QUANTA SERVICES, INC. quarterly report, Q2 FY2014

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Quanta Services, Inc. — Q2 2014 Form 10-Q

Reporting period: Three and six months ended June 30, 2014; unaudited. Quanta provides specialty contracting and infrastructure services, principally in electric power and oil and gas, plus fiber-optic licensing. Comparisons below are against the corresponding 2013 periods.

Financial performance

  • Second-quarter revenue: $1.865 billion, up 26.5%. Gross profit was $281.4 million; gross margin declined to 15.1% from 16.4%. Operating income rose to $133.4 million from $117.2 million, while operating margin fell to 7.2% from 7.9%. Net income attributable to common stock increased to $81.1 million from $70.2 million; diluted EPS was $0.37 versus $0.33.
  • First-half revenue: $3.627 billion, up 18.5%. Gross profit was $553.5 million and gross margin was 15.3%, down from 15.7%. Operating income fell to $223.9 million from $236.5 million; operating margin declined to 6.2% from 7.7%. Net income attributable to common stock was $135.5 million versus $142.3 million; diluted EPS was $0.62 versus $0.67.
  • Segment trends: Q2 Electric Power revenue rose 18.4% to $1.239 billion, but operating income declined 7.2% to $112.1 million. Oil and Gas revenue rose 51.7% to $585.4 million and operating income increased to $55.6 million from $27.6 million. Fiber Optic Licensing and Other revenue declined 4.9% to $40.0 million. For the first half, Oil and Gas operating income declined to $34.4 million from $38.0 million, reflecting unusual charges described below.
  • Cash flow and investment: Operating activities used $27.8 million in the first half, compared with $161.9 million provided in 2013. Investing activities used $220.6 million, including $146.8 million of capital expenditures and $79.6 million for acquisitions. Financing activities used $55.1 million, including $45.0 million of share repurchases. Cash fell to $188.9 million from $488.8 million at year-end 2013.
  • Liquidity and debt: Working capital was $1.28 billion. Quanta had no revolver borrowings at June 30 and reported $1.08 billion available under its $1.325 billion facility, after $243.8 million of letters of credit and bank guarantees. Balance-sheet current and long-term debt and notes payable totaled approximately $5.8 million. The company reported compliance with credit-facility covenants.
  • Other indicators: Total backlog was $8.68 billion, versus $8.73 billion at December 31, 2013; $4.71 billion was expected to be realized within 12 months. Days sales outstanding was 78 days, compared with 83 days a year earlier, on the company’s adjusted comparable basis.

Material changes and unusual items

  • Revenue growth reflected higher activity and acquisitions, especially in Oil and Gas. Acquired businesses contributed approximately $47.6 million of Q2 revenue and $84.6 million of first-half revenue following their acquisition dates.
  • Wet weather in Canada and northern U.S. regions and lower margins on certain power-generation projects pressured gross margins. Mainline pipe work supported Oil and Gas results, particularly in Q2.
  • First-half SG&A included a $38.8 million charge following an adverse arbitration decision involving National Gas Company of Trinidad and Tobago (NGC). Quanta paid $28.3 million in damages, fees and interest in April and wrote off approximately $10.5 million of related receivables.
  • Quanta recorded an increase in its Central States multi-employer pension withdrawal liability estimate during Q1. In July 2014, the plan issued a $39.6 million demand; Quanta disputes the amount and estimated a reasonable possible loss of up to $55.4 million. Final liability remains uncertain and could be materially higher than the amount recognized.
  • Quanta completed six acquisitions in the first half for total consideration of approximately $121.9 million, including cash and issued equity. It repurchased $45.0 million of common stock under a program authorizing up to $500 million through 2016.

Outlook, risks and contingencies

  • Management expected 2014 capital expenditures of $300–$325 million, including $50–$60 million for fiber-optic network expansion. It expected cash on hand, operating cash flows and available credit to fund operating needs and planned investment.
  • Management described electric-power opportunities as supportive of a strong backlog through the remainder of 2014 and into 2015, and saw potential for increased mainline-pipe activity in the second half of 2014 and into 2015. These are expectations, not quantified revenue or earnings guidance.
  • Key operating uncertainties include weather and seasonality, project timing and cancellations, customer spending and collections, permitting and regulation, labor availability, fixed-price project execution, commodity-market cycles, foreign exchange, and acquisition integration. Backlog includes estimates and may change; many master service agreements can be terminated on 30–90 days’ notice.
  • In the Sunrise Powerlink dispute, Quanta had recorded approximately $165 million in contract price adjustments and was pursuing arbitration against San Diego Gas & Electric. The customer counterclaimed for approximately $32 million; the hearing was scheduled for July 2015. Quanta warned an adverse outcome could materially affect its financial condition, results and cash flows.
  • The SEC notified Quanta in March 2014 of an inquiry into certain activities in foreign jurisdictions, including South Africa and the UAE, and requested document preservation. The filing states the SEC had not alleged violations and Quanta was cooperating.
  • Other exposures include approximately $3.1 billion of outstanding performance bonds (with estimated completion costs of about $750 million), $366.7 million of maximum guaranteed equipment residual values, self-insurance accruals of $170.5 million, and uncertain multi-employer pension obligations. Management did not expect significant claims under bonds or residual guarantees, but provided no assurance.
  • Management cited gradual economic improvement but continuing regulatory, environmental and permitting uncertainty. No material changes to previously disclosed risk factors were reported.

Important facts for investors to verify

  • Progress and cash collection from the Sunrise Powerlink arbitration, including any developments in the claim and counterclaim.
  • Final Central States Plan withdrawal liability, amounts paid under the demand, and the difference from the liability recognized.
  • Whether operating cash flow recovers from the first-half outflow as receivables, project billing milestones and working-capital needs evolve.
  • Whether backlog converts to revenue as estimated, given termination rights, project delays and the high share of master service agreements.
  • Execution and margin trends in Electric Power and Oil and Gas, alongside acquisition contributions, integration costs and planned capital spending.
  • Developments in the SEC inquiry, customer concentration and the collectability of the Sunrise-related receivable.