INTEGRATED ELECTRICAL SERVICES INC - 10-Q Quarterly Report

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

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended June 30, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from_____to_____.

Commission File No. 1-13783

INTEGRATED ELECTRICAL SERVICES, INC.

(Exact name of registrant as specified in its charter)

DELAWARE 76-0542208
(State or other jurisdiction of
incorporation or organization) (I.R.S. Employer Identification No.)

1800 West Loop South
Suite 500
Houston, Texas 77027-3290
(Address of principal executive offices) (zip code)

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

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]

The number of shares outstanding as of July 30, 2002 of the issuer's common
stock was 39,975,328 and of the issuer's restricted voting common stock was
2,605,709.

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

INDEX

1

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE INFORMATION)

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

2

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE INFORMATION)

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

3

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE INFORMATION)

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

4

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE INFORMATION)

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

5

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

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

6

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

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

7

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. OVERVIEW

Integrated Electrical Services, Inc. (the "Company" or "IES"), a Delaware
corporation, was founded in June 1997 to create a leading national provider of
electrical services, focusing primarily on the commercial and industrial,
residential, communications and related service and maintenance markets.

The accompanying unaudited condensed historical financial statements of the
Company have been prepared in accordance with accounting principles generally
accepted in the United States and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required for complete
financial statements, and therefore should be reviewed in conjunction with the
financial statements and related notes thereto contained in the Company's annual
report for the year ended September 30, 2001 filed on Form 10-K with the
Securities and Exchange Commission. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Actual operating results for the nine
months ended June 30, 2002, are not necessarily indicative of the results that
may be expected for the fiscal year ended September 30, 2002.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

For a description of these policies, refer to Note 2 of the Notes to
Consolidated Financial Statements included in the Company's Annual Report on
Form 10-K for the year ended September 30, 2001.

SUBSIDIARY GUARANTIES

All of the Company's operating income and cash flows are generated by its wholly
owned subsidiaries, which are the subsidiary guarantors of the Company's
outstanding 9 3/8% senior subordinated notes due 2009 (the "Senior Subordinated
Notes"). The Company is structured as a holding company and substantially all of
its assets and operations are held by its subsidiaries. There are currently no
significant restrictions on the Company's ability to obtain funds from its
subsidiaries by dividend or loan. The separate financial statements of the
subsidiary guarantors are not included herein because (i) the subsidiary
guarantors are all of the direct and indirect subsidiaries of the Company; (ii)
the subsidiary guarantors have fully and unconditionally, jointly and severally
guaranteed the Senior Subordinated Notes; and (iii) the aggregate assets,
liabilities, earnings, and equity of the subsidiary guarantors is substantially
equivalent to the assets, liabilities, earnings and equity of the Company on a
consolidated basis. As a result, the presentation of separate financial
statements and other disclosures concerning the subsidiary guarantors is not
deemed material.

8

USE OF ESTIMATES AND ASSUMPTIONS

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires the use of estimates and
assumptions by management in determining the reported amounts of assets and
liabilities, disclosures of contingent liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Estimates
are primarily used in the Company's revenue recognition of construction in
progress, fair value assumptions in analyzing goodwill impairment, allowance for
doubtful accounts and self-insured claims liability.

NEW ACCOUNTING PRONOUNCEMENT

In August 2001, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets." SFAS No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of". SFAS No. 144
establishes a single accounting model for long-lived assets to be disposed of by
sale and requires that those long-lived assets be measured at the lower of
carrying amount or fair value less cost to sell, whether reported in continuing
operations or in discontinued operations. SFAS No. 144 is effective for fiscal
years beginning after December 15, 2001. The Company is in the process of
assessing the impact that the adoption of this standard will have on its
financial position and results of operations.

2. GOODWILL AND OTHER INTANGIBLE ASSETS

Effective October 1, 2001, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," which establishes new accounting and reporting requirements
for goodwill and other intangible assets. Under SFAS No. 142, all goodwill
amortization ceased effective October 1, 2001. Goodwill amortization for the
three and nine months ended June 30, 2002 would have otherwise been $3.2 million
and $9.7 million, respectively. Material amounts of recorded goodwill
attributable to each of the Company's reporting units were tested for impairment
by comparing the fair value of each reporting unit with its carrying value. Fair
value was determined using discounted cash flows, market multiples and market
capitalization. These impairment tests are required to be performed at adoption
of SFAS No. 142 and at least annually thereafter. Significant estimates used in
the methodologies include estimates of future cash flows, future short-term and
long-term growth rates, weighted average cost of capital and estimates of market
multiples for each of the reportable units. On an ongoing basis (absent any
impairment indicators), the Company expects to perform impairment tests annually
during the first fiscal quarter.

Based on the Company's impairment tests performed upon adoption of SFAS No. 142,
it recognized a charge of $283.3 million ($7.10 per share) in the first quarter
of 2002 to reduce the carrying value of goodwill of its reporting units to its
implied fair value. This impairment is a result of adopting a fair value
approach, under SFAS No. 142, to testing impairment of goodwill as compared to
the previous method utilized in which evaluations of goodwill impairment were
made by the Company using the estimated future undiscounted cash flows compared
to the assets

9

carrying amount. Under SFAS No. 142, the impairment adjustment recognized at
adoption of the new rules was reflected as a cumulative effect of change in
accounting principle in the Company's first quarter 2002 income statement.
Impairment adjustments recognized after adoption, if any, generally are required
to be recognized as operating expenses.

