    

Six Months Ended

March 31, 2004 (Unaudited)


 
    

As Reported Restated for

Discontinued Operations


    Contract
Adjustments


    Investment
Adjustments


    As Restated

 

Statement of Operations Data:

                                

Revenues

   $ 604,835     $ (3,594 )   $ —       $ 601,241  

Cost of services

     519,474       1,057       —         520,531  
    


 


 


 


Gross profit

     85,361       (4,651 )     —         80,710  

Selling, general and administrative expenses

     63,448       —         —         63,448  
    


 


 


 


Income from operations

     21,913       (4,651 )     —         17,262  

Interest and other expense, net

     18,056       —         432       18,488  
    


 


 


 


Income/(loss) before income taxes

     3,857       (4,651 )     (432 )     (1,226 )

Provision/(benefit) for income taxes

     (4,712 )     (1,837 )     (171 )     (6,720 )
    


 


 


 


Net income/(loss) from continuing operations

   $ 8,569     $ (2,814 )   $ (261 )   $ 5,494  

Net income from discontinued operations

     3,205       62       —         3,267  
    


 


 


 


Net income/(loss)

   $ 11,774     $ (2,752 )   $ (261 )   $ 8,761  
    


 


 


 


Basic earnings per share from continuing operations

   $ 0.22     $ (0.07 )   $ (0.01 )   $ 0.14  
    


 


 


 


Basic earnings per share from discontinued operations

   $ 0.08     $ 0.00     $ 0.00     $ 0.09  
    


 


 


 


Basic earnings per share

   $ 0.31     $ (0.07 )   $ (0.01 )   $ 0.23  
    


 


 


 


Diluted earnings per share from continuing operations

   $ 0.22     $ (0.07 )   $ (0.01 )   $ 0.14  
    


 


 


 


Diluted earnings per share from discontinued operations

   $ 0.08     $ 0.00     $ 0.00     $ 0.08  
    


 


 


 


Diluted earnings per share

   $ 0.30     $ (0.07 )   $ (0.01 )   $ 0.22  
    


 


 


 


 

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Table of Contents
     March 31, 2004

Consolidated Balance Sheet (Unaudited)


  

As Reported
Restated for

Discontinued
Operations


   Contract
Adjustments


    Investment
Adjustments


    As Restated

Assets:

                             

Cash and cash equivalents

   $ 19,043    $ —       $ —       $ 19,043

Accounts receivable, net

     248,457      —         —         248,457

Cost and estimated earnings in excess of Billings on uncompleted contracts

     42,494      (3,441 )     —         39,053

Inventories

     19,853      —         —         19,853

Prepaid expenses and other current assets

     8,126      —         —         8,126

Assets held for sale associated with discontinued operations

     97,767      62       —         97,829

Other current assets

     18,072                      18,072

Property and equipment, net

     44,456      —         —         44,456

Goodwill, net

     166,996      —         —         166,996

Other noncurrent assets

     31,224      1,846       (1,848 )     31,222
    

  


 


 

Total assets

   $ 696,488    $ (1,533 )   $ (1,848 )   $ 693,107
    

  


 


 

Liabilities:

                             

Current maturities of long-term debt

   $ 7,272    $ —       $ —       $ 7,272

Accounts payable and accrued expenses

     108,556      1,057       —         109,613

Billings in excess of cost and estimated earnings on uncompleted contracts

     31,519      1,871       —         33,390

Liabilities related to assets held for sale associated with discontinued operations

     18,155      —         —         18,155

Other current liabilities

     640                      640

Long-term debt, net of current maturities

     42,954      —         —         42,954

Senior subordinated notes, net

     173,244      —         —         173,244

Other noncurrent liabilities

     33,081      (647 )     —         32,434
    

  


 


 

Total liabilities

   $ 415,421    $ 2,281     $ —       $ 417,702

Stockholders’ equity

     281,067      (3,814 )     (1,848 )     275,405
    

  


 


 

Total liabilities and stockholders’ equity

   $ 696,488    $ (1,533 )   $ (1,848 )   $ 693,107
    

  


 


 

 

SUBSIDIARY GUARANTIES

 

All of the Company’s operating income and cash flows are generated by its 100% 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.

 

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 liabilities.

 

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Table of Contents

SEASONALITY AND QUARTERLY FLUCTUATIONS

 

The results of the Company’s operations, primarily from residential construction, are seasonal, dependent upon weather trends, with higher revenues typically 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 PRONOUNCEMENTS

 

On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 123 (revised 2004), Share Based Payment, (“SFAS 123R”). SFAS 123R requires all share-based payments to employees, including restricted stock grants and grants of employee stock options, to be recognized in income and measured at fair value. Additionally, employee stock purchase programs have increased restrictions to be considered noncompensatory; therefore, most of these plans, formerly accounted for as

noncompensatory stock purchase plans, will be required to be measured and recorded at fair value. Fair value is calculated utilizing a stock-option pricing model, where necessary, including specific input assumptions delineated in the standard. SFAS 123R utilizes a “modified grant-date approach” where, regardless of vesting conditions based on service and performance, measurement of the fair value of awards is calculated on the grant date and amortized into income over the requisite service period for all awards that vest. Where vesting of awards does not occur, no compensation cost will be recognized. SFAS 123R also significantly changes the treatment of taxes related to share based payments from that required under SFAS 123 or Accounting Principles Board Opinion No. 25, Account for Stock Issued to Employees, (“APB 25”). Through March 31, 2005, the Company has accounted for share-based payments pursuant to APB 25 and provided the requisite pro forma disclosures delineated in SFAS 123 in the notes to the consolidated financial statements. Pursuant to APB 25, the Company has only recognized compensation expense for certain restricted stock grants made in the fiscal years 2002 and 2004; however, no compensation expense has been required to be recognized for any stock option grants nor for the employee stock purchase plan. The Company is required to adopt SFAS 123R effective October 1, 2005 and has two transition options under the new standard; however, the recognition of compensation cost is the same under both options. The Company believes the adoption of SFAS 123R will have a material effect on the consolidated financial results of the Company during the period of adoption, however, the full effect the adoption of SFAS 123R has not been determined as of March 31, 2005. While not necessarily representative, Note 1 is intended to show expense related to expensing stock options.

 

STOCK-BASED COMPENSATION

 

The Company accounts for its stock-based compensation arrangements using the intrinsic value method in accordance with the provisions of 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 6). During the three and six months ended March 31, 2005, the Company recorded compensation expense of $0.4 million and $0.6 million, respectively, in connection with restricted stock awards (See Note 6). Additionally, the Company recorded no compensation expense associated with the Employee Stock Purchase Plan which is defined as a non-compensatory plan pursuant to Financial Accounting Standards Board Interpretation No. 44 (See Note 7).

 

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Table of Contents

The following table illustrates the effect on net income and earnings per share assuming the compensation costs for the Company’s 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 Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation for the six and three months ended March 31, 2004 and 2005 (in thousands, except for per share data):

 

     Three months ended
March 31,


    Six months ended
March 31,


 
     2004

   2005

    2004

   2005

 

Net income, as reported

   $ 2,472    $ (13,226 )   $ 8,761    $ (30,834 )

Add: Stock-based employee compensation expense included in reported net income, net of related tax effects

     151      413       201      629  

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

     443      660       814      838  
    

  


 

  


Pro forma net income/(loss) for SFAS No. 123

   $ 2,180    $ (13,473 )   $ 8,148    $ (31,043 )
    

  


 

  


Earnings/(loss) per share:

                              

Basic – as reported

   $ 0.06    $ (0.34 )   $ 0.23    $ (0.79 )

Basic – pro forma for SFAS No. 123

   $ 0.06    $ (0.34 )   $ 0.21    $ (0.80 )

Earnings/(loss) per share:

                              

Diluted – as reported

   $ 0.06    $ (0.34 )   $ 0.22    $ (0.79 )

Diluted – pro forma for SFAS No. 123

   $ 0.06    $ (0.34 )   $ 0.21    $ (0.80 )

 

2. BUSINESS DIVESTITURES

 

Discontinued Operations

 

During October 2004, the Company announced plans to begin a strategic realignment including the planned divestiture of certain subsidiaries within the Company’s commercial segment. During November 2004, the Company’s management committed to a plan to complete the divestiture of these companies by the end of fiscal 2005. This plan included management actively seeking potential buyers of the selected companies among other activities necessary to complete the sales. Management expects to be able to sell all considered subsidiaries at their respective fair market values at the date of sale determined by a reasonably accepted valuation method. Management does not foresee any significant changes in the plan, nor anticipates events requiring withdrawal from the plan. The discontinued operations disclosures include only those identified subsidiaries qualifying for discontinued operations treatment for the periods presented; therefore, other subsidiaries included in the Company’s divestiture plan will be included in future periods as they qualify for discontinued operations treatment. Depreciation expense associated with discontinued operations for the six months ended March 31, 2004 and 2005 was $0.9 million and $0.5 million, respectively.

