UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

COMMISSION FILE NUMBER 001-32164

 

INFRASOURCE SERVICES, INC.

 

 

100 West Sixth Street,
Suite 300, Media, PA 19063
(Address of principal executive office)

 

(610) 480-8000

(Registrant’s telephone number, including area code)

 

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

 

Common Stock, par value $0.001 per share,
listed on the New York Stock Exchange

 

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 þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     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 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.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer o     Accelerated filer þ     Non-accelerated filer o.

 

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

 

The aggregate market value of common stock held by non-affiliates of the registrant as of June 30, 2006 was $521,061,322.

 

The number of shares outstanding of the registrant’s common stock as of February 23, 2007 was 40,454,799.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the following documents are incorporated by reference in this Report on Form 10-K:

 

1) The registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be filed not later than 120 days after the close of the fiscal year (incorporated into Part III).

 

 

INFRASOURCE SERVICES, INC.
AND SUBSIDIARIES

Annual Report on Form 10-K for the year ended December 31, 2006

Table of Contents

 

 

In this annual report on Form 10-K, InfraSource Services, Inc. (“InfraSource”) and its wholly owned subsidiaries on a consolidated basis (referred to as “the Company,” “we,” “us,” or “our,”) have made forward-looking statements. Generally, these forward-looking statements can be identified by words like “may,” “will,” “should,” “expect,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue” or the negative of those words and other comparable words. These forward-looking statements generally relate to our plans, objectives and expectations for future operations and are based upon our current estimates and projections of future results or trends. Although we believe that our plans and objectives reflected in or suggested by these forward-looking statements are reasonable, we may not achieve these plans or objectives. These statements are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from those contemplated by the statements. These statements only reflect our predictions. Except as required by law, we may not update forward-looking statements even though our situation may change in the future. With respect to forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. The factors that could affect future results and could cause those results to differ materially from those expressed in the forward-looking statements include, but are not limited to, those described under Item 1A, “Risk Factors” and other risks outlined in our periodic filings with the Securities and Exchange Commission (“SEC”).

 

The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room located at 100 Frank Street N.E., Washington, D.C., 20549. In order to obtain information about the operation of the Public Reference Room, you may call the SEC at 1-800-732-0330. The SEC also maintains a site on the Internet that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The SEC’s website is http://www.sec.gov. You can also read and download the various reports we file with the SEC from our website, http://www.infrasourceinc.com. The information on our website is not part of this Form 10-K filing.

 

Our corporate governance guidelines and the charters of the standing committees of our Board of Directors, together with our Code of Business Conduct and Ethics and additional information regarding our corporate governance, are available on our website at www.infrasourceinc.com and will be made available, without charge, in print to any shareholder who requests such documents from Deborah C. Lofton, Senior Vice President, General Counsel & Secretary, InfraSource Services, Inc., 100 West Sixth Street, Suite 300, Media, Pennsylvania 19063.

 

General

 

We are one of the largest specialty contractors servicing electric, natural gas and telecommunications infrastructure in the United States based on market share. Our broad range of services includes design, engineering, procurement, construction, testing, maintenance and repair services for electric, natural gas and telecommunications infrastructure.

 

We operate in two business segments. Our Infrastructure Construction Services (“ICS”) segment provides design, engineering, procurement, construction, testing, maintenance, and repair services for utility infrastructure. ICS customers include electric power utilities, natural gas utilities, telecommunication customers, government entities and heavy industrial companies, such as petrochemical, processing and refining businesses. ICS services are provided by five of our operating units, all of which have been aggregated into one reportable segment due to their similar economic characteristics, customer bases, products and production and distribution methods. Our Telecommunication Services (“TS”) segment, consisting of a single operating

unit, leases point-to-point telecommunications infrastructure in select markets and provides design, procurement, construction and maintenance services for telecommunications infrastructure. TS customers include communication service providers, large industrial and financial services customers, school districts and other entities with high bandwidth telecommunication needs. Within our TS segment, we are regulated as a public telecommunication utility in various states. We operate in multiple service territories throughout the United States and we do not have significant operations or assets outside the United States.

 

We provide services to our customers through contracts entered into by our operating subsidiaries. Those contracts, which generally are awarded through competitive bidding, include fixed-price contracts and master service agreements (“MSAs”). Our TS segment enters into indefeasible right of use (“IRU”) lease contracts for use of telecommunications fiber in addition to MSAs and fixed-price contracts for our infrastructure services.

 

We are a Delaware corporation formed in May 2003 by OCM/GFI Power Opportunities Fund, L.P., which was co-managed by Oaktree Capital Management, LLC (“Oaktree”) and GFI Energy Ventures LLC, and OCM Principal Opportunities Fund II, L.P., which was managed by Oaktree, (collectively, the “former Principal Stockholders”) to acquire InfraSource Incorporated and certain of its subsidiaries from Exelon Enterprises Company, LLC (“Exelon Enterprises”). InfraSource Incorporated was originally organized in 1999 and between 1999 and January 2001, InfraSource Incorporated acquired its operating subsidiaries.

 

On September 24, 2003, we acquired all of the voting interests of InfraSource Incorporated and certain of its wholly owned subsidiaries, pursuant to a merger transaction (the “Merger”). On May 12, 2004, we completed our initial public offering (“IPO”) of 8,500,000 shares of common stock. During 2006, the former Principal Stockholders and certain other stockholders completed two secondary underwritten public offerings of our common stock. The first occurred on March 24, 2006, in which they sold 13,000,000 shares of our common stock at $17.50 per share (plus an additional 1,950,000 shares sold following exercise of the underwriters’ over-allotment option). The second occurred on August 9, 2006, in which they sold 10,394,520 shares of our common stock at $17.25 per share (plus an additional 559,179 shares sold following exercise of the underwriters’ over-allotment option). We did not issue any primary shares; therefore, we did not receive any of the proceeds from those offerings. As of December 31, 2006, the former Principal Stockholders no longer own any of our common stock.

 

On December 15, 2006, we acquired all of the voting interests of Realtime Utility Engineers, Inc. (“RUE”), a company that provides substation and transmission line engineering services for electric utilities. RUE is part of our ICS segment.

 

During 2006, we sold certain assets of Mechanical Specialties, Inc. (“MSI”) which was part of the ICS segment. In November 2005, we acquired EHV Power Corporation (“EHVPC”), a Canadian company that specializes in splicing of underground high voltage electric transmission cables, which represents our only non-U.S. operations. Revenue from EHVPC customers represented less than 2% of our revenue in 2006. EHVPC assets are minimal. EHVPC is part of our ICS segment. Also during 2005, we sold substantially all of the assets of Utility Locate & Mapping Services, Inc. (“ULMS”) and all of the stock of Electric Services, Inc. (“ESI”), which were both part of the ICS segment.

 

End Markets Overview

 

We provide infrastructure services in our ICS segment primarily to the following end markets:

 

Electric Infrastructure.  We focus primarily on the construction and maintenance of electric transmission infrastructure, high voltage industrial facilities and electric distribution systems. Electric transmission refers to power lines and associated substations through which electricity is transmitted over long distances at high voltages. Electric distribution refers to lower voltage power lines that provide electricity to end users over shorter distances.

 

Natural Gas Infrastructure.  The services we provide to natural gas customers involve construction and maintenance of natural gas distribution and, to a lesser extent, transmission line compressor stations. Natural gas distribution refers to low pressure lines that carry natural gas from higher pressure transmission pipelines to end users. Customer spending in this market is driven by new residential, commercial and industrial

construction and sustained by on-going replacement of aging infrastructure, often mandated by state utilities commissions.

 

In addition, our TS and ICS segments provide the following infrastructure services:

 

Telecommunications Infrastructure.  We provide telecommunications infrastructure construction and maintenance services primarily to regional telephone companies and other telecommunications customers. The TS segment also provides IRU access to dark fiber infrastructure, encompassing design, construction and leasing to third parties’ point-to-point fiber connections.

 

Our revenue mix by end market for the years ended December 31, 2004, 2005 and 2006 was:

 

 

Approximately 58%, 40% and 38% of the telecommunications end market revenues were from the TS segment for the years ended December 31, 2004, 2005 and 2006, respectively.

 

For additional financial information about our segments, refer to Note 19 to our consolidated financial statements included in Item 8 of this report on Form 10-K.

 

Significant Projects

 

Arrowhead to Weston (formerly known as PowerUp Wisconsin).  On December 15, 2003, the Public Service Commission of Wisconsin issued an authorization to proceed with the construction of a 220 mile high-voltage transmission line linking Duluth, Minnesota and Wausau, Wisconsin. As of December 31, 2006 we have completed 159 miles of that line with the balance expected to be completed by the end of the second quarter of 2008.

 

Northeastern Reliability Interconnection.  In May 2006, we were awarded a contract by Bangor Hydro for the procurement and construction of an 85 mile high-voltage transmission line, known as the Northeast Reliability Interconnect (“NRI”) that will extend from Orrington, ME to the St. Croix River near Baileyville, ME. The NRI will interconnect with a similar new transmission line in New Brunswick, Canada linking the electrical systems of Maine and the Canadian Maritimes. As of December 31, 2006, construction was approximately 40% complete. We expect substantial completion prior to the end of 2007.

 

American Electric Power (“AEP”) — Mitchell Emissions Control Project.  In April 2006, we were awarded the electrical scope of work associated with a power plant emissions control retrofit project at the AEP Mitchell power plant in Moundsville, West Virginia. As of December 31, 2006, construction was approximately 70% complete. We expect substantial completion during the second quarter of 2007.

 

American Transmission Company.  In January 2007, we were selected to provide construction services for electric transmission line and substation projects for American Transmission Company in northeastern Wisconsin and Michigan’s Upper Peninsula under a three-year alliance agreement. We estimate that the three-year alliance will yield revenues of approximately $100 million.

 

Agreements with Exelon Corporation (“Exelon”).  In September 2003, in connection with the Merger, we entered into a volume agreement with Exelon, pursuant to which Exelon committed to provide us with an amount of work approximately equivalent to the total volume of work we would have received through 2006 if 2003 work levels remained constant. The actual volume of work received from Exelon was significantly higher than 2003 levels and the volume requirement set forth in the volume agreement was satisfied in the fourth

quarter of 2005. Despite the fulfillment of that agreement, based on current contracts and projected volumes of work, we anticipate that Exelon will continue to be our largest customer during 2007.

 

Backlog

 

Backlog represents the amount of revenue expected from work to be performed on uncompleted contracts, including new contracts for which we have received a notice to begin work. Contracts with contingent financing arrangements or those awaiting permits for commencement of work are not included in backlog. Backlog includes our estimate based on historical experience of work to be performed under our MSAs, which often have one-to-three year terms and revenues under lease commitments. Customers are not contractually committed to specific volumes of services under our MSAs or long-term maintenance contracts, and many of those contracts may be terminated with minimal notice.

 

Backlog at December 31, 2006 was approximately $902 million, of which approximately $769 million related to our ICS segment and $133 million related to our TS segment. We currently expect to complete approximately $590 million to $610 million of our year-end 2006 backlog during 2007. Backlog is not a measure defined in generally accepted accounting principles and our methodology in determining backlog may not be comparable to the methodology used by other companies. See also discussion of backlog in Item 1A, Risk Factors and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in this report on Form 10-K.

 

Industry Trends

 

We believe growth in our end markets will benefit from the following key factors:

 

Inadequacy of Current Electric Infrastructure.  The electric utility infrastructure in the United States will require significant spending to remedy historical underinvestment and to respond to increasing electricity demand. The increase in demand for electricity and growth in electric power generation capacity have outpaced the increase in transmission infrastructure expenditures. This relative underinvestment has contributed to the current inadequacy of the electric power grid, leading to increasing congestion and major disruptions. The 2002 National Transmission Grid Study prepared by the United States Department of Energy (the “DOE”) and studies developed by various industry groups have documented the inadequacies of the existing transmission grid. Those inadequacies, as demonstrated by the rolling blackouts in California in 2001 and the Midwest/Northeast power outage in 2003, contributed to the passage of the Energy Policy Act of 2005 (the “Energy Act”). Transmission reliability and access is a significant area of focus of the Energy Act. Recent reliability events, near misses, record load demand and tight summer power supplies continue to highlight the inadequacy of the electric utility infrastructure.

 

In September 2006, a survey of investor-owned utilities indicated that their transmission investments from 2006 to 2009 are expected to increase 60% over the previous four years. There continue to be frequent announcements of transmission expansion plans by utilities and regional planning organizations. Recent surveys and studies have confirmed that the anticipated increase in transmission investment is beginning to occur. A recent industry survey indicated that planned transmission line additions for the period 2006 to 2010 are 27% higher than previously reported planned transmission line additions for the period 2005 to 2009.