The carrying amount of goodwill attributable to each reportable operating unit
with goodwill balances and changes therein follows:

The unaudited results of operations presented below for the nine months ended
June 30, 2002 and adjusted results of operations for the nine months ended June
30, 2001 reflect the operations of the Company had we adopted the
non-amortization provisions of SFAS No. 142 effective October 1, 2000:

10

3. RESTRUCTURING CHARGES

In October 2001, the Company began implementation of a workforce reduction
program. The purpose of this program was to cut costs by reducing the number of
administrative staff both in the field and at the home office. The total number
of terminated employees was approximately 450. As a result of the program
implementation, the Company recorded pre-tax restructuring charges of $5.6
million associated with 45 employees during the nine months ended June 30, 2002.
The charges were based on the costs of the workforce reduction program and
include severance and other special termination benefits. At June 30, 2002,
approximately $1.5 million of these charges have not been paid and are included
in accrued expenses.

4. DEBT

Credit Facility

The Company is party to a $150.0 million revolving credit facility with a
syndicate of lending institutions to be used for working capital, capital
expenditure, acquisitions and other corporate purposes that matures May 22,
2004, as amended (the "Credit Facility"). Amounts borrowed under the Credit
Facility bear interest at an annual rate equal to either (a) the London
interbank offered rate (LIBOR) plus 1.75 percent to 3.50 percent, as determined
by the ratio of the Company's total funded debt to EBITDA (as defined in the
Credit Facility) or (b) the higher of (i) the bank's prime rate or (ii) the
Federal funds rate plus 0.50 percent plus an additional 0.25 percent to 2.00
percent, as determined by the ratio of the Company's total funded debt to
EBITDA. Commitment fees of 0.50 percent are assessed on any unused borrowing
capacity under the Credit Facility. The Company's existing and future
subsidiaries guarantee the repayment of all amounts due under the facility, and
the facility is secured by the capital stock of those subsidiaries and the
accounts receivable of the Company and those subsidiaries. Borrowings under the
Credit Facility are limited to 66 2/3% of outstanding receivables (as defined in
the agreement). The Credit Facility requires the consent of the lenders for
acquisitions exceeding a certain level of cash consideration, prohibits the
payment of cash dividends on the common stock, restricts the ability of the
Company to repurchase shares of common stock, to incur other indebtedness and
requires the Company to comply with various affirmative and negative covenants
including certain financial covenants. Among other restrictions, the financial
covenants include minimum net worth requirements; a maximum total consolidated
funded debt to EBITDA ratio, a maximum senior consolidated debt to EBITDA ratio,
and a minimum interest coverage ratio. The Company was in compliance with the
financial covenants of its Credit Facility, as amended, at June 30, 2002. As of
June 30, 2002, the Company had no borrowings outstanding under its Credit
Facility, letters of credit outstanding under its Credit Facility of $18.9
million, $1.8 million of other borrowings and available borrowing capacity under
its Credit Facility of $131.1 million.

Senior Subordinated Notes

The Company has $275.0 million in senior subordinated notes. The senior
subordinated notes bear interest at 9.375% and mature on February 1, 2009. The
Company pays interest on the

11

senior subordinated notes on February 1 and August 1 of each year. The senior
subordinated notes are unsecured obligations and are subordinated to all
existing and future senior indebtedness. The senior subordinated notes are
guaranteed on a senior subordinated basis by all of the Company's subsidiaries.
Under the terms of the senior subordinated notes, the Company is required to
comply with various affirmative and negative covenants including: (i)
restrictions on additional indebtedness, and (ii) restrictions on liens,
guarantees and dividends.

Interest Rate Swap

The Company entered into an interest rate swap agreement in August 2001,
designated as a fair value hedge, in order to minimize the risks and cost
associated with its financing activities. The interest rate swap agreement has a
notional amount of $100.0 million and was established to manage the interest
rate risk of the senior subordinated note obligations. Under the swap agreement,
the Company pays the counterparty variable rate interest (3-month LIBOR plus
3.49%) and the counterparty pays the Company fixed rate interest of 9.375% on a
semiannual basis over the life of the instrument. At September 30, 2001, the
interest rate swap had a fair value of $3.2 million and is included in the
balance sheet in other noncurrent assets. The Company terminated this interest
rate swap agreement in February 2002. The Company received proceeds equal to the
fair value of the swap on the date of termination of $1.5 million, which is
being amortized over the remaining life of the bonds.

The Company entered into a new interest rate swap agreement in February 2002,
designated as a fair value hedge, in order to minimize the risks and cost
associated with its financing activities. The interest rate swap agreement has a
notional amount of $100.0 million and was established to manage the interest
rate risk of the senior subordinated note obligations. Under the swap agreement,
the Company pays the counterparty variable rate interest (3-month trailing LIBOR
plus 3.86%) and the counterparty pays the Company fixed rate interest of 9.375%
on a semiannual basis over the life of the instrument. Such interest rate swap
contract is reflected at fair value on the Company's consolidated balance sheet
and the related portion of fixed-rate debt being hedged is reflected at an
amount equal to the sum of its carrying value plus an adjustment representing
the change in fair value of the debt obligation attributable to the interest
rate being hedged. The net effect of this accounting on the Company's operating
results is that interest expense on the portion of fixed-rate debt being hedged
is generally recorded based on variable interest rates. The interest rate swap
is considered to be perfectly effective because it qualifies for the "short-cut"
method and therefore there is no net change in fair value to be recognized in
income. At June 30, 2002, the interest rate swap had a fair value of $1.6
million and is included in the balance sheet in other noncurrent assets.