 

During the six months ended March 31, 2005, the Company completed the sale of all the net assets of seven of its operating subsidiaries for $24.1 million in cash. These operating subsidiaries were located in the North, South, West, and Residential regions and primarily provided electrical contracting services for the commercial and industrial segments. The sale generated an after-tax gain of $0.2 million and has been recognized in the six months ended March 31, 2005 as discontinued operations in the consolidated income statement and the prior year’s six months ended March 31, 2004 results of operations have been reclassified. Summarized financial data for discontinued operations are outlined below:

 

    

Six Months Ended

March 31,


 
     2004

   2005

 

Revenues

   $ 98,960    $ 62,469  
    

  


Gross profit

   $ 13,238    $ 5,464  
    

  


Pretax income/(loss)

   $ 5,356    $ (11,210 )
    

  


    

Three Months Ended

March 31,


 
     2004

   2005

 

Revenues

   $ 49,711    $ 24,470  
    

  


Gross profit

   $ 7,139    $ 1,912  
    

  


Pretax income/(loss)

   $ 3,451    $ (4,785 )
    

  


 

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Table of Contents
     Balance as of

     September
30, 2004


   March
31, 2005


Accounts receivable, net

   $ 50,385    $ 20,076

Inventory

     4,769      2,310

Costs and estimated earnings in excess of billings on uncompleted contracts

     8,427      3,567

Other current assets

     318      507

Property and equipment, net

     3,870      1,852

Goodwill, net

     10,656      —  

Other noncurrent assets

     788      82
    

  

Total assets

   $ 79,213    $ 28,394
    

  

Accounts payable and accrued liabilities

   $ 13,286    $ 5,769

Billings in excess of costs and estimated earnings on uncompleted contracts

     5,074      1,023

Long term debt, net of current portion

     5      —  

Other long term liabilities

     256      256
    

  

Total liabilities

     18,621      7,048
    

  

Net assets

   $ 60,592    $ 21,346
    

  

 

Goodwill Impairment Associated with Discontinued Operations

 

During the three and six months ended March 31, 2005, the Company recorded a goodwill impairment charge of $3.4 million and $8.6 million related to the identification of certain subsidiaries for disposal by sale prior to the end of the fiscal second quarter 2005. This impairment charge is included in the net loss from discontinued operations caption in the statement of operations. The impairment charge was calculated based on the assessed fair value ascribed to the subsidiaries identified for disposal less the net book value of the assets related to those subsidiaries. The fair value utilized in this calculation was the same as that discussed in the preceding paragraph addressing the impairment of discontinued operations. Where the fair value did not exceed the net book value of a subsidiary including goodwill, the goodwill balance was impaired as appropriate. This impairment of goodwill was determined prior to the disclosed calculation of any additional impairment of the identified subsidiary disposal group as required pursuant to Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. As of March 31, 2005, the Company had only sold a portion of the subsidiaries included in its divestiture plan; therefore, the Company utilized estimated gross proceeds to calculate the fair values associated with the goodwill impairment charge. The Company does not expect any significant differences between those estimates and the actual proceeds to be received upon the sale of the subsidiaries, nor expects any significant effect on the goodwill impairment charge taken.

 

Impairment Associated with Discontinued Operations

 

In accordance with the Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, during the three and six months ended March 31, 2005, the Company recorded an impairment charge of $0.3 million and $1.0 million related to the identification of certain subsidiaries for disposal by sale prior to the end of the fiscal second quarter 2005. The impairment was calculated as the difference between the fair values, less costs to sell, assessed at the date the companies individually were selected for sale and their respective net book values after all other adjustments had been recorded. In determining the fair value for the disposed assets and liabilities, the Company evaluated past performance, expected future performance, management issues, bonding requirements, market forecasts and the carrying value of such assets and liabilities and received a fairness opinion from an independent consulting and investment banking firm in support of this determination for certain of the subsidiaries included in the assessment. The impairment charge was related to subsidiaries included in the commercial and industrial segment of the Company’s operations (see Note 5).

 

3. DEBT

 

Credit Facility

 

On February 27, 2004, the Company amended and restated the $125.0 million revolving credit facility to a $125.0 million revolving credit facility and a $50.0 million term loan led by Bank One, NA. The Company used the proceeds from the term loan and available cash to redeem $75.0 million principal amount of the Company’s long term bonds. Since

 

13


Table of Contents

February 27, 2004, and through December 10, 2004, the Company amended the credit facility four times. The amendments reduced the facility commitment, provided for covenants or waivers that permitted the Company to file the Form 10-Q for the quarter ended June 30, 2004 on or before December 15, 2004, permitted the Company to issue senior convertible notes, specified mandatory debt reduction amounts by quarter, adjusted and redefined financial covenants on a monthly basis beginning December 31, 2004, increased pricing, established the borrowing base at 70 percent of qualifying receivables and permit the Company to release certain collateral related to bonded jobs to companies providing surety bonding. These amendments required the payments of fees upon their execution. These fees are capitalized as deferred financing costs and amortized over the life of the facility. The credit facility, as amended, matures on January 13, 2006. The Company has the ability to extend the facility until January 12, 2007 upon the payment of a fee if certain financial conditions are met. The term loan of the credit facility is due by September 30, 2005. At March 31, 2005, the term loan had no outstanding borrowings. Amounts borrowed under the credit facility, as amended, bear interest at an annual rate of the bank’s prime rate plus two percent. Fees of one percent per annum are assessed on the outstanding credit facility commitments as of the beginning of each quarter. The Company’s direct and indirect subsidiaries guarantee the repayment of all amounts due under the facility and the facility is secured by a first perfected security interest in all the assets of the Company and those subsidiaries, including all of the outstanding capital shares of the capital stock of those subsidiaries. Among other restrictions, the financial covenants include minimum EBITDA, as defined in the credit agreement, requirements for core and all operations, a maximum senior secured debt to EBITDA ratio and a minimum interest coverage ratio. As of March 31, 2005, the Company was in violation of the minimum EBITDA covenant of the Credit Facility, as amended. The Company is in discussions with its bank group to have the covenant waived or the Facility otherwise amended to bring the company into compliance.

 

As of March 31, 2005, the Company had no amounts outstanding under the term loan portion of its Credit Facility, and $2.3 million outstanding under the revolving credit line portion of its Credit Facility, letters of credit outstanding under its Credit Facility of $42.7 million, and if compliance with the terms of the Credit Facility would have available borrowing capacity under its Credit Facility of $33.4 million. During the time of the existing Event of Default, as defined in the Credit Facility, no draws may be made under the Credit Facility. As a result of the change in the Company’s total capacity under the Credit Facility, as amended, pursuant to Emerging Issues Task Force Issue 98-14, Debtor’s Accounting for Changes in Line-of-Credit or Revolving-Debt Arrangements, the Company recorded additional interest expense of $0.3 million related to the write off of deferred financing costs incurred prior to effecting the fourth amendment to the Credit Facility discussed above. This amount is included in interest expense related to the results of operations for the six months ended March 31, 2005.

 

Senior Subordinated Notes

 

The Company has outstanding two different series of senior subordinated notes with similar terms. The notes bear interest at 9 3/8% and will mature on February 1, 2009. Interest is paid on the notes on February 1 and August 1 of each year. The notes are unsecured senior subordinated obligations and are subordinated to all other existing and future senior indebtedness. The notes are guaranteed on a senior subordinated basis by all the Company’s subsidiaries. Under the terms of the notes, the Company is 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 six months ended March 31, 2004, the Company redeemed $75.0 million principal amount of its senior subordinated notes, paying a call premium of 4.7%, or $3.5 million. This premium along with a write off of previously capitalized deferred financing costs of $1.6 million was recorded as a loss in other income and expense. At March 31, 2005, the Company had $172.9 million in outstanding senior subordinated notes. The Company failed to timely file its June 30, 2004 Form 10-Q resulting in defaults under the indenture relating to the Company’s subordinated debt and senior secured credit facility. The Company has since cured all defaults under both series of its subordinated debt issues. If the senior Credit Facility is accelerated as a result of the default, then the trustee may declare a default under the senior subordinated notes.

 

Senior Convertible Notes

 

On November 24, 2004, the Company entered into a purchase agreement for a private placement of $36.0 million aggregate principal amount of its 6.5% Senior Convertible Notes due 2014. Investors in the notes agreed to a purchase price equal to 100% of the principal amount of the notes. The notes require payment of interest semi-annually in arrears at an annual rate of 6.5%, have a stated maturity of November 1, 2014, constitute senior unsecured obligations, are guaranteed on a senior unsecured basis by the Company’s significant domestic subsidiaries, and are convertible at the option of the holder under certain circumstances into shares of the Company’s common stock at an initial conversion price of $3.25 per share, subject to adjustment. On November 1, 2008, the Company has the option to redeem the Senior Convertible Notes, subject to certain conditions. The net proceeds from the sale of the notes were used to prepay a portion of our senior secured Credit Facility and for general corporate purposes. The notes, the guarantees and the shares of common stock issuable upon conversion of the notes to be offered have not been registered under the Securities Act of 1933, as amended, or any state securities laws and, unless so registered, the securities may not be offered or sold in the United States except pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act and applicable state securities laws. A default under the Credit Facility or the senior subordinated notes resulting in acceleration that is not cured within 30 days is also a cross default under the senior convertible notes.

