INTEGRATED ELECTRICAL SERVICES INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and the notes thereto, set forth in Item 8,"Financial Statements and Supplementary Data" of this Form 10-K. For additional information, see "Disclosure Regarding Forward Looking Statements" in Part I of this Form 10-K.

OVERVIEW Executive Overview Please refer to Item 1. "Business" of this Form 10-K for a discussion of the Company's services and corporate strategy. Integrated Electrical Services, Inc., a Delaware corporation, is a leading provider of infrastructure services to the residential, commercial and industrial industries as well as for data centers and other mission critical environments. We operate primarily in the electrical infrastructure markets, with a corporate focus on expanding into other markets through strategic acquisitions or investments.

Industry Trends Our performance is affected by a number of trends that drive the demand for our services. In particular, the residential, industrial, mission critical infrastructure and commercial industries in which we operate are exposed to many regional and national trends such as the demand for single and multi-family housing, the need for mission critical facilities as a result of technology-driven advancements, and changes in commercial, institutional, public infrastructure and electric utility spending. Over the long term, we believe that there are numerous factors that could positively drive demand and affect growth within the industries in which we operate, including (i) population growth, which will increase the need for commercial and residential facilities, (ii) aging public infrastructure, which must be replaced or repaired, (iii) increased emphasis on environmental and energy efficiency, which may lead to both increased public and private spending, and (iv) the low price of natural gas combined with an increase in domestic oil and gas output, which is expected to spur the construction of and modifications to heavy industrial facilities.

However, there can be no assurance that we will not experience a decrease in demand for our services due to economic, technological or other factors. For a further discussion of the industries in which we operate, please see Item 1.

"Business -Operating Segments"of this Form 10-K.

Business Outlook While differences exist among the Company's segments, on an overall basis, demand for the Company's services increased in fiscal 2012 as compared to fiscal 2011 resulting in aggregate year-over-year revenue growth. In addition, the Company's previous investment in growth initiatives and other business-specific factors discussed below contributed to year-over-year revenue growth.

Segment-wise, year-over-year revenue growth rates during fiscal 2012 were led primarily by growth in our Communications and Residential segments. The combination of increasing revenue, improved project execution within our Commercial & Industrial segment and lower costs due to our restructuring efforts resulted in a significant reduction in operating losses. Provided that no significant deterioration in general economic conditions occurs, the Company expects revenues from existing businesses to grow on a year-over-year basis during fiscal 2013 due to an increase in demand for our services.

21-------------------------------------------------------------------------------- Table of Contents To service our indebtedness and to fund working capital, we require a significant amount of cash. Our ability to generate cash depends on many factors that are beyond our control, including demand for our products and services, the availability of projects at margins acceptable to us, the ultimate collectability of our receivables and our ability to borrow on our 2012 Credit Facility, among many other factors. We anticipate that the combination of cash on hand, cash flows and available capacity under our 2012 Credit Facility will provide sufficient cash to enable us to meet our working capital needs, debt service requirements and capital expenditures for property and equipment through the next twelve months. We expect that our capital expenditures will range from $1.0 to $1.5 million for the fiscal year ending on September 30, 2013.

RESULTS OF OPERATIONS We report our operating results across three operating segments: Communications, Residential and Commercial & Industrial. Expenses associated with our Corporate office are classified as a fourth segment. The following table presents selected historical results of operations of IES and subsidiaries.

Years Ended September 30, 2012 2011 2010 $ % $ % $ % (Dollars in thousands, Percentage of revenues) Revenues $ 456,115 100.0 % $ 406,141 100.0 % $ 382,431 100.0 % Cost of services 398,063 87.3 % 361,757 89.1 % 326,939 85.5 % Gross profit 58,052 12.7 % 44,384 10.9 % 55,492 14.5 % Selling, general and administrative expenses 58,609 12.8 % 63,321 15.6 % 74,251 19.4 % Gain on sale of assets (168 ) - % (6,555 ) (1.6 )% (128 ) - % Asset impairment - - % 4,804 1.2 % - - % Restructuring charges - - % - - % 763 0.2 % Loss from operations (389 ) (0.1 )% (17,186 ) (4.3 )% (19,394 ) (5.1 )% Interest and other expense, net 2,228 0.5 % 2,203 0.5 % 3,253 0.9 % Loss from operations before income taxes (2,617 ) (0.6 )% (19,389 ) (4.8 )% (22,647 ) (6.0 )% Provision (benefit) for income taxes 38 - % 172 - % (36 ) - % Net loss from continuing operations (2,655 ) (0.6 )% (19,561 ) (4.8 )% (22,611 ) (6.0 )% Net income from discontinued operations (9,158 ) (2.0 )% (18,288 ) (4.5 )% (8,539 ) (2.2 )% (Benefit) provision for income taxes (11 ) - % (26 ) - % 5 - % Net loss from discontinued operations (9,147 ) (2.0 )% (18,262 ) (4.5 )% (8,544 ) (2.2 )% Net loss $ (11,802 ) 1.4 % $ (37,823 ) (0.3 )% $ (31,155 ) (3.8 )% Consolidated revenues for the year ended September 30, 2012 were $50.0 million greater than for the year ended September 30, 2011, an increase of 12.3%.

The $13.7 million increase in our consolidated gross profit for the year ended September 30, 2012, as compared to the year ended September 30, 2011, was primarily the result of company-wide concerted efforts to return the organization to profitability. Our organization as a whole, and each segment individually, was successful in executing projects, and managing costs to maximize gross profits. Our overall gross profit percentage increased to 12.7% during the year ended September 30, 2012 as compared to 10.9% during the year ended September 30, 2011.

Selling, general and administrative expenses include costs not directly associated with performing work for our customers. These costs consist primarily of compensation and benefits related to corporate, division and branch management, occupancy and utilities, training, professional services, information technology costs, consulting 22-------------------------------------------------------------------------------- Table of Contents fees, travel and certain types of depreciation and amortization. We allocate certain corporate selling, general and administrative costs across our segments as we believe this more accurately reflects the costs associated with operating each segment.

During the year ended September 30, 2012, our selling, general and administrative expenses were $58.6 million, a decrease of $4.7 million, or 7.4%, as compared to the year ended September 30, 2011. Included in the year ended September 30, 2012 is $0.9 million of severance attributable to the departures of our former CFO and our former Senior Vice President and General Counsel.

Included in year ended September 30, 2011 is $2.9 million of accelerated amortization attributable to the discontinuance of certain software and $1.3 million of severance attributable to the former CEO's departure.

During the year ended September 30, 2011, our results of operations included a gain on sale of a non-strategic facility of $6.8 million, partially offset by $4.8 million in asset impairments with no comparable charges in the current year.