12

Debt consists of the following (in thousands):

5. EARNINGS PER SHARE

The following table reconciles the numerators and denominators of the basic and
diluted earnings per share for the nine months ended June 30, 2001 and 2002 (in
thousands, except share information):

The Company excluded 47,766 shares from its calculation of weighted shares
outstanding because the Company reported a loss during the period, and including
them would have had an antidilutive effect on loss per share. For the nine
months ended June 30, 2001 and 2002, stock options of 4.4 million and 6.2
million respectively, were excluded from the computation of diluted earnings per
share because the option exercise prices were greater than the average market
price of the Company's common stock.

13

The following table reconciles the numerators and denominators of the basic and
diluted earnings per share for the three months ended June 30, 2001 and 2002 (in
thousands, except share information):

For the three months ended June 30, 2001 and 2002, stock options of 4.4 million
were excluded from the computation of diluted earnings per share because the
options exercise prices were greater than the average market price of the
Company's common stock.

6. OPERATING SEGMENTS

The Company follows SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information." Certain information is disclosed, per SFAS No. 131,
based on the way management organizes financial information for making operating
decisions and assessing performance.

The Company's reportable segments are strategic business units that offer
products and services to two distinct customer groups. They are managed
separately because each business requires different operating and marketing
strategies.

During the nine months ended June 30, 2002, the Company realigned its operations
between two reportable segments: commercial/industrial and residential. The
commercial/industrial segment provides electrical and communications
contracting, design, installation, renovation, engineering and upgrades and
maintenance and replacement services in facilities such as office buildings,
high-rise apartments and condominiums, theaters, restaurants, hotels, hospitals
and critical-care facilities, school districts, manufacturing and processing
facilities, military installations, airports, refineries, petrochemical and
power plants, outside plant, network enterprise and switch network customers.
The residential segment consists of electrical and communications contracting,
installation, replacement and renovation services in single family and low-rise
multifamily housing units. Other includes expenses associated with the Company's
home office and regional infrastructure.

14

The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance
based on income from operations of the respective business units prior to
unallocated home office expenses. Management allocates costs between segments
for selling, general and administrative expenses, goodwill amortization,
depreciation expense, capital expenditures and total assets. Those methods used
for allocation may change in the future.

Segment information for the nine months ended June 30, 2001 and 2002 is as
follows (in thousands):

The Company's information for the nine months ended June 30, 2001 has been
restated for consistency with the current year presentation.

15

Segment information for the three months ended June 30, 2001 and 2002 is as
follows (in thousands):

The Company's information for the three months ended June 30, 2001 has been
restated for consistency with the current year presentation. The Company does
not have significant operations or long-lived assets in countries outside of the
United States.

7. 1999 INCENTIVE COMPENSATION PLAN

In November 1999 the Board of Directors adopted the 1999 Incentive Compensation
Plan (the "1999 Plan"). The 1999 Plan authorizes the Compensation Committee of
the Board of Directors or the Board of Directors to grant employees of the
Company awards in the form of options, stock appreciation rights, restricted
stock or other stock based awards. The Company has up to 5.5 million shares of
Common Stock authorized for issuance under the 1999 Plan.

16

The Company granted a restricted stock award of 400,000 shares under its 1999
Plan. The market value of the stock on the date of grant for this award was $2.3
million. During the nine months ended June 30, 2001 and 2002, the Company
amortized $0.3 million and $1.4 million, respectively, in connection with this
award. During the three months ended June 30, 2001 the Company amortized $0.1
million in connection with this award. The award became fully vested and was
fully amortized during the three months ended December 31, 2001. Accordingly,
the Company had no amortization expense related to this award during the three
months ended June 30, 2002.

8. COMMITMENTS AND CONTINGENCIES

Subsidiaries of the Company are involved in various legal proceedings that have
arisen in the ordinary course of business. While it is not possible to predict
the outcome of such proceedings with certainty and it is possible that the
results of legal proceedings may materially adversely affect us, in the opinion
of the Company, all such proceedings are either adequately covered by insurance
or, if not so covered, should not ultimately result in any liability which would
have a material adverse effect on the financial position, liquidity or results
of operations of the Company. The Company expenses routine legal costs related
to such proceedings as incurred.

The Company has committed to invest up to $5.0 million in EnerTech Capital
Partners II L.P. ("EnerTech"). EnerTech is a private equity firm specializing in
investment opportunities emerging from the deregulation and resulting
convergence of the energy, utility and telecommunications industries. Through
June 30, 2002, the Company had invested $1.8 million under its commitment to
EnerTech.

9. SUBSEQUENT EVENTS

On July 11, 2002 and July 30, 2002, the Company purchased $10.0 million and $1.5
million of its 9.375% senior subordinated notes due February 1, 2009 at 96% and
91% of par, respectively.

On July 25, 2002, the Company sold one of its subsidiaries for approximately
$6.6 million in cash and approximately 241,000 shares of its common stock.

17

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

INTRODUCTION

The following should be read in conjunction with the response to Part I, Item 1
of this Report. Any capitalized terms used but not defined in this Item have the
same meaning given to them in Part I, Item 1.

This report on Form 10-Q includes certain statements that may be deemed to be
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These statements are based on our expectations and involve risks and
uncertainties that could cause our actual results to differ materially from
those set forth in the statements. Such risks and uncertainties include, but are
not limited to, the inherent uncertainties related to estimating future results,
fluctuations in operating results because of downturns in levels of
construction, incorrect estimates used in entering into fixed price contracts,
difficulty in managing the operation and growth of existing and newly acquired
businesses, the high level of competition in the construction industry and the
effects of seasonality. The foregoing and other factors are discussed in our
filings with the SEC including our Annual Report on Form 10-K for the year ended
September 30, 2001.

