- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
---------------------
<Table>
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
</Table>
COMMISSION FILE NO. 001-13831
---------------------
QUANTA SERVICES, INC.
(Exact name of registrant as specified in its charter)
<Table>
DELAWARE 74-2851603
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
</Table>
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 [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
115,511,093 shares of Common Stock were outstanding as of November 10,
2003. As of the same date, 1,067,750 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................................. 2
Consolidated Statements of Operations....................... 3
Consolidated Statements of Cash Flows....................... 4
Notes to Condensed Consolidated Financial Statements........ 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 17
Item 4. Controls and Procedures..................................... 28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 29
Item 6. Exhibits and Reports on Form 8-K............................ 29
Signature............................................................ 30
</Table>
1
QUANTA SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
<Table>
<Caption>
DECEMBER 31, SEPTEMBER 30,
2002 2003
------------ -------------
(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 27,901 $ 77,827
Accounts receivable, net of allowances of $37,585 and
$29,343, respectively.................................. 367,057 388,630
Costs and estimated earnings in excess of billings on
uncompleted contracts.................................. 54,749 53,460
Inventories............................................... 25,646 25,665
Current deferred taxes.................................... 28,968 6,779
Prepaid expenses and other current assets................. 25,176 33,366
---------- ----------
Total current assets.............................. 529,497 585,727
Property and equipment, net................................. 369,568 346,022
Accounts and notes receivable, net of allowances of $28,389
and $46,320, respectively................................. 50,900 35,689
Other assets, net........................................... 19,250 24,428
Goodwill and other intangibles, net......................... 395,597 395,400
---------- ----------
Total assets...................................... $1,364,812 $1,387,266
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt...................... $ 6,652 $ 5,144
Accounts payable and accrued expenses..................... 189,080 188,772
Billings in excess of costs and estimated earnings on
uncompleted contracts.................................. 16,409 19,994
---------- ----------
Total current liabilities......................... 212,141 213,910
Long-term debt, net of current maturities................... 213,167 211,535
Convertible subordinated notes.............................. 172,500 172,500
Deferred income taxes and other non-current liabilities..... 82,411 102,517
---------- ----------
Total liabilities................................. 680,219 700,462
---------- ----------
Commitments and Contingencies
Redeemable common stock..................................... 72,922 --
Stockholders' Equity:
Preferred Stock, $.00001 par value, 10,000,000 shares
authorized:
Series A Convertible Preferred Stock, 3,199,961 and no
shares issued and outstanding, respectively........... -- --
Common Stock, $.00001 par value, 300,000,000 shares
authorized, 70,632,899 and 116,439,340 shares issued
and 69,706,528 and 115,512,969 outstanding,
respectively(a)........................................ -- --
Limited Vote Common Stock, $.00001 par value, 3,345,333
shares authorized, 1,083,750 and 1,067,750 shares
issued and outstanding, respectively................... -- --
Additional paid-in capital................................ 980,303 1,070,446
Deferred compensation..................................... (302) (8,142)
Retained deficit.......................................... (356,605) (363,775)
Treasury Stock, 926,371 common shares, at cost............ (11,725) (11,725)
---------- ----------
Total stockholders' equity........................ 611,671 686,804
---------- ----------
Total liabilities and stockholders' equity........ $1,364,812 $1,387,266
========== ==========
</Table>
- ---------------
(a) Shares issued and outstanding as of December 31, 2002 do not include the
24,370,410 shares of Redeemable Common Stock valued at $72.9 million which
was reclassified to stockholders' equity on February 20, 2003.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
QUANTA SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------------
2002 2003 2002 2003
-------- -------- ---------- ----------
Revenues........................................ $436,215 $436,133 $1,317,957 $1,211,564
Cost of services (including depreciation)....... 381,947 381,125 1,139,842 1,065,281
-------- -------- ---------- ----------
Gross profit.................................. 54,268 55,008 178,115 146,283
Selling, general and administrative expenses.... 68,747 38,886 178,956 135,963
Goodwill impairment............................. -- -- 166,580 --
-------- -------- ---------- ----------
Income (loss) from operations................. (14,479) 16,122 (167,421) 10,320
Other Income (Expense):
Interest expense.............................. (9,807) (8,080) (25,696) (24,182)
Other, net.................................... (1,674) 182 (56) 72
-------- -------- ---------- ----------
Income (loss) before income tax provision
(benefit) and cumulative effect of change in
accounting principle.......................... (25,960) 8,224 (193,173) (13,790)
Provision (benefit) for income taxes............ (17,644) 2,825 (17,926) (4,511)
-------- -------- ---------- ----------
Income (loss) before cumulative effect of change
in accounting principle....................... (8,316) 5,399 (175,247) (9,279)
Cumulative effect of change in accounting
principle, net of tax......................... -- -- 445,422 --
-------- -------- ---------- ----------
Net income (loss)............................... (8,316) 5,399 (620,669) (9,279)
Dividends (forfeitures) on preferred stock,
net........................................... 234 -- 698 (2,109)
-------- -------- ---------- ----------
Net income (loss) attributable to common
stock......................................... $ (8,550) $ 5,399 $ (621,367) $ (7,170)
======== ======== ========== ==========
(RESTATED -- (RESTATED --
NOTE 2) NOTE 2)
Earnings (Loss) Per Share:
Basic Earnings (Loss) per Share Before
Cumulative Effect of Change in Accounting
Principle.................................. $ (0.14) $ 0.05 $ (2.89) $ (0.06)
Cumulative Effect of Change in Accounting
Principle, Net of Tax...................... -- -- (7.30) --
-------- -------- ---------- ----------
Basic Earnings (Loss) per Share............... $ (0.14) $ 0.05 $ (10.19) $ (0.06)
======== ======== ========== ==========
Diluted Earnings (Loss) per Share Before
Cumulative Effect of Change in Accounting
Principle.................................. $ (0.14) $ 0.05 $ (2.89) $ (0.06)
Cumulative Effect of Change in Accounting
Principle, Net of Tax...................... -- -- (7.30) --
-------- -------- ---------- ----------
Diluted Earnings (Loss) per Share............. $ (0.14) $ 0.05 $ (10.19) $ (0.06)
======== ======== ========== ==========
Shares Used in Computing Earnings (Loss) Per
Share:
Basic......................................... 60,808 116,567 60,964 112,484
======== ======== ========== ==========
Diluted....................................... 60,808 116,645 60,964 112,484
======== ======== ========== ==========
</Table>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
QUANTA SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
2002 2003 2002 2003
-------- -------- --------- --------
Cash Flows from Operating Activities:
Net income (loss) attributable to common stock............ $ (8,550) $ 5,399 $(621,367) $ (7,170)
Adjustments to reconcile net income (loss) attributable to
common stock to net cash provided by (used in) operating
activities --
Cumulative effect of change in accounting principle, net
of tax................................................ -- -- 445,422 --
Goodwill impairment..................................... -- -- 166,580 --
Depreciation and amortization........................... 15,276 14,920 45,293 45,128
Loss on sale of property and equipment.................. 527 307 1,223 1,001
Provision for doubtful accounts......................... 24,642 504 30,209 19,761
Deferred income tax provision (benefit)................. 6,761 3,558 (11,509) 35,862
Amortization of deferred compensation................... 62 839 187 1,923
Preferred stock dividends, net of forfeitures........... 234 -- 698 (2,109)
Changes in operating assets and liabilities, net of
non-cash transactions --
(Increase) decrease in --
Accounts receivable................................... (2,316) (37,113) 29,116 (27,993)
Costs and estimated earnings in excess of billings on
uncompleted contracts.............................. (2,183) 2,032 (11,692) 1,289
Inventories........................................... 3,949 1,173 (2,125) (19)
Prepaid expenses and other current assets............. 2,663 (3,582) 2,873 (3,597)
Increase (decrease) in --
Accounts payable and accrued expenses................. (30,956) 10,462 (781) 6,188
Billings in excess of costs and estimated earnings on
uncompleted contracts.............................. (4,246) 4,699 (14,819) 3,585
Other, net............................................ 3,334 389 2,711 2,900
-------- -------- --------- --------
Net cash provided by operating activities.......... 9,197 3,587 62,019 76,749
-------- -------- --------- --------
Cash Flows from Investing Activities:
Proceeds from sale of property and equipment.............. 1,325 1,009 3,054 1,913
Additions of property and equipment....................... (6,433) (11,459) (39,804) (23,936)
Cash paid for acquisitions, net of cash acquired.......... -- -- (8,000) --
Cash restricted for self-insurance programs............... -- (1,248) -- (8,448)
Notes receivable.......................................... (46) -- (17,252) --
-------- -------- --------- --------
Net cash used in investing activities.............. (5,154) (11,698) (62,002) (30,471)
-------- -------- --------- --------
Cash Flows from Financing Activities:
Net borrowings under the credit facility.................. 7,920 -- 21,590 --
Proceeds from other long-term debt........................ 633 353 2,449 2,491
Payments on other long-term debt.......................... (2,412) (1,882) (8,511) (5,631)
Debt issuance and amendment costs......................... (2,700) (315) (2,700) (315)
Issuances of stock, net of offering costs................. 3,222 1,667 6,872 7,103
Stock repurchases......................................... 77 -- (11,725) --
Exercise of stock options................................. 5 -- 1,086 --
-------- -------- --------- --------
Net cash provided by (used in) financing
activities....................................... 6,745 (177) 9,061 3,648
-------- -------- --------- --------
Net increase (decrease) in cash and cash equivalents........ 10,788 (8,288) 9,078 49,926
Cash and cash equivalents, beginning of period.............. 4,577 86,115 6,287 27,901
-------- -------- --------- --------
Cash and cash equivalents, end of period.................... $ 15,365 $ 77,827 $ 15,365 $ 77,827
======== ======== ========= ========
Supplemental Disclosure of Cash Flow Information
Cash paid for --
Interest................................................ $ 11,676 $ 9,093 $ 23,183 $ 20,042
Income taxes, net of refunds............................ 787 (1,144) 6,282 (39,566)
</Table>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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. Quanta's
comprehensive services include designing, installing, repairing and maintaining
network infrastructure. The consolidated financial statements of Quanta include
the accounts of Quanta and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
In the course of its operations, Quanta is subject to certain risk factors,
including but not limited to risks related to: economic downturn, access to
capital, compliance with lenders' financial covenants, the financial condition
of Quanta's customers, the collectibility of receivables, significant
fluctuations in quarterly results, contract terms, recoverability of goodwill,
rapid technological and structural changes in the industries Quanta serves,
competition, internal growth and operating strategies, management of growth,
acquisition integration and financing, unionized workforce, dependence on key
personnel, availability of qualified employees, potential exposure to
environmental liabilities and anti-takeover measures.
