NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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1.
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BUSINESS AND ORGANIZATION:
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Quanta Services, Inc. (Quanta) is a leading provider of specialty contracting services, delivering comprehensive infrastructure solutions for the electric power, energy and communications industries in the United States, Canada, Australia, Latin America and select other international markets. Quanta reports its results under two reportable segments: (1) Electric Power Infrastructure Services and (2) Pipeline and Industrial Infrastructure Services.
Electric Power Infrastructure Services Segment
The Electric Power Infrastructure Services segment provides comprehensive network solutions to customers in the electric power industry. Services performed by the Electric Power Infrastructure Services segment generally include the design, installation, upgrade, repair and maintenance of electric power transmission and distribution infrastructure and substation facilities along with other engineering and technical services. This segment also provides emergency restoration services, including the repair of infrastructure damaged by inclement weather, the energized installation, maintenance and upgrade of electric power infrastructure utilizing unique bare hand and hot stick methods and Quanta’s proprietary robotic arm technologies, and the installation of “smart grid” technologies on electric power networks. In addition, this segment provides services that support the development of renewable energy generation, including solar, wind and certain types of natural gas generation facilities, and related switchyards and transmission infrastructure. This segment also provides comprehensive communications infrastructure services to wireline and wireless telecommunications companies, cable multi-system operators and other customers within the communications industry; services in connection with the construction of electric power generation facilities; and the design, installation, maintenance and repair of commercial and industrial wiring. This segment also includes Quanta’s postsecondary educational institution, which specializes in pre-apprenticeship training, apprenticeship training and specialized utility task training for electric workers, and has been recently expanded to include curriculum for the gas distribution and communications industries.
Pipeline and Industrial Infrastructure Services Segment
The Pipeline and Industrial Infrastructure Services segment provides comprehensive infrastructure solutions to customers involved in the development, transportation, storage and processing of natural gas, oil and other products. Services performed by the Pipeline and Industrial Infrastructure Services segment generally include the design, installation, repair and maintenance of pipeline transmission and distribution systems, gathering systems, production systems, storage systems and compressor and pump stations, as well as related trenching, directional boring and mechanized welding services. In addition, this segment’s services include pipeline protection, integrity testing, rehabilitation and replacement, and the fabrication of pipeline support systems and related structures and facilities for natural gas utilities and midstream companies. Quanta also provides high-pressure and critical-path turnaround services to the downstream and midstream energy markets and instrumentation and electrical services, piping, fabrication and storage tank services. To a lesser extent, this segment serves the offshore and inland water energy markets and designs, installs and maintains fueling systems and water and sewer infrastructure.
Acquisitions
In January 2019, Quanta acquired an electric power specialty contracting business that provides aerial power line and construction support services and is located in the United States. The results of the acquired business have generally been included in Quanta’s Electric Power Infrastructure Services segment and consolidated financial statements beginning on the acquisition date.
During the year ended December 31, 2018, Quanta acquired an electrical infrastructure services business specializing in substation construction and relay services, a postsecondary educational institution that provides pre-apprenticeship training and programs for experienced linemen and two communications infrastructure services businesses, all of which are located in the United States. The results of the acquired businesses have generally been included in Quanta’s Electric Power Infrastructure Services segment and have been included in Quanta’s consolidated financial statements beginning on the respective acquisition dates.
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The condensed consolidated financial statements of Quanta include the accounts of Quanta Services, Inc. and its wholly owned subsidiaries, which are also referred to as its operating units. The condensed consolidated financial statements also include the accounts of certain of Quanta’s investments in joint ventures, which are either consolidated or proportionately consolidated, as discussed in the following summary of significant accounting policies. Investments in affiliated entities in which Quanta does not have a controlling financial interest, but over which Quanta has significant influence, usually because Quanta holds a voting interest of between 20% and 50%, are accounted for using the equity method. All significant intercompany accounts and transactions have been eliminated in consolidation. Unless the context requires otherwise, references to Quanta include Quanta Services, Inc. and its consolidated subsidiaries.
Interim Condensed Consolidated Financial Information
These unaudited condensed consolidated financial statements have been prepared pursuant to the rules of the U.S. Securities and Exchange Commission (SEC). Certain information and footnote disclosures, normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States (GAAP), have been condensed or omitted pursuant to those rules and regulations. Quanta believes that the disclosures made are adequate to make the information presented not misleading. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to fairly state the financial position, results of operations, comprehensive income and cash flows with respect to the interim condensed consolidated financial statements have been included. The results of operations and comprehensive income for the interim periods are not necessarily indicative of the results for the entire fiscal year. The results of Quanta have historically been subject to significant seasonal fluctuations.
Quanta recommends that these unaudited condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto of Quanta and its consolidated subsidiaries included in Quanta’s Annual Report on Form 10-K for the year ended December 31, 2018 (2018 Annual Report), which was filed with the SEC on February 28, 2019.
Reclassifications
Quanta reclassified certain amounts related to cash paid for investments in unconsolidated affiliates and other entities and cash received from investments in unconsolidated affiliates and other entities in the accompanying statements of cash flows to conform to the current period presentation.
Use of Estimates and Assumptions
The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions by management in determining the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities known to exist as of the date the financial statements are published, and the reported amounts of revenues and expenses recognized during the periods presented. Quanta reviews all significant estimates affecting its consolidated financial statements on a recurring basis and records the effect of any necessary adjustments prior to their publication. Judgments and estimates are based on Quanta’s 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. Estimates are primarily used in Quanta’s assessment of the allowance for doubtful accounts, valuation of inventory, useful lives of assets, fair value assumptions in analyzing goodwill, other intangibles and long-lived asset impairments, equity and other investments, purchase price allocations, acquisition-related contingent consideration liabilities, liabilities for insurance and other claims and guarantees, multiemployer pension plan withdrawal liabilities, contingent liabilities, revenue recognition for construction contracts inclusive of contractual change orders and claims, share-based compensation, operating results of reportable segments, as well as the provision for income taxes and the calculation of uncertain tax positions.
Revenue Recognition
Contracts
Quanta designs, installs, upgrades, repairs and maintains infrastructure for customers in the electric power, energy and communications industries. These services may be provided pursuant to master service agreements (MSAs), repair and maintenance contracts and fixed price and non-fixed price installation contracts. These contracts are classified into three categories based on how transaction prices are determined and revenue is recognized: unit-based contracts, cost-plus contracts and fixed price contracts. Transaction prices for unit-based contracts are determined on a per unit basis, transaction prices for cost-plus contracts are
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
determined by applying a profit margin to costs incurred on the contracts and transaction prices for fixed price contracts are determined on a lump-sum basis. All of Quanta’s revenues are recognized from contracts with its customers. In addition to the considerations described below, revenue is not recognized unless collectability under the contract is considered probable, the contract has commercial substance and the contract has been approved. Additionally, the contract must contain payment terms, as well as the rights and commitments of both parties.
Performance Obligations
A performance obligation is a promise in a contract with a customer to transfer a distinct good or service. Most of Quanta’s contracts are considered to have a single performance obligation whereby Quanta is required to integrate complex activities and equipment into a deliverable for the customer. For contracts with multiple performance obligations, Quanta allocates the transaction price to each performance obligation using its best estimate of the standalone selling price of each distinct good or service in the contract. The standalone selling price is estimated using the expected costs plus a margin approach for each performance obligation.
At March 31, 2019, the aggregate transaction price allocated to unsatisfied or partially satisfied performance obligations was estimated to be approximately $4.71 billion, of which 70.3% was expected to be recognized in the subsequent twelve months. This amount represents management’s estimate of the consolidated revenues that are expected to be realized from the remaining portion of firm orders under fixed price contracts not yet completed or for which work has not yet begun. For purposes of calculating remaining performance obligations, Quanta includes all estimated revenues attributable to consolidated joint ventures and variable interest entities, revenues from funded and unfunded portions of government contracts to the extent they are reasonably expected to be realized and revenues from change orders and claims to the extent management believes additional contract revenues will be earned and are deemed probable of collection. Excluded from remaining performance obligations are potential orders under MSAs and non-fixed price contracts expected to be completed within one year.
Recognition of Revenue Upon Satisfaction of Performance Obligations
A transaction price is determined for each contract, and that amount is allocated to each performance obligation within the contract and recognized as revenue when, or as, the performance obligation is satisfied. Quanta generally recognizes revenue over time as it performs its obligations because there is a continuous transfer of control of the deliverable to the customer. Under unit-based contracts with an insignificant amount of partially completed units, Quanta recognizes revenue as units are completed based on contractual pricing amounts. Under unit-based contracts with more than an insignificant amount of partially completed units and fixed price contracts, Quanta recognizes revenues as performance obligations are satisfied over time, with the percentage completion generally measured as the percentage of costs incurred to total estimated costs for such performance obligation. Under cost-plus contracts, Quanta recognizes revenue on an input basis, as labor hours are incurred, materials are utilized and services are performed.
Under contracts where Quanta has a right to consideration in an amount that directly corresponds to the value of completed performance, Quanta recognizes revenue in such amount and does not include such performance as a remaining performance obligation. Also, contract consideration is not adjusted for a significant financing component if payment is expected to be collected less than one year from when the services are performed.
Contract costs include all direct materials, labor and subcontract costs and indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation costs. The majority of the materials associated with Quanta’s work are owner-furnished, and therefore not included in contract revenues and costs. Additionally, Quanta may incur incremental costs to obtain certain contracts, such as selling and marketing costs, bid and proposal costs, sales commissions, and legal fees or initial set-up or mobilization costs, certain of which can be capitalized. Such costs were not material during the three months ended March 31, 2019 and 2018.
Contract Estimates
Actual revenues and project costs can vary, sometimes substantially, from previous estimates due to changes in a variety of factors, including unforeseen or changed circumstances not included in Quanta’s cost estimates or covered by its contracts. The estimating process is based on the professional knowledge and experience of Quanta’s engineers, project managers and financial professionals. Some of the factors that may lead to changes in estimates include concealed or unknown environmental conditions; changes in the cost of equipment, commodities, materials or labor; unanticipated costs or claims due to delays caused by customers or third parties; customer failure to provide required materials or equipment; errors in engineering, specifications or designs; project modifications or contract termination; weather conditions; changes in estimates related to the length of time to complete a performance obligation; and performance and quality issues requiring rework or replacement. These factors, along with other risks inherent in performing services under fixed price contracts, are routinely evaluated by management. Any changes in estimates could result in changes to profitability or losses associated with the related performance obligations. For example, estimated costs for a performance obligation may increase from the original estimate and contractual provisions may not allow for adequate
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
compensation or reimbursement for such additional costs. Changes in estimated revenues, costs and profit are recorded in the period they are determined to be probable and can be reasonably estimated. Contract losses are recognized in full when losses are determined to be probable and can be reasonably estimated.
Changes in cost estimates on certain contracts may result in the issuance of change orders and/or claims, which may be approved or unapproved by the customer. Quanta determines the probability that such costs will be recovered based on, among other things, contractual entitlement, past practices with the customer, specific discussions or preliminary negotiations with the customer or verbal approvals by the customer. Quanta recognizes amounts associated with change orders and claims as revenue if it is probable that the contract price will be adjusted and the amount of any such adjustment can be reliably estimated. Most of Quanta’s change orders are for services that are not distinct from an existing contract and are accounted for as part of an existing contract on a cumulative catch-up basis. Quanta accounts for a change order as a separate contract if the additional goods or services are distinct from and increase the scope of the contract, and the price of the contract increases by an amount commensurate to Quanta’s standalone selling price for the additional goods or services.
As of March 31, 2019 and December 31, 2018, Quanta had recognized revenues of $122.8 million and $121.8 million related to change orders and claims included as contract price adjustments and that were in the process of being negotiated in the normal course of business. These aggregate amounts, which were included in “Contract assets” in the accompanying condensed consolidated balance sheets, represent management’s estimates of additional contract revenues that were earned and probable of collection. However, Quanta’s estimates could be incorrect and the amount ultimately realized could be significantly higher or lower than the estimated amount.
Variable consideration amounts, including performance incentives, early pay discounts and penalties, may also cause changes in contract estimates. The amount of variable consideration is estimated based on the most likely amount that is deemed probable of realization. Contract consideration is adjusted for variable consideration when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur once the uncertainty related to the variable consideration is resolved.
Changes in contract estimates are recognized on a cumulative catch-up basis in the period in which the revisions to the estimates are made. Such changes in estimates can result in the recognition of revenue in a current period for performance obligations that were satisfied or partially satisfied in prior periods. Such changes in estimates may also result in the reversal of previously recognized revenue if the current estimate differs from the previous estimate. The impact of a change in estimate is measured as the difference between the revenue or gross profit recognized in the prior period as compared to the revenue or gross profit which would have been recognized had the revised estimate been used as the basis of recognition in the prior period.
Quanta’s operating results for the three months ended March 31, 2019 and 2018 were impacted by less than 5% as a result of aggregate changes in contract estimates related to projects that were in progress at December 31, 2018 and 2017, respectively. However, certain projects were materially impacted by changes to total estimated contract revenues and/or costs during the three months ended March 31, 2019 and 2018. During the three months ended March 31, 2019, Quanta completed construction of an electrical transmission project in Canada ahead of schedule, resulting in lower costs than previously estimated. This change positively impacted gross profit related to work performed in prior periods by $25.5 million during the three months ended March 31, 2019, which was partially offset by an aggregate negative change in estimates on other ongoing projects. During the three months ended March 31, 2018, Quanta successfully executed through project procurement, winter schedule challenges and productivity risks on the electrical transmission project in Canada referenced above, resulting in reductions to the estimated total costs necessary to complete the project. These changes positively impacted gross profit related to work performed in prior periods by $16.8 million during the three months ended March 31, 2018. This positive change was partially offset by an aggregate negative change in estimates on other ongoing projects.
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Revenues by Category
The following tables present Quanta’s revenue disaggregated by geographic location and contract type for the three months ended March 31, 2019 and 2018 (in thousands):
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Three Months Ended March 31,
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2019
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2018
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By primary geographic location:
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United States
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$
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2,200,615
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78.4
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%
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$
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1,712,427
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70.8
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%
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Canada
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485,430
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17.3
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%
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538,358
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22.3
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%
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Australia
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41,324
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1.5
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%
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119,457
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4.9
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%
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Latin America and Other
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79,890
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2.8
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%
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47,334
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2.0
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%
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Total revenues
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$
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2,807,259
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100.0
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%
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$
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2,417,576
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100.0
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%
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Three Months Ended March 31,
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2019
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2018
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By contract type:
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Unit-price contracts
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$
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895,044
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31.9
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%
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$
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613,438
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25.3
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%
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Fixed price contracts
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953,860
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34.0
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%
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1,225,089
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50.7
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%
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Cost-plus contracts
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958,355
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34.1
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%
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579,049
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24.0
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%
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Total revenues
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$
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2,807,259
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|
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100.0
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%
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$
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2,417,576
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|
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100.0
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%
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As described above, under unit-based contracts with more than an insignificant amount of partially completed units and fixed price contracts, revenue is recognized as performance obligations are satisfied over time, with the percentage completion generally measured as the percentage of costs incurred to total estimated costs for such performance obligation. Approximately 49.0% and 54.2% of Quanta’s revenues recognized during the three months ended March 31, 2019 and 2018 were associated with this revenue recognition method.
Contract Assets and Liabilities
With respect to Quanta’s contracts, interim payments are typically received as work progresses in accordance with agreed-upon contractual terms, either at periodic intervals or upon achievement of contractual milestones. As a result, under fixed price contracts the timing of revenue recognition and contract billings results in contract assets and contract liabilities. Contract assets represent revenues recognized in excess of amounts billed for fixed price contracts and are current assets that are transferred to accounts receivable when billed or the billing rights become unconditional. Contract assets are not considered a significant financing component as the intent is to protect the customer in the event Quanta does not perform on its obligations under the contract.
