================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-Q ---------- (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002 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. 001-13831 ---------- QUANTA SERVICES, INC. (Exact name of registrant as specified in its charter) DELAWARE 74-2851603 (State or other jurisdiction of (I.R.S. Employer Incorporation or organization) Identification No.) 1360 POST OAK BLVD. SUITE 2100 HOUSTON, TEXAS 77056 (Address of principal executive offices) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (713) 629-7600 ---------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] 59,799,848 shares of Common Stock were outstanding as of August 9, 2002. As of the same date, 1,083,750 shares of Limited Vote Common Stock were outstanding. ================================================================================ QUANTA SERVICES, INC. AND SUBSIDIARIES INDEX <Table> <Caption> PAGE ---- PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements QUANTA SERVICES, INC. AND SUBSIDIARIES Consolidated Balance Sheets........................................ 1 Consolidated Statements of Operations.............................. 2 Consolidated Statements of Cash Flows.............................. 3 Notes to Condensed Consolidated Financial Statements............... 4 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................ 12 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk........................................................ 19 PART II. OTHER INFORMATION ITEM 2. Changes in Securities....................................... 21 ITEM 4. Submission of Matters to a Vote of Security Holders......... 21 ITEM 6. Exhibits and Reports on Form 8-K............................ 22 Signature............................................................ 23 </Table> i QUANTA SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE INFORMATION) <Table> <Caption> DECEMBER 31, JUNE 30, 2001 2002 ------------ ------------ (UNAUDITED) ASSETS CURRENT ASSETS: Cash and cash equivalents ...................................... $ 6,287 $ 4,577 Accounts receivable, net of allowance of $35,856 and $41,423, respectively ....................................... 451,870 419,098 Costs and estimated earnings in excess of billings on uncompleted contracts ....................................... 57,433 59,951 Inventories .................................................... 25,053 31,127 Prepaid expenses and other current assets ...................... 36,477 40,914 ------------ ------------ Total current assets ................................... 577,120 555,667 PROPERTY AND EQUIPMENT, net ...................................... 385,480 389,761 OTHER ASSETS, net ................................................ 43,319 65,476 GOODWILL AND OTHER INTANGIBLES, net .............................. 1,036,982 395,725 ------------ ------------ Total assets ........................................... $ 2,042,901 $ 1,406,629 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of long-term debt ........................... $ 8,063 $ 7,590 Accounts payable and accrued expenses .......................... 202,327 214,582 Billings in excess of costs and estimated earnings on uncompleted contracts ....................................... 31,140 20,693 ------------ ------------ Total current liabilities .............................. 241,530 242,865 LONG-TERM DEBT, net of current maturities ........................ 327,774 338,693 CONVERTIBLE SUBORDINATED NOTES ................................... 172,500 172,500 DEFERRED INCOME TAXES AND OTHER NON-CURRENT LIABILITIES .......... 94,346 60,466 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred Stock, $.00001 par value, 10,000,000 shares authorized: Series A Convertible Preferred Stock, 3,444,961 shares issued and outstanding ..................................... -- -- Common Stock, $.00001 par value, 300,000,000 shares authorized, 60,629,965 and 61,245,531 shares issued and 59,643,965 and 60,321,031 outstanding, respectively ......... -- -- Limited Vote Common Stock, $.00001 par value, 3,345,333 shares authorized, 1,116,238 and 1,087,550 shares issued and outstanding, respectively ........................ -- -- Additional paid-in capital ..................................... 952,380 946,920 Deferred compensation .......................................... (1,770) (1,644) Retained earnings .............................................. 271,448 (341,369) Treasury Stock, at cost, 986,000 and 924,500 common shares, respectively ................................................ (15,307) (11,802) ------------ ------------ Total stockholders' equity ............................. 1,206,751 592,105 ------------ ------------ Total liabilities and stockholders' equity ............. $ 2,042,901 $ 1,406,629 ============ ============ </Table> The accompanying notes are an integral part of these condensed consolidated financial statements. 1 QUANTA SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE INFORMATION) (UNAUDITED) <Table> <Caption> THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------------ ------------------------------ 2001 2002 2001 2002 ------------ ------------ ------------ ------------ REVENUES .................................................. $ 503,342 $ 432,522 $ 1,022,360 $ 881,742 COST OF SERVICES (including depreciation) ................. 392,588 384,362 802,654 757,895 ------------ ------------ ------------ ------------ Gross profit ............................................ 110,754 48,160 219,706 123,847 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES .............. 60,495 59,489 102,528 110,209 GOODWILL IMPAIRMENT ....................................... -- 166,580 -- 166,580 GOODWILL AMORTIZATION ..................................... 6,553 -- 12,857 -- ------------ ------------ ------------ ------------ Income (loss) from operations ........................... 43,706 (177,909) 104,321 (152,942) OTHER INCOME (EXPENSE): Interest expense ........................................ (9,138) (8,035) (18,366) (15,889) Other, net .............................................. (581) 1,183 (559) 1,618 ------------ ------------ ------------ ------------ INCOME (LOSS) BEFORE INCOME TAX PROVISION (BENEFIT) AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 33,987 (184,761) 85,396 (167,213) PROVISION (BENEFIT) FOR INCOME TAXES ...................... 17,304 (7,564) 39,410 (282) ------------ ------------ ------------ ------------ INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 16,683 (177,197) 45,986 (166,931) CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, NET OF TAX ................................... -- -- -- 445,422 ------------ ------------ ------------ ------------ NET INCOME (LOSS) ......................................... 16,683 (177,197) 45,986 (612,353) DIVIDENDS ON PREFERRED STOCK .............................. 232 232 464 464 ------------ ------------ ------------ ------------ NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCK ............ $ 16,451 $ (177,429) $ 45,522 $ (612,817) ============ ============ ============ ============ EARNINGS (LOSS) PER SHARE: Basic and Diluted Earnings (Loss) per Share Before Cumulative Effect of Change in Accounting Principle. $ 0.21 $ (2.26) $ 0.59 $ (2.13) Cumulative Effect of Change in Accounting Principle, Net of Tax .............................. -- -- -- (5.69) ------------ ------------ ------------ ------------ Basic and Diluted Earnings (Loss) per Share .......... $ 0.21 $ (2.26) $ 0.59 $ (7.82) ============ ============ ============ ============ SHARES USED IN COMPUTING EARNINGS (LOSS) PER SHARE: Basic ................................................ 77,073 78,272 76,643 78,269 ============ ============ ============ ============ Diluted .............................................. 78,649 78,272 78,182 78,269 ============ ============ ============ ============ </Table> The accompanying notes are an integral part of these condensed consolidated financial statements. 2 QUANTA SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) <Table> <Caption> THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------------- -------------------------- 2001 2002 2001 2002 ---------- ---------- ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) attributable to common stock .............. $ 16,451 $ (177,429) $ 45,522 $ (612,817) Adjustments to reconcile net income attributable to common stock to net cash provided by operating activities -- Cumulative effect of change in accounting principle, net of tax ................................................ -- -- -- 445,422 Goodwill impairment ......................................... -- 166,580 -- 166,580 Depreciation and amortization ............................... 19,496 15,442 38,158 30,017 Loss on sale of property and equipment ...................... 655 444 755 696 Allowance for doubtful accounts ............................. 14,958 6,362 17,924 5,567 Deferred income tax benefit ................................. (4,801) (22,868) (3,901) (18,270) Preferred stock dividend .................................... 232 232 464 464 Changes in operating assets and liabilities, net of non-cash transactions -- (Increase) decrease in -- Accounts receivable ....................................... (34,502) (23,974) (31,011) 31,432 Costs and estimated earnings in excess of billings on uncompleted contracts ................................ 1,011 (2,113) (5,400) (9,509) Inventories ............................................... (2,370) (1,030) (4,012) (6,074) Prepaid expenses and other current assets ................. 999 (1,165) 3,613 210 Increase (decrease) in -- Accounts payable and accrued expenses ..................... 16,525 26,283 24,663 30,175 Billings in excess of costs and estimated earnings on uncompleted contracts ................................ 3,339 (2,599) 6,058 (10,573) Other, net ................................................ (1,236) 142 (1,462) (498) ---------- ---------- ---------- ---------- Net cash provided by (used in) operating activities ... 30,757 (15,693) 91,371 52,822 ---------- ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of property and equipment ................ 827 1,173 1,911 1,729 Additions of property and equipment ......................... (25,755) (16,623) (54,357) (33,371) Cash paid for acquisitions, net of cash acquired ............ (5,582) (7,035) (82,452) (8,000) Notes receivable ............................................ -- (410) 2,658 (17,206) ---------- ---------- ---------- ---------- Net cash used in investing activities ................. (30,510) (22,895) (132,240) (56,848) ---------- ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings (payments) under bank lines of credit ........ (2,170) 49,890 27,120 13,670 Proceeds from other long-term debt .......................... 101 1,187 1,570 1,816 Payments on other long-term debt ............................ (6,566) (3,235) (11,905) (6,099) Issuances of stock, net of offering costs ................... -- -- 4,098 3,650 Stock repurchases ........................................... -- (11,802) -- (11,802) Exercise of stock options ................................... 4,598 816 5,452 1,081 ---------- ---------- ---------- ---------- Net cash provided by (used in) financing activities ... (4,037) 36,856 26,335 2,316 ---------- ---------- ---------- ---------- NET DECREASE IN CASH AND CASH EQUIVALENTS ..................... (3,790) (1,732) (14,534) (1,710) CASH AND CASH EQUIVALENTS, beginning of period ................ 6,562 6,309 17,306 6,287 ---------- ---------- ---------- ---------- CASH AND CASH EQUIVALENTS, end of period ...................... $ 2,772 $ 4,577 $ 2,772 $ 4,577 ========== ========== ========== ========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid for -- Interest ................................................. $ 2,889 $ 1,197 $ 17,374 $ 11,507 Income taxes ............................................. 5,661 4,873 6,175 5,495 </Table> The accompanying notes are an integral part of these condensed consolidated financial statements. 