Interim Condensed Consolidated Financial Information
These unaudited condensed consolidated financial statements have been
prepared pursuant to the rules of the Securities and Exchange Commission (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. Quanta 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 Quanta have historically
been subject to significant seasonal fluctuations.
It is suggested that these unaudited condensed consolidated financial
statements be read in conjunction with the audited consolidated financial
statements and notes thereto of Quanta Services, Inc. and subsidiaries included
in Quanta's Annual Report on Form 10-K, which was filed with the SEC on March
31, 2003, as amended by Amendment No. 1 thereto on Form 10-K/A, which was filed
with the SEC on October 2, 2003.
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
revenues and expenses recognized during the periods presented. Quanta 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 Quanta's beliefs and
assumptions derived from information available at the time such judgments and
estimates are made. Uncertainties with respect to such estimates and assumptions
are inherent in the preparation of financial statements. Estimates are primarily
used in Quanta's assessment of the allowance for doubtful accounts, valuation of
inventory, fair value assumption in analyzing goodwill and long-lived asset
impairments, self-insured claims liabilities, revenue recognition under
percentage-of-completion accounting and income taxes.
5
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Current and Non-Current Accounts and Notes Receivable and Provision for
Doubtful Accounts
Quanta provides an allowance for doubtful accounts when collection of an
account or note 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, the customer's
willingness or ability to pay, general economic conditions and the ongoing
relationship with the customer. Under certain circumstances, such as
foreclosures or negotiated settlements, Quanta may take title to the underlying
assets in lieu of cash in settlement of receivables. As of September 30, 2003,
Quanta has provided allowances for doubtful accounts of approximately $75.7
million. Certain of Quanta's customers, several of them large public
telecommunications carriers, have filed for bankruptcy or have been experiencing
financial difficulties. Also, a number of Quanta'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, Quanta 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.
In June 2002, a large Quanta customer, Adelphia Communications Corporation
(Adelphia), filed for bankruptcy protection under Chapter 11 of the Bankruptcy
Code, as amended. Quanta has filed liens on various properties to secure
substantially all of its pre-petition receivables. The carrying value is based
upon Quanta's understanding of the current status of the Adelphia bankruptcy
proceeding and a number of assumptions, including assumptions about the
validity, priority and enforceability of our security interests. Quanta
currently believes it will collect a substantial majority of the balances owed.
Should any of the factors underlying Quanta's estimate change, the amount of
Quanta's allowance could change significantly. Quanta is uncertain as to whether
such receivables will be collected within one year and therefore has included
this amount in non-current assets as Accounts and Notes Receivable. Also
included in non-current Accounts and Notes Receivable are amounts due from
another customer relating to the construction of independent power plants.
Quanta has agreed to long-term payment terms for this customer. The notes
receivable are partially secured and bear interest at 9.5% per year. Quanta has
provided allowances for these notes receivable due to a substantial
deterioration in the estimated future cash flows of the plants, resulting in a
carrying value equal to the estimated value of the collateral securing these
notes. As of September 30, 2003, the total long-term balances due from both of
these customers was $81.2 million, net of an allowance for doubtful accounts of
$46.3 million.
Concentration of Credit Risk
Quanta grants credit, generally without collateral, to its 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, Quanta is subject to potential
credit risk related to changes in business and economic factors throughout the
United States. However, Quanta typically has certain lien rights on the services
provided.
Stock-Based Compensation
Quanta accounts for its stock-based compensation under Accounting
Principles Board Opinion No. 25 (APB Opinion No. 25), "Accounting for Stock
Issued to Employees." Under this accounting method, no compensation expense is
recognized in the consolidated statements of operations if no intrinsic value of
the option exists at the date of grant. In October 1995, the Financial
Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." SFAS No.
123 encourages companies to account for stock-based compensation awards based on
the fair
6
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
value of the awards at the date they are granted. The resulting compensation
cost would be shown as an expense in the consolidated statements of operations.
Companies can choose not to apply the new accounting method and continue to
apply current accounting requirements; however, disclosure is required as to
what net income and earnings per share would have been had SFAS No. 123 been
followed. In addition, Quanta has an Employee Stock Purchase Plan (ESPP). SFAS
No. 123 requires the inclusion of stock issued pursuant to an ESPP in the as
adjusted disclosure.
Had compensation costs for the 2001 Stock Incentive Plan and the ESPP been
determined consistent with SFAS No. 123, Quanta's net income attributable to
common stock and earnings per share would have been reduced to the following as
adjusted amounts (in thousands, except per share information):
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
2002 2003 2002 2003
--------- ------- --------- --------
Net income (loss) attributable to common
stock
As Reported............................... $ (8,550) $5,399 $(621,367) $ (7,170)
As Adjusted -- Basic...................... $(14,088) $4,897 $(637,849) $(12,705)
As Adjusted -- Diluted.................... $(14,088) $4,897 $(637,849) $(12,705)
Earnings (loss) per share
As Reported -- Basic...................... $ (0.14) $ 0.05 $ (10.19) $ (0.06)
As Adjusted -- Basic...................... $ (0.23) $ 0.04 $ (10.46) $ (0.11)
As Reported -- Diluted.................... $ (0.14) $ 0.05 $ (10.19) $ (0.06)
As Adjusted -- Diluted.................... $ (0.23) $ 0.04 $ (10.46) $ (0.11)
</Table>
See Note 7 for additional discussion of the restricted stock issued under
Quanta's 2001 Stock Incentive Plan and the effects thereof.
7
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 (loss) per share for the three and nine months ended September 30, 2002
and 2003 is illustrated below (in thousands):
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------- ------------------------------------
2002 2002 2003 2002 2002 2003
------------- ---------- -------- ------------- ---------- -------
(AS REPORTED) (RESTATED) (AS REPORTED) (RESTATED)
Net Income (Loss):
Net income (loss)
attributable to common
stock..................... $(8,550) $(8,550) $ 5,399 $(621,367) $(621,367) $(7,170)
Dividends on Series A
Convertible Preferred
Stock, net of forfeitures,
if assumed conversion is
dilutive.................. 234 -- -- 698 -- --
------- ------- -------- --------- --------- -------
Net income (loss) for basic
earnings (loss) per
share..................... (8,316) (8,550) 5,399 (620,669) (621,367) (7,170)
------- ------- -------- --------- --------- -------
Effect of convertible
subordinated notes under
the "if converted"
method -- interest expense
addback, net of taxes..... -- -- -- -- -- --
------- ------- -------- --------- --------- -------
Net income (loss) for diluted
earnings (loss) per
share..................... $(8,316) $(8,550) $ 5,399 $(620,669) $(621,367) $(7,170)
======= ======= ======== ========= ========= =======
Weighted Average Shares:
Weighted average shares
outstanding for basic
earnings (loss) per share,
including Series A
Convertible Preferred
Stock, if dilutive........ 77,552 60,808 116,567 76,941 60,964 112,484
Effect of dilutive stock
options................... 654 -- 78 1,243 -- --
Effect of convertible
subordinated notes under
the "if converted"
method -- weighted
convertible shares........ -- -- -- -- -- --
------- ------- -------- --------- --------- -------
Weighted average shares
outstanding for diluted
earnings (loss) per
share..................... 78,206 60,808 116,645 78,184 60,964 112,484
======= ======= ======== ========= ========= =======
</Table>
For the three and nine months ended September 30, 2002, approximately 9.3
million and 8.3 million stock options were excluded from the computation of
diluted earnings (loss) per share because the options' exercise prices were
greater than the average market price of Quanta's common stock. For the three
and nine months ended September 30, 2003, approximately 1.0 million and 1.4
million stock options were excluded from the computation of diluted earnings
(loss) per share because the options' exercise prices were greater than the
average market price of Quanta's common stock. For the three and nine months
ended September 30, 2002, Quanta excluded 72,762 and 270,020 stock options, with
exercise prices lower than the average
8
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
market price of Quanta's Common Stock, from the computation of diluted earnings
(loss) per share because the effect of including them would be antidilutive. For
the nine months ended September 30, 2003, Quanta excluded 9,237 stock options,
with exercise prices lower than the average market price of Quanta's Common
Stock, from the computation of diluted earnings (loss) per share because the
effect of including them would be antidilutive. For the three and nine months
ended September 30, 2002 and 2003, the effect of assuming conversion of the
convertible subordinated notes would be antidilutive and they were therefore
excluded from the calculation of diluted earnings (loss) per share.