Communications 2012 Compared to 2011 Years Ended September 30, 2012 2011 $ % $ % (Dollars in thousands, Percentage of revenues) Revenue $ 121,492 100.0 % $ 83,615 100.0 % Gross Profit 18,204 15.0 % 12,473 14.9 % Selling, general and administrative expenses 13,431 11.1 % 9,578 11.5 % Revenue. Our Communications segment revenues increased $37.9 million during the year ended September 30, 2012, a 45.3% increase compared to the year ended September 30, 2011. This increase is primarily due to an increase in data center projects and high tech manufacturing projects during 2012, along with our establishment of an operation in San Diego, California. We believe the expansion of technology, cloud computing and increased demands for consumer focused data storage and collection, has led to an increase in demand for additional data center capacity. Revenues attributable to data centers were $38.9 million for the year ended September 30, 2012 compared to $29.9 million for the year ended September 30, 2011. The increase in high tech manufacturing projects is related to a major expansion by a high tech manufacturer in the greater Phoenix, Arizona area. Revenues from high tech manufacturing projects were $28.1 million during the year ended September 30, 2012, and $9.4 million during the year ended September 30, 2011. Although the growth in data center and high tech manufacturing projects was significant for the year ended September 30, 2012, there can be no assurance that this level of business or growth will continue, as a significant amount of our project work is awarded through a competitive bid process. Revenue from the establishment of our San Diego operations increased overall revenue by $10.5 million for the year ended September 30, 2012.

Gross Profit. Our Communications segment's gross profit during the year ended September 30, 2012 increased $5.7 million, or 46.0%, as compared to the year ended September 30, 2011. The increase in gross profit is attributable to a higher volume of contract revenues as noted in the revenue analysis above.

Overall gross profit as a percentage of revenue remained unchanged during 2012.

Exclusive of our San Diego operations, which were established in the fourth quarter of 2011, gross profit increased 0.9%.

Selling, General and Administrative Expenses. Our Communications segment's selling, general and administrative expenses increased $3.9 million, or 40.2%, during the year ended September 30, 2012 compared to the year ended September 30, 2011. Selling, general and administrative expenses as a percentage of revenues in the Communication segment decreased to 11.1% of segment revenue during the year ended September 30, 2012. The increase in selling, general and administrative expenses is primarily due to a $1.2 million legal 23-------------------------------------------------------------------------------- Table of Contents settlement reserve, detailed in Note 16, "Commitment and Contingencies-TekWorks, Inc" in the notes to our Consolidated Financial Statements. Additionally, we incurred higher expenses associated with our expansion of facilities in Southern California, including litigation expenses, increased staff in response to revenue growth, and to a lesser extent, incentive awards for achieving specific performance goals.

2011 Compared to 2010 Years Ended September 30, 2011 2010 $ % $ % (Dollars in thousands, Percentage of revenues) Revenue $ 83,615 100.0 % $ 69,171 100.0 % Gross Profit 12,473 14.9 % 12,411 17.9 % Selling, general and administrative expenses 9,578 11.5 % 7,298 10.6 % Revenue. Our Communications segment revenues increased $14.4 million during the year ended September 30, 2011, a 20.9% increase compared to the year ended September 30, 2010. This increase is primarily due to an increase in data center projects and national account activity. We believe the expansion of technology, cloud computing and increased demands for consumer focused data storage and collection have led to an increase in demand for additional data center capacity. Revenues attributable to data centers were $29.9 million for the year ended September 30, 2011 compared to $18.4 million for the year ended September 30, 2010. National accounts are used within this segment to describe customers who have multiple mission critical facilities throughout the United States; we provide a wide range of project and maintenance services to these customers. Revenues from our national accounts were $21.5 million during the year ended September 30, 2011, and $12.8 million during the year ended September 30, 2010. Although the growth in data center and national account projects was significant for the year ended September 30, 2011, there can be no assurance that this level of business or growth will continue, as substantially all of our project work is awarded through a competitive bid process.

Gross Profit. Our Communications segment's gross profit during the year ended September 30, 2011 increased $0.1 million, as compared to the year ended September 30, 2010. Gross profit as a percent of revenue decreased to 14.9% in 2011, compared to 17.9% in 2010. The decrease in gross profit percentage is attributed to increased competition driving down margin rates on individual contracts when compared to 2010.

Selling, General and Administrative Expenses Our Communications segment's selling, general and administrative expenses increased $2.3 million, or 31.2%, during the year ended September 30, 2011 compared to the year ended September 30, 2010. Selling, general and administrative expenses as a percentage of revenues in the Communication segment increased to 11.5% of segment revenue during the year ended September 30, 2011. The increase can be attributed to higher expenses associated with our expansion of facilities in San Diego, and to a lesser extent, incentive awards for achieving specific performance goals.

Residential 2012 Compared to 2011 Years Ended September 30, 2012 2011 $ % $ % (Dollars in thousands, Percentage of revenues) Revenue $ 129,974 100.0 % $ 114,732 100.0 % Gross Profit 20,700 15.9 % 18,690 16.3 % Selling, general and administrative expenses 19,703 15.2 % 18,441 16.1 % 24 -------------------------------------------------------------------------------- Table of Contents Revenue. Our Residential segment revenues increased $15.3 million during the year ended September 30, 2012, an increase of 13.3% as compared to the year ended September 30, 2011. Revenues for our multi-family construction increased by $4.2 million. In 2012, multi-family industry starts were attributed to improved demand for rental housing. Rental housing demand was partially driven by the deferral of purchases of single family homes due to continued restrictive lending practices for single family purchases, an uncertain job market and lower apartment vacancy rates. Single family construction revenues increased by $11.6 million, primarily in the Texas markets. We entered into the solar installation market during fiscal 2012, resulting in revenues of $9.5 million. Included in our fiscal 2011 balance are revenues attributable to a non-core electrical distribution facility, totaling $13.1 million. We sold this business in February 2011, and as such, no revenues from this facility are included in our fiscal 2012 balance.

Gross Profit. During the year ended September 30, 2012, our Residential segment experienced a $2.0 million, or 10.8%, increase in gross profit as compared to the year ended September 30, 2011. Gross margin percentage in the Residential segment decreased to 15.9% during the year ended September 30, 2012. We attribute much of the increase in Residential's gross margin primarily to the higher volume of single family projects.

Selling, General and Administrative Expenses. Our Residential segment experienced a $1.3 million, or 6.8%, increase in selling, general and administrative expenses during the year ended September 30, 2012 compared to the year ended September 30, 2011. Selling, general and administrative expenses as a percentage of revenues in the Residential segment decreased to 15.2% of segment revenue during the year ended September 30, 2012. We attribute much of the increase in Residential selling, general and administrative expenses primarily to increased incentives and our expansion into the solar installation market.

2011 Compared to 2010 Years Ended September 30, 2011 2010 $ % $ % (Dollars in thousands, Percentage of revenues) Revenue $ 114,732 100.0 % $ 115,947 100.0 % Gross Profit 18,690 16.3 % 23,525 20.3 % Selling, general and administrative expenses 18,441 16.1 % 23,736 20.5 % Revenue. Our Residential segment revenues decreased $1.2 million during the year ended September 30, 2011, a decrease of 1.0% as compared to the year ended September 30, 2010. Approximately $4.4 million of this decrease is primarily attributable to the sale of a non-core electrical distribution facility in February 2011. Revenues for our multi-family construction increased by $10.7 million as multi-family industry project starts increased to 195,000 units from 154,000 units in 2010. In 2011, multi-family industry starts were attributed to improved demand for rental housing. Rental housing demand was partially driven by the deferral of purchases of single family homes due to more restrictive lending practices for single family purchases, an uncertain job market and lower apartment vacancy rates. Single family construction revenues declined by $6.6 million, partially due to the end in tax stimulus for new home buyers, more restrictive lending practices and an uncertain job market. Nationwide demand for single-family homes declined, particularly in markets such as Southern California, Arizona, Nevada, Texas and Georgia.