Conversely, contract liabilities represent billings in excess of revenues recognized for fixed price contracts. These arise under certain contracts that allow for upfront payments from the customer or contain contractual billing milestones, which result in billings that exceed the amount of revenues recognized for certain periods. Contract liabilities are current liabilities and are not considered a significant financing component, as they are used to meet working capital requirements that are generally higher in the early stages of a contract and protect Quanta from the other party failing to meet its obligations under the contract. Contract assets and liabilities are recorded on a performance obligation basis at the end of each reporting period.
Contract assets and liabilities consisted of the following (in thousands):
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March 31, 2019
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December 31, 2018
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Contract assets
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$
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573,248
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$
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576,891
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Contract liabilities
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$
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403,372
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$
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425,961
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During the three months ended March 31, 2019 and 2018, Quanta recognized revenue of approximately $262 million and $264 million related to contract liabilities outstanding at December 31, 2018 and 2017. Additionally, during the three months ended March 31, 2019 and 2018, revenues were favorably impacted by $17 million and $26 million as a result of changes in
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
estimates associated with performance obligations on fixed price contracts partially satisfied prior to December 31, 2018 and 2017. Impairment losses recognized on contract assets were not material for the three months ended March 31, 2019 and 2018.
Current and Long-Term Accounts Receivable, Notes Receivable and Allowance for Doubtful Accounts
Quanta provides an allowance for doubtful accounts when collection of an account or note receivable is considered doubtful, and receivables are written off against the allowance when deemed uncollectible. Inherent in the assessment of the allowance for doubtful accounts are certain judgments and estimates regarding, among other factors, the customer’s access to capital, the customer’s willingness or ability to pay, general economic and market conditions, the ongoing relationship with the customer and uncertainties related to the resolution of disputed matters. Quanta considers accounts receivable delinquent after 30 days but does not generally include delinquent accounts in its analysis of the allowance for doubtful accounts unless the accounts receivable have been outstanding for at least 90 days. Quanta also includes accounts receivable balances that relate to customers in bankruptcy or with other known difficulties in its analysis of the allowance for doubtful accounts. Material changes to a customer’s business, cash flows or financial condition, which may be impacted by negative economic and market conditions, could affect Quanta’s ability to collect amounts due. Should anticipated recoveries relating to receivables fail to materialize (including anticipated recoveries relating to existing bankruptcies or other workout situations), Quanta could experience reduced cash flows and losses in excess of current allowances provided. As of March 31, 2019 and December 31, 2018, Quanta had allowances for doubtful accounts on current receivables of $8.5 million and $5.8 million. See Note 11 for additional information related to the bankruptcy matter involving PG&E Corporation and its primary operating subsidiary, Pacific Gas and Electric Company (collectively PG&E), a significant customer of Quanta, which was filed on January 29, 2019.
Long-term accounts receivable are included within “Other assets, net” in the accompanying condensed consolidated balance sheets. As of March 31, 2019 and December 31, 2018, long-term accounts receivable were $69.0 million and $25.9 million. Included in the March 31, 2019 balance was $41.2 million of pre-petition receivables due from PG&E, which were reclassified from current accounts receivable during the three months ended March 31, 2019, as further described in Note 11.
Some contracts allow customers to withhold a small percentage of billings pursuant to retainage provisions, and such amounts are generally due upon completion of the contracts and acceptance by the customer. Based on Quanta’s experience with similar contracts in recent years, the majority of the retainage balances at each balance sheet date are expected to be collected within the next twelve months. Current retainage balances as of March 31, 2019 and December 31, 2018 were $467.5 million and $337.1 million and were included in “Accounts receivable.” Retainage balances with settlement dates beyond the next twelve months were included in “Other assets, net,” and as of March 31, 2019 and December 31, 2018 were $8.6 million and $99.6 million.
Quanta recognizes unbilled receivables for non-fixed price contracts within “Accounts receivable” in certain circumstances, such as when revenues have been earned and recorded but the amount cannot be billed under the terms of the contract until a later date or amounts arise from routine lags in billing (for example, work completed one month but not billed until the next month). These balances do not include revenues recognized for work performed under fixed-price contracts, as these amounts are recorded as “Contract assets.” At March 31, 2019 and December 31, 2018, the balances of unbilled receivables included in “Accounts receivable” were $481.3 million and $434.9 million. Quanta also recognizes unearned revenues for non-fixed price contracts when cash is received prior to recognizing revenues for the related performance obligation. Unearned revenues, which are included in “Accounts payable and accrued expenses,” were $28.8 million and $40.1 million at March 31, 2019 and December 31, 2018.
Cash and Cash Equivalents
Amounts related to Quanta’s cash and cash equivalents based on geographic location of the bank accounts were as follows (in thousands):
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March 31, 2019
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December 31, 2018
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Cash and cash equivalents held in domestic bank accounts
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$
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57,706
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$
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62,495
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Cash and cash equivalents held in foreign bank accounts
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27,717
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16,192
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Total cash and cash equivalents
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$
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85,423
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$
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78,687
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Cash consisting of interest-bearing demand deposits is carried at cost, which approximates fair value. Quanta considers all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents, which are carried at fair value. At March 31, 2019 and December 31, 2018, cash equivalents were $37.6 million and $37.2 million and consisted primarily of money market investments and money market mutual funds and are discussed further in Fair Value Measurements below.
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Cash and cash equivalents held by joint ventures, which are either consolidated or proportionately consolidated, are available to support joint venture operations, but Quanta cannot utilize those assets to support its other operations. Quanta generally has no right to the joint ventures’ cash and cash equivalents other than participating in distributions and in the event of dissolution. Amounts related to cash and cash equivalents held by joint ventures, which are included in Quanta’s total cash and cash equivalents balances, were as follows (in thousands):
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March 31, 2019
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December 31, 2018
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Cash and cash equivalents held by domestic joint ventures
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$
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12,337
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|
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$
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8,544
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Cash and cash equivalents held by foreign joint ventures
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|
11
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|
441
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Total cash and cash equivalents held by joint ventures
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|
12,348
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|
|
8,985
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Cash and cash equivalents not held by joint ventures
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|
73,075
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|
|
69,702
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|
Total cash and cash equivalents
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|
$
|
85,423
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|
|
$
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78,687
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|
Goodwill
Goodwill, net of accumulated impairment losses, which represents the excess of cost over the fair market value of net tangible and identifiable intangible assets of acquired businesses, is stated at cost. Goodwill is not amortized but instead is annually tested for impairment, or more frequently if events or circumstances indicate that the carrying amount of goodwill may be impaired. Quanta has recorded goodwill in connection with its historical acquisitions of businesses. Upon acquisition, these businesses were either combined into one of Quanta’s existing operating units or managed on a stand-alone basis as an individual operating unit. Quanta’s operating units are organized into one of two internal divisions. The two internal divisions are: the Electric Power Infrastructure Services Division and the Pipeline and Industrial Infrastructure Services Division. As most of the companies acquired by Quanta provide multiple types of services for multiple types of customers, these divisional designations are based on the predominant type of work performed by an operating unit at the point in time the divisional designation is made. Goodwill is required to be measured for impairment at the reporting unit level, which represents the operating segment level or one level below the operating segment level for which discrete financial information is available. Quanta has determined that its individual operating units represent its reporting units for the purpose of assessing goodwill impairment. An annual assessment for impairment is performed for each reporting unit that carries a balance of goodwill.
Quanta’s goodwill impairment assessment is performed during the fourth quarter of its fiscal year, or more frequently if events or circumstances arise which indicate that goodwill may be impaired. An assessment can be performed by first completing a qualitative assessment on none, some or all of its reporting units. Quanta can also bypass the qualitative assessment for any reporting unit in any period and proceed directly to the quantitative impairment test, and then resume the qualitative assessment in any subsequent period. Qualitative indicators that may trigger the need for annual or interim quantitative impairment testing include, among other things, deterioration in macroeconomic conditions, declining financial performance, deterioration in the operational environment, or an expectation of selling or disposing of a portion of a reporting unit. Additionally, a significant change in business climate, a loss of a significant customer, increased competition, a sustained decrease in share price, or a decrease in Quanta’s market capitalization below book value may trigger the need for interim impairment testing of goodwill associated with one or more of Quanta’s reporting units.
If Quanta believes that, as a result of its qualitative assessment, it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. The quantitative test involves comparing the fair value of each of Quanta’s reporting units with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recorded as a reduction to goodwill with a corresponding charge to “Asset impairment charges” in the condensed consolidated statements of operations. The income tax effect associated with an impairment of tax deductible goodwill is also considered in the measurement of the goodwill impairment. Any goodwill impairment is limited to the total amount of goodwill allocated to that reporting unit.
Quanta determines the fair value of its reporting units using a weighted combination of the income approach (discounted cash flow method) and market multiples valuation techniques (market guideline transaction method and market guideline public company method), with heavier weighting on the discounted cash flow method because management believes this method results in the most appropriate calculation of fair value and reflects an expectation of market value as determined by a “held and used” model.
Under the discounted cash flow method, Quanta determines fair value based on the estimated future cash flows for each reporting unit, discounted to present value using a risk-adjusted industry weighted average cost of capital, which reflects the overall
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
level of inherent risk for each reporting unit and the rate of return an outside investor would expect to earn. Cash flow projections are derived from budgeted amounts (typically a one-year model) and subsequent period cash flows are developed for each reporting unit using growth rates that management believes are reasonably likely to occur. All cash flow projections by reporting unit are evaluated by management. A terminal value is derived from a multiple of the reporting unit’s earnings before interest, taxes, depreciation and amortization (EBITDA). The EBITDA multiples for each reporting unit are based on observed purchase transactions for similar businesses adjusted for size, volatility and risk.
Under the market guideline transaction and market guideline public company methods, Quanta determines the estimated fair value for each of its reporting units by applying transaction multiples and public company multiples, respectively, to each reporting unit’s projected EBITDA and then averaging that estimate with similar historical calculations using either a one, two or three year average. The transaction multiples are based on observed purchase transactions for similar businesses adjusted for size, volatility and risk. The public company multiples are based on peer group multiples adjusted for size, volatility and risk. For the market guideline public company method, Quanta adds a reasonable control premium, which is estimated as the premium that would be appropriate to convert the reporting unit value to a controlling interest basis.
For Quanta’s annual goodwill impairment assessment performed during the fourth quarter of 2018, Quanta concluded to first assess qualitative factors to determine whether it was necessary to perform a quantitative fair value impairment analysis. As a result of the qualitative assessment, Quanta identified certain reporting units for which a quantitative goodwill impairment assessment was determined appropriate based on either changes in market conditions or specific performance indicators. Ultimately, the quantitative analyses indicated that the fair value of each of the selected reporting units was in excess of its carrying amount. Accordingly, Quanta did not record any impairment charges related to goodwill during the fourth quarter of 2018.
Although, no goodwill impairment charges were recorded during the year ended December 31, 2018, the determination of a reporting unit’s fair value requires judgment and the use of significant estimates and assumptions. Quanta believes the estimates and assumptions used in its impairment assessments are reasonable and based on available market information obtained from relevant industry sources; however, variations in any of the assumptions could result in materially different calculations of fair value and impairment determinations. Accordingly, management considered the sensitivity of its fair value estimates to changes in certain valuation assumptions. After taking into account a 10% decrease in the fair value of the reporting units for which a quantitative impairment test was performed, two reporting units within Quanta’s Pipeline and Industrial Infrastructure Services Division would have fair values below their carrying amounts. One of the reporting units is a material handling services business, and the other reporting unit operates within the midstream and smaller-scale pipeline market. Goodwill and intangible assets associated with these two reporting units were $48.5 million and $10.7 million at March 31, 2019.
If an operating unit experiences prolonged periods of declining revenues, operating margins or both, it may be at risk of failing the quantitative goodwill impairment test. The reporting units referenced above have experienced declines over the short-term due to challenging macroeconomic conditions in certain geographic areas and low oil and natural gas prices, which have negatively impacted customer spending and resulted in project cancellations and delays. Additionally, customer capital spending has been constrained as a result of an increasingly complex regulatory and permitting environment. Quanta monitors these conditions and others to determine if it is necessary to perform the quantitative fair value impairment test for one or more operating units prior to the annual impairment assessment.
Due to the cyclical nature of Quanta’s business, and the other factors described above, the profitability of its individual reporting units may suffer from decreases in customer demand and other factors. These factors may have a disproportionate impact on the individual reporting units as compared to Quanta as a whole and might adversely affect the fair value of individual reporting units. If material adverse conditions occur that impact Quanta’s reporting units, its future estimates of fair value may not support the carrying amount of one or more of its reporting units, and the related goodwill would need to be written down to an amount considered recoverable.
Other Intangible Assets
Quanta’s intangible assets include customer relationships, backlog, trade names, non-compete agreements, patented rights and developed technology and curriculum, all of which are subject to amortization, as well as an engineering license, which is not subject to amortization. The value of customer relationships is estimated as of the date a business is acquired based on the value-in-use concept utilizing the income approach, specifically the multi-period excess earnings method. This analysis discounts to present value the projected cash flows attributable to the customer relationships, with consideration given to customer contract renewals and estimated customer attrition rates.
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The following table presents the significant estimates used by management in determining the fair values of customer relationships associated with acquisitions in the three months ended March 31, 2019 and year ended December 31, 2018:
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2019
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2018
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Discount rates
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21%
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20% to 27%
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Customer attrition rates
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27%
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20% to 33%
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Quanta values backlog for acquired businesses as of the acquisition date based upon the contractual nature of the backlog within each service line, discounted to present value. The values of trade names and curriculum are estimated using the relief-from-royalty method of the income approach, which is based on the assumption that in lieu of ownership, a company would be willing to pay a royalty for use of the trade name and curriculum. The value of a non-compete agreement is estimated based on the difference between the present value of the prospective cash flows with the agreement in place and the present value of the prospective cash flows without the agreement in place. The value of the engineering license is based on cash paid to acquire the asset.
Quanta amortizes the intangible assets that are subject to amortization based upon the estimated consumption of their economic benefits, or on a straight-line basis if the pattern of economic benefit cannot otherwise be reliably estimated. Intangible assets are reviewed for impairment and tested for recoverability whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. For instance, a significant change in business climate or a loss of a significant customer, among other things, may trigger the need for interim impairment testing of intangible assets. An impairment loss is recognized if the carrying amount of an intangible asset is not recoverable and its carrying amount exceeds its fair value. Intangible asset impairments are included within “Asset impairment charges” in the condensed consolidated statements of operations, when applicable.
Leases
As described further in Note 3, effective January 1, 2019, Quanta adopted the new lease accounting standard utilizing the transition method that allows entities to apply the new standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption, if applicable. Quanta’s financial results for reporting periods after January 1, 2019 are presented under the new standard, while financial results for prior periods continue to be reported in accordance with the prior standard and Quanta’s historical accounting policy. The adoption of the new standard resulted in the recording of operating lease right-of-use assets and operating lease liabilities of $301.1 million as of January 1, 2019. Lease liabilities are recognized as the present value of the future minimum lease payments over the lease term as of the commencement date. Lease assets are recognized as the present value of future minimum lease payments over the lease term as of the commencement date, plus any initial direct costs incurred and lease payments made, less any lease incentives received. Although the adoption of the new standard had a material impact on Quanta’s consolidated balance sheet, there was not a material impact on its consolidated statements of operations, comprehensive income, cash flows or equity.
Quanta determines if an arrangement contains a lease at inception. If an arrangement is considered a lease, Quanta determines whether the lease is an operating or finance lease at the commencement of the lease. In accordance with the new standard, finance leases are leases that meet any of the following criteria: the lease transfers ownership of the underlying asset at the end of the lease term; the lessee is reasonably certain to exercise an option to purchase the underlying asset; the lease term is for the major part of the remaining economic life of the underlying asset (except when the commencement date falls at or near the end of such economic life); the present value of the sum of the lease payments and any additional residual value guarantee by the lessee equals or exceeds substantially all of the fair value of the underlying asset; or the underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term. A lease that does not meet any of these criteria is considered an operating lease. After the commencement date, lease cost for an operating lease is recognized over the remaining lease term on a straight-line basis, while lease cost for a finance lease is based on the depreciation of the lease asset and interest on the lease liability.