Restatement -- The weighted average number of basic and dilutive shares and
the computation of basic and diluted earnings (loss) per share for the three and
nine months ended September 30, 2002, have been restated to conform to Quanta's
Amendment No. 1 on Form 10-K/A filed with the SEC on October 2, 2003. The
weighted average number of shares for the three and nine months ended September
30, 2002 were restated to exclude the shares issuable upon conversion of the
Series A Convertible Preferred Stock from the computation of basic and diluted
earnings (loss) per share, as the effect of including those shares was
antidilutive. The restatement of the weighted average number of shares results
in the restatement of basic and diluted earnings (loss) per share for the three
and nine months ended September 30, 2002 to $(0.14) and $(10.19) compared to the
originally reported earnings (loss) per share of $(0.11) and $(7.94). For the
nine months ended September 30, 2002, the restated basic and diluted earnings
(loss) per share before cumulative effect of change in accounting principle is
$(2.89) per share, compared to the originally reported amount of $(2.24) per
share and the restated basic and diluted earnings (loss) per share of the
cumulative effect of change in accounting principle is $(7.30) per share
compared to $(5.70) per share as originally reported.
3. INCOME TAXES
Quanta follows the liability method of accounting for income taxes in
accordance with SFAS No. 109, "Accounting for Income Taxes." Under this method,
deferred tax assets and liabilities are recorded for future tax consequences of
temporary differences between the financial reporting and tax bases of assets
and liabilities, and are measured using the enacted tax rates and laws that will
be in effect when the underlying assets or liabilities are recovered or settled.
4. NEW ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133. This statement is effective for contracts
entered into or modified after June 30, 2003 (with certain exceptions) and for
hedging relationships entered into after June 30, 2003. We do not have any
financial instruments that fall under the scope of this statement and do not
believe that the adoption of SFAS No. 149 will have a material effect on either
our financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. Financial
instruments that fall within the scope of SFAS No. 150 will be classified as
liabilities (or assets in some circumstances). This statement is effective at
the beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have a material impact on our results of
operations or financial position.
9
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. GOODWILL AND OTHER INTANGIBLES
Effective January 1, 2002, Quanta 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 Quanta'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 or more frequently if events or changes in
circumstances indicate that the asset might be impaired. 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), Quanta performs impairment tests
annually during the fourth quarter.
Based on Quanta's transitional impairment test performed upon adoption of
SFAS No. 142 during the nine months ended September 30, 2002, Quanta recognized
a $488.5 million non-cash charge, ($445.4 million, net of tax) to reduce the
carrying value of goodwill to the implied fair value of Quanta's reporting
units. Under SFAS No. 142, the impairment adjustment recognized upon adoption of
the new rules was reflected as a cumulative effect of change in accounting
principle, net of tax.
Quanta further recognized an interim non-cash goodwill impairment charge of
approximately $166.6 million during the nine months ended September 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 Quanta serves as evidenced by an increased number of bankruptcies in the
telecommunications industry, continued devaluation of several of Quanta's
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. Interim goodwill impairment assessments are
required whenever events or changes occur during the year that indicate that the
goodwill may not be recoverable.
Late in the second quarter of 2003, a dispute developed between one of
Quanta's subsidiaries and its primary customer, leading to a suspension of work
for that customer. It is unclear whether the dispute will be resolved favorably
or whether work for this customer will resume. If the dispute settles
unfavorably for the subsidiary or the subsidiary is unable to replace this work
with comparable cash flows, Quanta may record a non-cash goodwill impairment
charge of up to $6.5 million.
6. DEBT
Credit Facility
As of September 30, 2003, Quanta had a $225.0 million credit facility with
14 participating banks, which would have matured on June 14, 2004. The credit
facility was secured by a pledge of substantially all of the capital stock of
Quanta's subsidiaries and the majority of Quanta's assets and was to provide
funds to be used for working capital and for other general corporate purposes.
Quanta's subsidiaries guaranteed the repayment of all amounts due under the
facility and the facility restricted pledges on all material assets. 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 1.12% at September
30, 2003) plus 1.50% to 3.50%, as determined by the ratio of Quanta's total
funded debt to EBITDA (as defined in the credit facility) or (b) the bank's
prime rate (which was 4.0% at September 30, 2003) plus up to 2.00%, as
determined by the ratio of Quanta's total funded debt to EBITDA. Commitment fees
of 0.375% to 0.50%, based on Quanta's total funded debt to
10
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
EBITDA, were due on any unused borrowing capacity under the credit facility. The
credit facility contained certain financial ratio and indebtedness covenants,
including a maximum funded debt to EBITDA ratio, a minimum interest coverage
ratio and a maximum senior debt to EBITDA ratio. The credit facility also
prohibited the payment of dividends and stock repurchase programs and limited
capital expenditures and asset sales. Additionally the credit facility required
a mandatory reduction in the banks' commitment by a portion of the proceeds from
asset sales in excess of $5.0 million annually or upon the issuance of
additional debt in excess of $15.0 million. As of September 30, 2003, Quanta had
$90.7 million of letters of credit outstanding under the credit facility,
primarily to secure Quanta's potential obligations under its casualty insurance
programs.
In November 2003, Quanta amended its credit facility to convert it into a
fully funded term loan of $60.0 million and a letter of credit facility of up to
$120.0 million with one bank, maturing on January 1, 2005. The term loan was
used to repay a portion of the senior secured notes, discussed below. Amounts
borrowed under the term loan bear interest at a rate equal to LIBOR plus 3.25%.
The credit facility as amended is secured by a pledge of substantially all of
the capital stock of Quanta's subsidiaries and the majority of Quanta's assets.
Quanta's U.S. subsidiaries guarantee the repayment of all amounts due under the
facility and the facility restricts pledges on all material assets. The facility
contains certain financial ratio and indebtedness covenants, including a maximum
funded debt to EBITDA ratio, a minimum interest coverage ratio and a maximum
senior debt to EBITDA ratio, that are generally less restrictive than those in
existence prior to amendment. The facility also prohibits the payment of
dividends and stock repurchase programs and limits capital expenditures and
asset sales. The facility requires cash collateralization of all letters of
credit, and Quanta has collateralized the $90.7 million in letters of credit
that were outstanding as of September 30, 2003. As a result of the amendment,
$1.1 million in unamortized deferred financing costs will be expensed during the
fourth quarter of 2003.
Quanta currently has a commitment from a lender for a new $200.0 million
credit facility, subject to certain conditions precedent. Quanta anticipates
closing the new credit facility in the fourth quarter of 2003 and plans to pay
off the above discussed term loan and letter of credit facility with the
proceeds of the new facility.
4.0% Convertible Subordinated Notes
During the third quarter of 2000, Quanta issued $172.5 million principal
amount of convertible subordinated notes. These convertible subordinated notes
bear interest at 4.0% per year and are convertible into shares of Quanta's
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 beginning December 31, 2000, until the notes mature on July 1,
2007. Quanta has the option to redeem the notes beginning July 3, 2003 at
specified redemption prices, together with accrued and unpaid interest; however
redemption is prohibited by Quanta's credit facility as amended. If certain
fundamental changes occur, as described in the indenture under which Quanta
issued the notes, holders of the convertible subordinated notes may require
Quanta to purchase all or part of the notes at a purchase price equal to 100% of
the principal amount, plus accrued and unpaid interest. In the event of such
circumstance, consent to repurchase the convertible subordinated notes would be
required under Quanta's credit facility as amended.
4.5% Convertible Subordinated Notes
In October 2003, Quanta issued $270.0 million principal amount of
convertible subordinated notes. Quanta used the net proceeds to repay a portion
of the senior secured notes, discussed below, and to cash collateralize the
letters of credit under the credit facility as amended. These convertible
subordinated notes bear interest at 4.5% per year and are convertible into
shares of Quanta's common stock at a price of
11
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$11.14 per share, subject to adjustment as a result of certain events. The
convertible subordinated notes require semi-annual interest payments beginning
April 1, 2004, until the notes mature on October 1, 2023.