 

Enactment of the Energy Policy Act of 2005 Mandates Transmission Reliability and Encourages Investment.  The Energy Act was enacted on August 8, 2005 and provided several measures designed to increase grid reliability and stimulate investment in transmission infrastructure. The Energy Act mandated establishment of an Electric Reliability Organization, subject to oversight by the Federal Energy Regulatory Commission (“FERC”), to develop and enforce minimum standards of reliability. The Energy Act also repealed the Public Utility Holding Company Act of 1935, or PUHCA. The repeal removed significant restrictions on industry investment and could change the ownership landscape of transmission-owning entities by allowing new classes of non-utility investors. Progress is being made on the implementation of Energy Act provisions pertaining to electric transmission reliability and development.

 

Increased Outsourcing of Infrastructure Services.  Driven in part by pressures from investors, regulators and consumer advocates, utilities are seeking ways to lower costs and improve efficiencies. Utilities are frequently able to achieve those objectives by outsourcing a range of services to third parties. Specialty contractors, such as InfraSource, can manage their technical skills, labor force and equipment across various projects and multiple customers, often in a more efficient and cost-effective manner than utilities maintaining dedicated full-time labor forces. Furthermore, a shrinking pool of qualified managerial, technical, supervisory and craft labor may provide additional incentive to shift utility infrastructure services to specialty contractors. According to industry research, approximately 50% of the utility craft labor force is expected to retire by 2010. A separate report from an industry association noted that “skilled trades,” including line, maintenance and construction trade workers, are viewed as having the highest percentage of retirements over the next five years. As a result, many utilities are increasing their reliance on third-party service providers to perform infrastructure services.

 

Spending Driven by Environmental Clean Air Regulations.  Increasingly stringent environmental clean air regulations, primarily in the hydrocarbon processing and power generation sectors, require renewed compliance efforts. Many electric utilities have announced plans for significant investment in physical plant improvements, retrofits and upgrades to reduce harmful emissions at existing plants. We believe that this work will primarily be performed by third-party infrastructure services companies such as InfraSource. Additionally, many states are requiring increased amounts of renewable energy for electricity generation, with 23 states and the District of Columbia having passed such legislation. We believe that those mandates, combined with high natural gas prices, environmental concerns and certain provisions of the Energy Act, will foster growth in wind generation and the development of related transmission infrastructure.

 

Increasing Demand for High-Bandwidth Communications Infrastructure.  Individuals and businesses continue to seek faster and higher-bandwidth communications infrastructure. We provide fiber to the premises (“FTTP”) build-out services to select telecommunications companies, and through our TS segment, we own proprietary dark fiber networks providing point-to-point connectivity in select geographic areas in the United States.

 

Business Strategy

 

Capitalize on Favorable Industry Trends in Utility Infrastructure Markets.  We believe we are well positioned to capitalize on increased spending on utility infrastructure and increased outsourcing by customers in our end markets. In particular, we believe that the Energy Act could lead to increased investment in electric power transmission infrastructure and that our experience in executing complex large-scale electric transmission projects will enable us to benefit from those opportunities.

 

Increase Our Market Share.  We intend to leverage our competitive strengths to increase our market share by:

 

 

Focus on Specialized Services that Generate High Margins.  We intend to continue to increase our focus on technically complex projects where the specialized capabilities of our highly skilled personnel differentiates us from many of our competitors. For example, our core competencies in turnkey substation services and high voltage transmission systems enable us to generate attractive margins while providing high quality and cost effective services for our customers. We intend to expand our telecommunications services to other cities and acquire or lease dark fiber assets for this purpose where available. We will continue to evaluate contracts in the natural gas industry to ensure that they meet our profitability standards.

 

Capitalize on Complementary Capabilities of our Operating Units.  In our ICS segment, we actively seek contract opportunities to utilize the skills, labor or equipment of our operating companies rather than outsource work to non-affiliate contractors. For example, subsidiary M.J. Electric, LLC (“MJE”) utilizes employees from InfraSource Transmission Services Company (“ITS”) to assist in foundation work for electric utility work, and electrical engineering subsidiary InfraSource Dashiell, LLC supports MJE and ITS with substation engineering and construction work. Our acquisition of RUE will expand our capacity to deliver engineering, procurement and construction (“EPC”) transmission delivery capabilities.

 

Expand our Dark Fiber Network.  We significantly expanded our dark fiber network through organic expansion into additional regions of the country and intend to continue that growth through organic expansion and acquisition of fiber assets and businesses similar to ours. We signed a significant number of new leases in 2006 including new geographic areas we have targeted for expansion. More than half of the expected capital spending for 2007 is targeted at new dark fiber network construction.

 

Pursue Strategic Acquisitions.  Although acquisitions are not essential to achieving our objectives, we will evaluate acquisition opportunities to bolster our presence in select regional markets or to broaden and enhance our service offerings. For example, our acquisitions of ITS in early 2004, EHVPC in November 2005 and RUE in December 2006 expanded our capabilities to perform large, high-voltage transmission projects and cross-sell other services across a larger territory. Future acquisitions may, among other things, focus on expanding our presence in our ICS segment and acquiring additional dark fiber assets in our TS segment in targeted metropolitan areas.

 

Services

 

Our broad range of services includes design, engineering, procurement, construction, testing, maintenance and repair services for electric, natural gas and telecommunications infrastructure. We also provide ancillary field services such as project management, permitting, materials management, work scheduling and customer interface management, and lease point-to-point telecommunications infrastructure through our TS segment.

 

The following is an overview of the infrastructure we target for the services we provide:

 

 

Marketing and Customers

 

Most of our marketing is conducted regionally, and our sales and marketing efforts are primarily the responsibility of our operating subsidiaries. A centralized business development group coordinates, promotes and markets our services for existing and prospective large national accounts and projects that require services from multiple operating subsidiaries. Cross-selling and coordination have enabled us to sell natural gas distribution services to existing long-term electric power customers. We plan to expand cross-selling complementary offerings within our broad range of services.

 

Primary customers include electric power utilities, natural gas utilities, government entities, telecommunications companies, and heavy industrial companies, such as petrochemical, processing and

refining businesses. Many of our customers, particularly utility customers, are highly regulated and may require numerous regulatory and siting approvals to undertake new infrastructure projects.

 

Our top ten customers accounted for approximately 45% and 44% of aggregate revenues during the years ended December 31, 2005 and 2006, respectively, which includes work done for those customers as a subcontractor through others. Sales to Exelon accounted for 18% and 14% of revenues for the years ended December 31, 2005 and 2006, respectively.

 

The TS segment had one customer that provided approximately 26% and 14% of its revenues for the years ended December 31, 2005 and 2006, respectively.

 

Seasonality and Cyclicality

 

The results of operations of our ICS segment are subject to seasonal variations. During the winter months, demand for new projects and new maintenance service arrangements is normally lower in some geographic areas due to reduced construction activity, especially for services to natural gas distribution customers. As a consequence, our ICS segment typically experiences lower revenues and gross and operating profits in the first quarter. Those lower first quarter revenues and profits may be partially offset by repair and maintenance services attributable to damage caused by inclement weather or, as during the three months ended March 31, 2006, unusually mild weather contributed to increased volume and financial performance in our natural gas, underground telecommunications and electric transmission services.

 

Like others in our industry, our working capital needs are influenced by seasonality. We generally experience a need for additional working capital during the spring and summer due to increased levels of outdoor construction in weather-affected regions of the country. Conversely, we typically convert working capital assets to cash during the winter months. Our TS segment’s leasing of point-to-point telecommunications infrastructure is not significantly affected by seasonality.

 

Activity in our industry and the available volume of work is affected by the highly cyclical spending patterns in the telecommunications and independent power producers (“IPP”) sectors. As a result, our volume of business may be adversely affected by declines in new projects in various geographic regions or industries in the United States.

 

Competition

 

The end markets in which both of our segments operate are highly fragmented and competitive. In the vast majority of cases, we are bidding against numerous competitors for contract and project awards. Many of our competitors are small, owner-operated companies that typically operate in a limited geographic area. Several of our competitors are large regional or national companies focused on providing services to larger utilities and other customers. Competition, in some cases, includes utility customers that may choose to perform their own infrastructure work. In the future, competition may be encountered from new market entrants.

 

Competitive factors in the end markets in which we operate include:

 

 

To compete successfully, we may be required to reduce prices, assume greater risk, increase our operating costs or take other measures that could significantly reduce our revenues, margins and cash flow. For example, the petrochemical industry reduced capital spending due to natural gas price increases, which decreased available work and increased competition, thereby reducing revenues and gross margins.

 

We believe the following are important aspects of our ability to compete:

 

 

Types of Contracts

 

Our project-based work tends to be fixed-price on an agreed scope and schedule. Although we sometimes recover cost overruns, we are not always able to do so. A unit-price contract is essentially a fixed-price contract with the only variable being the number of work units performed. In our transmission and distribution contracts, units are generally measured by distance of infrastructure installed. We must estimate the costs of completing a project to bid for fixed-price and unit-price contracts. Under our time-and-materials contracts, we are paid for labor at negotiated hourly billing rates and for other expenses, including materials, as incurred.

 

We provide services under MSAs on a project-by-project basis. MSAs are typically one-to-three years in duration. Under MSAs, customers generally agree to use us for certain services in a specified geographic region. However, most of our contracts, including MSAs, may be terminated by our customers or by us on short notice, typically 30 to 90 days, sometimes less. Furthermore, most MSA customers have no obligation to assign specific volumes of work to us and are not required to use us exclusively, in some cases subject to our right of first refusal. Many of our contracts, including MSAs, are open to public bid at expiration and generally attract numerous bidders. Work performed under MSAs is typically billed on a unit-price or time-and-materials basis.

 

Through our TS segment, we have licensing agreements under which we agree to construct and lease fiber-optic telecommunications facilities, typically with lease terms from five to twenty-five years including renewal options. Under those licensing agreements, we own and maintain the fiber-optic facility and our customers lease a portion of the capacity. We receive a recurring monthly rental fee and, generally, an upfront payment, often as an installation fee.

 

Materials and Independent Contractors

 

Our clients generally supply the majority of the materials and supplies necessary to carry out our contracted work. However, occasionally we obtain materials and supplies for our own account from independent third-party providers. We do not manufacture a significant amount of materials or supplies for resale. We are not dependent on one supplier for materials or supplies we obtain for our own account. The recent increase in demand for transmission services has strained production resources, creating significant lead-time for obtaining large transformers, transmission towers and poles. Our electric transmission project

revenues could be significantly reduced or delayed due to the difficulty we or our customers may experience in obtaining required materials. We are not presently experiencing, nor do we anticipate experiencing, any difficulties in timely procuring an adequate amount of materials and supplies other than large transformers, transmission towers and poles.

 

We use subcontractors to perform portions of our contracts and to manage workflow. Those independent contractors are often sole proprietorships or small business entities. Independent contractors normally provide their own employees, vehicles, tools and insurance coverage. We are not dependent on any single independent contractor. Contracts with subcontractors often contain provisions limiting our obligation to pay the subcontractor if our client has not paid us and holding our subcontractors liable for their work. We generally require surety bonding from subcontractors on projects for which we supply surety bonds to customers.

 

Equipment

 

We operate a fleet of owned and leased trucks and trailers, support vehicles and specialty construction equipment, such as backhoes, excavators, trenchers, generators, boring machines, cranes and wire pullers and tensioners. Our fleet and equipment comprise approximately 9,000 units. Most of this fleet is serviced by our own mechanics who work at various maintenance sites and facilities with the remainder serviced by nationwide distributor networks. We believe that those vehicles are well maintained and adequate for present operations.

 

Training, Quality Assurance and Safety

 

Performance of our services requires the use of heavy equipment and exposure to potentially dangerous conditions. We are committed to a policy of operating safely and prudently. We require that employees complete their operating unit’s prescribed training program in addition to those required by the National Electrical Contractors Association (“NECA”), the International Brotherhood of Electrical Workers (“IBEW”) and Office of Pipeline Safety Operator Qualification prior to performing more sophisticated and technical jobs. For example, all journeyman linemen are required by the IBEW and NECA to complete a minimum of 7,000 hours of on-the-job training, approximately 200 hours of classroom education and extensive testing and certification. Each operating subsidiary requires additional training, depending upon the sophistication and technical requirements of each particular job. Certain of our employees maintain Department of Transportation Commercial Drivers Licenses and Operator Qualifications as required by their job functions. The Occupational Safety and Health Administration’s (“OSHA”) recordable rates of all but one operating subsidiary have been better than the industry’s average rate. Significant effort is underway in all units to continue to improve safety awareness and performance. As is common in our industry, we have been and will continue to be subject to claims by employees, customers and third parties for property damage and personal injuries.

 

Risk Management and Insurance

 

We are committed to ensuring that employees perform their work safely. We continuously communicate with employees and subcontractors to promote safety and to instill safe work habits.