Gross Profit. During the year ended September 30, 2011, our Residential segment experienced a $4.8 million, or 20.6%, reduction in gross profit as compared to the year ended September 30, 2010. Gross margin percentage in the Residential segment decreased to 16.1% during the year ended September 30, 2011. We attribute much of the decline in Residential's gross margin to increased competition and increased costs of materials creating lower margins in both single-family and multi-family construction. As our contracts provide for fixed prices, near term increases in costs for raw materials, such as copper, steel and fuel can significantly erode the margins which currently exist in the highly competitive residential construction marketplace. For example, copper prices are 25 -------------------------------------------------------------------------------- Table of Contents particularly volatile. During the year ended September 30, 2011, commodity prices for copper ranged from $3.15 to $4.62 per pound. The average spot price for copper was $4.13 per pound during the twelve months ended September 30, 2011, an increase of 29.0% over the prior twelve month period.

Selling, General and Administrative Expenses. Our Residential segment experienced a $5.3 million, or 22.3%, reduction in selling, general and administrative expenses during the year ended September 30, 2011 compared to the year ended September 30, 2010. Selling, general and administrative expenses as a percentage of revenues in the Residential segment declined to 16.1% of segment revenue during the year ended September 30, 2011. We attribute much of the decline in Residential selling, general and administrative expenses to lower management and incentive compensation expense.

Commercial & Industrial 2012 Compared to 2011 Years Ended September 30, 2012 2011 $ % $ % (Dollars in thousands, Percentage of revenues) Revenue $ 204,649 100.0 % $ 207,794 100.0 % Gross Profit 19,148 9.4 % 13,221 6.4 % Selling, general and administrative expenses 17,166 8.4 % 21,788 10.5 % Revenue. Revenues in our Commercial & Industrial segment decreased $3.2 million during the year ended September 30, 2012, a decrease of 1.5% compared to the year ended September 30, 2011. Our Commercial & Industrial segment is impacted not only by industry construction trends, but also specific industry and local economic trends. Impacts from these trends on our revenues may be delayed due to the long lead time of our projects. Our revenues were also impacted by a refocusing of our business development strategy on projects within our demonstrated areas of expertise and with increased margin expectations. Projects in all sectors remain subject to delays or cancellation with little advance notice. In many of our Commercial markets, we continue to experience increased competition from new entrants, including residential contractors or contractors from other geographic markets.

Gross Profit. Our Commercial & Industrial segment's gross profit during the year ended September 30, 2012 increased $5.9 million, or 44.8%, as compared to the year ended September 30, 2011. Commercial & Industrial's gross margin percentage increased to 9.4% during the year ended September 30, 2012, primarily due to improved execution of projects in all locations. Although the competitive market that has existed during the prolonged recession has continued to depress project bid margins, we have begun to experience some reprieve. In 2011, we experienced margin erosion and project difficulties due to a combination of project management turnover, projects outside our historical area of expertise, and delays in receipt of material and labor productivity, all of which significantly increased our cost on those projects. In 2012, we focused our efforts on winning projects within our areas of expertise, and significantly reduced the project inefficiencies due to delay and labor turnover.

Selling, General and Administrative Expenses. Our Commercial & Industrial segment's selling, general and administrative expenses during the year ended September 30, 2012 decreased $4.6 million, or 21.2%, compared to the year ended September 30, 2011. Selling, general and administrative expenses as a percentage of revenues in the Commercial & Industrial segment decreased to 8.4% of segment revenue during the year ended September 30, 2012. This decrease is primarily attributed to the consolidation of back offices in several locations late in fiscal 2011.

26 -------------------------------------------------------------------------------- Table of Contents 2011 Compared to 2010 Years Ended September 30, 2011 2010 $ % $ % (Dollars in thousands, Percentage of revenues) Revenue $ 207,794 100.0 % $ 197,313 100.0 % Gross Profit 13,221 6.4 % 19,556 9.9 % Selling, general and administrative expenses 21,788 10.5 % 29,047 14.7 % Revenue. Revenues in our Commercial & Industrial segment increased $10.5 million during the year ended September 30, 2011, an increase of 5.3% compared to the year ended September 30, 2010. Our Commercial & Industrial segment is impacted not only by industry construction trends, but also specific industry and local economic trends. Impacts from these trends on our revenues may be delayed due to the long lead time of our projects. According to McGraw Hill, total nonresidential building starts in the United States, in terms of millions of square feet, decreased 13% in 2010 and was unchanged in 2011. Our Industrial projects experienced revenue increases while our Commercial projects were essentially unchanged as the rate of decline for most industry sectors has begun to stabilize. Revenues from our Industrial projects increased by $10.7 million, during the year ended September 30, 2011, as compared to the year ended September 30, 2010, primarily due to a project at a refinery in Southeast Texas.

Although the growth in Industrial projects were significant for the year over year comparison for the period ended September 30, 2011, there can be no assurance that this level of business or growth will continue, as substantially all of our project work is awarded through a competitive bid process.

Gross Profit. Our Commercial & Industrial segment's gross profit during the year ended September 30, 2011 decreased $6.3 million, or 32.4%, as compared to the year ended September 30, 2010. Commercial & Industrial's gross margin percentage decreased to 6.4% during the year ended September 30, 2011, primarily due to lower margin construction projects and operating difficulties in several locations. The competitive market that has existed during the prolonged recession continued to depress project bid margins. In addition we experienced margin erosion and project difficulties due to a combination of project management turnover, projects outside our historical area of expertise, and delays in receipt of material and labor productivity, all of which significantly increased our cost on those projects. In many of our Commercial markets, we continued to experience increased competition from new entrants, including residential contractors or contractors from other geographic markets.

Selling, General and Administrative Expenses. Our Commercial & Industrial segment's selling, general and administrative expenses during the year ended September 30, 2011 decreased $7.3 million, or 25.0%, compared to the year ended September 30, 2010. Selling, general and administrative expenses as a percentage of revenues in the Commercial & Industrial segment declined to 10.5% of segment revenue during the year ended September 30, 2011. The reduction is attributed primarily to the reduction of office personnel, and reduction in discretionary spending.

Restructuring Charges In the first quarter of our 2009 fiscal year, we began a restructuring program (the "2009 Restructuring Plan") that was designed to consolidate operations within our three segments. In connection with the 2009 Restructuring Plan, we incurred pre-tax restructuring charges, including severance benefits and facility consolidations and closings, of $0.8 million during the year ended September 30, 2010. Costs incurred related to our Commercial & Industrial segment were $0.7 million and costs related to our Corporate office were $0.1 million for the year ended September 30, 2010.

In the second quarter of our 2011 fiscal year, we began the 2011 Restructuring Plan that was designed to consolidate operations within our Commercial & Industrial business. Pursuant to the 2011 Restructuring Plan, we planned to either sell or close certain underperforming facilities within our Commercial & Industrial operations.