The convertible subordinated notes are convertible by the holder if (i)
during any fiscal quarter commencing after December 31, 2003 the last reported
sale price of Quanta's common stock is greater than or equal to 120% of the
conversion price for at least 20 trading days in the period of 30 consecutive
trading days ending on the first trading day of such fiscal quarter, (ii) during
the five business day period after any five consecutive trading day period in
which the trading price per note for each day of that period was less than 98%
of the product of the last reported sale price of Quanta's common stock and the
conversion rate, (iii) upon Quanta calling the notes for redemption or (iv) upon
the occurrence of specified corporate transactions. If the notes become
convertible under one of these circumstances, Quanta has the option to deliver
cash, shares of Quanta's common stock or a combination thereof, with a value
equal to the par value of the notes divided by the conversion price multiplied
by the average trading price of Quanta's common stock. The maximum number of
shares of common stock that could be issued under these circumstances is equal
to the par value of the notes divided by the conversion price.
Beginning October 8, 2008, Quanta may redeem for cash some or all of the
notes at par value plus accrued and unpaid interest. The holders of the notes
may require Quanta to repurchase all or some of the notes at par value plus
accrued and unpaid interest on October 1, 2008, 2013 or 2018, or upon the
occurrence of a fundamental change, as defined by the indenture under which
Quanta issued the notes. Any repurchases on October 1, 2008 must be paid in
cash, and for all other repurchases, Quanta has the option of settling with
cash, shares of Quanta's common stock or a combination thereof. If Quanta elects
to settle with shares of common stock, the number of shares delivered will equal
the dollar amount to be paid in common stock divided by 98.5% of the market
price of Quanta's common stock, as defined by the indenture. The number of
shares to be issued under this circumstance is not limited. The right to settle
for shares of common stock can be surrendered by Quanta.
Senior Secured Notes
As of September 30, 2003, Quanta had $210.0 million principal amount of
senior secured notes outstanding, primarily with insurance companies, with
maturities currently ranging from March 2005 to September 2010. The senior
secured notes bore interest at a weighted average interest rate between 8.41%
and 9.91% as determined by the ratio of Quanta's total funded debt to EBITDA.
The weighted average interest rate as of September 30, 2003 was 9.91%. In
addition, the senior secured notes carried a make-whole provision customary for
this type of debt instrument on prepayment of principal, including any mandatory
prepayments. The senior secured notes carried cross-default provisions and
ranked equally in right of repayment with indebtedness under Quanta's then
existing credit facility.
In the fourth quarter of 2003, Quanta retired the $210.0 million of senior
secured notes and paid associated make-whole prepayment premiums in the amount
of $31.3 million. The make-whole prepayment premiums, along with the related
unamortized deferred financing costs in the amount of approximately $2.6
million, will be expensed in the fourth quarter of 2003.
7. STOCKHOLDERS' EQUITY
Series A Convertible Preferred Stock
In September 1999, Quanta issued shares of Series A Convertible Preferred
Stock, $.00001 par value per share. All outstanding shares of Series A
Convertible Preferred Stock remaining were converted into common stock during
the first quarter of 2003 and the series was eliminated during the second
quarter of 2003.
12
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
First Reserve Investment
During the fourth quarter of 2002, First Reserve Fund IX, L.P. (First
Reserve) purchased from Quanta approximately 2.4 million shares of newly issued
Series E Preferred Stock at $30.00 per share. The Series E Preferred Stock was
converted into 24.3 million shares of common stock on December 31, 2002 and the
series was eliminated during the second quarter of 2003.
Through February 20, 2003, First Reserve had the right to require Quanta to
repurchase for cash the shares of common stock issued as a result of the
conversion of the shares of Series E Preferred Stock if Quanta had a change in
control. As such, the $72.9 million investment was reflected in the consolidated
balance sheet as Redeemable Common Stock at December 31, 2002. On February 20,
2003, at the expiration of this right, the Redeemable Common Stock was
reclassified to stockholders' equity.
In connection with their investment, First Reserve is entitled to a
pre-emptive right to purchase shares of common stock upon Quanta's issuance of
shares to third parties. During the first nine months of 2003, First Reserve
acquired 1,201,128 shares pursuant to such right.
Restricted Stock
Pursuant to the 2001 Stock Incentive Plan, Quanta issues restricted common
stock at the fair market value of the common stock as of the date of issuance.
The shares of restricted 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 common stock, an
unamortized compensation expense equivalent to the market value of the shares on
the date of grant is charged to stockholders' equity and is amortized over the
restriction period, typically three years.
On January 21, 2003, Quanta offered eligible employees and consultants the
opportunity to exchange certain outstanding stock options, with an exercise
price of $10.00 or more, for restricted shares of Quanta's common stock at an
exchange ratio of one share of restricted stock for every 2.24 option shares
tendered. As restricted stock, the shares are subject to forfeiture and other
restrictions until they vest. Regardless of the vesting schedule of the eligible
options offered for exchange, the restricted stock granted in the offer vests
over three years in equal annual installments on February 28 of each year,
beginning February 28, 2004, assuming the employee or consultant continues to
meet the requirements for vesting. On March 10, 2003, Quanta accepted for
exchange and canceled eligible options to purchase an aggregate of 6,769,483
shares of its common stock, representing approximately 93% of the 7,289,750
options that were eligible to be tendered in the offer as of the expiration
date. Pursuant to the terms of the offer, Quanta granted restricted stock
representing an aggregate of 3,022,112 shares of its common stock, or
approximately $9.0 million in value, in exchange for the tendered eligible
options. This restricted stock issuance will require Quanta to recognize a
non-cash compensation charge of approximately $3.0 million per year over the
three-year vesting period of the restricted stock. The remaining eligible
options that were not exchanged will be required to be accounted for under
variable plan accounting under APB Opinion No. 25. In the future, to the extent
that Quanta's stock price exceeds the exercise price of an eligible option that
was not exchanged, the difference will be recorded as a non-cash compensation
charge with an offset to additional paid-in capital. No charges have been
recorded with respect to these options under variable plan accounting through
September 30, 2003.
As of September 30, 2002 and 2003, 63,614 and 3,229,262 shares of
restricted stock were outstanding. The compensation expense recognized with
respect to all restricted stock during the three and nine months ended September
30, 2002 was approximately $62,000 and $187,500, and for the three and nine
months ended September 30, 2003 was approximately $839,000 and $1,923,000.
13
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. SEGMENT INFORMATION
Quanta has aggregated each of its individual operating units into one
reportable segment as a specialty contractor. Quanta provides comprehensive
network solutions to the electric power, gas, telecommunications and cable
television industries, including designing, installing, repairing and
maintaining network infrastructure. In addition, Quanta provides ancillary
services such as inside electrical wiring, intelligent traffic networks, cable
and control systems for light rail lines, airports and highways, and specialty
rock trenching, directional boring and road milling for industrial and
commercial customers. The following table presents information regarding
revenues derived from the industries noted above. Certain reclassifications have
been made to the prior period in order to conform to the current period
presentation.
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2002 2003
---------- ----------
(IN THOUSANDS)
Electric power and gas network services..................... $ 714,333 $ 736,631
Telecommunications network services......................... 224,053 180,523
Cable television network services........................... 160,791 84,809
Ancillary services.......................................... 218,780 209,601
---------- ----------
$1,317,957 $1,211,564
========== ==========
</Table>
Quanta currently does not have significant operations or long-lived assets
in countries outside of the United States.
9. COMMITMENTS AND CONTINGENCIES
Litigation
Quanta is from time to time party to various lawsuits, claims and other
legal proceedings that arise in the ordinary course of business. These actions
typically seek, among other things, compensation for alleged personal injury,
breach of contract, property damage, punitive damages, civil penalties or other
losses, or injunctive or declaratory relief. With respect to such lawsuits,
claims and proceedings, Quanta establishes reserves when it is probable a
liability has been incurred and the amount of loss can be reasonably estimated.
Quanta does not believe that any of these proceedings, separately or in the
aggregate, would be expected to have a material adverse effect on Quanta's
results of operations or financial position.
Self-Insurance
As of September 30, 2003, Quanta was insured for employer's liability and
general liability claims, subject to a deductible of $1,000,000 per occurrence
and for auto liability and workers' compensation, subject to a deductible of
$2,000,000 per occurrence. Quanta's consolidated non-union employee related
health care benefits plan is subject to a deductible of $250,000 per claimant
per year. Losses up to the deductible amounts under all plans are accrued based
upon Quanta'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, 2002 and September 30, 2003, the amounts accrued for
self-insured claims were $45.0 million and $60.4 million, with $27.4 million and
$34.4 million considered to be long-term and included in Other Non-Current
Liabilities.
Quanta is contractually obligated to fund its casualty self-insurance
obligations applicable to the policy period from March 1, 2003 to February 29,
2004 with a combination of a cash trust account of $14.4 million and letters of
credit totaling $24.4 million. Through September 30, 2003, Quanta had funded the
cash trust account with $10.8 million and issued $18.6 million in letters of
credit pursuant to the policy period from
14
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
March 1, 2003 to February 29, 2004. As of September 30, 2003, the remaining
restricted cash balance totaled $8.4 million, with $4.6 million classified as
current and included in Prepaid Expenses and Other Current Assets and $3.8
million classified as non-current and included in Other Assets, Net.
Performance Bonds
In certain circumstances, Quanta is required to provide performance bonds
in connection with its contractual commitments. Quanta has indemnified the
surety for any expenses paid out under these performance bonds. As of September
30, 2003, the total amount of outstanding performance bonds was approximately
$515.6 million.
