IES Holdings, Inc. - Annual Report: 2009 (Form 10-K)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

 

Commission File Number 1-13783

 

 

Integrated Electrical Services, Inc.

(Exact name of registrant as specified in its charter)

 

 

1800 West Loop South, Suite 500, Houston, Texas 77027
(Address of principal executive offices and ZIP code)

 

Registrant’s telephone number, including area code: (713) 860-1500

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o No x

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  Yes o No x

 

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 o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller

reporting company)

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

 

Indicate by check mark whether the Registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of the securities under a plan confirmed by a court.  Yes x No o

 

The aggregate market value of the voting stock of the Registrant on March 31, 2009 held by non-affiliates was approximately $51.8 million. On December 11, 2009, there were 14,617,741 shares of common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Certain information contained in the Proxy Statement for the Annual Meeting of Stockholders of the Registrant to be held on February 2, 2010 is incorporated by reference into Part III of this Form 10-K.

 

 

FORM 10-K

 

INTEGRATED ELECTRICAL SERVICES, INC.

Table of Contents

 

 

In this Annual Report on Form 10-K, the words “IES”, the “Company”, the “Registrant”, “we”, “our”, “ours” and “us” refer to Integrated Electrical Services, Inc. and, except as otherwise specified herein, to our subsidiaries.

 

This Annual Report on Form 10-K includes certain statements that may be deemed “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, all of which are based upon various estimates and assumptions that the Company believes to be reasonable as of the date hereof. These statements involve risks and uncertainties that could cause the Company’s actual future outcomes to differ materially from those set forth in such statements. Such risks and uncertainties include, but are not limited to:

 

 

 

You should understand that the foregoing, as well as other risk factors discussed in this document, including those listed in Part I, Item 1A of this report under the heading “Risk Factors” could cause future outcomes to differ materially from those experienced previously or those expressed in such forward-looking statements. We undertake no obligation to publicly update or revise information concerning our restructuring efforts, borrowing availability, cash position or any forward-looking statements to reflect events or circumstances that may arise after the date of this report. Forward-looking statements are provided in this Form 10-K pursuant to the safe harbor established under the Private Securities Litigation Reform Act of 1995 and should be evaluated in the context of the estimates, assumptions, uncertainties and risks described herein.

 

 

Integrated Electrical Services, Inc., a Delaware corporation, was founded in June 1997 to create a leading national provider of electrical services, focusing primarily on the commercial, industrial, residential, low voltage and service and maintenance markets. We provide a broad range of services including designing, building, maintaining and servicing electrical, data communications and utilities systems for commercial, industrial and residential customers. As of September 2009, we provide our services from 89 locations serving the continental 48 states.

 

Our electrical contracting services include design of electrical systems within a building or complex, procurement and installation of wiring and connection to power sources, end-use equipment and fixtures, as well as contract maintenance. We service commercial, industrial and residential markets and have a diverse customer base including: general contractors; property managers and developers; corporations; government agencies; municipalities; and homeowners. We focus on projects that require special expertise, such as design-and-build projects that utilize the capabilities of our in-house experts or projects which require specific market expertise such as hospitals or power generation facilities. We also focus on service, maintenance and certain renovation and upgrade work, which tends to be either recurring or have lower sensitivity to economic cycles, or both. We provide services for a variety of projects including: high-rise residential and office buildings, power plants, manufacturing facilities, data centers, chemical plants, refineries, wind farms, solar facilities, municipal infrastructure and health care facilities and residential developments, including both single-family housing and multi-family apartment complexes. We also offer low voltage contracting services as

a complement to our electrical contracting business. Our low voltage services include design and installation of structured cabling for corporations, universities, data centers and switching stations for data communications companies as well as the installation of fire and security alarm systems. Our utility services consist of overhead and underground installation and maintenance of electrical and other utilities transmission and distribution networks, installation and splicing of high-voltage transmission and distribution lines, substation construction and substation and right-of-way maintenance. Our maintenance services generally provide recurring revenues that are typically less affected by levels of construction activity.

 

Competitive Strengths

 

Our competitive strengths include the following:

 

 

 

Strategy

 

We believe that we are well-positioned to capitalize on future capital spending by customers across certain key end markets. Our strong and diverse customer relationships, geographic reach, financial strength, experienced employees, and effective enterprise processes should allow us to benefit from investments over the long-term.

 

Leveraging Customer Relationships and Enhancing Our Offering

 

We continue to leverage our scale and target customer segments where our capabilities give us an advantage. In parallel, we continue to foster and build on local, regional and national relationships in order to adapt to our customers changing needs. We are working to expand the portfolio of services and solutions we provide to both existing and potential customers. Finally, we believe our geographic reach and capabilities, together with the deployment of best practices and cross-selling of our services, positions us well to capitalize upon opportunities and trends in the industries and customers that we serve.

Resource Enhancement

 

Our people are one of the key success factors in fully realizing our strategy. We seek to attract and retain quality employees through an enhanced career path, quality training and attractive benefits packages. We continue to provide industry leading training programs to enhance employee skills and expertise that will provide us with a competitive advantage. We believe these programs can lead to increased efficiency and improved safety performance. We will continue to monitor our organizational structure and roles to optimize resources in order to focus on winning new work and executing projects more effectively.

 

Systems and Infrastructure

 

We continue to leverage our proprietary project management system, which allows us to execute projects more reliably and predictably in order to improve profitability. We have made investments in systems to maintain compliance, transparency, and productivity. We will continue to invest in systems that improve techniques, lead to more efficient processes and drive profitable project execution.

 

Industry Overview

 

According to McGraw Hill Construction, construction starts in the United States were estimated at $419 billion in 2009, a 25% year over year decline, that follows shortfalls of 13% in 2008 and 7% in 2007. Since the middle of 2007, slowing economic conditions have lead to a sharp decrease in demand for residential housing. Commercial demand began to slow during 2008. A more severe decline was experienced during 2009 for commercial as well as industrial and multi-family construction.

 

McGraw Hill Construction further indicated that construction starts are forecasted to be $466 billion in 2010, an increase of 11% from 2009. While the recession may near its end in 2010, employment is projected to stay weak. In addition, bank lending standards will remain tight, impeding development and construction projects. Construction activity will be helped in 2010 by a modest improvement in housing and a boost to public works coming from stimulus funding.

 

McGraw Hill Construction included the following information which we consider key points for the construction markets we compete within:

 

 

Looking well beyond the current economic downturn, numerous factors could positively affect construction industry growth, including (i) population growth, which will increase the need for commercial, industrial and residential facilities, (ii) aging public infrastructure which must be replaced or repaired, and (iii) increased

emphasis on environmental and energy efficiency, which may lead to both increased public and private spending. We believe these factors will continue to drive demand for the electrical contracting services we offer over the long-term.

 

The Markets We Serve

 

Commercial Market — Our Commercial service offerings consist primarily of electrical, communications, renovation, replacement and service and maintenance work for customers within a variety of markets:

 

 

Demand for our Commercial services is driven by construction and renovation activity levels, economic growth, and availability of bank lending. Commercial construction starts have slowed since mid 2008, with a more severe decline experienced during 2009 due to the recession and tightening of the credit markets. Our Commercial segment represented approximately 63%, 58% and 52% of our consolidated revenues for the twelve-month periods ended September 30, 2009, 2008 and 2007, respectively. For additional financial information on the Commercial segment, see Note 11 to the consolidated financial statements, which are incorporated herein by reference.

 

Projects we design and build generally provide us with higher margins. “Design and build” gives the Company full or partial responsibility for the design specifications of the installation. “Design and build” is an alternative to the traditional “plan and spec” model, where the contractor builds to the exact specifications of the architect and engineer. We prefer to perform “design and build” work because it allows us to use our specialized expertise to install a more value-added system for our customers with generally lower risk and higher profitability. Once a project is awarded, it is executed in scheduled phases and progress billings are rendered to the customer for payment, typically less retention of 5% to 10% of the construction cost of the project. We generally provide the materials to be installed as a part of these contracts, which vary significantly in size from a few hundred dollars up to several million dollars and vary in duration from less than a day to more than a year.

 

We also design and install communications infrastructure systems for the Commercial market. We believe the demand for our communications services is driven by the following factors:

 

 

Service and maintenance revenues, which represent less than 10% of consolidated revenues, are derived from service calls and routine maintenance contracts, which tend to be recurring and less sensitive to short term

economic fluctuations. Most service work is warranted for 30 days. Service personnel work out of our service vehicles, which carry an inventory of equipment, tools, parts and supplies needed to complete the typical service and maintenance requests.

 

Industrial Market — Our Industrial work consists of design and build solutions and project delivery services for industrial and manufacturing projects across the country. Our Industrial work is also supported with comprehensive, preventive, and on-site maintenance services. Our Industrial line of business supports a variety of customers and markets, including:

 

 

The Industrial business generally has longer cycle times than the commercial and residential markets and generally follows the economic trends with a lag. Demand for our construction services is driven primarily by manufacturing capacity utilization, while demand for our utilities services is driven by industry deregulation, maintenance activities, capital expenditures on existing systems, and electricity demand growth. Due to the recession in the U.S., manufacturing capacity utilization rates declined considerably coupled with reduced availability of bank lending, which has had a negative effect on our Industrial segment during 2009. We believe however, that due to our safety record, our surety bonding capacity and significant resource base are factors that allow us to be competitive and give us an advantage in the Industrial sector. Our Industrial segment represented approximately 13%, 16% and 13% of our consolidated revenues for the twelve-month periods ended September 30, 2009, 2008 and 2007, respectively. For additional financial information on the Industrial segment, see Note 11 to the consolidated financial statements, which are incorporated herein by reference.

 

Residential Market—Our work for the Residential market consists primarily of electrical installations in new single-family housing and low-rise, multi-family housing, for local, regional and national homebuilders and developers. Demand for our Residential services is dependent on the number of single-family and multi-family home starts in the markets we serve. Single-family housing starts are affected primarily by the level of interest rates and general economic conditions in the region. A competitive factor particularly important in the Residential market is our ability to develop relationships with homebuilders and developers by providing services in multiple areas of their operations. Also bolstering these relationships is our financial strength which differentiates us from many of the smaller, private competitors in the current challenging economic and credit market environment. This ability has become increasingly important as consolidation has occurred in the Residential construction industry, and homebuilders and developers have sought out service providers that can provide consistent service in all of their operating regions. In addition to our core electrical construction work, the Residential group is expanding their offerings by providing services for the installation of residential solar power, installing smart meters, and installing and servicing stand-by generators, both for new construction and existing residences.

 

The Residential business is generally less capital intensive than our Commercial and Industrial businesses; however, market conditions experienced in 2008 and 2009 have greatly reduced demand for new home construction. Residential contracting also has lower barriers to entry and has a much lower requirement for surety bonding.

 

We are one of the largest providers of electrical contracting services to the United States residential construction market and we have a large market share in many of the markets we serve. Over the past three years, however, our results of operations have been adversely impacted by the downturn in the residential housing market. In line with the downturn in single-family housing, we experienced a 27% decline in our

Residential revenues in fiscal year 2009 as compared to fiscal year 2008. Our Residential segment represented approximately 24%, 26% and 35% of our consolidated revenues for the twelve-month periods ended September 30, 2009, 2008 and 2007, respectively. For additional financial information on the Residential segment, see Note 11 to the consolidated financial statements, which are incorporated herein by reference.

 

Customers

 

We have a diverse customer base. During the twelve-month periods ended September 30, 2009, 2008 and 2007, no single customer accounted for more than 10% of our revenues. We will continue our emphasis on developing and maintaining relationships with our customers by providing superior, high-quality service.

 

Management at each of our operating units is responsible for developing and maintaining relationships with customers. Our operating unit management teams build upon existing customer relationships to secure additional projects and increase revenue from our customer base. These customer relationships are maintained through a partnering approach that includes project evaluation and consulting and quality performance. On an operating unit level, management maintains a parallel focus on pursuing growth opportunities with prospective customers. We also in some cases provide services of other operating units to their customers. In addition, our business development group promotes and markets our services for prospective large national accounts and projects that would require services from multiple operating units across the country.