27 -------------------------------------------------------------------------------- Table of Contents The 2011 Restructuring Plan was a key element of our commitment to return the Company to profitability. The results of operations for these facilities has now been re-classified as discontinued operations for the current and prior periods.

The facilities directly affected by the 2011 Restructuring Plan were in several locations throughout the country, including Arizona, Florida, Iowa, Louisiana, Massachusetts, Nevada and Texas. These facilities were selected due to current and future business prospects and the extended time frame needed to return the facilities to a profitable position. Restructuring expenses in respect of the 2011 Restructuring Plan totaling $5.0 million, including $1.2 million and $3.8 million for the years ended September 30, 2012 and 2011, respectively, were comprised of severance costs, lease terminations, and external consulting and management services. We have recognized substantially all costs related to the 2011 Restructuring Plan as of September 30, 2012. We will continue to incur professional fees in conjunction with the finalization of facility closure in fiscal year 2013.

Expenses related to the 2009 Restructuring Plan are classified as restructuring charges within our Consolidated Statements of Operations for the year ended September 30, 2010. Expenses related to the 2011 Restructuring Plan are included in the net loss from discontinued operations within our Consolidated Statements of Operations for the years ended September 30, 2012 and 2011.

The following table presents the elements of costs incurred for both the 2011 and 2009 Restructuring Plans: Years Ended September 30, 2012 2011 2010 (In thousands) Severance compensation $ (62 ) $ 1,455 $ 644 Consulting and other charges 1,099 1,531 119 Lease termination costs 133 799 Total restructuring charges $ 1,170 $ 3,785 $ 763 Interest and Other Expense, net Years Ended September 30, 2012 2011 2010 (In thousands) Interest expense $ 1,755 $ 1,940 $ 3,175 Deferred financing charges 569 338 338 Total interest expense 2,324 2,278 3,513 Interest income (34 ) (68 ) (242 ) Other (income) expense, net (62 ) (7 ) (18 ) Total interest and other expense, net $ 2,228 $ 2,203 $ 3,253 During the year ended September 30, 2012, we incurred interest expense of $1.8 million primarily comprised of the Tontine Term Loan (as defined in "Working Capital" below) and the Insurance Financing Agreements (as defined in "Working Capital" below), an average letter of credit balance of 8.8 million under the 2006 Credit Facility (as defined in "Working Capital" below) and an average unused line of credit balance of $29.7 million. This compares to interest expense of $1.9 million for the year ended September 30, 2011, on a debt balance primarily comprised of the Tontine Term Loan and the Insurance Financing Agreements, an average letter of credit balance of $12.7 million under the 2006 Credit Facility and an average unused line of credit balance of $38.9 million.

For the years ended September 30, 2012 and 2011, we earned interest income of $34 thousand and $68 thousand, respectively, on the average Cash and Cash Equivalents balances of 26.1 million and $29.9 million, respectively.

28-------------------------------------------------------------------------------- Table of Contents Sale of Non-Strategic Manufacturing Facility On November 30, 2010, a subsidiary of the Company sold substantially all the assets and certain liabilities of a non-strategic manufacturing facility engaged in manufacturing and selling fabricated metal buildings housing electrical equipment, such as switchgears, motor starters and control systems, to Siemens Energy, Inc. As part of this transaction, Siemens Energy, Inc. also acquired certain real property where the fabrication facilities are located from another subsidiary of the Company. The purchase price of $10.1 million was adjusted to reflect working capital variances. The transaction was completed on December 10, 2010 at which time we recognized a gain of $6.8 million.

Sale of Non-Core Electrical Distribution Facility On February 28, 2011, Key Electrical Supply, Inc, a wholly owned subsidiary of the Company, sold substantially all the assets and certain liabilities of a non-core electrical distribution facility engaged in distributing wiring, lighting, electrical distribution, power control and generators for residential and commercial applications to Elliot Electric Supply, Inc. The purchase price of $6.7 million was adjusted to reflect working capital variances. The loss on this transaction was immaterial.

PROVISION FOR INCOME TAXES Our provision for income taxes decreased from of $0.2 million for the year ended September 30, 2011 to $38 thousand for the year ended September 30, 2012. The decrease is mainly attributable to an increase in the reversal of unrecognized tax benefits, resulting in a $0.2 million decrease in the income tax expense. We provided a valuation allowance for the federal tax benefit resulting from the loss of operations for the years ended September 30, 2012 and 2011, respectively. As a result, we did not recognize any net benefit for federal taxes for the years ended September 30, 2012 and 2011.

Our provision for income taxes increased from a benefit of $36 thousand for the year ended September 30, 2010 to an expense of $0.2 million for the year ended September 30, 2011. The increase is mainly attributable to a decrease in the reversal of unrecognized tax benefits, resulting in a $0.1 million increase in the income tax expense. We provided a valuation allowance for the federal tax benefit resulting from the loss of operations for the years ended September 30, 2011 and 2010, respectively. As a result, we did not recognize any net benefit for federal taxes for the years ended September 30, 2011 and 2010.

WORKING CAPITAL During the year ended September 30, 2012, working capital decreased by $18.7 million from September 30, 2011, reflecting a $13.1 million decrease in current assets and a $5.6 million increase in current liabilities during the period.

During the year ended September 30, 2012, our current assets decreased by $13.1 million, or 8.2%, to $147.4 million, as compared to $160.5 million as of September 30, 2011. Cash and cash equivalents decreased by $9.7 million during the year ended September 30, 2012 as compared to September 30, 2011. The current trade accounts receivables, net, decreased by $9.5 million at September 30, 2012, as compared to September 30, 2011. Days sales outstanding ("DSOs") decreased to 56 as of September 30, 2012 from 70 days as of September 30, 2011.

The improvement was driven predominantly by increased collection efforts. While the rate of collections may vary, our secured position, resulting from our ability to secure liens against our customers' overdue receivables, reasonably assures that collection will occur eventually to the extent that our security retains value. In light of the volatility of the current financial markets, we closely monitor the collectability of our receivables. We also experienced a $0.9 million decrease in retainage and a $1.8 million decrease in costs in excess of billings during the year ended September 30, 2012 compared to September 30, 2011.

29 -------------------------------------------------------------------------------- Table of Contents During the year ended September 30, 2012, our total current liabilities increased by $5.6 million to $104.4 million, compared to $98.8 million as of September 30, 2011. During the year ended September 30, 2012 accounts payable and accrued expenses decreased $10.3 million. Billings in excess of costs increased by $5.6 million during the year ended September 30, 2012 compared to September 30, 2011. Finally, current maturities of long-term debt decreased by $10.2 million during the year ended September 30, 2012 compared to September 30, 2011 primarily due to the shifting of classification of the Tontine Term Loan from long term to current portion of long-term debt.

Surety Many customers, particularly in connection with new construction, require us to post performance and payment bonds issued by a surety. These bonds provide a guarantee to the customer that we will perform under the terms of our contract and that we will pay our subcontractors and vendors. If we fail to perform under the terms of our contract or to pay subcontractors and vendors, the customer may demand that the surety make payments or provide services under the bond. We must reimburse the sureties for any expenses or outlays they incur on our behalf. To date, we have not been required to make any reimbursements to our sureties for bond-related costs.