 

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Table of Contents

On February 24, 2005 and following shareholder approval, the Company sold $14 million in principal amount of its Series B 6.5% Senior Convertible Notes due 2014 (the Notes), pursuant to separate option exercises by the holders of the aforementioned $36 million aggregate principal amount of Notes issued by the Company in an initial private placement on November 24, 2004. The senior convertible notes are a hybrid instrument comprised of two components: (1) a debt instrument and (2) certain embedded derivatives. The embedded derivatives include a redemption premium and a make-whole provision and the value of the redemption premium that may be due in the event the Company redeems the notes prior to the stated maturity. In accordance with the guidance that Statement of Financial Accounting Standards No. 133, as amended, Accounting for Derivative Instruments and Hedging Activities, (“SFAS 133”) and Emerging Issues Task Force Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (“EITF 00-19”) provide, the embedded derivatives must be removed from the debt host and accounted for separately as a derivative instrument. These derivative instruments will be marked-to-market each reporting period. During the three months ended December 31, 2004, the Company was required to also value the portion of the Notes that would settle in cash because of shareholder approval of the Notes had not yet been obtained. The initial value of this derivative was $1.4 million and the value at December 31, 2004 was $4.0 million, and consequently, a $2.6 million mark to market loss was recorded. The value of this derivative immediately prior to the affirmative shareholder vote was $2.0 million and accordingly, the Company recorded a mark to market gain of $2.0 million during the three months ended March 31, 2005. The calculation of the fair value of the conversion option was performed utilizing the Black-Scholes option pricing model with the following assumptions effective over the six months ended March 31, 2005: expected dividend yield of 0.00%, expected stock price volatility of 40.00%, weighted average risk free interest rate ranging from 3.67% to 4.15% for four to ten years, respectively, and an expected term of four to ten years. The valuation of the other embedded derivatives was derived by other valuation methods, including present value measures and binomial models. At March 31, 2005, the fair value of the two remaining derivatives was $1.6 million. Additionally, the Company recorded at March 31, 2005 a net discount of $0.9 million which is being amortized over the remaining term of the Notes.

 

Debt consists of the following (in thousands):

 

    

September 30,

2004


   

March 31,

2005


 

Secured Credit Facility and term loan with a group of lending institutions, due January 13, 2006, with an interest rate of 7.75%

   $ 57,929     $ 2,334  

Senior Convertible Notes, due November 1, 2014, bearing interest at 6.5% with an effective interest rate of 6.5%

     —         50,000  

Senior Subordinated Notes, due February 1, 2009, bearing interest at 9.375% with an effective interest rate of 9.8%

     62,885       62,885  

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

     125       174  
    


 


Total debt

     230,939       225,393  

Less—short-term debt and current maturities of long-term debt

     (42,993 )     (2,382 )

Less—unamortized discount on Senior Subordinated Notes

     (2,307 )     (2,044 )

Less—unamortized discount on Senior Convertible Notes

     —         (859 )

Add—fair value of derivatives associated with the Senior Convertible Notes

     —         1,595  

Add—fair value of terminated interest rate hedge

     2,630       2,328  
    


 


Total long-term debt

   $ 188,269     $ 224,031  
    


 


 

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Table of Contents

4. EARNINGS PER SHARE

 

The following table reconciles the numerators and denominators of the basic and diluted earnings per share for the six months ended March 31, 2004 and 2005 (in thousands, except share data):

 

    

Six Months Ended

March 31,


 
     2004

   2005

 
     (restated)       

Numerator:

               

Net income/(loss)

   $ 8,761    $ (30,834 )
    

  


Denominator:

               

Weighted average shares outstanding—basic

     38,408,067      39,033,061  

Effect of dilutive stock options

     605,820      —    
    

  


Weighted average shares outstanding—diluted

     39,013,887      39,033,061  
    

  


Earnings/(loss) per share:

               

Basic

   $ 0.23    $ (0.79 )

Diluted

   $ 0.22    $ (0.79 )

 

For the six months ended March 31, 2004 and 2005, stock options of 2.2 million and 3.0 million representing common stock shares, 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 March 31, 2004 and 2005 (in thousands, except share data):

 

    

Three Months Ended

March 31,


 
     2004

   2005

 
     (restated)       

Numerator:

               

Net income/(loss)

   $ 2,472    $ (13,226 )
    

  


Denominator:

               

Weighted average shares outstanding—basic

     38,544,198      39,149,769  

Effect of dilutive stock options

     698,263      —    
    

  


Weighted average shares outstanding—diluted

     39,242,461      39,149,769  
    

  


Earnings/(loss) per share:

               

Basic

   $ 0.06    $ (0.34 )

Diluted

   $ 0.06    $ (0.34 )

 

For the three months ended March 31, 2004 and 2005, stock options of 2.2 million and 3.5 million representing common stock shares, 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.

 

5. OPERATING SEGMENTS

 

The Company follows SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information (SFAS 131).” Certain information is disclosed, per SFAS 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 geographical 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

 

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home office expenses. Management allocates costs between segments for selling, general and administrative expenses, goodwill impairment, depreciation expense, capital expenditures and total assets.

 

Segment information for the six months ended March 31, 2004 and 2005 is as follows (in thousands):

 

    

Six Months Ended

March 31, 2004


 
     (restated)  
     Commercial
and Industrial


    Residential

   Corporate

    Total

 

Revenues

   $ 456,802     $ 144,439    $ —       $ 601,241  

Cost of services

     405,935       114,596      —         520,531  
    


 

  


 


Gross profit

     50,867       29,843      —         80,710  

Selling, general and administrative

     36,179       16,818      10,451       63,448  
    


 

  


 


Income (loss) from operations

   $ 14,688     $ 13,025    $ (10,451 )   $ 17,262  
    


 

  


 


Other data:

                               

Depreciation and amortization expense

   $ 4,148     $ 605    $ 1,111     $ 5,864  

Capital expenditures

     1,089       724      1,024       2,837  

Total assets

     503,900       102,777      89,811       696,488  
    

Six Months Ended

March 31, 2005


 
     Commercial
and Industrial


    Residential

   Corporate

    Total

 

Revenues

   $ 432,012     $ 141,044    $ —       $ 573,056  

Cost of services

     394,407       111,950      —         506,357  
    


 

  


 


Gross profit

     37,605       29,094      —         66,699  

Selling, general and administrative

     38,428       17,515      15,565       71,508  
    


 

  


 


Income (loss) from operations

   $ (823 )   $ 11,579    $ (15,565 )   $ (4,809 )
    


 

  


 


Other data:

                               

Depreciation and amortization expense

   $ 4,310     $ 421    $ 1,259     $ 5,990  

Capital expenditures

     1,139       523      525       2,187  

Total assets

     407,075       37,154      88,237       532,466  

 

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Segment information for the three months ended March 31, 2004 and 2005 is as follows (in thousands):

 

    

Three Months Ended

March 31, 2004


 
     (restated)  
     Commercial
and Industrial


    Residential

   Corporate

    Total

 

Revenues

   $ 217,085     $ 73,199    $ —       $ 290,284  

Cost of services

     196,016       58,386      —         254,402  
    


 

  


 


Gross profit

     21,069       14,813      —         35,882  

Selling, general and administrative

     17,667       8,486      5,224       31,377  
    


 

  


 


Income (loss) from operations

   $ 3,402     $ 6,327    $ (5,224 )   $ 4,505  
    


 

  


 


Other data:

                               

Depreciation and amortization expense

   $ 2,058     $ 327    $ 564     $ 2,949  

Capital expenditures

     447       422      398       1,267  

Total assets

     503,900       102,777      89,811       696,488  
    

Three Months Ended

March 31, 2005


 
     Commercial
and Industrial


    Residential

   Corporate

    Total

 

Revenues

   $ 216,134     $ 71,387    $ —       $ 287,521  

Cost of services

     198,357       56,109      —         254,466  
    


 

  


 


Gross profit

     17,777       15,278      —         33,055  

Selling, general and administrative

     18,921       9,023      7,960       35,904  
    


 

  


 


Income (loss) from operations

   $ (1,144 )   $ 6,255    $ (7,960 )   $ (2,849 )
    


 

  


 


Other data:

                               

Depreciation and amortization expense

   $ 2,332     $ 214    $ 750     $ 3,296  

Capital expenditures

     495       347      146       988  

Total assets

     407,075       37,154      88,237       532,466  

 

The Company does not have significant operations or long-lived assets in countries outside of the United States.

 

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 2003, the Company granted a restricted stock award of 242,295 shares under its 1999 Plan to certain employees. This award vests 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 is recognized as compensation expense over the related two year vesting period. On December 1, 2004, 113,275 restricted shares vested under this award. During the period December 1, 2003 through November 30, 2004, 15,746 shares of those originally awarded were forfeited.

 

In January 2005, the Company granted a restricted stock award of 365,564 shares under its 1999 Plan to certain employees. This award vests in equal installments on January 3, 2006 and 2007, provided the recipient is still employed by the Company. The market value of the stock on the date of grant for this award was $1.7 million, which is recognized as compensation expense over the related two year vesting period. During the three months ended March 31, 2004 and 2005, the Company amortized $0.2 million and $0.4 million, respectively to expense in connection with these awards. During the six months ended March 31, 2004 and 2005, the Company amortized $0.3 million and $0.6 million, respectively, to expense in connection with these awards.

 

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7. EMPLOYEE STOCK PURCHASE PLAN

 

The Company has an Employee Stock Purchase Plan (the “ESPP”), which provides for the sale of common stock to participants as defined at a price equal to the lower of 85% of the Company’s closing stock price at the beginning or end of the option period, as defined. The ESPP is intended to qualify as an “Employee Stock Purchase Plan” under Section 423 of the Internal Revenue Code of 1986, as amended. In the six months ended March 31, 2004 and 2005, 199,438 and 61,541 shares were issued under the ESPP, respectively. The Company suspended contributions to the Plan for the period January 1, 2005 through June 30, 2005 and may elect to do so in the future.