Leases
Quanta leases certain buildings and equipment under non-cancelable lease
agreements including related party leases. The following schedule shows the
future minimum lease payments under these leases as of September 30, 2003 (in
thousands):
<Table>
<Caption>
CAPITAL OPERATING
LEASES LEASES
------- ---------
Year Ending December 31 --
2003........................................................ $ 45 $ 4,880
2004........................................................ 103 14,734
2005........................................................ 4 10,421
2006........................................................ -- 5,304
2007........................................................ -- 2,309
Thereafter.................................................. -- 4,483
---- -------
Total minimum lease payments...................... $152 $42,131
==== =======
Less -- Amounts representing interest..................... 2
----
Present value of minimum lease payments................... 150
Less -- Current portion................................... 45
----
Total long-term obligations............................... $105
====
</Table>
Quanta has guaranteed a residual value on certain equipment operating
leases. Quanta guarantees the difference between this residual value and the
fair market value of the underlying asset at the date of termination of the
leases. At September 30, 2003, the maximum guaranteed residual value would have
been approximately $121.8 million. Quanta believes that no significant payments
will be made as a result of the difference between the fair market value of the
leased equipment and the guaranteed residual value. However, there can be no
assurance that future significant payments will not be required.
Contingent Payments
Quanta 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 or losses on certain projects, the collection of
the underlying receivables and the result of pending litigation. Quanta may be
required to make additional payments to such former owners with a combination of
common stock and cash. At September 30, 2003, the amount of additional payments
could equal up to $15.5 million, depending on the contingencies outlined above.
This amount may be adjusted significantly higher or lower over the term of the
agreement.
15
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Employment Agreements
Quanta has entered into various employment agreements with certain
executives which provide for compensation and certain other benefits and for
severance payments under certain circumstances. In addition, certain employment
agreements contain clauses which become effective upon a change of control of
Quanta. Upon any of the defined events in the various employment agreements,
Quanta will pay certain amounts to the employee, which vary with the level of
the employee's responsibility.
Collective Bargaining Agreements
Certain of the subsidiaries are party to various collective bargaining
agreements with certain of their employees. The agreements require such
subsidiaries to pay specified wages and provide certain benefits to their union
employees. These agreements expire at various times.
Other
Quanta is subject to audit by tax authorities for varying periods in
various federal, state and local foreign tax jurisdictions. Disputes arise
during the course of such audits as to facts and matters of law.
Quanta has indemnified various parties against specified liabilities that
those parties might incur in the future in connection with companies previously
acquired or disposed of by Quanta. These indemnities usually are contingent upon
the other party incurring liabilities that reach specified thresholds. As of
September 30, 2003, Quanta is not aware of circumstances that would lead to
future indemnity claims against it for material amounts in connection with these
transactions.
16
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 March 31, 2003, as amended by Amendment No. 1
thereto on Form 10-K/A which was filed on October 2, 2003 and 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 or cost-plus 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 higher margins on our
labor-intensive projects. Operating margins could be impacted by fluctuations in
insurance accruals related to our deductibles in the period in which such
adjustments are made. As of September 30, 2003, we had a deductible of
$1,000,000 per occurrence related to employer's liability and general liability
claims and a deductible of $2,000,000 per occurrence for automobile liability
and workers' compensation insurance. We also have a non-union employee related
health care benefit plan that is subject to a deductible of $250,000 per
claimant per year.
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.
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 United States. Typically, we experience lower gross and operating margins
during the winter months due to lower demand for our services and more difficult
operating conditions. The financial condition of our
17
customers and their access to capital, variations in the margins of projects
performed during any particular quarter, the timing and magnitude of acquisition
assimilation costs, regional economic conditions and timing of acquisitions 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.
SIGNIFICANT BALANCE SHEET CHANGES
Total assets increased $22.5 million as of September 30, 2003 compared to
December 31, 2002. These fluctuations were primarily due to the following:
- Cash increased $49.9 million primarily due to the receipt of a $38.2
million income tax refund in the second quarter of 2003, and the receipt
of $7.1 million associated with the issuance of common stock.
- Accounts receivable increased $21.6 million primarily due to a higher
proportion of revenues for the third quarter being earned in the last
month of the quarter.
- Current deferred taxes decreased $22.2 million due to certain items that
we deducted for tax purposes in the 2002 tax return, which were
originally not expected to be deducted in 2002.
- Prepaid expenses and other current assets increased $8.2 million due to
the funding of a cash trust account for the current portion of
self-insurance claims liability in the amount of $4.6 million and to a
net change in prepayments for insurance policy renewals in the amount of
$4.9 million, partially offset by monthly amortization of various prepaid
balances.
- Property and equipment, net decreased $23.5 million due to depreciation
expense of $44.6 million recorded during the period and $2.9 million for
the sale of equipment that was no longer being used by certain of our
subsidiaries, partially offset by increases as a result of capital
expenditures of $23.9 million.
- Accounts and notes receivable, net decreased $15.2 million primarily due
to additional allowances recorded during the nine months ended September
30, 2003.
- Other assets, net increased $5.2 million primarily due to the funding of
a cash trust account for self-insurance in the amount of $3.8 million.
As of September 30, 2003, total liabilities increased approximately $20.2
million, redeemable common stock decreased $72.9 million and stockholders'
equity increased approximately $75.1 million compared to December 31, 2002.
These fluctuations were primarily due to the following:
- Deferred income taxes and other non-current liabilities increased $20.1
million as a result of the recording of $13.7 million in additional
long-term deferred tax liabilities due to increased differences between
the book and tax bases of certain of our assets and an increase of $7.0
million in the long-term portion of our self-insurance reserves.
- Redeemable common stock decreased $72.9 million. On December 20, 2002,
First Reserve purchased from us approximately 2.4 million shares of newly
issued Series E Preferred Stock at $30.00 per share, for an investment of
approximately $72.9 million. The shares of Series E Preferred Stock were
converted into 24.3 million shares of common stock on December 31, 2002.
Through February 20, 2003, First Reserve had the right to require us to
repurchase for cash the shares of common stock issued as a result of the
conversion of the shares of Series E Preferred Stock if we had a change
in control. As such, the investment had been reflected in the
consolidated balance sheet as redeemable common stock at December 31,
2002. On February 20, 2003, at the expiration of the right, the
redeemable common stock was reclassified to stockholders' equity.
- Stockholders' equity increased $75.1 million primarily due to the
reclassification of redeemable common stock of $72.9 million to
stockholders' equity, the issuance of approximately $3.5 million of
common stock pursuant to our Employee Stock Purchase Plan, the issuance
of approximately $3.6 million of common stock pursuant to First Reserve's
exercise of their preemptive rights and the
18
net effect of restricted stock in the amount of $1.6 million. These
increases were partially offset by a net loss attributable to common
stock of $7.2 million.
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 SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------- ---------------------------------------
2002 2003 2002 2003
---------------- ---------------- ------------------ ------------------
(DOLLARS IN THOUSANDS)
Revenues........................ $436,215 100.0% $436,133 100.0% $1,317,957 100.0% $1,211,564 100.0%
Cost of services (including
depreciation)................. 381,947 87.6 381,125 87.4 1,139,842 86.5 1,065,281 87.9
-------- ----- -------- ----- ---------- ----- ---------- -----
Gross profit.............. 54,268 12.4 55,008 12.6 178,115 13.5 146,283 12.1
Selling, general and
administrative expenses....... 68,747 15.7 38,886 8.9 178,956 13.6 135,963 11.2
Goodwill impairment............. -- -- -- -- 166,580 12.6 -- --
-------- ----- -------- ----- ---------- ----- ---------- -----
Income (loss) from
operations............. (14,479) (3.3) 16,122 3.7 (167,421) (12.7) 10,320 0.9
Interest expense................ (9,807) (2.2) (8,080) (1.8) (25,696) (1.9) (24,182) (2.0)
Other income, net............... (1,674) (0.4) 182 -- (56) -- 72 --
-------- ----- -------- ----- ---------- ----- ---------- -----
Income (loss) before income tax
provision (benefit) and
cumulative effect of change in
accounting principle.......... (25,960) (5.9) 8,224 1.9 (193,173) (14.6) (13,790) (1.1)
Provision (benefit) for income
Taxes......................... (17,644) (4.0) 2,825 0.7 (17,926) (1.3) (4,511) (0.3)
-------- ----- -------- ----- ---------- ----- ---------- -----
Income (loss) before cumulative
effect of change in accounting
principle..................... (8,316) (1.9) 5,399 1.2 (175,247) (13.3) (9,279) (0.8)
Cumulative effect of change in
accounting principle, net of
tax........................... -- -- -- -- 445,422 33.8 -- --
-------- ----- -------- ----- ---------- ----- ---------- -----
Net income (loss)............. (8,316) (1.9) 5,399 1.2 (620,669) (47.1) (9,279) (0.8)
Dividends on preferred stock,
net of forfeitures............ 234 -- -- -- 698 0.1 (2,109) (0.2)
-------- ----- -------- ----- ---------- ----- ---------- -----
Net income (loss) attributable
to common stock............. $ (8,550) (1.9)% $ 5,399 1.2% $ (621,367) (47.2)% $ (7,170) (0.6)%
======== ===== ======== ===== ========== ===== ========== =====
</Table>
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003, COMPARED TO THE THREE AND NINE
MONTHS ENDED SEPTEMBER 30, 2002
Revenues. Revenues did not vary significantly from period to period for
the three months ended September 30, 2003. Revenues decreased $106.4 million to
$1.21 billion, or 8.1%, for the nine months ended September 30, 2003, with
revenues derived from the cable television network services industry decreasing
by approximately $76.0 million, revenues from the telecommunications network
services industry decreasing by approximately $43.5 million and revenues from
ancillary services decreasing approximately $9.2 million. These decreases were
partially offset by increases in revenues derived from the electric power and
gas network services industry of approximately $22.3 million. The overall
decrease was due to the continued decrease in capital spending by our customers,
the inability of certain of these customers to raise new capital, and the
continued downturn in the national economy, which have negatively impacted the
award of work to specialty contractors. Pricing pressures have also contributed
to lower revenues as the competitive bid environment has tightened.