As is common in the surety industry, sureties issue bonds on a project-by-project basis and can decline to issue bonds at any time. We believe that our relationships with our sureties will allow us to provide surety bonds as they are required. However, current market conditions, as well as changes in our sureties' assessment of our operating and financial risk, could cause our sureties to decline to issue bonds for our work. If our sureties decline to issue bonds for our work, our alternatives would include posting other forms of collateral for project performance, such as letters of credit or cash, seeking bonding capacity from other sureties, or engaging in more projects that do not require surety bonds. In addition, if we are awarded a project for which a surety bond is required but we are unable to obtain a surety bond, the result could be a claim for damages by the customer for the costs of replacing us with another contractor.

As of September 30, 2012, the estimated cost to complete our bonded projects was approximately $67.2 million. We believe the bonding capacity presently provided by our sureties is adequate for our current operations and will be adequate for our operations for the foreseeable future. As of September 30, 2012, we utilized $1.0 million of cash (as is included in "Other Non-Current Assets" in our Consolidated Balance Sheet) as collateral for certain of our previous bonding programs.

The 2012 Revolving Credit Facility On August 9, 2012, we entered into a Credit and Security Agreement (the "Credit Agreement"), for a $30.0 million revolving credit facility (the "2012 Credit Facility") with Wells Fargo Bank, National Association. The 2012 Credit Facility will mature on August 9, 2015, unless earlier terminated. The 2012 Credit Facility replaced our 2006 Credit Facility with Bank of America, as described below.

The 2012 Credit Facility contains customary affirmative, negative and financial covenants. The 2012 Credit Facility requires that we maintain a fixed charge coverage ratio of not less than 1.0:1.0 at any time that our aggregate amount of unrestricted cash and cash equivalents on hand plus Excess Availability (as defined in the Credit Agreement) is less than $20.0 million or Excess Availability is less than $7.5 million.

Borrowings under the 2012 Credit Facility may not exceed a "borrowing base" that is determined monthly by our lenders based on available collateral, primarily certain accounts receivables and inventories. Under the terms of the 2012 Credit Facility, amounts outstanding bear interest at a per annum rate equal to a Daily Three Month 30 -------------------------------------------------------------------------------- Table of Contents LIBOR (as defined in the Credit Agreement), plus an interest rate margin, which is determined quarterly, based on the following thresholds: Level Thresholds Interest Rate Margin I Liquidity £ $20.0 million at any time during the period; or Excess Availability £ $7.5 million at any time during the period; or Fixed charge coverage ratio < 1.0:1.0 4.00 percentage points II Liquidity > $20.0 million at all times during the period; and Liquidity £ $30.0 million at any time during the period; and Excess Availability $7.5 million; and Fixed charge coverage ratio ³ 1.0:1.0 3.50percentage points III Liquidity > $30.0 million at all times during the period 3.00 percentage points In addition, we are charged monthly in arrears for (1) an unused commitment fee of 0.50% per annum, (2) a collateral monitoring fee ranging from $1 thousand to $2 thousand, based on the then-applicable interest rate margin, (3) a letter of credit fee based on the then-applicable interest rate margin and (4) certain other fees and charges as specified in the Credit Agreement.

The 2012 Credit Facility is guaranteed by our subsidiaries and secured by first priority liens on substantially all of our subsidiaries' existing and future acquired assets, exclusive of collateral provided to our surety providers. The 2012 Credit Facility also restricts us from paying cash dividends and places limitations on our ability to repurchase our common stock and our ability to repay the Tontine Term Loan.

At September 30, 2012, we had $21.6 million available to us under the 2012 Credit Facility, $0.7 million in outstanding letters of credit with Wells Fargo and no outstanding borrowings. The Credit Agreement requires that we cash collateralize 100% of our letter of credit balance. As such, we have $0.7 million classified as restricted cash within the Balance Sheet as of September 30, 2012.

At September 30, 2012, we were subject to the financial covenant under the 2012 Credit Facility requiring that we maintain a fixed charge coverage ratio of not less than 1.0:1.0 at any time that our aggregate amount of unrestricted cash and cash equivalents on hand plus Excess Availability is less than $20.0 million or Excess Availability is less than $7.5 million. As of September 30, 2012, our aggregate amount of unrestricted cash and cash equivalents on hand plus Excess Availability was in excess of $20.0 million and Excess Availability was in excess of $7.5 million; had we not met these thresholds at September 30, 2012, we would not have met the required 1.0:1.0 fixed charge coverage ratio test.

While we expect to meet our financial covenants, in the event that we are not able to meet the covenants of the 2012 Credit Facility in the future and are unsuccessful in obtaining a waiver from our lenders, the Company expects to have adequate cash on hand to fully collateralize our outstanding letters of credit and to provide sufficient cash for ongoing operations.

The 2006 Revolving Credit Facility On May 12, 2006, we entered into a Loan and Security Agreement (the "Loan and Security Agreement"), for a revolving credit facility (as amended, the "2006 Credit Facility") with Bank of America, N.A. and certain other lenders. Under the terms of the amended 2006 Credit Facility, the size of the facility was $40.0 million and the maturity date was November 12, 2012. On August 9, 2012, the amended 2006 Credit Facility was replaced by the 2012 Credit Facility.

Under the terms of the amended 2006 Credit Facility, we were required to cash collateralize all of our letters of credit issued by the banks. The cash collateral was added to the borrowing base calculation at 100% throughout the term of the agreement. The 2006 Credit Facility required that we maintain a fixed charge coverage ratio of 31-------------------------------------------------------------------------------- Table of Contents not less than 1.0:1.0 at any time that our aggregate amount of unrestricted cash on hand plus availability was less than $25.0 million and, thereafter, until such time as our aggregate amount of unrestricted cash on hand plus availability had been at least $25.0 million for a period of 60 consecutive days. The amended Agreement also called for cost of borrowings of 4.0% over LIBOR per annum. Cost for letters of credit was the same as borrowings and also included a 25 basis point "fronting fee." In connection with the most recent amendment to the 2006 Credit Facility, we incurred an amendment fee of $0.1 million which, together with unamortized balance of the prior amendment was amortized using the straight line method through August 30, 2012.

The 2006 Credit Facility was guaranteed by our subsidiaries and secured by first priority liens on substantially all of our subsidiaries' existing and future acquired assets, exclusive of collateral provided to our surety providers. The 2006 Credit Facility contained customary affirmative, negative and financial covenants. The 2006 Credit Facility also restricted us from paying cash dividends and placed limitations on our ability to repurchase our common stock.