The terms of Quanta’s lease arrangements vary from lease to lease, and certain leases include one or more of the following: renewal options, cancellation options, residual value guarantees, purchase options and escalation clauses. Options to extend or terminate leases are included within the lease terms when it is reasonably certain that Quanta will exercise such options. Quanta has made a policy election to classify leases with an initial lease term of 12 months or less as short-term leases, and these leases are not recorded in the accompanying condensed consolidated balance sheets unless the lease contains a purchase option that is reasonably certain to be exercised. Lease cost related to short-term leases is recognized on a straight-line basis over the lease term.
Determinations with respect to lease term (including any extension thereof), discount rate, variable lease cost and future minimum lease payments require the use of judgment based on the facts and circumstances related to each lease. Quanta considers
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various factors, including economic incentives, intent, past history and business need, to determine if a renewal option is reasonably certain of exercise. Unless a renewal option is reasonably certain to be exercised, which is at Quanta’s sole discretion, the initial non-cancelable lease term is used. Quanta generally uses its incremental borrowing rates to determine the present value of future minimum lease payments.
Investments in Affiliates and Other Entities
In the normal course of business, Quanta enters into various types of investment arrangements, each having unique terms and conditions. These investments may include equity interests held by Quanta in business entities, including general or limited partnerships, contractual joint ventures, or other forms of equity or profit participation. These investments may also include Quanta’s participation in different financing structures, such as the extension of loans to project-specific entities, the acquisition of convertible notes issued by project specific entities, or other strategic financing arrangements. Quanta also enters into strategic partnerships with customers and infrastructure investors to provide fully integrated infrastructure services on certain projects, including planning and feasibility analyses, engineering, design, procurement, construction and project operation and maintenance. These projects include public-private partnerships and concessions, along with private infrastructure projects such as build, own, operate (and in some cases transfer) and build-to-suit arrangements. As part of this strategy, Quanta formed a partnership with select investors that provides up to $1.0 billion of capital, including approximately $80.0 million from Quanta, available to invest in certain of these infrastructure projects through August 2024. Wholly owned subsidiaries of Quanta serve as the general partner of this partnership and as a separately operated registered investment adviser that manages the invested capital. As of March 31, 2019, Quanta had contributed $15.1 million to this partnership in connection with certain investments and the payment of management fees.
Quanta determines whether investments involve a variable interest entity (VIE) based on the characteristics of the subject entity. If the entity is determined to be a VIE, then management determines if Quanta is the primary beneficiary of the entity and whether or not consolidation of the VIE is required. The primary beneficiary consolidating the VIE must normally have both (i) the power to direct the activities that most significantly affect the VIE’s economic performance and (ii) the obligation to absorb significant losses of or the right to receive significant benefits from the VIE. When Quanta is deemed to be the primary beneficiary, the VIE is consolidated and the other party’s equity interest in the VIE is accounted for as a non-controlling interest. In cases where Quanta determines that it has an undivided interest in the assets, liabilities, revenues and profits of an unincorporated VIE (e.g., a general partnership interest), such amounts are consolidated on a basis proportional to Quanta’s ownership interest in the unincorporated entity.
Investments in entities of which Quanta is not the primary beneficiary, but over which Quanta has the ability to exercise significant influence, are accounted for using the equity method of accounting. Quanta’s share of net income or losses from unconsolidated equity investments is reported as equity in earnings (losses) of unconsolidated affiliates, which is included in “Other income (expense), net” in the accompanying condensed consolidated statements of operations. Equity investments are reviewed for impairment by assessing whether any decline in the fair value of the investment below the carrying amount is other than temporary. In making this determination, factors such as the ability to recover the carrying amount of the investment and the inability of the investee to sustain an earnings capacity are evaluated in determining whether a loss in value should be recognized. Any impairment losses related to investments would be recognized in equity in earnings (losses) of unconsolidated affiliates. Equity method investments are carried at original cost adjusted for Quanta’s proportionate share of the investees’ income, losses and distributions and are included in “Other assets, net” in Quanta’s accompanying condensed consolidated balance sheets.
Quanta has a minority ownership interest in a limited partnership that was selected during 2014 to build, own and operate a new 500 kilometer electric transmission line and two 500 kV substations in Alberta, Canada and has accounted for this interest as an equity-method investment. The limited partnership contracted with a Quanta subsidiary to perform the engineering, procurement and construction (EPC) services for the project, and the Quanta subsidiary recognizes revenue and related cost of services as performance progresses on the project. However, due to Quanta’s ownership interest, a proportional amount of the EPC profit was deferred until the electric transmission line and related substations were constructed and ownership of the assets were deemed to be transferred to the third party customer, which occurred in the three months ended March 31, 2019. The deferral of earnings and recognition of such earnings deferral were recorded as components of equity in earnings (losses) of unconsolidated affiliates, which is included in “Other income (expense), net” in the accompanying condensed consolidated statements of operations. During the three months ended March 31, 2019, deferred earnings of $60.3 million were recognized, the majority of which was attributable to profit earned and deferred in the years ended December 31, 2018 and 2017.
Investments in entities which Quanta is not the primary beneficiary, and over which Quanta does not have the ability to exercise significant influence, are accounted for using the cost method of accounting. These investments are required to be measured at fair value with changes in fair value recognized in net income unless the investments do not have readily determinable fair
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(Unaudited)
values, in which case the investments are measured at cost minus impairment, if any, plus or minus observable price changes in orderly transactions for an identical or a similar investment of the same company.
During 2018, Quanta acquired a 30% equity interest in a water and gas pipeline infrastructure contractor located in Australia for $22.2 million. This investment includes an option to acquire the remaining equity of the company through 2020 and provides for certain additional earnings and distribution participation rights during a designated 25-month post-investment period, as well as preferential liquidation rights. Quanta’s equity interest has been recorded at cost and will be adjusted for impairment, if any, plus or minus observable changes in the value of the company’s equity. Earnings on this investment are recognized as dividends are received and are reported in “Other income (expense), net” in the accompanying condensed consolidated statements of operations. Quanta received and recognized $3.9 million in cash dividends from this investment during 2018. Additionally, during the year ended December 31, 2018, Quanta acquired a 49% equity interest in an electric power infrastructure services company, together with certain related customer relationship and other intangible assets, for $12.3 million in total. See Notes 9 and 11 for additional information related to investments.
Income Taxes
Quanta follows the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recorded based on future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the underlying assets or liabilities are recovered or settled.
Quanta regularly evaluates valuation allowances established for deferred tax assets for which future realization is uncertain, including in connection with changes in tax laws. The estimation of required valuation allowances includes estimates of future taxable income. 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. Quanta considers projected future taxable income and tax planning strategies in making this assessment. If actual future taxable income differs from these estimates, Quanta may not realize deferred tax assets to the extent estimated.
Quanta records reserves for income taxes related to certain tax positions in those instances where Quanta considers it more likely than not that additional taxes may be due in excess of amounts reflected on income tax returns filed. When recording these reserves, Quanta assumes that taxing authorities have full knowledge of the position and all relevant facts. Quanta continually reviews exposure to additional tax obligations, and as further information is known or events occur, changes in tax reserves may be recorded. To the extent interest and penalties may be assessed by taxing authorities on any underpayment of income tax, such amounts have been accrued and included in the provision for income taxes.
As of March 31, 2019, the total amount of unrecognized tax benefits relating to uncertain tax positions was $38.8 million, a $2.3 million decrease from December 31, 2018. This decrease resulted primarily from the favorable settlement of a pre-acquisition obligation associated with certain non-U.S. income taxes and the expiration of U.S. state income tax statutes. Quanta and certain subsidiaries remain under examination by various U.S. state and Canadian and other foreign tax authorities for multiple periods. Quanta believes it is reasonably possible that within the next 12 months unrecognized tax benefits may decrease by up to $5.9 million as a result of settlement of these examinations or as a result of the expiration of certain statute of limitations periods.
U.S. federal and state and foreign income tax laws and regulations are voluminous and often ambiguous. As such, Quanta is required to make many subjective assumptions and judgments regarding its tax positions that could materially affect amounts recognized in its future consolidated balance sheets, consolidated statements of operations and consolidated statements of comprehensive income. For example, the Tax Cuts and Jobs Act of 2017 (the Tax Act) significantly revised the U.S. corporate tax regime which, among other things, resulted in a reduction of Quanta’s current and estimated future effective tax rate and a remeasurement of its deferred tax assets and liabilities.
Earnings Per Share
Basic and diluted earnings per share attributable to common stock are computed using the weighted average number of shares of common stock outstanding during the applicable period. Exchangeable shares that were issued pursuant to certain of Quanta’s historical acquisitions (as further discussed in Note 9), which are exchangeable on a one-for-one basis with shares of Quanta common stock, have been included in the calculation of weighted average shares outstanding for basic and diluted earnings per share attributable to common stock for the portion of the periods that they were outstanding. Additionally, unvested stock-based awards that contain non-forfeitable rights to dividends or dividend equivalents (participating securities) have been included in the calculation of basic and diluted earnings per share attributable to common stock for the portion of the periods that the awards
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
were outstanding. Weighted average shares outstanding for basic and diluted earnings per share attributable to common stock for the three months ended March 31, 2019 and 2018 included 2.8 million and 2.7 million weighted average participating securities. Diluted earnings per share attributable to common stock is computed using the weighted average number of shares of common stock outstanding during the period adjusted for all potentially dilutive common stock equivalents, except in cases where the effect of the common stock equivalents would be antidilutive.
Insurance
Quanta is insured for employer’s liability, workers’ compensation, auto liability and general liability claims. Under these programs, the deductible for employer’s liability is $1.0 million per occurrence, the deductible for workers’ compensation is $5.0 million per occurrence, and the deductibles for auto liability and general liability are $10.0 million per occurrence. Quanta manages and maintains a portion of its casualty risk through its wholly-owned captive insurance company, which insures all claims up to the amount of the applicable deductible of its third-party insurance programs. Quanta also has employee health care benefit plans for most employees not subject to collective bargaining agreements, of which the primary plan is subject to a deductible of $0.5 million per claimant per year.
Losses under all of these insurance programs are accrued based upon Quanta’s estimate of the ultimate liability for claims reported and an estimate of claims incurred but not reported, with assistance from third-party actuaries. These insurance liabilities are difficult to assess and estimate due to unknown factors, including the severity of an injury, the extent of damage, the determination of Quanta’s liability in proportion to other parties and the number of incidents not reported. The accruals are based upon known facts and historical trends, and management believes such accruals are adequate.
Collective Bargaining Agreements
Some of Quanta’s operating units are parties to various collective bargaining agreements with unions that represent certain of their employees. The collective bargaining agreements expire at various times and have typically been renegotiated and renewed on terms similar to those in the expiring agreements. The agreements require the operating units to pay specified wages, provide certain benefits to their union employees and contribute certain amounts to multiemployer pension plans and employee benefit trusts. Quanta’s multiemployer pension plan contribution rates generally are specified in the collective bargaining agreements (usually on an annual basis), and contributions are made to the plans on a “pay-as-you-go” basis based on its union employee payrolls. The location and number of union employees that Quanta employs at any given time and the plans in which they may participate vary depending on the projects Quanta has ongoing at that time and the need for union resources in connection with those projects. Therefore, Quanta is unable to accurately predict the union employee payroll and the amount of the resulting multiemployer pension plan contribution obligations for future periods.
Stock-Based Compensation
Quanta recognizes compensation expense for restricted stock, restricted stock units (RSUs) and performance units to be settled in common stock based on the fair value of the awards, net of estimated forfeitures. The fair value of these awards is generally determined based on the number of shares or units granted and the closing price of Quanta’s common stock on the date of grant. For those performance units with market-based metrics, the fair value is determined using a Monte Carlo simulation valuation methodology. An estimate of future forfeitures, based on historical data, is utilized to determine the period expense. Such estimates are subject to change and may impact the value that will ultimately be recognized as compensation expense. The resulting compensation expense for performance unit and time-based RSU awards is recognized on a straight-line basis over the requisite service period, which is generally the vesting period, and the resulting compensation expense for performance-based RSU awards is recognized using the graded vesting method over the requisite service period. The compensation expense related to outstanding performance units can also vary from period to period based on changes in the total number of shares of common stock that Quanta anticipates will be issued upon vesting of such performance units. Payments made by Quanta to satisfy employee tax withholding obligations associated with awards settled in common stock are classified as financing cash flows.
Compensation expense associated with liability-based awards, such as RSUs that are expected to or may settle in cash, is recognized based on a remeasurement of the fair value of the award at the end of each reporting period. Upon settlement, the holders receive for each RSU an amount in cash equal to the fair market value on the settlement date of one share of Quanta common stock, as specified in the applicable award agreement. For additional information on Quanta’s restricted stock, RSU and performance unit awards, see Note 10.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Functional Currency and Translation of Financial Statements
The U.S. dollar is the functional currency for the majority of Quanta’s operations, which are primarily located within the United States. The functional currency for Quanta’s foreign operations, which are primarily located in Canada, Australia and Latin America, is typically the currency of the country where the foreign operating unit is located and transacts the majority of its activities, including billings, financing, payroll and other expenditures. When preparing its consolidated financial statements, Quanta translates the financial statements of its foreign operating units from their functional currency into U.S. dollars. Statements of operations, comprehensive income and cash flows are translated at average monthly rates, while balance sheets are translated at month-end exchange rates. The translation of the balance sheet results in translation gains or losses, which are included as a separate component of equity under “Accumulated other comprehensive income (loss).” Gains and losses arising from transactions not denominated in functional currencies are included within “Other income (expense), net” in the accompanying condensed consolidated statements of operations.
Comprehensive Income
Components of comprehensive income include all changes in equity during a period except those resulting from changes in Quanta’s capital-related accounts. Quanta records other comprehensive income (loss) for foreign currency translation adjustments related to its foreign operations and for other revenues, expenses, gains and losses that are included in comprehensive income but excluded from net income.
Litigation Costs and Reserves
Quanta records reserves when the likelihood of incurring a loss is probable and the amount of loss can be reasonably estimated. Costs incurred for litigation are expensed as incurred. See Note 11 for additional information related to legal proceeding and other contingencies.
Fair Value Measurements
For disclosure purposes, qualifying assets and liabilities are categorized into three broad levels based on the priority of the inputs used to determine their fair values. The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Certain assumptions and other information as they relate to these qualifying assets and liabilities are described below.
Contingent Consideration Liabilities. As of March 31, 2019 and December 31, 2018, financial instruments required to be measured at fair value on a recurring basis consisted primarily of Quanta’s liabilities related to contingent consideration associated with certain acquisitions, the payment of which is contingent upon the achievement of certain performance objectives by the acquired businesses during post-acquisition periods and, if earned, would be payable to the former owners of the acquired businesses. The liabilities recorded represent the estimated fair values of future amounts payable to the former owners of the acquired businesses and are estimated by management based on entity-specific assumptions that are evaluated on an ongoing basis. As of March 31, 2019 and December 31, 2018, the aggregate fair value of these outstanding and unearned contingent consideration liabilities totaled $70.7 million and $70.8 million, all of which was included in “Insurance and other non-current liabilities” in the accompanying condensed consolidated balance sheets. Quanta expects a significant portion of these liabilities to be settled by late 2020 or early 2021. The fair values of contingent consideration liabilities as of March 31, 2019 was primarily determined using a Monte Carlo simulation valuation methodology based on probability-weighted performance projections and other inputs, including a discount rate and an expected volatility factor for each acquisition. The expected volatility factors ranged from 22.2% to 30.0% based on historical asset volatility of selected guideline public companies. Depending on contingent consideration payment terms, the present values of the estimated payments are discounted based on a risk-free rate and/or Quanta’s cost of debt, ranging from 2.1% to 3.9%.The fair value determinations incorporate significant inputs not observable in the market. Accordingly, the level of inputs used for these fair value measurements is the lowest level (Level 3). Significant changes in any of these assumptions could result in a significantly higher or lower potential liability.