In response to the SEC's Release No. 33-8040, "Cautionary Advice Regarding
Disclosure About Critical Accounting Policies," we have identified the
accounting principles which we believe are most critical to our reported
financial status by considering accounting policies that involve the most
complex or subjective decisions or assessments. We identified our most critical
accounting policies to be those related to revenue recognition, the assessment
of goodwill impairment, our allowance for doubtful accounts receivable and the
recording of our self-insurance liabilities. These accounting policies, as well
as others, are described in the Notes to the Consolidated Financial Statements
of our Annual Report on Form 10-K for the year ended September 30, 2001 and at
relevant sections in this discussion and analysis.

Our revenues are derived by providing specialty contracting services to the
commercial and industrial and residential markets. Those markets comprise our
reportable segments.

We enter into contracts principally on the basis of competitive bids. We
frequently negotiate the final terms and prices of those contracts with the
customer. Although the terms of our contracts vary considerably, most are made
on either a fixed price or unit price basis in which we agree to do the work for
a fixed amount for the entire project (fixed price) or for units of work
performed (unit price). We also perform services on a cost-plus or time and
materials basis. We are generally able to achieve higher margins on fixed price
and unit price than on cost-plus contracts. We currently generate, and expect to
continue to generate, more than half of our revenues under fixed price
contracts. The cost of labor and materials, however, may vary from the costs we
originally estimated. Variations from estimated contract costs along with other
risks inherent in performing fixed price and unit price contracts may result in
actual revenue and gross profits for

18

a project differing from those we originally estimated and could result in
losses on projects. Depending on the size of a particular project, variations
from estimated project costs could have a significant impact on our operating
results for any fiscal quarter or year. We believe our exposure to losses on
fixed price contracts is limited in aggregate by the high volume and relatively
short duration of the fixed price contracts we undertake. Additionally, we
derive a significant amount of our revenues from new construction and from the
southern part of the United States. Downturns in new construction activity or in
construction in the southern United States could affect our results.

We complete most projects within one year, while we frequently provide service
and maintenance work under open-ended, unit price master service agreements
which are renewable annually. We recognize revenue on service and time and
material work when services are performed. Work performed under a construction
contract generally provides that the customers accept completion of progress to
date and compensate us for services rendered measured in terms of units
installed, hours expended or some other measure of progress. Revenues from
construction contracts are recognized on the percentage-of-completion method in
accordance with the American Institute of Certified Public Accountants Statement
of Position 81-1 "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts". Percentage-of-completion for construction contracts
is measured principally by the percentage of costs incurred and accrued to date
for each contract to the estimated total costs for each contract at completion.
We generally consider contracts to be substantially complete upon departure from
the work site and acceptance by the customer. Contract costs include all direct
material and labor costs and those indirect costs related to contract
performance, such as indirect labor, supplies, tools, repairs and depreciation
costs. Changes in job performance, job conditions, estimated contract costs and
profitability and final contract settlements may result in revisions to costs
and income and the effects of these revisions are recognized in the period in
which the revisions are determined. Provisions for total estimated losses on
uncompleted contracts are made in the period in which such losses are
determined.

We provide an allowance for doubtful accounts for unknown collection issues in
addition to reserves for specific accounts receivable where collection is
considered doubtful. Inherent in the assessment of the allowance for doubtful
accounts are certain judgments and estimates including, among others, our
customers' access to capital, our customers' willingness to pay, general
economic conditions and the ongoing relationships with our customers.

We are self-insured for workers' compensation, auto liability, general liability
and employee-related health care claims, subject to large deductibles. Losses up
to the deductible amounts are accrued based upon our estimates of the liability
for claims incurred and an estimate of claims incurred but not reported.
However, insurance liabilities are difficult to assess and estimate due to
unknown factors, including the severity of an injury, the determination of our
liability in proportion to other parties, the number of incidents not reported
and the effectiveness of our safety program. The accruals are based upon known
facts and historical trends and management believes such accruals to be
adequate.

19

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED JUNE 30, 2001 COMPARED TO THE
NINE MONTHS ENDED JUNE 30, 2002

The following table presents selected unaudited historical financial information
for the nine months ended June 30, 2001 and 2002.

REVENUES

Total revenues decreased $163.1 million, or 13%, from $1,269.6 million for the
nine months ended June 30, 2001 to $1,106.5 million for the nine months ended
June 30, 2002. This decrease in revenues is primarily the result of
non-recurring work performed for one customer during the nine months ended June
30, 2001, a decrease in revenues from communications work and a decrease of
non-residential revenues in the Midwest, as well as increased competition across
the country for available work during the nine months ended June 30, 2002.

Commercial and industrial revenues decreased $172.6 million, or 16 %, from
$1,075.7 million for the nine months ended June 30, 2001, to $903.1 million for
the nine months ended June 30, 2002. This decrease in revenues is primarily the
result of non-recurring work performed for one customer during the nine months
ended June 30, 2001, a decrease in revenues from

20

communications work and a decrease of non-residential revenues in the Northwest
and Midwest, as well as increased competition across the country for available
work during the nine months ended June 30, 2002.