 

We have insurance to cover workers’ compensation and employer’s liability, auto liability and general liability, subject to deductibles of $0.75 million, $0.5 million and $0.75 million per occurrence, respectively. The nature and frequency of employee claims directly affect operating performance. Because of the physical and sometimes dangerous nature of our business, we maintain substantial loss reserves for workers’ compensation claims. The reserves are based upon known facts and historical trends and management believes such accruals to be adequate. Many contracts require specific insurance coverage. Our insurers require letters of credit to cover deductible payment obligations, and the total amount of these letters of credit outstanding increased to approximately $28.9 million in 2006. In January 2004, we replaced our $0.1 million deductible non-union health care benefit program with a fully indemnified program. As of January 1, 2006 we reverted back to a self-insured program with a $0.15 million stop loss per employee per year. We also have a $1.0 million indemnity for claims over an aggregate loss of $14.8 million.

 

Regulation

 

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

 

 

Many state and local regulations governing electrical construction require permits and licenses to be held by employees who have passed an examination or met other requirements.

 

Environmental Matters

 

We are committed to the protection of the environment and train employees to perform their duties accordingly. We are subject to numerous federal, state and local environmental laws and regulations governing our operations, including the handling, transportation and disposal of non-hazardous and hazardous substances and wastes, as well as emissions and discharges into the environment, including discharges to air, surface water, groundwater and soil. We are subject to laws and regulations that impose liability and cleanup responsibility for releases of hazardous substances into the environment. Such laws and regulations can apply not only to owned and leased sites but to properties where we are performing services. Under certain of these laws and regulations, such liabilities can be imposed for cleanup of previously owned or operated properties, properties where we have performed services, in some cases, or properties to which substances or wastes were sent by current or former operations at our facilities, regardless of whether we directly caused the contamination or violated any law at the time of discharge or disposal. The presence of contamination from such substances or wastes could interfere with ongoing operations, adversely affect our ability to sell or lease properties, or use them as collateral for financing. We could be held liable for significant penalties and damages under environmental laws and be subject to a revocation of licenses or permits, which could materially and adversely affect our business and results of operations.

 

From time to time, we have incurred and are incurring costs and obligations for correcting environmental noncompliance matters and for remediation at or relating to certain of our properties. We believe we have complied with, or are currently complying with, environmental obligations to date and that such liabilities will not have a material adverse effect on our business or financial performance. For a number of these matters, we obtained indemnification or covenants from third parties (including predecessors or lessors) for such cleanup and other obligations and liabilities that we believe are adequate to cover such obligations and liabilities. However, third-party indemnities or covenants may not cover all our costs, creating unanticipated obligations or liabilities that could have a material adverse effect on our business operations or financial condition. Furthermore, we cannot be certain that we will be able to identify or be indemnified for all potential environmental liabilities relating to any acquired business.

 

Performance Bonds and Letters of Credit

 

Historically, approximately 10% to 20% of our annual volume of business requires performance bonds or other means of financial assurance to secure contractual performance. Surety market conditions are currently difficult as a result of significant losses incurred by many sureties in recent periods, both in the construction industry as well as in certain larger corporate bankruptcies. As a result, less bonding capacity is available in the market and terms continue to be restrictive. In September 2003, we entered into a new bonding program, which we continue to believe should be sufficient for normal operations. We will continue to seek additional

bonding capacity at acceptable terms to position ourselves for business opportunities that may arise in amounts greater than covered by our current program.

 

Certain of our vendors require letters of credit to ensure reimbursement for amounts they are disbursing on our behalf, such as to beneficiaries under our self-funded insurance programs. Customers may require us to post letters of credit to guarantee performance under certain contracts. We had $33.6 million in letters of credit outstanding as of December 31, 2006 under our senior credit facility, primarily to secure obligations under our casualty insurance program.

 

Employees

 

At December 31, 2006 we employed approximately 4,000 persons, of whom approximately 53% were unionized.

 

Our number of employees, particularly the number of general laborers, fluctuates depending upon the number and size of the projects and contracts undertaken by us at a particular time. For example, in 2006, our number of employees ranged from approximately 4,000 to 5,100. We are a party to contracts with numerous unions, including the NECA and the IBEW. We believe that our relationships with employees and union representatives are good.

 

We have from time-to-time experienced shortages of certain types of qualified personnel. For example, there is currently a shortage of engineers, project managers, field supervisors, linemen and other skilled workers capable of performing the construction of high-voltage lines and substations. This shortage can be exacerbated during periods of storm restoration work. Linemen are frequently recruited across geographic regions to satisfy demand, including for storm response work. The supply of experienced engineers, project managers, field supervisors, linemen and other skilled workers may not be sufficient to meet current or expected demand. These shortages could adversely affect our ability to operate at optimal levels of efficiency or pursue new work in accordance with our business strategies.

 

Our business involves numerous risks, many of which are beyond our control. The following is a description of those risks and their potential impact on our business. For additional information about factors that may affect our business, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Our ability to obtain new contracts and the timing of the award and performance of any such contracts may result in unpredictable fluctuations in cash flow and profitability.

 

A substantial portion of revenues is derived from project-based work. It is not possible to predict with certainty whether and when we will be awarded contracts for significant projects or when work for new contracts will be released, which adversely effects the predictability of related cash flow and profitability. We expect to have a higher percentage of revenues from large-scale projects going forward, which may increase the difficulty of predicting as well as the volatility of operating results.

 

Limited availability or other difficulties obtaining credit enhancements, including surety bonds, letters of credit and, in rare instances, cash collateral requirements, could limit our ability to expand or place us at a competitive disadvantage. In addition, monetary restrictions associated with certain credit enhancements could adversely affect our liquidity and limit our ability to secure additional contracts.

 

For awarded contracts, we face additional risks that could affect whether or when work will begin. Some contracts are subject to financing and other contingencies outside our control that may delay or cancel projects. The uncertainty of the timing of contract awards and work release can also present difficulties in matching workforce size with contract needs. In some cases, we maintain and bear the cost of a ready workforce larger than necessary in anticipation of future needs. If an expected contract award or the related work release is delayed or not received, we could incur substantial costs without receipt of corresponding

revenues. Delays by our customers in obtaining required approvals for their infrastructure projects may delay contract awards and work release.

 

Demand for our services is cyclical and vulnerable to downturns in the industries we serve, which may result in extended periods of low demand for our services.

 

The demand for infrastructure services in our customers’ industries has been, and will likely continue to be, cyclical in nature and vulnerable to downturns in the industries we serve as well as the U.S. economy in general. A number of other factors, including customer financial conditions, could adversely affect our customers’ ability or willingness to fund capital expenditures. Since 2003, we have experienced reductions in revenues from independent power producers due to a significant decline in construction activity and new construction awards for power generation projects. The demand for our services to natural gas distribution customers is affected by the level of industrial, commercial and residential construction. The recent downturn in new housing construction in certain regions has negatively impacted demand from some of our natural gas distribution customers. Petrochemical customers’ capital spending has recently been restrained by higher natural gas prices. We are also dependent on the amount of infrastructure services that our customers outsource. The historical trend toward outsourcing of infrastructure services may not continue as we expect. As a result, demand for our services could decline substantially for extended periods, particularly during economic downturns, which could decrease revenues, margins, profits and cash flows.

 

Our participation in fixed-price contracts exposes us to declines in profitability and contract losses related to cost overruns.

 

We currently generate, and expect to continue to generate, approximately 50% of our revenues under fixed-price contracts. Under fixed-price contracts, we agree to perform the entire project for a fixed price on an agreed schedule. We may be unable to recover cost overruns above the approved contract price. In the past, we have experienced delays and additional costs from severe weather conditions and the required replacement of third-party defective materials, which we are not always able to recover. During the year ended December 31, 2006, we recorded an $8.9 million loss, after giving effect to assumed claims collections, and a reversal of $1.6 million of income previously recognized relating to one or our electric transmission projects. This loss was attributable primarily to lower than expected productivity due to ineffective supervision, insufficient access to experienced labor, supplier issues and extremely hot weather. In the second quarter of 2005, we recorded an $8.5 million loss, which subsequently increased to $10.1 million on one of our fixed-price underground utility construction projects. This loss resulted from lower than expected productivity, higher materials costs and unforeseen delays and was partially the result of a failure to accurately estimate project costs during the bidding phase. Those and other factors, such as increased fuel and labor costs, could adversely affect profitability on fixed-price contracts.

 

The claims resolution process is often lengthy, can require legal action to conclude and the ultimate amount to be collected is difficult to estimate. Actual revenue and profit for any particular project will usually differ from original estimates and could result in reduced profitability or loss. Our acquisition of ITS resulted in an increase in the proportion of our fixed-price contracts, as most of ITS’s business is performed on a fixed-price basis.

 

Percentage-of-completion accounting on fixed-price contracts requires recognition of the total amount of any expected loss from a contract during the quarter when first determined and could result in a reduction or elimination of previously reported profits and significant fluctuations in financial results.

 

As more fully discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Critical Accounting Policies and Estimates” and in the notes to our consolidated financial statements, a significant portion of our revenues are recognized on a percentage-of-completion method of accounting, using primarily the cost-to-cost method. This method is used because management considers expended costs versus total estimated costs to be the best available measure of progress on fixed-price contracts. Under percentage-of-completion accounting, we recognize contract revenues and earnings over the contract term in proportion to incurred contract costs, relative to estimated total contract revenues, costs

and profitability. Although we update these estimates regularly, they are inherently uncertain, and ultimate contract profitability is usually not known until completion.

 

Estimated contract losses for the full term of a contract are recognized when first determined. During a period in which an estimated contract loss is recognized, or in a period when expected profits become lower than previously recorded profits, prior period income on such contract is reversed to the extent necessary to give effect to the current estimate. This could cause the profit or loss contribution from any given contract to fluctuate significantly from quarter to quarter. For example, during the year ended December 31, 2006, we recorded a project loss of approximately $8.9 million, after giving effect to assumed claims collections, and also reversed approximately $1.6 million of income previously recorded on such project. During the second quarter of 2005, we recognized an $8.5 million project loss, which was subsequently increased to $10.1 million. Estimated revenues include assumptions regarding the amount of claims we expect to collect from the customer. We record revenue up to costs incurred on claims and unapproved change orders when we believe recovery is probable and the amounts can be reasonably estimated. Final resolution of those claims is difficult to predict and actual revenues may be less than estimates. Profit related to those costs is recorded in the period such amounts are agreed to with the customer. The timing and amount of actual collection of claims and unapproved change orders is difficult to predict and could differ from estimates and could result in a reduction or elimination of previously recognized profits. In certain circumstances, it is possible that such adjustments could be significant. As of December 31, 2006, we had $3.1 million of unrecovered contract claims on the consolidated balance sheet under “costs and estimated earnings in excess of billings.” Claims settlements less than $3.1 million would result in a reduction of profits.

 

A substantial portion of our contracts contain performance-related provisions, including liquidated damages. Such provisions may further increase our period-to-period volatility. For example, we received a performance bonus on certain projects during 2006, compared to performance-related concessions during 2005. Incentives and penalties are recorded when known or finalized, generally during the latter stages of the contract.

 

We derive a significant portion of revenue from a small group of customers. The loss of one or more of those customers could negatively impact revenues.

 

Our top ten customers accounted for approximately 46%, 45% and 44% of revenues for the years ended December 31, 2004, 2005 and 2006, respectively, including work performed as a subcontractor through other firms. Revenues from Exelon accounted for 17%, 18% and 14% of revenues for the years ended December 31, 2004, 2005 and 2006, respectively. In September 2003, we entered into a volume agreement with Exelon, pursuant to which Exelon committed to provide us with a level of work roughly equivalent to the amount of work which we would have received through 2006 if 2003 work levels remained constant. The actual volume of work received from Exelon under the volume agreement was significantly higher than 2003 levels and the volume requirements set forth in the agreement were satisfied in the fourth quarter of 2005. Exelon recently indicated its intent to curtail expenditures to a level below that sustained in recent years and, therefore, we may be unable to sustain Exelon business volume. Exelon has begun to modify its contracting practices and is seeking alternative commercial arrangements with suppliers, including increased use of competitive bidding on certain projects. If we lose significant customers and are not able to replace them or if they reduce their volume of work from us, we could sustain decreased revenues, margins and profits.

 

Inability to hire or retain key personnel could disrupt business.

 

We depend on the continued efforts of our executive officers and senior management, including management at each operating subsidiary. We cannot be certain that any individual will continue in such capacity for any particular period of time. Industry-wide competition for managerial talent has increased and the loss of one or more of our key employees could have an adverse effect on our business. The loss of key personnel, or the inability to hire and retain qualified employees, could negatively impact our ability to manage our business. We do not carry key person life insurance on employees.

 

Skilled worker shortages and increased labor costs could negatively affect the ability to compete for new projects and the performance on existing projects.

 

We have from time-to-time experienced shortages of certain types of qualified personnel. For example, there is a shortage of engineers, project managers, field supervisors, linemen and other skilled workers capable of working on and supervising the construction of high-voltage electric lines and substations. This shortage can be exacerbated during periods of storm restoration work. Linemen are frequently recruited across geographic regions to satisfy demand, including for storm response work. The supply of experienced engineers, project managers, field supervisors, linemen and other skilled workers may not be sufficient to meet current or expected demand. The commencement of new, large-scale infrastructure projects or increased demand for infrastructure improvements as well as the aging utility workforce further depletes the pool of skilled workers available to us, even if we are not awarded such projects. As a result, we are bidding selectively in all business units. We have recently declined to bid on certain projects that we could not staff adequately with experienced engineers, and in the future we may not be able to maintain an adequate skilled workforce necessary to operate efficiently or to pursue new projects we consider attractive. Furthermore, the limited supply of skilled workers has negatively impacted, and may continue to negatively impact, the productivity and profitability of certain projects.