 

Backlog

 

Backlog is a measure of revenue that we expect to recognize from work that has yet to be performed on uncompleted contracts, and from work that has been contracted but has not started. Backlog is not a guarantee of future revenues, as contractual commitments may change. As of September 30, 2009, our backlog was approximately $241 million compared to $337 million as of September 30, 2008. The Residential segment experienced a significant decline in backlog in fiscal 2009 as compared to fiscal 2008 as financing for multi-family housing projects became less available with the economic deterioration and increased competition as fewer projects were available in the marketplace. The Commercial segment declined year-over-year, due to competitive market pressures and ongoing selectivity, while the Industrial segment reflected a slight increase. We do not include single-family housing or time and material work in our backlog.

 

Employee Development

 

In the United States, the number of qualified electricians has fallen in recent years, making the recruitment, development and retention of these individuals an essential part of our overall strategy. We are committed to providing the highest level of customer service through the development of a highly trained workforce. Employees are encouraged to complete a progressive training program to advance their technical competencies and to ensure that they understand and follow the applicable codes, safety practices and our internal policies. We support and fund continuing education for our employees, as well as apprenticeship training for technicians under the Bureau of Apprenticeship and Training of the Department of Labor and similar state agencies. Employees who train as apprentices for four years may seek to become journeymen electricians and after additional years of experience, they may seek to become master electricians. We pay progressive increases in compensation to employees who acquire this additional training, and more highly trained employees serve as foremen, estimators and project managers. We also actively recruit and screen applicants for our technical positions and have established programs to recruit apprentice technicians directly from high schools and vocational technical schools in certain areas.

 

At September 30, 2009, we had 3,504 employees. We are not a party to any collective bargaining agreements with our employees. We believe that our relationship with our employees is strong.

 

Competition

 

The markets in which we operate are highly competitive. The electrical contracting industry is highly fragmented and is served by many small, owner-operated private companies. There are also several large private regional companies and a small number of large public companies in our industry. In addition, there

are relatively few barriers to entry into some of the industries in which we operate and, as a result, any organization that has adequate financial resources and access to technical expertise may become a competitor. We believe that our strengths such as our safety performance, technical expertise and experience, financial and operational resources, nationwide presence, and industry reputation put us in a strong position. There can be no assurance, however, that our competitors will not develop the expertise, experience and resources to provide services that are superior in both price and quality to our services, or that we will be able to maintain or enhance our competitive position.

 

Regulations

 

Our operations are subject to various federal, state and local laws and regulations, including:

 

 

Many state and local regulations governing electricians require permits and licenses to be held by individuals. In some cases, a required permit or license held by a single individual may be sufficient to authorize specified activities for all our electricians who work in the state or county that issued the permit or license. It is our policy to ensure that, where possible, any permits or licenses that may be material to our operations in a particular geographic area are held by multiple IES employees within that area.

 

We believe we have all licenses required to conduct our operations and are in substantial compliance with applicable regulatory requirements. Failure to comply with applicable regulations could result in substantial fines or revocation of our operating licenses or an inability to perform government work.

 

Risk Management and Insurance

 

The primary risks in our operations include bodily injury, property damage and construction defects. We maintain automobile, general liability and construction defect insurance for third party health, bodily injury and property damage and workers’ compensation coverage, which we consider appropriate to insure against these risks. Our third-party insurance is subject to deductibles for which we establish reserves.

 

Seasonality and Quarterly Fluctuations

 

Results of our operations from Residential construction segment are more seasonal, depending on weather trends, with typically higher revenues generated during spring and summer and lower revenues during fall and winter. The Commercial and Industrial aspect of our business is less subject to seasonal trends, as this work generally is performed inside structures protected from the weather. Our service and maintenance business is generally not affected by seasonality. In addition, the construction industry has historically been highly cyclical. Our volume of business may be adversely affected by declines in construction projects resulting from adverse regional or national economic conditions. Quarterly results may also be materially affected by the timing of new construction projects. Accordingly, operating results for any fiscal period are not necessarily indicative of results that may be achieved for any subsequent fiscal period.

 

Available Information

 

General information about us can be found on our website at www.ies-co.com under “Investor Relations.” We file our interim and annual financial reports, as well as other reports required by the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with the United States Securities and Exchange Commission (the “SEC”).

Our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any amendments and exhibits to those reports are available free of charge through our website as soon as it is reasonably practicable after we file them with, or furnish them to, the SEC. You may also contact our Investor Relations department and they will provide you with a copy of these reports. The materials that we file with the SEC are also available free of charge through the SEC website at www.sec.gov. You may also read and copy these materials at the SEC’s Public Reference Room at 100 F Street, NE., Washington, D.C. 20549. Information on the operation of the Public Reference Room is available by calling the SEC at 1–800–SEC–0330.

 

We have adopted a Code of Ethics for Financial Executives, a Code of Business Conduct and Ethics for directors, officers and employees (the Legal Compliance and Corporate Policy Manual), and established Corporate Governance Guidelines and adopted charters outlining the duties of our Audit, Human Resources and Compensation and Nominating/Governance Committees, copies of which may be found on our website. Paper copies of these documents are also available free of charge upon written request to us. We have designated an “audit committee financial expert” as that term is defined by the SEC. Further information about this designee may be found in the Proxy Statement for the Annual Meeting of Stockholders of the Company.

 

 

You should consider carefully the risks described below, as well as the other information included in this document before making an investment decision. Our business, results of operations or financial condition could be materially and adversely affected by any of these risks, and the value of your investment may decrease due to any of these risks.

 

Existence of a controlling shareholder.

 

A majority of our outstanding common stock is owned by Tontine Capital Partners, L.P. (“Tontine”). As a result, Tontine can control some of our affairs, including the election of directors who in turn appoint management. Tontine controls any action requiring the approval of shareholders, including the adoption of amendments to our corporate charter and approval of any potential merger or sale of all or substantially all assets, divisions, or the Company itself. This control also gives Tontine the ability to bring matters to a shareholder vote that may not be in the best interest of our other stakeholders. Tontine also controls decisions requiring shareholder approval affecting our capital structure, such as the issuance or repurchase of capital stock, the issuance or repayment of debt, and the declaration of dividends. Additionally, Tontine is in the business of investing in companies and may, from time to time, acquire and hold interests in businesses that compete directly or indirectly with us.

 

Our controlling shareholder has announced its intention to explore alternatives relative to the possible disposition of its holdings in our Company.

 

On November 10, 2008, Tontine, our controlling shareholder, filed an amended Schedule 13D indicating, among other things, that it has begun to explore alternatives for the disposition of its holdings in our Company, including both common stock and a $25.0 million term loan. In addition, on October 22, 2009 Tontine filed a further amendment to it’s Schedule 13D indicating, among other things, that it has determined to form TCP Overseas Master Fund II, L.P., (“TCP 2”) during the fourth quarter of 2009 and that it anticipates that the newly formed TCP 2 will become the beneficial owner of an as-yet-undetermined portion of IES securities. To the extent that TCP 2 acquires beneficial ownership of any such securities, TCP 2 may hold and/or dispose of such securities or may purchase additional securities of the Company, at any time and from time to time in the open market or otherwise. Our credit agreements contain provisions for default in the event of a change in control. Similarly, certain of our financial arrangements and employment contracts contain provisions that will be triggered or accelerated upon the occurrence of a change of control event. Tontine, together with its affiliates, owns approximately 58% of our outstanding common stock. Should Tontine sell its position in the Company to a single shareholder or a non Tontine affiliated group of shareholders, a change in control event would occur, causing us to be in default under our credit agreements and triggering the

change of control provisions in certain of our employment contracts. Tontine also holds our $25.0 million term loan due on May 12, 2013, which may or may not be negotiated for repayment in connection with Tontine’s exploration process or under the terms of a potential sale of the Company.

 

Availability of net operating losses may be reduced by a change in ownership.

 

A change in ownership, as defined by Internal Revenue Code Section 382, could reduce the availability of net operating losses for federal and state income tax purposes. Should Tontine sell or exchange all or a portion of its position in IES, a change in ownership could occur. In addition a change in ownership could occur resulting from the purchase of common stock by an existing or a new 5% shareholder as defined by Internal Revenue Code Section 382. Currently, we have approximately $185 million of federal net operating losses that are available to use to offset taxable income, exclusive of net operating losses from the amortization of additional tax goodwill. In addition, we have approximately $52 million of net operating loss not currently available due to the limitation imposed by Internal Revenue Code Section 382, exclusive of net operating losses from the amortization of additional tax goodwill, and will be available to offset taxable income in future periods. Should a change in ownership occur, all net operating losses incurred prior to the change in ownership would be subject to limitation imposed by Internal Revenue Code Section 382 and this would substantially reduce the amount of net operating loss currently available to offset taxable income.

 

We may be unsuccessful at generating internal growth.

 

Our ability to generate internal growth will be affected by, among other factors, our ability to:

 

 

In addition, our customers may delay, reduce or cancel the number or size of projects available to us due to their inability to obtain capital or pay for services provided, the demand for their products and services and the risk of which has become heightened in light of the recent economic downturn. Many of the factors affecting our ability to generate internal growth may be beyond our control, and we cannot be certain that our strategies will be successful or that we will be able to generate cash flow sufficient to fund our operations and to support internal growth. If we are unsuccessful, we may not be able to achieve internal growth of our business or expand our operations.

 

To service our indebtedness and to fund working capital, we will require a significant amount of cash. Our ability to generate cash depends on many factors that are beyond our control.

 

Our ability to make payments on and to refinance our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future. This is subject to our operational performance, as well as general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.

 

We cannot provide assurance that our business will generate sufficient cash flow from operations or asset sales and, that future borrowings will be available to us under our credit facility in an amount sufficient to enable us to pay our indebtedness, or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness, on or before maturity. We cannot provide assurance that we will be able to refinance any of our indebtedness on commercially reasonable terms, or at all. Our inability to refinance our debt on commercially reasonable terms could have a material adverse effect on our business.

The highly competitive nature of our industry could affect our profitability by reducing our profit margins.

 

The electrical contracting industry is highly fragmented and is served by many small, owner-operated private companies. There are also several large private regional companies and a small number of large public companies from which we face competition in the industry. In the future, we could also face competition from new competitors entering these markets because certain segments of electrical contracting have a relatively low barrier for entry. Some of our competitors offer a greater range of services, including mechanical construction, facilities management, plumbing and heating, ventilation and air conditioning services. Competition in our markets depends on a number of factors, including price. Some of our competitors may have lower overhead cost structures and may, therefore, be able to provide services comparable to ours at lower rates than we do. If we are unable to offer our services at competitive prices or if we have to reduce our prices to remain competitive, our profitability would be impaired.

 

Backlog may not be realized or may not result in profits.

 

Customers often have no obligation under our contracts to assign or release work to us, and many contracts may be terminated on short notice. Reductions in backlog due to cancellation of one or more contracts by a customer or for other reasons could significantly reduce the revenue and profit we actually receive from contracts included in backlog. In the event of a project cancellation, we may be reimbursed for certain costs but typically have no contractual right to the total revenues reflected in our backlog.

 

Our use of percentage-of-completion accounting could result in a reduction or elimination of previously reported profits.

 

As discussed in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” and in the notes to our consolidated financial statements included in Item 8 hereof, a significant portion of our revenues are recognized using the percentage-of-completion method of accounting, utilizing the cost-to-cost method. This method is used because management considers expended costs to be the best available measure of progress on these contracts. The percentage-of-completion accounting practice we use results in our recognizing contract revenues and earnings ratably over the contract term in proportion to our incurrence of contract costs. The earnings or losses recognized on individual contracts are based on estimates of contract revenues, costs and profitability. Contract losses are recognized in full when determined to be probable and reasonably estimatable and contract profit estimates are adjusted based on ongoing reviews of contract profitability. Further, a portion of our contracts contain various cost and performance incentives. Penalties are recorded when known or finalized, which generally occurs during the latter stages of the contract. In addition, we record cost recovery claims when we believe recovery is probable and the amounts can be reasonably estimated. Actual collection of claims could differ from estimated amounts and could result in a reduction or elimination of previously recognized earnings. In certain circumstances, it is possible that such adjustments could be significant.

 

The availability and cost of surety bonds affect our ability to enter into new contracts and our margins on those engagements.