 

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 individually or cumulatively may materially adversely affect the Company, in the opinion of the Company, all such proceedings are either adequately covered by insurance or financial reserves 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.

 

On August 20, 2004, August 23, 2004, September 10, 2004, September 15, 2004, and October 4, 2004, Corinne Orem, Elaine English, Park Partners, L.P., Jack Zimny, and James Elmore, respectively, each filed a putative class action complaint against IES, and certain of our officers and directors, in the United States District Court for the Southern District of Texas, alleging that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and seeking a class determination for purchasers of IES stock between November 10, 2003 and August 13, 2004. The complaints seek unspecified amounts of compensatory damages, interest and costs, including legal fees. On November 19, 2004, these cases were consolidated. A motion to appoint a lead plaintiff is pending before the Court, and once an appointment is made, the plaintiff will have sixty days to file a consolidated amended complaint. Defendants will have sixty days from the filing of this consolidated amended complaint to respond.

 

On September 3, 2004, Chris Radek filed a shareholder derivative action in the District Court of Harris County, Texas naming Herbert R. Allen, Richard L. China, William W. Reynolds, Britt Rice, David A. Miller, Ronald P. Badie, Donald P. Hodel, Alan R. Sielbeck, C. Byron Snyder, Donald C. Trauscht, and James D. Woods as individual defendants and IES as nominal defendant. In this derivative action, the plaintiff makes substantially similar claims as made in the putative class action complaints, and adds common law claims against the individual defendants. The complaint in the shareholder derivative actions seeks unspecified amounts of damages, interest and costs, including legal fees. By agreement, the Defendants will not respond to this action until the plaintiff files an amended petition.

 

The Company intends to vigorously contest these actions. However, because they are at an early stage, it is premature at this time to predict liability or to estimate the damages, or the range of damages, if any, that we might incur in connection with these actions. An adverse outcome in these actions could have a material adverse effect on our business, consolidated financial condition, results of operations or cash flows.

 

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 March 31, 2005, $1.1 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 March 31, 2005, $36.3 million of the Company’s outstanding letters of credit were to collateralize its insurance program.

 

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 issue 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 March 31, 2005, the Company’s cost to complete projects covered by surety bonds

 

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was approximately $150.6 million and utilized a combination of $17.5 million in cash and letters of credit totaling $5.0 million to collateralize its bonding program.

 

In April 2000, the Company 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 March 31, 2005, the Company had invested $3.5 million under the Company’s commitment to EnerTech. The carrying value of this EnerTech investment at September 30, 2004 and March 31, 2005 was $3.0 million and $3.3 million, respectively. This investment is accounted for on the cost basis of accounting and accordingly, the Company does not record unrealized losses for the EnerTech investment that it believes are temporary in nature. As of March 31, 2005, the fair value of the Company’s share of the EnerTech fund approximated the carrying value. If facts arise that lead the Company to determine that such unrealized losses are not temporary, the Company will write down the investment in EnerTech through a charge to other expense during the period of such determination.

 

9. SUBSEQUENT EVENTS

 

Subsequent to March 31, 2005, the Company sold substantially all the net assets of three commercial business units for total proceeds of $4.9 million. These business units were included in the Company’s aforementioned plan (see Note 2) to divest certain identified subsidiaries. The business units had revenues of $11.1 million and $9.1 million and operating income of $1.1 million and $0.4 million for the six months ended March 31, 2004 and 2005, respectively. The results of operations from these business units are included in the results from discontinued operations in the statement of operations for the three and six months ended March 31, 2004 and 2005.

 

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 quarterly 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 our fiscal year ended September 30, 2004.

 

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, 2004 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 perform 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 and the cost of casualty and health insurance. These costs may vary from the costs we originally estimated. Variations from original estimated contract costs and variations from ongoing estimates of costs to complete projects in progress, along with other risks inherent in performing fixed price and unit price contracts, may result in actual revenue and gross profits or interim projected revenue and gross profits for a project differing from those we estimated and could result in losses on projects. Depending on the size of a particular project, variations from estimated project costs

 

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could have a significant impact on our operating results for any quarter or fiscal 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 contracts performed in the southern United States. Downturns in new construction activity in the southern part of the United States could negatively affect our results.

 

We complete most projects in less than 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 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 project management, 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, their willingness to pay, general economic conditions and our ongoing relationships. In addition to these factors, our business and the method of accounting for construction contracts requires the review and analysis of not only the net receivables, but the amount of billings in excess of costs and costs in excess of billings integral to the overall review of collectibility associated with our billings in total. The analysis management utilizes to assess collectibility of its receivables includes detailed review of older balances, analysis of days sales outstanding where we include in the calculation, in addition to accounts receivable balances net of any allowance for doubtful accounts, the level of costs in excess of billings netted against billings in excess of costs, and the ratio of accounts receivable, net of any allowance for doubtful accounts plus the level of costs in excess of billings, to revenues. These analyses provide an indication of those amounts billed ahead or behind the recognition of revenue on our construction contracts and are important to consider in understanding the operational cash flows related to our revenue cycle.

 

We are insured for workers’ compensation, automobile liability, general liability, employment practices and employee-related health care claims, subject to large deductibles. Our general liability program provides coverage for bodily injury and property damage that is neither expected nor intended. Losses up to the 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 quarterly at the end of each fiscal quarter 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 March 31, 2005, 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

 

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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 SIX MONTHS ENDED MARCH 31, 2004 COMPARED TO THE SIX MONTHS ENDED MARCH 31, 2005

 

The following table presents selected unaudited historical financial information for the three months ended March 31, 2004 and 2005.

 

    

Six Months Ended

March 31,


 
     2004

    %

    2005

    %

 
     (restated)              
     (dollars in millions)  

Revenues

   $ 601.2     100 %   $ 573.1     100 %

Cost of services (including depreciation)

     520.5     87 %     506.4     88 %
    


 

 


 

Gross profit

     80.7     13 %     66.7     12 %

Selling, general & administrative expenses

     63.4     10 %     71.5     13 %
    


 

 


 

Income/(loss) from operations

     17.3     3 %     (4.8 )   (1 )%

Interest and other expense, net

     18.5     3 %     13.8     2 %
    


 

 


 

Income/(loss) before income taxes

     (1.2 )   0 %     (18.6 )   (3 )%

Provision/(benefit) for income taxes

     (6.7 )   (1 )%     0.9     0 %
    


 

 


 

Income/(loss) from continuing operations

     5.5     1 %     (19.5 )   (3 )%

Net income/(loss) from discontinued operations

     3.3     1 %     (11.3 )   (2 )%
    


 

 


 

Net income/(loss)

   $ 8.8     2 %   $ (30.8 )   (5 )%
    


 

 


 

 

REVENUES

 

     Percent of Total
Revenues


 
     Six Months Ended
March 31,


 
     2004

    2005

 

Commercial and Industrial

   76 %   75 %

Residential

   24 %   25 %
    

 

Total Company

   100 %   100 %
    

 

 

Total revenues decreased $28.1 million, or 4.7%, from $601.2 million for the six months ended March 31, 2004, to $573.1 million for the six months ended March 31, 2005. This decrease in revenues is primarily the result of a decrease in revenues of $36.4 million in certain commercial markets resulting from the decrease in the award of bonded projects and a decrease of $3.4 million in residential revenues for the six months ended March 31, 2005.

 

Commercial and industrial revenues decreased $24.6 million, or 5.4%, from $456.8 million for the six months ended March 31, 2004, to $432.0 million for the six months ended March 31, 2005. The decrease is due to a decrease in industrial revenues of $30.0 million primarily in the North, South and West regions for the six months ended March 31, 2004 versus March 31, 2005 due to decreased spending in these markets and a decrease in the award of bonded projects. Additionally, a decrease of $7.9 million in service and maintenance revenues in our North and West regions attributed to the overall decrease for the same periods compared.

 

Residential revenues decreased $3.4 million, or 2.4%, from $144.4 million for the six months ended March 31, 2004 to $141.0 million for the six months ended March 31, 2005, primarily as a result of decreased demand for new single-family and multi-family housing.

 

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GROSS PROFIT

 

     Segment Gross Profit Margins
As a Percent of Segment
Revenues


 
     Six Months Ended March 31,

 
     2004

    2005

 

Commercial and Industrial

   11.1 %   8.7 %

Residential

   20.7 %   20.6 %
    

 

Total Company

   13.4 %   11.8 %
    

 

 

Gross profit decreased $14.0 million, or 17.3%, from $80.7 million for the six months ended March 31, 2004, to $66.7 million for the six months ended March 31, 2005. Gross profit margin as a percentage of revenues decreased from 13.4% to 11.6% for the six months ended March 31, 2004 compared to six months ended March 31, 2005. The decline in gross margin from the six months ended March 31, 2004 compared to the six months ended March 31, 2005 was primarily due to a combination of an increase in insurance reserves of $1.0 million, increased competition and costs of materials that have not fully been passed to customers in our residential segment, decreased profitability due to closing utility and plant work at one subsidiary and decreased award of bonded projects in our commercial and industrial segment. During the six months ended March 31, 2005, we recorded $0.2 million additional accumulated amortization in cost of revenues for leasehold improvements. These costs were incurred to correct errors from prior periods where we amortized leasehold improvements over a period longer than the original lease term. We do not believe these errors or the related correction is material to any affected period.

