Dycom Industries - 10-Q quarterly report FY

          The Company’s stock-based award plans are comprised of the 1991 Incentive Stock Option Plan (“1991 Plan”), the Arguss Communications, Inc. 1991 Stock Option Plan (“1991 Arguss Plan”), the 1994 Directors Stock Option Plan (“1994 Directors Plan”), the 1998 Incentive Stock Option Plan (“1998 Plan”), the 2001 Directors Stock Option Plan (“2001 Directors Plan”), the 2002 Directors Restricted Stock Plan (“2002 Directors Plan”), and the 2003 Long-term Incentive Plan (“2003 Plan”), collectively (“the Plans”). The Company’s policy is to issue new shares to satisfy stock option exercises and restricted stock awards. The following table lists the number of shares available and outstanding under each plan as of October 28, 2006:

 

* Pursuant to the terms of the 2003 Plan, the 731,228 shares that are authorized but not issued are available for grant under the 2003 Plan.

          The 1991 Plan and the 1994 Directors Plan have expired and no further options will be granted under these plans. Additionally, no further options will be granted under the 1991 Arguss Plan. The 1998 Plan, the 2001 Directors Plan, the 2002 Directors Plan, and the 2003 Plan expire in 2008, 2011, 2012, and 2013, respectively. Under the terms of these plans, stock options are granted at the closing price on the date of the grant and are exercisable over a period of up to ten years. The outstanding options under the 1991 Plan, the 1994 Plan, and the 1991 Arguss Plan are all fully vested. The options under the 1998 Plan, the 2001 Directors Plan, and the 2003 Plan vest and become exercisable ratably over a four-year period, beginning on the date of the grant. The above table includes performance shares that will be issued under outstanding awards if certain three year cumulative targeted performance goals are met. On October 17, 2006, the Compensation Committee of the Board of Directors approved an amendment to the 2003 Plan to increase the aggregate number of shares available for issuance under the 2003 plan by 2,000,000 shares. On November 21, 2006, the Dycom shareholders approved the amendment.

          Under the Company’s 2002 Directors Plan, the Company has authorized 100,000 shares of the Company’s common stock for issuance to non-employee directors. The non-employee directors are required to receive a predetermined percentage of their annual retainer fees in restricted shares of the Company’s common stock based on their ownership level of Dycom’s shares. The number of restricted shares of the Company’s common stock to be granted under the 2002 Directors Plan is based on the fair market value of a share of common stock on the date such annual retainer fees are payable. As of October 28, 2006, 16,640 shares had been issued under the 2002 Directors Plan at a weighted average market price of $20.32 per share.

          The following tables summarize the stock-based awards outstanding at October 28, 2006:

          Time vesting restricted shares granted to employees and officers of the Company during fiscal 2006 vest ratably over a period of four years, primarily in December of each year. Upon each annual vesting of the prior year grants, 50% of the newly vested shares (net of any shares used to satisfy tax withholding obligations) are restricted from sale or transferability (“restricted holdings”). The restrictions on sale or transferability of the restricted holdings will end at the earlier of (a) the future vesting date in which the holder has accumulated restricted holdings of common stock having a value equal or greater to the holder’s annual base salary then in effect, or (b) 90 days after termination of employment of the holder. The time vesting restricted shares are considered issued and outstanding as of the date of grant and carry voting and dividend rights.

          During fiscal 2006, 569,478 shares of performance vesting restricted stock were granted to employees and officers of the Company. Additionally, during the quarter ended October 28, 2006, the Company granted 25,158 and 16,563 performance vesting restricted units to the Company’s Chief Executive Officer and Chief Operating Officer, respectively. Each restricted unit will be settled in one share of the Company’s common stock on the vesting date. The performance vesting restricted shares and units vest over a three year period from grant date, if certain Company performance targets are met. The performance targets are based on a combination of the Company’s fiscal year operating earnings (adjusted for certain non-cash items) as a percentage of contract revenues and the Company’s fiscal year operating cash flow level. The awards include three year performance goals with similar measures as the fiscal year targets. Based upon the fiscal 2006 performance targets, including the three year cumulative targets, the Company expects approximately 130,000 shares will vest during December 2006 related to the fiscal 2006 awards. The fiscal 2006 performance vesting restricted stock issued under the awards carries voting and dividend rights.

          For the three months ended October 28, 2006 and October 29, 2005, approximately $1.7 million and $1.0 million, respectively, in compensation expense has been recognized in general and administrative expenses related to stock options and restricted stock. Compensation expense for these awards is based on the fair value at the original grant date. The amount of compensation expense recognized during the three months ended October 28, 2006 and October 29, 2005 may not be representative of future stock-based compensation expense as the fair value of stock-based awards on the date of grant is amortized over the vesting period, and the vesting of certain options were accelerated in fiscal 2005 prior to the implementation of SFAS No. 123(R), “Share-Based Payment.”

          The total tax benefit recognized related to stock options and restricted stock for the three months ended October 28, 2006 and October 29, 2005, was approximately $0.6 million and $0.2 million, respectively. During the three months ended October 28, 2006 and October 29, 2005, the Company received cash of $0.3 million and $0.1 million, respectively, from the exercise of stock options. During the three months ended October 28, 2006, the Company realized a tax benefit of less than $0.1 million from the exercise of stock options.

          As of October 28, 2006, the total unrecognized compensation cost related to unvested stock options outstanding under the

Plans is $0.6 million. That cost is expected to be recognized over a weighted-average period of 3.1 years. As of October 28, 2006 the total unrecognized compensation cost related to unvested time vesting restricted stock was $2.5 million, which is expected to be recognized over a weighted-average period of 2.2 years. The maximum unrecognized compensation cost related to unvested performance-based awards is $10.1 million as of October 28, 2006. This cost is expected to be recognized over a weighted-average period of 2.3 years if all performance conditions are met and the maximum amount of restricted stock under outstanding awards is granted. If the performance goals are not met for performance vesting restricted stock, no compensation cost will be recognized for those shares and any compensation cost recognized previously for those shares will be reversed.

          During the first quarter of fiscal 2007, in response to a public letter to Financial Executives International and the American Institute of Certified Public Accountants from the Office of the Chief Accountant of the Securities and Exchange Commission dated September 19, 2006, the Company initiated a voluntary review of its stock-based award granting practices covering the period from August 1, 1996 (the first day of fiscal 1997) through October 28, 2006. The Company found that the number and exercise price of all stock-based awards were approved by the applicable committee of the Board of Directors. Additionally, no instances of intentional back dating of equity awards nor any evidence of fraud or manipulative conduct associated with the Company’s granting practices was discovered during this review. However, in some instances, primarily associated with annual grants, the administrative activities necessary to complete the allocation of stock options to individual employees were not final at the grant date. APB No. 25 “Accounting for Stock Issued to Employees” provides that the measurement date of an award can not occur until the number of shares that the individual employee is entitled to receive is finalized.

          Pursuant to APB No. 25, proper measurement dates were not applied for certain awards as the administrative activities related to the allocation of the stock options to employees had not been finalized as of the grant date. The Company considered the available information related to each of the stock-based awards and applied judgment in determining the measurement date. In certain instances, the stock price increased from the grant date to the measurement date which resulted in additional non-cash stock-based compensation expense. The Company determined the impact to the consolidated operating results of applying the new measurement date to the awards would not change fiscal 2006 results, but would reduce fiscal 2005 results by approximately $0.4 million, net of taxes. For each year between fiscal 1998 through fiscal 2004, the impact of the non-cash stock-based compensation expense, net of taxes, was less than $0.3 million per year with no impact upon fiscal 1997. Pursuant to the footnote disclosure provisions of SFAS No. 123 and SFAS No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure”, the Company determined the pro forma non-cash stock-based compensation expense would decrease by approximately $2.2 million for fiscal 2005 resulting in an increase in pro forma net income. For fiscal 1997 through fiscal 2004, the Company determined the footnote disclosure of pro forma non-cash stock-based compensation expense and pro forma net income (loss) would change by less than $0.2 million on an annual basis.

          The Company has determined that the impact of the above amounts is not material to net income (loss), earnings (loss) per share, additional paid-in capital, retained earnings and pro-forma disclosures for all periods between fiscal 1997 through the period ended July 29, 2006 and with respect to the trends in earnings. The applicable amounts and pro forma disclosures for periods prior to fiscal 2006 will be reflected in the Form 10-K for the fiscal year ending July 28, 2007. The accompanying condensed consolidated balance sheet as of July 29, 2006 includes an adjustment of $1.9 million to increase additional paid-in capital and decrease retained earnings from the amounts previously reported reflecting the cumulative impact of the non-cash stock-based compensation expense, net of taxes.

          The Company leases administrative offices from entities related to officers of certain of its subsidiaries. The total expense under these arrangements for the three months ended October 28, 2006 and October 29, 2005 was $0.3 million and $0.4 million, respectively. Additionally, the Company paid approximately $0.1 million and $0.2 million for the three months ended October 28, 2006 and October 29, 2005, respectively, in subcontracting services to entities related to officers of certain of its subsidiaries.