3 QUANTA SERVICES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BUSINESS AND ORGANIZATION: Quanta Services, Inc. (Quanta) is a leading provider of specialized contracting services, offering end-to-end network solutions to the electric power, gas, telecommunications and cable television industries. Our comprehensive services include designing, installing, repairing and maintaining network infrastructure. Reference herein to the "Company" includes Quanta and its subsidiaries. The consolidated financial statements of the Company include the accounts of Quanta and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Since its inception and through 2001, Quanta acquired 86 businesses. The Company has acquired two additional businesses through June 30, 2002 for an aggregate consideration of 251,079 shares of common stock and approximately $8.0 million in cash, net of cash acquired. In the course of its operations, the Company is subject to certain risk factors, including but not limited to risks related to: rapid technological and structural changes in the industries the Company serves, internal growth and operating strategies, economic downturn, the collectibility of receivables, acquisition integration and financing, significant fluctuations in quarterly results, contracts, management of growth, dependence on key personnel, availability of qualified employees, unionized workforce, competition, recoverability of goodwill, potential exposure to environmental liabilities and anti-takeover measures. On May 20, 2002, the Company and Aquila, Inc. (Aquila) announced that they reached an agreement for Aquila to terminate its proxy contest for control of Quanta's board of directors. Under the terms of the settlement, Aquila withdrew all pending litigation and arbitration against Quanta. The companies also agreed to a standstill whereby Aquila agreed not to purchase shares of Quanta's common stock on the open market, not to wage another proxy fight for control of Quanta and Quanta agreed to terminate the Stock Employee Compensation Trust (SECT). We recorded approximately $5.9 million and $10.5 million in proxy costs for the three and six months ended June 30, 2002 which are included in selling, general and administrative expenses. Interim Condensed Consolidated Financial Information These unaudited condensed consolidated financial statements have been prepared pursuant to the rules of the SEC. Certain information and footnote disclosures, normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States, have been condensed or omitted pursuant to those rules and regulations. The Company believes that the disclosures made are adequate to make the information presented not misleading. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to fairly present the financial position, results of operations and cash flows with respect to the interim consolidated financial statements have been included. The results of operations for the interim periods are not necessarily indicative of the results for the entire fiscal year. The results of the Company have historically been subject to significant seasonal fluctuations. It is suggested that these condensed consolidated financial statements be read in conjunction with the audited financial statements and notes thereto of Quanta Services, Inc. and subsidiaries included in the Company's Annual Report on Form 10-K, which was filed with the SEC on April 1, 2002. 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 assets and liabilities known to exist as of the date the financial statements are published and the reported amount of net revenues and expenses recognized during the periods presented. The Company reviews all significant estimates affecting its consolidated financial statements on a recurring basis and records the effect of any necessary adjustments prior to their publication. Judgments and estimates are based on the Company's beliefs and assumptions derived from information available at the time such judgments and estimates are made. Adjustments made with respect to the use of these estimates often relate to improved information not previously available. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of financial statements. Estimates are primarily used in the Company's assessment of the allowance for doubtful accounts, fair value assumptions 4 in analyzing goodwill impairment, revenue recognition under percentage-of-completion accounting and self-insured claims liabilities. The accompanying consolidated balance sheets include preliminary allocations of the respective purchase price paid for the companies acquired during the latest 12 months using the "purchase" method of accounting and, accordingly, are subject to final adjustment. As of June 30, 2002, the Company has provided allowances for doubtful accounts of approximately $41.4 million. Certain of the Company's customers, several of them large public telecommunications carriers, have filed for bankruptcy in the quarter ended June 30, 2002 or have been experiencing financial difficulties. Also, a number of the Company's utility customers are experiencing financial difficulties in the current business climate. Should additional customers file for bankruptcy or continue to experience difficulties, or should anticipated recoveries relating to receivables in existing bankruptcies or other workout situations fail to materialize, the Company could experience reduced cash flows and losses in excess of current allowances provided. In addition, material changes in our customers revenues or cash flows could affect our ability to collect amounts due from them. 2. PER SHARE INFORMATION: Earnings (loss) per share amounts are based on the weighted average number of shares of common stock and common stock equivalents outstanding during the period. The weighted average number of shares used to compute basic and diluted earnings per share for the three and six months ended June 30, 2001 and 2002 is illustrated below (in thousands): <Table> <Caption> THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------------- ----------------------------- 2001 2002 2001 2002 ------------ ------------ ------------ ------------ NET INCOME (LOSS): Net income (loss) attributable to common stock ....... $ 16,451 $ (177,429) $ 45,522 $ (612,817) Dividends on Preferred Stock ......................... 232 232 464 464 ------------ ------------ ------------ ------------ Net income (loss) for basic earnings per share ....... 16,683 (177,197) 45,986 (612,353) ------------ ------------ ------------ ------------ Effect of convertible subordinated notes under the "if converted" method -- interest expense addback, net of taxes ............................. -- -- -- -- ------------ ------------ ------------ ------------ Net income (loss) for diluted earnings per share ..... $ 16,683 $ (177,197) $ 45,986 $ (612,353) ============ ============ ============ ============ WEIGHTED AVERAGE SHARES: Weighted average shares outstanding for basic earnings per share, including Convertible Preferred Stock ................................... 77,073 78,272 76,643 78,269 Effect of dilutive stock options ..................... 1,576 -- 1,539 -- Effect of convertible subordinated notes under the "if converted" method -- weighted convertible shares ................................ -- -- -- -- ------------ ------------ ------------ ------------ Weighted average shares outstanding for diluted earnings per share ................................ 78,649 78,272 78,182 78,269 ============ ============ ============ ============ </Table> Pursuant to EITF Topic D-95, "Effect of Participating Convertible Securities on the Computation of Basic Earnings Per Share," the impact of the Series A Convertible Preferred Stock has been included in the computation of basic earnings per share. For the three and six months ended June 30, 2001, stock options of approximately 1.1 million 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. For the three and six months ended June 30, 2002, stock options of approximately 8.1 million and 7.9 million, respectively, were excluded from the computation of diluted earnings per share, as the effect would have been antidilutive. For the three and six months ended June 30, 2001 and June 30, 2002, the effect of assuming conversion of the convertible subordinated notes would be antidilutive and they were therefore excluded from the calculation of diluted earnings per share. 3. INCOME TAXES: Certain of the businesses the Company has acquired were S corporations for income tax purposes and, accordingly, any income tax liabilities for the periods prior to the acquisitions are the responsibility of the respective stockholders. Effective with the acquisitions, the S corporations converted to C corporations. Accordingly, an estimated deferred tax liability has been recorded to provide for the estimated future income tax liability as a result of the difference between the book and tax bases of the net assets of these former S corporations. For purposes of these consolidated financial statements, federal and state income taxes have been provided for the post-acquisition periods. 4. NEW ACCOUNTING PRONOUNCEMENTS: In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 requires that gains and losses from extinguishment of debt be classified as extraordinary items only if they meet the criteria in Accounting Principles Board Opinion No. 30 (Opinion No. 30). Applying the 5 provisions of Opinion No. 30 will distinguish transactions that are part of an entity's recurring operations from those that are unusual and infrequent and meet the criteria for classification as an extraordinary item. SFAS No. 145 is effective for the Company beginning January 1, 2003. Upon the adoption of SFAS No. 145, if the Company records any extraordinary items related to the extinguishment of debt, the Company will have to reclassify such items in its prior period statements of operations to conform to the presentation required by SFAS No. 145. Under SFAS No. 145, the Company will report gains and losses on the extinguishment of debt in pre-tax earnings rather than in extraordinary items. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities, such as restructurings, involuntarily terminating employees and consolidating facilities, initiated after December 31, 2002. 5. GOODWILL AND OTHER INTANGIBLES: Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which establishes new accounting and reporting requirements for goodwill and other intangible assets. Under SFAS No. 142, all goodwill amortization ceased effective January 1, 2002. Material amounts of recorded goodwill attributable to each of the Company's reporting units were tested for impairment by comparing the fair value of each reporting unit with its carrying value. Fair value was determined using a combination of the discounted cash flow, market multiple and market capitalization valuation approaches. These impairment tests are required to be performed at adoption of SFAS No. 142 and at least annually thereafter. Significant estimates used in the methodologies include estimates of future cash flows, future short-term and long-term growth rates, weighted average cost of capital and estimates of market multiples for each of the reportable units. On an ongoing basis (absent any impairment indicators), the Company expects to perform impairment tests annually during the fourth quarter after the annual budgeting process. Based on the Company's transitional impairment test performed upon adoption of SFAS No. 142, it recognized a $488.5 million charge, ($445.4 million, net of tax) to reduce the carrying value of goodwill to the implied fair value of the Company's reporting units. This impairment is a result of adopting a fair value approach, under SFAS No. 142, to testing impairment of goodwill as compared to the previous method utilized, as permitted under accounting standards existing at that time, in which evaluations of goodwill impairment were made by the Company using estimated future undiscounted cash flows to determine if goodwill would be recoverable. Under SFAS No. 142, the impairment adjustment recognized at adoption of the new rules was reflected as a cumulative effect of change in accounting principle, net of tax, in the six months ended June 30, 2002. The Company further recognized an interim non-cash goodwill impairment charge of approximately $166.6 million for the three months ended June 30, 2002. Impairment adjustments recognized after adoption are required to be recognized as operating expenses. The primary factor contributing to the interim impairment charge was the overall deterioration of the business climate during 2002 in the markets the Company serves as evidenced by an increased number of bankruptcies in the telecommunications industry, continued devaluation of several of our customers debt and equity securities and pricing pressures resulting from challenges faced by major industry participants. Fair value was determined using a combination of the discounted cash flow, market multiple and market capitalization valuation approaches. A summary of changes in the Company's goodwill for the six months ended June 30, 2002 is as follows (in thousands): <Table> Balance, January 1, 2002 ........... $ 1,036,982 Acquisitions and adjustments ....... 11,826 Transitional impairment ............ (488,472) Interim impairment ................. (166,580) ------------ Balance, June 30, 2002 ............. $ 393,756 ============ </Table> The Company has also recorded an Other Intangible Asset of $2.1 million related to customer relationships. The weighted average life of this intangible is eight years and accumulated amortization as of June 30, 2002 was approximately $0.1 million. Estimated annual amortization expense for future periods is approximately $0.3 million. 6 The unaudited results of operations presented below for the three and six months ended June 30, 2002 and adjusted results of operations for the three and six months ended June 30, 2001, reflect the operations of the Company had the non-amortization provisions of SFAS No. 142 been adopted effective January 1, 2001 (in thousands): <Table> <Caption> THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------------- ----------------------------- 2001 2002 2001 2002 ------------ ------------ ------------ ------------ Net income (loss) attributable to common stock .... $ 16,451 $ (177,429) $ 45,522 $ (612,817) Addback: Cumulative effect of change in accounting principle, net of tax ................ -- -- -- 445,422 ------------ ------------ ------------ ------------ Reported income (loss) before cumulative effect of change in accounting principle ........ 16,451 (177,429) 45,522 (167,395) Addback: Goodwill amortization, net of tax ........ 5,570 -- 10,918 -- ------------ ------------ ------------ ------------ Adjusted net income (loss) attributable to common stock before cumulative effect of change in accounting principle ............... $ 22,021 $ (177,429) $ 56,440 $ (167,395) ============ ============ ============ ============ Basic earnings (loss) per share before cumulative effect of change in accounting principle: Reported net income (loss) before cumulative effect of change in accounting principle ....................................... $ 0.21 $ (2.26) $ 0.59 $ (2.13) Goodwill amortization, net of tax ................ 0.07 -- 0.14 -- ------------ ------------ ------------ ------------ Adjusted net income (loss) before cumulative effect of change in accounting principle ........ $ 0.28 $ (2.26) $ 0.73 $ (2.13) ============ ============ ============ ============ Diluted earnings (loss) per share before cumulative effect of change in accounting principle: Reported net income (loss) attributable to common stock before cumulative effect of change in accounting principle .................. $ 0.21 $ (2.26) $ 0.59 $ (2.13) Goodwill amortization, net of tax ................ 0.07 -- 0.14 -- ------------ ------------ ------------ ------------ Adjusted net income (loss) attributable to common stock before cumulative effect of change in accounting principle .................. $ 0.28 $ (2.26) $ 0.73 $ (2.13) ============ ============ ============ ============ </Table> 6. DEBT: Credit Facility The Company has a credit facility with 14 participating banks which matures on June 14, 2004. As of June 30, 2002, the commitment level of the banks was $350.0 million. The credit facility is secured by a pledge of all of the capital stock of the Company's subsidiaries and the majority of the Company's assets and is to provide funds to be used for working capital and for other general corporate purposes. The Company's subsidiaries guarantee the repayment of all amounts due under the facility and the facility restricts pledges on all material assets. As of June 30, 2002, amounts borrowed under the credit facility bore interest at a rate equal to either (a) the London Interbank Offered Rate (the 30 day LIBOR rate was 1.88% at June 30, 2002) plus 1.00% to 2.00%, as determined by the ratio of the Company's total funded debt to EBITDA (as defined in the credit facility) or (b) the bank's prime rate (which was 4.75% at June 30, 2002) plus up to 0.25%, as determined by the ratio of the Company's total funded debt to EBITDA. Commitment fees of 0.25% to 0.50%, based on the Company's total funded debt to EBITDA, were due on any unused borrowing capacity under the credit facility. The credit facility contained usual and customary covenants for a credit facility of its nature, including the prohibition of the payment of dividends on common stock, certain financial ratios and indebtedness covenants and the consent of the lenders for acquisitions exceeding a certain level of cash consideration. As of June 30, 2002, $123.0 million was borrowed under the credit facility, and the Company had $62.3 million of letters of credit outstanding, resulting in a borrowing availability of $164.7 million under the credit facility. On August 12, 2002, the Company amended the credit facility. As of August 12, 2002, the commitment of the banks under the credit facility was reduced to $275.0 million. The commitment will remain in effect at $275.0 million through March 31, 2003, then reduce to $250.0 million and remain in effect at such amount through December 31, 2003. Effective January 1, 2004, the credit facility will reduce to $225.0 million and remain in effect at such amount through the remainder of the term of the credit facility, which matures on June 14, 2004. Amounts borrowed under the credit facility will bear interest at a rate equal to either (a) LIBOR plus 1.50% to 3.50%, as determined by the ratio of the Company's total funded debt to EBITDA or (b) the bank's prime rate plus up to 2.00%, as determined by the ratio of the Company's total funded debt to EBITDA. Commitment fees of 0.375% to 0.50%, based the Company's total funded debt to EBITDA, are due on any unused borrowing capacity under the credit facility. The amended credit 7 facility is less restrictive with respect to certain financial ratios and indebtedness covenants, including the maximum funded debt to EBITDA, maximum senior debt to EBITDA and minimum interest coverage ratios. However, the amendment is more restrictive with respect to the Company's capital expenditures and asset sales, prohibits any stock repurchase programs or acquisitions, and requires a mandatory reduction in the banks' commitment by a portion of the proceeds from asset sales or upon the issuance of additional debt in excess of $15.0 million. As of August 9, 2002, we had approximately $131.9 million in outstanding borrowings under the credit facility and $62.3 million of letters of credit outstanding, resulting in a borrowing availability of $80.8 million under the credit facility, as amended. Senior Secured Notes In 2000, the Company closed a private placement of $210.0 million principal amount of senior secured notes primarily with insurance companies. The senior secured notes have maturities ranging from three to eight years and, as of June 30, 2002, had a weighted average interest rate of 8.41%. On August 12, 2002, the Company amended the senior secured notes. The senior secured notes, as amended, have financial covenants and restrictions substantially identical to the credit facility and a weighted average interest rate of 9.91%. The amendment also requires a mandatory prepayment of a portion of the proceeds of any asset sales or upon the issuance of additional debt in excess of $15.0 million. In addition, the senior secured notes carry a make-whole provision customary for this type of debt instrument on prepayment of principal, including any mandatory prepayments. Pursuant to an intercreditor agreement, the senior secured notes rank equally in right of repayment with indebtedness under the Company's credit facility. In connection with the amendments of both the credit facility and the senior secured notes completed in August 2002, the Company incurred additional debt issuance costs estimated at approximately $3.5 million. The Company will account for these costs in accordance with EITF 98-14 for the credit facility and EITF 96-19 for the senior secured notes. Accordingly, a majority of these costs will be capitalized and amortized over the remaining term of the respective agreements, as amended. As a result of the amendment decreasing the commitment amount of the credit facility, in accordance with EITF 98-14, the Company will be expensing a portion of the unamortized debt issuance costs as interest expense in the third quarter of 2002. The Company has specifically provided for non-cash goodwill impairment charges of up to $800 million in its credit facility and senior secured notes resulting from the adoption of SFAS No. 142. Goodwill impairment charges do not violate any covenants in the Company's convertible subordinated notes. Convertible Subordinated Notes During the third quarter of 2000, the Company issued $172.5 million principal amount of convertible subordinated notes. The convertible subordinated notes bear interest at 4.0% per year and are convertible into shares of the Company's common stock at a price of $54.53 per share. The convertible subordinated notes require semi-annual interest payments beginning December 31, 2000, until the notes mature on July 1, 2007. The Company has the option to redeem the notes beginning July 3, 2003; however, redemption is currently prohibited by the Company's credit facility and senior secured notes. 7. STOCKHOLDERS' EQUITY: Series A Convertible Preferred Stock In September 1999, the Company entered into a securities purchase agreement with Aquila pursuant to which the Company issued 1,860,000 shares of Series A Convertible Preferred Stock, $.00001 par value per share, for an initial investment of $186.0 million, before transaction costs. In September 2000, Aquila converted 7,924,805 shares of common stock into an additional 1,584,961 shares of Series A Convertible Preferred Stock at a rate of one share of Series A Convertible Preferred Stock for five shares of common stock. The holders of the Series A Convertible Preferred Stock are entitled to receive dividends in cash at a rate of 0.5% per annum on an amount equal to $53.99 per share, plus all unpaid dividends accrued. In addition to the preferred dividend, the holders are entitled to participate in any cash or non-cash dividends or distributions declared and paid on the shares of common stock, as if each share of Series A Convertible Preferred Stock had been converted into common stock at the applicable conversion price immediately prior to the record date for payment of such dividends or distributions. However, holders of Series A Convertible Preferred Stock will not participate in non-cash dividends or distributions if such dividends or distributions cause an adjustment in the price at which Series A Convertible Preferred Stock converts into common stock. At any time after the sixth anniversary of the issuance of the Series A Convertible Preferred Stock, if the closing price per share of the Company's common stock is greater than $20.00, then the Company may terminate the preferred dividend. At any time after the sixth anniversary of the issuance of the Series A Convertible Preferred Stock, if the closing price per share of the Company's common stock is equal to or less than $20.00, then the preferred dividend may, at the option of Aquila, be adjusted to the then "market coupon rate," which shall equal the Company's after-tax cost of obtaining financing, excluding common stock, to replace Aquila's investment in the Company. Aquila is entitled to that number of votes equal to the number of shares of common stock into which the outstanding shares of Series A Convertible Preferred Stock are then convertible on any matter voted on by the holders of common stock. Subject to certain limitations, Aquila is entitled to elect up to three of the total number of directors of the Company. All or any portion of the outstanding shares of Series A Convertible Preferred Stock may, at the option of Aquila, be converted at any time into fully paid and non-assessable 8 shares of common stock. The conversion price currently is $20.00, yielding 17,224,805 shares of common stock upon conversion of all outstanding shares of Series A Convertible Preferred Stock. The conversion price may be adjusted under certain circumstances. Stockholder Rights Plan On March 8, 2000, the board of directors of the Company adopted a Stockholder Rights Plan. On November 15, 2001, the board of directors amended the Stockholder Rights Plan and on November 18, 2001 and December 1, 2001, the board of directors ratified such amendments to the Stockholder Rights Plan. Under the Stockholder Rights Plan, a dividend of one Preferred Stock Purchase Right (the Rights) was declared on each outstanding share of the Company's common stock and Series A Convertible Preferred Stock (on an as-converted basis) for holders of record as of the close of business on March 27, 2000. The Rights also attach to all common stock and Series A Convertible Preferred Stock issued after March 27, 2000. No separate certificates evidencing the Rights will be issued unless and until they become exercisable. Each Right has an initial exercise price of $153.33. The Rights will be exercisable if a person or group (other than Aquila) becomes the beneficial owner of, or tenders for, 15% or more of the Company's common shares. The Rights also will be exercisable if Aquila, together with any affiliates or associates, becomes the beneficial owner of, or tenders for more than 39.0% of the outstanding shares of the Company's common stock on an as-converted basis, or if there is a change of control of Aquila. Upon a "Flip-In Event" as defined in the Stockholder Rights Plan, the Rights issued pursuant to the Stockholder Rights Plan would be exercisable for Series B Junior Participating Preferred Stock of the Company at a discount. In addition, the Rights held by an "Acquiring Person" as defined in the Stockholder Rights Plan will become exercisable upon a Flip-In Event for Series C Junior Convertible Preferred Stock. The Rights will expire in ten years. On February 12, 2002, the board of directors further amended the Stockholder Rights Plan to provide that only outstanding shares of the Company's common stock and Series A Convertible Preferred Stock are to be counted in calculating the number of shares that Aquila could acquire