 

Commercial and industrial gross profit decreased $13.3 million, or 26.1%, from $50.9 million for the six months ended March 31, 2004 to $37.6 million for the six months ended March 31, 2005. Commercial and industrial gross profit margin as a percentage of revenues decreased from 11.1% for the six months ended March 31, 2004, to 8.7% for the six months ended March 31, 2005. This decrease in gross profit margin as a percentage of revenues was primarily the result of reduced job profitability at specific subsidiaries and decreased awards of bonded projects. Additionally, we are also closing the utility and plant work at one subsidiary which accounted for $2.9 million gross profit loss during the six months ended March 31, 2005.

 

Residential gross profit decreased $0.7 million, or 2.5%, from $29.8 million for the six months ended March 31, 2004, to $29.1 million for the six months ended March 31, 2005. Residential gross profit margin as a percentage of revenues decreased from 20.7% for the six months ended March 31, 2004, to 20.6% for the six months ended March 31, 2005. This decrease in gross profit margin as a percentage of revenues was primarily the result of increased competition for work and higher overall costs for materials that we cannot pass on to our customers in markets we serve.

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

Selling, general and administrative expenses increased $8.1 million, or 12.8%, from $63.4 million for the six months ended March 31, 2004, to $71.5 million for the six months ended March 31, 2005. Selling, general and administrative expenses as a percentage of revenues increased from 10.6% for the six months ended March 31, 2004 to 12.5% for the six months ended March 31, 2005. Additional costs of $2.4 million in legal fees resulted from the combination of not timely filing our fiscal third quarter 2004 Form 10-Q and other litigation during the six months ended March 31, 2005. Additional consulting fees during the six months ended March 31, 2005 associated with Sarbanes-Oxley compliance was $0.4 million that were not incurred during the six months ended March 31, 2004. Additional costs of $2.3 million were incurred during the six months ended March 31, 2005 associated with an incentive program that were not incurred during the six months ended March 31, 2004. Additional costs for the impairment of goodwill were included during the six months ended March 31, 2005 relating to a company formally included in discontinued operations and currently included in continuing operations of $0.6 million. During the six months ended March 31, 2005, we recorded $0.5 million additional accumulated amortization in selling, general and administrative expenses for leasehold improvements. These costs were incurred to correct errors from prior periods where we amortized leasehold improvements over a period longer than the original lease term. We do not believe these errors or the related correction is material to any affected period.

 

INCOME FROM OPERATIONS

 

Income from operations decreased $22.1 million, or 127.7%, from $17.3 million for the six months ended March 31, 2004, to an operating loss of $4.8 million for the six months ended March 31, 2005. This decrease in income from operations was attributed to increased competition and costs of materials that have not fully been passed to customers, closing utility and plant work at one subsidiary and additional accumulated depreciation recorded for leasehold improvements during the six months

 

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ended March 31, 2005 over the same period in the prior year and the increase in selling, general, and administrative costs of $8.1 million during the six months ended March 31, 2005.

 

NET INTEREST AND OTHER EXPENSE

 

Interest and other expense, net decreased from $18.5 million for the six months ended March 31, 2004, to $13.8 million for the six months ended March 31, 2005. This decrease in net interest and other expense was primarily the result of a $5.2 million loss associated with retiring $75 million of senior subordinated notes during the six months ended March 31, 2004 not included during the six months ended March 31, 2005. This decrease is partially offset by an increase in interest expense during the six months ended March 31, 2005 for $0.7 million in non-cash mark-to-market interest associated with the embedded conversion option within our senior convertible notes issued in November 2004.

 

PROVISION FOR INCOME TAXES

 

Our tax provision increased from a tax benefit of $6.7 million for the six months ended March 31, 2004 to a tax provision of $0.9 million for the six months ended March 31, 2005. This increase is attributable a pretax net loss, permanent differences required to be added back for income tax purposes, the impairment of non-deductible goodwill, an additional valuation allowance against certain federal and state deferred tax assets and a change in contingent tax liabilities. Additionally, we released valuation allowances of $6.3 million during the six months ended March 31, 2004 that did not occur during the six months ended March 31, 2005.

 

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2005

 

The following table presents selected unaudited historical financial information for the three months ended March 31, 2004 and 2005.

 

    

Three Months Ended

March 31,


 
     2004

    %

    2005

    %

 
     (restated)              
     (dollars in millions)  

Revenues

   $ 290.3     100 %   $ 287.5     100 %

Cost of services (including depreciation)

     254.4     88 %     254.5     88 %
    


 

 


 

Gross profit

     35.9     12 %     33.0     11 %

Selling, general & administrative expenses

     31.4     11 %     35.9     12 %
    


 

 


 

Income/(loss) from operations

     4.5     1 %     (2.9 )   (1 )%

Interest and other expense, net

     11.9     4 %     4.9     2 %
    


 

 


 

Income/(loss) before income taxes

     (7.4 )   (3 )%     (7.8 )   (3 )%

Provision/(benefit) for income taxes

     (7.8 )   (3 )%     0.7     0 %
    


 

 


 

Income/(loss) from continuing operations

     0.4     0 %     (8.5 )   (3 )%

Net income/(loss) from discontinued operations

     2.1     0 %     (4.8 )   (2 )%
    


 

 


 

Net income/(loss)

   $ 2.5     0 %   $ (13.3 )   (5 )%
    


 

 


 

 

REVENUES

 

     Percent of Total Revenues

 
     Three Months Ended
March 31,


 
     2004

    2005

 

Commercial and Industrial

   75 %   75 %

Residential

   25 %   25 %
    

 

Total Company

   100 %   100 %
    

 

 

Total revenues decreased $1.6 million, or 0.6%, from $290.3 million for the three months ended March 31, 2004, to $288.7 million for the three months ended March 31, 2005. This decrease in revenues is primarily the result of a decrease in revenues of $1.8 million in residential revenues for the three months ended March 31, 2005, offset partially by an increase of $0.2 million in commercial and industrial revenues.

 

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Commercial and industrial revenues decreased $1.0 million, or 0.5%, from $217.1 million for the three months ended March 31, 2004, to $216.1 million for the three months ended March 31, 2005. The decrease was primarily related to an underperforming subsidiary in the South region.

 

Residential revenues decreased $1.8 million, or 2.5%, from $73.2 million for the three months ended March 31, 2004 to $71.4 million for the three months ended March 31, 2005, primarily as a result of decreased demand for new single-family and multi-family housing.

 

GROSS PROFIT

 

     Segment Gross Profit Margins
As a Percent of Segment
Revenues


 
    

Three Months Ended

March 31,


 
     2004

    2005

 

Commercial and Industrial

   9.7 %   8.2 %

Residential

   20.2 %   21.4 %
    

 

Total Company

   12.4 %   11.9 %
    

 

 

Gross profit decreased $1.7 million, or 4.7%, from $35.9 million for the three months ended March 31, 2004, to $33.0 million for the three months ended March 31, 2005. Gross profit margin as a percentage of revenues decreased from 12.4% to 11.5% for the three months ended March 31, 2004 compared to three months ended March 31, 2005. The decline in gross margin from the three months ended March 31, 2004 compared to the three months ended March 31, 2005 was primarily due to a combination of increased insurance reserves, increased competition and costs of materials that have not fully been passed to customers in our residential segment, decreased profitability due to closing utility and plant work at one subsidiary and decreased award of bonded projects in our commercial and industrial segment. During the three months ended March 31, 2005, we recorded $0.2 million additional accumulated amortization in cost of revenues for leasehold improvements. These costs were incurred to correct errors from prior periods where we amortized leasehold improvements over a period longer than the original lease term. We do not believe these errors or the related correction is material to any affected period.

 

Commercial and industrial gross profit decreased $2.1 million, or 10.1%, from $21.1 million for the three months ended March 31, 2004 to $17.7 million for the three months ended March 31, 2005. Commercial and industrial gross profit margin as a percentage of revenues decreased from 9.7% for the three months ended March 31, 2004, to 8.2% for the three months ended March 31, 2005. This decrease in gross profit margin as a percentage of revenues was primarily the result of reduced job profitability at specific subsidiaries and decreased awards of bonded projects. Additionally, we are also closing the utility and plant work at one subsidiary which accounted for $2.1 million gross profit loss during the three months ended March 31, 2005.

 

Residential gross profit increased $0.5 million, or 3.1%, from $14.8 million for the three months ended March 31, 2004, to $15.3 million for the three months ended March 31, 2005. Residential gross profit margin as a percentage of revenues increased from 20.2% for the three months ended March 31, 2004, to 21.4% for the three months ended March 31, 2005.

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

Selling, general and administrative expenses increased $4.5 million, or 14.3%, from $31.4 million for the three months ended March 31, 2004, to $35.9 million for the three months ended March 31, 2005. Selling, general and administrative expenses as a percentage of revenues increased from 10.8% for the three months ended March 31, 2004 to 12.5% for the three months ended March 31, 2005. Additional costs of $1.3 million were incurred during the three months ended March 31, 2005 associated with an incentive program that were not incurred during the three months ended March 31, 2004. Additional costs for legal fees during the three months ended March 31, 2005 resulted from litigation was $2.4 million. Additional consulting fees during the three months ended March 31, 2005 associated with Sarbanes-Oxley compliance was $0.3 million that were not incurred during the three months ended March 31, 2004. During the three months ended March 31, 2005, we recorded $0.5 million additional accumulated amortization in selling, general and administrative expenses for leasehold improvements. These costs were incurred to correct errors from prior periods where we amortized leasehold

 

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improvements over a period longer than the original lease term. We do not believe these errors or the related correction is material to any affected period.