The majority of Quanta’s contingent consideration liabilities are subject to a maximum payment amount, which aggregated to $157.3 million as of March 31, 2019. One contingent consideration liability is not subject to a maximum payout amount, and that liability had a fair value of $1.0 million as of March 31, 2019.
Quanta’s aggregate contingent consideration liabilities can change due to additional business acquisitions, payments to settle outstanding liabilities, changes in the fair value of amounts owed based on actual or forecasted performance, and foreign currency translation gains or losses. During the three months ended March 31, 2019, Quanta recognized a net decrease in the fair value of contingent consideration liabilities of $0.1 million, which was reflected in “Change in fair value of contingent consideration
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
liabilities” in the accompanying condensed consolidated statements of operations. There was no change in fair value of contingent consideration liabilities in the three months ended March 31, 2018.
Goodwill and Other Intangible Assets. As discussed in the Goodwill and Other Intangible Assets sections within this Note 2 above, Quanta has recorded goodwill and identifiable intangible assets in connection with certain of its historical business acquisitions. Quanta utilizes the fair value premise as the primary basis for its impairment valuation procedures. The Goodwill and Other Intangible Assets sections provide information regarding valuation methods, including the income approach, market approach and cost approach, and assumptions used to determine fair values of these assets based on the appropriateness of each method in relation to the type of asset being valued. Quanta believes that these valuation methods appropriately represent the methods that would be used by other market participants in determining fair value, and periodically engages the services of an independent valuation firm when a new business is acquired to assist management with this valuation process, including assistance with the selection of appropriate valuation methodologies and the development of market-based valuation assumptions. The level of inputs used for these fair value measurements is the lowest level (Level 3).
Investments and Financial Instruments. Quanta also uses fair value measurements in connection with the valuation of its investments in private company equity interests and financial instruments. These valuations require significant management judgment due to the absence of quoted market prices, the inherent lack of liquidity and the long-term nature of such assets. Typically, the initial costs of these investments are considered to represent fair market value, as such amounts are negotiated between willing market participants. On a quarterly basis, Quanta performs an evaluation of its investments to determine if an other-than-temporary decline in the value of each investment has occurred and whether the recorded amount of each investment will be recoverable. If an other-than-temporary decline in the value of an investment occurs, a fair value analysis would be performed to determine the degree to which the investment was impaired and a corresponding charge to earnings would be recorded during the period. These types of fair market value assessments are similar to other nonrecurring fair value measures used by Quanta, which include the use of significant judgment and available relevant market data. Such market data may include observations of the valuation of comparable companies, risk adjusted discount rates and an evaluation of the expected performance of the underlying portfolio asset, including historical and projected levels of profitability or cash flows. In addition, a variety of additional factors may be reviewed by management, including, but not limited to, contemporaneous financing and sales transactions with third parties, changes in market outlook and the third-party financing environment. The level of inputs used for these fair value measurements is the lowest level (Level 3).
Other. The carrying amounts of cash equivalents, accounts receivable and accounts payable and accrued expenses approximate fair value due to the short-term nature of these instruments. The carrying amount of variable rate debt also approximates fair value. All of Quanta’s cash equivalents were categorized as Level 1 assets at March 31, 2019 and December 31, 2018, as all values were based on unadjusted quoted prices for identical assets in an active market that Quanta has the ability to access.
3. NEW ACCOUNTING PRONOUNCEMENTS:
Adoption of New Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board (FASB) issued an update that requires the recognition of operating lease right-of-use assets and corresponding lease liabilities on an entity’s balance sheet. Effective January 1, 2019, Quanta adopted the new lease accounting standard utilizing the transition method that allows entities to apply the new standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption, if applicable. Quanta’s financial results for reporting periods after January 1, 2019 are presented under the new standard, while financial results for prior periods continue to be reported in accordance with the prior standard and Quanta’s historical accounting policy. The adoption of the new standard resulted in the recording of operating lease right-of-use assets and operating lease liabilities of $301.1 million as of January 1, 2019. Although the adoption of the new standard had a material impact on Quanta’s consolidated balance sheet, there was not a material impact on its consolidated statements of operations, comprehensive income, cash flows or equity. Additionally, the adoption of this standard did not have a material impact on Quanta’s debt covenant compliance under its senior secured credit facility.
Quanta elected certain practical expedients that, among other things, permit the identification and classification of leases in accordance with the previous guidance. Additionally, certain of Quanta’s real estate and equipment arrangements contain both lease and non-lease components (e.g., maintenance services). Quanta elected the practical expedient that allows an entity to not separate lease components from their associated non-lease components for such arrangements and accounted for both lease and non-lease components under the new standard. Quanta also made an accounting policy election allowed under the new standard whereby leases with terms of twelve months or less are not recorded on the balance sheet unless they contain a purchase option that is reasonably certain to be exercised.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Quanta also implemented new internal controls related to the preparation of financial information necessary for adoption of the new standard. The new lease standard also requires new disclosures that are designed to enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases, which are included in Notes 2, 8 and 13.
In August 2017, the FASB issued an update that amends and simplifies existing guidance for presenting the economic effects of risk management activities in the financial statements. The update is effective for interim and annual periods beginning after December 15, 2018. The amended presentation and disclosure guidance is required only prospectively, but certain amendments, if applicable, could require a cumulative-effect adjustment. Quanta adopted the new standard effective January 1, 2019; however, as of March 31, 2019, Quanta had no hedging relationships outstanding.
Accounting Standards Not Yet Adopted
In June 2016, the FASB issued an update that will change the way companies measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The update will require companies to use an “expected loss” model for instruments measured at amortized cost and to record allowances for available-for-sale debt securities rather than reduce the carrying amounts. The update will also require disclosure of information regarding how a company developed its allowance, including changes in the factors that influenced management’s estimate of expected credit losses and the reasons for those changes. Companies will apply this standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The new standard is effective for interim and annual reporting periods beginning after December 15, 2019. Quanta is currently evaluating the potential impact of this authoritative guidance on its consolidated financial statements and will adopt this guidance effective January 1, 2020.
In August 2018, the FASB issued an update that amends certain disclosure requirements related to fair value measurements. Certain disclosure requirements will be removed, such as the valuation processes for Level 3 fair value measurements, and other disclosure requirements will be modified or added, including a new requirement to disclose the range and weighted average (or a more reasonable and rational method to reflect the distribution) of significant unobservable inputs used to develop Level 3 fair value measurements. This update is effective for interim and annual periods beginning after December 15, 2019. Certain amendments, including the disclosure of the range and weighted average of significant observable inputs used to develop Level 3 fair value measurements, should be applied prospectively, while other amendments should be applied retrospectively. Quanta is evaluating the impact of this new standard on its consolidated financial statements and will adopt the new standard effective January 1, 2020.
In January 2019, Quanta acquired an electric power specialty contracting business that provides aerial power line and construction support services and is located in the United States. The consideration for this acquisition was $50.9 million in cash. The results of the acquired business have generally been included in Quanta’s Electric Power Infrastructure Services segment and consolidated financial statements beginning on the acquisition date.
During the year ended December 31, 2018, Quanta acquired an electrical infrastructure services business specializing in substation construction and relay services, a postsecondary educational institution that provides pre-apprenticeship training and programs for experienced linemen and two communications infrastructure services businesses, all of which are located in the United States. The aggregate consideration for these acquisitions was $106.8 million paid or payable in cash, subject to certain adjustments, and 679,668 shares of Quanta common stock, which had a fair value of approximately $22.9 million as of the respective acquisition dates. Additionally, the acquisitions of the postsecondary educational institution and one of the communications infrastructure services businesses include the potential payment of up to $18.0 million of contingent consideration, payable if the acquired businesses achieve certain performance objectives over five-year and three-year post-acquisition periods. Based on the estimated fair value of the contingent consideration, Quanta recorded $16.5 million of liabilities as of the respective acquisition dates. The results of the acquired businesses have generally been included in Quanta’s Electric Power Infrastructure Services segment and have been included in Quanta’s consolidated financial statements beginning on the respective acquisition dates.
Quanta is in the process of finalizing its assessments of the fair values of the acquired assets and assumed liabilities related to businesses acquired subsequent to March 31, 2018, and further adjustments to the purchase price allocations may occur. As of March 31, 2019, the estimated fair values of the net assets acquired were preliminary, with possible updates primarily related to certain tax estimates. The aggregate purchase consideration of the businesses acquired subsequent to March 31, 2018 through March 31, 2019 was allocated to acquired assets and assumed liabilities, which resulted in an allocation of $43.6 million to net tangible assets, $39.9 million to identifiable intangible assets and $34.3 million to goodwill.
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
The following table summarizes the aggregate consideration paid or payable as of March 31, 2019 for the 2019 acquisitions and 2018 acquisitions and presents the allocation of these amounts to net tangible and identifiable intangible assets based on their estimated fair values as of the respective acquisition dates, inclusive of any purchase price adjustments. These allocations require significant use of estimates and are based on information that was available to management at the time these consolidated financial statements were prepared. Quanta uses a variety of information to estimate fair values, including quoted market prices, carrying amounts and valuation techniques such as discounted cash flows. When deemed appropriate, third-party appraisal firms are engaged to assist in fair value determination of fixed assets, intangible assets and certain other assets and liabilities (in thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
Consideration:
|
|
|
|
|
|
Cash paid or payable
|
|
$
|
50,907
|
|
|
$
|
106,804
|
|
|
Value of Quanta common stock issued
|
|
—
|
|
|
22,882
|
|
|
Contingent consideration
|
|
—
|
|
|
16,471
|
|
|
Fair value of total consideration transferred or estimated to be transferred
|
|
$
|
50,907
|
|
|
$
|
146,157
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
$
|
7,912
|
|
|
$
|
18,405
|
|
|
Contract assets
|
|
—
|
|
|
1,905
|
|
|
Other current assets
|
|
6,142
|
|
|
8,484
|
|
|
Property and equipment
|
|
19,371
|
|
|
23,674
|
|
|
Other assets
|
|
5
|
|
|
576
|
|
|
Identifiable intangible assets
|
|
7,337
|
|
|
52,364
|
|
|
Contract liabilities
|
|
—
|
|
|
(175
|
)
|
|
Other current liabilities
|
|
(5,899
|
)
|
|
(11,205
|
)
|
|
Deferred tax liabilities, net
|
|
(5,870
|
)
|
|
(4,208
|
)
|
|
Total identifiable net assets
|
|
28,998
|
|
|
89,820
|
|
|
Goodwill
|
|
21,909
|
|
|
56,337
|
|
|
|
|
$
|
50,907
|
|
|
$
|
146,157
|
|
Goodwill represents the amount by which the purchase price for an acquired business exceeds the net fair value of the assets acquired and liabilities assumed. The 2019 and 2018 acquisitions strategically expanded Quanta’s domestic electric power and communications service offerings, which Quanta believes contributes to the recognition of the goodwill. No goodwill is expected to be deductible for income tax purposes related to the 2019 acquisition, and $20.1 million is expected to be deductible for income tax purposes related to the 2018 acquisitions.
The following table summarizes the estimated fair values of identifiable intangible assets for the 2019 acquisition as of the acquisition date and the related weighted average amortization periods by type (in thousands, except for weighted average amortization periods, which are in years).
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated Fair Value
|
|
Weighted Average Amortization Period in Years
|
|
Customer relationships
|
|
$
|
3,996
|
|
|
5.0
|
|
Backlog
|
|
1,058
|
|
|
1.0
|
|
Trade names
|
|
908
|
|
|
15.0
|
|
Non-compete agreements
|
|
1,375
|
|
|
3.0
|
|
Total intangible assets subject to amortization related to the 2019 acquisition
|
|
$
|
7,337
|
|
|
5.3
|
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
The following unaudited supplemental pro forma results of operations have been provided for illustrative purposes only and do not purport to be indicative of the actual results that would have been achieved by the combined companies for the periods presented or that may be achieved by the combined companies in the future. Future results may vary significantly from the results reflected in the following pro forma financial information because of future events and transactions, as well as other factors (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2019
|
|
2018
|
|
Revenues
|
|
$
|
2,811,139
|
|
|
$
|
2,454,974
|
|
|
Gross profit
|
|
$
|
364,779
|
|
|
$
|
313,628
|
|
|
Selling, general and administrative expenses
|
|
$
|
232,361
|
|
|
$
|
220,234
|
|
|
Amortization of intangible assets
|
|
$
|
12,868
|
|
|
$
|
12,982
|
|
|
Net income
|
|
$
|
121,021
|
|
|
$
|
41,715
|
|
|
Net income attributable to common stock
|
|
$
|
120,474
|
|
|
$
|
40,718
|
|
|
|
|
|
|
|
|
Earnings per share:
|
|
|
|
|
|
Basic
|
|
$
|
0.83
|
|
|
$
|
0.26
|
|
|
Diluted
|
|
$
|
0.82
|
|
|
$
|
0.26
|
|
The pro forma combined results of operations for the three months ended March 31, 2019 and 2018 were prepared by adjusting the historical results of Quanta to include the historical results of the 2019 acquisition as if it occurred January 1, 2018 and the historical results of the 2018 acquisitions as if they occurred January 1, 2017. These pro forma combined historical results were adjusted for the following: a reduction of interest expense as a result of the repayment of outstanding indebtedness of the acquired businesses; an increase in interest expense as a result of the cash consideration paid; an increase in amortization expense due to the incremental intangible assets recorded; changes in depreciation expense to adjust acquired property and equipment to the acquisition date fair value and to conform with Quanta’s accounting policies; an increase in the number of outstanding shares of Quanta common stock; and reclassifications to conform the acquired businesses’ presentation to Quanta’s accounting policies. The pro forma results of operations do not include any adjustments to eliminate the impact of acquisition-related costs or any cost savings or other synergies that resulted or may result from the acquisitions. As noted above, the pro forma results of operations do not purport to be indicative of the actual results that would have been achieved by the combined company for the periods presented or that may be achieved by the combined company in the future.
Revenues of approximately $7.4 million and a loss before income taxes of approximately $1.0 million, which included $2.4 million of acquisition-related costs, were included in Quanta’s consolidated results of operations for the three months ended March 31, 2019 related to the 2019 acquisition. Revenues of approximately $8.1 million and a loss before income taxes of approximately $5.3 million, which included $5.6 million of acquisition-related costs, were included in Quanta’s consolidated results of operations for the three months ended March 31, 2018 related to the 2018 acquisitions.
5. GOODWILL AND OTHER INTANGIBLE ASSETS:
As described in Note 2, Quanta’s operating units are organized into one of Quanta’s two internal divisions, and accordingly the goodwill associated with the operating units has been aggregated on a divisional basis in the table below. These divisions are closely aligned with Quanta’s reportable segments, and operating units are assigned to a division based on the predominant type of work performed. From time to time, an operating unit may be reorganized between divisions if warranted due to changes in its predominant business.