 

Many of our customers require us to post performance and payment bonds issued by a surety. Those bonds guarantee the customer that we will perform under the terms of a contract and that we will pay subcontractors and vendors. We obtain surety bonds from two primary surety providers; however, there is no commitment from either of these providers to guarantee our ability to issue bonds for projects as they are required. Our ability to access this bonding capacity is at the sole discretion of our surety providers.

 

Due to seasonality and differing regional economic conditions, our results may fluctuate from period to period.

 

Our business is subject to seasonal variations in operations and demand that affect the construction business, particularly in residential construction. Untimely weather delay from rain, heat, ice, cold or snow can not only

delay our work but can negatively impact our schedules and profitability by delaying the work of other trades on a construction site. Our quarterly results may also be affected by regional economic conditions that affect the construction market. Accordingly, our performance in any particular quarter may not be indicative of the results that can be expected for any other quarter or for the entire year. Additionally, cost increases in construction materials such as steel, aluminum, copper and lumber can alter the rate of new construction.

 

The estimates we use in placing bids could be materially incorrect. The use of incorrect estimates could result in losses on a fixed price contract. These losses could be material to our business.

 

We currently generate, and expect to continue to generate, more than half of our revenues under fixed price contracts. The cost of fuel, labor and materials, including copper wire, may vary significantly from the costs we originally estimate. Variations from estimated contract costs along with other risks inherent in performing fixed price contracts may result in actual revenue and gross profits for a project differing from those we originally estimated and could result in losses on projects. Depending upon the size of a particular project, variations from estimated contract costs can have a significant impact on our operating results.

 

Commodity costs may fluctuate materially and we may not be able to pass on all cost increases during the term of a contract.

 

We enter into many contracts at fixed prices and if the cost associated with commodities such as copper, aluminum, steel, fuel and certain plastics increase, our expected profit may decline under that contract.

 

We may be unsuccessful at integrating companies that we may acquire.

 

As a part of our business strategy, we may seek to acquire companies that complement or enhance our business. However, we cannot be sure that we will be able to successfully integrate each of these companies with our existing operations without substantial costs, delays or other operational or financial problems. If we do not implement proper overall business controls, our strategy could result in inconsistent operating and financial practices at the companies we acquire and our overall profitability could be adversely affected. Integrating acquired companies involves a number of risks, which could have a negative impact on our business, financial condition and results of operations.

 

We may experience difficulties in managing our billings and collections.

 

Our billings under fixed price contracts are generally based upon achieving certain milestones and will be accepted by the customer once we demonstrate those milestones have been met. If we are unable to demonstrate compliance with billing requests, or if we fail to issue a project billing, our likelihood of collection could be delayed or impaired, which, if experienced across several large projects, could have a materially adverse effect on our results of operations.

 

We have restrictions and covenants under our credit facility.

 

We may not be able to remain in compliance with the covenants in our credit facility. A failure to fulfill the terms and requirements of our credit facility may result in a default under one or more of our material agreements, which could have a material adverse effect our ability to conduct our operations and our financial condition.

 

We may be unsuccessful in renewing or replacing our existing credit facility upon maturity at May 12, 2010.

 

Our existing credit facility includes a facility for letters of credit which we use as collateral for bonding, insurance, and projects. Should we be unsuccessful in renewing or replacing our existing facility, cash would be used to collateralize existing and new letters of credit. We cannot provide assurance that we will have available cash on hand to collateralize any or all needed letters of credit and maintain adequate cash balances to meet our operating needs.

Our reported operating results could be adversely affected as a result of goodwill impairment write-offs.

 

When we acquire a business, we record an asset called “goodwill” if the amount we pay for the business, including liabilities assumed, is in excess of the fair value of the assets of the business we acquire. Generally accepted accounting principles (“GAAP”) requires that goodwill attributable to each of our reporting units be tested at least annually. The testing includes comparing the fair value of each reporting unit with its carrying value. Fair value is determined using discounted cash flows, market multiples and market capitalization. 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, we expect to perform impairment tests at least annually as of September 30. Impairment adjustments, if any, are required to be recognized as operating expenses. We cannot assure that we will not have future impairment adjustments to our recorded goodwill.

 

The vendors who make up our supply chain may be adversely affected by the current operating environment and credit market conditions.

 

We are dependent upon the vendors within our supply chain to maintain a steady supply of inventory, parts and materials under our existing just-in-time inventory system. Many of our divisions are dependent upon a limited number of suppliers, and significant supply disruptions could adversely affect our operations. Under current market conditions, including both the construction slowdown and the tightening credit market, it is possible that one or more of our suppliers will be unable to meet the terms of our operating agreements due to financial hardships, liquidity issues or other reasons related to the market slowdown.

 

Our operations are subject to numerous physical hazards associated with the construction of electrical systems. If an accident occurs, it could result in an adverse effect on our business.

 

Hazards related to our industry include, but are not limited to, electrocutions, fires, machinery-caused injuries, mechanical failures and transportation accidents. These hazards can cause personal injury and loss of life, severe damage to or destruction of property and equipment, and may result in suspension of operations. Our insurance does not cover all types or amounts of liabilities. Our third-party insurance is subject to deductibles for which we establish reserves. No assurance can be given that our insurance or our provisions for incurred claims and incurred but not reported claims will be adequate to cover all losses or liabilities we may incur in our operations; nor can we provide assurance that we will be able to maintain adequate insurance at reasonable rates.

 

Our internal controls over financial reporting and our disclosure controls and procedures may not prevent all possible errors that could occur. Internal controls over financial reporting and disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objective will be met.

 

On a quarterly basis, we evaluate our internal controls over financial reporting and our disclosure controls and procedures, which include a review of the objectives, design, implementation and effectiveness of the controls and the information generated for use in our periodic reports. In the course of our controls evaluation, we sought (and seek) to identify data errors, control problems and to confirm that appropriate corrective action, including process improvements, are being undertaken. This type of evaluation is conducted on a quarterly basis so that the conclusions concerning the effectiveness of our controls can be reported in our periodic reports.

 

A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be satisfied. Internal controls over financial reporting and disclosure controls and procedures are designed to give reasonable assurance that they are effective and achieve their objectives. We cannot provide absolute assurance that all possible future control issues have been detected. These inherent limitations include the possibility that our judgments can be faulty, and that isolated breakdowns can occur because of human error or mistake. The design of our system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any

design will succeed absolutely in achieving our stated goals under all potential future or unforeseeable conditions. Because of the inherent limitations in a cost-effect control system, misstatements due to error could occur without being detected.

 

We have adopted tax positions that a taxing authority may view differently. If a taxing authority differs with our tax positions, our results may be adversely affected.

 

Our effective tax rate and cash paid for taxes are impacted by the tax positions that we have adopted. Taxing authorities may not always agree with the positions we have taken. We have established reserves to be used in the event that a taxing authority differs with the positions we have taken; however, in the event that disagreement over our tax positions does arise, there can be no assurance that our results of operations will not be adversely affected.

 

Litigation and claims can cause unexpected losses.

 

In the construction business there are frequently claims and litigation. There are also inherent claims and litigation risk associated with the number of people that work on construction sites and the fleet of vehicles on the road everyday. Claims are sometimes made and lawsuits filed for amounts in excess of their value or in excess of the amounts for which they are eventually resolved. Claims and litigation normally follow a predictable course of time to resolution. However, there may be periods of time in which a disproportionate amount of our claims and litigation are concluded in the same quarter or year. If multiple matters are resolved during a given period, then the cumulative effect of these matters may be higher than the ordinary level in any one reporting period.

 

Latent defect claims could expand.

 

Latent defect litigation is normal for residential home builders in some parts of the country; however, such litigation is increasing in certain states where we perform work. Also, in recent years, latent defect litigation has expanded to aspects of the Commercial market. Should we experience similar increases in our latent defect claims and litigation, additional pressure may be placed on the profitability of the Residential and Commercial segments of our business.

 

The loss of a group or several key personnel, either at the corporate or operating level, could adversely affect our business.

 

The loss of key personnel or the inability to hire and retain qualified employees could have an adverse effect on our business, financial condition and results of operations. Our operations depend on the continued efforts of our executive officers, senior management and management personnel at our divisions. We cannot guarantee that any member of management at the corporate or subsidiary level will continue in their capacity for any particular period of time. We have employment agreements in place with our executives and many of our key senior leadership; however, such employment agreements cannot guarantee that we will not lose key employees, nor prevent them from competing against us, which is often dependent on state and local employment laws. If we lose a group of key personnel or even one key person at a division, we may not be able to recruit suitable replacements at comparable salaries or at all, which could adversely affect our operations. Additionally, we do not maintain key man life insurance for members of our management.

 

 

None.

 

 

Equipment

 

We operate a fleet of approximately 1,800 owned and leased trucks, vans, trailers, support vehicles and specialty equipment We believe these vehicles are adequate for our current operations.

Facilities

 

At September 30, 2009, we maintained branch offices, warehouses, sales facilities and administrative offices at 89 locations. Substantially all of our facilities are leased. We lease our corporate office located in Houston, Texas. We believe that our properties are adequate for our present needs, and that suitable additional or replacement space will be available as required.

 

 

On August 14, 2009, we entered into a mediated settlement agreement with Clark Construction (“Clark”) for claims asserted to recover expenses incurred by Clark and its sub-guard surety to complete a project, following Clark’s termination of one of our former divisions, J.W. Gray (“Gray”), from the project in December 2005. As first reported in our Annual Report on Form 10-K for the fiscal year ended September 30, 2008, in September 2008, Clark filed suit against the Company in the U.S. District Court of Maryland (Southern Division) to recover these expenses. During the five-month period ended September 30, 2006, Gray received approximately $4.9 million in backcharges from Clark, which we disputed. After assessment, we recorded $0.4 million as a loss reserve, which were included in current liabilities, specifically related to these backcharges. The remaining claim associated with the backcharges was approximately $4.5 million, an amount for which we had not previously recorded any liability. In 2006, we reversed previously recognized revenues related to this project of $0.5 million and wrote off $0.4 million of receivables and $0.1 million in underbillings. Clark alleged the expenses were the result of delays caused by Gray’s insufficient staffing of the project. We contended that delays were the result of Clark’s failure to properly manage the project, delays of other subcontractors and issues not in the control of Gray. Clark claimed that the cost to complete the project and other damages totaled $4.5 million. We counterclaimed seeking payment of $0.3 million due for work completed and an additional amount in excess of $0.8 million for delay and productivity impact on our costs. In September 2009, we participated in a mediation with Clark to potentially settle the dispute. During the mediation, we were made aware of facts that we believed were detrimental to our defense. Therefore, in order to avoid the costly expenses inherent in protracted litigation and to eliminate the risk of an injurious adverse decision, we settled the lawsuit. Under the terms of the settlement agreement, we paid Clark $3.2 million to resolve all claims by Clark against us related to the project. The net effect to the Company of this settlement, after consideration of the previous reserve amount of $0.4 million, was $2.8 million in expenses.

 

For further information regarding legal proceedings, see Note 16 to the consolidated financial statements, which is incorporated herein by reference.

 

 

There were no matters submitted to a vote of security holders during the fourth quarter of our fiscal year ended September 30, 2009.

 

 

Our common stock trades on NASDAQ under the ticker symbol “IESC.” The following table sets forth the daily high and low close price for our common stock as reported on NASDAQ for each of the four quarters of the years ended September 30, 2009 and 2008.

 

 

As of December 11, 2009, the closing market price of our common stock was $6.60 per share and there were approximately 320 holders of record.

 

We have never paid cash dividends on our common stock, and we do not anticipate paying cash dividends in the foreseeable future. We expect that we will utilize all available earnings generated by our operations and borrowings under our credit facility for the development and operation of our business, to retire existing debt, or the repurchase of our common stock. Any future determination as to the payment of dividends will be made at the discretion of our Board of Directors and will depend upon our operating results, financial condition, capital requirements, general business conditions and other factors that the Board of Directors deems relevant. Our debt instruments restrict us from paying cash dividends and also place limitations on our ability to repurchase our common stock. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

 

On December 12, 2007, our Board of Directors authorized the repurchase of up to one million shares of our common stock, and the Company has established a Rule 10b5-1 plan to facilitate this repurchase. This stock repurchase was allowed under an amendment to our Loan and Security Agreement that also allowed us to repay our Eton Park Term Loan and enter into our Tontine Term Loan. This share repurchase program is authorized through December 2009. During the year ended September 30, 2009 and 2008, we repurchased 301,418 and 584,942 common shares, respectively, under the share repurchase program at an average price of $13.36 and $17.73 per share, respectively.