 

INCOME FROM OPERATIONS

 

Income from operations decreased $7.4 million, or 164.4%, from $4.5 million for the three months ended March 31, 2004, to an operating loss of $2.9 million for the three months ended March 31, 2005. This decrease in income from operations was attributed to increase competition and costs of materials that have not fully been passed to customers, closing utility and plant work at one subsidiary and additional accumulated depreciation recorded for leasehold improvements during the three months ended March 31, 2005 over the same period in the prior year and the increase in selling, general, and administrative costs of $4.6 million during the three months ended March 31, 2005.

 

NET INTEREST AND OTHER EXPENSE

 

Interest and other expense, net decreased from $11.9 million for the three months ended March 31, 2004, to $4.9 million for the three months ended March 31, 2005. This decrease in net interest and other expense was primarily the result of a $5.2 million loss associated with retiring $75 million of senior subordinated notes during the six months ended March 31, 2004 not included during the six months ended March 31, 2005 and $2.0 million related to the marking to market of certain derivatives associated with our senior convertible notes.

 

PROVISION FOR INCOME TAXES

 

Our tax provision increased from a tax benefit of $7.8 million for the three months ended March 31, 2004 to a tax provision of $0.6 million for the three months ended March 31, 2005. This increase is attributable a pretax net loss, permanent differences required to be added back for income tax purposes, the impairment of non-deductible goodwill, an additional valuation allowance against certain federal and state deferred tax assets and a change in contingent tax liabilities. Additionally, we released valuation allowances of $4.8 million during the three months ended March 31, 2004, that did not occur during the three months ended March 31, 2005.

 

DISCONTINUED OPERATIONS

 

During October 2004, we announced plans to begin a strategic alignment including the planned divestiture of certain commercial segment, underperforming subsidiaries and those that rely heavily on surety bonding for obtaining a majority of their projects. During November 2004, management committed to a plan to complete the divestiture of these companies by the end of fiscal 2005. This plan included management’s actively seeking potential buyers of the selected companies among other activities necessary to complete the sales. Management expects to be able to sell all considered subsidiaries at their respective fair market values at the date of sale determined by a reasonably accepted valuation method. Management does not foresee any significant changes in the plan, nor anticipates events requiring withdrawal from the plan. The discontinued operations disclosures include only those identified subsidiaries qualifying for discontinued operations treatment for the periods presented; therefore, other subsidiaries included in our divestiture plan will be included in future periods as they qualify for discontinued operations treatment.

 

During the six months ended March 31, 2005, the Company completed the sale of all the net assets of seven of its operating subsidiaries for $24.1 million in cash. These operating subsidiaries primarily provided electrical contracting services for the commercial segment. The sale generated an after-tax gain of $0.2 million and has been recognized in the six months ended March 31, 2005 as discontinued operations in the consolidated income statement and the prior year’s six months ended March 31, 2004 results of operations have been reclassified. Summarized financial data for discontinued operations are outlined below:

 

    

Six Months Ended

March 31,


 
     2004

   2005

 

Revenues

   $ 98,960    $ 62,469  
    

  


Gross profit

   $ 13,238    $ 5,464  
    

  


Pretax income/(loss)

   $ 5,356    $ (11,210 )
    

  


    

Three Months Ended

March 31,


 
     2004

   2005

 

Revenues

   $ 49,711    $ 24,470  
    

  


Gross profit

   $ 7,139    $ 1,912  
    

  


Pretax income/(loss)

   $ 3,451    $ (4,785 )
    

  


 

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     Balance as of

     September
30, 2004


   March
31, 2005


Accounts receivable, net

   $ 50,385    $ 20,076

Inventory

     4,769      2,310

Costs and estimated earnings in excess of billings on uncompleted contracts

     8,427      3,567

Other current assets

     318      507

Property and equipment, net

     3,870      1,852

Goodwill, net

     10,656      —  

Other noncurrent assets

     788      82
    

  

Total assets

   $ 79,213    $ 28,394
    

  

Accounts payable and accrued liabilities

   $ 13,286    $ 5,769

Billings in excess of costs and estimated earnings on uncompleted contracts

     5,074      1,023

Long term debt, net of current portion

     5      —  

Other long term liabilities

     256      256
    

  

Total liabilities

     18,621      7,048
    

  

Net assets

   $ 60,592    $ 21,346
    

  

 

During the fiscal second quarter ended March 31, 2005, we recorded a goodwill impairment charge of $8.6 million related to the identification of certain subsidiaries for disposal by sale prior to the end of the fiscal third quarter 2005. This impairment charge is included in the net loss from discontinued operations caption in the statement of operations. The impairment charge was calculated based on the assessed fair value ascribed to the subsidiaries identified for disposal less the net book value of the assets related to those subsidiaries. The fair value utilized in this calculation was the same as that discussed in the preceding paragraph addressing the impairment of discontinued operations. Where the fair value did not exceed the net book value of a subsidiary including goodwill, the goodwill balance was impaired as appropriate. This impairment of goodwill was determined prior to the disclosed calculation of any additional impairment of the identified subsidiary disposal group as required pursuant to Statement of Financial Accounting Standards No. 144, Accounting for the Impairment of Disposal of Long-Lived Assets. As of March 31, 2005, we had only sold a portion of the subsidiaries included in our divestiture plan; therefore, we utilized estimated gross proceeds to calculate the fair values associated with the goodwill impairment charge. We do not expect any significant differences between those estimates and the actual proceeds to be received upon the sale of the subsidiaries, nor expect any significant effect on the goodwill impairment charge taken.

 

In accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, during the fiscal second quarter ended March 31, 2005, we recorded an impairment charge of $1.0 million related to the identification of certain subsidiaries for disposal by sale prior to the end of the fiscal third quarter 2005. The impairment was calculated as the difference between the fair values, less costs to sell, assessed at the date the companies individually were selected for sale and their respective net book values after all other adjustments had been recorded. In determining the fair value for the disposed assets and liabilities, we evaluated past performance, expected future performance, management issues, bonding requirements, market forecasts and the carrying value of such assets and liabilities and received a fairness opinion from an independent consulting and investment banking firm in support of this determination for certain of the subsidiaries included in the assessment. The impairment charge was related to subsidiaries included in the commercial and industrial segment of our operations (see Note 5).

 

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WORKING CAPITAL

 

     September 30,
2004


   March 31,
2005


     (restated)     

CURRENT ASSETS:

             

Cash and cash equivalents

   $ 22,232    $ 32,384

Accounts receivable:

             

Trade, net of allowance of $4,103 and $2,962 respectively

     211,279      195,416

Retainage

     57,647      55,577

Costs and estimated earnings in excess of billings on uncompleted contracts

     33,389      34,983

Inventories

     17,888      19,509

Prepaid expenses and other current assets

     12,989      22,064

Assets held for sale associated with discontinued operations

     79,213      28,394
    

  

Total current assets

   $ 434,637    $ 388,327
    

  

CURRENT LIABILITIES:

             

Current maturities of long-term debt

   $ 42,993      2,382

Accounts payable and accrued expenses

     136,213      129,845

Billings in excess of costs and estimated earnings on uncompleted contracts

     32,515      36,016

Liabilities related to assets held for sale associated with discontinued operations

     18,621      7,048
    

  

Total current liabilities

   $ 230,342    $ 175,291
    

  

Working capital

   $ 204,295    $ 213,036
    

  

 

Total current assets decreased $46.3 million, or 10.7%, from $434.6 million as of September 30, 2004 to $388.3 million as of March 31, 2005. This decrease is primarily the result of a $15.9 million decrease in trade accounts receivable, net, due to a company-wide focus on collections and the timing of billings on projects in progress, $50.8 million decrease in assets held for sale associated with discontinued operations due to the sale of seven business units during the six months ended March 31, 2005; offset by an increase in prepaid expenses and other current assets of $9.1 million from additional cash collateral deposited with our surety bonding company, and a net increase in cash of $10.2 resulting from the proceeds received from the issuance of our senior convertible bonds in November 2004 and $65.6 million in payments on the term loan portion of our Credit Facility, a portion of the proceeds received from assets sales and the focus on collections.

 

As of March 31, 2005, the status of our costs in excess of billings versus our billings in excess of costs improved over that at September 30, 2004; and days sales outstanding decreased 1.3% from September 30, 2004 to March 31, 2005. Our receivables and costs and earnings in excess of billings on uncompleted contracts as compared to quarterly revenues decreased from 97.9% at September 30, 2004 to 97.7% at March 31, 2005, when adjusted for a balance of $5.2 million as of March 31, 2005 in long-standing receivables also outstanding at September 30, 2004, but not fully collected by March 31, 2005. As is common in the construction industry, some of these receivables are in litigation or require us to exercise our contractual lien rights and are expected to be collected within the fiscal year ended September 30, 2005. These receivables are primarily associated with a few operating companies within our commercial and industrial segments. Although improvement was experienced over the periods discussed, some of our receivables are slow pay in nature or require us to exercise our contractual or lien rights. We believe that our allowances for doubtful accounts are sufficient to cover any uncollectible accounts.