19
Gross profit. Gross profit increased $0.7 million, or 1.4%, to $55.0
million for the three months ended September 30, 2003; as a percentage of
revenues, gross margin did not vary significantly from period to period. Gross
profit decreased $31.8 million, or 17.9%, to $146.3 million for the nine months
ended September 30, 2003. As a percentage of revenue, gross margin decreased
from 13.5% for the nine months ended September 30, 2002 to 12.1% for the nine
months ended September 30, 2003. The decrease in gross margin was attributable
to shutdowns, delays and substantial operating inefficiencies resulting from
severe snowfall in the Northeast and Mountain regions of the United States
during the first quarter of 2003, substantially higher than normal rainfall
amounts in the South and Southeast during the first and second quarters of 2003
and negative impacts due to the economic factors and pricing pressures noted
above, partially offset by increased margins on telecommunications revenues
during the second quarter of 2003.
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased $29.9 million, or 43.4%, to $38.9 million for
the three months ended September 30, 2003. During the three months ended
September 30, 2002, we recorded $25.7 million in bad debt expense compared to
$0.5 million during the three months ended September 30, 2003. Absent bad debt
expense, selling, general and administrative expenses for the three months ended
September 30, 2003 decreased $4.7 million primarily due to reductions in salary
and benefit costs, facility related costs and travel and entertainment costs as
a result of reductions in personnel and the closure of certain offices. Selling,
general and administrative expenses decreased $43.0 million, or 24.0%, to $136.0
million for the nine months ended September 30, 2003. During the nine months
ended September 30, 2002, we recorded $34.3 million in bad debt expense and
proxy defense costs in the amount of $10.5 million. During the nine months ended
September 30, 2003, we recorded $19.8 million in bad debt expense. Absent these
items, selling, general and administrative expenses for the nine months ended
September 30, 2003 decreased $18.0 million primarily due to reductions in salary
and benefit costs, facility related costs and travel and entertainment costs as
a result of reductions in personnel and the closure of certain offices.
Goodwill impairment. During the nine months ended September 30, 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. We did not recognize an interim
non-cash goodwill impairment charge during the nine months ended September 30,
2003.
Interest expense. Interest expense decreased $1.7 million, or 17.6%, to
$8.1 million for the three months ended September 30, 2003. This decrease was
due to lower levels of debt in 2003, partially offset by increased interest
rates. Interest expense decreased $1.5 million, or 5.9%, to $24.2 million for
the nine months ended September 30, 2003, also due to lower levels of debt in
2003, partially offset by increased interest rates.
Provision (benefit) for income taxes. The provision for income taxes was
$2.8 million for the three months ended September 30, 2003, with an effective
tax rate of 34.4%, compared to a benefit of $17.6 million for the three months
ended September 30, 2002, with an effective tax rate of 68.0%. The benefit for
income taxes was $4.5 million for the nine months ended September 30, 2003, with
an effective tax rate of 32.7%, compared to a benefit of $17.9 million, with an
effective tax rate of 9.3% for the nine months ended September 30, 2002. The
2003 estimated annual effective tax rate reflects a benefit for income taxes at
a rate that is lower than the combined federal and blended state tax rate due to
tax expense on permanent differences. The tax rates in 2002 reflect the
recording of 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 in
2002, 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 nine months ended September 30, 2002.
Dividends on preferred stock, net of forfeitures. For the nine months
ended September 30, 2003, we recorded approximately $2.1 million in forfeitures
of dividends on the Series A Convertible Preferred Stock.
20
During the first quarter of 2003, all outstanding shares of Series A Convertible
Preferred Stock were converted into shares of common stock and the series was
eliminated during the second quarter of 2003. Any dividends that had accrued on
the respective shares of Series A Convertible Preferred Stock were reversed on
the date of conversion.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2003, we had cash and cash equivalents of $77.8
million, working capital of $371.8 million and long-term debt of $384.0 million,
net of current maturities. Our long-term debt balance at that date included
borrowings of $210.0 million of senior secured notes, $1.5 million of other debt
and $172.5 million of convertible subordinated notes.
During the nine months ended September 30, 2003, operating activities
provided net cash flow of $76.7 million after considering $45.1 million in
depreciation and amortization, $19.8 million for provision for doubtful accounts
and $35.9 million for deferred income taxes. We used net cash in investing
activities of $30.5 million, including $23.9 million used for capital
expenditures and $8.4 million used to fund a cash trust account for our
self-insurance. Financing activities provided net cash flow of $3.6 million,
resulting primarily from approximately $3.5 million from the issuance of stock
under the Employee Stock Purchase Plan (ESPP) and approximately $3.6 million for
shares of common stock sold pursuant to First Reserve's exercise of their
preemptive rights, partially offset by $3.1 million of net repayments of other
long-term debt and $0.3 million of debt issuance costs.
As of September 30, 2003, we had a $225.0 million credit facility with 14
participating banks, which would have matured on June 14, 2004. The credit
facility was secured by a pledge of substantially all of the capital stock of
our subsidiaries and the majority of our assets and was to provide funds to be
used for working capital and for other general corporate purposes. Our
subsidiaries guaranteed the repayment of all amounts due under the facility and
the facility restricted pledges on all material assets. Amounts borrowed under
the credit facility bore 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 (as
defined by the credit facility) 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, were due on any
unused borrowing capacity under the credit facility. The credit facility
contained certain financial ratio and indebtedness covenants, including a
maximum funded debt to EBITDA ratio, a minimum interest coverage ratio and a
maximum senior debt to EBITDA ratio. The credit facility also prohibited the
payment of dividends and stock repurchase programs and limited capital
expenditures and asset sales. Additionally the credit facility required a
mandatory reduction in the banks' commitment by a portion of the proceeds from
asset sales in excess of $5.0 million annually or upon the issuance of
additional debt in excess of $15.0 million. As of September 30, 2003, we had
$90.7 million of letters of credit outstanding under the credit facility,
primarily to secure our potential obligations under the casualty insurance
programs.
In November 2003, we amended our credit facility to convert it into a fully
funded term loan of $60.0 million and a letter of credit facility of up to
$120.0 million with one bank, maturing on January 1, 2005. The term loan was
used to repay a portion of the senior secured notes, discussed below. Amounts
borrowed under the term loan bear interest at a rate equal to LIBOR plus 3.25%.
The credit facility as amended is secured by a pledge of substantially all of
the capital stock of our subsidiaries and the majority of our assets. Our U.S.
subsidiaries guarantee the repayment of all amounts due under the facility and
the facility restricts pledges on all material assets. The facility contains
certain financial ratio and indebtedness covenants including a maximum funded
debt to EBITDA ratio, a minimum interest coverage ratio and a maximum senior
debt to EBITDA ratio, that are generally less restrictive than those in
existence prior to amendment. The facility also prohibits the payment of
dividends and stock repurchase programs and limits capital expenditures and
asset sales. The facility requires cash collateralization of all letters of
credit, and we have collateralized the $90.7 million in letters of credit that
were outstanding as of September 30, 2003. As a result of the amendment, $1.1
million in unamortized deferred financing costs will be expensed into interest
expense during the fourth quarter of 2003.
21
We currently have a commitment from a lender for a new $200.0 million
credit facility, subject to certain conditions precedent. We anticipate closing
the new credit facility in the fourth quarter of 2003 and plan to pay off the
above discussed term loan and letter of credit facility with the proceeds of the
new facility.
As of September 30, 2003, we had $172.5 million in convertible subordinated
notes outstanding. These convertible subordinated notes 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. These
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; however, redemption is
prohibited by our credit facility as amended. 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
principal amount, plus accrued and unpaid interest. In the event of such
circumstance, consent to repurchase the convertible subordinated notes would be
required under our credit facility as amended.
In October 2003, we issued $270.0 million principal amount of convertible
subordinated notes. These convertible subordinated notes bear interest at 4.5%
per year and are convertible into shares of Quanta's common stock at a price of
$11.14 per share, subject to adjustment as a result of certain events. We used
the net proceeds to repay a portion of the senior secured notes, discussed
below, and to cash collateralize the letters of credit under the credit facility
as amended. The convertible subordinated notes require semi-annual interest
payments beginning April 1, 2004, until the notes mature on October 1, 2023.