 

Five-Year Stock Performance Graph

 

The following performance graph compares the Company’s cumulative total stockholder return on its common stock with the cumulative total return of (i) the Russell 2000, (ii) a peer group stock index (the “Peer Group”) selected in good faith by the Company and comprised of the following publicly traded companies: Comfort Systems USA, Inc., Dycom Industries, Inc., Mastec, Inc., Pike Electric Corp., Black Box Corporation, Layne Christensen Company, Matrix Service Company, Quanta Services, Inc., Tetra Tech, Inc. and Willbros Group, Inc. The cumulative total return computations set forth in the following performance graph assume (i) the investment of $100 in each of the Company’s common stock, the Russell 2000 and the Peer Group on September 30, 2004, and (ii) that all dividends have been reinvested. Shareholder returns over the period indicated should not be considered indicative of future shareholder returns.

 

The information contained in the following performance graph shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under

the Securities Act of 1933, as amended (the “Securities Act”), or the Exchange Act, except to the extent the Company specifically incorporates it by reference into such filing.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*

Among Integrated Electrical Services, Inc., The Russell 2000 Index

And A Peer Group

 

 

*$100 invested on 9/30/04 in stock or index, including reinvestment of dividends.

Fiscal year ending September 30.

 

 

Purchases of Equity Securities by the Issuer and Affiliated Persons

 

 

 

 

 

The following selected consolidated historical financial information for IES should be read in conjunction with the audited historical consolidated financial statements of Integrated Electrical Services, Inc. and subsidiaries, and the notes thereto, set forth in Item 8 to this Form 10-K.

 

 

The following discussion and analysis should be read in conjunction with our consolidated financial statements and the notes thereto, set forth in Item 8, “Financial Statements and Supplementary Data,” of this Form 10-K. For additional information, see “Disclosure Regarding Forward-Looking Statements” in Part I of this Form 10-K.

 

General

 

Recent Developments

 

Consistent with our strategy described in Item 1. “Business,” selected significant actions undertaken prior to and subsequent to our year ended September 30, 2009 include the following:

 

 

Basis of Presentation

 

We applied “fresh-start” accounting as of April 30, 2006. Under the provisions of fresh-start accounting, a new entity has been deemed created for financial reporting purposes. Fresh-start accounting requires us to allocate the reorganization value to our assets and liabilities in a manner similar to that which is required under Business Combinations accounting. References to “Successor” in Item 6. Selected Financial Data are in reference to reporting dates after April 30, 2006. References to “Predecessor” in Item 6. Selected Financial Data are in reference to reporting dates through April 30, 2006, including the impact of Plan provisions and the adoption of fresh-start reporting. As such, our financial information for the Successor is presented on a basis different from, and is therefore not comparable to, our financial information for the Predecessor for the period ended and as of April 30, 2006 or for prior periods.

 

Exit or Disposal Activities

 

In June 2007, we shut down our Mid-States Electric division, located in Jackson, Tennessee. Mid-States’ operating equipment was either transferred to other IES companies or sold to third parties. All project work was completed prior to closing Mid-States. Mid-States’ assets, liabilities and operating results for both the current and prior periods have been reclassified as discontinued operations.

 

In August 2008, we shut down our Haymaker division, located in Birmingham, Alabama. All project work was completed prior to closing Haymaker. Haymaker’s assets, liabilities, and operating results for both the current and prior periods have been classified as discontinued operations.

 

Remaining net working capital related to these divisions was zero and $1.5 million as of September 30, 2009 and 2008, respectively. As a result of inherent uncertainty in the exit plan and the monetization of these divisions’ working capital, we could experience additional losses of working capital.

 

Mid-States’ operations were shut down as of June 30, 2007. Haymaker’s operations where shut down as of August 31, 2008. Revenue for these subsidiaries totaled zero, $3.7 million and $11.5 million for the years ended September 30, 2009, 2008 and 2007, respectively.

Strategic Actions

 

The 2007 Restructuring Plan

 

During the 2008 fiscal year, we completed the restructuring of our operations from the previous geographic structure into three major lines of business: Commercial, Industrial and Residential. This operational restructuring (the “2007 Restructuring Plan”) was part of our long-term strategic plan to reduce our cost structure, reposition the business to better serve our customers, strengthen financial controls and, as a result, position us to implement a market-based growth strategy. The 2007 Restructuring Plan consolidated certain leadership roles, administrative support functions and eliminated redundant functions that were previously performed at 27 division locations. We recorded a total of $5.6 million of restructuring charges for the 2007 Restructuring Plan.

 

As part of the restructuring charges, we recognized $2.2 million, $0.5 million and $0.2 million in severance costs at our Commercial, Industrial and Residential segments, respectively. In addition to the severance costs described above, we incurred other charges of approximately $2.6 million predominately for consulting services associated with the 2007 Restructuring Plan and wrote off $0.1 million of leasehold improvements at an operating location that we closed.

 

The 2009 Restructuring Plan

 

In the first quarter of our 2009 fiscal year, we began a new restructuring program (the “2009 Restructuring Plan”) that was designed to consolidate operations within our three segments. The 2009 Restructuring Plan was the next level of our business optimization strategy. Our plan was to streamline local projects and support operations, which are managed through regional operating centers, and to capitalize on the investments we had made over the past year to further leverage our resources. We accelerated our trade name amortization during the 2009 fiscal year recording a charge of $1.6 million that has been identified within the “Restructuring Charges” caption in our consolidated statements of operations.

 

In addition, as a result of the continuing significant effects of the recession, during the third quarter of 2009 fiscal year we implemented a more expansive cost reduction program, by reducing additional administrative personnel, primarily in the corporate office and began consolidating our Commercial and Industrial back office functions into one service center. As part of this expanded 2009 Restructuring Plan, we expect to incur additional pre-tax restructuring charges, including severance benefits and facility consolidations and closings, of approximately $1.0 million to $2.0 million, which will be implemented over approximately 6 months.

 

During the twelve months ended September 30, 2009, we have incurred pre-tax restructuring charges, including severance benefits and facility consolidations and closings of $7.4 million associated with the 2009 Restructuring Plan, of which $1.2 million, $2.1 million, $2.7 million, and $1.4 million was charged to our Commercial, Industrial and Residential segments and our Corporate office, respectively.

 

Surety

 

Co-Surety Arrangement

 

We are party to that certain Underwriting, Continuing Indemnity and Security Agreement, dated May 12, 2006, as amended (the “Surety Agreement”), with one of our existing surety providers and certain of its affiliates (collectively, the “Initial Surety Provider”), which provides for surety bonds to support our contracts with certain of our customers. As of September 30, 2009, we had $292.3 million in aggregate face value of bonds insured under this bonding facility, and we had $75.7 million in bonded costs to complete under this facility. In April 2009, the Initial Surety Provider returned $10.0 million of this collateral to us. As of September 30, 2009, we maintained $4.6 million in cash collateral plus accrued interest with the Initial Surety Provider, as well as $11.0 million in letters of credit under the Surety Agreement.

 

Effective October 27, 2008, we entered into an amendment to our Surety Arrangement with the Initial Surety Provider and a second surety provider and certain of its affiliates (collectively, the “Co-Surety Provider”). This co-surety financing arrangement (the “Co-Surety Financing Arrangement”) provides for the Initial Surety

Provider and the Co-Surety Provider, at their sole and absolute discretion, to issue up to an aggregate of $325.0 million in new surety bonds. The bond premium is an average of $11.25 per one thousand dollars of contract cost for projects less than 24 months in duration, with additional surcharges for projects extending beyond 24 months. Each surety provider will assume 50% of the risk of each bond written.

 

In early December, 2009, our Co-Surety Provider agreed to increase our surety capacity by $25 million, from $325 million to $350 million. In addition, our Initial Surety Provider agreed to return $4.5 million in letters of credit being used as collateral.

 

We are also party to a General Agreement of Indemnity, dated March 21, 2006, as amended, with an individual surety (the “Individual Surety Provider”), to supplement the bonding capacity. Under this facility, the Individual Surety Provider has agreed to extend aggregate bonding capacity not to exceed $150.0 million in additional bonding capacity, with a limitation on individual bonds of $15.0 million. The bonds from the Individual Surety Provider are not rated (as opposed to those of our other surety providers); however, the issuance of these bonds to an obligee/contractor is backed by an instrument referred to as an irrevocable trust receipt issued by First Mountain Bancorp, as trustee, for investors who pledge assets to support the receipt and thus the bond. The bonds are also reinsured. The Individual Surety Provider’s obligation to issue new bonds is discretionary, and as of September 30, 2009, we maintained $2.0 million in letters of credit as collateral for the Individual Surety Provider. Bank of America, N.A. and the Individual Surety Provider have entered into an inter-creditor agreement. As of September 30, 2009, we had $18.6 million in aggregate face value of bonds issued under this bonding facility, and we had $0.2 million of bonded cost to complete under this facility.

 

Financing

 

The Tontine Capital Partners Term Loan

 

On December 12, 2007, we entered into a $25.0 million senior subordinated loan agreement (the “Tontine Term Loan”) with Tontine Capital Partners, L.P., a related party. The proceeds of the Tontine Term Loan, together with cash on hand, were used to fund the repayment of the Eton Park Term Loan (defined below). The Tontine Term Loan bears interest at 11.0% per annum and is due on May 15, 2013. Interest is payable quarterly in cash or in-kind at our option. Any interest paid in-kind will bear interest at 11.0% in addition to the loan principal. We may repay the Tontine Term Loan at any time prior to the maturity date at par, plus accrued interest without penalty. The Tontine Term Loan is subordinated to our existing Revolving Credit Facility (defined below) with Bank of America, N.A. The Tontine Term Loan is an unsecured obligation of the Company and its subsidiary borrowers. The Tontine Term Loan contains no financial covenants or restrictions on dividends or distributions to stockholders.

 

Camden Notes Payable

 

Insurance policies financed through Camden Premium Finance, Inc. (“Camden”), collectively referred to as the “Camden Notes”, consist of the following:

 

 

On August 1, 2008, we financed insurance policies with a note payable from Camden in the total initial principal amount of $4.6 million. During 2009, the balance of this note was paid off in two parts and the related insurance policies were cancelled at payoff. Concurrent with each cancellation, new insurance policies were issued, and new notes were executed with Camden.

The original $4.6 million note was to mature on July 1, 2010. Under the terms of this note, we were to make thirteen equal payments of $243,525 (including principal and interest) beginning September 1, 2008 until September 1, 2009, followed by ten equal payments of $167,589 (including principal and interest).

 

On April 1, 2009, the first policy cancellation and reissuance occurred together with the execution of a new note payable in the initial principal amount of $1.2 million. Under the terms of this note, we are to make fourteen equal payments of $91,595 (including principal and interest) beginning May 1, 2009 and ending on the June 1, 2010, maturity date.

 

On September 1, 2009, the second policy cancellation and reissuance occurred together with the execution of a new note payable in the initial principal amount of $2.1 million. Under the terms of this note, we are to make twenty three equal payments of $94,653 (including principal and interest) beginning October 1, 2009 and ending on the August 1, 2011, maturity date.

 

On March 1, 2009, we financed an additional insurance policy in the initial principal amount of $0.7 million with Camden, which matures on January 1, 2010. Under the terms of the note, we are to make ten equal payments of $69,409 (including principal and interest) beginning April 1, 2009.

 

The Camden Notes Payable are collateralized by the gross unearned premiums on the respective insurance policies plus any payments for losses claimed under the policies.

 

Capital Lease

 

The Company leases certain equipment under agreements classified as capital leases and is included in property, plant and equipment. Accumulated amortization of this equipment at September 30, 2009, 2008 and 2007 was $0.1, zero and zero, respectively, which is included in depreciation expense in the accompanying statements of operations.