Borrowings under the 2006 Credit Facility could not exceed a "borrowing base" that was determined monthly by our lenders based on available collateral, primarily certain accounts receivables and inventories. Under the terms of the 2006 Credit Facility in effect as of August 30,2012, interest for loans and letter of credit fees was based on our Total Liquidity, which is calculated for any given period as the sum of average daily availability for such period plus average daily unrestricted cash on hand for such period as follows: Annual Interest Rate for Annual Interest Rate for Letters of Total Liquidity Loans Credit Greater than or equal to 3.00% plus $60.0 million LIBOR plus 3.00% or Base 0.25% Rate plus 1.00% fronting fee Greater than $40.0 million 3.25% plus and less than $60.0 million LIBOR plus 3.25% or Base 0.25% Rate plus 1.25% fronting fee Less than or equal to $40.0 3.50% plus million LIBOR plus 3.50% or Base 0.25% Rate plus 1.50% fronting fee At September 30, 2012, we had $6.1 million in outstanding letters of credit with Bank of America. The terms surrounding the termination of the 2006 Credit Facility require that we cash collateralize 105% of our letter of credit balance. As such, we have $6.5 million classified as restricted cash within the Balance Sheet as of September 30, 2012.

For the year ended September 30, 2012, we paid no interest for loans under the 2006 Credit Facility and had a weighted average interest rate, including fronting fees, of 3.55% for letters of credit. In addition, we were charged monthly in arrears (1) an unused commitment fee of 0.50%, and (2) certain other fees and charges as specified in the Loan and Security Agreement, as amended.

As of August 9, 2012, we were subject to the financial covenant under the 2006 Credit Facility requiring that we maintain a fixed charge coverage ratio of not less than 1.0:1.0 at any time that our aggregate amount of unrestricted cash on hand plus availability is less than $25.0 million and, thereafter, until such time as our aggregate amount of unrestricted cash on hand plus availability has been at least $25.0 million for a period of 60 consecutive days. As of August 9, 2012, our Total Liquidity was in excess of $25.0 million.

The Tontine Term Loan On December 12, 2007, we entered into, a $25.0 million senior subordinated loan agreement (the "Tontine Term Loan"), with Tontine Capital Partners, L.P., an affiliate of our controlling shareholder. The Tontine Term Loan bears interest at 11.0% per annum and is due on May 15, 2013. Interest is payable quarterly in cash or in-kind at our option. Any interest paid in-kind will bear interest at 11.0% in addition to the loan principal. On April 30, 2010, we prepaid $15.0 million of principal on the Tontine Term Loan. On May 1, 2010, Tontine assigned the 32 -------------------------------------------------------------------------------- Table of Contents Tontine Term Loan to Tontine Capital Overseas Master Fund II, L.P., also a related party. We may repay the Tontine Term Loan at any time prior to the maturity date at par, plus accrued interest without penalty within the restrictions of the 2012 Credit Facility. The Company is currently evaluating its options with regard to repayment of the loan, including through a refinancing of the loan prior to or at its maturity.

The Tontine Term Loan is subordinated to the 2012 Credit Facility. The Tontine Term Loan is an unsecured obligation of the Company and its subsidiary borrowers, and contains no financial covenants or restrictions on dividends or distributions to stockholders. The Tontine Term Loan was amended on August 9, 2012 in connection with the Company entering into the 2012 Credit Facility. The amendment did not materially impact the Company's obligations under the Tontine Term Loan.

Capital Lease The Company leases certain equipment under agreements, which are classified as capital leases and included in property, plant and equipment. Accumulated amortization of this equipment for the years ended September 30, 2012, 2011 and 2010 was $0.2 million, $0.2 million and $0.2 million, respectively, which amounts are included in depreciation expense in the accompanying statements of operations.

Insurance Financing Agreements From time to time, we elect to finance our commercial insurance policy premiums over a term equal to or less than the term of the policy (each, an "Insurance Financing Agreement"). The terms of the Insurance Financing Agreement for fiscal year 2012 was for twelve months at an interest rate of 1.99%. The Insurance Financing Agreement was collateralized by the gross unearned premiums on the respective insurance policies plus any payments for losses claimed under the policies. The remaining balance due on the Insurance Financing Agreement at September 30, 2012 was $0.2 million. We did not elect to finance our insurance policy premiums in fiscal year 2011.

LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2012, we had cash and cash equivalents of $18.7 million, working capital of $43.0 million, $6.2 million of letters of credit outstanding under our 2006 Credit Facility, and $0.7 million of letters of credit and $21.6 million of available capacity under our 2012 Credit Facility. We anticipate that the combination of cash on hand, cash flows and available capacity under our 2012 Credit Facility will provide sufficient cash to enable us to meet our working capital needs, debt service requirements and capital expenditures for property and equipment through the next twelve months. Our ability to generate cash flow is dependent on many factors, including demand for our services, the availability of projects at margins acceptable to us, the ultimate collectability of our receivables, and our ability to borrow on our 2012 Credit Facility, if needed. We were not required to test our covenants under our 2006 Credit Facility or our 2012 Credit Facility during the period.

Had we been required to test our covenants, we would have failed at September 30, 2012.

We continue to closely monitor the financial markets and general national and global economic conditions. To date, we have experienced no loss or lack of access to our invested cash or cash equivalents; however, we can provide no assurances that access to our invested cash and cash equivalents will not be impacted in the future by adverse conditions in the financial markets.

Operating Activities Our cash flow from operations is not only influenced by cyclicality, demand for our services, operating margins and the type of services we provide, but can also be influenced by working capital needs such as the timing of our receivable collections. Working capital needs are generally lower during our fiscal first and second quarters due to the seasonality that we experience in many regions of the country.

33 -------------------------------------------------------------------------------- Table of Contents Operating activities used net cash of $7.4 million during the year ended September 30, 2012, as compared to $11.9 million of net cash used in the year ended September 30, 2011. We used substantially more cash to reduce our accounts payable and accrued expenses and increase inventory in 2012. This was directly correlated to the increase in revenues year over year. Additionally, our increased billings produced $11.1 million in cash. We were able to increase our billings in excess of cost in fiscal 2012, by $5.7 million. Depreciation expense was significantly reduced in fiscal 2012, resulting from the accelerated amortization of certain assets in 2011.

Operating activities used net cash of $11.9 million during the year ended September 30, 2011, as compared to $13.2 million of net cash used in the year ended September 30, 2010. The increase in operating cash flows in the year ended September 30, 2011 was due primarily to the gain on the sale of a non-strategic manufacturing facility of $6.8 million, offset by an impairment loss recognized of $4.9 million.

Operating activities from discontinued operations used net cash of $2.0 million during the year ended September 30, 2012, as compared to $9.5 million of net cash used in the year ended September 30, 2011. We completed substantially all projects within our discontinued operations. As we completed these projects we used the cash to satisfy outstanding accounts payable, and collected cash for the accounts receivable related to these completed projects.

Investing Activities In the year ended September 30, 2012, net cash from investing activities used $1.9 million as compared to $15.3 million of net cash provided by investing activities in the year ended September 30, 2011. Investing activities in the year ended September 30, 2012 was comprised of $1.9 million used for capital expenditures. Investing activities in the year ended September 30, 2011 included $16.8 million from the sale of facilities, and $1.2 million of proceeds from the sale of equipment, partially offset by $1.3 million used for capital expenditures.

Net cash from investing activities generated $15.3 million in the year ended September 30, 2011 as compared to $0.2 million of net cash used in investing activities in the year ended September 30, 2010. In the year ended September 30, 2011, investing activities included $16.8 million from the sale of facilities, and $1.2 million of proceeds from the sale of equipment, partially offset by $1.3 million used for capital expenditures. Investing activities in the year ended September 30, 2010 included $0.9 million used for capital expenditures, partially offset by a cash distribution from an investment of $0.4 million and $0.3 million of proceeds from the sale of equipment.

Financing Activities Financing activities used net cash of $7.6 million in the year ended September 30, 2012 compared to $0.8 million used in the year ended September 30, 2011. Financing activities in the year ended September 30, 2012 included an increase of $7.1 million in restricted cash to satisfy the requirements of our 2012 Credit Facility. Financing activities in the year ended September 30, 2011 included $0.8 million used for repayments of debt.

Financing activities used net cash of $0.8 million in the year ended September 30, 2011 compared to $17.9 million used in the year ended September 30, 2010. Financing activities in the year ended September 30, 2011 included $0.8 million used for repayments of debt. Financing activities in the year ended September 30, 2010 included $17.8 million used for repayments of debt, of which $15.0 million was used as a prepayment on the Tontine Term Loan, $0.3 million was used for debt issuance costs and $0.2 million was used for the acquisition of treasury stock netted against $0.8 million provided by new insurance financing.

Bonding Capacity At September 30, 2012, we had adequate surety bonding capacity under our surety agreements. Our ability to access this bonding capacity is at the sole discretion of our surety providers. As of September 30, 2012, the 34-------------------------------------------------------------------------------- Table of Contents expected cumulative cost to complete for projects covered by our surety providers was $67.2 million. We believe we have adequate remaining available bonding capacity to meet our current needs, subject to the sole discretion of our surety providers. For additional information, please refer to Note 16, "Commitments and Contingencies - Surety" in the notes to our Consolidated Financial Statements.

CONTROLLING SHAREHOLDER James M. Lindstrom, has served as Chief Executive Officer and President of the Company since October 3, 2011. Mr. Lindstrom previously served in such capacities on an interim basis since June 2011 and has served as Chairman of the Company's Board of Directors since February 2011. Mr. Lindstrom was an employee of Tontine from 2006 until October 2011. In his capacity as Chief Executive Officer and President, Mr. Lindstrom has the ability to affect the composition of the Company's management and influence the business operations of the Company or extraordinary transactions outside the normal course of the Company's business.

On July 21, 2011, Tontine filed an amended Schedule 13D indicating its ownership level of 57.4% of the Company's outstanding common stock. While Tontine is subject to restrictions under federal securities laws on sales of its shares as an affiliate, Tontine is party to a Registration Rights Agreement with the Company under which it has the ability, subject to certain restrictions, to demand registration of its shares in order to permit unrestricted sales of those shares. Tontine has indicated to the Company that it may seek to register some or all of its shares in the near future.

Should Tontine sell or exchange all or a portion of its position in IES, a change in ownership could occur. A change in ownership, as defined by Internal Revenue Code Section 382, could reduce the availability of net operating losses for federal and state income tax purposes. While the Company is currently evaluating steps it may take to protect its federal NOLs, including evaluating implementing a tax benefit protection plan that would be designed to deter an acquisition of the Company's stock in excess of a threshold amount that could trigger a change of control within the meaning of Internal Revenue Code Section 382, there can be no assurance that such a plan will be implemented or that, if enacted, it would be effective in deterring a change of control or protecting the NOLs. Furthermore, a change in control would trigger the change of control provisions in a number of our material agreements, including our 2012 Credit Facility, bonding agreements with our sureties and employment contracts with certain officers and employees of the Company.

On April 30, 2010, we prepaid $15.0 million of the original $25.0 million principal outstanding on the Tontine Term Loan; accordingly $10.0 million remains outstanding under the Tontine Term Loan, which is scheduled to mature on May 15, 2013. The Company is currently evaluating its options with regard to repayment of the loan, including through a refinancing of the loan prior to or at its maturity.

On March 29, 2012, we entered into a sublease agreement with Tontine Associates, LLC, an affiliate of our controlling shareholder, for corporate office space in Greenwich, Connecticut. The lease extends from April 1, 2012 through March 31, 2014, with monthly payments due in the amount of $6 thousand. The lease has terms at market rates and payments by the Company are at a rate consistent with that paid by Tontine Associates, LLC to its landlord.

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

35 -------------------------------------------------------------------------------- Table of Contents We enter into non-cancelable 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 cancel or terminate a lease before the end of its term. Typically, we would be liable to the lessor for various lease cancellation or termination costs and the difference between the fair market value of the leased asset and the implied book value of the leased asset as calculated in accordance with the lease agreement.

Some of our customers and vendors require us to post letters of credit as a means of guaranteeing performance under our contracts and ensuring payment by us to subcontractors and vendors. If our customer has reasonable cause to effect payment under a letter of credit, we would be required to reimburse our creditor for the letter of credit. At September 30, 2012, $0.6 million of our outstanding letters of credit were to collateralize our customers and vendors.

Some of the underwriters of our casualty insurance program require us to post letters of credit as collateral, as is common in the insurance industry. To date, we have not had a situation where an underwriter has had reasonable cause to effect payment under a letter of credit. At September 30, 2012, $6.8 million of our outstanding letters of credit were to collateralize our insurance programs.

From time to time, we may enter into firm purchase commitments for materials such as copper wire and aluminum wire, among others, which we expect to use in the ordinary course of business. These commitments are typically for terms less than one year and require us to buy minimum quantities of materials at specified intervals at a fixed price over the term. As of September 30, 2012, we did not have any open purchase commitments.

Many of our customers require us to post performance and payment bonds issued by a surety. Those bonds guarantee the customer that we will perform under the terms of a contract and that we will pay subcontractors and vendors. In the event that we fail to perform under a contract or pay subcontractors and vendors, the customer may demand the surety to pay or perform under our bond.

Our relationship with our sureties is such that we will indemnify the sureties for any expenses they incur in connection with any of the bonds they issue on our behalf. To date, we have not incurred any costs to indemnify our sureties for expenses they incurred on our behalf.

As of September 30, 2012, our future contractual obligations due by September 30 of each of the following fiscal years include (in thousands) (1): Less than 1 to 3 3 to 5 More than 1 Year Years Years 5 Years Total Long-term debt obligations $ 10,196 $ - $ - $ - $ 10,196 Operating lease obligations $ 3,464 $ 2,477 $ 1,493 $ 2,233 $ 9,667 Capital lease obligations $ - $ 344 $ - $ - $ 344 Total $ 13,660 $ 2,821 $ 1,493 $ 2,233 $ 20,207 (1) The tabular amounts exclude the interest obligations that will be created if the debt and capital lease obligations are outstanding for the periods presented.

Our other commitments expire by September 30 of each of the following fiscal years (in thousands): 2012 2013 2014 Thereafter Total Standby letters of credit $ - $ 6,848 $ - $ - $ 6,848 Other commitments $ - $ - $ - $ - $ - Total $ - $ 6,848 $ - $ - $ 6,848 36 -------------------------------------------------------------------------------- Table of Contents CRITICAL ACCOUNTING POLICIES The discussion and analysis of our financial condition and results of operations are based on our Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of our Consolidated Financial Statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities known to exist as of the date the Consolidated Financial Statements are published and the reported amounts of revenues and expenses recognized during the periods presented. We review all significant estimates affecting our Consolidated Financial Statements on a recurring basis and record the effect of any necessary adjustments prior to their publication. Judgments and estimates are based on our beliefs and assumptions derived from information available at the time such judgments and estimates are made. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of financial statements. There can be no assurance that actual results will not differ from those estimates.