          In the normal course of business, there are transactions for which the ultimate tax outcome is uncertain. Consequently, judgment is required in determining the provision for income taxes and the associated income tax assets and liabilities. The Company regularly assesses its position with regard to individual tax exposures and records liabilities for uncertain tax positions in accordance with SFAS No. 5, “Accounting for Contingencies”. These liabilities reflect management’s best estimate of the likely outcomes of current and potential future audits. The Company was recently notified that its fiscal 2003 and 2004 income tax returns were selected for examination by the Internal Revenue Service. Management believes its provision for income taxes is adequate; however, any material assessment could affect the Company’s results of operations, cash flows and liquidity.

          Recently, a number of the Company’s competitors have been subject to class action lawsuits alleging violations of the Fair Labor Standards Act and state wage and hour laws. A number of these lawsuits have resulted in the payment of substantial damages by the defendants. The Company has been contacted by counsel representing current and former employees alleging similar violations at certain of its subsidiaries. Regardless of whether any of these allegations are valid or whether the Company is ultimately determined to be liable, claims may be expensive to defend and may adversely affect the Company’s financial condition and results of operations.

          Certain of the Company’s subsidiaries also have pending claims and legal proceedings in the normal course of business. It is the opinion of the Company’s management, based on information available at this time, that none of these current claims or proceedings will have a material effect on the Company’s condensed consolidated financial statements.

          The Company has obligations under performance bonds related to certain of its customer contracts as of October 28, 2006. Performance bonds generally give the Company’s customer the right to obtain payment and/or performance from the issuer of the bond if the Company fails to perform it’s obligations under the contract. As of October 28, 2006, the Company has $20.1 million of outstanding performance bonds with remaining contract work to be completed under these performance bonds of $15.9 million. As of October 28, 2006, no events have occurred in which the customers have exercised their rights under the performance bonds.

          Included in the above amount is an outstanding performance bond of $10.6 million issued in favor of a customer where the Company is no longer the party performing the contract. This guarantee for the third party’s performance arose in connection with the disposition of the contract for which the bond has been procured. The term of the bond is less than one year and the obligations under the customer contract are expected to be performed in a satisfactory manner by the current performing party. In accordance with FIN No. 45, “Accounting and Disclosure Requirements for Guarantees”, the Company has recorded the estimated fair market value of the guarantee of approximately $0.1 million in accrued liabilities as of October 28, 2006. The Company is not holding any collateral; however, it does have recourse to the party performing the contract with respect to claims related to periods subsequent to the disposition of the contract.

          The Company operates in one reportable segment as a specialty contractor, providing engineering, construction, maintenance and installation services to telecommunications providers, underground locating services to various utilities including telecommunications providers, and other construction and maintenance services to electric utilities and others. These services are provided by the Company’s various subsidiaries throughout the United States and, on a limited basis, in Canada. All of the Company’s subsidiaries have been aggregated into one reporting segment due to their similar economic characteristics, products and production methods, and distribution methods. The following table presents information regarding revenues by type of customer (dollars in thousands):

          One of the Company’s subsidiaries derived revenues from contracts in Canada of approximately $0.9 million for the three months ended October 28, 2006. The Company had no revenues from contracts in Canada during the three months ended October 29, 2005. Additionally, the Company had no material long-lived assets in the Canadian operations at October 28, 2006 and July 29, 2006.

          During the first quarter of fiscal 2006, the Company completed an offering of $150.0 million of 8.125% senior subordinated notes (see Note 10). The Notes were issued by Dycom Investments, Inc. (“Issuer’’), a wholly owned subsidiary of the Company. The following condensed consolidating financial statements present, in separate columns, financial information for (i) Dycom Industries, Inc. (“Parent’’) on a parent only basis, (ii) the Issuer, (iii) the guarantor subsidiaries for the Notes on a combined basis, (iv) other non-guarantor subsidiaries on a combined basis, (v) the eliminations and reclassifications necessary to arrive at the information for the Company on a condensed consolidated basis, and (vi) the Company on a condensed consolidated basis. The consolidating financial statements are presented on the equity method. Under this method, the investments in subsidiaries are recorded at cost and adjusted for the Company’s share of subsidiaries’ cumulative results of operations, capital contributions, distributions and other equity changes.

          Each guarantor and non-guarantor subsidiary is wholly owned, directly or indirectly, by the Issuer and the Parent. The Notes are fully and unconditionally guaranteed on a joint and several basis by each guarantor subsidiary and Parent. There are no contractual restrictions limiting transfers of cash from guarantor and non-guarantor subsidiaries to Issuer or Parent, within the meaning of Rule 3-10 of Regulation S-X.