 

The Revolving Credit Facility

 

On May 12, 2006, we entered into a Loan and Security Agreement (the “Loan and Security Agreement”), for a revolving credit facility (the “Revolving Credit Facility”) with Bank of America, N.A. and certain other lenders. On May 7, 2008, we renegotiated the terms of our Revolving Credit Facility and entered into an amended agreement with the same financial institutions. In May 2008 we incurred a $275,000 charge from Bank of America as a result of this amendment, of which $200,000 was classified as a prepaid expense and amortized over 12 months, and $75,000 was classified as a deferred financing fee and is being amortized over 24 months. The Loan and Security Agreement was most recently amended on August 13, 2008.

 

The Loan and Security Agreement, as amended, provides access to a Revolving Credit Facility with a maximum borrowing capacity of $60.0 million. At September 30, 2009, we had $21.2 million in outstanding letters of credit against the Revolving Credit Facility, no borrowings outstanding, and $15.7 million available under the Revolving Credit Facility.

 

The Revolving Credit Facility is guaranteed by our subsidiaries and secured by first priority liens on substantially all of our and our subsidiaries’ existing and future acquired assets, exclusive of collateral provided to our surety providers. The Revolving Credit Facility contains customary affirmative, negative and financial covenants. These were modified in conjunction with renewal and amendment of the Loan and Security Agreement on May 7, 2008. The financial covenants are described below in the section titled “Financial Covenants”. The Revolving Credit Facility also restricts us from paying cash dividends, and places limitations on our ability to repurchase our common stock. The maturity date of the Revolving Credit Facility is May 12, 2010.

 

The company plans to successfully negotiate a Credit Facility prior to the maturity date of its existing facility. In the event the company is unsuccessful, the company expects to have adequate cash on hand to fully collateralize our outstanding letters of credits and to provide sufficient cash for ongoing operations.

 

Under the terms of the Revolving Credit Facility as amended, through September 30, 2008, interest for loans was calculated at LIBOR plus 3.0%, or the lender’s prime rate (the “Base Rate”) plus 1.0%, and at 3.25% for

letter of credit fees. Thereafter, interest for loans and letter of credit fees is based on our total liquidity, which is calculated for any given period as the sum of average daily availability for such period plus average daily unrestricted cash on hand for such period, as shown in the following table.

 

 

At September 30, 2009, our total liquidity was $76.7 million. For the twelve months ended September 30, 2009, we paid no interest for loans, and a weighted average interest rate including fronting fees, of 3.3% for letters of credit.

 

In addition, we are charged monthly in arrears (i) an unused commitment fee of either 0.5% or 0.375%, depending on the utilization of the credit line, and (ii) certain other fees and charges as specified in the Loan and Security Agreement as amended. Finally, the Revolving Credit Facility is subject to termination charges of 0.25% of the aggregate borrowing capacity if such termination occurs on or after May 12, 2009 and before May 12, 2010.

 

Through May 9, 2008, loans under the Revolving Credit Facility bore interest at LIBOR plus 3.5% or the base rate plus 1.5% on the terms set in the Loan and Security Agreement. In addition, we were charged monthly in arrears (1) an unused line fee of either 0.5% or 0.375%, depending on the utilization of the credit line, (2) a letter of credit fee equal to the applicable per annum LIBOR margin times the amount of all outstanding letters of credit, and (3) certain other fees and charges as specified in the Loan and Security Agreement.

 

Financial Covenants

 

We are subject to the following financial covenant for the Revolving Credit Facility. As of September 30, 2009, we were in compliance with this covenant.

 

 

Two additional financial covenants for the Revolving Credit Facility are in effect any time the aggregate amount of unrestricted cash on hand plus availability is less than $50 million, until such time as the aggregate amount of unrestricted cash on hand plus availability has been $50 million for a period of 60 consecutive days. The first is a minimum Fixed Charge Coverage ratio of 1.25 to 1.00. The second is a maximum Leverage Ratio of 3.50 to 1.0. As of September 30, 2009, we would not have met either of these financial covenants, had they been applicable. As of September 30, 2008, we were in compliance with all of our financial covenants under the Revolving Credit Facility.

 

In the event we are not able to meet the financial covenants of our Revolving Credit Facility in the future, and are unsuccessful in obtaining a waiver from our lenders, the company expects to have adequate cash on hand to fully collateralize our outstanding letters of credits and to provide sufficient cash for ongoing operations.

 

The Eton Park / Flagg Street Term Loan

 

On May 12, 2006, we entered into a $53.0 million senior secured term loan (the “Eton Park Term Loan”) with Eton Park Fund L.P. and certain of its affiliates and Flagg Street Partners L.P. and certain of its affiliates to refinance $51.9 million in senior convertible notes then outstanding. On December 12, 2007, we terminated the Eton Park Term Loan by prepaying in full all outstanding principal and accrued interest on the loan. On the same day, we entered into the $25.0 million Tontine Term Loan, as described above. Along with a prepayment penalty of $2.1 million that was included in interest expense and accrued interest of $1.0 million,

the payoff amount under the Eton Park Term Loan was $48.7 million. We wrote off previously unamortized debt issuance costs of $0.3 million on the Eton Park Term Loan. Our weighted average interest rate under the Eton Park Term Loan was 10.75% for the period from October 1, 2007 to December 12, 2007.

 

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 as of the date the consolidated financial statements are published and the reported amounts of revenues and expenses recognized during the periods presented. We review all significant estimates affecting our consolidated financial statements on a recurring basis and record the effect of any necessary adjustments prior to their publication. Judgments and estimates are based on our 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. There can be no assurance that actual results will not differ from those estimates.

 

Accordingly, we have identified the accounting principles, which we believe are most critical to our reported financial status by considering accounting policies that involve the most complex or subjective decisions or assessments. We identified our most critical accounting policies to be those related to revenue recognition, the assessment of goodwill and asset impairment, our allowance for doubtful accounts receivable, the recording of our self-insurance liabilities and estimation of the valuation allowance for deferred tax assets. These accounting policies, as well as others, are described in Note 2 of our consolidated financial statements, set forth in Item 8 of this Form 10-K, and at relevant sections in this discussion and analysis.

 

Revenue Recognition. We enter into contracts principally on the basis of competitive bids. We frequently negotiate the final terms and prices of those contracts with the customer. Although the terms of our contracts vary considerably, most are made on either a fixed price or unit price basis in which we agree to do the work for a fixed amount for the entire project (fixed price) or for units of work performed (unit price). We also perform services on a cost-plus or time and materials basis. We currently generate, and expect to continue to generate, more than half of our revenues under fixed price contracts. Our most significant cost drivers are the cost of labor, the cost of materials and the cost of casualty and health insurance. These costs may vary from the costs we originally estimated. Variations from estimated contract costs along with other risks inherent in performing fixed price and unit price contracts may result in actual revenue and gross profits or interim projected revenue and gross profits for a project differing from those we originally estimated and could result in losses on projects. Depending on the size of a particular project, variations from estimated project costs could have a significant impact on our operating results for any fiscal quarter or year. We believe our exposure to losses on fixed price contracts is limited in aggregate by the high volume and relatively short duration of the fixed price contracts we undertake.

 

We complete most of our projects within one year. We frequently provide service and maintenance work under open-ended, unit price master service agreements which are renewable annually. We recognize revenue on service, time and material work when services are performed. Work performed under a construction contract generally provides that the customers accept completion of progress to date and compensate us for services rendered, measured in terms of units installed, hours expended or some other measure of progress. Revenues from construction contracts are recognized on the percentage-of-completion method. The percentage-of-completion method for construction contracts is measured principally by the percentage of costs incurred and accrued to date for each contract to the estimated total costs for each contract at completion. We generally consider contracts substantially complete upon departure from the work site and acceptance by the customer. Contract costs include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation costs. Changes in job performance, job conditions, estimated contract costs, profitability and final contract settlements may result in revisions to costs and income, and the effects of such revisions are recognized in the period in which the

revisions are determined. Provisions for total estimated losses on uncompleted contracts are made in the period in which such losses are determined.

 

Valuation of Intangibles and Long-Lived Assets. We evaluate goodwill for potential impairment at least annually at year end, however, if impairment indicators exist, we will evaluate as needed. Included in this evaluation are certain assumptions and estimates to determine the fair values of reporting units such as estimates of future cash flows and discount rates, as well as assumptions and estimates related to the valuation of other identified intangible assets. Changes in these assumptions and estimates or significant changes to the market value of our common stock could materially impact our results of operations or financial position. We did not record goodwill impairment during the years ended September 30, 2009, 2008 and 2007.

 

We assess impairment indicators related to long-lived assets and intangible assets at least annually at year end. If we determine impairment indicators exist, we conduct an evaluation to determine whether any impairment has occurred. This evaluation includes certain assumptions and estimates to determine fair value of asset groups, including estimates about future cash flows and discount rates, among others. Changes in these assumptions and estimates or significant changes to the market value of our common stock could materially impact our results of operations or financial projections.

 

Current and Non-Current Accounts and Notes Receivable and Provision for Doubtful Accounts. We provide an allowance for doubtful accounts for unknown collection issues, in addition to reserves for specific accounts receivable where collection is considered doubtful. Inherent in the assessment of the allowance for doubtful accounts are certain judgments and estimates including, among others, our customers’ access to capital, our customers’ willingness to pay, general economic conditions, and the ongoing relationships with our customers. In addition to these factors, the method of accounting for construction contracts requires the review and analysis of not only the net receivables, but also the amount of billings in excess of costs and costs in excess of billings. The analysis management utilizes to assess collectability of our receivables includes detailed review of older balances, analysis of days sales outstanding where we include in the calculation, in addition to accounts receivable balances net of any allowance for doubtful accounts, the level of costs in excess of billings netted against billings in excess of costs, and the ratio of accounts receivable, net of any allowance for doubtful accounts plus the level of costs in excess of billings, to revenues. These analyses provide an indication of those amounts billed ahead or behind the recognition of revenue on our construction contracts and are important to consider in understanding the operational cash flows related to our revenue cycle.

 

Self-Insurance. We are insured for workers’ compensation, automobile liability, general liability, construction defects, employment practices and employee-related health care claims, subject to deductibles. Our general liability program provides coverage for bodily injury and property damage. Losses up to the deductible amounts are accrued based upon our estimates of the liability for claims incurred and an estimate of claims incurred but not reported. The accruals are derived from actuarial studies, known facts, historical trends and industry averages utilizing the assistance of an actuary to determine the best estimate of the ultimate expected loss. We believe such accruals to be adequate; however, self-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 incurred but not reported and the effectiveness of our safety program. Therefore, if actual experience differs from the assumptions used in the actuarial valuation, adjustments to the reserve may be required and would be recorded in the period that the experience becomes known.

 

Valuation Allowance for Deferred Tax Assets. We regularly evaluate valuation allowances established for deferred tax assets for which future realization is uncertain. We perform this evaluation at least annually at the end of each fiscal year. The estimation of required valuation allowances includes estimates of future taxable income. In assessing the realizability of deferred tax assets at September 30, 2009, we considered that it was more likely than not that some or all of the deferred tax assets would not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.

Income Taxes

 

Effective October 1, 2007, a new methodology by which a company must identify, recognize, measure and disclose in its financial statements the effects of any uncertain tax return reporting positions that a company has taken or expects to take was required under generally accepted accounting principles (“GAAP”). GAAP requires financial statement reporting of the expected future tax consequences of uncertain tax return reporting positions on the presumption that all relevant tax authorities possess full knowledge of those tax reporting positions, as well as all of the pertinent facts and circumstances, but it prohibits discounting of any of the related tax effects for the time value of money.

 

The evaluation of a tax position is a two-step process. The first step is the recognition process to determine if it is more likely than not that a tax position will be sustained upon examination by the appropriate taxing authority, based on the technical merits of the position. The second step is a measurement process whereby a tax position that meets the more likely than not recognition threshold is calculated to determine the amount of benefit/expense to recognize in the financial statements. The tax position is measured at the largest amount of benefit/expense that is more likely than not of being realized upon ultimate settlement.

 

In December 2007, the Financial Accounting Standards Board, (“FASB”) issued updated standards on business combinations and accounting and reporting of noncontrolling interests in consolidated financial statements. Beginning October 1, 2009, with the adoption of the updates, reductions in the valuation allowance and contingent tax liabilities attributable to all periods, if any should occur, will be recorded as an adjustment to income tax expense. We believe the impact of the change will be significant.