while remaining an exempt person under the Stockholder Rights Plan. As amended, the Stockholder Rights Plan permits Aquila to beneficially own up to 39.0% of the outstanding shares of the Company's common stock (assuming conversion of all outstanding shares of the Company's Series A Convertible Preferred Stock) or such greater percentage as it may own as of the earlier of notice to Aquila of, or public announcement of, the February 2002 amendment. On March 13, 2002, the board of directors further amended the Stockholder Rights Plan to render the Rights inapplicable to an offer for all outstanding shares of the Company's common stock in a manner that treats all stockholders equally if upon completion of the offer, the offeror owns shares of the Company's voting stock representing 75% or more of the then outstanding voting stock. The Stockholder Rights Plan as so amended would also require the bidder to commit irrevocably to purchase all shares not tendered at the same price paid to the tendering stockholders. As part of the settlement of the proxy contest with Aquila, the Company agreed with Aquila to amend and restate the Stockholder Rights Plan (or to adopt a new rights plan) so that the Rights will become exercisable if a person or group (other than Aquila) becomes the beneficial owner of 15% of the voting power of the Company's capital stock, or if Aquila's beneficial ownership level in the Company increases from its level of beneficial ownership as of May 20, 2002. Restricted Stock Under the 2001 Stock Incentive Plan, 72,701 shares of the Company's common stock were issued in 2001 at a price of $27.51 per share, which reflected the fair market value of the common stock at the date of issuance. The shares of common stock issued pursuant to the 2001 Stock Incentive Plan are subject to restrictions on transfer and certain other conditions. During the restriction period, the plan participants are entitled to vote and receive dividends on such shares. Upon issuance of the 72,701 shares of the Company's common stock pursuant to the 2001 Stock Incentive Plan, an unamortized compensation expense equivalent to the market value of the shares on the date of grant was charged to stockholders' equity and will be amortized over the six year restriction period. The compensation expense taken with respect to the restricted shares during the three and six months ended June 30, 2002 was approximately $62,000 and $125,000, respectively. Stock Employee Compensation Trust On March 13, 2002, the Company's board of directors approved the creation of a SECT, to fund certain of the Company's future employee benefit obligations using the Company's common stock. The SECT was established by selling 8.0 million shares of the Company's common stock, including the 986,000 shares of treasury stock the Company purchased in 2001 pursuant to the Company's 9 Stock Repurchase Plan, to the SECT in exchange for a promissory note plus an amount in cash equal to the aggregate par value of the shares. As part of the settlement of the proxy contest with Aquila, on May 20, 2002, the Company terminated the SECT and repurchased the 7,911,069 shares of common stock remaining in the SECT by canceling the promissory note. The 7,911,069 shares were transferred into treasury stock on May 21, 2002, and were retired on June 28, 2002. Treasury Stock The board of directors of the Company authorized a Stock Repurchase Plan under which up to $75.0 million of the Company's common stock could be repurchased. Under the Stock Repurchase Plan, the Company could conduct purchases through open market transactions in accordance with applicable securities laws. During the second quarter of 2002, the Company purchased 924,500 shares of its common stock for approximately $11.8 million under the Stock Repurchase Plan. As of July 1, 2002, the independent committee of Quanta's board of directors determined to cease the Stock Repurchase Plan. As a result of the credit facility and senior secured notes amendments, any further stock repurchases are prohibited. 8. SEGMENT INFORMATION: The Company operates in one reportable segment as a specialty contractor. The Company provides comprehensive network solutions to the electric power, gas, telecommunications and cable television industries, including designing, installing, repairing and maintaining network infrastructure. Each of these services is provided by various Company subsidiaries and discrete financial information is not provided to management at the service level. The following table presents information regarding revenues derived from the industries noted above. <Table> <Caption> SIX MONTHS ENDED JUNE 30, ----------------------------- 2001 2002 ------------ ------------ (IN THOUSANDS) Electric power network services ............. $ 379,296 $ 455,861 Telecommunications network services ......... 343,513 146,369 Cable television network services ........... 133,929 108,454 Ancillary services .......................... 165,622 171,058 ------------ ------------ $ 1,022,360 $ 881,742 ============ ============ </Table> The Company does not have significant operations or long-lived assets in countries outside of the United States. 9. RELATED PARTY TRANSACTIONS: In September 1999, the Company entered into a strategic alliance agreement with Aquila. Under the terms of the strategic alliance agreement, Aquila will use the Company, subject to the Company's ability to perform the required services, as a preferred contractor in outsourced transmission and distribution infrastructure installation and maintenance and natural gas distribution, installation and maintenance in all areas serviced by Aquila, provided that the Company provides such services at a competitive cost. The strategic alliance agreement has a term of six years. 10. COMMITMENTS AND CONTINGENCIES: Litigation On December 21, 2001, a purported stockholder of Quanta filed a putative class action and derivative complaint against directors Vincent D. Foster, Jerry J. Langdon, Louis C. Golm, James R. Ball, John R. Colson, John R. Wilson and Gary A. Tucci. The complaint also named Quanta as a nominal defendant. The complaint alleged that the named directors breached their fiduciary duties by taking certain actions, including the Stockholder Rights Plan amendment, in response to the announcement by Aquila that it intended to acquire control of Quanta through open market purchases of the Company's shares. The complaint sought an order rescinding any actions taken by the named directors in response to the announcement by Aquila and requiring the directors to take steps necessary to maximize the value of Quanta. The complaint further sought damages from the named directors on behalf of a class of stockholders and purportedly on behalf of Quanta for the alleged harm inflicted by the actions of the named directors. On January 22, 2002, Quanta and the named directors filed a motion to dismiss the stockholder complaint. There has been no activity since January 2002. Although the ultimate outcome and liability, if any, cannot be determined, management, after consultation and review with counsel, believes that the facts do not support the plaintiff's claims and that the Company and the named directors have meritorious defenses. 10 On March 21, 2002, Aquila filed a complaint in the Delaware Court of Chancery naming Quanta and each member of the special committee of the Company's board of directors, consisting of all directors other than those designated by Aquila, as defendants. The Aquila complaint alleged that the special committee breached its fiduciary duty in connection with the March 13, 2002 adoption of the Company's SECT and the new employment agreements entered into with certain of the Company's employees and that under Delaware statutory law the shares sold to the SECT were not entitled to vote. As part of the settlement of Aquila's proxy contest, this lawsuit was dismissed with prejudice. In addition, certain subsidiaries of the Company are involved in disputes or legal actions arising in the ordinary course of business. Management does not believe the outcome of such legal actions will have a material adverse effect on the Company's financial position or results of operations. Self-Insurance The Company is insured for workers' compensation, employer's liability, auto liability and general liability claims, subject to a deductible, as of June 30, 2002, of $500,000 per accident or occurrence. On August 1, 2002, upon renewal of the Company's policies, the deductible was increased to $1,000,000 per occurrence. In addition, effective January 1, 2002, the Company consolidated the various non-union employee related health care benefits plans that existed at certain of its subsidiaries into one corporate plan that is subject to a deductible of $250,000 per claimant per year. Losses up to the deductible amounts are accrued based upon the Company's estimates of the ultimate liability for claims incurred and an estimate of claims incurred but not reported. The accruals are based upon known facts and historical trends and management believes such accruals to be adequate. At December 31, 2001 and June 30, 2002, the amounts accrued for self-insured claims were $28.3 million and $39.6 million, respectively, with $14.7 million and $24.4 million, respectively, considered to be long-term and included in Other Non-Current Liabilities. Derivatives SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, was effective for the Company on January 1, 2001. These statements establish accounting and reporting standards requiring that all derivative instruments be recorded as either assets or liabilities measured at fair value. These statements also require that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. In October 2001, the Company entered into a forward purchase contract (Contract A) with settlements through 2006, in order to secure pricing on anticipated gas requirements related to a project in process at December 31, 2001 that was substantially complete at March 31, 2002. The objective was to mitigate the variability in the price of natural gas by securing the price the Company will have to pay the Contract A counterparty. On March 29, 2002, the Company entered into a sub-services agreement with one of its customers (the Counterparty Contract) whereby the customer assumed all obligations associated with Contract A. If the customer is unable to fulfill its obligations under the Counterparty Contract, the Company will be responsible for settling the obligations of Contract A. As of June 30, 2002, the fair value of Contract A and the Counterparty Contract was a receivable of $1.2 million and a payable of $1.2 million, respectively. In April 2002, the Company entered into another forward purchase contract (Contract B) with settlements through March 2003, in order to secure pricing on anticipated gas requirements related to a project in process at June 30, 2002. The objective was to mitigate the variability in the price of natural gas by securing the price the Company will have to pay the Contract B counterparty. As of June 30, 2002, the fair value of Contract B was $354,000. Performance Bonds In certain circumstances, the Company is required to provide performance bonds in connection with its contractual commitments. Contingent Consideration The Company is subject to an agreement with the former owners of an operating unit that was acquired in 2000. Under the terms of this agreement, and depending upon the ultimate profitability of certain contracts obtained by the operating unit, the Company may be required to pay additional consideration to such former owners with a combination of common stock and cash. At June 30, 2002, the amount of additional consideration based on performance to date was approximately $16.9 million. This amount could be adjusted significantly higher or lower over the term of the agreement. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K, which was filed with the SEC on April 1, 2002, which is available at the SEC's Web site at www.sec.gov. We derive our revenues from one reportable segment by providing specialized contracting services and offering comprehensive network solutions. Our customers include electric power, gas, telecommunications and cable television companies, as well as commercial, industrial and governmental entities. We enter into contracts principally on the basis of competitive unit price or fixed price bids, the final terms and prices of which we frequently negotiate with the customer. Although the terms of our contracts vary considerably, most are made on either a unit price or fixed price basis in which we agree to do the work for a price per unit of work performed (unit price) or for a fixed amount for the entire project (fixed price). We also perform services on a cost-plus or time and materials basis. We complete most installation projects within one year, while we frequently provide maintenance and repair work under open-ended, unit price master service agreements which are renewable annually. We generally recognize revenue when services are performed except when work is being performed under fixed price contracts. We typically record revenues from fixed price contracts on a percentage-of-completion basis, using the cost-to-cost method based on the percentage of total costs incurred to date in proportion to total estimated costs to complete the contract. Some of our customers require us to post performance and payment bonds upon execution of the contract, depending upon the nature of the work to be performed. Our fixed price contracts often include payment provisions pursuant to which the customer withholds a 5% to 10% retainage from each progress payment and remits the retainage to us upon completion and approval of the work. Cost of services consists primarily of salaries, wages and benefits to employees, depreciation, fuel and other vehicle expenses, equipment rentals, subcontracted services, insurance, facilities expenses, materials and parts and supplies. Our gross margin, which is gross profit expressed as a percentage of revenues, is typically higher on projects where labor, rather than materials, constitutes a greater portion of the cost of services. We can predict materials costs more accurately than labor costs. Therefore, to compensate for the potential variability of labor costs, we seek to maintain higher margins on our labor-intensive projects. As of June 30, 2002, we had a deductible of $500,000 per accident or occurrence related to workers' compensation, employer's liability, automobile and general liability claims. On August 1, 2002, upon renewal of our policies, the deductible was increased to $1,000,000 per occurrence. In addition, effective January 1, 2002, we consolidated the various non-union employee related health care benefits plans that existed at certain of our subsidiaries into one corporate plan that is subject to a deductible of $250,000 per claimant per year. Fluctuations in insurance accruals related to these deductibles could have an impact on operating margins in the period in which such adjustments are made. Selling, general and administrative expenses consist primarily of compensation and related benefits to management, administrative salaries and benefits, marketing, office rent and utilities, communications, professional fees and bad debt expense. Selling, general and administrative expenses can be impacted by our customers' inability to pay for services performed. 12 SIGNIFICANT BALANCE SHEET CHANGES Total assets decreased approximately $636.3 million as of June 30, 2002 compared to December 31, 2001. This decrease is primarily due to the following: o Goodwill and other intangibles, net decreased $641.3 million due to impairments of goodwill pursuant to Statement of Financial Accounting Standard (SFAS) No. 142, "Goodwill and Other Intangible Assets," which requires goodwill to be tested for impairment by comparing the fair value of each subsidiary with its carrying value. o Accounts receivable and costs and estimated earnings in excess of billings on uncompleted contracts decreased $30.3 million primarily due to lower levels of revenue during the first six months of 2002, collections on accounts that were outstanding at December 31, 2001 and an increase of $5.6 million in the allowance for doubtful accounts to reserve for certain customers that have declared bankruptcy during 2002. o Inventories increased $6.1 million due primarily to $5.0 million paid for deposits for turbines to be used in future projects, and $1.1 million due to the purchase of cable to perform work on master service contracts. o Property and equipment, net increased $4.3 million due to expenditures for equipment necessary to perform contracts and equipment obtained through the acquisition of two companies during the first six months of 2002, offset by depreciation expense recorded during the period. o Other assets, net increased $22.2 million due primarily to notes receivable from one of our customers. We have agreed to long-term payment terms until this customer is able to secure alternative financing. The receivables are partially secured and bear interest at 9% per year. At June 30, 2002, the total amount due under these arrangements was $45.6 million, with $40.6 million classified as non-current. As of June 30, 2002, total liabilities decreased approximately $21.7 million and stockholders' equity decreased approximately $614.6 million. These fluctuations were primarily due to the following: o Deferred income taxes and other non-current liabilities decreased $33.9 million primarily as a result of the recording of a deferred tax asset for the tax benefit related to the impairments of goodwill pursuant to SFAS No. 142, partially offset by increases in the long-term portion of self-insurance reserves. o Long-term debt, net of current maturities increased $10.9 million due primarily to borrowings made against our credit facility for the purchase of two companies during the first six months of 2002. o Stockholders' equity decreased $614.6 million during the first six months of 2002. This was primarily the result of a net loss attributable to common stock of $612.8 million associated with the impairments of goodwill recorded pursuant to SFAS No. 142 and the purchase of approximately $11.8 million of treasury stock under the Company's Stock Repurchase Plan, partially offset by the issuance of approximately $3.7 million in shares of common stock pursuant to the employee stock purchase plan and the acquisition of two companies which resulted in increased additional paid in capital of $3.4 million. 13 RESULTS OF OPERATIONS The following table sets forth selected unaudited statements of operations data and such data as a percentage of revenues for the periods indicated: <Table> <Caption> THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ---------------------------------------- ------------------------------------------ 2001 2002 2001 2002 ------------------ ------------------ ------------------- ------------------- (DOLLARS IN THOUSANDS) (DOLLARS IN THOUSANDS) Revenues ............................... $ 503,342 100.0% $ 432,522 100.0% $1,022,360 100.0% $ 881,742 100.0% Cost of services (including depreciation) ......................... 392,588 78.0 384,362 88.9 802,654 78.5 757,895 86.0 --------- ------ --------- ------ ---------- ------ --------- ------- Gross profit ...................... 110,754 22.0 48,160 11.1 219,706 21.5 123,847 14.0 Selling, general and administrative expenses .............. 60,495 12.0 59,489 13.7 102,528 10.0 110,209 12.5 Goodwill impairment .................... -- 0.0 166,580 38.5 -- 0.0 166,580 18.8 Goodwill amortization .................. 6,553 1.3 -- 0.0 12,857 1.3 -- 0.0 --------- ------ --------- ------ ---------- ------ --------- ------- Income (loss) from operations ..... 43,706 8.7 (177,909) (41.1) 104,321 10.2 (152,942) (17.3) Interest expense ....................... (9,138) (1.8) (8,035) (1.9) (18,366) (1.8) (15,889) (1.8) Other income, net ...................... (581) (0.1) 1,183 0.3 (559) 0.0 1,618 0.2 --------- ------ --------- ------ ---------- ------ --------- ------- Income (loss) before income tax provision (benefit) and cumulative effect of change in accounting principle ................ 33,987 6.8 (184,761) (42.7) 85,396 8.4 (167,213) (18.9) Provision (benefit) for income taxes ... 17,304 3.5 (7,564) 1.7 39,410 3.9 (282) (0.0) --------- ------ --------- ------ ---------- ------ --------- ------- Income (loss) before cumulative effect of change in accounting principle ........................... 16,683 3.3 (177,197) (41.0) 45,986 4.5 (166,931) (18.9) Cumulative effect of change in accounting principle, net of tax .... -- 0.0 -- 0.0 -- 0.0 445,422 50.5 --------- ------ --------- ------ ---------- ------ --------- ------- Net income (loss) ..................... $ 16,683 3.3% $(177,197) (41.0)% $ 45,986 4.5% $(612,353) (69.4)% ========= ====== ========= ====== ========== ====== ========= ======= </Table> THREE AND SIX MONTHS ENDED JUNE 30, 2002, COMPARED TO THE THREE AND SIX MONTHS ENDED JUNE 30, 2001. Revenues. Revenues decreased $70.8 million and $140.6 million or, 14.1% and 13.8%, to $432.5 million and $881.7 million for the three and six months ended June 30, 2002. The decrease was attributable to lower revenues, primarily from telecommunications and cable customers, due in part to the continued decrease in capital spending by our customers, the inability of certain of these customers to raise new capital, bankruptcies of certain customers and the overall downturn in the national economy, which have negatively impacted the award of work to specialty contractors. This decrease was partially offset by a full period of contributed revenues for the three and six months ended June 30, 2002 for those companies acquired during 2001. Gross profit. Gross profit decreased $62.6 million and $95.9 million, or 56.5% and 43.6%, to $48.2 million and $123.8 million for the three and six months ended June 30, 2002. As a percentage of revenues, gross margin decreased from 22.0% for the three months ended June 30, 2001, to 11.1% for the three months ended June 30, 2002. This decrease in gross margin resulted primarily from declining volumes due to economic factors noted above, significantly lower margins on work performed due to increased pricing pressures and lower asset utilization. Gross margin decreased from 21.5% for the six months ended June 30, 2001, to 14.0% for the six months ended June 30, 2002. The decrease in gross margins for the six months ended June 30, 2002, resulted from the factors noted above for the three months ended June 30, 2002, and higher than normal transition costs on one telecommunications outsourcing contract. Selling, general and administrative expenses. Selling, general and administrative expenses decreased $1.0 million and increased $7.7 million, or 1.7% and 7.5%, to $59.5 million and $110.2 million for the three and six months ended June 30, 2002. During the three months ended June 30, 2002, we recorded $8.4 million in bad debt expense and $5.9 million in additional proxy costs. During the three months ended June 30, 2001, we recorded $19.4 million in charges including $16.2 million in bad debt expense and $3.2 million in charges associated with the realignment of field personnel and discontinuance of negotiations regarding certain acquisitions. Absent the charges discussed above, selling, general and administrative expenses for the three months ended June 30, 2002 increased approximately $4.1 million, primarily due to the inclusion of a full three months of costs associated with companies acquired after June 2001, higher professional fees due to increased collection efforts on troubled accounts and higher advertising and travel costs associated with increased marketing efforts. For the six months ended June 30, 2002, selling, general and administrative expenses increased due to the impact of the costs previously described and proxy costs incurred in the first quarter of 2002 of $4.6 million. Goodwill impairment. During the second quarter of 2002, we recognized an interim non-cash SFAS No. 142 goodwill impairment charge of $166.6 million. Any interim impairment adjustments recognized after adoption are required to be recognized as operating expenses. The primary factor contributing to the interim impairment charge was the overall deterioration of the business climate during 2002 in the markets we serve. 14 Interest expense. Interest expense decreased $1.1 million and $2.5 million, or 12.1% and 13.5%, to $8.0 million and $15.9 million, for the three and six months ended June 30, 2002, due to lower average levels of debt outstanding under the credit facility for the three and six months ended June 30, 2002 and lower average interest rates. Provision (benefit) for income taxes. The benefit for income taxes was $7.6 million and $0.3 million for the three and six months ended, June 30, 2002, with an effective tax rate of (4.1%) and 0.2%, respectively, compared to a provision of $17.3 million and $39.4 million for the three and six months ended June 30, 2001, with effective tax rates of 50.9% and 46.1%, respectively. The lower tax rate in 2002 reflects the elimination of goodwill amortization expense according to the current accounting standard, the majority of which had been non-deductible in 2001. Our 2002 annual tax rate is expected to be approximately 0.0% due to the net realizable benefit relating to the goodwill impairment charge offset by tax expense on permanent differences. Cumulative effect of change in accounting principle, net of tax. Based on our transitional impairment test performed upon adoption of SFAS No. 142, we recognized a charge, net of tax, of $445.4 million to reduce the carrying value of the goodwill of our reporting units to its implied fair value. Under SFAS No. 142, the impairment adjustment recognized at adoption of the new rule was reflected as a cumulative effect of change in accounting principle in the six months ended June 30, 2002. Net Income (loss). Net income decreased $193.9 million and $658.3 million to net losses of $177.2 million and $612.4 million for the three and six months ended June 30, 2002, compared to net income of $16.7 million and $46.0 million for the three and six months ended June 30, 2001, primarily due to impairments of goodwill recorded pursuant to SFAS No. 142 and decreased gross profit as described above. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2002, we had cash and cash equivalents of $4.6 million, working capital of $312.8 million and long-term debt of $511.2 million, net of current maturities. Our long-term debt balance at that date included borrowings of $123.0 million under our credit facility, $210.0 million of senior secured notes, $172.5 million of convertible subordinated notes and $5.7 million of other debt. In addition, we had $62.3 million of letters of credit outstanding under the credit facility. During the six months ended June 30, 2002, operating activities provided net cash flow of $52.8 million. We used net cash in investing activities of $56.8 million, including $33.4 million used for capital expenditures, $8.0 million used for the purchase of two businesses, net of cash acquired, and $17.2 million in additional notes receivable issued during the six months. Financing activities provided a net cash flow of $2.3 million, resulting primarily from $13.7 million of borrowings under our credit facility, partially offset by $11.8 million from the purchase of common stock under the Stock Repurchase Plan. On August 12, 2002, we amended our credit facility. As of August 12, 2002, the commitment of the banks under the credit facility was reduced to $275.0 million. The commitment will remain in effect at $275.0 million through March 31, 2003, then reduce to $250.0 million and remain in effect at such amount through December 31, 2003. Effective January 1, 2004, the credit facility will reduce to $225.0 million and remain in effect at such amount through the remainder of the term of the credit facility, which matures on June 14, 2004. Amounts borrowed under the credit facility will bear interest at a rate equal to either (a) LIBOR plus 1.50% to 3.50%, as determined by the ratio of our total funded debt to EBITDA or (b) the bank's prime rate plus up to 2.00%, as determined by the ratio of our total funded debt to EBITDA. Commitment fees of 0.375% to 0.50%, based on our total funded debt to EBITDA, are due on any unused borrowing capacity under the credit facility. The amended credit facility is less restrictive with respect to certain financial ratios and indebtedness covenants, including the maximum funded debt to EBITDA, maximum senior debt to EBITDA and minimum interest coverage. However, the amendment is more restrictive with respect to our capital expenditures and asset sales, prohibits any stock repurchase programs or acquisitions, and requires mandatory reduction in the banks' commitment by a portion of the proceeds from asset sales or upon the issuance of additional debt in excess of $15.0 million. As of August 9, 2002, we had approximately $131.9 million in outstanding borrowings under the credit facility and $62.3 million of letters of credit outstanding, resulting in a borrowing availability of $80.8 million under the credit facility, as amended. Our current borrowing rate is LIBOR plus 3.50%. As of June 30, 2002, we had $210.0 million of senior secured notes which have maturities ranging from three to eight years with a weighted average interest rate of 8.41%. On August 12, 2002, we amended the senior secured notes. The senior secured notes, as amended, have financial covenants and restrictions substantially identical to those under the credit facility and a weighted average interest rate of 9.91%. The amendment also requires a mandatory prepayment of a portion of the proceeds of any asset sales or upon the issuance of additional debt in excess of $15.0 million. In addition, the senior secured notes carry a make-whole provision customary for this type of debt instrument on prepayment of principal, including, any mandatory prepayments. Pursuant to an intercreditor agreement, the senior secured notes rank equally in right of repayment with indebtedness under our credit facility. 15 In connection with the amendments of both the credit facility and the senior secured notes in August 2002, we incurred additional debt issuance costs estimated at approximately $3.5 million. We will account for these costs in accordance with EITF 98-14 for the credit facility and EITF 96-19 for the senior secured notes. Accordingly, a majority of these costs will be capitalized and amortized over the remaining term of the respective agreements, as amended. As a result of the amendment decreasing the commitment amount of the credit facility, in accordance with EITF 98-14, we will be expensing a portion of the unamortized debt issuance costs as interest expense in the third quarter of 2002. As of June 30, 2002, we had $172.5 million in convertible subordinated notes that bear interest at 4.0% per year and are convertible into shares of our common stock at a price of $54.53 per share, subject to adjustment as a result of certain events. The convertible subordinated notes require semi-annual interest payments until the notes mature on July 1, 2007. We have the option to redeem some or all of the convertible subordinated notes beginning July 3, 2003 at specified redemption prices, together with accrued and unpaid interest. If certain fundamental changes occur, as described in the indenture under which we issued the convertible subordinated notes, holders of the convertible subordinated notes may require us to purchase all or part of their notes at a purchase price equal to 100% of the principle amount, plus accrued and unpaid interest. We anticipate that our cash flow from operations and our credit facility will provide sufficient cash to enable us to meet our working capital needs, debt service requirements and planned capital expenditures for property and equipment for at least the next 12 months. However, further deterioration in the markets we serve, coupled with the lowered capacity under our credit facility, may negatively impact our ability to meet such needs. We have specifically provided for non-cash goodwill impairment charges up to $800 million in our credit facility and senior secured notes resulting from the adoption of SFAS No. 142. Goodwill impairment charges do not violate any covenants in our convertible subordinated notes. Other Commitments. As is common in our industry, we have entered into certain off-balance sheet arrangements in the ordinary course of business that result in risks not directly reflected in our balance sheets. Our significant off-balance sheet transactions include liabilities associated with non-cancelable operating leases, letter of credit obligations and surety guarantees. We have not engaged in any off-balance sheet financing arrangements through special purpose entities. We enter into non-cancelable operating leases for many of our facility, vehicle and equipment needs. These leases allow us to conserve cash by paying a monthly lease rental fee for use of facilities, vehicles and equipment rather than purchasing them. At the end of the lease, we have no further obligation to the lessor. We may decide to cancel or terminate a lease before the end of its term. Typically we are liable to the lessor for the remaining lease payments under the term of the lease. Some customers require us to post letters of credit to guarantee performance under our contracts and to ensure payment to our subcontractors and vendors under those contracts. Certain of our vendors also require letters of credit to ensure reimbursement for amounts they are disbursing on behalf of us, such as to beneficiaries under our self-funded insurance programs. Such letters of credit are generally issued by a bank or similar financial institution. The letter of credit commits the issuer to pay specified amounts to the holder of the letter of credit if the holder demonstrates that we have failed to perform specified actions. If this were to occur, we would be required to reimburse the issuer of the letter of credit. Depending on the circumstances of such a reimbursement, we may also have to record a charge to earnings for the reimbursement. To date, we have not had a claim made against a letter of credit that resulted in payments by the issuer of the letter of credit or by us and do not believe that it is likely that any claims will be made under a letter of credit in the foreseeable future. Many customers, particularly in connection with new construction, require us to post performance and payment bonds issued by a financial institution known as a surety. These bonds provide a guarantee to the customer that we will perform under the terms of a contract and that we will pay subcontractors and vendors. If we fail to perform under a contract or to pay subcontractors and vendors, the customer may demand that the surety make payments or provide services under the bond. We must reimburse the surety for any expenses or outlays it incurs. To date, we have not had any significant reimbursements to our surety for bond-related costs. We believe that it is unlikely that we will have to fund significant claims under our surety arrangements in the foreseeable future. Our future contractual obligations, including interest under capital leases, are as follows (in thousands): <Table> <Caption> TOTAL 2002 2003 2004 2005 2006 THEREAFTER -------- -------- -------- -------- -------- -------- ---------- Long-term debt obligations including capital leases .... $518,804 $ 5,059 $ 5,342 $124,896 $103,811 $ 5,196 $274,500 Operating lease obligations ... $ 55,891 $ 16,839 $ 16,427 $ 9,124 $ 7,241 $ 3,347 $ 2,913 </Table> 16 We also had $62.3 million in letters of credit outstanding under our credit facility primarily to secure obligations under our casualty insurance program at June 30, 2002. While not actual borrowings, letters of credit do reflect potential liabilities under our credit facility and therefore are treated as a use of borrowing capacity under our credit facility. These are irrevocable stand-by letters of credit with maturities expiring at various times throughout 2002. Upon maturity, it is expected that the majority of these letters of credit will be renewed for subsequent one year periods. Borrowing availability under our credit facility was $164.7 million as of June 30, 2002 and was $80.8 under the credit facility, as amended, as of August 9, 2002. Stock Repurchase Plan. Our board of directors authorized a Stock Repurchase Plan under which up to $75.0 million of our common stock could be repurchased. Under the Stock Repurchase Plan, we could conduct purchases through open market transactions in accordance with applicable securities laws. During 2001, we purchased 986,000 shares of common stock for approximately $15.3 million. On March 13, 2002, the 986,000 shares of common stock were sold to the Stock Employee Compensation Trust (SECT), and were no longer considered treasury stock. These shares were subsequently retired on June 28, 2002, after we terminated the SECT. During the second quarter of 2002, Quanta purchased 924,500 shares of its common stock for approximately $11.8 million under the Stock Repurchase Plan. As of July 1, 2002, the independent committee of our board of directors determined to cease the Stock Repurchase Plan. As a result of the credit facility and senior secured notes amendments, any further stock repurchases are prohibited. Stock Employee Compensation Trust. On March 13, 2002, our board of directors approved the creation of a SECT, to fund certain of our future employee benefit obligations using our common stock. The SECT was established by selling 8.0 million shares of our common stock, including the 986,000 shares of treasury stock we purchased during 2001 pursuant to our Stock Repurchase Plan, to the SECT in exchange for a promissory note plus an amount in cash equal to the aggregate par value of the shares. As part of the settlement of the proxy contest with Aquila, on May 20, 2002, we terminated the SECT and repurchased the 7,911,069 shares of common stock remaining in the SECT by canceling the promissory note. The 7,911,069 shares transferred into treasury stock on May 21, 2002 and were retired on June 28, 2002. Litigation. On December 21, 2001, a purported stockholder of Quanta filed a putative class action and derivative complaint against directors Vincent D. Foster, Jerry J. Langdon, Louis C. Golm, James R. Ball, John R. Colson, John R. Wilson and Gary A. Tucci. The complaint also named Quanta as a nominal defendant. The complaint alleged that the named directors breached their fiduciary duties by taking certain actions, including the Stockholder Rights Plan amendment, in response to the announcement by Aquila that it intended to acquire control of Quanta through open market purchases of our shares. The complaint sought an order rescinding any actions taken by the named directors in response to the announcement by Aquila and requiring the directors to take steps necessary to maximize the value of Quanta. The complaint further sought damages from the named directors on behalf of a class of stockholders and purportedly on behalf of Quanta for the alleged harm inflicted by the actions of the named directors. On January 22, 2002 Quanta and the named directors filed a motion to dismiss the