 

Total current liabilities decreased $55.0 million, or 23.9%, from $230.3 million as of September 30, 2004 to $175.3 million as of March 31, 2005. This decrease is primarily the result of a $40.6 million decrease in current maturities of long-term debt related to payments on our Credit Facility, $5.7 million decrease in accounts payable and accrued expenses due to the timing of payments made and reduced operating activity resulting from the seasonality of our business during the six months ended March 31, 2005, a $11.6 million decrease related to the sale of six business units during the six months ended March 31, 2005 pursuant to a divestiture plan previously disclosed; offset by a $2.3 million increase in billings in excess of costs.

 

Working capital increased $8.7 million, or 4.3%, due primarily to cash proceeds received from the issuance of $50.0 million in senior convertible bonds during the six months ended March 31, 2005; offset by a net $10.0 million decrease resulting from net decreases in accounts receivable and accounts payable and accrued expenses associated with reduced operating activity resulting from both seasonality of the business and a decrease in the award of bonded projects, $39.2 decrease in working capital from the sale of seven subsidiaries during the six months ended March 31, 2005. See “Liquidity and Capital Resources” below for further information.

 

LIQUIDITY AND CAPITAL RESOURCES

 

As of March 31, 2005, we had cash and cash equivalents of $32.4 million, working capital of $213.0 million, outstanding borrowings of $2.3 million under our credit facility and term loan, $42.7 million of letters of credit outstanding, and if we were in compliance with the terms of our Credit Facility would have available capacity under our credit facility of $33.4 million. The amount outstanding under our senior subordinated notes was $172.9 million and $50.0 million outstanding under our senior convertible notes.

 

During the six months ended March 31, 2005, we used $3.5 million of net cash from operating activities. This net cash used by operating activities comprised of a net loss of $30.8 million, decreased by a $11.3 million net loss from discontinued operations, $0.4 million net operating cash flows from discontinued operations, and $11.9 million of non-cash charges related primarily to $1.7 million of depreciation of deferred financing costs and $6.0 million of other depreciation and amortization expense, and $1.3 million bad debt expense; and offset by changes in working capital of $2.5 million. Working capital changes consisted of a $1.6 million increase in trade accounts receivable due to the timing of collections, $9.5 million increase in prepaid expenses and other current assets due to cash deposited with

 

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our surety bonding company collateralizing our surety bonds. Additionally, accounts payable and accrued expenses decreased $5.7 million due to the timing of payments from period to period, and billings in excess of costs increased $3.5 million. Net cash provided by investing activities was $21.8 million, consisting primarily of $24.1 million in proceeds received for the sale of six business units during the six months ended March 31, 2005 included in net cash provided by investing activities related to discontinued operations, offset by $2.2 million related to the purchase of property and equipment. Net cash provided by financing activities was $8.5 million, resulting primarily from the receipt of $60.0 million in senior convertible notes and additional drawings on our Credit Facility and $0.6 million in proceeds from exercise of stock options, offset by $65.6 million in payments made on our Credit Facility and term loan and $3.9 million in financing costs capitalized primarily associated with the issuance of our senior convertible notes.

 

On November 5, 2003, we commenced a $13 million share repurchase program. We used approximately $4.6 million in cash generated from operations to repurchase 549,200 shares during the year ended September 30, 2004 under this program. The terms of our credit facility, as amended, restrict our ability to repurchase shares under this program; therefore, no shares were repurchased under this program for the six months ended March 31, 2005.

 

On February 27, 2004, we amended and restated our $125.0 million revolving credit facility to a $125.0 million revolving credit facility and a $50.0 million term loan led by Bank One, NA. We used the proceeds from the term loan and available cash to redeem $75.0 million principal amount of our long term bonds. Since February 27, 2004, and through December 10, 2004, we have amended the credit facility four times. The amendments provided, among other things, for covenants or waivers that permit us to file our Form 10-Q for the quarter ended June 30, 2004 on or before December 15, 2004, permitted us to issue senior convertible notes, specified mandatory debt reduction amounts by quarter, adjusted and redefined financial covenants on a monthly basis beginning December 31, 2004, increased pricing, established the borrowing base at 70 percent of qualifying receivables and permit us to release certain collateral related to bonded jobs to companies providing surety bonding. These amendments required the payments of fees upon their execution. These fees are capitalized as deferred financing costs and amortized over the life of the facility. The credit facility, as amended, matures on January 13, 2006. We have the ability to extend the facility until January 12, 2007 upon the payment of a fee if certain financial conditions are met. The term loan of the credit facility is due by September 30, 2005. At March 31, 2005, the term loan had no outstanding borrowings. Amounts borrowed under the credit facility, as amended, bear interest at an annual rate of the banks prime rate plus two percent. Fees of one percent per annum are assessed on the outstanding credit facility commitment as of the beginning of each quarter beginning January 1, 2005. Our direct and indirect subsidiaries guarantee the repayment of all amounts due under the facility and the facility is secured by a first perfected security interest in all the assets of the company and those subsidiaries, including all of the outstanding capital shares of the capital stock of those subsidiaries. Among other restrictions, the financial covenants include minimum EBITDA requirements for core and all operations, a maximum senior secured debt to EBITDA ratio and a minimum interest coverage ratio. As of March 31, 2005, we were in violation of the minimum EBITDA covenant of the credit facility, as amended. We are in discussions with the bank group to have the covenant waived or otherwise amended to bring the company into compliance.

 

We have outstanding two different series of senior subordinated notes with similar terms. 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 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 six months ended March 31, 2004, we redeemed $75.0 million principal amount of our senior subordinated notes, paying a call premium of 4.7%, or $3.5 million. This premium along with a write off of previously capitalized deferred financing costs of $1.6 million was recorded as a loss in other income and expense. At March 31, 2005, we had $172.9 million in outstanding senior subordinated notes. We failed to timely file our June 30, 2004 Form 10-Q resulting in defaults under the indenture relating to our subordinated debt and senior secured credit facility. We have since cured all defaults under our subordinated debt. If the senior Credit Facility is accelerated as a result of the existing default, then the trustee may declare a default under the senior subordinated notes.

 

Senior Convertible Notes

 

On November 24, 2004, we entered into a purchase agreement for a private placement of $36.0 million aggregate principal amount of its 6.5% Senior Convertible Notes due 2014. Investors in the notes agreed to a purchase price equal to 100% of the principal amount of the notes. The notes require payment of interest semi-annually in arrears at an annual rate of 6.5%, have a stated maturity of November 1, 2014, constitute senior unsecured obligations, are guaranteed on a senior unsecured basis by our significant domestic subsidiaries, and are convertible at the option of the holder under certain circumstances into shares of our common stock at an initial conversion price of $3.25 per share, subject to adjustment. On November 1, 2008, we have the option to redeem the Senior Convertible Notes, subject to certain conditions. The net proceeds from the sale of the notes were used to prepay a portion of our senior secured Credit Facility and for general corporate purposes. The notes, the guarantees and the shares of common stock issuable upon conversion of the notes to be offered have not been registered under the Securities Act of 1933, as amended, or any state securities laws and, unless so

 

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registered, the securities may not be offered or sold in the United States except pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act and applicable state securities laws. An acceleration under the Credit Facility or the senior subordinated notes that is not cured within 30 days is also a cross default under the senior convertible notes. As a result, unless our existing default under our credit facility is cured within 30 days, it will become a default under our senior convertible notes.

 

On February 24, 2005, and following shareholder approval, we sold $14 million in principal amount of its Series B 6.5% Senior Convertible Notes due 2014 (the Notes), pursuant to separate option exercises by the holders of the aforementioned $36 million aggregate principal amount of Notes issued by us in an initial private placement on November 24, 2004. The senior convertible notes are a hybrid instrument comprised of two components: (1) a debt instrument and (2) certain embedded derivatives. The embedded derivatives include a redemption premium and a make-whole provision and the value of the redemption premium that may be due in the event we redeem the notes prior to the stated maturity. In accordance with the guidance that Statement of Financial Accounting Standards No. 133, as amended, Accounting for Derivative Instruments and Hedging Activities, (“SFAS 133”) and Emerging Issues Task Force Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (“EITF 00-19”) provide, the embedded derivatives must be removed from the debt host and accounted for separately as a derivative instrument. These derivative instruments will be marked-to-market each reporting period. During the three months ended December 31, 2004, we were required to also value the portion of the Notes that would settle in cash because shareholder approval of the notes had not yet been obtained. The initial value of this derivative was $1.4 million and the value at December 31, 2004 was $4.0 million and consequently, a $2.6 million mark to market loss was recorded. The value of this derivative immediately prior to the affirmative shareholder vote was $2.0 million and accordingly, we recorded a mark to market gain of $2.0 million during the three months ended March 31, 2005. The calculation of the fair value of the conversion option was performed utilizing the Black-Scholes option pricing model with the following assumptions effective over the six months period ended March 31, 2005: expected dividend yield of 0.00%, expected stock price volatility of 40.00%, weighted average risk free interest rate ranging from 3.67% to 4.15% and an expected term of four to ten years. The valuation of the other embedded derivatives was derived by other valuation methods, including present value measures and binomial models. At March 31, 2005, the fair value of the two remaining derivatives was $1.6 million. Additionally, we recorded at March 31, 2005 a net discount of $0.9 million which is being amortized over the remaining term of the Notes.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

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 commitments 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.