The 4.5% convertible subordinated notes are convertible by the holder if
(i) during any fiscal quarter commencing after December 31, 2003 the last
reported sale price of our common stock is greater than or equal to 120% of the
conversion price for at least 20 trading days in the period of 30 consecutive
trading days ending on the first trading day of such fiscal quarter, (ii) during
the five business day period after any five consecutive trading day period in
which the trading price per note for each day of that period was less than 98%
of the product of the last reported sale price of our common stock and the
conversion rate, (iii) upon us calling the notes for redemption or (iv) upon the
occurrence of specified corporate transactions. If the notes become convertible
under one of these circumstances, we have the option to deliver cash, shares of
our common stock or a combination thereof, with a valve equal to the par value
of the notes divided by the conversion price multiplied by the average trading
price of our common stock. The maximum number of shares of common stock that
could be issued under these circumstances is equal to the par value of the notes
divided by the conversion price.
Beginning October 8, 2008, we may redeem for cash some or all of the 4.5%
convertible subordinated notes at par value plus accrued and unpaid interest.
The holders of the notes may require us to repurchase some or all of the notes
at par value plus accrued and unpaid interest on October 1, 2008, 2013, or 2018,
or upon the occurrence of a fundamental change, as defined by the indenture
under which we issued the notes. Any repurchases on October 1, 2008 must be paid
in cash, and for all other repurchases, we have the option of settling with
cash, shares of our common stock or a combination thereof. If we elect to settle
with shares of common stock, the number of shares delivered will equal the
dollar amount to be paid in common stock divided by 98.5% of the market price of
our common stock, as defined by the indenture. The number of shares to be issued
under this circumstance is not limited. The right to settle for shares of common
stock can be surrendered by us.
As of September 30, 2003, we had $210.0 million principal amount of senior
secured notes outstanding, primarily with insurance companies, with maturities
currently ranging from March 2005 to September 2010. The senior secured notes
bore interest at a weighted average interest rate between 8.41% and 9.91% as
determined by the ratio of our total funded debt to EBITDA. The weighted average
interest rate as of September 30, 2003 was 9.91%. In addition, the senior
secured notes carried a make-whole provision customary for this type of debt
instrument on prepayment of principal, including any mandatory prepayments. The
senior secured notes carried cross-default provisions and ranked equally in
right of repayment with indebtedness under our then existing credit facility.
22
In the fourth quarter of 2003, we retired the $210.0 million of senior
secured notes and paid associated make-whole prepayment premiums in the amount
of $31.3 million. The make-whole prepayment premiums, along with related
unamortized deferred financing costs in the amount of approximately $2.6
million, will be expensed in the fourth quarter of 2003.
On December 20, 2002, First Reserve purchased from us approximately 2.4
million shares of newly issued Series E Preferred Stock at $30.00 per share, for
an investment of approximately $72.9 million. The Series E Preferred Stock was
converted into 24.3 million shares of common stock on December 31, 2002 and the
series was eliminated during the second quarter of 2003. Through February 20,
2003, First Reserve had the right to require us to repurchase for cash the
shares of common stock issued as a result of the conversion of the shares of
Series E Preferred Stock if we had a change in control. As such, the investment
was reflected in the consolidated balance sheet as redeemable common stock at
December 31, 2002. On February 20, 2003, at the expiration of this right, the
redeemable common stock was reclassified to stockholders' equity.
During the first quarter of 2003, all outstanding shares of Series A
Convertible Preferred Stock were converted into shares of common stock and the
series was eliminated during the second quarter of 2003. Dividends of $2.3
million that had accrued on the shares of Series A Convertible Preferred Stock,
which included $0.2 million accrued during the first quarter of 2003, were
reversed on the date of the conversion.
As of November 12, 2003, after considering the refinancing transactions
discussed above, we have approximately $63 million in unrestricted cash. We
anticipate that our cash on hand and cash flow from operations 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, material changes in our customers' revenues or cash flows or adverse
weather conditions may negatively impact our revenues and cash flows and the
ability to meet such needs.
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, in which case we are typically liable to the lessor for the remaining
lease payments under the term of the lease.
We have guaranteed a residual value on certain equipment operating leases.
We guarantee the difference between this residual value and the fair market
value of the underlying asset at the date of termination of the leases. At
September 30, 2003, the maximum guaranteed residual value would have been
approximately $121.8 million. We believe that no significant payments will be
made as a result of the difference between the fair market value of the leased
equipment and the guaranteed residual value. However, there can be no assurance
that future significant payments will not be required.
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 our behalf,
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
23
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.
As of September 30, 2003, we had $90.7 million in letters of credit
outstanding under our credit facility primarily to secure obligations under our
casualty insurance program. These are irrevocable stand-by letters of credit
with maturities expiring at various times throughout 2003 and 2004. Upon
maturity, it is expected that the majority of these letters of credit will be
renewed for subsequent one-year periods. The credit facility as amended requires
cash collateralization of all letters of credit, and we have collateralized the
$90.7 million in letters of credit that were outstanding as of September 30,
2003.
We are contractually obligated to fund our casualty self-insurance
obligations applicable to the policy period from March 1, 2003 to February 29,
2004 with a combination of a cash trust account of $14.4 million and letters of
credit totaling $24.4 million. Through September 30, 2003, we had funded the
cash trust account with $10.8 million and issued $18.6 million in letters of
credit pursuant to the policy period from March 1, 2003 to February 29, 2004.
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 claims under our surety arrangements in the foreseeable future. As
of September 30, 2003, the total amount of outstanding performance bonds was
approximately $515.6 million.
As of September 30, 2003, our future contractual obligations, including
interest under capital leases, were as follows (in thousands):
<Table>
<Caption>
TOTAL 2003 2004 2005 2006 2007 THEREAFTER
-------- ------ ------- -------- ------ -------- ----------
Long-term debt obligations
including capital leases..... $389,181 $3,399 $ 2,200 $103,802 $5,263 $214,017 $60,500
Operating lease obligations.... $ 42,131 $4,880 $14,734 $ 10,421 $5,304 $ 2,309 $ 4,483
</Table>
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, and builders, owners and managers of commercial and
industrial properties located primarily in the United States. Consequently, we
are subject to potential credit risk related to changes in business and economic
factors throughout the United States. However, we generally have certain lien
rights on our services provided. Under certain circumstances, such as
foreclosures or negotiated settlements, we may take title to the underlying
assets in lieu of cash in settlement of receivables. As previously discussed
herein, our customers in the telecommunications business have experienced
significant financial difficulties and in several instances have filed for
bankruptcy. A number of our utility customers are also experiencing business
challenges in the current business climate. These economic conditions expose us
to increased risk related to collectibility of receivables for services we have
performed.
In June 2002, a large customer, Adelphia Communications Corporation
(Adelphia), filed for bankruptcy protection under Chapter 11 of the Bankruptcy
Code, as amended. We have filed liens on various properties to secure
substantially all of our pre-petition receivables. Our carrying value is based
upon our understanding of the current status of the Adelphia bankruptcy
proceeding and a number of assumptions, including assumptions about the
validity, priority and enforceability of our security interests. We currently
believe we will collect a substantial majority of the balances owed. Should any
of the factors underlying our estimate change, the amount of our allowance could
change significantly. We are uncertain as to whether such receivables will be
collected within one year and therefore have included this amount in non-current
assets as Accounts and Notes Receivable as of June 30, 2003. Also included in
non-current Accounts and Notes Receivable are amounts due from another customer
relating to the construction of independent power plants. We have agreed
24
to long-term payment terms for this customer. The notes receivable are partially
secured and bear interest at 9.5% per year. We have provided allowances for
these notes receivable due to a substantial deterioration in the estimated
future cash flows of the plants, resulting in a carrying value equal to the
estimated value of the collateral securing these notes. As of September 30,
2003, the total long-term balances due from both of these customers was $81.2
million, net of an allowance for doubtful accounts of $46.3 million.
Litigation. We are from time to time a party to various lawsuits, claims
and other legal proceedings that arise in the ordinary course of business. These
actions typically seek, among other things, compensation for alleged personal
injury, breach of contract, property damage, punitive damages, civil penalties
or other losses, or injunctive or declaratory relief. With respect to all such
lawsuits, claims and proceedings, we accrue reserves when it is probable a
liability has been incurred and the amount of loss can be reasonably estimated.
We do not believe that any of these proceedings, separately or in the aggregate
would be expected to have a material adverse effect on our results of operations
or financial position.
Change of Control. We have employment agreements with certain employees
that become effective upon a change of control of Quanta (as defined in the
employment agreements). The employment agreements provide that, following a
change in control, if we terminate the employee's employment without cause (as
defined in the employment agreements), the employee terminates employment for
good reason (as defined in the employment agreements), or the employee's
employment terminates due to death or disability, we will pay certain amounts to
the employee, which may vary with the level of the employee's responsibility and
the terms of the employee's prior employment arrangements. In addition, in the
case of certain senior executives except Mr. Colson, our chief executive
officer, these payments would also be due if the employee terminates his or her
employment within the 30-day window period commencing six months after the
change in control.
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 facility leases with prior owners.