Accordingly, we have identified the accounting principles, which we believe are most critical to our reported financial status by considering accounting policies that involve the most complex or subjective decisions or assessments.

We identified our most critical accounting policies to be those related to revenue recognition, the assessment of goodwill and asset impairment, our allowance for doubtful accounts receivable, the recording of our insurance liabilities and estimation of the valuation allowance for deferred tax assets, and unrecognized tax benefits. These accounting policies, as well as others, are described in Note 2, "Summary of Significant Accounting Policies" in the notes to our Consolidated Financial Statements, and at relevant sections in this discussion and analysis.

Revenue Recognition. We enter into contracts principally on the basis of competitive bids. We frequently negotiate the final terms and prices of those contracts with the customer. Although the terms of our contracts vary considerably, most are made on either a fixed price or unit price basis in which we agree to do the work for a fixed amount for the entire project (fixed price) or for units of work performed (unit price). We also perform services on a cost-plus or time and materials basis. Our most significant cost drivers are the cost of labor, the cost of materials and the cost of casualty and health insurance. These costs may vary from the costs we originally estimated.

Variations from estimated contract costs along with other risks inherent in performing fixed price and unit price contracts may result in actual revenue and gross profits or interim projected revenue and gross profits for a project differing from those we originally estimated and could result in losses on projects. Depending on the size of a particular project, variations from estimated project costs could have a significant impact on our operating results for any fiscal quarter or year.

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

The current asset "Costs and estimated earnings in excess of billings on uncompleted contracts" represents revenues recognized in excess of amounts billed that management believes will be billed and collected within the 37-------------------------------------------------------------------------------- Table of Contents next twelve months. The current liability "Billings in excess of costs and estimated earnings on uncompleted contracts" represents billings in excess of revenues recognized. Costs and estimated earnings in excess of billings on uncompleted contracts are amounts considered recoverable from customers based on different measures of performance, including achievement of specific milestones, completion of specified units or completion of the contract. Also included in this asset, from time to time, are claims and unapproved change orders, which include amounts that we are in the process of collecting from our customers or agencies for changes in contract specifications or design, contract change orders in dispute or unapproved as to scope and price, or other related causes of unanticipated additional contract costs. Claims and unapproved change orders are recorded at estimated realizable value when collection is probable and can be reasonably estimated. We do not recognize profits on construction costs incurred in connection with claims. Claims made by us involve negotiation and, in certain cases, litigation. Such litigation costs are expensed as incurred.

Valuation of Intangibles and Long-Lived Assets. We evaluate goodwill for potential impairment at least annually at year end, however, if impairment indicators exist, we will evaluate as needed. Included in this evaluation are certain assumptions and estimates to determine the fair values of reporting units such as estimates of future cash flows and discount rates, as well as assumptions and estimates related to the valuation of other identified intangible assets. Changes in these assumptions and estimates or significant changes to the market value of our common stock could materially impact our results of operations or financial position. We recorded goodwill impairment during the year ended September 30, 2011 of $0.1 million. We did not record goodwill impairment during the years ended September 30, 2012 and 2010.

We assess impairment indicators related to long-lived assets and intangible assets at least annually at year end. If we determine impairment indicators exist, we conduct an evaluation to determine whether any impairment has occurred. This evaluation includes certain assumptions and estimates to determine fair value of asset groups, including estimates about future cash flows and discount rates, among others. Changes in these assumptions and estimates could materially impact our results of operations or financial projections. We recorded long-lived or intangible asset impairment during the years ended September 30, 2012 and 2011 of $0.7 and $0.1 million, respectively; primarily attributable to real estate we are offering to sell. The write down was made to reduce the carrying value of the property to its current expected fair value. We did not record long-lived or intangible asset impairment during the year ended September 30, 2010.

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

In addition to these factors, the method of accounting for construction contracts requires the review and analysis of not only the net receivables, but also the amount of billings in excess of costs and costs in excess of billings.

The analysis management utilizes to assess collectability of our receivables includes detailed review of older balances, analysis of days sales outstanding where we include in the calculation, in addition to accounts receivable balances net of any allowance for doubtful accounts, the level of costs in excess of billings netted against billings in excess of costs, and the ratio of accounts receivable, net of any allowance for doubtful accounts plus the level of costs in excess of billings, to revenues. These analyses provide an indication of those amounts billed ahead or behind the recognition of revenue on our construction contracts and are important to consider in understanding the operational cash flows related to our revenue cycle.

Risk-Management. We are insured for workers' compensation, automobile liability, general liability, construction defects, employment practices and employee-related health care claims, subject to deductibles. Our general liability program provides coverage for bodily injury and property damage.

Losses up to the deductible amounts are accrued based upon our estimates of the liability for claims incurred and an estimate of claims incurred but not reported. The accruals are derived from actuarial studies, known facts, historical trends and industry averages utilizing the assistance of an actuary to determine the best estimate of the ultimate expected loss. We believe 38-------------------------------------------------------------------------------- Table of Contents such accruals to be adequate; 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 incurred but not reported and the effectiveness of our safety program.

Therefore, if actual experience differs from the assumptions used in the actuarial valuation, adjustments to the reserve may be required and would be recorded in the period that the experience becomes known.

Valuation Allowance for Deferred Tax Assets. We regularly evaluate valuation allowances established for deferred tax assets for which future realization is uncertain. We perform this evaluation at least annually at the end of each fiscal year. The estimation of required valuation allowances includes estimates of future taxable income. In assessing the realizability of deferred tax assets at September 30, 2012, we considered that it was more likely than not that some or all of the deferred tax assets would not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.

Income Taxes. GAAP specifies the methodology by which a company must identify, recognize, measure and disclose in its financial statements the effects of any uncertain tax return reporting positions that it has taken or expects to take.

GAAP requires financial statement reporting of the expected future tax consequences of uncertain tax return reporting positions on the presumption that all relevant tax authorities possess full knowledge of those tax reporting positions, as well as all of the pertinent facts and circumstances, but it prohibits discounting of any of the related tax effects for the time value of money.

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

The Financial Accounting Standards Board, ("FASB") has issued standards on business combinations and accounting and reporting of non-controlling interests in consolidated financial statements. Beginning October 1, 2009, with the adoption of the updates, reductions in the valuation allowance and contingent tax liabilities attributable to all periods, if any should occur, are recorded as an adjustment to income tax expense.

We are currently not under federal audit by the Internal Revenue Service. The tax years ended September 30, 2009 and forward are subject to audit as are prior tax years, to the extent of unutilized net operating losses generated in those years.

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

New Accounting Pronouncements. Newly adopted accounting policies are described in Note 2, "Summary of Significant Accounting Policies - New Accounting Pronouncements" in the notes to our Consolidated Financial Statements, and at relevant sections in this discussion and analysis.

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