 

The Energy Act may fail to spur the anticipated increased investment in electric infrastructure, which could slow our growth.

 

Implementation and impact of the Energy Act is subject to considerable fiscal and regulatory uncertainty. Some of the regulations implementing the components of the bill have not been finalized and many others have only recently been finalized and the effect of those regulations remains uncertain. As a result, the legislation may not increase spending on electric power transmission infrastructure in a manner that will increase demand for our services. Continued uncertainty regarding new infrastructure investments and the implementation and impact of the Energy Act may result in slower growth in demand for our services.

 

Seasonal and other variations, including severe weather conditions, may cause significant fluctuations in cash flows and profitability, which may cause the market price of our common stock to fall.

 

A significant portion of our business is performed outdoors, subjecting financial results to seasonal variations. Less work is performed in the winter months, and work is hindered during other inclement weather events. Our profitability often decreases during the winter months and during severe weather conditions because work performed during these periods is restricted and more costly to complete. Working capital needs are influenced by the seasonality of our business. Generally, we experience a need for additional working capital during the spring when we increase outdoor construction in weather-affected regions of the country, and we convert working capital assets to cash during the winter months. During periods of peak electricity demand, utilities are generally unable to remove their electric power transmission and distribution equipment from service, decreasing the demand for our maintenance services during such periods. Significant disruptions in our ability to perform services because of those factors could have a material adverse effect on cash flows and results of operations. Additionally, as we expand our dark fiber network into regions of the country subject to catastrophic storms and earthquakes, we have the potential for damage to our assets which may not be covered by insurance.

 

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

 

Backlog is difficult to determine with certainty. Customers often have no obligation to assign or release work to us and many contracts may be terminated on short notice. Reductions in backlog due to cancellation by a customer or for other reasons could significantly reduce the revenue and profit we actually receive from contracts 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. The backlog we obtain in connection with any companies we acquire may not be as large as we believed or may not result in the revenue or profits we expected. In addition, projects may remain in backlog for extended periods of time. Consequently, we cannot assure you as to our customers’ requirements or our estimates.

 

We work with customers under MSAs. Backlog includes estimated work to be performed under those agreements. Our MSA customers generally have no obligation to assign work to us. Most contracts, including MSAs, may be terminated by our customers on short notice, typically 30 to 90 days, sometimes less, or may be negatively impacted by the utilities’ inability to recover their costs in the rates charged to their customers.

 

Many of our contracts, including MSAs, are open to competitive bidding at their expiration. We have been displaced on contracts by competitors from time to time. Revenues could materially decline if customers do not assign work to us or if they cancel a significant number of contracts and we cannot replace them with similar contracts.

 

Project delays or cancellations may result in additional costs to us, reductions in revenues or the payment of liquidated damages.

 

In certain circumstances, we guarantee project completion by a scheduled acceptance date or achievement of certain acceptance and performance testing levels. Failure to meet any of those schedules or performance requirements could result in additional costs or penalties, including liquidated damages, and such amounts could exceed expected project profit. Many projects involve challenging engineering, procurement and construction phases that may occur over extended time periods, sometimes up to two years. We may encounter difficulties in engineering, delays in designs or materials provided by the customer or a third party, equipment and material delivery, schedule changes, weather-related delays and other factors, some of which are beyond our control, that impact our ability to complete the project in accordance with the original delivery schedule. For example, the recent increase in demand for transmission services has strained production resources, creating significant lead times for obtaining large transformers, transmission towers and poles. As a result, electric transmission project revenues could be significantly reduced or delayed due to the difficulty we or our customers may experience in obtaining required materials. In addition, we occasionally contract with third-party subcontractors to assist us with the completion of contracts. Any delay by suppliers or by subcontractors in the completion of their portion of the project, or any failure by a subcontractor to satisfactorily complete its portion of the project may result in delays in the overall progress of the project or may cause us to incur additional costs, or both. We also may encounter project delays due to local opposition to the siting of transmission lines or other facilities, which may include injunctive actions as well as public protests. For example, the construction of the Arrowhead to Weston transmission line project between Minnesota and Wisconsin was delayed for several years due to such factors.

 

Delays and additional costs may be substantial and, in some cases, we may be required to compensate the customer for such delays. We may not be able to recover all of such costs.

 

In extreme cases, the above-mentioned factors could cause project cancellations, and we may not be able to replace such projects with similar projects or at all. Such delays or cancellations may impact our reputation or relationships with customers, adversely affecting our ability to secure new contracts.

 

Project contracts may require customers or other parties to provide design, engineering information, equipment or materials to be used on a project. In some cases, the project schedule or the design, engineering information, equipment or materials may be deficient or delivered later than required by the project schedule. Our customers may change various elements of the project after its commencement. Under these circumstances, we generally negotiate with the customer with respect to the amount of additional time required and the compensation to be paid to us. We are subject to the risk that we may be unable to obtain, through negotiation, arbitration, litigation or otherwise, adequate amounts to compensate us for the additional work or expenses incurred by us due to customer-requested change orders or failure by the customer to timely deliver items, such as engineering drawings or materials, required to be provided by the customer. A failure to obtain adequate compensation for these matters could require us to record a reduction to amounts of revenue and gross profit recognized in prior periods under the percentage-of-completion accounting method. Any such adjustments could be substantial.

 

Provisions of our senior credit facility restrict business operations and may restrict access to sufficient funding, including letters of credit, to finance desired growth.

 

We have a senior credit facility with a group of financial institutions secured by substantially all of our assets. The senior credit facility contains customary events of default and covenants, limiting certain actions without obtaining the consent of the lenders and requiring us to achieve certain financial ratios, as described in our consolidated financial statements. These restrictions and covenants may limit our ability to respond to changing business and economic conditions and we may be prevented from engaging in transactions that might otherwise be considered beneficial to us, including strategic acquisitions. Covenants in our senior credit facility also restrict our ability to incur indebtedness, subject to certain exceptions including domestic intercompany indebtedness; guarantee obligations incurred in the ordinary course of business; secured indebtedness up to $20.0 million incurred to acquire fixed or capital assets; indebtedness with respect to performance bonds, letters of credit and similar obligations incurred in the ordinary course of business; and up to $40.0 million of additional indebtedness. In the future, we may require substantial additional working capital to fund growth. However, there is no assurance that we will be able expand availability under our senior credit facility or obtain other sources of liquidity in a timely manner, at favorable cost or at all.

 

A breach of our senior credit facility, including failure to comply with the required financial ratios, could result in an event of default. Upon such event of default, the lenders would be entitled to accelerate the repayment of amounts outstanding, plus accrued and unpaid interest. Moreover, the lenders would have the option to terminate any obligation to make further extensions of credit under our senior credit facility. Upon the event of a default under any of our secured indebtedness, including our senior credit facility, the lenders could proceed to foreclose against the assets securing such obligations. In the event of a foreclosure on all or substantially all of our assets, we may not be able to continue to operate as a going concern.

 

We are subject to acquisition risks. If we are not successful in integrating acquired companies, we may not achieve the expected benefits and profitability could suffer. In addition, the cost of evaluating and pursuing acquisitions may not result in a corresponding benefit.

 

One of our business strategies is to pursue strategic acquisitions. We completed acquisitions during 2004, 2005 and 2006. We continue to consider strategic acquisitions, some of which may be larger than those previously completed and could be material. Integrating acquisitions is often costly, and delays or other operational or financial problems may interfere with our operations. In addition, our operating subsidiaries generally maintain their own procedures and operating systems, which make it more difficult for us to evaluate and integrate systems and controls on a company-wide basis. If we fail to implement proper overall business controls for companies we acquire or fail to successfully integrate acquired companies in our systems and controls, our financial condition and results of operations could be adversely affected. We may incur significant expenses in the evaluation and pursuit of potential acquisitions that may not be successfully completed, incurring substantial costs without corresponding benefit. For example, during 2005 we incurred a $1.6 million charge related to due diligence costs for evaluation of an acquisition target we chose not to pursue. Other risks inherent in our acquisition strategy include diversion of management’s attention and resources, failure to retain key personnel and risks associated with unanticipated events or liabilities. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” we are required to test goodwill for impairment at least annually, or more frequently if events or circumstances exist which indicate that goodwill may be impaired. Changes in circumstances after valuing assets in connection with acquisitions could necessitate write-downs of intangible assets, including goodwill, which could be significant.

 

We cannot be certain of the future effectiveness of internal controls over financial reporting or the impact thereof on our operations or the market price of our common stock.

 

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we include in our annual reports on Form 10-K our assessment of the effectiveness of internal controls over financial reporting. We cannot assure you that our system of internal controls will be effective in the future as our operations and control environment change. If we cannot adequately maintain the effectiveness of our internal controls over financial

reporting, financial reporting may be inaccurate. If reporting errors actually occur, we could be subject to sanctions or investigation by regulatory authorities, such as the SEC. These results could adversely affect financial results and the market price of our common stock.

 

We are implementing a company-wide Enterprise Resource Planning system which could temporarily disrupt day-to-day operations.

 

The Enterprise Resource Planning (“ERP”) system is intended to replace disparate operating subsidiary information systems for functions such as accounting and finance, human resources and customer relationships with a uniform company-wide information system. Implementation of the ERP system will require substantial financial and personnel resources. While the ERP system is intended to improve and enhance information systems, large scale implementation of new information systems across all of our operating companies exposes us to delay, higher costs and disruption of financial reporting due to risks associated with start up and integration with existing systems and processes. In addition, if we fail to implement the ERP system or fail to implement the ERP system successfully, we will have to continue to rely on the disparate operating subsidiary information systems.

 

A significant portion of our business depends on our ability to obtain surety bonds. We may be unable to compete for or work on certain projects if we are not able to obtain the necessary surety bonds.

 

Surety markets are currently challenging as a result of significant recent losses incurred by many sureties in the construction industry and the corporate market in general. As a result, less bonding capacity is available in the market and terms have become more expensive and restrictive. Under standard terms in the surety market, sureties issue bonds on a project-by-project basis and can decline to issue bonds at any time. Historically, approximately 10% to 20% of our annual volume of business, including a number of our fixed-price contracts, has required bonds. Those percentages may increase depending on our mix of contracts. Current or future surety market conditions, including our surety’s assessment of our operating and financial risk, could cause our surety provider to decline issuance, substantially reduce bonding capacity or increase bonding costs, including providing letters of credit. Such actions can be taken unilaterally and on short notice. If our surety provider were to limit or eliminate our access to bonding, alternatives include seeking bonding capacity from other sureties, posting other forms of collateral for project performance, such as letters of credit or cash, or finding other business that does not require surety bonds. We may be unable to provide such alternatives in a timely manner, on acceptable terms or at all. Consequently, if we experience an interruption or reduction in the availability of bonding capacity, we may be unable to compete for or work on certain projects.

 

Higher fuel prices and material costs may increase our cost of doing business, and we may not be able to pass those added costs to customers.

 

Fuel costs have increased significantly over the last two years and we have limited ability to pass higher fuel costs to customers. Even if we are able to incorporate higher fuel and materials costs into new contracts, higher overall project costs may depress the market for large-scale infrastructure projects. Therefore, higher fuel and material costs may directly or indirectly negatively impact our financial condition and results of operations.

 

We are subject to the risks associated with government contracts.

 

We are from time to time a provider of services to government agencies, primarily the DOE’s federal power marketing agencies, such as our recently completed contract with the Bonneville Power Administration. A reduction in spending could limit the continued funding of existing contracts, limit our ability to obtain additional contracts and result in lower revenues from those customers. The risks of government contracting include the risk of civil and criminal fines and penalties for violations of applicable regulations and statutes and the risk of public scrutiny of our performance on high profile sites. For example, we recently entered a consent decree to settle an investigation by the Department of Labor with respect to employee pay and work hours in connection with one of our electric transmission projects. Any failure to comply with the terms of

one or more of our government contracts, other government agreements or government regulations and statutes could result in being suspended or barred from future government contract projects for a significant period of time.

 

Government customers can in most cases terminate or modify contracts at their convenience. Government customers can reduce the value of existing contracts, issue modifications to a contract and control and potentially prohibit the export of services and associated materials. Some government contracts are subject to annual renewal or extension. If a government customer terminates a contract or fails to renew or extend a contract, backlog or revenue may be reduced or we may incur a loss, either of which could impair financial condition and operating results. A termination due to unsatisfactory performance could expose us to liability and adversely affect our ability to compete for future contracts and orders. In cases where we are a subcontractor, the prime contract could be terminated, regardless of the quality of our services as a subcontractor or our relationship with the relevant government agency.