 

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 March 31, 2005, $1.1 million of our outstanding letters of credit were to collateralize our customers.

 

Some of the underwriters of our casualty insurance program 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

 

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effect payment under a letter of credit. At March 31, 2005, $36.3 million of our outstanding letters of credit were to collateralize our insurance program.

 

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 sureties is such that we will indemnify the sureties for any expenses they incur in connection with any of the bonds they issues on our behalf. To date, we have not incurred significant costs to indemnify our sureties for expenses they incurred on our behalf. As of March 31, 2005, our cost to complete projects covered by surety bonds was approximately $150.6 million and utilized a combination of $17.5 million in cash and letters of credit totaling $5.0 million to collateralize its bonding program.

 

In April 2000, we 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 March 31, 2005, we had invested $3.5 million under our commitment to EnerTech. The carrying value of this EnerTech investment at September 30, 2004 and March 31, 2005 was $3.0 million and $3.3 million, respectively. This investment is accounted for on the cost basis of accounting and accordingly, we do not record unrealized losses for the EnerTech investment that we believe are temporary in nature. As of March 31, 2005, the fair value of our share of the EnerTech fund approximated the carrying value. If facts arise that lead us to determine that such unrealized losses are not temporary, we would write down our investment in EnerTech through a charge to other expense during the period of such determination.

 

Our future contractual obligations due by September 30 of each of the following fiscal years include (in thousands)(1):

 

     2005

   2006

   2007

   2008

   2009

   Thereafter

   Total

Debt obligations

   $ 2,401    $ 32    $ 16    $ 10    $ 172,889    $ 50,000    $ 225,348

Operating lease obligations

     8,208      10,728      7,689      4,622      3,011      3,281      37,539

Deferred and contingent tax liabilities

     525      8,620      4,461      236      —        —        13,842

Capital lease obligations

     24      11      3      3      3      1      45

(1) The tabular amounts exclude the interest obligations that will be created if the debt and capital lease obligations are outstanding for the periods presented.

 

Our other commercial commitments expire by September 30 of each of the following fiscal years (in thousands):

 

     2005

   2006

   2007

   2008

   2009

   Thereafter

    Total

Standby letters of credit

   $ —      $ 42,696    $ —      $ —      $ —      $ —       $ 42,696

Other commercial commitments

   $ —      $ —      $ —      $ —      $ —      $ 1,100 (2)   $ 1,100

(2) Balance of investment commitment in EnerTech.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

(a) Disclosure controls and procedures. An evaluation was performed under the supervision and with the participation of the Company’s management, including the CEO and the CFO, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2004. Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were not effective, as of December 31, 2004. Based upon that evaluation, the Company took the following steps to improve the functioning of its disclosure controls:

 

    Changed the reporting relationships of regional controllers, so that they report directly to IES’ chief accounting officer and have a direct line of communication to the chief accounting officer and the disclosure committee.

 

    Conducted further follow up of the investigation of accounting matters related to the identified material weaknesses at the direction and under the supervision of the Audit Committee.

 

    Provided accounting briefings to subsidiary management to clarify and strengthen management’s understanding of the Company’s revenue recognition policies and the reporting by subsidiaries of revenue and write-downs on contracts.

 

    Expanded the form of certification used for subsidiary presidents and controllers so that exceptions are identified to the chief accounting officer and the disclosure committee to permit further review and gathering of information and more timely disclosure.

 

The conclusion that the Company’s disclosure controls and procedures were not effective as of December 31, 2004, was based on the identification of two material weaknesses in internal control in August 2004, for which remediation is still ongoing, and follow up items to the external investigation by special counsel that extended past December 31, 2004.

 

(b) Internal Controls. During the fourth quarter of fiscal 2004, IES conducted an evaluation of the financial results relating to certain projects at one of its subsidiaries. Following the internal investigation, the Company’s Audit Committee engaged special counsel to conduct an investigation of those matters. The special investigation has been concluded, and the Company believes that the issues regarding its financial results were not widespread. The issues at one subsidiary related to (1) a series of large contracts accounted for on a percentage of completion basis in which actual costs projected to be incurred exceeded the original projected costs, but appropriate adjustments were not reflected, (2) general and administrative costs recorded to a particular contract that did not relate to that contract and (3) the recognition of revenue related to the recording of incorrect margin on a particular long-term contract. The issues at another subsidiary related to incorrectly recorded revenues attributable to a large project that were not detected as part of the Company’s normal closing process. The aggregate amount of the issues at these two subsidiaries is approximately $5.7 million.

 

As a result of the above matters, the independent auditors of IES advised the Company that they would not be able to complete their procedures in accordance with AU 722, “Interim Financial Information,” on the Company’s third quarter results. They advised IES that until the audit of its fiscal year 2004 financial statements was completed, they would be unable to complete their procedures in accordance with AU 722 on third quarter results. The reasons for the delay were the two material weaknesses identified by the independent auditors as described below and concerns that the size of the adjustments taken for the items identified above, coupled with any other adjustments that may have been identified in the course of the audit, could have resulted in a requirement to restate prior periods.

 

In response to the issues identified above, by letter dated August 12, 2004, Ernst & Young, IES’ independent auditors, issued a letter to IES advising the Company that they had identified two deficiencies in the design of internal controls that are material weaknesses:

 

    First, at one subsidiary, certain administrative costs were inappropriately recorded as additional contract costs on a large cost-plus contract, which resulted in the deferral of expenses and overstatement of revenues for the first quarter of fiscal 2002. Additionally, the subsidiary recorded margin on that same contract of up to 8% when the contract only allowed for costs plus a maximum of 6%.

 

    Second, the Company recorded an additional $4.3 million in adjustments to contract cost, reversal of revenue and other issues. The auditors concluded that the Company’s lack of timely updating of estimated costs to complete contracts and lack of monitoring revenue recognition policies was a deficiency and material weakness.

 

To address the issues described above, IES’ management made the policy, training, controls and organizational changes described below:

 

    IES is reviewing its internal controls by to improve the functioning of internal controls and address the potential deficiencies and weaknesses.

 

    The number of reporting regions was reduced, and a new “rapid response” team was created to step in and assist subsidiaries experiencing difficulties to accelerate corrective measures.

 

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    Implementation of new and significantly expanded training programs for employees responsible for financial reporting.

 

    The form of certification used for subsidiary presidents and controllers was revised and expanded.

 

    Reporting relationships were changed so that regional controllers report directly to IES’ chief accounting officer and have a direct line of communication to the chief accounting officer.

 

    A centralized accounting system has been implemented at 90 percent of the Company’s subsidiaries as of December 2004. This accounting system permits remote access and increased oversight of the accounting records at each subsidiary location. The increased automation of the revenue reporting process has strengthened the Company’s internal controls.

 

    IES is in the process of implementing policies to require additional support in narrative or other form to document probable collection of larger aged accounts receivable. Under the revised policy, evidence required to recognize revenue will be a written or oral change order or notice to proceed.

 

    IES is in the process of clarifying and improving its accounting policies, including its policies regarding revenue recognition, ethics compliance and contract documentation, and providing the policies in language and format that are more readily usable.

 

    IES increased its regional and corporate monitoring procedures including consolidated five quarter fade reviews, troubled contract reviews, revenues at risk analysis and increased involvement from regional and corporate accounting in significant judgments.

 

    IES will continue to leverage the capabilities of its Forefront reporting system, improve the documentation of the cost to complete calculation and formalize the process for monthly work in process review meetings.

 

At December 31, 2004, the Company does not believe that the material weakness relating to the timely updating of estimated costs to complete contracts has been remediated. The company expects that further training, process improvement, and monitoring of compliance with the Company’s revenue recognition policies is required to fully remediate this material weakness. The Company’s auditors concur that these steps are required to fully remediate the material weakness and include their suggestions. IES believes these changes allow it to better enforce controls and detect potential issues more quickly in the future.

 

Subsequent to December 31, 2004, the Company received a letter from its external auditors identifying matters involving internal control over financial reporting and its operation that they considered to be a material weakness. This weakness was identified upon the Company filing an amended Form 10-Q to correct a material error in the Company’s segment reporting footnote. The material weakness relates to the operation of the Company’s financial reporting process including an under resourced accounting staff which prevents adequate review and supervision, and the lack of certain management review during the financial reporting process.

 

The Company’s management is taking the following steps to remediate the material weakness:

 

    The Company recently hired a new senior accountant that will provide supervisory accounting staff the ability to increase review and supervision within the accounting department.

 

    The Company has in place its Financial Reporting Manager who was unavailable for the December 2004 close.

 

    The Company is in the process of filling its vacant Chief Accounting Officer position.

 

    The Company has also reinforced a more rigorous review of public filings by other areas of management, including legal, operations and other executives.

 

The Company believes the additional staff and processes identified above will serve to remediate the identified material weakness.

 

ITEM 6. EXHIBITS

 

31.1   Rule 13a-14(a)/15d-14(a) Certification of Herbert R. Allen, Chief Executive Officer
31.2   Rule 13a-14(a)/15d-14(a) Certification of David A. Miller, Chief Financial Officer
32.1   Section 1350 Certification of Herbert R. Allen, Chief Executive Officer
32.2   Section 1350 Certification of David A. Miller, Chief Financial Officer

 

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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: May 23, 2005

     

By:

  /S/ DAVID A. MILLER
                David A. Miller
                Senior Vice President
                and Chief Financial Officer

 

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