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
A summary of changes in Quanta’s goodwill is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Electric Power Infrastructure Services
Division
|
|
Pipeline and Industrial Infrastructure Services
Division
|
|
Total
|
|
Balance at December 31, 2017:
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
1,272,527
|
|
|
$
|
693,905
|
|
|
$
|
1,966,432
|
|
|
Accumulated impairment
|
|
—
|
|
|
(97,832
|
)
|
|
(97,832
|
)
|
|
|
|
1,272,527
|
|
596,073
|
|
1,868,600
|
|
|
|
|
|
|
|
|
|
Goodwill recorded related to 2018 acquisitions
|
|
56,337
|
|
|
—
|
|
|
56,337
|
|
|
Purchase price allocation adjustments
|
|
51
|
|
|
—
|
|
|
51
|
|
|
Foreign currency translation adjustments
|
|
(15,837
|
)
|
|
(9,272
|
)
|
|
(25,109
|
)
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2018:
|
|
|
|
|
|
|
|
Goodwill
|
|
1,313,078
|
|
|
683,284
|
|
|
1,996,362
|
|
|
Accumulated impairment
|
|
—
|
|
|
(96,483
|
)
|
|
(96,483
|
)
|
|
|
|
1,313,078
|
|
|
586,801
|
|
|
1,899,879
|
|
|
|
|
|
|
|
|
|
|
Goodwill recorded related to 2019 acquisition
|
|
21,909
|
|
|
—
|
|
|
21,909
|
|
|
Foreign currency translation adjustments
|
|
3,470
|
|
|
1,770
|
|
|
5,240
|
|
|
|
|
|
|
|
|
|
|
Balance at March 31, 2019:
|
|
|
|
|
|
|
|
Goodwill
|
|
1,338,457
|
|
|
685,137
|
|
|
2,023,594
|
|
|
Accumulated impairment
|
|
—
|
|
|
(96,566
|
)
|
|
(96,566
|
)
|
|
|
|
$
|
1,338,457
|
|
|
$
|
588,571
|
|
|
$
|
1,927,028
|
|
Quanta’s intangible assets and the remaining weighted average amortization periods related to its intangible assets subject to amortization were as follows (in thousands except for weighted average amortization periods, which are in years):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
As of
|
|
As of
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
|
March 31, 2019
|
|
|
|
Intangible
Assets
|
|
Accumulated
Amortization
|
|
Intangible
Assets, Net
|
|
Intangible
Assets
|
|
Accumulated
Amortization
|
|
Intangible
Assets, Net
|
|
Remaining Weighted Average Amortization Period in Years
|
|
Customer relationships
|
|
$
|
358,177
|
|
|
$
|
(172,528
|
)
|
|
$
|
185,649
|
|
|
$
|
359,967
|
|
|
$
|
(165,715
|
)
|
|
$
|
194,252
|
|
|
5.9
|
|
Backlog
|
|
136,780
|
|
|
(135,348
|
)
|
|
1,432
|
|
|
135,578
|
|
|
(134,592
|
)
|
|
986
|
|
|
0.7
|
|
Trade names
|
|
82,254
|
|
|
(22,916
|
)
|
|
59,338
|
|
|
81,058
|
|
|
(21,559
|
)
|
|
59,499
|
|
|
15.2
|
|
Non-compete agreements
|
|
40,797
|
|
|
(29,905
|
)
|
|
10,892
|
|
|
40,728
|
|
|
(30,168
|
)
|
|
10,560
|
|
|
3.3
|
|
Patented rights and developed technology
|
|
32,017
|
|
|
(24,597
|
)
|
|
7,420
|
|
|
22,482
|
|
|
(19,175
|
)
|
|
3,307
|
|
|
2.6
|
|
Curriculum
|
|
9,448
|
|
|
(1,109
|
)
|
|
8,339
|
|
|
9,448
|
|
|
(872
|
)
|
|
8,576
|
|
|
8.8
|
|
Total intangible assets subject to amortization
|
|
659,473
|
|
|
(386,403
|
)
|
|
273,070
|
|
|
649,261
|
|
|
(372,081
|
)
|
|
277,180
|
|
|
7.8
|
|
Engineering license
|
|
3,000
|
|
|
—
|
|
|
3,000
|
|
|
3,000
|
|
|
—
|
|
|
3,000
|
|
|
|
|
Total intangible assets
|
|
$
|
662,473
|
|
|
$
|
(386,403
|
)
|
|
$
|
276,070
|
|
|
$
|
652,261
|
|
|
$
|
(372,081
|
)
|
|
$
|
280,180
|
|
|
|
Amortization expense for intangible assets was $12.7 million and $10.4 million for the three months ended March 31, 2019 and 2018.
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
The estimated future aggregate amortization expense of intangible assets subject to amortization as of March 31, 2019 is set forth below (in thousands):
|
|
|
|
|
|
|
|
|
Year Ending December 31:
|
|
|
|
|
Remainder of 2019
|
|
$
|
36,849
|
|
|
2020
|
|
46,651
|
|
|
2021
|
|
44,131
|
|
|
2022
|
|
40,359
|
|
|
2023
|
|
32,242
|
|
|
Thereafter
|
|
72,838
|
|
|
Total
|
|
$
|
273,070
|
|
6. PER SHARE INFORMATION:
The amounts used to compute basic and diluted earnings per share attributable to common stock for the three months ended March 31, 2019 and 2018 consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2019
|
|
2018
|
|
Amounts attributable to common stock:
|
|
|
|
|
|
Net income attributable to common stock
|
|
$
|
120,488
|
|
|
$
|
37,614
|
|
|
|
|
|
|
|
|
Weighted average shares:
|
|
|
|
|
|
Weighted average shares outstanding for basic earnings per share attributable to common stock
|
|
145,110
|
|
|
156,546
|
|
|
Effect of dilutive unvested non-participating stock-based awards
|
|
1,348
|
|
|
1,010
|
|
|
Weighted average shares outstanding for diluted earnings per share attributable to common stock
|
|
146,458
|
|
|
157,556
|
|
Basic and diluted earnings per share attributable to common stock are computed using the weighted average number of shares of common stock outstanding during the applicable period. Exchangeable shares that were issued pursuant to certain of Quanta’s historical acquisitions (as further discussed in Note 9), which are exchangeable on a one-for-one basis with shares of Quanta common stock, have been included in the calculation of weighted average shares outstanding for basic and diluted earnings per share attributable to common stock for the portion of the periods that they were outstanding. Additionally, unvested stock-based awards that contain non-forfeitable rights to dividends or dividend equivalents (participating securities) have been included in the calculation of basic and diluted earnings per share attributable to common stock for the portion of the periods that the awards were outstanding. Weighted average shares outstanding for basic and diluted earnings per share attributable to common stock for each of the three months ended March 31, 2019 and 2018 included 2.8 million and 2.7 million weighted average participating securities.
For purposes of calculating diluted earnings per share attributable to common stock, there were no adjustments required to derive Quanta’s net income attributable to common stock. Diluted earnings per share attributable to common stock is computed using the weighted average number of shares of common stock outstanding during the period adjusted for all potentially dilutive common stock equivalents, except in cases where the effect of the common stock equivalents would be antidilutive.
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
7. DEBT OBLIGATIONS:
Quanta’s long-term debt obligations consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
|
Borrowings under senior secured credit facility
|
|
$
|
1,372,050
|
|
|
$
|
1,070,299
|
|
|
Other long-term debt
|
|
4,284
|
|
|
1,523
|
|
|
Finance leases
|
|
1,746
|
|
|
934
|
|
|
Total long-term debt obligations
|
|
1,378,080
|
|
|
1,072,756
|
|
|
Less — Current maturities of long-term debt
|
|
33,081
|
|
|
32,224
|
|
|
Total long-term debt obligations, net of current maturities
|
|
$
|
1,344,999
|
|
|
$
|
1,040,532
|
|
Quanta’s current maturities of long-term debt and short-term debt consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
|
Short-term debt
|
|
$
|
11,264
|
|
|
$
|
33,422
|
|
|
Current maturities of long-term debt
|
|
33,081
|
|
|
32,224
|
|
|
Current maturities of long-term debt and short-term debt
|
|
$
|
44,345
|
|
|
$
|
65,646
|
|
Senior Secured Credit Facility
Quanta has a credit agreement with various lenders that, as amended on October 10, 2018, provides for (i) a $1.99 billion revolving credit facility and (ii) a term loan facility with total term loan commitments of $600.0 million. In addition, subject to the conditions specified in the credit agreement, Quanta has the option to increase the capacity of the credit facility, in the form of an increase in the revolving credit facility, incremental term loans or a combination thereof, by up to an additional $400.0 million, from time to time, upon receipt of additional commitments from new or existing lenders. Borrowings under the credit agreement are to be used to refinance existing indebtedness and for working capital, capital expenditures and other general corporate purposes. The maturity date for both the revolving credit facility and the term loan facility is October 31, 2022, and Quanta is required to make quarterly payments on the term loan facility as described below.
With respect to the revolving credit facility, the entire amount available may be used by Quanta for revolving loans and letters of credit in U.S. dollars and certain alternative currencies. Up to $600.0 million may be used by certain subsidiaries of Quanta for revolving loans and letters of credit in certain alternative currencies, up to $100.0 million may be used for swing line loans in U.S. dollars, up to $50.0 million may be used for swing line loans in Canadian dollars and up to $50.0 million may be used for swing line loans in Australian dollars.
On October 10, 2018, Quanta borrowed the full amount of the term loan facility and used all of such proceeds to repay outstanding revolving loans. As of March 31, 2019, Quanta had $1.37 billion of borrowings outstanding under the credit agreement, which included $585.0 million borrowed under the term loan facility and $787.1 million of outstanding revolving loans. Of the total outstanding borrowings, $1.21 billion were denominated in U.S. dollars, $123.6 million were denominated in Canadian dollars and $36.2 million were denominated in Australian dollars. Quanta also had $385.0 million of letters of credit and bank guarantees issued under the revolving credit facility, of which $240.6 million were denominated in U.S. dollars and $144.4 million were denominated in currencies other than the U.S. dollar, primarily Canadian and Australian dollars. The remaining $812.9 million of available commitments under the credit facility was available for loans or issuing new letters of credit and bank guarantees. Borrowings under the credit facility and the applicable interest rates during the three months ended March 31, 2019 and 2018 were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2019
|
|
2018
|
|
Maximum amount outstanding under the credit facility during the period
|
|
$
|
1,453,150
|
|
|
$
|
936,012
|
|
|
Average daily amount outstanding under the credit facility
|
|
$
|
1,264,498
|
|
|
$
|
684,947
|
|
|
Weighted-average interest rate
|
|
3.92
|
%
|
|
3.34
|
%
|
Revolving loans borrowed in U.S. dollars bear interest, at Quanta’s option, at a rate equal to either (i) the Eurocurrency Rate
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
(as defined in the credit agreement) plus 1.125% to 2.000%, as determined based on Quanta’s Consolidated Leverage Ratio (as described below), or (ii) the Base Rate (as described below) plus 0.125% to 1.000%, as determined based on Quanta’s Consolidated Leverage Ratio. Revolving loans borrowed in any currency other than U.S. dollars bear interest at a rate equal to the Eurocurrency Rate plus 1.125% to 2.000%, as determined based on Quanta’s Consolidated Leverage Ratio. Additionally, standby or commercial letters of credit issued under the credit agreement are subject to a letter of credit fee of 1.125% to 2.000%, based on Quanta’s Consolidated Leverage Ratio, and Performance Letters of Credit (as defined in the credit agreement) issued under the credit agreement in support of certain contractual obligations are subject to a letter of credit fee of 0.675% to 1.150%, based on Quanta’s Consolidated Leverage Ratio.
Term loans bear interest at rates generally consistent with the revolving loans borrowed in U.S. dollars, except that the additional amount over the Eurocurrency Rate is 1.125% to 1.875% based on Quanta’s Consolidated Leverage Ratio. Quanta is also required to make quarterly principal payments of $7.5 million on the last business day of each March, June, September and December, which began in December 2018. The aggregate outstanding principal amount of all outstanding term loans must be paid on the maturity date; however, we may voluntarily prepay that amount from time to time, in whole or in part, without premium or penalty.
Quanta is also subject to a commitment fee of 0.20% to 0.40%, based on its Consolidated Leverage Ratio, on any unused availability under the revolving credit facility.
Consolidated Leverage Ratio is the ratio of Quanta’s Consolidated Funded Indebtedness to Consolidated EBITDA (as those terms are defined in the credit agreement). For purposes of calculating Quanta’s Consolidated Leverage Ratio, Consolidated Funded Indebtedness is reduced by available cash and cash equivalents (as defined in the credit agreement) in excess of $25.0 million. The Base Rate equals the highest of (i) the Federal Funds Rate (as defined in the credit agreement) plus 0.5%, (ii) the prime rate publicly announced by Bank of America, N.A. and (iii) the Eurocurrency Rate plus 1.00%. Consolidated Interest Coverage Ratio is the ratio of (i) Consolidated EBIT (as defined in the credit agreement) for the four fiscal quarters most recently ended to (ii) Consolidated Interest Expense (as defined in the credit agreement) for such period (excluding all interest expense attributable to capitalized loan costs and the amount of fees paid in connection with the issuance of letters of credit on behalf of Quanta during such period).
The credit agreement contains certain covenants, including (i) a maximum Consolidated Leverage Ratio of 3.0 to 1.0 (except that in connection with certain permitted acquisitions in excess of $200.0 million, such ratio is 3.5 to 1.0 for the fiscal quarter in which the acquisition is completed and the two subsequent fiscal quarters) and (ii) a minimum Consolidated Interest Coverage Ratio of 3.0 to 1.0. As of March 31, 2019, Quanta was in compliance with all of the covenants under the credit agreement.
Subject to certain exceptions, (i) all borrowings under the credit agreement are secured by substantially all the assets of Quanta and Quanta’s wholly owned U.S. subsidiaries and by a pledge of all of the capital stock of Quanta’s wholly owned U.S. subsidiaries and 65% of the capital stock of direct foreign subsidiaries of Quanta’s wholly owned U.S. subsidiaries and (ii) Quanta’s wholly owned U.S. subsidiaries guarantee the repayment of all amounts due under the credit agreement. Subject to certain conditions, all collateral will automatically be released from the liens at any time Quanta maintains an Investment Grade Rating (defined in the credit agreement as two of the following three conditions being met: (i) a corporate credit rating that is BBB- or higher by Standard & Poor’s Rating Services, (ii) a corporate family rating that is Baa3 or higher by Moody’s Investors Services, Inc. or (iii) a corporate credit rating that is BBB- or higher by Fitch Ratings, Inc.).
The credit agreement also limits certain acquisitions, mergers and consolidations, indebtedness, asset sales and prepayments of indebtedness and, subject to certain exceptions, prohibits liens on Quanta’s assets. The credit agreement allows cash payments for dividends and stock repurchases subject to compliance with the following requirements (after giving effect to the dividend or stock repurchase): (i) no default or event of default under the credit agreement; (ii) continued compliance with the financial covenants in the credit agreement; and (iii) at least $100.0 million of availability under the revolving credit facility and/or cash and cash equivalents on hand.
The credit agreement provides for customary events of default and contains cross-default provisions with Quanta’s underwriting, continuing indemnity and security agreement with its sureties and certain other debt instruments exceeding $150.0 million in borrowings or availability. If an Event of Default (as defined in the credit agreement) occurs and is continuing, on the terms and subject to the conditions set forth in the credit agreement, the lenders may declare all amounts outstanding and accrued and unpaid interest immediately due and payable, require that Quanta provide cash collateral for all outstanding letter of credit obligations, terminate the commitments under the credit agreement, and foreclose on the collateral.
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
8. LEASES:
As discussed in Note 3, effective January 1, 2019, Quanta adopted the new lease accounting standard utilizing the transition method that allows entities to initially apply the new standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption, if applicable. Quanta’s financial results for reporting periods after January 1, 2019 are presented under the new standard, while financial results for prior periods continue to be reported in accordance with the prior standard and Quanta’s historical accounting policy.
Quanta’s leases primarily include leases of land, buildings, vehicles, construction equipment and office equipment. As of March 31, 2019, Quanta’s leases had remaining lease terms of up to nine years. Certain leases include options to extend their terms in increments of up to seven years and/or options to terminate. The components of lease costs in the accompanying condensed consolidated statement of operations were as follows (in thousands):
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|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
March 31, 2019
|
|
Lease cost
|
Classification
|
|
|
|
Finance lease cost:
|
|
|
|
|
Amortization of lease assets
|
Depreciation (1)
|
|
$
|
373
|
|
|
Interest on lease liabilities
|
Interest expense
|
|
21
|
|
|
Operating lease cost
|
Costs of services and Selling, general and administrative expenses
|
|
30,358
|
|
|
Short-term lease cost (2)
|
Costs of services and Selling, general and administrative expenses
|
|
195,165
|
|
|
Variable lease cost (3)
|
Costs of services and Selling, general and administrative expenses
|
|
5,133
|
|
|
Total lease cost
|
|
|
$
|
231,050
|
|
|
|
|
|
(1)
|
Depreciation is included within “Cost of services” and “Selling, general and administrative expenses” in the accompanying condensed consolidated statements of operations.
|
|
|
|
|
(2)
|
Short-term lease cost includes both leases and rentals with initial terms of one year or less.
|
|
|
|
|
(3)
|
Variable lease cost primarily relates to real estate leases and consists of common area maintenance charges, real estate taxes, insurance and other variable costs.
|
For the three months ended March 31, 2018, rent expense related to operating leases was $76.0 million; however, this amount did not include rent expense related to certain equipment under month-to-month rental periods, which is included in short-term lease cost in the table above.
Additionally, Quanta has entered into lease arrangements for real property and facilities with related parties, typically employees of Quanta who are the former owners of acquired businesses that utilize the leased premises. These lease agreements generally have lease terms of up to 5 years and may include renewal options. Related party lease expense for the three months ended March 31, 2019 and 2018 was $4.1 million and $3.2 million.
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
The components of leases in the accompanying condensed consolidated balance sheet were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
Lease type
|
Classification
|
|
|
|
Assets:
|
|
|
|
|
Operating lease right-of-use assets
|
Operating lease right-of-use assets
|
|
$
|
285,768
|
|
|
Finance lease assets
|
Property and equipment, net of accumulated depreciation
|
|
2,313
|
|
|
Total lease assets
|
|
|
$
|
288,081
|
|
|
Liabilities:
|
|
|
|
|
Current:
|
|
|
|
|
Operating
|
Current portion of operating lease liabilities
|
|
$
|
92,293
|
|
|
Finance
|
Current maturities of long-term debt and short-term debt
|
|
1,168
|
|
|
|
|
|
|
|
Non-current:
|
|
|
|
|
Operating
|
Operating lease liabilities, net of current portion
|
|
193,475
|
|
|
Finance
|
Long-term debt, net of current maturities
|
|
578
|
|
|
Total lease liabilities
|
|
|
$
|
287,514
|
|
Certain of Quanta’s equipment rental agreements contain purchase options pursuant to which the purchase price is offset by a portion of the rental payments. For rental purchase options exercised through a third-party lessor and for which a substantive benefit is deemed to be transferred to the lessor, such benefit is recorded in “Property, plant and equipment, net of accumulated depreciation,” with a corresponding increase in “Current maturities of long-term debt and short-term debt” and “Long-term debt, net of current maturities.” As of March 31, 2019, the benefit recorded was $2.8 million.
Future minimum lease payments for operating and finance leases were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2019
|
|
|
|
Operating Leases
|
|
Finance Leases
|
|
Total
|
|
Remainder of 2019
|
|
$
|
79,484
|
|
|
$
|
1,130
|
|
|
$
|
80,614
|
|
|
2020
|
|
82,627
|
|
|
291
|
|
|
82,918
|
|
|
2021
|
|
56,831
|
|
|
267
|
|
|
57,098
|
|
|
2022
|
|
35,537
|
|
|
97
|
|
|
35,634
|
|
|
2023
|
|
22,310
|
|
|
33
|
|
|
22,343
|
|
|
Thereafter
|
|
37,152
|
|
|
2
|
|
|
37,154
|
|
|
Total future minimum lease payments
|
|
$
|
313,941
|
|
|
$
|
1,820
|
|
|
$
|
315,761
|
|
|
Less imputed interest
|
|
(28,173
|
)
|
|
(74
|
)
|
|
(28,247
|
)
|
|
Total lease liabilities
|
|
$
|
285,768
|
|
|
$
|
1,746
|
|
|
$
|
287,514
|
|
Future minimum lease payments for operating leases under the prior standard were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2018
|
|
|
|
Operating Leases
|
|
2019
|
|
$
|
124,530
|
|
|
2020
|
|
81,189
|
|
|
2021
|
|
55,827
|
|
|
2022
|
|
34,337
|
|
|
2023
|
|
21,450
|
|
|
Thereafter
|
|
37,217
|
|
|
Total minimum lease payments
|
|
$
|
354,550
|
|
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
The weighted average remaining lease terms and discount rates were as follows:
|
|
|
|
|
|
|
|
|
|
As of March 31, 2019
|
|
Weighted average remaining lease term (in years):
|
|
|
|
Operating leases
|
|
4.35
|
|
|
Finance leases
|
|
1.77
|
|
|
Weighted average discount rate:
|
|
|
|
Operating leases
|
|
4.3
|
%
|
|
Finance leases
|
|
4.1
|
%
|
Quanta has also guaranteed the residual value on certain of its equipment operating leases, agreeing to pay any difference between this residual value and the fair market value of the underlying asset at the date of termination of such leases. At March 31, 2019, the maximum guaranteed residual value was $697.3 million. While Quanta believes that no significant payments will be made as a result of these residual value guarantees, there can be no assurance that significant payments will not be required in the future.
From time to time, Quanta has additional obligations related to operating and/or finance leases that have not commenced. These arrangements were not deemed material as of March 31, 2019.
9. EQUITY:
Exchangeable Shares and Preferred Stock
In connection with certain prior acquisitions of Canadian businesses, the former owners of the acquired businesses received exchangeable shares of certain Canadian subsidiaries of Quanta, which may be exchanged at the option of the holders for Quanta common stock on a one-for-one basis. The holders of exchangeable shares can make an exchange only once in any calendar quarter and must exchange a minimum of either 50,000 shares or, if less, the total number of remaining exchangeable shares registered in the name of the holder making the request. Additionally, in connection with two of such acquisitions, Quanta issued one share of Quanta Series F preferred stock and one share of Quanta Series G preferred stock to voting trusts on behalf of the respective holders of the exchangeable shares issued in such acquisitions, which provided such holders with voting rights in Quanta common stock equivalent to the number of exchangeable shares outstanding. The share of Quanta Series F preferred stock was redeemed and retired effective October 6, 2017. All holders of exchangeable shares have rights equivalent to Quanta common stockholders with respect to dividends and other economic rights.
During the three months ended March 31, 2019, 0.4 million exchangeable shares were exchanged for Quanta common stock, and as of March 31, 2019, 36,183 exchangeable shares remained outstanding. After completion of the exchange during the three months ended March 31, 2019, no exchangeable shares associated with the share of Quanta Series G preferred stock remained outstanding. Accordingly, that share was redeemed, deemed retired and canceled and may not be reissued.
Treasury Stock
General
Treasury stock is recorded at cost. Under Delaware corporate law, treasury stock is not counted for quorum purposes or entitled to vote.
Shares withheld for tax withholding obligations
The tax withholding obligations of employees upon vesting of restricted stock, RSUs and performance units settled in common stock are typically satisfied by Quanta making tax payments and withholding the number of vested shares having a value on the date of vesting equal to the tax withholding obligation. For the settlement of these liabilities, Quanta withheld 0.4 million shares of Quanta common stock during each the three months ended March 31, 2019 and 2018, which had a total market value of $15.3 million and $13.4 million. These shares and the related costs to acquire them were accounted for as adjustments to the balance of treasury stock.
Notional amounts recorded related to deferred compensation plans
For RSUs and performance units that vest but the settlement of which is deferred under Quanta’s deferred compensation plans, Quanta records a notional amount to “Treasury stock” and an offsetting amount to “Additional paid-in capital” (APIC).
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
However, the only shares added to outstanding treasury stock at vesting are shares withheld for tax liabilities other than income taxes, as the shares of Quanta common stock associated with deferred equity awards are not issued. Upon settlement of the deferred equity awards and issuance of the associated Quanta common stock, the original accounting entry is reversed. The amounts recorded to treasury stock related to the deferred compensation plans during the three months ended March 31, 2019 and 2018 were $3.8 million and $3.3 million.
Stock repurchases
During the second quarter of 2017, Quanta’s Board of Directors approved a stock repurchase program that authorized Quanta to purchase, from time to time through June 30, 2020, up to $300.0 million of its outstanding common stock (the 2017 Repurchase Program). During the third quarter of 2018, Quanta’s Board of Directors approved an additional stock repurchase program that authorizes Quanta to purchase, from time to time through June 30, 2021, up to $500.0 million of its outstanding common stock (the 2018 Repurchase Program). Repurchases can be made in open market and privately negotiated transactions. During the three months ended March 31, 2019 and 2018, Quanta repurchased 0.4 million and 5.0 million shares of its common stock in the open market at a cost of $12.0 million and $173.9 million. During 2018, Quanta repurchased 13.9 million shares of its common stock in the open market at a cost of $451.3 million. Quanta’s policy is to record a stock repurchase as of the trade date; however, the payment of cash related to the repurchase is made on the settlement date of the trade. As a result of this policy, during the quarters ended March 31, 2019 and 2018, cash payments related to stock repurchases were $19.9 million and $173.9 million. As of March 31, 2019, $286.8 million remained under the 2018 Repurchase Program.
Non-controlling Interests
Quanta holds interests in various entities through both joint venture entities that provide infrastructure services under specific customer contracts, either directly or through subcontracting relationships, and other equity investments in partially owned entities that own and operate certain infrastructure assets, including investments that may be entered into through the partnership structure Quanta has formed with certain infrastructure investors. Quanta has determined that certain of these joint ventures where Quanta provides the majority of the infrastructure services, which management believes most significantly influences the economic performance of such joint ventures, are VIEs. Management has concluded that Quanta is the primary beneficiary of these joint ventures and has accounted for each on a consolidated basis. The other parties’ equity interests in these joint ventures have been accounted for as “Non-controlling interests” in Quanta’s condensed consolidated balance sheets. Net income attributable to the other participants in the amounts of $0.5 million and $1.0 million for the three months ended March 31, 2019 and 2018 has been accounted for as a reduction of net income in deriving “Net income attributable to common stock” in Quanta’s condensed consolidated statements of operations.
The carrying amount of the investments held by Quanta in all of its VIEs was $9.6 million at March 31, 2019 and December 31, 2018. The carrying amount of investments held by the non-controlling interests in these VIEs at March 31, 2019 and December 31, 2018 was $1.3 million. During the three months ended March 31, 2019 and 2018, net distributions to non-controlling interests were $0.5 million and $1.0 million. There were also notes receivable discharged by a joint venture partner of $0.5 million, which were accounted for as a “Buyout of a non-controlling interest” in the accompanying condensed consolidated statements of equity during the three months ended March 31, 2018. There were no other changes in equity as a result of transfers to/from the non-controlling interests during the three months ended March 31, 2019 or 2018. See Note 11 for further disclosures related to Quanta’s joint venture arrangements.
Dividends
On December 6, 2018, Quanta’s Board of Directors declared a cash dividend of $0.04 per share of its common stock, or $5.8 million, which was paid on January 16, 2019 to stockholders of record as of January 2, 2019. On March 21, 2019, Quanta’s Board of Directors declared a cash dividend of $0.04 per share of its common stock, or $5.9 million, which was paid on April 19, 2019 to stockholders of record as of April 5, 2019.
The declaration, payment and amount of future cash dividends will be at the discretion of Quanta’s Board of Directors after taking into account various factors, including Quanta’s financial condition, results of operations, cash flows from operations, current and anticipated capital requirements and expansion plans, income tax laws then in effect and the requirements of Delaware law. In addition, as discussed in Note 7, Quanta’s credit agreement restricts the payment of cash dividends unless certain conditions are met.
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
10. EQUITY-BASED COMPENSATION:
Stock Incentive Plans
On May 19, 2011, Quanta’s stockholders approved the 2011 Omnibus Equity Incentive Plan (the 2011 Plan). The 2011 Plan provides for the award of non-qualified stock options, incentive (qualified) stock options, stock appreciation rights, restricted stock, RSUs, stock bonus awards, performance compensation awards (including performance units and cash bonus awards) or any combination of the foregoing. The purpose of the 2011 Plan is to attract and retain key personnel and provide participants with additional performance incentives by increasing their proprietary interest in Quanta. Employees, directors, officers, consultants or advisors of Quanta or its affiliates are eligible to participate in the 2011 Plan, as are prospective employees, directors, officers, consultants or advisors of Quanta who have agreed to serve Quanta in those capacities. An aggregate of 13,300,000 shares of Quanta common stock may be issued pursuant to awards granted under the 2011 Plan.
RSUs to be Settled in Common Stock
During the three months ended March 31, 2019 and 2018, Quanta granted 1.5 million and 1.3 million of RSUs to be settled in common stock under the 2011 Plan with weighted average grant date fair values of $35.85 and $34.46. The grant date fair value for RSUs to be settled in common stock is based on the market value of Quanta common stock on the date of grant. RSU awards to be settled in common stock are subject to forfeiture, restrictions on transfer and certain other conditions until vesting, which generally occurs in three equal annual installments following the date of grant. Holders of RSUs to be settled in common stock are entitled to receive a cash dividend equivalent payment equal to any cash dividend payable on account of common shares.
During each of the three months ended March 31, 2019 and 2018, vesting activity consisted of 1.2 million of RSUs settled in common stock with an approximate fair value at the time of vesting of $41.5 million and $42.4 million.
During the three months ended March 31, 2019 and 2018, Quanta recognized $11.3 million and $11.2 million of non-cash stock compensation expense related to RSUs to be settled in common stock. Such expense is recorded in selling, general and administrative expenses. As of March 31, 2019, there was $77.2 million of total unrecognized compensation expense related to unvested RSUs to be settled in common stock granted to both employees and non-employees. This cost is expected to be recognized over a weighted average period of 2.50 years.
Performance Units to be Settled in Common Stock
Performance units awarded pursuant to the 2011 Plan provide for the issuance of shares of common stock upon vesting. These performance units cliff-vest at the end of a three-year performance period based on achievement of certain performance metrics established by Quanta’s compensation committee, including company performance goals and, with respect to certain awards, Quanta’s total shareholder return as compared to a predetermined group of peer companies. The final number of shares of common stock issuable upon vesting of performance units can range from 0% to 200% of the number of performance units initially granted, depending on the level of achievement, as determined by Quanta’s compensation committee.
During each of the three months ended March 31, 2019 and 2018, Quanta granted 0.3 million performance units to be settled in common stock under the 2011 Plan with a weighted average grant date fair value of $15.49 and $12.24 per unit. The grant date fair values for awards of performance units granted in the three months ended March 31, 2019 and 2018, which included market-based metrics, were determined using a Monte Carlo simulation valuation methodology using the following key inputs:
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
Valuation date stock price based on the March 8, 2019 and February 28, 2018
|
|
$35.19
|
|
$34.44
|
|
Expected volatility
|
|
25
|
%
|
|
34
|
%
|
|
Risk-free interest rate
|
|
2.43
|
%
|
|
2.39
|
%
|
|
Term in years
|
|
2.81
|
|
|
2.84
|
|
Quanta recognizes expense related to performance units with market-based metrics based on the probability of achievement of the underlying performance metrics, multiplied by the portion of the three-year period that has expired and the fair value of the total number of shares of common stock that Quanta anticipates will be issued based on such achievement. Quanta recognizes expense related to performance units without market-based metrics based on the portion of the three-year period that has expired multiplied by the fair value of the total number of shares of common stock that Quanta anticipates will be issued. During the three months ended March 31, 2019 and 2018, Quanta recognized $1.7 million and $3.5 million in compensation expense associated with performance units. Such expense is recorded in “Selling, general and administrative expenses.” During the three months ended March 31, 2019, 0.2 million performance units vested, and 0.4 million shares of common stock were earned and either
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
issued or deferred for future issuance in connection with performance units. During the three months ended March 31, 2018, 0.1 million performance units vested, and 0.1 million shares of common stock were earned and either issued or deferred for future issuance in connection with performance units.
RSUs to be Settled in Cash
Certain RSUs granted by Quanta under the 2011 Plan are settled solely in cash. These cash-settled RSUs are intended to provide plan participants with cash performance incentives that are substantially equivalent to the risks and rewards of equity ownership in Quanta, typically vest in three equal annual installments following the date of grant, and are subject to forfeiture under certain conditions, primarily termination of service. Additionally, subject to certain restrictions, Quanta’s non-employee directors may elect to settle a portion of their RSU awards in cash. For RSUs settled in cash, the holders receive for each vested RSU an amount in cash equal to the fair market value of one share of Quanta common stock on the settlement date, as specified in the applicable award agreement.
Compensation expense related to RSUs to be settled in cash was $2.6 million and $1.3 million for the three months ended March 31, 2019 and 2018. Such expense is recorded in “Selling, general and administrative expenses.” RSUs that are anticipated to be settled in cash are not included in the calculation of earnings per share, and the estimated earned value of such RSUs is classified as a liability. Quanta paid $2.9 million and $2.2 million to settle liabilities related to cash-settled RSUs in the three months ended March 31, 2019 and 2018. Accrued liabilities for the estimated earned value of outstanding RSUs to be settled in cash were $2.8 million and $3.4 million at March 31, 2019 and December 31, 2018.
11. COMMITMENTS AND CONTINGENCIES:
Investments in Affiliates and Other Entities
As described in Note 9, Quanta holds investments in various entities, including joint venture entities that provide infrastructure services under specific customer contracts and partially owned entities that own and operate certain infrastructure assets constructed by Quanta. Losses incurred by these entities are generally shared ratably based on the percentage ownership of the participants in these structures. However, in Quanta’s joint venture structures that provide infrastructure services, each participant is typically jointly and severally liable for all of the obligations of the joint venture entity pursuant to the contract with the customer, as a general partner or through a parent guarantee and, therefore, can be liable for full performance of the contract with the customer. In circumstances where Quanta’s participation in a joint venture qualifies as a general partnership, the joint venture partners are jointly and severally liable for all of the obligations of the joint venture, including obligations owed to the customer or any other person or entity. Quanta is not aware of circumstances that would lead to future claims against it for material amounts in connection with these joint and several liabilities.
Additionally, in the joint venture structures entered into by Quanta, typically each party indemnifies the other party for any liabilities incurred in excess of the liabilities such other party is obligated to bear under the respective joint venture agreement or in accordance with the scope of work subcontracted to each party. It is possible, however, that Quanta could be required to pay or perform obligations in excess of its share if the other party is unable or refuses to pay or perform its share of the obligations. Quanta is not aware of circumstances that would lead to future claims against it for material amounts that would not be indemnified.
As described in Note 2, Quanta has also formed a partnership with select infrastructure investors that provides up to $1.0 billion of capital, including approximately $80.0 million from Quanta, available to invest in certain specified infrastructure projects through August 2024. As of March 31, 2019, Quanta had contributed $15.1 million to this partnership in connection with certain investments and the payment of management fees.
Additionally, as of March 31, 2019, Quanta had outstanding capital commitments associated with investments in unconsolidated affiliates related to planned oil and gas infrastructure projects of $2.3 million, of which $1.6 million is expected to be paid in 2019. The remaining $0.7 million of these capital commitments is anticipated to be paid by May 31, 2022.
During 2014, a limited partnership in which Quanta is a partner was selected for an engineering, procurement and construction (EPC) electric transmission project in Canada to construct approximately 500 kilometers of transmission line and two 500 kV substations. A subsidiary of Quanta, engaged by the limited partnership, is contracted to provide turnkey EPC services for the entire project. As of March 31, 2019, Quanta made aggregate contributions to this unconsolidated affiliate of $88.7 million, received $60.6 million as a return of capital and had no outstanding additional capital commitments associated with this project.
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Contingent Consideration Liabilities
As discussed in further detail in Note 2, Quanta is obligated to pay contingent consideration amounts to the former owners of certain acquired businesses in the event that such acquired businesses achieve specified performance objectives. As of March 31, 2019 and December 31, 2018, the estimated fair value of Quanta’s contingent consideration liabilities totaled $70.7 million and $70.8 million.
Committed Expenditures
Quanta has capital commitments for the expansion of its vehicle fleet in order to accommodate manufacturer lead times on certain types of vehicles. As of March 31, 2019, Quanta had $44.0 million of production orders with expected delivery dates in 2019. Although Quanta has committed to purchase these vehicles at the time of their delivery, Quanta anticipates that the majority of these orders will be assigned to third party leasing companies and made available under certain master equipment lease agreements, thereby releasing Quanta from its capital commitments.
Legal Proceedings
Quanta is from time to time party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of business. These actions typically seek, among other things, compensation for alleged personal injury, breach of contract and/or property damages, employment-related damages, punitive damages, civil penalties or other losses, or injunctive or declaratory relief. With respect to all such lawsuits, claims and proceedings, Quanta records a reserve when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. In addition, Quanta discloses matters for which management believes a material loss is at least reasonably possible. Except as otherwise stated below, none of these proceedings are expected to have a material adverse effect on Quanta’s consolidated financial position, results of operations or cash flows. In all instances, management has assessed the matter based on current information and made a judgment concerning its potential outcome, giving due consideration to the nature of the claim, the amount and nature of damages sought and the probability of success. Management’s judgment may prove materially inaccurate, and such judgment is made subject to the known uncertainties of litigation.
Maurepas Project Dispute. During the third quarter of 2017, Maurepas Pipeline, LLC (Maurepas) notified QPS Engineering, LLC (QPS), a subsidiary of Quanta, of Maurepas’ assertion of a claim for liquidated damages allegedly arising from delay in mechanical completion of a project in Louisiana. Quanta disputes the claim and believes that QPS is not responsible for liquidated damages under the contract terms. The matter remains subject to contractual dispute resolution measures; however, either party may choose to institute a formal legal proceeding upon completion of such measures. If, upon final resolution of this matter, Quanta is unsuccessful, any such liquidated damages would be recorded as additional costs on the project. As of March 31, 2019, Quanta had recorded an accrual with respect to this matter based on the current estimated amount of probable loss and believes that the range of any additional reasonably possible loss would be the difference between the accrued amount and $22.0 million, which is the maximum liability for liquidated damages pursuant to the contract terms. In July and August 2018, Quanta also received notice from Maurepas claiming certain warranty defects on the project. Quanta is evaluating the claimed defects, and based on information currently available, no estimate of reasonably possible loss related to the warranty claim can be determined.
Lorenzo Benton v. Telecom Network Specialists, Inc., et al. In June 2006, plaintiff Lorenzo Benton filed a class action complaint in the Superior Court of California, County of Los Angeles, alleging various wage and hour violations against Telecom Network Specialists (TNS), a former subsidiary of Quanta. Quanta retained liability associated with this matter pursuant to the terms of Quanta’s sale of TNS in December 2012. Benton represents a class of workers that includes all persons who worked on certain TNS projects, including individuals that TNS retained through numerous staffing agencies. The plaintiff class in this matter is seeking damages for unpaid wages, penalties associated with the failure to provide meal and rest periods and overtime wages, interest and attorneys’ fees. In January 2017, the trial court granted a summary judgment motion filed by the plaintiff class and found that TNS was a joint employer of the class members and that it failed to provide adequate meal and rest breaks and failed to pay overtime wages. In February 2019, the court granted, in part, the plaintiff class’s final motion for summary judgment on damages awarding the class approximately $7.5 million for its meal/rest break and overtime claims, and denied the motion as to penalties. Quanta believes the court’s decisions on liability and damages are not supported by controlling law and continues to contest its liability and the damage calculation asserted by the plaintiff class in this matter.
Additionally, in November 2007, TNS filed cross complaints for indemnity and breach of contract against the staffing agencies, which employed many of the individuals in question. In December 2012, the trial court heard cross-motions for summary judgment filed by TNS and the staffing agencies pertaining to TNS’s demand for indemnity. The court denied TNS’s motion and granted the motions filed by the staffing agencies; however, the California Appellate Court reversed the trial court’s decision in part and instructed the trial court to reconsider its ruling. In February 2017, the court denied a new motion for summary judgment
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
filed by the staffing companies and has since stated that the staffing companies would be liable to TNS for any damages owed to the class members that the staffing companies employed.
The final amount of liability, if any, payable in connection with this matter remains the subject of pending litigation and will ultimately depend on various factors, including the outcome of Quanta’s appeal of the trial court’s rulings on liability and damages, the final determination with respect to any additional damages owed by Quanta, and the solvency of the staffing agencies. Based on review and analysis of the trial court’s rulings on liability, Quanta does not believe, at this time, that it is probable this matter will result in a material loss. However, if Quanta is unsuccessful in this litigation and the staffing agencies are unable to fund damages owed to class members, Quanta believes the range of reasonably possible loss to Quanta upon final resolution of this matter could be up to approximately $11.0 million, plus attorneys’ fees and expenses of the plaintiff class.
Concentrations of Credit Risk
Quanta is subject to concentrations of credit risk related primarily to its cash and cash equivalents and its net receivable position with customers, which includes amounts related to billed and unbilled accounts receivable and contract assets net of advanced billings with the same customer. Substantially all of Quanta’s cash and cash equivalents are managed by what it believes to be high credit quality financial institutions. In accordance with Quanta’s investment policies, these institutions are authorized to invest cash and cash equivalents in a diversified portfolio of what Quanta believes to be high quality cash and cash equivalent investments, which consist primarily of interest-bearing demand deposits, money market investments and money market mutual funds. Although Quanta does not currently believe the principal amount of these cash and cash equivalents is subject to any material risk of loss, changes in economic conditions could impact the interest income Quanta receives from these investments. In addition, Quanta grants credit under normal payment terms, generally without collateral, to its customers, which include electric power and energy companies, governmental entities, general contractors, and builders, owners and managers of commercial and industrial properties located primarily in the United States, Canada, Australia and Latin America. Consequently, Quanta is subject to potential credit risk related to changes in business and economic factors throughout these locations, which may be heightened as a result of uncertain economic and financial market conditions that have existed in recent years. However, Quanta generally has certain statutory lien rights with respect to services provided. Some of Quanta’s customers have experienced significant financial difficulties (including bankruptcy), and customers may experience financial difficulties in the future. These difficulties expose Quanta to increased risk related to collectability of billed and unbilled receivables and contract assets for services Quanta has performed.
On January 29, 2019, one of Quanta’s largest customers, PG&E, filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code, as amended. Quanta is monitoring the bankruptcy proceeding and evaluating the treatment of, and potential claims related to, its pre-petition receivables. As of the bankruptcy filing date, Quanta had approximately $157 million of billed and unbilled receivables, which remained unpaid as of March 31, 2019. Subsequent to March 31, 2019, the bankruptcy court approved the assumption by PG&E of two substantial contracts with a subsidiary of Quanta, which authorizes PG&E to pay approximately $116 million of pre-petition receivables due under those contracts. As a result of the contract assumptions, Quanta expects to receive payment of the $116 million in the near term. Quanta also believes it will ultimately collect the remaining approximately $41 million of pre-petition receivables, and that amount has been classified as non-current within “Other assets, net” in the accompanying condensed consolidated balance sheet as of March 31, 2019. However, the ultimate outcome of the bankruptcy proceeding is uncertain, and Quanta’s belief regarding collection of the remaining receivables is based on a number of assumptions that are potentially subject to change as the proceeding progresses. Should any of those assumptions change, the amount collected could be materially less than the amount of the remaining receivables. Additionally, Quanta is continuing to perform services for PG&E while the bankruptcy case is ongoing and believes that amounts billed for post-petition services will continue to be collected in the ordinary course of business.
At March 31, 2019 and December 31, 2018, no customer represented 10% or more of Quanta’s consolidated net receivable position. No customer represented 10% or more of Quanta’s consolidated revenues for the three months ended March 31, 2019 and March 31, 2018.
Insurance
As discussed in Note 2, Quanta is insured for employer’s liability, workers’ compensation, auto liability, general liability and group health claims. As of March 31, 2019 and December 31, 2018, the gross amount accrued for insurance claims totaled $268.7 million and $272.9 million, with $200.8 million and $210.1 million considered to be long-term and included in “Insurance and other non-current liabilities.” Related insurance recoveries/receivables as of March 31, 2019 and December 31, 2018 were $35.8 million and $56.5 million, of which $0.4 million and $0.3 million were included in “Prepaid expenses and other current assets” and $35.4 million and $56.2 million were included in “Other assets, net.”
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Project Insurance Claim. In June 2018, while performing a horizontal directional drill and installing an underground gas pipeline, one of Quanta’s subsidiaries experienced a partial collapse of a borehole. Subsequent to the incident, Quanta has been working with its customer to mitigate the impact of the incident and to complete the project; however, Quanta has encountered additional challenges due to the collapsed borehole. As required by the contract, the customer procured certain insurance coverage for the project, with the Quanta subsidiary as an additional insured. Quanta believes the incident is covered under such insurance and is working collaboratively with the customer to pursue insurance claims with the customer’s insurance carriers. To the extent such claims are not successful, Quanta would expect to pursue contractual relief from the customer.
As of March 31, 2019, Quanta had recorded an insurance receivable of $45.8 million in accordance with GAAP related to accounting for insurance claims and potential recoveries. The amount represents a portion of the insurance claims being pursued as of such date. Quanta expects the insurance claims and the amount of the insurance receivable to increase in future periods as mitigation activities continue. The mitigation plan remains subject to inherent risks associated with underground pipeline installation, which could cause the costs to mitigate the incident to increase materially. The project is ongoing and the final amount of the insurance claims is not currently known. However, Quanta’s claims associated with the project, including both insurance claims and potential contractual claims, will be substantially in excess of the currently recognized receivable. To the extent Quanta is unsuccessful in realizing insurance or contractual recoveries, additional charges to operating results, which could be material, would be required.
Letters of Credit
Certain of Quanta’s vendors require letters of credit to ensure reimbursement for amounts they are disbursing on Quanta’s behalf, such as to beneficiaries under its insurance programs. In addition, from time to time, certain customers require Quanta to post letters of credit to ensure payment of subcontractors and vendors and guarantee performance under contracts. Such letters of credit are generally issued by a bank or similar financial institution, typically pursuant to Quanta’s senior secured credit facility. Each letter of credit commits the issuer to pay specified amounts to the holder of the letter of credit if the holder claims that Quanta has failed to perform specified actions. If this were to occur, Quanta would be required to reimburse the issuer of the letter of credit. Depending on the circumstances of such a reimbursement, Quanta may also be required to record a charge to earnings for the reimbursement. Quanta does not believe it is likely that any material claims will be made under a letter of credit in the foreseeable future.
As of March 31, 2019, Quanta had $385.0 million in outstanding letters of credit and bank guarantees under its senior secured credit facility securing its casualty insurance program and various contractual commitments. These are irrevocable stand-by letters of credit with maturities generally expiring at various times throughout 2019 and 2020. Quanta expects to renew the majority of the letters of credit related to the casualty insurance program for subsequent one-year periods upon maturity.
Performance Bonds and Parent Guarantees
Many customers, particularly in connection with new construction, require Quanta to post performance and payment bonds issued by a financial institution known as a surety. These bonds provide a guarantee to the customer that Quanta will perform under the terms of a contract and pay its subcontractors and vendors. If Quanta fails to perform, the customer may demand that the surety make payments or provide services under the bond. Quanta must reimburse the surety for any expenses or outlays it incurs. Under Quanta’s underwriting, continuing indemnity and security agreement with its sureties and with the consent of the lenders that are party to Quanta’s credit agreement, Quanta has granted security interests in certain of our assets as collateral for its obligations to the sureties. Subject to certain conditions and consistent with terms of Quanta’s credit agreement, these security interests will be automatically released if Quanta maintains a credit rating that meets two of the following three conditions: (i) a corporate credit rating that is BBB- or higher by Standard & Poor’s Rating Services, (ii) a corporate family rating that is Baa3 or higher by Moody’s Investors Services, Inc. or (iii) a corporate credit rating that is BBB- or higher by Fitch Ratings, Inc. Quanta may be required to post letters of credit or other collateral in favor of the sureties or Quanta’s customers in the future, which would reduce the borrowing availability under its senior secured credit facility. Through March 31, 2019, Quanta had not been required to make any reimbursements to our sureties for bond-related costs. To the extent a reimbursement is required, the amount could be material. See Note 14 for additional information regarding an exercise of on-demand bonds by a customer subsequent to March 31, 2019.
These performance bonds expire at various times ranging from mechanical completion of the related projects to a period extending beyond contract completion in certain circumstances, and as such a determination of maximum potential amounts outstanding requires the use of certain estimates and assumptions. Such amounts can also fluctuate from period to period based upon the mix and level of Quanta’s bonded operating activity. As of March 31, 2019, the total amount of the outstanding performance bonds was estimated to be approximately $2.5 billion. Quanta’s estimated maximum exposure as it relates to the value of the
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
performance bonds outstanding is lowered on each bonded project as the cost to complete is reduced, and each of its commitments under the performance bonds generally extinguishes concurrently with the expiration of its related contractual obligation. The estimated cost to complete these bonded projects was approximately $839 million as of March 31, 2019.
Additionally, from time to time, Quanta guarantees certain obligations and liabilities of its subsidiaries that may arise in connection with, among other things, contracts with customers, equipment lease obligations, joint venture arrangements and contractors’ licenses. These guarantees may cover all of the subsidiary’s unperformed, un-discharged and un-released obligations and liabilities under or in connection with the relevant agreement. For example, with respect to customer contracts, a guarantee may cover a variety of obligations and liabilities arising during the ordinary course of the subsidiary’s business or operations, including, among other things, warranty and breach of contract claims, third party and environmental liabilities arising from the subsidiary’s work and for which it is responsible, liquidated damages amounts, or indemnity claims. Quanta is not aware of any obligations or liabilities currently asserted under any of these guarantees that are material, individually or in the aggregate. However, to the extent a subsidiary incurs a material obligation or liability and Quanta has guaranteed the performance or payment of such liability, the recovery by a customer or other counterparty or a third party will not be limited to the assets of the subsidiary. As a result, responsibility under the guarantee could exceed the amount recoverable from the subsidiary alone and could materially and adversely affect Quanta’s consolidated business, financial condition, results of operations and cash flows.
Employment Agreements
Quanta has various employment agreements with certain executives and other employees, which provide for compensation, other benefits and, under certain circumstances, severance payments and post-termination equity-related benefits. Certain employment agreements also contain clauses that become effective upon a change in control of Quanta, and Quanta may be obligated to pay certain amounts to such employees upon the occurrence of any of the defined change in control events.
Collective Bargaining Agreements
Some of Quanta’s operating units are parties to various collective bargaining agreements with unions that represent certain of their employees. The collective bargaining agreements expire at various times and have typically been renegotiated and renewed on terms similar to those in the expiring agreements. From time to time, Quanta is a party to grievance actions based on claims arising out of the collective bargaining agreements. The agreements require the operating units to pay specified wages, provide certain benefits to their union employees and contribute certain amounts to multiemployer pension plans and employee benefit trusts. Quanta’s multiemployer pension plan contribution rates generally are specified in the collective bargaining agreements (usually on an annual basis), and contributions are made to the plans on a “pay-as-you-go” basis based on its union employee payrolls. The location and number of union employees that Quanta employs at any given time and the plans in which they may participate vary depending on the projects Quanta has ongoing at any time and the need for union resources in connection with those projects. Therefore, Quanta is unable to accurately predict its union employee payroll and the amount of the resulting multiemployer pension plan contribution obligations for future periods.
The Pension Protection Act of 2006 also added special funding and operational rules generally applicable to plan years beginning after 2007 for multiemployer plans that are classified as “endangered,” “seriously endangered” or “critical” status based on multiple factors (including, for example, the plan’s funded percentage, cash flow position and whether it is projected to experience a minimum funding deficiency). Plans in these classifications must adopt measures to improve their funded status through a funding improvement or rehabilitation plan, as applicable, which may require additional contributions from employers (which may take the form of a surcharge on benefit contributions) and/or modifications to retiree benefits. Certain plans to which Quanta contributes or may contribute in the future are in “endangered,” “seriously endangered” or “critical” status. The amount of additional funds, if any, that Quanta may be obligated to contribute to these plans in the future cannot be reasonably estimated due to uncertainty of the future levels of work that require the specific use of union employees covered by these plans, as well as the future contribution levels and possible surcharges on contributions applicable to these plans.
Quanta may be subject to additional liabilities imposed by law as a result of its participation in multiemployer defined benefit pension plans. For example, the Employee Retirement Income Security Act of 1974, as amended by the Multiemployer Pension Plan Amendments Act of 1980, imposes certain liabilities upon an employer who is a contributor to a multiemployer pension plan if the employer withdraws from the plan or the plan is terminated or experiences a mass withdrawal. These liabilities include an allocable share of the unfunded vested benefits in the plan for all plan participants, not merely the benefits payable to a contributing employer’s own retirees. As a result, participating employers may bear a higher proportion of liability for unfunded vested benefits if other participating employers cease to contribute or withdraw, with the reallocation of liability being more acute in cases when a withdrawn employer is insolvent or otherwise fails to pay its withdrawal liability. Quanta is not aware of any material amounts of withdrawal liability that have been incurred or asserted and that remain outstanding as a result of a withdrawal by Quanta from
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
a multiemployer defined benefit pension plan.
Indemnities
Quanta generally indemnifies its customers for the services it provides under its contracts, as well as other specified liabilities, which may subject Quanta to indemnity claims and liabilities and related litigation. Additionally, in connection with certain acquisitions and dispositions, Quanta has indemnified various parties against specified liabilities that those parties might incur in the future. The indemnities under acquisition or disposition agreements are usually contingent upon the other party incurring liabilities that reach specified thresholds. As of March 31, 2019, except as otherwise set forth above in Legal Proceedings, Quanta does not believe any material liabilities for claims exist against it in connection with any of these indemnity obligations.
In the normal course of Quanta’s acquisition transactions, Quanta obtains rights to indemnification from the sellers or former owners of acquired businesses for certain risks, liabilities and obligations arising from their prior operations, such as performance, operational, safety, workforce or tax issues, some of which Quanta may not have discovered during due diligence. However, the indemnities may not cover all of Quanta’s exposure for such pre-acquisition matters, and the indemnitors may be unwilling or unable to pay the amounts owed to Quanta. Accordingly, Quanta may incur expenses for which it is not reimbursed. Quanta is currently in the process of negotiating certain pre-acquisition obligations associated with non-U.S. payroll taxes that may be due from a business acquired by Quanta in 2013. As of March 31, 2019, Quanta had recorded $7.4 million as its estimate of the pre-acquisition tax obligations and a corresponding indemnification asset, as management expects to recover from the indemnity counterparties any amounts that Quanta may be required to pay in connection with any such obligations.
12. SEGMENT INFORMATION:
Quanta presents its operations under two reportable segments: (1) Electric Power Infrastructure Services and (2) Pipeline and Industrial Infrastructure Services. This structure is generally based on the broad end-user markets for Quanta’s services. See Note 1 for additional information regarding Quanta’s reportable segments.
Quanta’s segment results are derived from the types of services provided across its operating units in each of its end user markets. Quanta’s entrepreneurial business model allows each of its operating units to serve the same or similar customers and to provide a range of services across end user markets. Quanta’s operating units are organized into one of two internal divisions, namely, the Electric Power Infrastructure Services Division and the Pipeline and Industrial Infrastructure Services Division. These internal divisions are closely aligned with the reportable segments and are based on their operating units’ predominant type of work.
Reportable segment information, including revenues and operating income by type of work, is gathered from each operating unit for the purpose of evaluating segment performance in support of Quanta’s market strategies. These classifications of Quanta’s operating unit revenues by type of work for segment reporting purposes can at times require judgment on the part of management. Quanta’s operating units may perform joint projects for customers in multiple industries, deliver multiple types of services under a single customer contract or provide service offerings to various industries. For example, Quanta performs joint trenching projects to install distribution lines for electric power and natural gas customers.
In addition, Quanta’s integrated operations and common administrative support for its operating units require that certain allocations be made to determine segment profitability, including allocations of shared and indirect costs (e.g., facility costs), indirect operating expenses (e.g., depreciation), and general and administrative costs. Certain corporate costs are not allocated and include payroll and benefits, employee travel expenses, facility costs, professional fees, acquisition costs and amortization related to intangible assets.
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Summarized financial information for Quanta’s reportable segments is presented in the following table (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2019
|
|
2018
|
|
Revenues:
|
|
|
|
|
|
|
|
Electric Power Infrastructure Services
|
|
$
|
1,664,023
|
|
|
$
|
1,568,507
|
|
|
Pipeline and Industrial Infrastructure Services
|
|
1,143,236
|
|
|
849,069
|
|
|
Consolidated revenues
|
|
$
|
2,807,259
|
|
|
$
|
2,417,576
|
|
|
Operating income (loss):
|
|
|
|
|
|
|
|
Electric Power Infrastructure Services
|
|
$
|
161,617
|
|
|
$
|
140,895
|
|
|
Pipeline and Industrial Infrastructure Services
|
|
40,699
|
|
|
10,057
|
|
|
Corporate and non-allocated costs
|
|
(82,829
|
)
|
|
(75,731
|
)
|
|
Consolidated operating income
|
|
$
|
119,487
|
|
|
$
|
75,221
|
|
|
Depreciation:
|
|
|
|
|
|
|
|
Electric Power Infrastructure Services
|
|
$
|
25,251
|
|
|
$
|
24,270
|
|
|
Pipeline and Industrial Infrastructure Services
|
|
22,555
|
|
|
20,695
|
|
|
Corporate and non-allocated costs
|
|
4,410
|
|
|
3,754
|
|
|
Consolidated depreciation
|
|
$
|
52,216
|
|
|
$
|
48,719
|
|
Separate measures of Quanta’s assets and cash flows by reportable segment, including capital expenditures, are not produced or utilized by management to evaluate segment performance. Quanta’s fixed assets, which are held at the operating unit level, include operating machinery, equipment and vehicles, as well as office equipment, buildings and leasehold improvements, and are used on an interchangeable basis across its reportable segments. As such, for reporting purposes, total depreciation expense is allocated each quarter among Quanta’s reportable segments based on the ratio of each reportable segment’s revenue contribution to consolidated revenues.
Foreign Operations
During the three months ended March 31, 2019 and 2018, Quanta derived $606.6 million and $705.1 million of its revenues from foreign operations. Of Quanta’s foreign revenues, 80% and 76% were earned in Canada during the three months ended March 31, 2019 and 2018. In addition, Quanta held property and equipment of $310.0 million and $304.0 million in foreign countries, primarily Canada, as of March 31, 2019 and December 31, 2018.
13. SUPPLEMENTAL CASH FLOW INFORMATION:
The net effects of changes in operating assets and liabilities, net of non-cash transactions, on cash flows from operating activities are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2019
|
|
2018
|
|
Accounts and notes receivable
|
|
$
|
(159,469
|
)
|
|
$
|
(131,712
|
)
|
|
Contract assets
|
|
5,267
|
|
|
(6,184
|
)
|
|
Inventories
|
|
28,996
|
|
|
(13,682
|
)
|
|
Prepaid expenses and other current assets
|
|
(29,339
|
)
|
|
(18,742
|
)
|
|
Accounts payable and accrued expenses and other non-current liabilities
|
|
(66,678
|
)
|
|
(27,211
|
)
|
|
Contract liabilities
|
|
(23,380
|
)
|
|
77,274
|
|
|
Other, net
|
|
(5,553
|
)
|
|
2,663
|
|
|
Net change in operating assets and liabilities, net of non-cash transactions
|
|
$
|
(250,156
|
)
|
|
$
|
(117,594
|
)
|
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
A reconciliation of cash, cash equivalents, and restricted cash reported within the condensed consolidated balance sheets that sum to the total of such amounts shown in the statements of cash flows are as follows (in thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
|
2019
|
|
2018
|
|
Cash and cash equivalents
|
|
$
|
85,423
|
|
|
$
|
101,736
|
|
|
Restricted cash included in “Prepaid expenses and other current assets”
|
|
3,038
|
|
|
3,160
|
|
|
Restricted cash included in “Other assets, net”
|
|
1,031
|
|
|
384
|
|
|
Total cash, cash equivalents, and restricted cash reported in the statements of cash flows
|
|
$
|
89,492
|
|
|
$
|
105,280
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2018
|
|
2017
|
|
Cash and cash equivalents
|
|
$
|
78,687
|
|
|
$
|
138,285
|
|
|
Restricted cash included in “Prepaid expenses and other current assets”
|
|
3,286
|
|
|
5,106
|
|
|
Restricted cash included in “Other assets, net”
|
|
1,283
|
|
|
384
|
|
|
Total cash, cash equivalents, and restricted cash reported in the statements of cash flows
|
|
$
|
83,256
|
|
|
$
|
143,775
|
|
Restricted cash includes any cash that is legally restricted as to withdrawal or usage.
Supplemental cash flow information related to leases was as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31, 2019
|
|
Cash paid for amounts included in the measurement of lease liabilities:
|
|
|
|
Operating cash flows from operating leases
|
|
$
|
(29,447
|
)
|
|
Operating cash flows from finance leases
|
|
$
|
(21
|
)
|
|
Financing cash flows from finance leases
|
|
$
|
(630
|
)
|
|
Lease assets obtained in exchange for lease liabilities:
|
|
|
|
Operating leases
|
|
$
|
15,939
|
|
|
Finance leases
|
|
$
|
401
|
|
Additional supplemental cash flow information is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2019
|
|
2018
|
|
Cash (paid) received during the period for —
|
|
|
|
|
|
Interest paid
|
|
$
|
(13,432
|
)
|
|
$
|
(5,960
|
)
|
|
Income taxes paid
|
|
$
|
(8,193
|
)
|
|
$
|
(17,957
|
)
|
|
Income tax refunds
|
|
$
|
1,278
|
|
|
$
|
1,018
|
|
14. SUBSEQUENT EVENT:
A subsidiary of Quanta is a party to two concession agreements for the construction and operation of telecommunication networks in rural regions of Peru. Aggregate consideration for the projects is approximately $260 million, of which $182 million has been allocated to the construction portion of the projects. During the construction phase, the projects have experienced challenges primarily related to items outside of the Quanta subsidiary’s control, including significant weather events, local opposition in certain areas to the projects, permitting delays, and the inability to acquire clear title to certain required parcels of land. The Quanta subsidiary had been working collaboratively with Peru’s FITEL (Fondo de Inversion en Telecomunicaciones / Telecommunications Investment Fund) throughout the construction phase of the projects in addressing the challenges and received extensions to contractual deadlines. Subsequent to March 31, 2019, PRONATEL (FITEL’s successor - Programa Nacional de Telecomunicaciones/National Program for Telecommunications) issued to Quanta’s subsidiary a notice of contract termination for
QUANTA SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
cause based on the schedule delays and on April 30, 2019 presented a call to exercise on-demand bonds against Quanta in the amount of $25 million. Additionally, the concession agreements provide for liquidated damages in the event of default. Quanta believes it has contractual relief for much of the schedule delays and disputes the termination for cause and the exercise of the on-demand bonds.
As of March 31, 2019, the construction phase of the projects was approximately 85% complete and is expected to be completed in either the fourth quarter of 2019 or the first quarter of 2020. As of March 31, 2019, Quanta’s net receivable position on the projects was $54.9 million. Although Quanta expects to seek resolution of the disputes with PRONATEL through arbitration, there can be no assurance Quanta will prevail. If Quanta is not successful, this matter could result in a significant loss that could have a material adverse effect on Quanta’s consolidated results of operations and cash flows. Based on information currently available, Quanta is not able to estimate the range of reasonably possible or probable loss, if any, and accordingly has not accrued for any such loss as of March 31, 2019.