Residential revenues increased $9.5 million, or 5%, from $193.9 million for the
nine months ended June 30, 2001, to $203.4 million for the nine months ended
June 30, 2002, primarily as a result of increased awards of construction
contracts in markets we serve.

GROSS PROFIT

Gross profit decreased $62.6 million, or 27%, from $233.0 million for the nine
months ended June 30, 2001, to $170.4 million for the nine months ended June 30,
2002. Gross profit margin as a percentage of revenues decreased approximately 3
percentage points from 18% for the nine months ended June 30, 2001 to 15% for
the nine months ended June 30, 2002. This decrease in gross profit margin as a
percentage of revenues was primarily the result of increased competition for
available work, project fade recorded on fixed-price contracts at some of our
subsidiaries during the nine months ended June 30, 2002 and lower margins on
work in the communications market.

Commercial and industrial gross profit decreased $63.1 million, or 34%, from
$187.6 million for the nine months ended June 30, 2001, to $124.5 million for
the nine months ended June 30, 2002. Commercial and industrial gross profit
margin as a percentage of revenues decreased 3 percentage points from 17% for
the nine months ended June 30, 2001, to 14% for the nine months ended June 30,
2002. This decrease in gross profit margin as a percentage of revenues was
primarily the result of increased competition for available work, project fade
recorded on fixed-price contracts at one of our subsidiaries during the nine
months ended June 30, 2002 and lower margins on work in the communications
market.

Residential gross profit increased $0.5 million, or 1%, from $45.4 million for
the nine months ended June 30, 2001, to $45.9 million for the nine months ended
June 30, 2002. Residential gross profit margin as a percentage of revenues
remained the same at 23% for the nine months ended June 30, 2001 and 2002.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses decreased $23.7 million, or 15%,
from $156.7 million for the nine months ended June 30, 2001, to $133.0 million
for the nine months ended

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June 30, 2002. This decrease was primarily the result of the termination of
certain administrative field and home office personnel during the nine months
ended June 30, 2002. Selling, general and administrative expenses as a
percentage of revenues remained the same at 12% for the nine months ended June
30, 2001 and 2002.

RESTRUCTURING CHARGES

In October 2001, we began implementation of a workforce reduction program. The
purpose of this program was to reduce the number of administrative staff both in
the field and in the home office. The total number of terminated employees was
approximately 450. As a result of the program implementation, we recorded
pre-tax restructuring charges of $5.6 million associated with 45 employees
during the nine months ended June 30, 2002. The charges were based on the cost
of the workforce reduction program, including severance and other termination
benefits. At June 30, 2002, approximately $1.5 million of these charges have not
been paid and are included in accrued expenses.

INCOME FROM OPERATIONS

Income from operations decreased $34.8 million, or 52%, from $66.6 million for
the nine months ended June 30, 2001, to $31.8 million for the nine months ended
June 30, 2002. This decrease in income from operations was primarily attributed
to decreased revenues year over year, decreased margins earned on those revenues
and restructuring charges of $5.6 million incurred during the nine months ended
June 30, 2002, partially offset by the non-recurring goodwill amortization of
$9.7 million incurred during the nine months ended June 30, 2001 in accordance
with the current accounting standard.

NET INTEREST AND OTHER EXPENSE

Interest and other expense, net increased $0.8 million from $19.3 million for
the nine months ended June 30, 2001, to $20.1 million for the nine months ended
June 30, 2002, primarily as a result of interest expense attributable to
increased average borrowings over the period and a $0.7 million loss recorded on
our investment in Energy Photovoltaics, Inc.

PROVISION FOR INCOME TAXES

Our effective tax rate decreased from 45.9% for the nine months ended June 30,
2001 to 33.6% for the nine months ended June 30, 2002. The effective rate for
the nine months ended June 30, 2001 included a provision for non-deductible
goodwill amortization expense while the effective tax rate for the nine months
ended June 30, 2002 included the effect of the reversal of certain valuation
allowances due to the projected utilization of certain net operating loss carry
forwards.

22

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THE
THREE MONTHS ENDED JUNE 30, 2002

The following table presents selected unaudited historical financial information
for the three months ended June 30, 2001 and 2002.

REVENUES

Total revenues decreased $49.2 million, or 12%, from $424.0 million for the
three months ended June 30, 2001, to $374.8 million for the three months ended
June 30, 2002. This decrease in revenues is primarily the result of
non-recurring work performed for one customer during the three months ended June
30, 2001, a decrease in revenues from communications work and a decrease of
non-residential revenues in the Midwest, as well as increased competition across
the country for available work during the three months ended June 30, 2002.

Commercial and industrial revenues decreased $50.1 million, or 14%, from $352.2
million for the three months ended June 30, 2001, to $302.1 million for the
three months ended June 30, 2002. This decrease in revenues is primarily the
result of non-recurring work performed for one customer during the three months
ended June 30, 2001, a increase in revenues from communications work and a
decrease of non-residential revenues in the Midwest, as well as increased
competition across the country for available work during the three months ended
June 30, 2002.

23

Residential revenues increased $0.9 million, or 1%, from $71.8 million for the
three months ended June 30, 2001, to $72.7 million for the three months ended
June 30, 2002, primarily as a result of increased awards of construction
contracts in markets we serve.

GROSS PROFIT

Gross profit decreased $23.3 million, or 28%, from $81.8 million for the three
months ended June 30, 2001, to $58.5 million for the three months ended June 30,
2002. Gross profit margin as a percentage of revenues decreased approximately 3
percentage points from 19% for the three months ended June 30, 2001 to 16% for
the three months ended June 30, 2002. This decrease in gross profit margin as a
percentage of revenues was primarily the result of increased competition for
available work and lower margins on work in the communications market.