NEW ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133. This statement is effective for contracts
entered into or modified after June 30, 2003 (with certain exceptions) and for
hedging relationships entered into after June 30, 2003. We do not have any
financial instruments that fall under the scope of this statement and do not
believe that the adoption of SFAS No. 149 will have a material effect on either
our financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. Financial
instruments that fall within the scope of SFAS No. 150 will be classified as
liabilities (or an asset in some circumstances). This statement is effective at
the beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have a material impact on our results of
operations or financial position.
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
25
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:
Current and Non-Current Accounts and Notes Receivable and Provision
for Doubtful Accounts. We provide an allowance for doubtful accounts when
collection of an account or note 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 or have been
experiencing financial difficulties, and as a result we increased our
allowance for doubtful accounts to reflect that certain customers may be
unable to meet 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 and Other Intangibles. As stated in Note 5 of Notes to
Condensed Consolidated Financial Statements, SFAS No. 142 provides that
goodwill and other intangible assets that have indefinite useful lives 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. SFAS 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. SFAS No. 142 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. Estimating future cash flows requires significant judgment and our
projections may vary from cash flows eventually realized.
Late in the second quarter of 2003, a dispute developed between one of
our subsidiaries and its primary customer, leading to a suspension of work
for that customer. It is unclear whether the dispute will be resolved
favorably or whether work for this customer will resume. If the dispute
settles unfavorably for the subsidiary or the subsidiary is unable to
replace this work with comparable cash flows, we may record a non-cash
goodwill impairment charge of up to $6.5 million.
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 employer's liability and general
liability claims, subject to a deductible of $1,000,000 per occurrence, and
for auto liability and workers' compensation insurance subject to a
deductible of $2,000,000 per occurrence. We also have a corporate non-union
employee related health care benefit plan that 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.
Stock Options. We account for our stock-based compensation under
Accounting Principles Board Opinion No. 25 (APB Opinion No. 25),
"Accounting for Stock Issued to Employees." Under this
26
accounting method, no compensation expense is recognized in the
consolidated statements of operations if no intrinsic value of the option
exists at the date of grant. In October 1995, the FASB issued SFAS No. 123,
"Accounting for Stock Based Compensation." SFAS No. 123 encourages
companies to account for stock-based compensation awards based on the fair
value of the awards at the date they are granted. The resulting
compensation costs would be shown as an expense in the consolidated
statements of operations. Companies can choose not to apply the new
accounting method and continue to apply current accounting requirements;
however, disclosure is required as to what net income and earnings per
share would have been had the new accounting method been followed.
As a result of our stock option exchange offer during the first
quarter of 2003, certain stock options are required to be accounted for
under variable plan accounting. See additional discussion in Note 7 to the
Notes to Condensed Consolidated Financial Statements.
OUTLOOK
The following statements are based on current expectations. These
statements are forward looking, and actual results may differ materially.
Like many companies that provide installation and maintenance services to
the electrical power, gas, telecommunications and cable television industries,
we are facing a number of challenges. The telecommunications and utility markets
experienced substantial change during 2002 as evidenced by an increased number
of bankruptcies in the telecommunications market, continued devaluation of many
of our customers' 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, facilities
shutdown and consolidation, property disposal and other exit costs as we execute
these initiatives.
We expect consistent demand for our services from our electric power and
gas customers throughout 2003 and 2004 with stabilization in the demand for our
services from our telecommunications and cable customers and relatively level
demand for our ancillary services. Financial and economic pressures have led our
customers to return to their core competencies and focus on cost reductions,
resulting in an increased focus on outsourcing services. We believe that we are
adequately positioned to provide these services because of our proven
full-service operating units with broad geographic reach, financial capability
and technical expertise.
Capital expenditures in 2003 are expected to be approximately $30.0
million. A majority of the expenditures will be for operating equipment. We
expect expenditures for 2003 to be funded substantially through internal cash
flows and, to the extent necessary, from cash on hand.
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," "could," "expect," "believe" 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;
27
- 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 our forward-looking statements may turn out to be wrong. They can
be affected by inaccurate assumptions and by known or unknown risks and
uncertainties, including the following:
- The duration and extent of the current economic downturn;
- The cost of borrowing, availability of credit, debt covenant compliance
and other factors affecting our financing activities;
- Quarterly variations in our operating results due to seasonality and
adverse weather conditions;
- Material adverse changes in economic conditions in the markets served by
us or by our customers;
- The adverse impact of goodwill impairments;
- Replacement of our contracts as they are completed or expire;
- Rapid technological and structural changes that could reduce the demand
for the services we provide;
- Our ability to effectively compete for market share;
- Our ability to generate internal growth;
- Our growth outpacing our infrastructure;
- Retention of key personnel and qualified employees;
- The impact of our unionized workforce on our operations and acquisition
strategy;
- Potential exposure to environmental liabilities;
- Our ability to effectively integrate the operations of our companies;
- Beliefs and assumptions about the collectibility of receivables;
- Our dependence on fixed price contracts;
- Cancellation provisions within our contracts; and
- Beliefs or assumptions about the outlook for markets we serve.
Many of these factors will be important in determining our actual future
results. Consequently, no forward-looking statement can be guaranteed. Our
actual future results may vary materially from those expressed or implied in any
forward-looking statements.
All of our 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, we
disclaim any obligation to update any forward-looking statements to reflect
events or circumstances after the date of this report.
ITEM 4. CONTROLS AND PROCEDURES
Our management evaluated, with the participation of our Chairman and Chief
Executive Officer and Chief Financial Officer the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (Exchange Act)), as of
September 30, 2003. Based on their evaluation, our Chairman and Chief Executive
Officer and Chief
28
Financial Officer concluded that our disclosure controls and procedures were
effective as of September 30, 2003.
There has been no change in our internal control over financial reporting
(as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that
occurred during the quarter ended September 30, 2003, that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
PART II -- OTHER INFORMATION
QUANTA SERVICES, INC. AND SUBSIDIARIES
ITEM 1. LEGAL PROCEEDINGS
We are from time to time a party to various lawsuits, claims and other
legal proceedings that arise in the ordinary course of business. These actions
typically seek, among other things, compensation for alleged personal injury,
breach of contract, property damage, punitive damages, civil penalties or other
losses, or injunctive or declaratory relief. With respect to all such lawsuits,
claims and proceedings, we establish reserves when it is probable a liability
has been incurred and the amount of loss can be reasonably estimated. We do not
believe that any of these proceedings, separately or in the aggregate, would be
expected to have a material adverse effect on our results of operations or
financial position.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3.1 -- Restated Certificate of Incorporation (previously filed as
Exhibit 3.3 to Quanta's Form 10-Q (No. 001-13831) filed
August 14, 2003 and incorporated herein by reference)
3.2 -- Amended and Restated Bylaws (previously filed as Exhibit 3.2
to Quanta's 2000 Form 10-K (No. 001-13831) filed April 2,
2001 and incorporated herein by reference)
4.1 -- Indenture regarding 4.5% Convertible Subordinated Debentures
between Quanta Services, Inc. and Wells Fargo Bank, N.A.,
Trustee, dated as of October 17, 2003 (filed herewith)
10.1 -- 4.5% Convertible Subordinated Debentures Resale Registration
Rights Agreement dated October 17, 2003 (filed herewith)
10.2 -- Fourth Amended and Restated Secured Credit Agreement (filed
herewith)
31.1 -- Certification of Periodic Report by Chief Executive Officer
pursuant to Rule 13a-14(a)/15d-14(a) and pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
31.2 -- Certification of Periodic Report by Chief Financial Officer
pursuant to Rule 13a-14(a)/15d-14(a) and pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
32.1 -- Certification of Periodic Report by Chief Executive Officer
and Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (furnished herewith)
</Table>
(b) Reports on Form 8-K
(1) On August 6, 2003, Quanta furnished a Form 8-K announcing under Items 7
and 12 its press release reporting earnings for the second quarter of 2003.
29
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: November 13, 2003
30
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3.1 -- Restated Certificate of Incorporation (previously filed as
Exhibit 3.3 to Quanta's Form 10-Q (No. 001-13831) filed
August 14, 2003 and incorporated herein by reference)
3.2 -- Amended and Restated Bylaws (previously filed as Exhibit 3.2
to Quanta's 2000 Form 10-K (No. 001-13831) filed April 2,
2001 and incorporated herein by reference)
4.1 -- Indenture regarding 4.5% Convertible Subordinated Debentures
between Quanta Services, Inc. and Wells Fargo Bank, N.A.,
Trustee, dated as of October 17, 2003 (filed herewith)
10.1 -- 4.5% Convertible Subordinated Debentures Resale Registration
Rights Agreement dated October 17, 2003 (filed herewith)
10.2 -- Fourth Amended and Restated Secured Credit Agreement (filed
herewith)
31.1 -- Certification of Periodic Report by Chief Executive Officer
pursuant to Rule 13a-14(a)/15d-14(a) and pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
31.2 -- Certification of Periodic Report by Chief Financial Officer
pursuant to Rule 13a-14(a)/15d-14(a) and pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
32.1 -- Certification of Periodic Report by Chief Executive Officer
and Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (furnished herewith)
</Table>