 

We recognize interest and penalties related to unrecognized tax benefits as part of the provision for income taxes. Upon the adoption of the new methodology effective October 1, 2007, we had approximately $0.4 million in accrued interest and penalties included in liabilities for unrecognized tax benefits. The accrued interest and penalties are a component of “Other Non-Current Liabilities” in our consolidated balance sheet. The reversal of the accrued interest and penalties would result in a $0.2 million adjustment that would first go to reduce goodwill, then intangible assets and then additional paid-in capital. The remaining $0.2 million would result in a decrease in the provision for income tax expense.

 

We are currently not under federal audit by the Internal Revenue Service. The tax years ended September 30, 2006 and forward are subject to audit as are tax years prior to September 30, 2006, to the extent of unutilized net operating losses generated in those years. Currently, one of our business units is under a state audit for the tax years ended September 30, 2002, 2003 and 2005.

 

We anticipate that approximately $0.1 million of liabilities for unrecognized tax benefits, including accrued interest, may be reversed in the next twelve months. This reversal is predominately due to the expiration of the statues of limitation for unrecognized tax benefits and the settlement of a state audit.

 

New Accounting Pronouncements. Newly adopted accounting policies are described in Note 2 of our consolidated financial statements, set forth in Item 8 of this Form 10-K, and at relevant sections in this discussion and analysis.

 

Results of Operations

 

We report our operating results across three operating segments: Commercial, Industrial and Residential. Expenses associated with our Corporate office are classified as a fourth segment. Presently, each of our 27 former divisions is classified into one of these three segments based on the primary market that division serves, and all of the operating activity of that division is considered part of that segment’s operating results, regardless of the nature of the work. In previous years, we allocated earnings according to the nature of the service provided; therefore, a division that served more than one customer group allocated its earnings according to the volume of services it provided each segment. In order to be consistent with our current three operating segments approach, we have reclassified our 2007 year earnings. This reclassification does not have any effect on our consolidated financial statements.

The following table presents selected historical results of operations of IES and subsidiaries (in millions).

 

 

YEAR ENDED SEPTEMBER 30, 2009 COMPARED TO YEAR
ENDED SEPTEMBER 30, 2008

 

Revenues

 

 

Consolidated revenues for the year ended September 30, 2009 were $152.3 million less than the fiscal year ended September 30, 2008, a decline of 18.6%. Each of our three business segments experienced declines in construction activity during the period, primarily due to the very challenging economic environment where a nationwide decline in construction activity has occurred.

 

Revenues in our Commercial segment decreased $53.4 million during the year ended September 30, 2009, an 11.3% decline compared to the year ended September 30, 2008. Many of our Commercial operating locations experienced revenue shortfalls, as most industry sectors have begun to reduce, delay or cancel proposed construction projects, including high rise office towers, hotels, condominiums and casinos, as a result of the recession and tight credit markets. We have also experienced increased competition from residential contractors who have been affected by the housing slowdown for less specialized retail work with lower barriers to entry, such as restaurants, movie theaters and local shopping centers, which could be correlated to

the slowdown in the housing sector. The revenue declines have been most notably experienced in our Florida market, due to the strong ties to hospitality and condominium projects. Despite national trends to the contrary, four of our Commercial business units experienced significant revenue increases that partially offset this revenue decline. These business units were located in the northeastern and western regions of the country. We attribute these increases in part to progress in implementing our business development strategy in these regions and mature customer relationships.

 

Our Industrial segment posted a decrease in revenues of $41.4 million during the year ended September 30, 2009, a decrease of 31.9% as compared to the year ended September 30, 2008. The key factor in our revenue decline during the period was significantly decreased construction activity at electrical substations, ethanol plants, and pulp and paper mills, as many projects were deferred, cancelled or are awaiting financing due to the challenging economic environment. In addition, there were no hurricane disaster recovery services that occurred during 2009, as no major hurricanes impacted the United States as compared to the activity experienced during 2008. Revenues were also negatively impacted by a decrease in electric power distribution services and other electric power infrastructure service revenues, primarily from reduced service work and capital spending by our customers.

 

Our Residential segment revenues decreased $57.5 million during the year ended September 30, 2009, a decrease of 26.7% as compared to the year ended September 30, 2008. This decrease is primarily attributable to the nationwide decline in demand for single-family homes, particularly in markets such as Southern California, Arizona, Nevada, Texas and Georgia. We attribute the majority of this decrease directly to reduced building activity, while the remainder is mainly due to pricing pressure from our customers and increased competition. This revenue decline was partially offset by increased revenue from our multi-family housing division due to increased demand for apartments.

 

Gross Profit

 

 

The $22.4 million decrease in our consolidated gross profit for the fiscal year ended September 30, 2009, as compared to the fiscal year ended September 30, 2008, was primarily the result of lower consolidated revenues, as discussed above. Our overall gross profit percentage, however, increased to 16.4% during the year ended September 30, 2009 versus 16.1% during the year ended September 30, 2008. This increase was due to improved margins in the Commercial and Residential segments, offset by a decline of the gross margin percentage in the Industrial segment.

 

Our Commercial segment’s gross profit decreased $6.4 million during the year ended September 30, 2009, as compared to the year ended September 30, 2008, driven primarily by $53.4 million reduction in revenue. In spite of the revenue decline, the Commercial segment’s gross margin percentage of revenues improved to 14.4% during the year ended September 30, 2009, as compared to 14.1% from the prior year. The improvement in gross margin percentage reflects improved project execution as well as a decrease in materials pricing, resulting in fewer projects with losses. This is primarily due to a combination of enhanced cost controls and increased profitability on jobs awarded due to the project management operating system initiative implemented in the past year. In addition, gross profit was negatively impacted during the year ended September 30, 2009, by the settlement of a legal dispute totaling $2.1 million, which originated from a project in 2005.

 

Gross profit at our Industrial segment declined $9.8 million during the year ended September 30, 2009 as compared to the year ended September 30, 2008. The decrease in gross profit in our Industrial segment is

primarily a result of the aforementioned reduced revenue of $41.4 million, largely due to lower volume of petrochemical and utility projects, as well as a dramatically lower volume of pulp and paper related projects. During the year ended September 30, 2009, Industrial’s gross margin percentage declined from approximately 16.9% as of September 30, 2008 to approximately 13.7%, primarily as a result of reduced volumes and in part due to mix of lower margin work being performed during 2009. The project mix in 2008 included several large time and material projects with considerably higher margins.

 

During the year ended September 30, 2009, our Residential segment experienced a $6.1 million reduction in gross profit as compared to the year ended September 30, 2008. This decline is due to the previously mentioned $57.5 million decrease in revenues during the period caused by reduced demand for single-family housing across the United States. However, the gross margin percentage in the Residential segment improved approximately 340 basis points during the 2009 fiscal year. We attribute the improvement in the Residential segment gross margin percentage to improved execution in multi-family and to a greater mix of higher margin multifamily projects when compared to the single family construction activities. In addition to improved profitability at our multifamily housing division, we also benefited from a stabilization of material costs and the ability to increase and decrease labor to meet project demands.

 

Selling, General and Administrative Expenses

 

 

Selling, general and administrative expenses include costs not directly associated with performing work for our customers. These costs consist primarily of compensation and benefits related to corporate and division management, occupancy and utilities, training, professional services, information technology costs, consulting fees, travel and certain types of depreciation and amortization.

 

During the year ended September 30, 2009, our selling, general and administrative expenses were $108.3 million, a decrease of $10.8 million, or 9.1%, as compared to the year ended September 30, 2008. This decrease was primarily due to our continued strategic efforts to restructure our operations and to eliminate redundant positions and facilities. The decrease in expenses for the fiscal year ended September 30, 2009 was primarily due to (1) a $12.4 million decrease in employment costs, (2) $1.2 million reduction in occupancy costs, and (3) a decrease in other general business and other expenses of approximately $1.1 million primarily at our divisions. The decrease in selling, general, and administrative expenses for year ended September 30, 2009 were partially offset by (1) an increase of $2.0 million in temporary support labor, in lieu of full time hires, and other increased spending related to providing support for the new software systems and outsourcing of payroll processes implemented during 2008, (2) ongoing legal costs and the settlement of legal disputes of approximately $1.9 million, and (3) $0.4 million in severance costs which were not included in restructuring charges.

 

As previously indicated, we have been focused on restructuring the business since 2007, whereby we integrated 27 companies into three business segments and we have significantly streamlined back office and operations support activities since this time. As a result, during the year ended September 30, 2009, we experienced a net $12.0 million, or a 15.1% reduction in our combined Commercial, Industrial and Residential selling, general and administrative expenses, compared to the prior year ended September 30, 2008, while our Corporate selling, general and administrative expenses have somewhat increased as a result of our investments in systems and various consolidation of services which have yielded efficiencies throughout the business. During 2009, we began to leverage our new software programs and work processes implemented during late

2008 which include (1) a comprehensive project management operating system now being utilized across our divisions to standardize our project management and reporting processes and provide our businesses up-to-date visibility into project performance, (2) an accounting consolidation and reporting system which supplies management more timely financial data and improved transparency, and (3) an outsourced payroll solution that utilizes more real time workers labor application technologies and employed technology to capture current labor utilization. In addition, we have invested in new sales capabilities to accelerate our target market growth strategy.

 

Restructuring Charges

 

As discussed previously in this report, we restructured our operations from a decentralized structure into three major lines of business: Commercial, Industrial and Residential. These lines of business are supported by two dedicated administrative shared service centers which has consolidated many of the back office functions into centralized locations. In addition, the next level of our business optimization strategy has been to streamline local projects and support operations, which will be managed through regional operating centers, and to capitalize on the investments we made over the past two years to further leverage our resources. Further, we have implemented a more enhanced cost reduction program during 2009, as a result of the continuing effects of the recession, by reducing additional administrative personnel, primarily at our corporate office, and began consolidating our Commercial and Industrial segments into one operational unit.

 

In conjunction with our restructuring program we recognized the following costs during the years ended September 30, 2009 and 2008 (in thousands)

 

 

Interest and Other Expense, net

 

 

During the year ended September 30, 2009, we incurred interest expense of $4.3 million on an average debt balance of $29.0 million primarily comprised of the Tontine Term Loan and the Camden Notes Payable, an average letter of credit balance of $28.9 million under the Revolving Credit Facility and an average unused line of credit balance of $31.1 million. This compares to interest expense of $4.8 million for the year ended September 30, 2008, on an average debt balance of $29.4 million for the Tontine Term Loan and the Eton

Park Term Loan, an average letter of credit balance of $37.9 million under the Revolving Credit Facility and an average unused line of credit balance of $34.4 million.

 

As previously mentioned in this report, we repaid our Eton Park Term Loan on December 12, 2007, using cash on hand and the proceeds from the Tontine Term Loan. We incurred a prepayment penalty of $2.1 million on the Eton Park Term Loan, and we recognized previously unamortized debt issuance costs of $0.3 million. In addition, we also recorded $1.8 million of deferred financing charges during the year ended September 30, 2008. These deferred financing charges reflect the amortization of fees incurred on the Tontine Term Loan and the Eton Park Term Loan before it was repaid.

 

For the fiscal years ended September 30, 2009 and 2008, we earned interest income of $0.4 and $2.1 million, respectively, on the average Cash and Cash Equivalents balances of $60.8 million and $70.3 million, respectively.

 

During the year ended September 30, 2009, other expense of $1.6 million included a $2.9 million impairment of our investment in EPV Solar, Inc. (“EPV”), formerly Energy Photovoltaics, Inc. This was partially offset by adjustments to our Executive Savings Plan balance totaling $0.8 million. The remaining $0.3 million primarily relates to administrative fee income received throughout the year in a Commercial operating unit. For the year ended September 30, 2008, other income of $0.9 million included a $1.1 million settlement with a group of former employees, out of which $0.4 million was recorded as a reduction against legal fees and the remainder as other income. This settlement was to compensate the Company for damages resulting from these employees’ departure from the Company. We collected this settlement in full in March 2008.

 

Provision for Income Taxes

 

Our effective tax rate from continuing operations decreased from 92.1% for year ended September 30, 2008 to (4.3)% for the year ended September 30, 2009. The decrease is attributable to a decrease in pretax net income resulting in a 70.3% reduction in the rate, an increase in additional valuation allowances against certain state and federal deferred tax assets, resulting in a 31.9% decrease in the rate, and is offset by a decrease in permanent tax difference resulting in a 3.7% increase in the rate and other adjustments, resulting in a 2.1% increase in the rate.