stockholder complaint. There has been no activity since January 2002. Although the ultimate outcome and liability, if any, cannot be determined, management, after consultation and review with counsel, believes that the facts do not support the plaintiff's claims and that Quanta and the named directors have meritorious defenses. On March 21, 2002, Aquila filed a complaint in the Delaware Court of Chancery naming Quanta and each member of the special committee of our board of directors, consisting of all directors other than those designated by Aquila, as defendants. The Aquila complaint alleged that the special committee breached its fiduciary duty in connection with the March 13, 2002 adoption of the SECT and the new employment agreements entered into with certain of our employees and that under Delaware statutory laws the shares sold to the SECT were not entitled to vote. As part of the settlement of Aquila's proxy contest, this lawsuit was dismissed with prejudice. In addition, certain of our subsidiaries are involved in disputes or legal actions arising in the ordinary course of business. We do not believe the outcome of such legal actions will have a material adverse effect on our financial position or results of operations. Acquisitions. During the first six months of 2002, we acquired two companies for an aggregate consideration of 251,079 shares of common stock and approximately $8.0 million in cash, net of cash acquired. The cash portion of such consideration was provided by proceeds from borrowings under the credit facility. In connection with the amendment of our credit facility and senior secured notes, we are prohibited from making additional acquisitions. Concentration of Credit Risk. We grant credit, generally without collateral, to our customers, which include electric power and gas companies, telecommunications and cable television system operators, governmental entities, general contractors, builders and owners and managers of commercial and industrial properties located primarily in the United States. Consequently, we are subject to 17 potential credit risk related to changes in business and economic factors throughout the United States. We generally are entitled for work performed and have certain lien rights on our services provided. As previously discussed herein, our customers in the telecommunications business have experienced significant financial difficulties and, in several instances, filed for bankruptcy. Also, our utility customers are experiencing business challenges in the current business climate. These economic conditions expose us to increased risk related to collectibility on services we have performed. No customer accounted for more than 10% of accounts receivable or revenues for the six months ended June 30, 2001 or 2002. Related Party Transactions. In the normal course of business, we from time to time enter into transactions with related parties. These transactions typically take the form of network service work for Aquila or facility leases with prior owners. See additional discussion in Note 9 of Notes to Condensed Consolidated Financial Statements. SEASONALITY; FLUCTUATIONS OF QUARTERLY RESULTS Our results of operations can be subject to seasonal variations. During the winter months, demand for new projects and new maintenance service arrangements may be lower due to reduced construction activity. However, demand for repair and maintenance services attributable to damage caused by inclement weather during the winter months may partially offset the loss of revenues from lower demand for new projects and new maintenance service arrangements. Additionally, our industry can be highly cyclical. As a result, our volume of business may be adversely affected by declines in new projects in various geographic regions in the U.S. Typically, we experience lower gross and operating margins during the winter months. The timing of acquisitions, variations in the margins of projects performed during any particular quarter, the timing and magnitude of acquisition assimilation costs, regional economic conditions and our customer's access to capital may also materially affect quarterly results. Accordingly, our operating results in any particular quarter may not be indicative of the results that can be expected for any other quarter or for the entire year. NEW ACCOUNTING PRONOUNCEMENTS In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 requires that gains and losses from extinguishment of debt be classified as extraordinary items only if they meet the criteria in Accounting Principles Board Opinion No. 30 (Opinion No. 30). Applying the provisions of Opinion No. 30 will distinguish transactions that are part of an entity's recurring operations from those that are unusual and infrequent and meet the criteria for classification as an extraordinary item. SFAS No. 145 is effective for us beginning January 1, 2003. Upon the adoption of SFAS No. 145, if we record any extraordinary items related to the extinguishment of debt, we will have to reclassify such items in our prior period statements of operations to conform to the presentation required by SFAS No. 145. Under SFAS No. 145, we will report gains and losses on the extinguishment of debt in pre-tax earnings rather than in extraordinary items. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities, such as restructurings, involuntarily terminating employees and consolidating facilities initiated after December 31, 2002. CRITICAL ACCOUNTING POLICIES The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities known to exist at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates on an ongoing basis, based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. There can be no assurance that actual results will not differ from those estimates. Management has reviewed its development and selection of critical accounting estimates with the audit committee of our board of directors. We believe the following accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements: Accounts Receivable and Provision for Doubtful Accounts. We provide an allowance for doubtful accounts when collection of an account receivable is considered doubtful. Inherent in the assessment of the allowance for doubtful accounts are certain judgments and estimates including, among others, our customer's access to capital, our customer's willingness or ability to pay, general economic conditions and the ongoing relationship with the customer. For example, certain of our customers, primarily large public telecommunications carriers, have filed for bankruptcy in the quarter ended June 30, 2002, or have been experiencing financial difficulties, and as a result we increased our reserves in June 2002 to reflect that certain customers may be unable to meet 18 their obligations to us in the future. Should additional customers file for bankruptcy or experience difficulties, or should anticipated recoveries relating to the receivables in existing bankruptcies and other workout situations fail to materialize, we could experience reduced cash flows and losses in excess of current reserves. Goodwill. As stated in Note 5 of Notes to Condensed Consolidated Financial Statements, FASB Statement No. 142 provides that goodwill and other intangible assets that have indefinite useful lives will not be amortized, but instead must be tested at least annually for impairment, and intangible assets that have finite useful lives should continue to be amortized over their useful lives. Statement No. 142 also provides specific guidance for testing goodwill and other nonamortized intangible assets for impairment. Goodwill of a reporting unit shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Examples of such events or circumstances may include a significant change in business climate, or a loss of key personnel, among others. The Statement requires that management make certain estimates and assumptions in order to allocate goodwill to reporting units and to determine the fair value of reporting unit net assets and liabilities, including, among other things, an assessment of market conditions, projected cash flows, cost of capital and growth rates, which could significantly impact the reported value of goodwill and other intangible assets, as compared to our accounting policy for the assessment of goodwill impairment in 2001, which was based on an undiscounted cash flow model. Estimating future cash flows requires significant judgment and our projections may vary from cash flows eventually realized. Revenue Recognition. We typically record revenues from fixed price contracts on a percentage-of-completion basis, using the cost-to-cost method based on the percentage of total costs incurred to date in proportion to total estimated costs to complete the contract. Changes in job performance, job conditions and final contract settlements, among others, are factors that influence the assessment of the total estimated costs to complete these contracts. Self-Insurance. We are insured for workers' compensation, employer's liability, auto liability and general liability claims, subject to a deductible of $500,000 per accident or occurrence. On August 1, 2002, upon renewal of our policies, the deductible was increased to $1,000,000 per occurrence. In addition, effective January 1, 2002, we consolidated the various non-union employee related health care benefits plans that existed at certain of our subsidiaries into one corporate plan which is subject to a deductible of $250,000 per claimant per year. Losses up to the deductible amounts are accrued based upon our estimates of the ultimate liability for claims incurred and an estimate of claims incurred but not reported. 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. The accruals are based upon known facts and historical trends and management believes such accruals to be adequate. OUTLOOK The following statements are based on current expectations. These statements are forward looking, and actual results may differ materially. Like many companies who provide installation and maintenance services to the electrical power, gas, telecommunications and cable television industries, we are facing a number of challenges. Our operating environment has changed dramatically. The telecommunications and utility markets have experienced substantial change in just the past few months as evidenced by an increased number of bankruptcies in the telecommunications market, continued devaluation of several of our utility clients debt and equity securities and pricing pressures resulting from challenges faced by major industry participants. These factors have contributed to the delay and cancellation of projects and reduction of capital spending that have impacted our operations and ability to grow at historical levels. We continue to focus on the elements of the business we can control, including cost control, the margins we accept on projects, collecting receivables, ensuring quality service and right sizing initiatives to match the markets we serve. These initiatives include aligning our work force with our current revenue base, evaluating opportunities to reduce the number of field offices and evaluating our non-core assets for potential sale. Such initiatives could result in future charges related to, among others, severance, facility and other exit costs as we execute upon these initiatives. We expect continued demand for our services from our utility and gas customers throughout 2002 with continued weakness in demand for our services from our telecommunications and cable customers and relatively level demand for our services from our ancillary customers. Competitive pressures on our customers caused by deregulation, return to core competencies and cost reductions have caused an increased focus on outsourcing services. We believe that we are adequately positioned to provide these services with our proven full-service providers with broad geographic reach, financial capability and technical expertise. UNCERTAINTY OF FORWARD-LOOKING STATEMENTS AND INFORMATION This Quarterly Report on Form 10-Q includes statements reflecting assumptions, expectations, projections, intentions or beliefs about future events that are intended as "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. You can identify these statements by the fact that they do not relate strictly to historical or current facts. They use words such as "anticipate," "estimate," "project," "forecast," "may," "will," "should," "expect" and other words of similar meaning. In particular, these include, but are not limited to, statements relating to the following: - - Projected operating or financial results; - - Expectations regarding capital expenditures; - - The effects of competition in our markets; - - The duration and extent of the current economic downturn; - - Materially adverse changes in economic conditions in the markets served by us or by our customers, and; - - Our ability to achieve cost savings. - - Any or all of Quanta's forward-looking statements may turn out to be wrong. They can be affected by inaccurate assumptions and or by known or unknown risks and uncertainties, including the following: - - Beliefs or assumptions about the outlook for markets we serve; - - The Company's ability to effectively compete for market share; - - The duration and extent of the current economic downturn; - - Beliefs and assumptions about the collectibility of receivables; - - Material adverse changes in economic conditions in the markets served by us or by our customers; - - Rapid technological and structural changes that could reduce the demand for the services we provide; - - Replacement of our contracts as they are completed or expire; - - Retention of key personnel and; - - The cost of borrowing, availability of credit and other factors affecting Quanta's financing activities. Many of these factors will be important in determining Quanta's actual future results. Consequently, no forward-looking statement can be guaranteed. Quanta's actual future results may vary materially from those expressed or implied in any forward-looking statements. All of Quanta's forward-looking statements, whether written or oral, are expressly qualified by these cautionary statements and any other cautionary statements that may accompany such forward-looking statements. In addition, Quanta disclaims any obligation to update any forward-looking statements to reflect events or circumstances after the date of this report. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risk primarily related to potential adverse changes in interest rates and, to a certain extent, commodity prices, as discussed below. Management does not generally use derivative financial instruments for trading or to speculate on changes in interest rates or commodity prices. As of June 30, 2002, however, we had two derivative contracts outstanding which related to anticipated exposure in the price of natural gas. We are exposed to credit risk in the event of non-performance by the derivative counterparty. However, we monitor our derivative positions by regularly evaluating our positions and the credit worthiness of the counterparties, which we consider credit worthy at June 30, 2002. Management is actively involved in monitoring exposure to market 19 risk and continues to develop and utilize appropriate risk management techniques. We are not exposed to any other significant market risks, foreign currency exchange risk or interest rate risk from the use of derivative financial instruments. The sensitivity analyses below, which illustrates our hypothetical potential market risk exposure, estimates the effects of hypothetical sudden and sustained changes in the applicable market conditions on 2002 earnings. The sensitivity analyses presented do not consider any additional actions we may take to mitigate our exposure to such changes. The hypothetical changes and assumptions may be different from what actually occurs in the future. Interest Rates. As of June 30, 2002, we had no derivative financial instruments to manage interest rate risk. As such, we are exposed to earnings and fair value risk due to changes in interest rates with respect to our long-term obligations. As of June 30, 2002, approximately 23.7% of our long-term obligations were floating rate obligations. As of June 30, 2002, the fair value of our variable rate debt of $123.0 million approximated book value, and the fair value of our fixed-rate debt of $395.8 million was approximately $334.4 million based upon discounted future cash flows using incremental borrowing rates and current market prices. The detrimental effect on our pretax earnings of a hypothetical 50 basis point increase in both variable and fixed interest rates would be approximately $0.6 million and $2.0 million, respectively. Commodity Price Exposure. In October 2001, we entered into a forward purchase contract (Contract A) with settlements through 2006, in order to secure pricing on anticipated gas requirements related to a project in process at December 31, 2001 that was substantially complete at March 31, 2002. Our objective was to mitigate the variability in the price of natural gas by securing the price we will have to pay the Contract A counterparty. On March 29, 2002, we entered into a sub-services agreement with one of our customers (the Counterparty Contract) whereby the customer assumed all obligations associated with Contract A. If the customer is unable to fulfill its obligations under the Counterparty Contract, we will be responsible for settling the obligations of Contract A. As of June 30, 2002, the fair value of Contract A and the Counterparty Contract was a receivable of $1.2 million and a payable of $1.2 million, respectively. In April 2002, we entered into another forward purchase contract (Contract B) with settlements through March 2003, in order to secure pricing on anticipated gas requirements related to a project in process at June 30, 2002. Our objective was to mitigate the variability in the price of natural gas by securing the price we will have to pay the Contract B counterparty. As of June 30, 2002, the fair value of Contract B was $354,000. 20 PART II -- OTHER INFORMATION QUANTA SERVICES, INC. AND SUBSIDIARIES ITEM 2. CHANGES IN SECURITIES. (c) Unregistered Sales of Securities. Between March 31, 2002, and June 30, 2002, the Company completed one acquisition in which some of the consideration was unregistered securities of the Company. The consideration paid in this transaction was $7.6 million in cash and 211,200 shares of common stock. This acquisition was not affiliated with any other acquisition prior to such transaction. All securities listed on the following table were shares of common stock. The Company relied on Section 4(2) of the Securities Act of 1933, as amended, as the basis for exemption from registration. All issuances were to the owners of businesses acquired in privately negotiated transactions, not pursuant to public solicitation. <Table> <Caption> NUMBER OF DATE SHARES PURCHASERS CONSIDERATION ---- --------- ---------------------- ---------------------- 04/15/02 211,200 Six owners of Mustang Acquisition of Mustang Line Contractors, Inc. Line Contractors, Inc. </Table> On March 13, 2002, the Company sold 8.0 million shares of common stock to the SECT in exchange for a promissory note, plus an amount equal to the aggregate par value of the shares. As part of the settlement of the proxy contest with Aquila, on May 20, 2002, the Company terminated the SECT and repurchased the 7,911,069 shares of common stock remaining in the SECT by canceling the promissory note. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. On May 20, 2002, the Company and Aquila announced that they reached an agreement for Aquila to terminate its proxy contest for control of Quanta's board of directors. The Company's definitive proxy statement filed on June 4, 2002, contains a discussion of the terms of the settlement. The costs associated with the proxy contest and negotiations with Aquila were approximately $11.6 million. The Company held its annual meeting of stockholders in Houston, Texas on June 28, 2002. Ten members were elected to the board of directors, each to serve until the next annual meeting of the Company and until their respective successors have been elected and qualified. The following six individuals were elected to the board of directors by the holders of the common stock and the Series A Convertible Preferred Stock of the Company, voting together: <Table> <Caption> Nominee For Withheld - ------- ---------- ---------- James R. Ball ............ 66,745,247 866,321 John R. Colson ........... 66,806,186 805,382 Terrence P. Dunn ......... 66,251,138 1,306,430 Louis C. Golm ............ 66,806,186 805,382 Gary A. Tucci ............ 66,806,186 805,382 John R. Wilson ........... 66,806,186 805,382 </Table> The following three individuals were elected to the board of directors by the holders of the Series A Convertible Preferred Stock of the Company: Robert K. Green, Edward K. Mills and Keith G. Stamm. Each of these individuals was elected by a vote of 3,444,961 shares of the Series A Convertible Preferred Stock, being all of the outstanding shares of Series A Convertible Preferred Stock cast for or against, with no shares voted against or abstaining. The holders of Limited Vote Common stock of the Company elected Vincent D. Foster to the board of directors. Mr. Foster was elected by a vote of 625,932 shares of the Limited Vote Common Stock, being more than a plurality of the outstanding shares of Limited Vote Common Stock cast for or against, with no shares voted against or abstaining. No other matters were submitted to a vote of the stockholders. 21 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. EXHIBIT NUMBER DESCRIPTION - ------- ----------- 3.1 -- Amended and Restated Certificate of Incoporation (previously filed as Exhibit 3.1 to the Company's Registration Statement on Form S-1 (No. 333-42957) and incorporated herein by reference) 3.2 -- Amended and Restated Bylaws (previously filed as Exhibit 3.2 to the Company's 2000 Form 10-K (No. 001-13831) filed April 2, 2001 and incorporated herein by reference) 3.3 -- Certificate of Amendment to the Amended and Restated Certificate of Incorporation (previously filed as Exhibit 3.3 to the Company's Registration Statement on Form S-3 (No. 333-81419) filed June 23, 1999 and incorporated herein by reference) 3.4 -- Certificate of Designation for the Series A Preferred Stock (previously filed as Exhibit 3.4 to the Company's Registration Statement of Form S-3 (No. 333- 90961) filed November 15, 1999 and incorporated herein by reference) 3.5 -- Certificate of Designation for the Series B Preferred Stock (previously filed as Exhibit 3.5 to the Company's 1999 Form 10-K (No. 001-13831) filed March 30, 2000 and incorporated herein by reference) 3.6 -- Certificate of Correction to Certificate of Designation for the Series A Preferred Stock (previously filed as Exhibit 3.6 to the Company's 1999 Form 10-K (No. 001-13831) filed March 30, 2000 and incorporated herein by reference) 3.7 -- Certificate of Amendment of the Certificate of Designation, Rights and Limitations of the Series A Convertible Preferred Stock (previously filed as Exhibit 3.7 to the Company's 2001 Form 10-K (No. 001-13831) filed April 1, 2002 and incorporated herein by reference) 3.8 -- Certificate of Amendment to the Amended and Restated Certificate of Incorporation (previously filed as Exhibit 3.8 to the Company's 2001 Form 10-K (No. 001-13831) filed April 1, 2002 and incorporated herein by reference) 3.9 -- Certificate of Designation of Series C Junior Convertible Preferred Stock (previously filed as Exhibit 3.9 to the Company's 2001 Form 10-K (No. 001- 13831) filed April 1, 2002 and incorporated herein by reference) 3.10 -- Certificate of Increase of Series B Junior Participating Preferred Stock (previously filed as Exhibit 3.10 to the Company's 2001 Form 10-K (No. 001- 13831) filed April 1, 2002 and incorporated herein by reference) 4.14 -- Eighth Amendment and Consent to Third Amended and Restated Secured Credit Agreement (filed herewith) 10.30 -- Employment Agreement, dated as of March 13, 2002, by and between Quanta Services, Inc. and James F. O'Neill, III (filed herewith) 10.31 -- Settlement and Governance Agreement between Quanta Services, Inc. and Aquila, Inc., dated as of May 20, 2002 (previously filed as Exhibit 10.1 to the Company's Form 8-K (No. 001-13831) filed May 22, 2002 and incorporated herein by reference) 10.32 -- Amended and Restated Investors' Rights Agreement between Quanta Services, Inc. and Aquila, Inc., dated as of May 20, 2002 (previously filed as Exhibit 10.2 to the Company's Form 8-K (No. 001-13831) filed May 22, 2002 and incorporated herein by reference) 10.33 -- Amendment No. 1 to Note Purchase Agreement dated as of March 1, 2000 between Quanta Services, Inc. and the Purchasers named therein (filed herewith) 99.1 -- Certification of Periodic Report by Chief Executive Officer (filed herewith) 99.2 -- Certification of Periodic Report by Chief Financial Officer (filed herewith) (b) Reports on Form 8-K. (1) Quanta filed a Form 8-K on May 22, 2002 in which it reported that it reached an agreement for Aquila to terminate its proxy contest for control of Quanta's board of directors. 22 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant, Quanta Services, Inc., has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. QUANTA SERVICES, INC. By: /s/ DERRICK A. JENSEN ------------------------------------- Derrick A. Jensen Vice President, Controller and Chief Accounting Officer Dated: August 14, 2002 23 INDEX TO EXHIBITS <Table> <Caption> EXHIBIT NUMBER DESCRIPTION - ------- ----------- 4.14 -- Eighth Amendment and Consent to Third Amended and Restated Secured Credit Agreement (filed herewith) 10.30 -- Employment Agreement, dated as of March 13, 2002, by and between Quanta Services, Inc and James F. O'Neill, III (filed herewith) 10.33 -- Amendment No. 1 to Note Purchase Agreement dated as of March 1, 2000 between Quanta Services, Inc. and the Purchasers named therein (filed herewith) 99.1 -- Certification of Periodic Report by Chief Executive Officer (filed herewith) 99.2 -- Certification of Periodic Report by Chief Financial Officer (filed herewith) </Table> 24