Commercial and industrial gross profit decreased $23.5 million, or 36%, from
$64.3 million for the three months ended June 30, 2001, to $40.8 million for the
three months ended June 30, 2002. Commercial and industrial gross profit margin
as a percentage of revenues decreased 4 percentage points from 18% for the three
months ended June 30, 2001, to 14% for the three months ended June 30, 2002.
This decrease in gross profit margin as a percentage of revenues was primarily
the result of increased competition for available work and lower margins on work
in the communications market.

Residential gross profit increased $0.2 million, or 1%, from $17.5 million for
the three months ended June 30, 2001, to $17.7 million for the three months
ended June 30, 2002. Residential gross profit margin as a percentage of revenues
remained the same at 24% for the three months ended June 30, 2001 and 2002.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses decreased $13.1 million, or 25%,
from $53.0 million for the three months ended June 30, 2001, to $39.9 million
for the three months ended June 30, 2002. This decrease was primarily the result
of the termination of certain administrative field and home office personnel
during the three months ended June 30, 2002. Selling, general and administrative
expenses as a percentage of revenues decreased 1% from the three months ended
June 30, 2001 to the three months ended June 30, 2002 as a result of these
non-recurring expenses.

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INCOME FROM OPERATIONS

Income from operations decreased $7 million, or 27%, from $25.6 million for the
three months ended June 30, 2001, to $18.6 million for the three months ended
June 30, 2002. This decrease in income from operations was primarily attributed
to decreased revenues year over year, decreased margins earned on those revenues
partially offset by the non-recurring amortization of goodwill of $3.2 million
incurred during the three months ended June 30, 2001 in accordance with the
current accounting standard.

NET INTEREST AND OTHER EXPENSE

Interest and other expense, net decreased from $6.6 million for the three months
ended June 30, 2001, to $6.4 million for the three months ended June 30, 2002,
primarily as a result of decreased interest expense attributable to decreased
average borrowings over the period.

PROVISION FOR INCOME TAXES

Our effective tax rate decreased from 44.7% for the three months ended June 30,
2001 to 38.8% for the three months ended June 30, 2002. The lower effective tax
rate in the current three months was the result of non-deductible goodwill
amortization expense during the three months ended June 30, 2001.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2002, we had cash and cash equivalents of $33.0 million, working
capital of $244.0 million, no outstanding borrowings under our credit facility,
$18.9 million of letters of credit outstanding, and available capacity under our
credit facility of $131.1 million. The amount outstanding under our senior
subordinated notes was $275.0 million. All debt obligations are on our balance
sheet.

During the nine months ended June 30, 2002, we generated $47.3 million of net
cash from operating activities. This net cash provided by operating activities
was comprised of a net loss of $275.6 million, increased by $297.4 million of
non-cash charges related primarily to the cumulative effect of change in
accounting principle, depreciation expense, and non-cash compensation expenses
and increased by changes in working capital. Working capital changes consisted
of a $43.1 million decrease in accounts receivable due to the timing of
collections, offset by a $40.3 million decrease in accounts payable and accrued
expenses as a result of the timing of payments made. Working capital changes
also included a $14.3 million increase in costs and estimated earnings in excess
of billings on uncompleted projects, a $7.0 million increase in billings in
excess of costs and estimated earnings on uncompleted contracts, and a $9.1
million decrease in prepaids and other current assets with the balance of the
change due to other working capital changes. Net cash used in investing
activities was $7.6 million, consisting primarily of $7.5 million used for
capital expenditures. Net cash used in financing activities was $10.2 million,
resulting primarily from repayments, net of borrowings under our credit facility
and proceeds received in connection with the termination of the interest rate
swap in February 2002, as discussed below.

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Debt Financing. We are party to a $150.0 million revolving credit facility with
a syndicate of lending institutions to be used for working capital, capital
expenditures, acquisitions and other corporate purposes that matures May 22,
2004, as amended. Amounts borrowed under our credit facility bear interest at an
annual rate equal to either (a) the London interbank offered rate (LIBOR) plus
1.75 percent to 3.50 percent, as determined by the ratio of our total funded
debt to EBITDA (as defined in our credit facility) or (b) the higher of (i) the
bank's prime rate or (ii) the Federal funds rate plus 0.50 percent plus an
additional 0.25 percent to 2.00 percent, as determined by the ratio of our total
funded debt to EBITDA. Commitment fees of 0.50 percent are assessed on any
unused borrowing capacity under our credit facility. Our existing and future
subsidiaries guarantee the repayment of all amounts due under our facility, and
our facility is secured by the capital stock of those subsidiaries, our accounts
receivable and the accounts receivable of those subsidiaries. Borrowings under
our credit facility are limited to 66 2/3% of outstanding receivables (as
defined in the agreement). Our credit facility requires the consent of the
lenders for acquisitions exceeding a certain level of cash consideration,
prohibits the payment of cash dividends on our common stock, restricts our
ability to repurchase shares of common stock, to incur other indebtedness and
requires us to comply with various affirmative and negative covenants including
certain financial covenants. Among other restrictions, the financial covenants
include minimum net worth requirements, a maximum total consolidated funded debt
to EBITDA ratio, a maximum senior consolidated debt to EBITDA ratio, and a
minimum interest coverage ratio. We were in compliance with the financial
covenants of our credit facility, as amended, at June 30, 2002. At July 30,
2002, we had no outstanding borrowings under our credit facility.

We have $275.0 million in senior subordinated notes. The notes bear interest at
9.375% and will mature on February 1, 2009. We pay interest on the notes on
February 1 and August 1 of each year. The notes are unsecured senior
subordinated obligations and are subordinated to all of our existing and future
senior indebtedness. The notes are guaranteed on a senior subordinated basis by
all of our subsidiaries. Under the terms of the notes, we are required to comply
with various affirmative and negative covenants including (1) restrictions on
additional indebtedness, and (2) restrictions on liens, guarantees and
dividends.

All of our operating income and cash flows are generated by our wholly owned
subsidiaries, which are the subsidiary guarantors of our outstanding senior
subordinated notes. The separate financial statements of the subsidiary
guarantors are not included herein because (i) the subsidiary guarantors are all
of the direct and indirect subsidiaries of the Company; (ii) the subsidiary
guarantors have fully and unconditionally, jointly and severally guaranteed the
senior subordinated notes; (iii) the aggregate assets, liabilities, earnings,
and equity of the subsidiary guarantors is substantially equivalent to the
assets, liabilities, earnings and equity of the Company on a consolidated basis;
and (iv) the presentation of separate financial statements and other disclosures
concerning the subsidiary guarantors is not deemed material.

In August 2001, we entered into an interest rate swap contract that has a
notional amount of $100.0 million and was established to manage the interest
rate risk of the senior subordinated note obligations. At September 30, 2001 the
fair value of this derivative was $3.2 million and was included in other
noncurrent assets. We terminated this contract in February, 2002. We

26

received cash equal to the fair value of this derivative of $1.5 million, which
is being amortized over the remaining life of the bonds.

In February, 2002 we entered into a new interest rate swap contract that has a
notional amount of $100.0 million and was established to manage the interest
rate risk of the senior subordinated note obligations. At June 30, 2002 the fair
value of this derivative was $1.6 million and is included in the balance sheet
in other noncurrent assets. Under the fair value hedge method of accounting for
these types of derivatives, the change in the fair value of the interest rate
swap contract is recorded with an offsetting adjustment to the carrying value of
the hedged instrument and is thus included in the senior subordinated notes
classification as of June 30, 2002.

Borrowings outstanding on our credit facility, our senior subordinated notes and
our interest rate swap contract expose us to significant risks. Our credit
facility and interest rate swap contract expose us to risks associated with
floating interest rates. Our senior subordinated notes are fixed interest rate
obligations. The competitiveness of those fixed rates may impair our ability to
retire those obligations at reasonable rates before maturity.

Other Commitments. As is common in our industry, we have entered into certain
off balance sheet arrangements that expose us to increased risk. Our significant
off balance sheet transactions include liabilities associated with noncancelable
operating leases, letter of credit obligations and surety guarantees.

We enter into noncancelable operating leases for many of our vehicle and
equipment needs. These leases allow us to retain our cash when we do not own the
vehicles or equipment and we pay a monthly lease rental fee. At the end of the
lease, we have no further obligation to the lessor. We may determine to cancel
or terminate a lease before the end of its term. Typically we are liable to the
lessor for various lease cancellation or termination costs and the difference
between the then fair market value of the leased asset and the implied book
value of the leased asset as calculated in accordance with the lease agreement.

Some of our customers require us to post letters of credit as a means of
guaranteeing performance under our contracts and ensuring payment by us to
subcontractors and vendors. If our customer has reasonable cause to effect
payment under a letter of credit, we would be required to reimburse our creditor
for the letter of credit. Depending on the circumstances surrounding a
reimbursement to our creditor, we may have a charge to earnings in that period.
To date we have not had a situation where a customer has had reasonable cause to
effect payment under a letter of credit.

Many of our customers require us to post performance and payment bonds issued by
a surety. Those bonds guarantee the customer that we will perform under the
terms of a contract and that we will pay subcontractors and vendors. In the
event that we fail to perform under a contract or pay subcontractors and
vendors, the customer may demand the surety to pay or perform under our bond.
Our relationship with our surety is such that we will indemnify the surety for
any expenses it incurs in connection with any of the bonds it issues on our
behalf. To date, we have not incurred significant expenses to indemnify our
surety for expenses it incurred on our behalf.

27

We have committed to invest up to $5.0 million in EnerTech Capital Partners II,
L.P. ("EnerTech"). EnerTech is a private equity firm specializing in investment
opportunities emerging from deregulation and resulting convergence of the
energy, utility and telecommunications industries. Through June 30, 2002, we had
invested $1.8 million under our commitment to EnerTech.

Our future contractual obligations include (in thousands):

Our other commercial commitments expire as follows:

(1) Balance of investment commitment in EnerTech.

Outlook. The following statements are based on current expectations. These
statements are forward-looking and actual results may differ materially.
Economic conditions across the country are challenging. We continue to focus on
collecting receivables and reducing days sales outstanding. To improve our
position for continued success, we have taken steps to reduce costs. We have
made significant cuts in administrative overhead at the home office and in the
field. We believe these cuts will result in savings of over $40 million as
compared to the prior year. In connection with these cuts, we incurred
restructuring charges of $5.6 million during the nine months ended June 30,
2002.

We expect to generate cash flow from operations. Our cash flows from operations
tend to track with the seasonality of our business and historically have
improved in the latter part of our fiscal year. We anticipate that our cash flow
from operations will provide sufficient cash to enable us to meet our working
capital needs, debt service requirements and planned capital expenditures for
property and equipment through the next twelve months. Additionally, we expect
to generate enough cash flow from operations to repay any borrowings under our
credit facility. Our ability to generate cash flow from operations is dependent
on many factors, including demand for our products and services, the
availability of work at margins acceptable to us and the ultimate collectibility
of our receivables.

SEASONALITY AND QUARTERLY FLUCTUATIONS

Our results of operations, particularly from residential construction, are
seasonal, depending on weather trends, with typically higher revenues generated
during the spring and summer and lower revenues during the fall and winter. The
commercial and industrial aspect of our business

28

is less subject to seasonal trends, as this work generally is performed inside
structures protected from the weather. Our service business is generally not
affected by seasonality. In addition, the construction industry has historically
been highly cyclical. Our volume of business may be adversely affected by
declines in construction projects resulting from adverse regional or national
economic conditions. Quarterly results may also be materially affected by gross
margins for both bid and negotiated projects, the timing of new construction
projects and any acquisitions. Accordingly, operating results for any fiscal
period are not necessarily indicative of results that may be achieved for any
subsequent fiscal period.

NEW ACCOUNTING PRONOUNCEMENTS

Effective October 1, 2001, we adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," which establishes new accounting and reporting requirements
for goodwill and other intangible assets. Under SFAS No. 142, all goodwill
amortization ceased effective October 1, 2001. Goodwill amortization for the
three and nine months ended June 30, 2002 would have otherwise been $3.2 million
and $9.7 million, respectively. Material amounts of recorded goodwill
attributable to each of our reporting units were tested for impairment by
comparing the fair value of each reporting unit with its carrying value. Fair
value was determined using discounted cash flows, market multiples and market
capitalization. These impairment tests are required to be performed at adoption
of SFAS No. 142 and at least annually thereafter. Significant estimates used in
the methodologies include estimates of future cash flows, future short term and
long term growth rates, weighted average cost of capital and estimates of market
multiples for each of the reportable units. On an ongoing basis (absent any
impairment indicators), we expect to perform our impairment tests during our
first fiscal quarter following our annual budgeting process.

Based on initial impairment tests performed upon adoption of SFAS No. 142, we
recognized a charge of $283.3 million ($7.13 per share) in the first quarter of
2002 to reduce the carrying value of goodwill of our reporting units to their
implied fair value. This impairment is a result of adopting a fair value
approach, under SFAS No. 142, to testing impairment of goodwill as compared to
the previous method utilized in which we made evaluations of goodwill impairment
by using the estimated future undiscounted cash flows to the asset's carrying
amount. Under SFAS No. 142, the impairment adjustment recognized at adoption of
the new rules was reflected as a cumulative effect of change in accounting
principle in our first quarter 2002 income statement. Impairment adjustments
recognized after adoption, if any, generally are required to be recognized as
operating expenses.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of". SFAS No. 144 establishes a single accounting model for
long-lived assets to be disposed of by sale and requires that those long-lived
assets be measured at the lower of carrying amount or fair value less cost to
sell, whether reported in continuing operations or in discontinued operations.
SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. We
are in the process of assessing the impact that the adoption of this standard
will have on our financial position and results of operations.

29

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Management is actively involved in monitoring exposure to market risk and
continues to develop and utilize appropriate risk management techniques. We are
not exposed to any significant market risks from commodity price risk or foreign
currency exchange risk. Our exposure to significant market risks include
outstanding borrowings under our floating rate credit facility and interest rate
risks resulting from the use of an interest rate swap contract that we entered
into in February 2002. Management does not use derivative financial instruments
for trading purposes or to speculate on changes in interest rates or commodity
prices.

As a result, our exposure to changes in interest rates results from our
short-term and long-term debt with both fixed and floating interest rates. The
following table presents principal or notional amounts (stated in thousands) and
related interest rates by year of maturity for our debt obligations and their
indicated fair market value at June 30, 2002:

30

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

PART II. OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

A. EXHIBITS

10.1 Form of Employment Agreement between the Company and
H. Roddy Allen dated May 22, 1998 as Amended March
11, 2002.

10.2 Amendment No. 4 dated July 12, 2002, to the Credit
Agreement dated May 22, 2001, among the Company, as
borrower, the Financial Institutions named therein,
as banks, Credit Lyonnais and the Bank of Nova Scotia
as syndication agents, Toronto Dominion (Texas) Inc.
as documentation agent and the Chase Manhattan Bank,
as administrative agent.

B. REPORTS ON FORM 8-K

A report on Form 8-K was filed with the SEC on June 10, 2002
in connection with a change in the registrant's certifying
accountant.

31

INTEGRATED ELECTRICAL SERVICES, INC. AND SUBSIDIARIES

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, who has signed this report on behalf of
the Registrant and as the principal financial officer of the Registrant.

INTEGRATED ELECTRICAL SERVICES, INC.

Date: July 30, 2002 By: /s/ William W. Reynolds
--------------------------------------
William W. Reynolds
Executive Vice President and
Chief Financial Officer

32

EXHIBIT INDEX

EXHIBITS

10.1 Form of Employment Agreement between the Company and
H. Roddy Allen dated May 22, 1998 as Amended March 11,
2002.

10.2 Amendment No. 4 dated July 12, 2002, to the Credit
Agreement dated May 22, 2001, among the Company, as
borrower, the Financial Institutions named therein,
as banks, Credit Lyonnais and the Bank of Nova Scotia
as syndication agents, Toronto Dominion (Texas) Inc.
as documentation agent and the Chase Manhattan Bank,
as administrative agent.