 

Income (Loss) from Discontinued Operations

 

As discussed earlier in this report, since March 2006, we have shut down seven underperforming subsidiaries. Our exit plan is substantially complete. Such income statement amounts are classified as discontinued operations.

 

Revenues at these subsidiaries were zero and $3.7 million, respectively, for the years ended September 30, 2009 and 2008; net income (loss) at these subsidiaries was $0.2 million and $0.4 million, respectively, during these same periods.

 

YEAR ENDED SEPTEMBER 30, 2008 COMPARED TO YEAR

ENDED SEPTEMBER 30, 2007

 

Revenues

 

Consolidated revenues for the year ended September 30, 2008 were $72.0 million less than the year ended September 30, 2007, a decline of 8.1%. This reduction was primarily attributed to the nationwide decline in demand for single-family homes which has affected our Residential line of business, particularly in markets such as Southern California, Arizona, Georgia, Nevada and Texas. Consistent with the slowdown in housing construction, Residential revenues decreased $93.6 million during the year ended September 30, 2008, down 30.3% as compared to the year ended September 30, 2007. We attribute approximately three quarters of this decrease to reductions in building activity throughout many of the markets we serve, while the remaining portion of the decrease was attributable to the effect of lower prices in response to the competitive market conditions and falling input prices, which effect the prices that we may then pass then along to our customers.

 

Revenues in our Commercial segment increased $13.4 million during the year ended September 30, 2008, a 2.9% improvement compared to the year ended September 30, 2007. Our Commercial segment has benefited from our selectivity and an increased focus on large-scale projects that we have begun for institutional developers, including universities, high-rise office towers, data communication and data centers. Partially offsetting the overall increase in revenues was reduced demand for light construction projects such as restaurants, movie theaters and local shopping centers, which was correlated to the slowdown in the housing sector. We have also experienced increased competition from residential contractors who have been affected by the housing slowdown for less specialized retail work with lower barriers to entry.

 

Our Industrial segment posted an increase in revenues of $8.2 million during the year ended September 30, 2008, an increase of 6.7% as compared to the year ended September 30, 2007. The Industrial market generally has longer cycles than the rest of the construction industry due to the nature of the projects, which are often large-scale, multi-year contracts, financed by large corporations or government agencies. As such, many of these customers are better insulated from the market conditions that have affected our overall operating results. During the year ended September 30, 2008, our Industrial segment has seen growth in transmission and distribution service projects, including hurricane disaster recovery, as well as increased construction at electrical substations, ethanol plants and pulp and paper mills.

 

Gross Profit

 

 

The $13.0 million decrease in our consolidated gross profit for the year ended September 30, 2008, as compared to the year ended September 30, 2007, was the result of lower consolidated revenues, as discussed above. Our overall gross profit percentage decreased slightly to 16.1% during the year ended September 30, 2008 versus 16.3% during the year ended September 30, 2007.

 

During the year ended September 30, 2008, our Residential segment experienced a $14.3 million reduction in gross profit as compared to the year ended September 30, 2007. This decline resulted from the aforementioned $93.6 million decrease in revenues related to the reduction in demand for single-family homes. However, the gross margin percentage in the Residential segment improved approximately 140 basis points during the 2008 fiscal year in spite of the revenue declines. We attribute much of the improvement in the Residential gross margin to improved execution in our multi-family division, where our average gross margin is nearly 25% compared to single-family housing where our average gross margin is approximately 18%. In addition to improved profitability at our multi-family housing division, we also benefited from a stabilization of material costs and the ability to increase and decrease labor to meet project demands.

 

Our Commercial segment’s gross profit increased $0.7 million during the year ended September 30, 2008, as compared to the year ended September 30, 2007, driven primarily by $13.4 million of additional revenue,

slightly offset by a 20 basis point decrease in gross margin during the 2008 fiscal year. Although we did have some higher input and fuel costs which reduced our margins, we were able to offset nearly all of the impact of those items through improvements in our overall project execution, which resulted from better project management, increased focus on selectivity, and the winding down of underperforming legacy projects primarily at two of our divisions.

 

Gross profit at our Industrial segment improved $0.6 million during the year ended September 30, 2008 as compared to the year ended September 30, 2007. The improved gross profit in our Industrial sector was correlated to higher project volumes which resulted in an $8.2 million increase in revenue during the 2008 fiscal year. Although revenues have increased, Industrial’s overall gross margin percentage declined approximately 70 basis points during the same period primarily as a result of an increase in time and material projects that have a lower fixed margin. Also affecting profit margin during the year ended September 30, 2008 was the increase in certain operating costs, notably transportation expenses, and the completion of several older low margin jobs during the year.

 

Selling, General and Administrative Expenses

 

 

Selling, general and administrative expenses include costs not directly associated with performing work for our customers. These costs consist primarily of compensation and benefits related to corporate and division management, occupancy and utilities, training, professional services, consulting fees, travel and certain types of depreciation and amortization.

 

During the year ended September 30, 2008, our selling, general and administrative expenses were $119.1 million, a decrease of $17.9 million, or 13.1%, as compared to the year ended September 30, 2007. This decrease was due primarily to our strategic efforts to restructure our operations and to eliminate redundant positions and facilities. Since our restructuring program began we have eliminated approximately 160 positions. In addition, we have also been able to reduce many of our professional fees as we have improved our operating and financial controls and completed many of our turnaround efforts. Notable declines in our selling, general and administrative costs during the 2008 fiscal year as compared to the 2007 fiscal year, include: (i) a $9.7 million reduction in professional fees, including legal, consulting and accounting fees, (ii) a $6.6 million decrease in target incentives for our division leadership, (iii) a $1.1 million reduction in occupancy costs, and (iv) a $0.7 million reduction in general business and other expenses at our divisions.

 

Restructuring Charges

 

As discussed previously in this report, we have restructured our operations from our previously decentralized structure into three major lines of business: Commercial, Industrial and Residential. Each of these lines of business is now supported by its own dedicated administrative shared services center which has consolidated many of the back office functions into a centralized location. This integration has enabled us to eliminate a number of redundant functions.

In conjunction with our restructuring program we recognized the following costs during the years ended September 30, 2008 and 2007 (in thousands)

 

 

Interest and Other Expense, net

 

 

During the year ended September 30, 2008, we incurred interest expense of $4.8 million on an average debt balance of $29.4 million for the Tontine Term Loan and the Eton Park Term Loan, an average letter of credit balance of $37.9 million under the Revolving Credit Facility and an average unused line of credit balance of $34.4 million. We also incurred $35,000 interest expense on the $4.6 million Camden Note Payable we entered in August 2008. This compares to interest expense of $8.2 million for the year ended September 30, 2007, on an average debt balance of $52.5 million for the Eton Park Term Loan, an average letter of credit balance of $45.9 million under the Revolving Credit Facility and an average unused line of credit balance of $34.1 million.

 

As mentioned earlier in this report, on December 12, 2007, we repaid our Eton Park Term Loan using cash on hand and the proceeds from the Tontine Term Loan. We incurred a prepayment penalty of $2.1 million on the Eton Park Term Loan, and we recognized previously unamortized debt issuance costs of $0.3 million. During the year ended September 30, 2008, we also recorded $1.8 million of deferred financing charges, which reflect the amortization of fees incurred on the Tontine Term Loan and the Eton Park Term Loan before it was repaid. During the year ended September 30, 2007, we had deferred financing charges of $1.3 million, which reflect the amortization of fees incurred on the Eton Park Term Loan, and we incurred a debt prepayment penalty of $0.7 million on the Eton Park Term Loan.

 

During the year ended September 30, 2008, total interest expense was offset by $2.1 million in interest income on an average cash and cash equivalents balance of $70.3 million, as compared to $4.2 million in interest income on an average cash and cash equivalents balance of $91.7 million during the year ended September 30, 2007.

 

During the year ended September 30, 2008, other income of $0.9 million included a $1.1 million settlement with a group of former employees, out of which $0.4 million was recorded as a reduction against legal fees and the remainder as other income. This settlement was to compensate the Company for damages resulting from these employees’ departure from the Company. We collected this settlement in full in March 2008.

Provision for Income Taxes

 

Our effective tax rate from continuing operations decreased from 135.8% for year ended September 30, 2007 to 92.1% for the year ended September 30, 2008. The decrease is attributable to an increase in pretax net income resulting in a 39.9% reduction in the rate, a decrease in contingent tax liabilities resulting in a 8.1% decrease in the rate, and an increase in additional valuation allowances against certain state and federal deferred tax assets, resulting in a 17.6% decrease in the rate, and is offset by additional deferred tax assets incurred as a result of the enactment of the Texas Margins Tax, resulting in a 23.5% increase in the rate, and other adjustments, resulting in a 1.6% decrease in the rate.

 

Income (Loss) from Discontinued Operations

 

As discussed earlier in this report, since March 2006, we have shut down seven underperforming subsidiaries. Our exit plan is substantially complete. Such income statement amounts are classified as discontinued operations.

 

Revenues at these subsidiaries were $3.7 million and $11.5 million, respectively, for the years ended September 30, 2008 and 2007; net loss at these subsidiaries was $0.4 million and $3.8 million, respectively, during these same periods.

 

Cost Drivers

 

As a service business, our cost structure is highly variable. Our primary costs include labor, materials and insurance. For our 2009 fiscal year, costs derived from labor and related expenses accounted for 42% of our total costs. Our labor-related expenses totaled $230.6 million, $283.9 million and $303.9 million for the years ended September 30, 2009, 2008 and 2007, respectively. As of September 30, 2009, we had 3,504 full-time employees, of which 2,669 employees were field electricians, the number of which fluctuates depending upon the number and size of the projects undertaken by us at any particular time. The remaining 835 employees were project managers, job superintendents and administrative and management personnel, including executive officers, estimators or engineers, office staff and clerical personnel. We provide a health, welfare and benefit plan for all employees subject to eligibility requirements. We have a 401(k) plan pursuant to which eligible employees may contribute through a payroll deduction. We have suspended company matching cash contributions to employee’s contribution due to the significant impact the recession has had on the company’s financial performance.

 

For our 2009 fiscal year, costs incurred for materials installed on projects accounted for 47% of our total costs. This component of our expense structure is variable based on the demand for our services and material pricing. We generally incur costs for materials once we begin work on a project. We generally order materials when needed, ship those materials directly to the jobsite, and complete the installation within 30 days. Materials primarily consist of commodity-based items such as conduit, wire and fuses as well as specialty items such as fixtures, switchgear and control panels. Our materials expenses totaled $258.1 million, $329.7 million, and $397.7 million for the years ended September 30, 2009, 2008 and 2007, respectively.

 

We are insured for workers’ compensation, employer’s liability, auto liability, general liability and health insurance, subject to deductibles. Losses up to the deductible amounts are accrued based upon actuarial studies and our 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.

 

Discontinued Operations

 

Exit or Disposal Activities

 

In June 2007, we determined that our Mid-States Electric division, located in Jackson, Tennessee, would also be shut down. Mid-States’ operating equipment was either transferred to other IES companies or sold to third parties, and all project work was completed prior to closing the company.

In August 2008, we determined that our Haymaker division, located in Birmingham, Alabama, would be shut down. Haymaker’s operating equipment was either transferred to other IES companies or sold to third parties, and all project work was completed prior to closing the company.

 

Summary of Discontinued Operations

 

The discontinued operations disclosures include only those identified subsidiaries qualifying for discontinued operations treatment for the periods presented. Summarized operating results for all discontinued operations are outlined below (in thousands):

 

 

Working Capital

 

 

During the year ended September 30, 2009, working capital decreased by $5.6 million as compared to September 30, 2008, reflecting a $42.8 million decrease in current assets and a $37.3 million decrease in current liabilities during the period.