 

Our projects are subject to numerous hazards. If we do not maintain an adequate safety record, we may be ineligible to bid on certain projects, could be terminated from existing projects and could have difficulty procuring adequate insurance.

 

Hazards associated with our activities include electrocution, fire, natural gas explosion, mechanical failure, transportation accidents and damage to customer’s equipment. These hazards can and have caused personal injury and loss of life, severe damage to or destruction of property and equipment and other consequential damages, including blackouts, and may result in suspension of operations, large damage claims, and, in extreme cases, criminal liability. We are subject to multiple workers’ compensation and personal injury claims resulting from such hazards or other workplace accidents. We maintain substantial loss accruals for workers’ compensation claims. Our insurance does not cover all types or amounts of liabilities. Our third-party insurance is subject to large deductibles for which we establish reserves and effectively self-insure for much of our exposures. In addition, for a variety of reasons such as increases in claims, a weak economy, projected significant increases in medical costs and wages, lost compensation and reductions in coverage, insurance carriers may be unwilling to continue current levels of coverage without a significant increase in collateral requirements to cover our deductible obligations. We may not be able to maintain adequate insurance at reasonable rates or meet collateral requirements.

 

Regulatory changes implemented by OSHA could impose additional costs on us. Our safety record is an important consideration for customers. If serious accidents or fatalities occur or our safety record deteriorates, we may be ineligible to bid on certain projects and could be terminated from existing projects. In addition, our reputation and prospects for future projects could be negatively affected. The OSHA recordable rate of one transmission construction subsidiary has been higher than the industry average. If we cannot improve on this subsidiary’s safety record, we may not be able to bid successfully on future projects. As is common in our industry, we regularly have been and will continue to be subject to claims by employees, customers and third parties for property damage and personal injuries.

 

Our unionized workforce could cause interruptions in provision of services. In addition, we contribute to multiemployer plans that could result in liabilities to us if these plans are terminated or we withdraw.

 

A significant percentage of our workforce is covered by collective bargaining agreements. Strikes or work stoppages could occur that would adversely impact relationships with customers and our ability to conduct business. Alternatively, our non-union workforce could be disrupted by union organizing activities and similar actions.

 

We contribute to several multiemployer pension plans for employees covered by collective bargaining agreements. These plans are not administered by us, and contributions are determined in accordance with provisions of negotiated labor contracts. The Employee Retirement Income Security Act of 1974, or ERISA, as amended by the Multiemployer Pension Plan Amendments Act of 1980, imposes certain liabilities upon employers who are contributors to a multiemployer plan in the event of the employer’s withdrawal from, or upon termination of, such plan. We do not have information on the net assets and actuarial present value of

the multiemployer pension plans’ unfunded vested benefits allocable to us, if any, or the amounts, if any, for which we may be contingently liable if we were to withdraw from any of these plans.

 

Changes in, or interpretations of, existing state or federal telecommunications regulations or new regulations could adversely affect us.

 

Many of our telecommunications customers benefit from the Universal Service “E-rate” program, which was established by Congress in the 1996 Telecommunications Act and is administered by the Universal Service Administrative Company (the “USAC”) under the oversight of the Federal Communications Commission (the “FCC”). Under the E-rate program, schools, libraries and certain health-care facilities may receive subsidies for certain approved telecommunications services, internet access, and internal connections. From time to time, bills have been introduced in Congress that would eliminate or curtail the E-rate program. Passage of such actions by the FCC or USAC to further limit E-rate subsidies could decrease the demand for telecommunications infrastructure services by certain customers.

 

The telecommunications services we provide are subject to regulation by the FCC, to the extent that they are interstate telecommunications services and, by states, when wholly within a particular state. To remain eligible to provide services under the E-rate program, we must maintain telecommunications authorizations in every state where we operate. Changes in federal or state regulations could reduce the profitability of our telecommunications business. We could be subject to fines if the FCC or a state regulatory agency were to determine that any of our activities or positions are not in compliance.

 

None.

 

The Company’s headquarters are located in Delaware County, Pennsylvania. As of December 31, 2006, we owned 10 facilities and leased 92 properties. With the exception of the corporate offices and the leased properties used for TS operations, all facilities and properties are used for ICS operations. We have pledged owned properties as collateral under the senior credit facility. Most properties are used as offices or for fleet operations. We believe that the facilities are adequate for current operations.

 

On September 21, 2005, a petition, as amended, was filed against InfraSource, certain of its officers and directors and various other defendants in the Harris County, Texas District Court seeking unspecified damages. The plaintiffs allege that the defendants violated their fiduciary duties and committed constructive fraud by failing to maximize shareholder value in connection with certain acquisitions which closed in 1999 and 2000 and the Merger and committed other acts of misconduct following the filing of the petition. At this time, it is too early to form a definitive opinion concerning the ultimate outcome of this litigation. Management of InfraSource plans to vigorously defend against this claim.

 

We generally indemnify our customers for the services we provide under our contracts. Furthermore, because our services are integral to the operation and performance of the electric power transmission and distribution infrastructure, we may become subject to lawsuits or claims for any failure of the systems that we work on, even if our services are not the cause for such failures, and we could be subject to civil and criminal liabilities to the extent that our services contributed to any property damage or blackout. The outcome of these proceedings could result in significant costs and diversion of management’s attention to the business. Payments of significant amounts, even if reserved, could adversely affect our reputation and liquidity.

 

From time to time, we are a party to various other lawsuits, claims, other legal proceedings and are subject, due to the nature of our business, to governmental agency oversight, audits, investigations and review. Such actions may seek, among other things, compensation for alleged personal injury, breach of contract, property damage, punitive damages, civil penalties or other losses, or injunctive or declaratory relief. Under

such governmental audits and investigations, we may become subject to fines and penalties or other monetary damages. With respect to such lawsuits, claims, proceedings and governmental investigations and audits, we accrue reserves when it is probable a liability has been incurred and the amount of loss can be reasonably estimated. We do not believe any of these proceedings currently pending, individually or in the aggregate, would be expected to have a material adverse effect on results of operations, cash flows or financial condition.

 

None.

 

The Company’s common stock has been listed on the New York Stock Exchange (“NYSE”) under the symbol “IFS” since initially offered to the public on May 12, 2004 (the “IPO”). Prior to that time, there was not a public market for our common stock. The following table shows the high and low per share sale prices for our common stock for the periods indicated, based on the NYSE consolidated transaction report:

 

 

As of February 26, 2007, there were approximately 2,208 holders of record of our common stock.

 

We currently intend to retain earnings, if any, to finance the growth, development and expansion of our business, and to reduce outstanding debt. Accordingly, we do not currently intend to declare or pay cash dividends on common stock in the immediate future. The declaration, payment and amount of future cash dividends, if any, will be at the discretion of our board of directors after taking into account various factors. These factors include the Company’s financial condition, results of operations, cash flows from operations, current and anticipated capital requirements and expansion plans, income tax laws then in effect and requirements under Delaware corporate law. In addition, the terms of our senior credit facility include limitations on the payment of cash dividends by InfraSource Incorporated to us without the prior consent of the lenders.

 

Common Stock Performance Graph

 

The following graph compares the percentage change in cumulative total stockholder return on our common stock since May 7, 2004 with the cumulative total return of the companies included in the Standard and Poor’s 500 Index (“S&P 500”) and the Russell 2000 Index (“Russell 2000”) over the same period. We are using the Russell 2000, which consists of issuers with similar market capitalization, because we do not believe we can reasonably identify a peer group with similar business lines that will provide a meaningful comparison. The comparison assumes $100 was invested on May 7, 2004 in the common stock and in each of the indices and assumes reinvestment of dividends, if any, from that date to December 31, 2006. Historic stock prices are not indicative of future stock price performance.

 

CUMULATIVE TOTAL RETURN
Based upon an initial investment of $100 on May 7, 2004

 

 

 

The following table presents selected financial data for the last five fiscal years. The consolidated statement of operations data for the years ended December 31, 2002, the period January 1, 2003 to September 23, 2003, the period May 30, 2003 to December 31, 2003, and for the years ended December 31, 2004, 2005 and 2006 and the consolidated balance sheet data at December 31, 2002, 2003, 2004, 2005 and 2006 have been derived from our consolidated financial statements, which include the results of our predecessor entity, InfraSource Incorporated, as of and for the years ended December 31, 2002, and for the period January 1, 2003 to September 23, 2003, and our results for the period May 30, 2003 (date of inception) to December 31, 2003, and for the years ended December 31, 2004, 2005 and 2006 and at December 31, 2003, 2004, 2005 and 2006.

 

This selected financial data should be read in conjunction with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included in Items 7 and 8, respectively, of this report on Form 10-K.

 

 

 

 

 

Introduction

 

The following discussion and analysis is provided to increase understanding of, and should be read in conjunction with, the consolidated financial statements and accompanying notes, as well as the Business and Risk Factors sections of this report on Form 10-K.

 

Overview

 

InfraSource Services, Inc. (“InfraSource”) and its wholly owned subsidiaries on a consolidated basis (referred to as “the Company,” “we,” “us,” or “our,”) is one of the largest specialty contractors servicing electric, natural gas and telecommunications infrastructure in the United States based on market share.

 

On September 24, 2003, we acquired all of the voting interests of InfraSource Incorporated and certain of its wholly owned subsidiaries, pursuant to a merger transaction (the “Merger”). On May 12, 2004, we completed an IPO of 8,500,000 shares of common stock. In 2006, the former Principal Stockholders and certain other stockholders completed two secondary underwritten public offerings of our common stock. The first occurred on March 24, 2006, in which they sold 13,000,000 shares at $17.50 per share (plus an additional 1,950,000 shares sold following exercise of the underwriters’ over-allotment option). The second occurred on August 9, 2006, in which they sold 10,394,520 shares at $17.25 per share (plus an additional 559,179 shares sold following exercise of the underwriters’ over-allotment option). We did not issue any primary shares and did not receive any of the proceeds from those offerings. As of December 31, 2006, the former Principal Stockholders no longer own any of our common stock.

 

We operate in two business segments. Our Infrastructure Construction Services (“ICS”) segment provides design, engineering, procurement, construction, testing, maintenance and repair services for utility infrastructure. ICS customers include electric power utilities, natural gas utilities, telecommunication customers, government entities and heavy industrial companies, such as petrochemical, processing and refining businesses. ICS services are provided by five operating units, all of which have been aggregated into one reportable segment due to their similar economic characteristics, customer bases, products and production and distribution methods. Our Telecommunication Services (“TS”) segment, consisting of a single operating unit, leases point-to-point

telecommunications infrastructure in select markets and provides design, procurement, construction and maintenance services for telecommunications infrastructure. TS customers include communication service providers, large industrial and financial services customers, school districts and other entities with high bandwidth telecommunication needs. Within our TS segment, we are regulated as a public telecommunication utility in various states. We operate in multiple service territories throughout the United States and we do not have significant operations or assets outside the United States. We acquired EHV Power Corporation (“EHVPC”), a Canadian subsidiary, in November of 2005, which represented less than 2% of our revenue in 2006.

 

For the year ended December 31, 2006, we had revenues of $992.3 million, in comparison to $853.1 million for the year ended December 31, 2005. Revenue mix by end market for the years ended December 31, 2005 and 2006 is presented in the table below:

 

 

Our top ten customers accounted for 45% and 44% of consolidated revenues for the years ended December 31, 2005 and 2006, respectively. Exelon Corporation (“Exelon”) accounted for approximately 18% and 14% of consolidated revenues for the years ended December 31, 2005 and 2006, respectively. Earlier this calendar year, Exelon indicated its intent to curtail expenditures to a level below that sustained in recent years and they have also begun to modify contracting practices to seek alternative commercial arrangements with suppliers like us, including increased use of competitive bidding on certain projects. Approximately 26% and 14% of telecommunications end market revenues for the years ended December 31, 2005 and 2006, respectively, were from the TS segment.

 

Below is a year-over-year (2005 as compared to 2006) and sequential quarter (third quarter 2006 as compared to fourth quarter 2006) comparison of end market backlog:

 

 

 

The increase in our backlog from the third quarter to the fourth quarter of 2006 is primarily related to natural gas MSA award and renewal activities, as well as industrial electric contract awards.

 

Our performance is affected by the capital spending of our customers. In the last several years, our business has been impacted by several important end market trends.

 

 

In addition to the foregoing industry trends, the effects of adverse weather and losses on certain contracts contributed to lower gross margins in 2005 and 2006. As has been common in our industry, we have experienced significant increases in fuel expenses needed to operate our fleet of equipment over the past several years.

 

Acquisitions and Dispositions

 

Acquisition of ITS:  On January 27, 2004, we acquired all of the voting interests of Maslonka & Associates, Inc. (“Maslonka”), which we re-branded as InfraSource Transmission Services Company (“ITS”), a complementary infrastructure services business, for total purchase price consideration of $83.2 million, which included the issuance of 4,330,820 shares of common stock, transaction costs and purchase price contingencies. The value of the shares issued to Maslonka stockholders was determined to be approximately $50.7 million. The final allocation of the purchase price was subject to a working capital adjustment and settlement of holdback adjustments to the purchase price in accordance with the terms of the acquisition agreement. Under terms of the holdback provisions, we withheld $6.6 million in cash and 957,549 shares of common stock. We finalized the working capital adjustment in July 2005 and released half of the holdback equal to $3.3 million in cash and 478,775 shares of common stock to the sellers in accordance with the acquisition agreement. The balance of the cash holdback, including accrued interest, and the remaining 478,774 shares were released in January 2006. Of the cash holdback amount, $5.5 million was contingent upon ITS’s achievement of certain performance targets as well as satisfaction of any indemnification obligations owed to us. In the fourth quarter of 2004, based on an evaluation of the performance targets detailed in the acquisition agreement, we recorded the $5.5 million additional contingent purchase price. During the year ended December 31, 2005, the working capital settlement recorded in the second quarter of 2005 and remaining purchase price adjustments increased goodwill by $0.4 million. ITS results were included in our consolidated results beginning January 27, 2004.

 

We financed the cash portion of the ITS acquisition with cash on hand and the issuance of 5,931,950 shares of common stock to our then principal stockholders and certain members of our management team for $27.5 million in cash. The purchase price has been allocated to the assets acquired and liabilities assumed based on their estimated fair value, which resulted in goodwill of $62.8 million.

 

Acquisition of Utili-Trax:  On August 18, 2004, we acquired substantially all of the assets and assumed certain liabilities of Utili-Trax, which provides underground and overhead construction services for electric cooperatives and municipal utilities throughout the upper Midwest, for total purchase price consideration of $5.3 million in cash, including transaction costs. The results of Utili-Trax are included in our consolidated results beginning August 18, 2004. The purchase price has been allocated to the assets acquired and liabilities assumed based on their estimated fair value, which resulted in goodwill of $1.3 million.

 

Acquisition of EnStructure:  On September 3, 2004, we acquired substantially all of the assets and assumed certain liabilities of EnStructure’s operating companies, Sub-Surface Construction Company, Flint Construction Company and Iowa Pipeline Associates, for total purchase price consideration of $20.9 million in cash, including transaction costs. EnStructure, formerly the construction services business of SEMCO Energy, Inc., provides construction services within the utilities, oil and gas markets throughout the Midwestern, Southern and Southeastern regions of the United States. The results of EnStructure are included in our consolidated results beginning September 3, 2004. The fair value of the EnStructure net assets exceeded the purchase price. Therefore, as described in Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations”, we decreased the eligible assets by the excess amount.

 

Acquisition of EHVPC:  On November 14, 2005, we acquired all of the voting interests of EHVPC, a Canadian company that specializes in splicing of underground high voltage electric transmission cables, for total purchase price consideration of $4.1 million, which includes transaction costs and a $0.6 million holdback payment which is payable in 2007. Payment of the holdback is not contingent on future events, with the exception of any indemnification obligations owed to us. The results of EHVPC are included in our consolidated results beginning November 14, 2005. The purchase price has been allocated to the assets acquired and liabilities assumed based on their estimated fair value, which resulted in goodwill of $2.3 million. The final allocation of the purchase price reflects a working capital adjustment, which was finalized during the second quarter of 2006.

 

Acquisition of RUE:  On December 15, 2006, we acquired all of the voting interests of RUE, a company that provides substation and transmission line engineering services for electric utilities, for total purchase price consideration of $9.3 million in cash, including transaction costs. We held back $1.3 million of purchase price

consideration, of which $0.4 million is scheduled to be paid upon filing of the final 2006 seller-period tax returns and $0.9 million is scheduled to be paid 18 months after the date of acquisition. Those holdback amounts are reflected as liabilities on the balance sheet as their payment is not contingent on future performance or the achievement of future milestones by RUE. Final purchase price allocation remains subject to a working capital adjustment expected to occur during the first quarter of 2007 and valuation of intangible assets. The purchase agreement contains a provision allowing the sellers to realize additional purchase price consideration, payable as 93,186 shares of InfraSource Services, Inc. unregistered common stock, contingent upon achieving certain earnings-based targets in fiscal years 2007, 2008 and 2009. The results of RUE were included in our consolidated results beginning December 15, 2006. As RUE is part of our ICS segment, the resulting goodwill of $7.8 million is included in the ICS segment and is not tax deductible.

 

Disposition of RJE Telecom:  During 2003, subsequent to the Merger, we committed to a plan to sell substantially all of the assets of OSP Consultants, Inc. and subsidiaries (“OSP”). On September 21, 2004, we completed the sale of substantially all of the assets of RJE Telecom, Inc. (“RJE”), a wholly owned subsidiary of OSP, for aggregate cash proceeds of $9.4 million, net of transaction costs. The sale of the RJE assets resulted in a gain of $0.6 million (net of $0.4 million tax), which is included in gain on disposal of discontinued operations in our consolidated statement of operations. The RJE sale completed our commitment to sell substantially all of the assets of OSP. RJE was part of our TS segment.

 

Disposition of ULMS:  In the third quarter of 2004, we committed to a plan to sell substantially all of the assets of Utility Locate & Mapping Services, Inc. (“ULMS”). On August 1, 2005, we sold certain assets of ULMS for aggregate cash proceeds, net of transaction costs, of $0.3 million and received a cash advance of $0.3 million from the buyer for contingent consideration. The sale of the ULMS assets resulted in a loss of $0.2 million (net of $0.2 million tax), which is included in gain on disposal of discontinued operations in our consolidated statement of operations. ULMS was part of our ICS segment.

 

Disposition of ESI:  In the second quarter of 2005, we committed to a plan to sell substantially all of the assets of Electric Services, Inc. (“ESI”). On August 1, 2005, we sold all of the common stock of ESI for aggregate cash proceeds, net of transaction costs, of approximately $6.5 million subject to a working capital adjustment. The sale of ESI resulted in a gain of $2.0 million (net of $1.6 million tax), which is included in gain on disposal of discontinued operations in our consolidated statement of operations. ESI was part of our ICS segment.

 

Disposition of MSI:  In the third quarter of 2006, we committed to a plan to sell certain assets of Mechanical Specialties, Inc. (“MSI”). In the third and fourth quarters of 2006 we sold certain assets of MSI for a cash purchase price of approximately $2.6 million, resulting in a gain, net of taxes, of $0.3 million which is included in gain on disposal of discontinued operations in our consolidated statement of operations. MSI was part of our ICS segment.

 

Discontinued Operations:  In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the financial position, results of operations and cash flows of OSP, ULMS, ESI and MSI are reflected as discontinued operations in our accompanying consolidated financial statements. For the years ended December 31, 2004, 2005 and 2006, OSP, ULMS, ESI and MSI are reflected as discontinued operations, until their respective disposition dates.

 

Outlook

 

The statements in this section are based on our current expectations. These statements are forward-looking, and actual results may differ materially. Please refer to “Risk Factors” included elsewhere in this report on Form 10-K for more information on what may cause actual results to differ.

 

Like many companies that provide specialty contracting services, we are subject to market cycles in our end markets that can affect results of operations. Customer diversity provides some insulation from these effects. We focus on the elements of the business we can control, including improved bidding, cost control, the expected margins we accept on projects, collecting receivables, and providing quality service. Operating

margins can be affected by the seasonality of our business, our ability to perform on projects as planned and the mix of the work. The first quarter is typically the weakest for both revenue and profit as winter weather hampers outdoor construction operations. Fixed-price high-voltage electric project work typically generates higher margins than either distribution and industrial electric work or natural gas operations. Although other factors may impact us, including some we do not foresee, we believe performance over the next year will be affected by the following:

 

 

Inflation

 

Due to relatively low levels of inflation experienced during the fiscal years ended December 31, 2004, 2005 and 2006, inflation did not have a significant effect on our results. However, we have experienced significant increases in fuel expenses related to our equipment fleet over the past several years.

 

Basis of Reporting

 

Revenues.  We enter into contracts principally on the basis of competitive bids, the final terms and prices of which we frequently negotiate with the customer and which are often subject to changes in work scope during performance of the contract. Although the terms of our contracts vary considerably, most are on either a fixed-price or unit-price basis. For fixed-price contracts, we agree to perform the work for a fixed amount for the entire project. For unit-priced contracts, we agree to perform the work for a fixed price per unit of work performed. We also perform services on cost-plus and time-and-materials basis.

 

We complete most installation projects within twelve months, while we frequently provide maintenance and repair work under open-ended, unit-price or cost-plus MSAs that are generally renewable in one to three

year increments. Most of our revenues are derived from contractual services provided to customers and are recognized when earned by the completion of specific components of the contracts. See “— Critical Accounting Policies and Estimates — Revenue Recognition” for a discussion of our revenue recognition policy. Our fixed-price contracts often include payment provisions pursuant to which the customer withholds a 5% to 10% retainage from each progress payment, which we record as a receivable, and remits the retainage to us upon completion and approval of our services.

 

Cost of Services.  Cost of services consists primarily of salaries, wages and benefits to employees, depreciation, fuel and other vehicle expenses, equipment rentals, subcontracted services, insurance, facilities expenses, materials and parts and supplies. Gross margins, which are gross profits expressed as a percentage of revenues, are typically higher on projects where labor, rather than materials, constitutes a greater portion of the cost of services. We can generally estimate materials costs more accurately than labor costs, which can vary based upon site conditions, weather, project duration and the degree to which third-party subcontractors are involved on a project. Therefore, to compensate for the potential variability of labor costs, we seek higher margins on labor-intensive projects.

 

Due to the nature of our work, insurance represents a significant portion of the cost of our services. Fluctuations in insurance accruals related to deductibles could have an impact on operating margins in the period in which such adjustments are made. During 2003, we increased insurance reserves for periods prior to 2003 by $8.7 million due to a change in estimate from an updated actuarial analysis, and during the year ended 2005, we reduced those reserves by $1.3 million based on recent claims experience. Our accruals are based on known facts, historical trends and actuarial assumptions and management believes such accruals are adequate. See “— Critical Accounting Policies and Estimates — Self Insurance” for a discussion of our self insurance policy.

 

Selling, general and administrative expenses.  Selling, general and administrative expenses consist primarily of compensation and related benefits to management, administrative salaries and benefits, marketing, office rent and utilities, communications and professional fees. Also included in selling, general and administrative expenses are non-income related taxes and depreciation for assets not utilized in operations.

 

Critical Accounting Policies and Estimates

 

The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, contingent assets and liabilities, and revenues and expenses. We evaluate those estimates on an ongoing basis, based on historical experience and various other assumptions we believe to be reasonable. Actual results may differ from those estimates. We have identified the accounting policies below as critical to the accounting for our business operations and the understanding of our results of operations because they involve more significant judgments and estimates used in the preparation of our consolidated financial statements. Other significant accounting policies, primarily those with lower levels of uncertainty than those discussed below, are also critical to understanding our consolidated financial statements. The notes to our consolidated financial statements contain additional information related to our accounting policies and should be read in conjunction with this discussion.

 

Revenue Recognition.  We record revenues from fixed-price contracts on a percentage-of-completion basis, using primarily the cost-to-cost method based on the percentage of total costs incurred to date in proportion to total estimated costs to complete the contract. Management considers expended versus total estimated costs to be the best measure of progress on these contracts. The cost estimation process is based on the professional knowledge and experience of our engineers, project managers, and financial professionals. Changes in job performance, job conditions and final contract settlements, among others, are factors that influence management’s assessment of the total estimated costs to complete those contracts and, therefore, our profit recognition. We recognize the loss in full on any contract as soon as the estimated costs to complete exceeds expected revenues. Revenues up to costs incurred on claims and unapproved change orders are recognized when it is probable that additional revenues will result, and the amount can be reasonably estimated. For claims, this includes determining that we have a legal basis for the claim and objective evidence to support the claim and that costs incurred are reasonable and are not a result of deficiencies in our

performance under the contract. Profit on claims and unapproved change orders, if any, is recorded upon settlement with the customer. Amounts collected could differ from estimates and result in a reduction or elimination of previously recognized revenue and profit. If actual results significantly differ from our estimates used for revenue recognition and claim assessments, our financial condition and results of operations could be materially impacted.

 

Revenues from MSAs and maintenance contracts are based on unit prices or time and materials and are recognized as the units are completed for unit-price contracts and when the work is performed for time and materials contracts. Revenues earned on short-term projects and under contracts providing for substantial performance of services are generally recorded under the completed contract method. In limited instances, revenues on short-term projects are recorded on a percentage-of-completion basis. Revenues earned pursuant to fiber-optic facility licensing agreements, including initial fees, are recognized ratably over the expected length of the agreements.

 

Costs and estimated earnings in excess of billings, classified as a current asset, primarily relate to revenues for completed but unbilled units under unit-based contracts, as well as unbilled revenues recognized under the percentage-of-completion method for fixed-price contracts. For contracts in which billings exceed contract revenues recognized to date, such excesses are classified as a current liability in the caption “billings in excess of costs and estimated earnings” in the accompanying balance sheets.

 

Self-Insurance.  We are insured for workers’ compensation and employer’s liability, auto liability and general liability claims, subject to a deductible of $0.75 million, $0.5 million and $0.75 million per occurrence, respectively. Losses up to the deductible amounts are accrued based upon our estimates of the ultimate liability for claims incurred and an estimate of claims incurred but not reported. However, insurance liabilities are difficult to assess and estimate due to unknown factors, including the severity of an injury, the determination of our liability in proportion to other parties, the number of incidents not reported and the effectiveness of our safety program. Management utilizes known facts and historical trends, as well as actuarial valuations, in order to determine our self-insurance liabilities.

 

The method of calculating the estimated accrued liability for self-insured claims is subject to inherent uncertainty. If actual results significantly differ from our estimates used to calculate the liability, our financial condition and results of operations could be materially impacted.

 

Share-Based Compensation.  Effective January 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R “Share-Based Payments,” which requires the measurement and recognition of compensation expense for all share-based awards made to employees and directors, including stock options, restricted stock and employee stock purchases related to the employee stock purchase plan, based on estimated fair values. We have identified the accounting for share-based payments as critical to the accounting for our business operations and the understanding of our results of operations because they involve more significant judgments and estimates used in the preparation of our consolidated financial statements. Prior to the adoption of SFAS No. 123R, we accounted for share-based awards to employees and directors using the intrinsic value method in accordance with Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” as allowed under SFAS No. 123.

 

SFAS No. 123R requires companies to estimate the fair value of share-based awards on the grant-date using an option-pricing model. We value share-based awards using the Black-Scholes option pricing model. The Black-Scholes model is highly complex, and dependent on key estimates by management. The estimates with the greatest degree of subjective judgment are the estimated lives of the stock-based awards and the estimated volatility of our stock price. Beginning in fiscal year 2006, we calculated the estimated life of stock options granted using a “simplified” method, which is based on the average of the vesting term and the term of the option, as a result of guidance from the SEC as contained in Staff Accounting Bulletin (“SAB”) No. 107 permitting the initial use of this method. We determined expected volatility for fiscal year 2006 using the historical method, as we have not identified a more reliable or appropriate method to predict future volatility.

 

As share-based compensation expense recognized during the current period is based on the value of the portion of share-based awards that is ultimately expected to vest, SFAS No. 123R requires forfeitures to be

estimated at the time of grant in order to estimate the amount of share-based awards that will ultimately vest. The forfeiture rate is based on historical activity. The value of the portion of the award that is ultimately expected to vest is expensed on a straight-line basis over the requisite service periods in our consolidated statements of operations. Share-based compensation expense recognized under SFAS No. 123R for the twelve months ended December 31, 2006 was $3.5 million related to stock options, restricted stock and the discount on employee stock purchases. For the twelve months ended December 31, 2005, we recorded share-based compensation expense of $0.7 million related to restricted stock and stock option awards granted prior to the IPO to employees and directors below the estimated fair market value of the underlying stock at the date of grant. For accounting purposes, the estimated fair market value of the underlying stock for these pre-IPO grants was determined in retrospect based on an independent valuation. See Notes 1 and 18 to our consolidated financial statements for additional information regarding the adoption of SFAS No. 123R.

 

If factors change and we employ different assumptions in the application of SFAS No. 123R in future periods, the compensation expense that we record under SFAS No. 123R may differ significantly.

 

Valuation of Goodwill and Intangible Assets.  In accordance with SFAS No. 142 “Goodwill and Other Intangible Assets,” we test goodwill for impairment at least annually, or more frequently if events occur or circumstances exist which indicate that goodwill may be impaired. Examples of such events or circumstances may include a significant change in business climate or a loss of key personnel. We generally complete our annual analysis at fiscal year end. We apply a two-step fair value based test to assess goodwill for impairment. The first step compares the fair value of a reporting unit to its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, the second step is then performed. The second step compares the carrying amount of the reporting unit’s goodwill to the fair value of the goodwill. If the fair value of the goodwill is less than the carrying amount, an impairment loss would be recorded in income (loss) from operations. Intangible assets with definite lives are also reviewed for impairment if events or changes in circumstances indicate that the carrying amount may not be realizable.

 

Management makes certain estimates and assumptions in order to allocate goodwill to reporting units and to determine the fair value of reporting unit net assets and liabilities, including, among other things, an assessment of market conditions, projected cash flows, cost of capital and growth rates, which could significantly impact the reported value of goodwill and other intangible assets. Estimating future cash flows requires significant judgment and our projections may vary from cash flows eventually realized. When necessary, we engage third party specialists to assist us with our valuations. The valuations employ a combination of present value techniques to measure fair value, corroborated by comparisons to estimated market multiples. These valuations are based on a discount rate determined by management to be consistent with industry discount rates and the risks inherent in our current business model.

 

Income Taxes.  Income taxes are accounted for using SFAS No. 109 “Accounting for Income Taxes.” Deferred income taxes are provided at the currently enacted income tax rates for the difference between the financial statement and income tax basis of assets and liabilities and carry-forward items. The effective tax rate and the tax basis of assets and liabilities reflect management’s estimates of the ultimate outcome of various tax audits and issues. In addition, valuation allowances are established for deferred tax assets where the amount of expected future taxable income from operations does not support the realization of the asset. We believe that the current assumptions and other considerations used to estimate the current year effective and deferred tax positions are appropriate. If the actual outcome of future tax consequences differs from our estimates and assumptions, the resulting change to the provision for income taxes could have a material impact on our consolidated financial statements.

 

Results of Operations

 

Seasonality and Cyclicality

 

The ICS segment’s results of operations are subject to seasonal variations. During the winter months, demand for new projects and new maintenance service arrangements is normally lower in some geographic areas due to reduced construction activity, especially for services to natural gas distribution customers. Therefore, our ICS segment typically experiences lower gross and operating income in the first quarter.

However, demand for repair and maintenance services attributable to damage caused by inclement weather may partially offset the loss of revenues from lower demand for new projects and new MSAs. During the three months ended March 31, 2006 and the three months ended December 31, 2006, we experienced unusually mild weather which contributed to increased volume and financial performance in our natural gas, underground telecommunications and electric transmission services.

 

Working capital needs are influenced by the seasonality of our business. We generally experience a need for additional working capital during the spring and summer when we increase outdoor construction in weather-affected regions of the country. Conversely, we typically convert working capital assets to cash during the winter months. Activity in our industry and the available volume of work is affected by the highly cyclical spending patterns in the telecommunications and independent power producers (“IPP”) sectors. As a result, our volume of business may be adversely affected by declines in new projects in various geographic regions or industries in the United States.

 

Our TS segment’s leasing of point-to-point telecommunications infrastructure is not significantly affected by seasonality.

 

Segments

 

We manage our operations in two segments, ICS and TS. The primary financial measures we use to evaluate segment operations are contract revenues and income from operations as adjusted, a non-GAAP financial measure. Income from operations as adjusted excludes expenses for the amortization of intangibles related to acquisitions and share-based compensation because we believe those expenses do not reflect the core performance of business segment operations. A reconciliation of income from operations as adjusted to the nearest GAAP equivalent, income from continuing operations before income taxes, is provided in Note 19 to our consolidated financial statements, included elsewhere in this report on Form 10-K. Corporate overhead expenses have not been allocated to our segments because we evaluate segment performance prior to the allocation of corporate expenses.

Year ended December 31, 2006 compared to the year ended December 31, 2005

 

Consolidated

 

 

Revenues:  Total revenues increased $139.2 million, or 16%. Electric revenues increased by $138.0 million, or 29%, natural gas revenues were approximately the same as the comparable 2005 period, telecommunications revenues increased by $4.4 million, or 4%, and other revenue decreased by $6.2 million, or 39%.

 

Gross profit:  Gross profit increased $42.8 million, or 42% in 2006 due primarily to an increase in the volume of high voltage electric substation and transmission work as well as productivity and pricing improvements in our natural gas operations. Gross profit margins increased from 12.1% in 2005 to 14.7%.

 

Selling, general and administrative expenses:  Selling, general and administrative expenses increased $21.1 million, or 29%. The increase was due primarily to an increase in salaries and benefits of $15.9 million, including increases in costs for additional personnel hired to manage business growth, incentive bonus compensation, share-based compensation, additional personnel costs due to the acquisition of EHVPC and severance costs. We also incurred costs of $0.7 million for the secondary offering completed in the first half of 2006 and increased legal fees. Those increases were partially offset by the absence in 2006 of a $1.6 million charge, recorded in the third quarter of 2005 for due diligence related to an abandoned acquisition, and a decrease in Sarbanes-Oxley compliance costs.

 

Provision for uncollectible accounts:  The $1.3 million increase in provision for uncollectible accounts was due to additional reserves taken during the year and the write-off of receivables deemed uncollectible.

 

Amortization of intangible assets:  The $3.9 million decrease in amortization of intangible assets was due to a lesser amount of intangible amortization related to acquired construction backlog, due to the completion in 2005 of most of the acquired contracts.

 

Interest income:  The $0.6 million increase in interest income was principally due to higher average cash balances in 2006.

 

Interest expense:  The $1.2 million decrease in interest expense was principally due to the lack of line of credit borrowings in 2006 and lower interest rates due to the refinancing of our senior credit facility.

 

Write-off of deferred financing costs:  In the second quarter of 2006, we refinanced our existing credit facility and recorded a $4.3 million noncash charge to write-off deferred financing costs related to the previous facility.

 

Other income, net:  The $2.5 million decrease in other income was due primarily to the 2005 reversal of a $3.8 million charge related to a litigation judgment settled in our favor during the first quarter of 2005, offset in part by a $0.9 million increase in gains on sale of property and equipment.

 

Provision for income taxes:  The provision for income taxes increased $6.7 million, due primarily to higher taxable income in the year ended December 31, 2006, partially offset by a decrease in our effective tax rate as a result of the change in the mix and location by state of work performed, higher tax-exempt interest income and an increased benefit from the federal qualified production activities deduction.

 

Discontinued operations, net of tax:  The income from discontinued operations for the year ended December 31, 2006 was less than $0.01 million compared to a loss of $(1.1) million for the year ended December 31, 2005. For 2005, those amounts reflect the operations of ULMS, ESI and MSI. For 2006, those amounts reflect the operations of MSI and the final resolution of liabilities related to ULMS. In the third quarter of 2005, we sold the stock of ESI and certain assets of ULMS for a $1.8 million gain, net of tax. In the third and fourth quarters of 2006 we sold certain assets of MSI and recorded a $0.3 million gain, net of tax.

 

Segments

 

 

 

ICS

 

Revenues:  ICS revenues increased $137.0 million, or 17%. Electric revenues increased by $138.0 million, or 29%, including $98.8 million from electric transmission services and $65.4 million from electric substation

services, offset in part by a $26.3 million decrease from utility distribution and industrial electric services. The decrease in utility distribution and industrial electric work is due primarily to fewer IPP projects and delays in the timing of emission controls work. Natural gas revenues were approximately the same as the comparable 2005 period due to unusually mild weather in the first quarter of 2006 which enabled an increased volume of work to be performed, offsetting the exit of certain unprofitable contracts as planned and a decline in new housing construction in certain areas of the country. Telecommunications revenues increased by $4.4 million, or 4%, due primarily to an increase in demand for underground telecommunications infrastructure. Other revenue decreased by $6.2 million, or 39%.

 

Income from operations as adjusted:  Income from operations as adjusted increased $26.4 million, or 108%. The increase was due primarily to a $35.8 million increase in gross profit, partially offset by a $14.1 million increase in selling, general and administrative expenses. The increase in gross profit was due primarily to an increase in the volume of high voltage electric substation and transmission work; the earning of performance bonuses on certain electric distribution and substation projects; the absence of certain performance-related pricing concessions we made to a large customer in 2005; improvements in productivity in our natural gas operations; and the planned exit of certain unprofitable natural gas contracts. This increase was partially offset by a decrease in the volume of utility distribution and industrial electric work. Additionally, we recorded an $8.9 million charge for an electric transmission contract determined to be in a loss position and reversed the associated pre-tax profit of $1.6 million recognized in prior periods, which was greater than the $10.1 million charge in the comparable 2005 period for the loss on one underground utility construction project. Selling, general and administrative expenses increased primarily as a result of $11.0 million in higher personnel related expenses including costs for additional personnel hired to manage business growth, incentive bonus compensation, share-based compensation, additional personnel costs due to the acquisition of EHVPC and severance costs.

 

TS

 

Revenues:  TS revenues were approximately the same as the comparable 2005 period. We experienced a decrease in telecommunication construction services offset by an increase in dark fiber leases which is more profitable than construction work.

 

Income from operations as adjusted:  Income from operations as adjusted increased $1.6 million, or 9% due primarily to an increase in dark fiber lease revenue.

 

Corporate

 

Corporate and eliminations loss from operations as adjusted increased by $3.9 million due to an increase in corporate expenses, offset in part by an increase of $2.4 million for revenue related to administrative services we provide to one customer. Corporate expenses increased primarily for personnel related expenses including increased costs for additional personnel hired to manage business growth, incentive bonus compensation, share-based compensation and severance costs. We also incurred costs of $0.7 million for the secondary offering completed in the first half of 2006 and increased legal fees. Those increases were partially offset by the absence in 2006 of a $1.6 million charge, recorded in the third quarter of 2005 for due diligence related to an abandoned acquisition, and a decrease in Sarbanes-Oxley compliance costs.

 

Year ended December 31, 2005 compared to the year ended December 31, 2004

 

Consolidated

 

 

Revenues:  Total revenues increased $220.5 million, or 35%. Electric revenues increased by $114.9 million, or 32%, natural gas revenues increased by $53.6 million, or 25% and telecommunications revenues increased by $49.0 million, or 94%.

 

Gross profit:  Gross profit increased $1.9 million, or 1.8%, while gross profit margins declined from 16.0% in 2004 to 12.1% in 2005 due primarily to a $10.1 million loss on one underground utility construction project; a decline in the gross profit margin of aerial transmission work; an increase in the volume of lower margin electric and gas distribution work; and an increase in fuel prices. These decreases were partially offset by an increase in the volume of electric substation and telecommunications work, as well as a $1.3 million credit to insurance expense due to favorable loss development in our self-insured retentions.

 

Selling, general and administrative expenses:  Selling, general and administrative expenses increased $10.5 million, or 17%. The increase is due primarily to expenses of $2.4 million for Sarbanes-Oxley compliance, a $1.6 million charge for due diligence related to an abandoned acquisition, incremental expenses related to 2004 acquisitions and additional personnel hired to grow the business. The increase over the prior period was partially offset by the absence in 2005 of $2.4 million incurred during 2004 for accounting and other fees related to our IPO. Selling, general and administrative expenses decreased as a percentage of revenue from 10% in 2004 to 9% in 2005.

 

Merger related costs:  The $0.4 million increase in merger related costs was due primarily to retention bonuses earned by employees during 2005.

 

Provision (recoveries) for uncollectible accounts:  The $0.5 million increase in the provision for uncollectible accounts was due primarily to the absence of settlements with customers that occurred during 2004.

 

Amortization of intangible assets:  The $7.4 million decrease in amortization of intangible assets was due to a lesser amount of acquired construction backlog amortization in 2005 compared to 2004, due to the completion in 2004 of the Path 15 project and other acquired contracts.

 

Interest expense:  The $2.0 million decrease in interest expense was principally due to a lower average debt balance in the current year.

 

Loss on early extinguishment of debt:  During the year ended December 31, 2004, we recorded a charge of $5.7 million related to the early extinguishment of a note payable to Exelon, offset by $1.1 million for accrued interest that was forgiven. Approximately $4.5 million of the loss on extinguishment of debt is recorded in continuing operations; the remaining $0.1 million relates to ULMS and is included in discontinued operations.

 

Other income, net:  The $4.3 million increase in other income was due primarily to the reversal of a $3.8 million charge for a litigation judgment recorded in 2003 and gains on equipment sales of $2.7 million.

 

Provision for income taxes:  The provision for income taxes increased to $9.7 million was due to higher taxable income in the year ended December 31, 2005. In addition, our effective tax rate was increased by a change in the mix of subsidiary operating results, which changes our state tax apportionment and the state tax rates to which our income is subject.

 

Discontinued operations, net of tax:  The loss from discontinued operations for the year ended December 31, 2005 was $(1.1) million compared to income from discontinued operations of $0.6 million in the prior year. These amounts reflect the operations of ULMS, OSP, and ESI for the year ended December 31, 2004 and ULMS and ESI for the year ended December 31, 2005. We sold the stock of ESI and certain assets of ULMS on August 1, 2005. We recorded a gain, net of tax, from the sale of discontinued operations of $1.8 million, net of tax, for the year ended December 31, 2005 compared to $0.6 million, net of tax, for the year ended December 31, 2004.

 

Segments

 

 

 

ICS

 

Revenues:  ICS revenues increased $206.9 million, or 34%. Electric revenues increased by $114.9 million, or 32%, including $49.9 million from increased utility distribution and industrial electric services, $35.4 million from electric substation services and $29.6 million from electric transmission services. Natural gas revenues increased by $53.6 million, or 25%, due primarily to our 2004 acquisition of EnStructure. Underground telecommunications revenue increased by $38.8 million, or 177%, due to an increase in demand for underground telecommunications infrastructure.

 

Income from operations as adjusted:  Income from operations as adjusted decreased $12.8 million, or 34%, due primarily to a decrease in gross profit and higher selling, general and administrative costs. The decline in gross profit margin was due primarily to a $10.1 million loss on one underground utility construction project; a decline in the gross profit margin of aerial transmission work performed in 2005 compared to 2004; an increase in the volume of lower margin electric and gas distribution work; and an increase in fuel prices. These decreases were partially offset by an increase in the volume of electric substation work. Selling, general and administrative costs increased by $7.9 million, due primarily to incremental expenses incurred from third quarter 2004 acquisitions and additional personnel hired to grow the business.

 

TS

 

Revenues:  TS revenues increased $10.2 million, or 34%, due to an increase in dark fiber leases and facility construction services, including the build-out of telecommunication infrastructure.

 

Income from operations as adjusted:  Income from operations as adjusted increased $4.1 million, or 31%, due primarily to an increase in gross margins from the increased revenue, partially offset by an increase of $1.4 million in selling, general and administrative costs primarily related to higher payroll and related costs.

 

Corporate

 

Corporate and eliminations loss from operations as adjusted increased by $0.8 million due to an increase in corporate expenses, offset in part by a $3.5 million increase in revenue related to administrative services we provide to one of our customers. Corporate expenses increased $3.8 million due primarily to expenses of $2.4 million for Sarbanes-Oxley compliance, a $1.6 million charge for due diligence related to an abandoned acquisition and additional payroll and related costs.

 

Liquidity and Capital Resources

 

Cash, Working Capital Requirements and Capital Expenditures

 

We anticipate that cash and cash equivalents as of December 31, 2006, our senior credit facility and future cash flow from operations will provide sufficient cash to meet operating needs for the next twelve months, based on expected levels of business, debt service requirements and planned capital expenditures. We may, however, find it necessary or desirable to seek additional financing to support growth, such as increased demand for our services as a result of the Energy Policy Act of 2005, or fund strategic initiatives, such as

acquisitions. This could require an increase in our senior credit facility or the issuance of new debt or additional equity, which would be dilutive to existing shareholders.

 

Working capital needs are influenced by the seasonality of our business. We generally experience a need for additional working capital during the spring season when we increase outdoor construction in weather-affected regions of the country. Conversely, we typically convert working capital assets to cash during the winter months. We expect capital expenditures to range from $50 million to $55 million during 2007, which could vary depending on the timing of awards and work releases for new contracts. More than half of our expected capital expenditures are targeted for dark fiber expansion. We intend to fund these expenditures primarily with operating cash flows. We have reduced capital expenditures as a percentage of revenue over the past two years as a result of increased use of equipment leasing and improved equipment utilization.

 

Sources and Uses of Cash

 

As of December 31, 2006, we had cash and cash equivalents of $26.2 million and working capital of $107.4 million. As of the same date, we had $50.0 million drawn under our senior credit facility, $33.6 million in letters of credit outstanding thereunder, and $1.1 million drawn under our short-term credit facility, leaving $141.9 million available for additional borrowings. As of December 31, 2005, we had cash and cash equivalents of $31.6 million, working capital of $115.5 million, long-term debt of $83.9 million and $32.3 million in letters of credit outstanding, leaving $52.7 million available for additional borrowings at that time.

 

Cash from operating activities from continuing operations.  During the year ended December 31, 2006, net cash provided by operating activities from continuing operations was $68.0 million compared to $29.7 million for the year ended December 31, 2005. The principal source of operating cash was payments received from customers for contract services performed. The principal uses of operating cash were payments for labor and materials related to performance of services and selling, general, and administrative expenses. Changes in operating assets and liabilities during the year ended December 31, 2006 provided $14.6 million of operating cash flow from continuing operations, as compared to a usage of $11.3 million in operating cash flow from continuing operations during 2005. The greater source of cash from changes in operating assets and liabilities from continuing operations for the year ended December 31, 2006 included a $3.1 million decrease in contracts receivable, including costs and estimated earnings in excess of billings, net, compared to a $51.8 million increase during the year ended December 31, 2005. The decrease in contracts receivable and costs and estimated earnings in excess of billings, net, is due primarily to a decrease in days sales outstanding of 11 days offset by the 12% increase in revenues during the fourth quarter of 2006 compared to fourth quarter of 2005. A decrease in accounts payable offset by an increase in other current and accrued liabilities produced $4.5 million during the year ended December 31, 2006 as compared to a source of $28.2 million during 2005.

 

During the year ended December 31, 2005, net cash provided by operating activities from continuing operations was $29.7 million compared to $19.7 million for year ended December 31, 2004. The principal source of operating cash during 2005 was payments received from customers for contract services performed. The principal uses of operating cash during the 2005 were payments for labor and materials related to performance of services and selling, general, and administrative expenses. Changes in operating assets and liabilities during 2005 used $11.3 million of operating cash flow from continuing operations, while during 2004 changes in operating assets and liabilities used $22.1 million in operating cash flow from continuing operations. The greater use of cash from changes in operating assets and liabilities from continuing operations for the year ended December 31, 2005 included a $51.8 million increase in contracts receivable, including from related parties and costs and earnings in excess of billings, net, compared to a $22.7 million increase during the year ended December 31, 2004. The decrease in other current assets during the year ended December 31, 2005 provided a $3.4 million source of cash compared to at $3.2 million use of cash during the year ended December 31, 2004. The change in accounts payable resulted in a $19.2 million source of cash during the year ended December 31, 2005 compared to a $6.4 million source of cash during the year ended December 31, 2004. An increase in current and accrued liabilities related to income taxes, and employee retention and bonuses provided a $9.0 million source of cash during the year ended December 31, 2005 compared to a $10.8 million use of cash due to the increase in current and accrued liabilities during the year ended December 31, 2004.

 

Cash from investing activities from continuing operations.  During the year ended December 31, 2006, net cash used by investing activities from continuing operations was $46.3 million compared to net cash used by investing activities from continuing operations of $19.4 million for the year ended December 31, 2005. The primary uses of cash for the year ended December 31, 2006 were for the purchases of equipment of $38.5 million and business acquisitions of $18.4 million, offset in part, by cash proceeds from the sale of discontinued operations of $2.6 million and proceeds from the sale of equipment of $7.7 million. The principal uses of cash during the year ended December 31, 2005 were the purchases of equipment of $30.5 million and business acquisitions of $6.5 million, offset in part, by cash proceeds from the sale of discontinued operations of $7.2 million, proceeds from the sale of equipment of $5.4 million, and the release of $5.0 million from restricted cash. The principal uses of cash during the year ended December 31, 2004 were cash payments at closing for the acquisitions of ITS, EnStructure and Utili-trax, net of cash acquired of $44.2 million, and purchases of equipment of $25.1 million, offset in part by $9.6 million in cash proceeds from the sale of discontinued operations and $3.7 million proceeds from sales of equipment.

 

Cash from financing activities from continuing operations.  During the year ended December 31, 2006, net cash used by financing activities from continuing operations was $27.1 million compared to net cash provided by financing activities from continuing operations of $0.1 million for the year ended December 31, 2005. The primary use of cash from financing activities for the year ended December 31, 2006 was related to the repayment of long-term debt and capital leases of $108.9 million and debt issuance costs of $1.4 million, partially offset by $75.0 million in proceeds from long-term borrowings, $1.1 million in proceeds from a short-term credit facility, $5.1 million in proceeds from the exercise of stock options and employee stock plan purchases and $2.0 million in proceeds from excess tax benefits received from stock-based compensation. The primary source of cash from financing activities for the year ended December 31, 2005 were $2.2 million from the exercise of stock options and employee stock options, offset by repayments of long-term debt and capital leases of $1.9 million. During the year ended December 31, 2004, net cash provided by financing activities from continuing operations was $45.1 million. The primary source of cash from financing activities for the year ended December 31, 2004 were $128.1 million of proceeds from issuance of common stock, $100.8 million of which was from our IPO and the remainder was from the issuance to then principal stockholders and certain members of management in conjunction with the acquisition of ITS. A portion of the IPO proceeds were used to repay $50.2 million of long-term debt and the $30.0 million principal amount of the subordinated note with Exelon.

 

During the year ended December 31, 2005, there was $0.6 million net cash reclassified to discontinued operations. For the year ended December 31, 2006, cash produced by operating activities from discontinued operations was $0.1 million and cash used in investing activities from discontinued operations was $0.1 million. The investing activities related to purchases of equipment.

 

Financing Agreements