 

During the year ended September 30, 2009, our current assets decreased by $42.8 million, or 16.2%, to $221.3 million, as compared to $264.1 million as of September 30, 2008. Cash and cash equivalents decreased by $.5 million during the year ended September 30, 2009, as compared to September 30, 2008. Current trade accounts receivables, net, decreased by $31.5 million at September 30, 2009, as compared to September 30, 2008, as days sales outstanding (“DSOs”) increased to 72 days as of September 30, 2009, from 63 days as of September 30, 2008, and we transferred a $3.7 million receivable to long-term receivables during the period. While our DSOs increased from 63 to 72 between September 30, 2008 and September 30, 2009, our balance

of trade receivables declined by approximately 23.8% during the same period. The increase in DSOs between September 30, 2008 and September 30, 2009 was driven predominantly by the decline in revenues that we experienced during the year ended September 30, 2009, as compared to the year ended September 30, 2008 and, to a lesser extent, slow-downs in receipt of certain customer payments, both of which we attribute to distressed financial markets and the challenging economic environment. Additionally, it should be noted that historically our receivables write-offs have been low as a result of our ability to secure liens against our customers’ over-due receivables, and while this process of collection may not occur quickly, our secured position does ensure that it will occur eventually to the extent that our security retains value. In light of these impacts of the volatility in the current financial markets, we will continue to closely monitor the collectability of our receivables in the months ahead. We also experienced a $4.3 million and $1.2 million decrease in retainage and costs in excess of billings during the year ended September 30, 2009, compared to September 30, 2008, respectively, reflecting the slowdown in construction activity related to the current economic conditions. Inventories decreased by $2.7 million during the year ended September 30, 2009, compared to September 30, 2008, reflecting lower volumes plus the continued success of our strategic efforts to better manage our supply chain through utilization of just-in-time systems, improved material management and a vendor managed inventory strategy. Prepaid expenses and other current assets decreased by a total of $0.6 million and assets from discontinued operations decreased by $2.0 million during the year ended September 30, 2009, compared to September 30, 2008.

 

During the year ended September 30, 2009, our total current liabilities decreased by $37.3 million, to $99.7 million, compared to $137.0 million as of September 30, 2008. During the year ended September 30, 2009, accounts payable and accrued expenses decreased $23.4 million as a result of lower volume, early pay discounts associated with our Preferred Vendor Program and our cash management efforts at the end of our 2009 fiscal year. Billings in excess of costs decreased by $12.6 million during the year ended September 30, 2009, compared to September 30, 2008, primarily due to reduced volumes and in part due to a change in project mix. Finally, current maturities of long-term debt decreased by $0.8 million and liabilities on assets held for sale decreased by $0.5 million during the year ended September 30, 2009, compared to September 30, 2008.

 

Liquidity and Capital Resources

 

As of September 30, 2009, we had cash and cash equivalents of $64.2 million, working capital of $121.6 million, $25.0 million in outstanding borrowings under our Tontine Term Loan and $21.4 million of letters of credit outstanding and $15.7 million of available capacity under our Revolving Credit Facility. We anticipate that the combination of cash on hand, cash flows and available capacity under our Revolving Credit Facility will provide sufficient cash to enable us to meet our working capital needs, debt service requirements, capital expenditures for property and equipment, and our share buy back through the next twelve months. Our ability to generate cash flow is dependent on many other factors, including demand for our services, the availability of projects at margins acceptable to us, the ultimate collectability of our receivables, and our ability to borrow on our credit facility, if needed.

 

Recent distress in the financial markets did not have a significant impact on our overall financial position as of and for the year ended September 30, 2008, although certain of our operations revenue were impacted during the year ended September 30, 2009, as a result of the challenging economic environment. We are in compliance with our covenants under our Revolving Credit Facility at September 30, 2009. However, we continue to closely monitor the financial markets and general national and global economic conditions. To date, we have experienced no loss or lack of access to our invested cash or cash equivalents; however, we can provide no assurances that access to our invested cash and cash equivalents will not be impacted in the future by adverse conditions in the financial markets.

 

Operating Activities

 

Our cash flow from operations is primarily influenced by cyclicality, demand for our services, operating margins and the type of services we provide but can also be influenced by working capital needs such as the timing of our receivable collections. Working capital needs are generally higher during our fiscal third and fourth quarters due to increased services as a result of favorable weather conditions in many regions of the

country. Operating activities provided net cash of $10.8 million during the year ended September 30, 2009, as compared to $14.6 million of net cash provided in the year ended September 30, 2008, resulting in net operating cash used of $3.8 million. The decrease in operating cash flows in 2009 is primarily due to reduced cash earnings of approximately $12.1 million as a result of lower net income, partially offset by lower working capital needs and discontinued operations activities of approximately $5.6 million. The improvement in working capital is principally due to reduced volumes, improved collections of accounts receivable, lower inventory, and a reduction in retainage of totalling approximately $42.3 million, partially offset by the timing of our accounts payable and accrued expenses totalling $23.4 million, combined with reduced billings in excess of costs on uncompleted projects of $12.6 million. Additionally, we recognized an impairment loss in our investment in EPV Solar of $2.9 million.

 

Investing Activities

 

In the year ended September 30, 2009, we used net cash in investing activities of $5.4 million as compared to $8.2 million of net cash provided in investing activities in the year ended September 30, 2008. The primary change was due to the release of $20.0 million in restricted cash during 2008. Investing activities in 2009 included $4.1 million used for capital expenditures, partially offset by $0.8 million of proceeds from the sale of equipment. Investing activities in 2008 included $12.9 million used for capital expenditures, partially offset by $0.4 million of proceeds from the sale of equipment. In addition, investing activities in the year ended September 30, 2009, included $2.0 million used for an investment in EPV Solar and $0.2 million to satisfy our commitment to invest in EnerTech.

 

Financing Activities

 

In the year ended September 30, 2009, financing activities used net cash flow of $6.0 million as compared to $27.7 million in net cash used by financing activities in the year ended September 30, 2008. The primary change in net cash used in financing activities in the 2009, as compared to the year ended September 30, 2008, was due to borrowings of approximately $30.0 million that occurred during 2008 as a result of debt refinancing. Investing activities in 2009 included $2.4 million used for payments of long-term debt and $4.3 million used for the acquisition of treasury stock. Financing activities in 2008 included $46.1 million used for termination and prepayment of the Eton Park Term loan and $11.0 million used for the acquisition of treasury stock.

 

Bonding Capacity

 

As previously described in this report, in October 2008, we entered into a Co-Surety Financing Arrangement with our Initial Surety Provider and a second Co-Surety Provider. This Co-Surety Financing Arrangement increases our aggregate bonding capacity to $350.0 million. We have adequate surety bonding capacity under our Co-Surety Financing Arrangement to meet our current needs. Our ability to access this bonding capacity is at the sole discretion of our Initial Surety Provider and Co-Surety Provider and is subject to certain other limitations.

 

In addition to our Initial Surety Provider and Co-Surety Provider, we also have additional surety bonding from another provider. As of September 30, 2009, the expected cumulative cost to complete for projects covered by all surety providers was $75.9 million. As of September 30, 2009, we also had $18.6 million in aggregate face value of bonds issued by our Individual Surety Provider. For more information, see “Surety” above.

 

Off-Balance Sheet Arrangements

 

As is common in our industry, we have entered into certain off-balance sheet arrangements that expose us to increased risk. Our significant off-balance sheet transactions include commitments associated with non-cancellable operating leases, letter of credit obligations, firm commitments for materials and surety guarantees.

 

We enter into non-cancellable operating leases for many of our vehicle and equipment needs. These leases allow us to retain our cash when we do not own the vehicles or equipment, and we pay a monthly lease rental fee. At the end of the lease, we have no further obligation to the lessor. We may determine to cancel or

terminate a lease before the end of its term. Typically, we are liable to the lessor for various lease cancellation or termination costs and the difference between the then fair market value of the leased asset and the implied book value of the leased asset as calculated in accordance with the lease agreement.

 

Some of our customers and vendors require us to post letters of credit as a means of guaranteeing performance under our contracts and ensuring payment by us to subcontractors and vendors. If our customer has reasonable cause to effect payment under a letter of credit, we would be required to reimburse our creditor for the letter of credit. Depending on the circumstances surrounding a reimbursement to our creditor, we may have a charge to earnings in that period. At September 30, 2009, $11.0 million and $0.2 million of our outstanding letters of credit were to support our bonding facilities and collateralize our customers and vendors, respectively.

 

Some of the underwriters of our casualty insurance program require us to post letters of credit as collateral. This is common in the insurance industry. To date, we have not had a situation where an underwriter has had reasonable cause to effect payment under a letter of credit. At September 30, 2009, $10.2 million of our outstanding letters of credit were utilized to collateralize our insurance program.

 

From time to time, we may enter into firm purchase commitments for materials such as copper wire and aluminum wire, among others, which we expect to use in the ordinary course of business. These commitments are typically for terms less than one year and require us to buy minimum quantities of materials at specified intervals at a fixed price over the term. As of September 30, 2009, we did not have any open purchase commitments.

 

Many of our customers require us to post performance and payment bonds issued by a surety. Those bonds guarantee the customer that we will perform under the terms of a contract and that we will pay our subcontractors and vendors. In the event that we fail to perform under a contract or pay subcontractors and vendors, the customer may demand the surety to pay or perform under our bond. Our relationship with our sureties is such that we will indemnify the sureties for any expenses they incur in connection with any of the bonds they issue on our behalf. We have not incurred any expenses to date to indemnify our sureties for expenses they incurred on our behalf. As of September 30, 2009, our cost to complete on projects covered by surety bonds was $75.9 million. As of September 30, 2009, we utilized a combination of cash and letters of credit totaling $17.6 million, which was comprised of $11.0 million in letters of credit and $6.6 million of cash and accumulated interest (as is included in Other Non-Current Assets), to collateralize our bonding programs.

 

In April 2000, we committed to invest up to $5.0 million in EnerTech. EnerTech is a private equity firm specializing in investment opportunities emerging from the deregulation and resulting convergence of the energy, utility and telecommunications industries Through September 30, 2009, we had invested $5.0 million under our commitment to EnerTech.

 

As of September 30, 2009, our future contractual obligations due by September 30 of each of the following fiscal years include (in thousands) (1):

 

 

 

 

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

 

Outlook

 

We anticipate that the combination of cash on hand, cash flows and available capacity under our Revolving Credit Facility will provide sufficient cash to enable us to meet our working capital needs, debt service requirements, capital expenditures for property and equipment through the next twelve months. We expect capital expenditures to be approximately $3.0 million to $5.0 million for the fiscal year ending on September 30, 2010, as we invest in our infrastructure to improve management information and project management systems. Our ability to generate cash flow is dependent on our successful completion of our restructuring efforts and many other factors, including demand for our products and services, the availability of projects at margins acceptable to us, the ultimate collectability of our receivables, and our ability to borrow on our Revolving Credit Facility. For additional information, see “Disclosure Regarding Forward-Looking Statements” in Part I of this Form 10-K.

 

Inflation

 

During the year ended September 30, 2009, we experienced decreases in fuel prices and related travel costs, as well as reductions in steel and copper prices, which have declined from the recent historical highs in early 2008. These price declines have contributed to some gross margin improvement; however, due to the slowdown in the overall construction sector and the resulting competitive environment, we have adjusted our pricing as our cost of goods have fallen. Over the long-term, we will adjust our pricing to incorporate these conditions and other inflationary factors.

 

 

Management is actively involved in monitoring exposure to market risk and continues to develop and utilize appropriate risk management techniques. Our exposure to significant market risks includes fluctuations in commodity prices for copper, aluminum, steel and fuel. Commodity price risks may have an impact on our results of operations due to the fixed price nature of many of our contracts. We are also exposed to interest rate risk with respect to our outstanding debt obligations on the Revolving Credit Facility. For additional information see “Disclosure Regarding Forward-Looking Statements” in Part I of this Form 10-K.

 

Commodity Risk

 

Our exposure to significant market risks includes fluctuations in commodity prices for copper, aluminum, steel and fuel. Commodity price risks may have an impact on our results of operations due to fixed nature of many of our contracts. During 2009, commodity prices were volatile, and we experienced overall decreases in prices of copper, aluminum, steel and fuel. Over the long-term, we expect to be able to pass along a significant portion of these costs to our customers, as market conditions in the construction industry will allow.

 

Interest Rate Risk

 

We are also exposed to interest rate risk, with respect to our outstanding revolving debt obligations as well as our letters of credit.

 

The following table presents principal or notional amounts (stated in thousands) and related interest rates by fiscal year of maturity for our debt obligations at September 30, 2009: