UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form
(Mark One) | |
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to |
Commission file number:
(Exact name of registrant as specified in its charter)
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Registrant’s telephone number, including area code: (
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Accelerated filer ◻ | Non-accelerated filer ◻ | Smaller reporting company | Emerging growth company | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes
The number of shares outstanding of the issuer’s common stock as of October 20, 2023 was
COMFORT SYSTEMS USA, INC.
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2023
PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
COMFORT SYSTEMS USA, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Amounts)
September 30, | December 31, | ||||||
| 2023 |
| 2022 |
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(Unaudited) | |||||||
ASSETS | |||||||
CURRENT ASSETS: | |||||||
Cash and cash equivalents | $ | | $ | | |||
Billed accounts receivable, less allowance for credit losses of $ |
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Unbilled accounts receivable, less allowance for credit losses of $ |
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Other receivables, less allowance for credit losses of $ |
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Inventories |
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Prepaid expenses and other |
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Costs and estimated earnings in excess of billings, less allowance for credit losses of $ |
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Total current assets |
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PROPERTY AND EQUIPMENT, NET |
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LEASE RIGHT-OF-USE ASSET | | | |||||
GOODWILL |
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IDENTIFIABLE INTANGIBLE ASSETS, NET |
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DEFERRED TAX ASSETS | | | |||||
OTHER NONCURRENT ASSETS |
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Total assets | $ | | $ | | |||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
CURRENT LIABILITIES: | |||||||
Current maturities of long-term debt | $ | | $ | | |||
Accounts payable | | | |||||
Accrued compensation and benefits |
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Billings in excess of costs and estimated earnings and deferred revenue |
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Accrued self-insurance |
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Other current liabilities |
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Total current liabilities |
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LONG-TERM DEBT |
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LEASE LIABILITIES | |
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DEFERRED TAX LIABILITIES |
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OTHER LONG-TERM LIABILITIES |
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Total liabilities |
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COMMITMENTS AND CONTINGENCIES | |||||||
STOCKHOLDERS’ EQUITY: | |||||||
Preferred stock, $ |
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Common stock, $ |
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Treasury stock, at cost, |
| ( |
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Additional paid-in capital |
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Retained earnings |
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Total stockholders’ equity |
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Total liabilities and stockholders’ equity | $ | | $ | |
The accompanying notes are an integral part of these consolidated financial statements.
2
COMFORT SYSTEMS USA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Data)
(Unaudited)
| Three Months Ended | Nine Months Ended | |||||||||||
September 30, | September 30, | ||||||||||||
| 2023 |
| 2022 |
| 2023 |
| 2022 |
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REVENUE | $ | | $ | | $ | | $ | | |||||
COST OF SERVICES |
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Gross profit |
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SELLING, GENERAL AND ADMINISTRATIVE EXPENSES |
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GAIN ON SALE OF ASSETS |
| ( |
| ( |
| ( |
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Operating income |
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OTHER INCOME (EXPENSE): | |||||||||||||
Interest income |
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Interest expense |
| ( |
| ( |
| ( |
| ( | |||||
Changes in the fair value of contingent earn-out obligations |
| ( |
| ( |
| ( |
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Other |
| ( |
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Other income (expense) |
| ( |
| ( |
| ( |
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INCOME BEFORE INCOME TAXES |
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PROVISION (BENEFIT) FOR INCOME TAXES |
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| ( | |||||
NET INCOME | $ | | $ | | $ | | $ | | |||||
INCOME PER SHARE: | |||||||||||||
Basic | $ | | $ | | $ | | $ | | |||||
Diluted | $ | | $ | | $ | | $ | | |||||
SHARES USED IN COMPUTING INCOME PER SHARE: | |||||||||||||
Basic |
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Diluted |
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The accompanying notes are an integral part of these consolidated financial statements.
3
COMFORT SYSTEMS USA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In Thousands, Except Share Amounts)
(Unaudited)
Nine Months Ended | ||||||||||||||||||||
September 30, 2022 | ||||||||||||||||||||
Additional | Total |
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| Common Stock |
| Treasury Stock |
| Paid-In | Retained |
| Stockholders’ |
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| Shares |
| Amount |
| Shares |
| Amount |
| Capital |
| Earnings |
| Equity |
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BALANCE AT DECEMBER 31, 2021 |
| | $ | |
| ( | $ | ( | $ | | $ | |
| $ | | |||||
Net income |
| — | — | — | — | — | |
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Issuance of Stock: | ||||||||||||||||||||
Issuance of shares for options exercised |
| — | — | — | — | — | — |
| — | |||||||||||
Issuance of restricted stock & performance stock |
| — | — | | | | — |
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Shares received in lieu of tax withholding on vested stock |
| — | — | ( | ( | — | — |
| ( | |||||||||||
Stock-based compensation |
| — | — | — | — | | — |
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Dividends ($ |
| — | — | — | — | — | ( |
| ( | |||||||||||
Share repurchase |
| — | — | ( | ( | — | — |
| ( | |||||||||||
BALANCE AT MARCH 31, 2022 | | | ( | ( | | | | |||||||||||||
Net income |
| — | — | — | — | — | |
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Issuance of Stock: | ||||||||||||||||||||
Issuance of shares for options exercised |
| — | — | — | — | — | — |
| — | |||||||||||
Issuance of restricted stock & performance stock |
| — | — | | | ( | — |
| — | |||||||||||
Shares received in lieu of tax withholding on vested stock |
| — | — | ( | ( | — | — |
| ( | |||||||||||
Stock-based compensation |
| — | — | — | — | | — |
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Dividends ($ |
| — | — | — | — | — | ( |
| ( | |||||||||||
Share repurchase |
| — | — | ( | ( | — | — |
| ( | |||||||||||
BALANCE AT JUNE 30, 2022 | | | ( | ( | | | | |||||||||||||
Net income |
| — | — | — | — | — | |
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Issuance of Stock: | ||||||||||||||||||||
Issuance of shares for options exercised |
| — | — | | | ( | — |
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Issuance of restricted stock & performance stock |
| — | — | — | — | — | — |
| — | |||||||||||
Shares received in lieu of tax withholding on vested stock |
| — | — | — | — | — | — |
| — | |||||||||||
Stock-based compensation |
| — | — | — | — | | — |
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Dividends ($ |
| — | — | — | — | — | ( |
| ( | |||||||||||
Share repurchase |
| — | — | ( | ( | — | — |
| ( | |||||||||||
BALANCE AT SEPTEMBER 30, 2022 | | $ | | ( | $ | ( | $ | | $ | | $ | |
4
COMFORT SYSTEMS USA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In Thousands, Except Share Amounts)
(Unaudited)
Nine Months Ended | ||||||||||||||||||||
September 30, 2023 | ||||||||||||||||||||
Additional | Total | |||||||||||||||||||
| Common Stock |
| Treasury Stock |
| Paid-In | Retained |
| Stockholders’ |
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| Shares |
| Amount |
| Shares |
| Amount |
| Capital |
| Earnings |
| Equity |
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BALANCE AT DECEMBER 31, 2022 |
| | $ | | ( | $ | ( | $ | | $ | | $ | | |||||||
Net income |
| — | — | — | — | — | |
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Issuance of Stock: | ||||||||||||||||||||
Issuance of shares for options exercised |
| — | — | | | ( | — |
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Issuance of restricted stock & performance stock |
| — | — | | | | — |
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Shares received in lieu of tax withholding on vested stock |
| — | — | ( | ( | — | — |
| ( | |||||||||||
Stock-based compensation |
| — | — | — | — | | — |
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Dividends ($ |
| — | — | — | — | — | ( |
| ( | |||||||||||
Share repurchase |
| — | — | ( | ( | — | — |
| ( | |||||||||||
BALANCE AT MARCH 31, 2023 |
| | |
| ( | ( | | | | |||||||||||
Net income | — | — | — | — | — | | | |||||||||||||
Issuance of Stock: | ||||||||||||||||||||
Issuance of shares for options exercised | — | — | — | — | — | — | — | |||||||||||||
Issuance of restricted stock & performance stock | — | — | | | ( | — | — | |||||||||||||
Shares received in lieu of tax withholding on vested stock | — | — | ( | ( | — | — | ( | |||||||||||||
Stock-based compensation | — | — | — | — | | — | | |||||||||||||
Dividends ($ | — | — | — | — | — | ( | ( | |||||||||||||
Share repurchase | — | — | ( | ( | — | — | ( | |||||||||||||
BALANCE AT JUNE 30, 2023 | | | ( | ( | | | | |||||||||||||
Net income |
| — | — | — | — | — | |
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Issuance of Stock: | ||||||||||||||||||||
Issuance of shares for options exercised |
| — | — | — | — | — | — |
| — | |||||||||||
Issuance of restricted stock & performance stock |
| — | — | | | ( | — |
| — | |||||||||||
Shares received in lieu of tax withholding on vested stock |
| — | — | ( | ( | — | — |
| ( | |||||||||||
Stock-based compensation |
| — | — | — | — | | — |
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Dividends ($ |
| — | — | — | — | — | ( |
| ( | |||||||||||
Share repurchase |
| — | — | ( | ( | — | — |
| ( | |||||||||||
BALANCE AT SEPTEMBER 30, 2023 | | $ | | ( | $ | ( | $ | | $ | | $ | |
The accompanying notes are an integral part of these consolidated financial statements.
5
COMFORT SYSTEMS USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
Nine Months Ended | |||||||
September 30, | |||||||
| 2023 |
| 2022 |
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CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||
Net income | $ | | $ | | |||
Adjustments to reconcile net income to net cash provided by operating activities— | |||||||
Amortization of identifiable intangible assets |
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Depreciation expense |
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Change in right-of-use assets | | | |||||
Bad debt expense |
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Deferred tax provision |
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Amortization of debt financing costs |
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Gain on sale of assets |
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Changes in the fair value of contingent earn-out obligations |
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Stock-based compensation |
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Changes in operating assets and liabilities, net of effects of acquisitions and divestitures— | |||||||
(Increase) decrease in— | |||||||
Receivables, net |
| ( |
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Inventories |
| ( |
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Prepaid expenses and other current assets |
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Costs and estimated earnings in excess of billings and unbilled accounts receivable |
| ( |
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Other noncurrent assets |
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Increase (decrease) in— | |||||||
Accounts payable and accrued liabilities |
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Billings in excess of costs and estimated earnings and deferred revenue |
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Other long-term liabilities |
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Net cash provided by operating activities |
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CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||
Purchases of property and equipment |
| ( |
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Proceeds from sales of property and equipment |
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Cash paid for acquisitions, net of cash acquired |
| ( |
| ( | |||
Payments for investments | ( | ( | |||||
Net cash used in investing activities |
| ( |
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CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||
Proceeds from revolving credit facility |
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Payments on revolving credit facility |
| ( |
| ( | |||
Payments on term loan | — | ( | |||||
Payments on other debt |
| ( |
| ( | |||
Payments on finance lease liabilities | — | ( | |||||
Debt financing costs |
| — |
| ( | |||
Payments of dividends to stockholders |
| ( |
| ( | |||
Share repurchase |
| ( |
| ( | |||
Shares received in lieu of tax withholding |
| ( |
| ( | |||
Proceeds from exercise of options |
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Deferred acquisition payments | — | ( | |||||
Payments for contingent consideration arrangements |
| ( |
| ( | |||
Net cash used in financing activities |
| ( |
| ( | |||
NET INCREASE IN CASH AND CASH EQUIVALENTS |
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CASH AND CASH EQUIVALENTS, beginning of period |
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CASH AND CASH EQUIVALENTS, end of period | $ | | $ | |
The accompanying notes are an integral part of these consolidated financial statements.
6
COMFORT SYSTEMS USA, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2023
(Unaudited)
1. Business and Organization
Comfort Systems USA, Inc., a Delaware corporation, provides comprehensive mechanical and electrical contracting services, which principally includes heating, ventilation and air conditioning (“HVAC”), plumbing, electrical, piping and controls, as well as off-site construction, monitoring and fire protection. We build, install, maintain, repair and replace mechanical, electrical and plumbing (“MEP”) systems throughout the United States. The terms “Comfort Systems,” “we,” “us,” or the “Company,” refer to Comfort Systems USA, Inc. or Comfort Systems USA, Inc. and its consolidated subsidiaries, as appropriate in the context.
2. Summary of Significant Accounting Policies and Estimates
Basis of Presentation
These interim statements should be read in conjunction with the historical Consolidated Financial Statements and related notes of Comfort Systems included in the Annual Report on Form 10-K as filed with the Securities and Exchange Commission (“SEC”) for the year ended December 31, 2022 (the “Form 10-K”).
The accompanying unaudited consolidated financial statements were prepared using generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and applicable rules of Regulation S-X of the SEC. Accordingly, these financial statements do not include all the footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the Form 10-K. We believe all adjustments necessary for a fair presentation of these interim statements have been included and are of a normal and recurring nature. The results of operations for interim periods are not necessarily indicative of the results for the full fiscal year. Certain amounts in prior periods have been reclassified to conform to the current period presentation. The effects of the reclassifications were not material to the consolidated financial statements.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and assumptions by management in determining the reported amounts of assets and liabilities, revenue and expenses and disclosures regarding contingent assets and liabilities. Actual results could differ from those estimates. The most significant estimates used in our financial statements affect revenue and cost recognition for construction contracts, self-insurance accruals, accounting for income taxes, fair value accounting for acquisitions and the quantification of fair value for reporting units in connection with our goodwill impairment testing.
Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements
In October 2021, the FASB issued ASU 2021-08, “Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers.” This standard requires an acquirer to apply Accounting Standards Codification Topic 606 to recognize and measure contract assets and contract liabilities in a business combination. ASU 2021-08 is effective for fiscal years beginning after December 15, 2022 and interim periods within that year. We adopted this standard on January 1, 2023, and the impact on our consolidated financial statements was not material.
7
Revenue Recognition
We recognize revenue over time for all of our services as we perform them because (i) control continuously transfers to that customer as work progresses, and (ii) we have the right to bill the customer as costs are incurred. The customer typically controls the work in process, as evidenced either by contractual termination clauses or by our rights to payment for work performed to date, plus a reasonable profit, for delivery of products or services that do not have an alternative use to the Company.
For the reasons listed above, revenue is recognized based on the extent of progress towards completion of the performance obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. We generally use a cost-to-cost input method to measure our progress towards satisfaction of the performance obligation for our contracts, as it best depicts the transfer of assets to the customer that occurs as we incur costs on our contracts. Under the cost-to-cost input method, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenue, including estimated fees or profits, is recorded proportionally as costs are incurred. Costs to fulfill include labor, materials, subcontractors’ costs, other direct costs and an allocation of indirect costs.
For a small portion of our business in which our services are delivered in the form of service maintenance agreements for existing systems to be repaired and maintained, as opposed to constructed, our performance obligation is to maintain the customer’s mechanical system for a specific period of time. Similar to construction jobs, we recognize revenue over time; however, for service maintenance agreements in which the full cost to provide services may not be known, we generally use an input method to recognize revenue, which is based on the amount of time we have provided our services out of the total time we have been contracted to perform those services. Our revenue recognition policy is further discussed in Note 3 “Revenue from Contracts with Customers.”
Accounts Receivable and Allowance for Credit Losses
We are required to estimate and record the expected credit losses over the contractual life of our financial assets measured at amortized cost, including billed and unbilled accounts receivable, other receivables and contract assets. Accounts receivable include amounts from work completed in which we have billed or have an unconditional right to bill our customers. Our trade receivables are contractually due in less than a year.
We estimate our credit losses using a loss-rate method for each of our identified portfolio segments. Our portfolio segments are construction, service and other. While our construction and service financial assets are often with the same subset of customers and industries, our construction financial assets will generally have a lower loss-rate than service financial assets due to lien rights, which we are more likely to have on construction jobs. These lien rights result in lower credit loss expenses on average compared to receivables that do not have lien rights. Financial assets classified as Other include receivables that are not related to our core revenue producing activities, such as receivables related to our acquisition activity from former owners, our vendor rebate program or receivables for estimated losses in excess of our insurance deductible, which are accrued with a corresponding accrued insurance liability.
Loss rates for our portfolios are based on numerous factors, including our history of credit loss expense by portfolio, the financial strength of our customers and counterparties in each portfolio, the aging of our receivables, our expectation of likelihood of payment, macroeconomic trends in the U.S. and the current and forecasted nonresidential construction market trends in the U.S.
In addition to the loss-rate calculations discussed above, we also record allowance for credit losses for specific receivables that are deemed to have a higher risk profile than the rest of the respective pool of receivables (e.g., when we hold concerns about a specific customer going bankrupt and no longer being able to pay the receivables due to us).
Unbilled Accounts Receivable
Unbilled accounts receivable are amounts due to us that we have earned under a contract where our right to payment is unconditional. A right to consideration is unconditional if only the passage of time is required before payment of the consideration is due.
8
Income Taxes
We conduct business throughout the United States in virtually all fifty states. Our effective tax rate changes based upon our relative profitability, or lack thereof, in the federal and various state jurisdictions with differing tax rates and rules. In addition, discrete items such as tax law changes, judgments and legal structures, can impact our effective tax rate. These items can also include the tax treatment for impairment of goodwill and other intangible assets, changes in fair value of acquisition-related assets and liabilities, uncertain tax positions, and accounting for losses associated with underperforming operations.
Following an Internal Revenue Service (“IRS”) survey of previously filed refund claims for the 2016, 2017 and 2018 tax years, the Joint Committee on Taxation approved such refunds in late January 2022. As a result, our benefit for income taxes in the first quarter of 2022 included a $
Our benefit for income taxes in the first quarter of 2022 was further increased by $
The Inflation Reduction Act was enacted on August 16, 2022. This law, among other provisions, provides a corporate alternative minimum tax on adjusted financial statement income over $1 billion, which is effective for tax years beginning after December 31, 2022, and a 1% excise tax on net corporate stock repurchases after December 31, 2022. The impact of the excise tax is recorded in “Treasury Stock” within our Consolidated Balance Sheet. These provisions were not material to our current year overall financial results, financial position and cash flows.
In early September 2023, the IRS issued interim guidance addressing, together with other topics, the treatment of research and experimental (“R&E”) expenditures for taxpayers using the percentage of completion method to account for taxable income from long-term contracts. We have chosen to rely on such guidance beginning with the 2022 tax year, and the resultant reduction in taxable revenue offsets the deferral of tax deductions for R&E expenditures pursuant to the Tax Cuts and Jobs Act (2017). We recently filed our 2022 federal return requesting a refund of our $
Financial Instruments
Our financial instruments consist of cash and cash equivalents, accounts receivable, other receivables, accounts payable and life insurance policies, for which we deem the carrying values approximate their fair value due to the short-term nature of these instruments, as well as notes to former owners and a revolving credit facility.
Investments
We have a $
3. Revenue from Contracts with Customers
Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. Sales-based taxes are excluded from revenue.
We provide mechanical and electrical contracting services. Our mechanical segment principally includes HVAC, plumbing, piping and controls, as well as off-site construction, monitoring and fire protection. Our electrical segment includes installation and servicing of electrical systems. We build, install, maintain, repair and replace products
9
and systems throughout the United States. All of our revenue is recognized over time as we deliver goods and services to our customers. Revenue can be earned based on an agreed-upon fixed price or based on actual costs incurred, marked up at an agreed-upon percentage.
We account for a contract when: (i) it has approval and commitment from both parties, (ii) the rights of the parties are identified, (iii) payment terms are identified, (iv) the contract has commercial substance, and (v) collectability of consideration is probable. We consider the start of a project to be when the above criteria have been met and we either have written authorization from the customer to proceed or an executed contract.
We generally do not incur significant incremental costs related to obtaining or fulfilling a contract prior to the start of a project. On rare occasions, when significant pre-contract costs are incurred, they are capitalized and amortized over the life of the contract using a cost-to-cost input method to measure progress towards contract completion. We do not currently have any capitalized obtainment or fulfillment costs in our Consolidated Balance Sheet and have not incurred any impairment loss on such costs in the current year.
Due to the nature of the work required to be performed on many of our performance obligations, the estimation of total revenue and cost at completion (the process described below in more detail) is complex, subject to many variables and requires significant judgment. The consideration to which we are entitled on our long-term contracts may include both fixed and variable amounts. Variable amounts can either increase or decrease the transaction price. A common example of variable amounts that can either increase or decrease contract value are pending change orders that represent contract modifications for which a change in scope has been authorized or acknowledged by our customer, but the final adjustment to contract price is yet to be negotiated. Other examples of positive variable revenue include amounts awarded upon achievement of certain performance metrics, program milestones or cost of completion date targets and can be based upon customer discretion. Variable amounts can result in a deduction from contract revenue if we fail to meet stated performance requirements, such as complying with the construction schedule.
We include estimated amounts of variable consideration in the contract price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Our estimates of variable consideration and determination of whether to include estimated amounts in the contract price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available to us. We reassess the amount of variable consideration each accounting period until the uncertainty associated with the variable consideration is resolved. Changes in the assessed amount of variable consideration are accounted for prospectively as a cumulative adjustment to revenue recognized in the current period.
Contracts are often modified to account for changes in contract specifications and requirements. We consider contract modifications to exist when the modification either creates new, or changes the existing, enforceable rights and obligations. Most of our contract modifications are for goods or services that are not distinct from the existing performance obligation(s). The effect of a contract modification on the transaction price, and our measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase or decrease) on a cumulative catch-up basis.
We have a Company-wide policy requiring periodic review of the Estimate at Completion in which management reviews the progress and execution of our performance obligations and estimated remaining obligations. As part of this process, management reviews information including, but not limited to, any outstanding key contract matters, progress towards completion and the related program schedule, identified risks and opportunities and the related changes in estimates of revenue and costs. The risks and opportunities include management's judgment about the ability and cost to achieve the schedule (e.g., the number and type of milestone events), technical requirements (e.g., a newly developed product versus a mature product) and other contract requirements. Management must make assumptions and estimates regarding labor productivity and availability, the complexity of the work to be performed, the availability of materials, the length of time to complete the performance obligation (e.g., to estimate increases in wages and prices for materials and related support cost allocations), execution by our subcontractors, the availability and timing of funding from our customer, and overhead cost rates, among other variables.
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Based on this analysis, any adjustments to revenue, cost of services, and the related impact to operating income are recognized as necessary in the quarter when they become known. These adjustments may result from positive program performance if we determine we will be successful in mitigating risks surrounding the technical, schedule and cost aspects of those performance obligations or realizing related opportunities and may result in an increase in operating income during the performance of individual performance obligations. Likewise, if we determine we will not be successful in mitigating these risks or realizing related opportunities, these adjustments may result in a decrease in operating income. Changes in estimates of revenue, cost of services and the related impact to operating income are recognized quarterly on a cumulative catch-up basis, meaning we recognize in the current period the cumulative effect of the changes on current and prior periods based on our progress towards complete satisfaction of a performance obligation. A significant change in one or more of these estimates could affect the profitability of one or more of our performance obligations. For projects in which estimates of total costs to be incurred on a performance obligation exceed total estimates of revenue to be earned, a provision for the entire loss on the performance obligation is recognized in the period the loss is determined.
In the first nine months of 2023 and 2022, net revenue recognized from our performance obligations partially satisfied in previous periods was not material.
Disaggregation of Revenue
Our consolidated 2023 revenue was derived from contracts to provide service activities in the mechanical and electrical segments we serve. Refer to Note 11 “Segment Information” for additional information on our reportable segments. We disaggregate our revenue from contracts with customers by activity, customer type and service provided, as we believe it best depicts how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors.
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
Revenue by Service Provided |
| 2023 |
| 2022 |
| 2023 |
| 2022 | ||||||||||||||||
Mechanical Segment | $ | |
| | % | $ | |
| | % | $ | |
| | % | $ | |
| | % | ||||
Electrical Segment | | | % | | | % | | | % | | | % | ||||||||||||
Total | $ | | | % | $ | | | % | $ | | | % | $ | | | % | ||||||||
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
Revenue by Type of Customer | 2023 | 2022 |
| 2023 | 2022 |
| ||||||||||||||||||
Manufacturing | $ | | | % | $ | | | % | $ | | | % | $ | | | % | ||||||||
Technology | | | % | | | % | | | % | | | % | ||||||||||||
Healthcare | | | % | | | % | | | % | | | % | ||||||||||||
Education | | | % | | | % | | | % | | | % | ||||||||||||
Office Buildings | | | % | | | % | | | % | | | % | ||||||||||||
Retail, Restaurants and Entertainment | | | % | | | % | | | % | | | % | ||||||||||||
Government | | | % | | | % | | | % | | | % | ||||||||||||
Multi-Family and Residential | | | % | | | % | | | % | | | % | ||||||||||||
Other | | | % | | | % | | | % | | | % | ||||||||||||
Total | $ | | | % | $ | | | % | $ | | | % | $ | | | % | ||||||||
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
Revenue by Activity Type | 2023 | 2022 |
| 2023 | 2022 |
| ||||||||||||||||||
New Construction | $ | | | % | $ | | | % | $ | | | % | $ | | | % | ||||||||
Existing Building Construction | | | % | | | % | | | % | | | % | ||||||||||||
Service Projects | | | % | | | % | | | % | | | % | ||||||||||||
Service Calls, Maintenance and Monitoring | | | % | | | % | | | % | | | % | ||||||||||||
Total | $ | | | % | $ | | | % | $ | | | % | $ | | | % |
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Contract Assets and Liabilities
Contract assets include unbilled amounts typically resulting from sales under long term contracts when the cost-to-cost method of revenue recognition is used, revenue recognized exceeds the amount billed to the customer and right to payment is conditional or subject to completing a milestone, such as a phase of the project. Contract assets are not considered to have a significant financing component, as they are intended to protect the customer in the event that we do not perform our obligations under the contract.
Contract liabilities consist of advance payments and billings in excess of revenue recognized. Advanced payments from customers related to work not yet started are classified as “Deferred Revenue.” Contract liabilities are not considered to have 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 are intended to protect us from the other party failing to meet its obligations under the contract. Our contract assets and liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period.
Contract assets and liabilities in the Consolidated Balance Sheet consisted of the following amounts as of September 30, 2023 and December 31, 2022 (in thousands):
September 30, 2023 | December 31, 2022 | ||||
Contract assets: | |||||
Costs and estimated earnings in excess of billings, less allowance for credit losses | $ | | $ | | |
Contract liabilities: | |||||
Billings in excess of costs and estimated earnings and deferred revenue | $ | | $ | |
In the first nine months of 2023 and 2022, we recognized revenue of $
We did
Remaining Performance Obligations
Remaining construction performance obligations represent the remaining transaction price of firm orders for which work has not been performed and exclude unexercised contract options. As of September 30, 2023, the aggregate amount of the transaction price allocated to remaining performance obligations was $
4. Fair Value Measurements
Interest Rate Risk Management and Derivative Instruments
In April 2020, we entered into interest rate swap agreements to reduce our exposure to variable interest rates on our revolving credit facility. The interest rate swap agreements terminated on September 30, 2022.
At times, we use derivative instruments to manage exposure to market risk, including interest rate risk. Unsettled amounts under our interest rate swaps, if any, are recorded in the Consolidated Balance Sheet at fair value in “Other Receivables” or “Other Current Liabilities.” Gains and losses on our interest rate swaps are recorded in the Consolidated Statement of Operations in “Interest Expense.” For each period three and nine months ended September 30, 2022, we recognized a net gain of $
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Fair Value Measurement
We classify and disclose assets and liabilities carried at fair value in one of the following three categories:
● | Level 1—quoted prices in active markets for identical assets and liabilities; |
● | Level 2—observable market-based inputs or unobservable inputs that are corroborated by market data; and |
● | Level 3—significant unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. |
The following table summarizes the fair values, and levels within the fair value hierarchy in which the fair value measurements are included, for assets and liabilities measured on a recurring basis as of September 30, 2023 and December 31, 2022 (in thousands):
Fair Value Measurements at September 30, 2023 | ||||||||||||
| Level 1 |
| Level 2 |
| Level 3 |
| Total | |||||
Cash and cash equivalents | $ | | $ | — | $ | — | $ | | ||||
Life insurance—cash surrender value | $ | — | $ | | $ | — | $ | | ||||
Contingent earn-out obligations | $ | — | $ | — | $ | | $ | | ||||
Fair Value Measurements at December 31, 2022 | ||||||||||||
| Level 1 |
| Level 2 |
| Level 3 |
| Total | |||||
Cash and cash equivalents | $ | | $ | — | $ | — | $ | | ||||
Life insurance—cash surrender value | $ | — | $ | | $ | — | $ | | ||||
Contingent earn-out obligations | $ | — | $ | — | $ | | $ | |
Cash and cash equivalents consist primarily of highly rated money market funds at a variety of well-known institutions with original maturities of three months or less. The original cost of these assets approximates fair value due to their short-term maturity. We believe the carrying value of our debt associated with our revolving credit facility approximates its fair value due to the variable rate on such debt. We believe the carrying values of our notes to former owners approximate their fair values due to the relatively short remaining terms on these notes.
We have life insurance policies covering
We value contingent earn-out obligations using a probability weighted discounted cash flow method. This fair value measurement is based on significant unobservable inputs in the market and thus represents a Level 3 measurement within the fair value hierarchy. This analysis reflects the contractual terms of the purchase agreements (e.g., minimum and maximum payments, length of earn-out periods, manner of calculating any amounts due, etc.) and utilizes assumptions with regard to future cash flows and operating income, probabilities of achieving such future cash flows and operating income and a weighted average cost of capital. Significant changes in any of these assumptions could result in a significantly higher or lower potential liability. The contingent earn-out obligations are measured at fair value each reporting period, and changes in estimates of fair value are recognized in earnings. As of September 30, 2023, cash flows were discounted using a weighted average cost of capital ranging from
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The table below presents a reconciliation of the fair value of our contingent earn-out obligations that use significant unobservable inputs (Level 3) (in thousands):
| Nine Months Ended | Year Ended |
| |||||
| September 30, 2023 | December 31, 2022 |
| |||||
Balance at beginning of period |
| $ | |
| $ | |
|
|
Issuances |
| |
| — | ||||
Settlements | ( | ( | ||||||
Adjustments to fair value |
| |
| | ||||
Balance at end of period | $ | | $ | |
5. Acquisitions
On February 1, 2023, we acquired all of the issued and outstanding shares of capital stock of Eldeco, Inc. (“Eldeco”), headquartered in South Carolina, for a total preliminary purchase price of $
On April 1, 2022, we acquired Atlantic Electric, LLC and its related subsidiary (“Atlantic”), headquartered in Charleston, South Carolina, and with operations in South Carolina and Western North Carolina, for a total purchase price of $
The results of operations of acquisitions are included in our consolidated financial statements from their respective acquisition dates. Our Consolidated Balance Sheet includes preliminary allocations of the purchase price to the assets acquired and liabilities assumed for the applicable acquisitions pending the completion of the final valuation of intangible assets and accrued liabilities. The acquisitions completed in the current and prior year were not material, individually or in the aggregate. Additional contingent purchase price (“earn-out”) has been or will be paid if certain acquisitions achieve predetermined profitability targets. Such earn-outs, when they are not subject to the continued employment of the sellers, are estimated as of the purchase date and included as part of the consideration paid for the acquisition. If we have an earn-out under which continued employment is a condition to receipt of payment, then the earn-out is recorded as compensation expense over the period earned.
6. Goodwill and Identifiable Intangible Assets, Net
Goodwill
The changes in the carrying amount of goodwill are as follows (in thousands):
| Mechanical Segment |
| Electrical Segment | Total |
| |||||
Balance at December 31, 2021 | $ | | $ | | $ | | ||||
Acquisitions and purchase price adjustments (See Note 5) |
| | | | ||||||
Balance at December 31, 2022 | | | | |||||||
Acquisitions and purchase price adjustments (See Note 5) | — | | | |||||||
Balance at September 30, 2023 | $ | | $ | | $ | |
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Identifiable Intangible Assets, Net
At September 30, 2023, future amortization expense of identifiable intangible assets is as follows (in thousands):
Year ending December 31— |
|
| ||
2023 (remainder of the year) | $ | | ||
2024 |
| | ||
2025 |
| | ||
2026 |
| | ||
2027 | | |||
Thereafter |
| | ||
Total | $ | |
7. Debt Obligations
Debt obligations consist of the following (in thousands):
September 30, | December 31, | ||||||
| 2023 |
| 2022 |
| |||
Revolving credit facility | $ | — | $ | | |||
Notes to former owners | |
| | ||||
Other debt | | | |||||
Total debt | | | |||||
Less—current portion | ( |
| ( | ||||
Total long-term portion of debt | $ | | $ | |
Revolving Credit Facility
On May 25, 2022, we amended our senior credit facility (as amended, the “Facility”) arranged by Wells Fargo Bank, National Association, as administrative agent, and provided by a syndicate of banks, increasing our borrowing capacity to $
There are two interest rate options for borrowings under the Facility, the Base Rate Loan (as defined in the Facility) option and the Secured Overnight Financing Rate (“SOFR”) Loan option. These rates are floating rates determined by the broad financial markets, meaning they can and do move up and down from time to time. Additional margins are then added to these two rates:
Net Leverage Ratio | |||||||||||
| Less than |
| 1.00 to less than 1.75 |
| 1.75 to less than 2.50 |
| 2.50 to less than 3.00 |
| 3.00 or greater | ||
Additional Per Annum Interest Margin Added Under: | |||||||||||
Base Rate Loan Option | % | | % | | % | | % | | % | ||
SOFR Loan Option | | % | | % | | % | | % | | % |
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The weighted average interest rate applicable to the borrowings under the revolving credit facility was approximately
Certain of our vendors require letters of credit to ensure reimbursement for amounts they are disbursing on our behalf, such as to beneficiaries under our self-funded insurance programs. We have also occasionally used letters of credit to guarantee performance under our contracts and to ensure payment to our subcontractors and vendors under those contracts. Our lenders issue such letters of credit through the Facility. A letter of credit commits the lenders to pay specified amounts to the holder of the letter of credit if the holder demonstrates that we have failed to perform specified actions. If this were to occur, we would be required to reimburse the lenders for amounts they fund to honor the letter of credit holder’s claim. Absent a claim, there is no payment or reserving of funds by us in connection with a letter of credit. However, because a claim on a letter of credit would require immediate reimbursement by us to our lenders, letters of credit are treated as a use of Facility capacity. The letter of credit fees range from
Commitment fees are payable on the portion of the revolving loan capacity not in use for borrowings or letters of credit at any given time. These fees range from
The Facility contains financial covenants defining various financial measures and the levels of these measures with which we must comply. Covenant compliance is assessed as of each quarter end. We were in compliance with all of our financial covenants as of September 30, 2023.
Notes to Former Owners
As part of the consideration used to acquire
Balance at | Range of Stated | |||||
| September 30, 2023 | Interest Rates | ||||
2023 | $ | | % | |||
2024 |
| | | % | ||
2025 |
| | % | |||
2026 |
| | % | |||
Total | $ | |
F
8. Leases
We lease certain facilities, vehicles and equipment primarily under noncancelable operating leases. The most significant portion of these noncancelable operating leases is for the facilities occupied by our corporate office and our operating locations. Leases with an initial term of 12 months or less are not recorded in the Consolidated Balance Sheet. We do not separate lease components from their associated non-lease components pursuant to lease accounting guidance. We have certain leases with variable payments based on an index as well as some short-term leases on equipment and facilities. Variable lease expense and short-term lease expense aggregated to $
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million, respectively. Operating lease expense for the nine months ended September 30, 2023 and 2022 was $
The lease terms generally range from
A majority of the Company’s real property leases are with individuals or entities with whom we have no other business relationship. However, in certain instances the Company enters into real property leases with current or former employees. Rent paid to related parties for the three months ended September 30, 2023 and 2022 was approximately $
If we decide to cancel or terminate a lease before the end of its term, we would typically owe the lessor the remaining lease payments under the term of the lease. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. On rare occasions, we rent or sublease certain real estate assets that we no longer use to third parties.
The following table summarizes the operating lease assets and liabilities included in the Consolidated Balance Sheet as follows (in thousands):
September 30, 2023 | December 31, 2022 | ||||
Operating lease right-of-use assets | $ | | $ | | |
Operating lease liabilities: | |||||
$ | | $ | | ||
Long-term operating lease liabilities | | | |||
Total operating lease liabilities | $ | | $ | |
The maturities of operating lease liabilities are as follows (in thousands):
Year ending December 31— | |||
2023 (excluding the nine months ended September 30, 2023) | $ | | |
2024 | | ||
2025 | | ||
2026 | | ||
2027 | | ||
Thereafter | | ||
Total Lease Payments | | ||
Less—Present Value Discount | ( | ||
Present Value of Operating Lease Liabilities | $ | |
Supplemental information related to operating leases was as follows (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||
2023 | 2022 |
| 2023 | 2022 | |||||||
Cash paid for amounts included in the measurement of operating lease liabilities | $ | | $ | | $ | | $ | | |||
Operating lease right-of-use assets obtained in exchange for lease liabilities | $ | | $ | | $ | | $ | |
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9. Commitments and Contingencies
Claims and Lawsuits
We are subject to certain legal and regulatory claims, including lawsuits arising in the normal course of business. We maintain various insurance coverages to minimize financial risk associated with these claims. We have estimated and provided accruals for probable losses and related legal fees associated with certain litigation in the accompanying consolidated financial statements. While we cannot predict the outcome of these proceedings, in management’s opinion and based on reports of counsel, any liability arising from these matters individually and in the aggregate will not have a material effect on our operating results, cash flows or financial condition, after giving effect to provisions already recorded.
During the first quarter of 2023, we recorded a pre-tax gain of $
During the third quarter of 2022, we recorded a net gain of $
As of September 30, 2023, we recorded an accrual for unresolved matters, which is not material to our financial statements, based on our analysis of likely outcomes related to the respective matters; however, it is possible that the ultimate outcome and associated costs will deviate from our estimates and that, in the event of an unexpectedly adverse outcome, we may experience additional costs and expenses in future periods.
Surety
Many customers, particularly in connection with new construction, require us to post performance and payment bonds issued by a financial institution known as a surety. If we fail to perform under the terms of a contract or to pay subcontractors and vendors who provided goods or services under a contract, the customer may demand that the surety make payments or provide services under the bond. We must reimburse the surety for any expenses or outlays it incurs.
Current market conditions for surety markets and bonding capacity are adequate, with acceptable terms and conditions. Historically, approximately
Self-Insurance
We are substantially self-insured for workers’ compensation, employer’s liability, auto liability, general liability and employee group health claims, in view of the relatively high per-incident deductibles we absorb under our insurance arrangements for these risks. Losses are estimated and accrued based upon known facts, historical trends and industry
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averages. Estimated losses in excess of our deductible, which have not already been paid, are included in our accrual with a corresponding receivable from our insurance carrier. Loss estimates associated with the larger and longer-developing risks, such as workers’ compensation, auto liability and general liability, are reviewed by a third-party actuary quarterly.
10. Stockholders’ Equity
Earnings Per Share
Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Diluted EPS is computed considering the dilutive effect of stock options, restricted stock, restricted stock units and performance stock units. The vesting of unvested, contingently issuable performance stock units is based on the achievement of certain earnings per share targets and total shareholder return. These shares are considered contingently issuable shares for purposes of calculating diluted earnings per share. These shares are not included in the diluted earnings per share denominator until the performance criteria are met, if it is assumed that the end of the reporting period was the end of the contingency period.
Unvested restricted stock, restricted stock units and performance stock units are included in diluted earnings per share, weighted outstanding until the shares and units vest. Upon vesting, the vested restricted stock, restricted stock units and performance stock units are included in basic earnings per share weighted outstanding from the vesting date.
There were
The following table reconciles the number of shares outstanding with the number of shares used in computing basic and diluted earnings per share for each of the periods presented (in thousands):
Three Months Ended | Nine Months Ended | ||||||||
September 30, | September 30, | ||||||||
| 2023 |
| 2022 |
| 2023 |
| 2022 |
| |
Common shares outstanding, end of period | |
| | |
| | |||
Effect of using weighted average common shares outstanding | |
| | |
| | |||
Shares used in computing earnings per share—basic | |
| | |
| | |||
Effect of shares issuable under stock option plans based on the treasury stock method | |
| | |
| | |||
Effect of restricted and contingently issuable shares | |
| | |
| | |||
Shares used in computing earnings per share—diluted | |
| | |
| |
Share Repurchase Program
On March 29, 2007, our Board of Directors (the “Board”) approved a stock repurchase program to acquire up to
The share repurchases will be made from time to time at our discretion in the open market or privately negotiated transactions, as permitted by securities laws and other legal requirements, and subject to market conditions and other factors. The Board may modify, suspend, extend or terminate the program at any time. During the nine months ended September 30, 2023, we repurchased
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11. Segment Information
Our activities are within the mechanical services industry and the electrical services industry, which represent our
Three Months Ended September 30, 2023 | ||||||||||||
| Mechanical Segment |
| Electrical Segment |
| Corporate |
| Consolidated | |||||
Revenue | $ | | $ | | $ | — | $ | | ||||
Gross Profit | $ | | $ | | $ | — | $ | | ||||
Three Months Ended September 30, 2022 | ||||||||||||
| Mechanical Segment |
| Electrical Segment |
| Corporate |
| Consolidated | |||||
Revenue | $ | | $ | | $ | — | $ | | ||||
Gross Profit | $ | | $ | | $ | — | $ | | ||||
Nine Months Ended September 30, 2023 | ||||||||||||
| Mechanical Segment |
| Electrical Segment |
| Corporate |
| Consolidated | |||||
Revenue | $ | | $ | | $ | — | $ | | ||||
Gross Profit | $ | | $ | | $ | — | $ | | ||||
Nine Months Ended September 30, 2022 | ||||||||||||
| Mechanical Segment |
| Electrical Segment |
| Corporate |
| Consolidated | |||||
Revenue | $ | | $ | | $ | — | $ | | ||||
Gross Profit | $ | | $ | | $ | — | $ | |
The electrical segment included a benefit in the third quarter of 2022 related to favorable developments from a dispute with a customer. See Note 9 “Commitments and Contingencies” for further information.
12. Subsequent Event
On October 2, 2023, we acquired all of the issued and outstanding equity interests of DECCO, Inc. (“DECCO”). DECCO is headquartered in Nashua, New Hampshire, and performs mechanical and plumbing services with specialties in piping systems, steam, power, biotechnical processes and conveying systems, in addition to turnkey tool and equipment installation and critical equipment handling services and associated maintenance and support services, in the Northeastern United States. We expect DECCO to initially contribute annualized revenues of approximately $
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our historical Consolidated Financial Statements and related notes included elsewhere in this Form 10-Q and the Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2022 (the “Form 10-K”). This discussion contains “forward-looking statements” regarding our business and industry within the meaning of applicable securities laws and regulations. These statements are based on our current plans and expectations and involve risks and uncertainties that could cause our actual future activities and results of operations to be materially different from those set forth in the forward-looking statements. Important factors that could cause actual results to differ include risks set forth in “Item 1A. Risk Factors” included in our Form 10-K. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. The terms “Comfort Systems,” “we,” “us,” or the “Company,” refer to Comfort Systems USA, Inc. or Comfort Systems USA, Inc. and its consolidated subsidiaries, as appropriate in the context.
Introduction and Overview
We are a national provider of comprehensive mechanical and electrical installation, renovation, maintenance, repair and replacement services within the mechanical and electrical services industries. We operate primarily in the commercial, industrial and institutional markets and perform most of our work in manufacturing, healthcare, education, office, technology, retail and government facilities. We operate our business in two business segments: mechanical and electrical.
Nature and Economics of Our Business
In our mechanical business segment, customers hire us to ensure HVAC systems deliver specified or generally expected heating, cooling, conditioning and circulation of air in a facility. This entails installing core system equipment such as packaged heating and air conditioning units, or in the case of larger facilities, separate core components such as chillers, boilers, air handlers, and cooling towers. We also typically install connecting and distribution elements such as piping and ducting.
In our electrical business segment, our principal business activity is electrical construction and engineering in the commercial and industrial field. We also perform electrical logistics services, electrical service work, and electrical construction and engineering services.
In both our mechanical and electrical business segments, our responsibilities usually require conforming the systems to pre-established engineering drawings and equipment and performance specifications, which we frequently participate in establishing. Our project management responsibilities include staging equipment and materials to project sites, deploying labor to perform the work, and coordinating with other service providers on the project, including any subcontractors we might use to deliver our portion of the work.
Approximately 88.8% of our revenue is earned on a project basis for installation services in newly constructed facilities or for replacement of systems in existing facilities. When competing for project business, we usually estimate the costs we will incur on a project, and then propose a bid to the customer that includes a contract price and other performance and payment terms. Our bid price and terms are intended to cover our estimated costs on the project and provide a profit margin to us commensurate with the value of the installed system to the customer, the risk that project costs or duration will vary from estimate, the schedule on which we will be paid, the opportunities for other work that we might forego by committing capacity to this project, and other costs that we incur to support our operations but which are not specific to the project. Typically, customers will seek pricing from competitors for a given project. While the criteria on which customers select a provider vary widely and include factors such as quality, technical expertise, on-time performance, post-project support and service, and company history and financial strength, we believe that price for value is the most influential factor for most customers in choosing a mechanical or electrical installation and service provider.
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After a customer accepts our bid, we generally enter into a contract with the customer that specifies what we will deliver on the project, what our related responsibilities are and how much and when we will be paid. Our overall price for the project is typically set at a fixed amount in the contract, although changes in project specifications or work conditions that result in unexpected additional work are usually subject to additional payment from the customer via what are commonly known as change orders. Project contracts typically provide for periodic billings to the customer as we meet progress milestones or incur cost on the project. Project contracts in our industry also frequently allow for a small portion of progress billings or contract price to be withheld by the customer until after we have completed the work. Amounts withheld under this practice are known as retention or retainage.
Labor, materials and overhead costs account for the majority of our cost of service. Accordingly, labor management and utilization have the most impact on our project performance. Given the fixed price nature of much of our project work, if our initial estimate of project costs is wrong or we incur cost overruns that cannot be recovered in change orders, we can experience reduced profits or even significant losses on fixed price project work. We also perform some project work on a cost-plus or a time and materials basis, under which we are paid our costs incurred plus an agreed-upon profit margin, and such projects are sometimes subject to a guaranteed maximum cost. These margins are frequently less than fixed-price contract margins because there is less risk of unrecoverable cost overruns in cost-plus or time and materials work.
As of September 30, 2023, we had 10,412 projects in process. Our average project takes six to nine months to complete, with an average contract price of approximately $1.0 million. Our projects generally require working capital funding of equipment and labor costs. Customer payments on periodic billings generally do not recover these costs until late in the job. Our average project duration, together with typical retention terms as discussed above, generally allow us to complete the realization of revenue and earnings in cash within one year. We have what we consider to be a well-diversified distribution of revenue across end-use sectors that we believe reduces our exposure to negative developments in any given sector. Because of the integral nature of our services to most buildings, we have the legal right in almost all cases to attach liens to buildings or related funding sources when we have not been fully paid for installing systems, except with respect to some government buildings. The service work that we do, which is discussed further below, usually does not give rise to lien rights.
We also perform larger projects. Taken together, projects with contract prices of $2 million or more totaled $8.8 billion of aggregate contract value as of September 30, 2023, or approximately 84% of a total contract value for all projects in progress, totaling $10.5 billion. Generally, projects closer in size to $2 million will be completed in one year or less. It is unusual for us to work on a project that exceeds two years in length.
A stratification of projects in progress as of September 30, 2023, by contract price, is as follows:
|
| Aggregate |
| |||
Contract |
| |||||
No. of | Price Value |
| ||||
Contract Price of Project | Projects | (millions) |
| |||
Under $2 million |
| 9,514 | $ | 1,693.7 | ||
$2 million - $10 million |
| 674 |
| 2,973.9 | ||
$10 million - $20 million |
| 112 |
| 1,616.8 | ||
$20 million - $40 million |
| 83 |
| 2,337.8 | ||
Greater than $40 million |
| 29 |
| 1,847.3 | ||
Total |
| 10,412 | $ | 10,469.5 |
In addition to project work, approximately 11.2% of our revenue represents maintenance and repair service on already installed HVAC, electrical, and controls systems. This kind of work usually takes from a few hours to a few days to perform. Prices to the customer are based on the equipment and materials used in the service as well as technician labor time. We usually bill the customer for service work when it is complete, typically with payment terms of up to thirty days. We also provide maintenance and repair service under ongoing contracts. Under these contracts, we are paid regular monthly or quarterly amounts and provide specified service based on customer requirements. These agreements typically are for one or more years and frequently contain thirty- to sixty-day cancellation notice periods.
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A relatively small portion of our revenue comes from national and regional account customers. These customers typically have multiple sites and contract with us to perform maintenance and repair service. These contracts may also provide for us to perform new or replacement systems installation. We operate a national call center to dispatch technicians to sites requiring service. We perform the majority of this work with our own employees, with the balance being subcontracted to third parties that meet our performance qualifications.
Profile and Management of Our Operations
We manage our 43 operating units based on a variety of factors. Financial measures we emphasize include profitability and use of capital as indicated by cash flow and by other measures of working capital principally involving project cost, billings and receivables. We also monitor selling, general, administrative and indirect project support expense, backlog, workforce size and mix, growth in revenue and profits, variation of actual project cost from original estimate, and overall financial performance in comparison to budget and updated forecasts. Operational factors we emphasize include project selection, estimating, pricing, safety, management and execution practices, labor utilization, training, and the make-up of both existing backlog as well as new business being pursued, in terms of project size, technical application, facility type, end-use customers and industries and location of the work.
Most of our operations compete on a local or regional basis. Attracting and retaining effective operating unit managers is an important factor in our business, particularly in view of the relative uniqueness of each market and operation, the importance of relationships with customers and other market participants, such as architects and consulting engineers, and the high degree of competition and low barriers to entry in most of our markets. Accordingly, we devote considerable attention to operating unit management quality, stability, and contingency planning, including related considerations of compensation and non-competition protection where applicable.
Economic and Industry Factors
As a mechanical and electrical services provider, we operate in the broader nonresidential construction services industry and are affected by trends in this sector. While we do not have operations in all major cities of the United States, we believe our national presence is sufficiently large that we experience trends in demand for and pricing of our services that are consistent with trends in the national nonresidential construction sector. As a result, we monitor the views of major construction sector forecasters along with macroeconomic factors they believe drive the sector, including trends in gross domestic product, interest rates, business investment, employment, demographics and the fiscal condition of federal, state and local governments.
Spending decisions for building construction, renovation and system replacement are generally made on a project basis, usually with some degree of discretion as to when and if projects proceed. With larger amounts of capital, time, and discretion involved, spending decisions are affected to a significant degree by uncertainty, particularly concerns about economic and financial conditions and trends. We have experienced periods of time when economic weakness caused a significant slowdown in decisions to proceed with installation and replacement project work.
Operating Environment and Management Emphasis
In 2020, the advent of a global pandemic led to some delays in service and construction, including delayed project starts and air pockets or pauses during 2020 and 2021. We experienced strong demand in 2022 that has continued during the first nine months of 2023, and we expect that the demand environment, especially for industrial and technology customers, will remain at high levels in 2024. Although we have largely recovered from negative impacts caused by COVID-19, we continue to experience increased labor costs, supply constraints and cost increases, and delays in delivery of various materials and equipment. We expect that constraints and delays will continue to abate in 2024; however, we anticipate that pressure on cost and availability, especially for skilled labor, will continue for the remainder of this year and into 2024.
We have a credit facility in place with terms we believe are favorable that does not expire until July 2027. As of September 30, 2023, we had $780.0 million of credit available to borrow under our credit facility. We have strong surety relationships to support our bonding needs, and we believe our relationships with the surety markets are strong and benefit from our operating history and financial position. We have generated positive free cash flow in each of the last
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twenty-four calendar years and will continue our emphasis in this area. We believe that the relative size and strength of our Balance Sheet and surety relationships, as compared to most companies in our industry, represent competitive advantages for us.
As discussed at greater length in “Results of Operations” below, we expect price competition to continue as local and regional industry participants compete for customers. We will continue to invest in our service business, to pursue the more active sectors in our markets, and to emphasize our regional and national account business.
Cyclicality and Seasonality
The construction industry is subject to business cycle fluctuation. As a result, our volume of business, particularly in new construction projects and renovation, may be adversely affected by declines in new installation and replacement projects in various geographic regions of the United States during periods of economic weakness.
The mechanical and electrical contracting industries are also subject to seasonal variations. The demand for new installation and replacement is generally lower during the winter months (the first quarter of the year) due to reduced construction activity during inclement weather and less use of air conditioning during the colder months. Demand for our services is generally higher in the second and third calendar quarters due to increased construction activity and increased use of air conditioning during the warmer months. Accordingly, we expect our revenue and operating results generally will be lower in the first calendar quarter.
Critical Accounting Estimates
Management believes that there have been no significant changes during the three months ended September 30, 2023, to the items that we disclosed as our "Critical Accounting Estimates" in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. A summary of significant accounting policies and a summary of recent accounting pronouncements applicable to our Consolidated Financial Statements are included in Note 2 “Summary of Significant Accounting Policies and Estimates”.
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Results of Operations (dollars in thousands):
| Three Months Ended September 30, |
| Nine Months Ended September 30, | |||||||||||||||||||
| 2023 |
| 2022 |
| 2023 |
| 2022 |
| ||||||||||||||
Revenue | $ | 1,378,124 |
| 100.0 | % | $ | 1,120,012 |
| 100.0 | % | $ | 3,849,194 |
| 100.0 | % | $ | 3,023,176 |
| 100.0 | % | ||
Cost of services |
| 1,100,625 |
| 79.9 | % |
| 917,788 |
| 81.9 | % |
| 3,138,370 |
| 81.5 | % |
| 2,492,816 |
| 82.5 | % | ||
Gross profit |
| 277,499 |
| 20.1 | % |
| 202,224 |
| 18.1 | % |
| 710,824 |
| 18.5 | % |
| 530,360 |
| 17.5 | % | ||
Selling, general and administrative expenses |
| 142,935 |
| 10.4 | % |
| 121,194 |
| 10.8 | % |
| 414,397 |
| 10.8 | % |
| 357,694 |
| 11.8 | % | ||
Gain on sale of assets |
| (579) |
| — |
| (406) |
| — |
| (1,683) |
| — |
| (1,112) |
| — | ||||||
Operating income |
| 135,143 |
| 9.8 | % |
| 81,436 |
| 7.3 | % |
| 298,110 |
| 7.7 | % |
| 173,778 |
| 5.7 | % | ||
Interest income |
| 952 |
| 0.1 | % |
| 5 |
| — |
| 2,441 |
| 0.1 | % |
| 14 |
| — | ||||
Interest expense |
| (1,886) |
| (0.1) | % |
| (3,609) |
| (0.3) | % |
| (9,880) |
| (0.3) | % |
| (8,764) |
| (0.3) | % | ||
Changes in the fair value of contingent earn-out obligations |
| (8,727) |
| (0.6) | % |
| (3,443) |
| (0.3) | % |
| (14,207) |
| (0.4) | % |
| 530 |
| — | |||
Other income (expense) |
| (44) |
| — |
| 46 |
| — |
| 1 |
| — |
| 101 |
| — | ||||||
Income before income taxes |
| 125,438 |
| 9.1 | % |
| 74,435 |
| 6.6 | % |
| 276,465 |
| 7.2 | % |
| 165,659 |
| 5.5 | % | ||
Provision (benefit) for income taxes |
| 20,313 |
| 12,920 |
| 44,648 |
| (24,864) | ||||||||||||||
Net income | $ | 105,125 | 7.6 | % | $ | 61,515 | 5.5 | % | $ | 231,817 | 6.0 | % | $ | 190,523 | 6.3 | % |
We had 42 operating locations as of December 31, 2022. In the first quarter of 2023, we completed the acquisition of Eldeco, Inc. (“Eldeco”), which reports as a separate operating location. We had 43 operating locations as of September 30, 2023. Acquisitions are included in our results of operations from the respective acquisition date. The same-store comparison from 2023 to 2022, as described below, excludes Eldeco, which was acquired on February 1, 2023 and three months of results for Atlantic Electric, LLC (“Atlantic”), which was acquired on April 1, 2022. An operating location is included in the same-store comparison on the first day it has comparable prior year operating data, except for immaterial acquisitions that are often absorbed and integrated with existing operations.
Revenue—Revenue for the third quarter of 2023 increased $258.1 million, or 23.0%, to $1.38 billion compared to the same period in 2022. The increase included a 20.0% increase in revenue related to same-store activity and a 3.0% increase related to the Eldeco acquisition. The same-store revenue growth was largely driven by strong market conditions, including the increase in our backlog.
The following table presents our operating segment revenue (in thousands, except percentages):
| Three Months Ended September 30, |
| ||||||||||
| 2023 |
| 2022 |
| ||||||||
Revenue: |
| |||||||||||
Mechanical Segment | $ | 1,031,310 |
| 74.8 | % | $ | 858,768 |
| 76.7 | % | ||
Electrical Segment |
| 346,814 |
| 25.2 | % |
| 261,244 |
| 23.3 | % | ||
Total | $ | 1,378,124 |
| 100.0 | % | $ | 1,120,012 |
| 100.0 | % |
Revenue for our mechanical segment increased $172.5 million, or 20.1%, to $1,031.3 million for the third quarter of 2023 compared to the same period in 2022. The increase primarily resulted from an increase in activity in the technology sector at one of our Texas operations ($58.0 million) and at our North Carolina operation ($45.4 million), and in the manufacturing sector at one of our Indiana operations ($33.6 million).
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Revenue for our electrical segment increased $85.6 million, or 32.8%, to $346.8 million for the third quarter of 2023 compared to the same period in 2022. The increase primarily resulted from the acquisition of Eldeco ($33.8 million), as well as an increase in activity in the technology sector at our Texas electrical operation ($31.2 million) and in the manufacturing and office buildings sectors at our Kentucky electrical operation ($12.3 million).
Revenue for the first nine months of 2023 increased $826.0 million, or 27.3%, to $3.85 billion compared to the same period in 2022. The increase included a 24.3% increase in revenue related to same-store activity and a 3.0% increase related to the Eldeco and Atlantic acquisitions. The same-store revenue growth was largely driven by strong market conditions, including the increase in our backlog, as well as the impact of inflation on our cost of goods sold that was passed on to our customers.
The following table presents our operating segment revenue (in thousands, except percentages):
| Nine Months Ended September 30, |
| ||||||||||
| 2023 |
| 2022 |
| ||||||||
Revenue: |
| |||||||||||
Mechanical Segment | $ | 2,925,848 |
| 76.0 | % | $ | 2,318,036 |
| 76.7 | % | ||
Electrical Segment |
| 923,346 |
| 24.0 | % |
| 705,140 |
| 23.3 | % | ||
Total | $ | 3,849,194 |
| 100.0 | % | $ | 3,023,176 |
| 100.0 | % |
Revenue for our mechanical segment increased $607.8 million, or 26.2%, to $2.93 billion for the first nine months of 2023 compared to the same period in 2022. The increase primarily resulted from an increase in activity in the technology sector at one of our Texas operations ($221.8 million) and at our North Carolina operation ($117.5 million), in the manufacturing sector at one of our Indiana operations ($80.1 million) and at another one of our Texas operations ($32.4 million).
Revenue for our electrical segment increased $218.2 million to $923.3 million for the first nine months of 2023 compared to the same period in 2022. The increase primarily resulted from the acquisition of Eldeco ($83.3 million), as well as an increase in activity in the manufacturing sector at our Texas electrical operation ($73.9 million), our North Carolina electrical operation ($27.7 million) and our Kentucky electrical operation ($22.5 million).
Backlog reflects revenue still to be recognized under contracted or committed installation and replacement project work. Project work generally lasts less than one year. Service agreement revenue, service work and short duration projects, which are generally billed as performed, do not flow through backlog. Accordingly, backlog represents only a portion of our revenue for any given future period, and it represents revenue that is likely to be reflected in our operating results over the next six to twelve months. As a result, we believe the predictive value of backlog information is limited to indications of general revenue direction over the near term, and should not be interpreted as indicative of ongoing revenue performance over several quarters.
The following table presents our operating segment backlog (in thousands, except percentages):
| September 30, 2023 |
| December 31, 2022 |
| September 30, 2022 |
| ||||||||||||
Backlog: |
|
| ||||||||||||||||
Mechanical Segment | $ | 3,117,994 |
| 72.7 | % | $ | 3,299,630 |
| 81.2 | % | $ | 2,536,049 |
| 78.0 | % | |||
Electrical Segment |
| 1,169,592 |
| 27.3 | % |
| 764,113 |
| 18.8 | % |
| 714,487 |
| 22.0 | % | |||
Total | $ | 4,287,586 |
| 100.0 | % | $ | 4,063,743 |
| 100.0 | % | $ | 3,250,536 |
| 100.0 | % |
Backlog as of September 30, 2023 was $4.29 billion, a 2.4% increase from June 30, 2023 backlog of $4.19 billion, and a 31.9% increase from September 30, 2022 backlog of $3.25 billion. The sequential backlog increase was primarily a result of an increase in project bookings at Eldeco ($85.7 million), one of our Texas operations ($45.6 million), our Mississippi operation ($43.8 million), our Indiana electrical operation ($40.1 million) and one of our Virginia operations ($27.7 million). The sequential backlog increase was partially offset by the completion of project work at our Texas electrical operation ($50.1 million), another one of our Texas operations ($43.9 million), and our Tennessee electrical operation ($30.7 million). The year-over-year backlog increase included the acquisition of Eldeco
26
($163.1 million), as well as a same-store increase of $874.0 million, or 26.9%. Same-store year-over-year backlog growth was primarily attributable to increased project bookings at one of our Texas operations ($334.1 million), our North Carolina operations ($245.3 million), our Texas electrical operation ($94.2 million) and another one of our Texas operations ($82.1 million). The year-over-year backlog increase was partially offset by completion of project work at one of our Florida operations ($51.9 million) and our Tennessee electrical operation ($33.8 million).
Gross Profit—Gross profit increased $75.3 million, or 37.2%, to $277.5 million for the third quarter of 2023 as compared to the same period in 2022. The increase included a 2.5% increase related to the Eldeco acquisition, as well as a 34.7% increase in same-store activity. The same-store increase in gross profit was primarily driven by higher revenues in the current year, including increased volumes at one of our Texas operations ($13.6 million), and our North Carolina operations ($7.6 million). We had $8.0 million higher gross profit at one of our Indiana operations due to both higher volumes and improvements in project execution. Additionally, we achieved improvements in project execution at our Kentucky electrical operation ($10.4 million) and one of our Texas operations ($6.0 million). We recorded an increase of $4.3 million in gross profit related to positive developments on legal matters in the third quarter of 2022. As a percentage of revenue, gross profit for the third quarter increased from 18.1% in 2022 to 20.1% in 2023, primarily due to the factors discussed above.
Gross profit increased $180.5 million, or 34.0%, to $710.8 million for the first nine months of 2023 as compared to the same period in 2022. The increase included a 1.7% increase related to the Eldeco and Atlantic acquisitions, as well as a 32.3% increase in same-store activity. The same-store increase in gross profit was primarily driven by the higher revenues in the current year including increased volumes at one of our Texas operations ($38.0 million), our North Carolina operations ($17.6 million), our Texas electrical operation ($11.7 million), and one of our Indiana operations ($10.9 million). Additionally, we achieved improvements in project execution at our Kentucky electrical operation ($21.8 million) and one of our Texas operations ($11.8 million). These results included an increase of $6.6 million in gross profit related to positive developments on legal matters in the first quarter of 2023, the majority of which was recorded at our Texas operations and one of our Indiana operations. These increases were partially offset by an increase of $4.3 million in gross profit in the third quarter of 2022 related to positive developments on legal matters. As a percentage of revenue, gross profit for the nine-month period increased from 17.5% in 2022 to 18.5% in 2023, primarily due to the factors discussed above.
Selling, General and Administrative Expenses (“SG&A”)—SG&A increased $21.7 million, or 17.9%, to $142.9 million for the third quarter of 2023 as compared to 2022. On a same-store basis, excluding amortization expense, SG&A increased $17.6 million, or 15.7%. The same-store increase is primarily due to higher same-store revenue and increased compensation costs ($15.2 million), largely attributable to increased headcount. Amortization expense increased $0.3 million during the period, primarily as a result of the Eldeco acquisition. As a percentage of revenue, SG&A for the third quarter decreased from 10.8% in 2022 to 10.4% in 2023.
SG&A increased $56.7 million, or 15.9%, to $414.4 million for the first nine months of 2023 as compared to 2022. On a same-store basis, excluding amortization expense, SG&A increased $45.5 million, or 13.8%. The same-store increase is primarily due to higher same-store revenue and increased compensation costs ($41.9 million), largely attributable to increased headcount. This increase was partially offset by a decrease in professional fees of $3.3 million as compared to the prior year related to the credit for increasing research activities (the “R&D tax credit”) for prior tax years. Amortization expense increased $1.1 million during the period, primarily as a result of the Eldeco and Atlantic acquisitions. As a percentage of revenue, SG&A for the nine-month period decreased from 11.8% in 2022 to 10.8% in 2023.
We have included same-store SG&A, excluding amortization, because we believe it is an effective measure of comparative results of operations. However, same-store SG&A, excluding amortization, is not considered under generally accepted accounting principles to be a primary measure of an entity’s financial results, and accordingly, should not be considered an alternative to SG&A as shown in our consolidated statements of operations.
27
Three Months Ended |
| Nine Months Ended | |||||||||||
September 30, |
| September 30, | |||||||||||
| 2023 |
| 2022 |
| 2023 |
| 2022 |
| |||||
(in thousands) |
| (in thousands) | |||||||||||
SG&A | $ | 142,935 | $ | 121,194 | $ | 414,397 | $ | 357,694 | |||||
Less: SG&A from companies acquired |
| (3,809) |
| — |
| (10,074) |
| — | |||||
Less: Amortization expense |
| (9,516) |
| (9,194) |
| (28,326) |
| (27,231) | |||||
Same-store SG&A, excluding amortization expense | $ | 129,610 | $ | 112,000 | $ | 375,997 | $ | 330,463 |
Interest Income—Interest income increased $0.9 million for the third quarter of 2023 as compared to the same period in 2022. Interest income increased $2.4 million for the first nine months of 2023 as compared to the same period in 2022. The increase in interest income for both the third quarter and the first nine months of 2023 is due primarily to interest awarded to us related to a dispute with a customer.
Interest Expense—Interest expense decreased $1.7 million, or 47.7%, to $1.9 million for the third quarter of 2023 as compared to the same period in 2022. Interest expense increased $1.1 million for the first nine months of 2023 as compared to the same period in 2022. The decrease in interest expense for the third quarter of 2023 is due to a decrease in our average outstanding debt balance compared to the prior year. The increase in interest expense for the first nine months of 2023 is due to an increase in our average interest rate on our outstanding borrowings in 2023 compared to the prior year.
Changes in the Fair Value of Contingent Earn-out Obligations—The contingent earn-out obligations are measured at fair value each reporting period, and changes in estimates of fair value are recognized in earnings. Expense from changes in the fair value of contingent earn-out obligations for the third quarter of 2023 increased $5.3 million as compared to the same period in 2022. The increase in earn-out expense was primarily driven by improved earnings at our Kentucky electrical operation and Eldeco that we expect to continue during their respective remaining earn-out periods. Expense from changes in the fair value of contingent earn-out obligations for the first nine months of 2023 increased $14.7 million as compared to the same period in 2022. The increase in earn-out expense was primarily driven by improved earnings at our Kentucky electrical operation that we expect to continue during the remaining earn-out period.
Provision (Benefit) for Income Taxes—Our provision for income taxes for the nine months ended September 30, 2023 was $44.6 million with an effective tax rate of 16.1% as compared to a benefit for income taxes of $24.9 million with a negative effective tax rate of 15.0% for the same period in 2022. The effective tax rate for 2023 was lower than the 21% federal statutory rate primarily due to the current year R&D tax credit (5.6%) and an increase in the R&D tax credit for the 2022 tax year (3.9%). These R&D tax credit benefits were partially offset by net state income taxes (3.7%) and nondeductible expenses (1.4%). The effective tax rate for 2022 was significantly lower than the 21% federal statutory rate primarily due to a reduction in unrecognized tax benefits from settlement with the Internal Revenue Service for the 2016, 2017 and 2018 tax years (18.4%), the filing of returns to claim the R&D tax credit for the 2019, 2020 and 2021 tax years (17.4%) and inclusion of the R&D tax credit for 2022 (5.0%). These benefits were partially offset by net state income taxes (4.2%) and nondeductible expenses, including nondeductible expenses related to the TAS Energy Inc. (“TAS") acquisition (1.4%).
As a result of conforming amendments made to the R&D tax credit in connection with the deferral of tax deductions for research and experimental (“R&E”) expenditures pursuant to the Tax Cuts and Jobs Act (2017), our provision for income taxes for the nine months ended September 30, 2023 benefited from an $8.2 million increase in the R&D tax credit. Of the $8.2 million increase, $4.9 million related to the R&D tax credit for the 2022 tax year.
Outlook
We experienced strong ongoing demand in the first nine months of 2023, and, although we have largely recovered from negative impacts caused by COVID-19, we continue to experience increased labor costs, supply constraints, and delays in delivery of various materials and equipment. We are recognizing these challenges in our job planning and pricing, and we are working to order materials earlier than usual and seeking to collaborate with customers to share supply risks and to mitigate the effects of these challenges.
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We have a good pipeline of opportunities and potential backlog, and we have been generally successful in maintaining productivity and in procuring needed materials despite ongoing challenges. Considering our substantial advance bookings, we currently anticipate solid earnings and cash flow for the remainder of 2023 and for 2024. Although we are preparing for a wide range of challenges and economic circumstances, including a potential recession, we currently expect that supportive conditions for our industry, especially for our industrial and technology customers, are likely to continue in 2024.
Liquidity and Capital Resources (in thousands):
Nine Months Ended | |||||||
September 30, | |||||||
| 2023 |
| 2022 |
| |||
Cash provided by (used in): | |||||||
Operating activities | $ | 466,560 | $ | 169,524 | |||
Investing activities |
| (119,125) |
| (82,759) | |||
Financing activities |
| (267,026) |
| (74,402) | |||
Net increase (decrease) in cash and cash equivalents | $ | 80,409 | $ | 12,363 | |||
Free cash flow: | |||||||
Cash provided by operating activities | $ | 466,560 | $ | 169,524 | |||
Purchases of property and equipment |
| (69,574) |
| (34,793) | |||
Proceeds from sales of property and equipment |
| 5,093 |
| 2,151 | |||
Free cash flow | $ | 402,079 | $ | 136,882 |
Cash Flow
Our business does not require significant amounts of investment in long-term fixed assets. The substantial majority of the capital used in our business is working capital that funds our costs of labor and installed equipment deployed in project work until our customer pays us. Customary terms in our industry allow customers to withhold a small portion of the contract price until after we have completed the work, typically for six months. Amounts withheld under this practice are known as retention or retainage. Our average project duration, together with typical retention terms, generally allow us to complete the realization of revenue and earnings in cash within one year.
Cash Provided by Operating Activities—Cash flow from operations is primarily influenced by demand for our services and operating margins but can also be influenced by working capital needs associated with the various types of services that we provide. In particular, working capital needs may increase when we commence large volumes of work under circumstances where project costs, primarily associated with labor, equipment and subcontractors, are required to be paid before the receivables resulting from the work performed are billed and collected. Working capital needs are generally higher during the late winter and spring months as we prepare and plan for the increased project demand when favorable weather conditions exist in the summer and fall months. Conversely, working capital assets are typically converted to cash during the late summer and fall months as project completion is underway. These seasonal trends are sometimes offset by changes in the timing of major projects, which can be impacted by the weather, project delays or accelerations and other economic factors that may affect customer spending.
Cash provided by operating activities was $466.6 million during the first nine months of 2023 compared to $169.5 million during the same period in 2022. The $297.1 million increase in cash provided was primarily driven by higher pre-tax income and a $95.7 million benefit from increases in accounts payable and accrued liabilities driven by the size and timing of payments. Additionally, we benefited $104.7 million from higher billings in excess of costs and deferred revenue, including the impact of large advance payments received in 2023. The benefit from these advance payments received in 2023 will reverse when project costs are incurred, except to the extent that additional advanced payments are received. These increases were partially offset by $33.3 million of tax refunds received in the first nine months of 2022. In early September 2023, the IRS issued interim guidance addressing, together with other topics, the treatment of R&E expenditures for taxpayers using the percentage of completion method to account for taxable income from long-term contracts. We have chosen to rely on such guidance beginning with the 2022 tax year, and the resultant reduction in taxable revenue offsets the deferral of tax deductions for R&E expenditures. We recently filed our 2022
29
federal return requesting a refund of our $107.1 million overpayment, and we currently do not expect that we will need to fund any federal tax payments for the remainder of 2023.
Cash Used in Investing Activities—During the first nine months of 2023, cash used in investing activities was $119.1 million compared to $82.8 million during the same period in 2022. The $36.3 million increase in cash used primarily relates to higher purchases of property and equipment to support the growth in our business and an increase in cash paid (net of cash acquired) for acquisitions in the current year compared to the same period in 2022.
Cash Used in Financing Activities—Cash used in financing activities was $267.0 million for the first nine months of 2023 compared to $74.4 million during the same period in 2022. The $192.6 million increase in cash used is primarily due to a decrease in net proceeds from debt, which was driven by strong operating cash flow in the current year. This increase was partially offset by a reduction in share repurchases in the current year compared to the first nine months of 2022.
Free Cash Flow—We define free cash flow as cash provided by operating activities, less customary capital expenditures, plus the proceeds from asset sales. We believe free cash flow, by encompassing both profit margins and the use of working capital over our approximately one year working capital cycle, is an effective measure of operating effectiveness and efficiency. We have included free cash flow information here for this reason, and because we are often asked about it by third parties evaluating us. However, free cash flow is not considered under generally accepted accounting principles to be a primary measure of an entity’s financial results, and accordingly free cash flow should not be considered an alternative to operating income, net income, or amounts shown in our consolidated statements of cash flows as determined under generally accepted accounting principles. Free cash flow may be defined differently by other companies.
Share Repurchase Program
On March 29, 2007, our Board of Directors (the “Board”) approved a stock repurchase program to acquire up to 1.0 million shares of our outstanding common stock. Subsequently, the Board has from time to time increased the number of shares that may be acquired under the program and approved extensions of the program. On May 17, 2022, the Board approved an extension to the program by increasing the shares authorized for repurchase by 0.7 million shares. Since the inception of the repurchase program, the Board has approved 10.9 million shares to be repurchased. As of September 30, 2023, we have repurchased a cumulative total of 10.2 million shares at an average price of $25.21 per share under the repurchase program.
The share repurchases will be made from time to time at our discretion in the open market or privately negotiated transactions, as permitted by securities laws and other legal requirements, and subject to market conditions and other factors. The Board may modify, suspend, extend or terminate the program at any time. During the nine months ended September 30, 2023, we repurchased 0.1 million shares for approximately $8.6 million at an average price of $134.53 per share.
Debt
Revolving Credit Facility
On May 25, 2022, we amended our senior credit facility (as amended, the “Facility”) arranged by Wells Fargo Bank, National Association, as administrative agent, and provided by a syndicate of banks, increasing our borrowing capacity to $850 million. As amended, the Facility is composed of a revolving credit line guaranteed by certain of our subsidiaries, in the amount of $850.0 million. The amended Facility also provides for an accordion or increase option not to exceed the greater of (a) $250 million and (b) 1.0x Credit Facility Adjusted EBITDA (as defined below), as well as a sublimit of up to $175.0 million issuable in the form of letters of credit. The Facility expires in July 2027 and is secured by a first lien on substantially all of our personal property except for assets related to projects subject to surety bonds and the equity of, and assets held by, certain unrestricted subsidiaries and our wholly owned captive insurance company, and a second lien on our assets related to projects subject to surety bonds. In 2022, we incurred approximately $2.3 million in financing and professional costs in connection with the amendment to the Facility, which, combined with previously unamortized costs of $1.2 million, are being amortized on a straight-line basis as a non-cash charge to interest expense
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over the remaining term of the Facility. As of September 30, 2023, we had no outstanding borrowings on the revolving credit facility, $70.0 million in letters of credit outstanding and $780.0 million of credit available.
There are two interest rate options for borrowings under the Facility, the Base Rate Loan (as defined in the Facility) option and the Secured Overnight Financing Rate (“SOFR”) Loan option. These rates are floating rates determined by the broad financial markets, meaning they can and do move up and down from time to time. Additional margins are then added to these two rates.
Certain of our vendors require letters of credit to ensure reimbursement for amounts they are disbursing on our behalf, such as to beneficiaries under our self-funded insurance programs. We have also occasionally used letters of credit to guarantee performance under our contracts and to ensure payment to our subcontractors and vendors under those contracts. Our lenders issue such letters of credit through the Facility. A letter of credit commits the lenders to pay specified amounts to the holder of the letter of credit if the holder demonstrates that we have failed to perform specified actions. If this were to occur, we would be required to reimburse the lenders for amounts they fund to honor the letter of credit holder’s claim. Absent a claim, there is no payment or reserving of funds by us in connection with a letter of credit. However, because a claim on a letter of credit would require immediate reimbursement by us to our lenders, letters of credit are treated as a use of Facility capacity. The letter of credit fees range from 1.00% to 2.00% per annum, based on the Net Leverage Ratio.
Commitment fees are payable on the portion of the revolving loan capacity not in use for borrowings or letters of credit at any given time. These fees range from 0.15% to 0.25% per annum, based on the Net Leverage Ratio.
The Facility contains financial covenants defining various financial measures and the levels of these measures with which we must comply. Covenant compliance is assessed as of each quarter end. We were in compliance with all of our financial covenants as of September 30, 2023.
Notes to Former Owners
As part of the consideration used to acquire eleven companies, we have outstanding notes to the former owners. Together, these notes had an outstanding balance of $47.1 million as of September 30, 2023. At September 30, 2023, future principal payments of notes to former owners by maturity year are as follows (dollars in thousands):
Balance at | Range of Stated | |||||
| September 30, 2023 | Interest Rates | ||||
2023 | $ | 13,266 | 2.5 - 3.0 | % | ||
2024 |
| 1,000 | 2.5 | % | ||
2025 |
| 22,215 | 2.3 - 3.0 | % | ||
2026 |
| 10,625 | 2.5 - 3.8 | % | ||
Total | $ | 47,106 |
Outlook
We have generated positive net free cash flow for the last twenty-four calendar years, much of which occurred during challenging economic and industry conditions. We also continue to have significant borrowing capacity under our credit facility, and we maintain what we feel are reasonable cash balances. We believe these factors will provide us with sufficient liquidity to fund our operations for the foreseeable future.
Other Commitments
Certain of our vendors require letters of credit to ensure reimbursement for amounts they are disbursing on our behalf, such as to beneficiaries under our self-funded insurance programs. We have also occasionally used letters of credit to guarantee performance under our contracts and to ensure payment to our subcontractors and vendors under those contracts. The letters of credit we provide are actually issued by our lenders through the Facility as described above. A letter of credit commits the lenders to pay specified amounts to the holder of the letter of credit if the holder demonstrates that we have failed to perform specified actions. If this were to occur, we would be required to reimburse
31
the lenders. Depending on the circumstances of such a reimbursement, we may also have to record a charge to earnings for the reimbursement. Absent a claim, there is no payment or reserving of funds by us in connection with a letter of credit. However, because a claim on a letter of credit would require immediate reimbursement by us to our lenders, letters of credit are treated as a use of the Facility’s capacity just the same as actual borrowings. Claims against letters of credit are rare in our industry.
As of September 30, 2023, we have $70.0 million in letter of credit commitments, of which $44.0 million will expire in 2023 and $26.0 million will expire in 2024. The substantial majority of these letters of credit are posted with insurers who disburse funds on our behalf in connection with our workers’ compensation, auto liability and general liability insurance program. These letters of credit provide additional security to the insurers that sufficient financial resources will be available to fund claims on our behalf, many of which develop over long periods of time, should we ever encounter financial duress. Posting of letters of credit for this purpose is a common practice for entities that manage their self-insurance programs through third-party insurers as we do. While some of these letter of credit commitments expire in the next twelve months, we expect nearly all of them, particularly those supporting our insurance programs, will be renewed annually.
Many customers, particularly in connection with new construction, require us to post performance and payment bonds issued by a financial institution known as a surety. If we fail to perform under the terms of a contract or to pay subcontractors and vendors who provided goods or services under a contract, the customer may demand that the surety make payments or provide services under the bond. We must reimburse the sureties for any expenses or outlays they incur.
Under standard terms in the surety market, sureties issue bonds on a project-by-project basis, and can decline to issue bonds at any time. Historically, approximately 10% to 20% of our business has required bonds. While we currently have strong surety relationships to support our bonding needs, future market conditions or changes in our sureties’ assessment of our operating and financial risk could cause our sureties to decline to issue bonds for our work. If that were to occur, our alternatives include doing more business that does not require bonds, posting other forms of collateral for project performance, such as letters of credit or cash, and seeking bonding capacity from other sureties. We would likely also encounter concerns from customers, suppliers and other market participants as to our creditworthiness. While we believe our general operating and financial characteristics would enable us to ultimately respond effectively to an interruption in the availability of bonding capacity, such an interruption would likely cause our revenue and profits to decline in the near term.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risk primarily related to potential adverse changes in interest rates, as discussed below. We are actively involved in monitoring exposure to market risk and continue to develop and utilize appropriate risk management techniques. We are not exposed to any other significant financial market risks, including commodity price risk, or foreign currency exchange risk from the use of derivative financial instruments. At times, we use derivative financial instruments to manage our interest rate risk.
We have exposure to changes in interest rates under our revolving credit facility. The weighted average interest rate applicable to the borrowings under the revolving credit facility was approximately 5.7% as of December 31, 2022. There were no outstanding borrowings on the revolving credit facility as of September 30, 2023. Our debt with fixed interest rates consists of notes to former owners of acquired companies and acquired notes payable.
We measure certain assets at fair value on a nonrecurring basis. These assets are recognized at fair value when they are deemed to be other-than-temporarily impaired. We did not recognize any impairments in the current year on those assets required to be measured at fair value on a nonrecurring basis.
The valuation of the Company’s contingent earn-out payments is determined using a probability weighted discounted cash flow method. This analysis reflects the contractual terms of the purchase agreements (e.g., minimum and maximum payment, length of earn-out periods, manner of calculating any amounts due, etc.) and utilizes assumptions with regard to future cash flows, probabilities of achieving such future cash flows and a discount rate.
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Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our executive management is responsible for ensuring the effectiveness of the design and operation of our disclosure controls and procedures. We carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) are effective as of the end of the period covered by this report.
Changes in Internal Control over Financial Reporting
There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) during the three months ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II—OTHER INFORMATION
Item 1. Legal Proceedings
We are subject to certain legal and regulatory claims, including lawsuits arising in the normal course of business. We maintain various insurance coverages to minimize financial risk associated with these claims. We have estimated and provided accruals for probable losses and related legal fees associated with certain litigation in our consolidated financial statements. While we cannot predict the outcome of these proceedings, in management’s opinion and based on reports of counsel, any liability arising from these matters individually and in the aggregate will not have a material effect on our operating results, cash flows or financial condition, after giving effect to provisions already recorded.
During the first quarter of 2023, we recorded a pre-tax gain of $6.8 million from legal developments and settlements that primarily relate to disputes with customers regarding the outcome of completed projects as well as an obligation to perform subcontract work under two executed letters of intent for subsequent projects that we believed were not enforceable. The pre-tax gain of $6.8 million has been recorded as an increase in gross profit of $6.6 million, a reduction in SG&A of $0.7 million, an increase in interest income of $1.3 million and an increase in the change in fair value of contingent earn-out obligations expense of $1.8 million in our Consolidated Statements of Operations.
During the third quarter of 2022, we recorded a net gain of $4.5 million related to legal matters that merited changes to our assessments of the related accruals in the ordinary course of our business based on information received in the third quarter of 2022. The largest change in the third quarter resulted from favorable developments related to a dispute with a customer regarding the outcome of a completed project as well as the obligation to perform subcontract work under two executed letters of intent for subsequent projects that we believed were not enforceable. The net gain of $4.5 million was recorded primarily as an increase in gross profit in our Consolidated Statements of Operations.
As of September 30, 2023, we recorded an accrual for unresolved matters, which is not material to our financial statements, based on our analysis of likely outcomes related to the respective matters; however, it is possible that the ultimate outcome and associated costs will deviate from our estimates and that, in the event of an unexpectedly adverse outcome, we may experience additional costs and expenses in future periods.
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022, which could materially affect our business, financial condition, or future results. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, or future results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Recent Sales of Unregistered Securities
None.
Issuer Purchases of Equity Securities
On March 29, 2007, our Board of Directors (the “Board”) approved a stock repurchase program to acquire up to 1.0 million shares of our outstanding common stock. Subsequently, the Board has from time to time increased the number of shares that may be acquired under the program and approved extensions of the program. On May 17, 2022, the Board approved an extension to the program by increasing the shares authorized for repurchase by 0.7 million shares. Since the inception of the repurchase program, the Board has approved 10.9 million shares to be repurchased. As of September 30, 2023, we have repurchased a cumulative total of 10.2 million shares at an average price of $25.21 per share under the repurchase program.
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The share repurchases will be made from time to time at our discretion in the open market or privately negotiated transactions, as permitted by securities laws and other legal requirements, and subject to market conditions and other factors. The Board may modify, suspend, extend or terminate the program at any time. During the nine months ended September 30, 2023, we repurchased 0.1 million shares for approximately $8.6 million at an average price of $134.53 per share.
During the quarter ended September 30, 2023, we purchased our common shares in the following amounts at the following average prices:
|
|
| Total Number of Shares |
| Maximum Number of |
| ||||
Purchased as Part of | Shares that May Yet Be |
| ||||||||
Total Number of | Average Price | Publicly Announced Plans | Purchased Under the Plans |
| ||||||
Period | Shares Purchased | Paid Per Share | or Programs (1) | or Programs |
| |||||
July 1 - July 31 |
| 500 | $ | 154.60 |
| 10,170,746 |
| 773,379 | ||
August 1 - August 31 |
| — | $ | — |
| 10,170,746 |
| 773,379 | ||
September 1 - September 30 |
| 9,750 | $ | 175.37 |
| 10,180,496 |
| 763,629 | ||
| 10,250 | $ | 174.36 |
| 10,180,496 |
| 763,629 |
________________________________________
(1) | Purchased as part of a program announced on March 29, 2007 under which, since the inception of this program, 10.9 million shares have been approved for repurchase. |
Under our stock incentive plans, employees may elect to have us withhold common shares to satisfy statutory federal, state and local tax withholding obligations arising on the vesting of restricted stock awards and exercise of options. When we withhold these shares, we are required to remit to the appropriate taxing authorities the market price of the shares withheld, which could be deemed a purchase of the common shares by us on the date of withholding.
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Item 6. Exhibits
Incorporated by Reference | ||||||
Exhibit |
| Description of Exhibits |
| Exhibit |
| Filing or |
3.1 | Second Amended and Restated Certificate of Incorporation of the Registrant | 3.1 | 333-24021 | |||
3.2 | 3.2 | 1998 Form 10-K | ||||
3.3 | 3.3 | 2003 Form 10-K | ||||
3.4 | 3.1 | May 20, 2016 Form 8-K | ||||
3.5 | 3.1 | March 25, 2016 Form 8-K | ||||
31.1* | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |||||
31.2* | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |||||
32.1** | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |||||
32.2** | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |||||
101.INS* | Inline XBRL Instance Document | |||||
101.SCH* | Inline XBRL Taxonomy Extension Schema Document | |||||
101.CAL* | Inline XBRL Taxonomy Extension Calculation Linkbase Document | |||||
101.DEF* | Inline XBRL Taxonomy Extension Definition Linkbase Document | |||||
101.LAB* | Inline XBRL Taxonomy Extension Label Linkbase Document | |||||
101.PRE* | Inline XBRL Taxonomy Extension Presentation Linkbase | |||||
104 | Cover Page Interactive Data File (the cover page XBRL tags are embedded in the Inline XBRL document) | |||||
* Filed herewith.
** Furnished herewith.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Comfort Systems USA, Inc. | ||
October 26, 2023 | By: | /s/ Brian E. Lane |
Brian E. Lane | ||
President, Chief Executive Officer and Director | ||
October 26, 2023 | By: | /s/ William George |
William George | ||
Executive Vice President and Chief Financial Officer | ||
October 26, 2023 | By: | /s/ Julie S. Shaeff |
Julie S. Shaeff | ||
Senior Vice President and Chief Accounting Officer |
37
Exhibit 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
I, Brian E. Lane, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Comfort Systems USA, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: October 26, 2023 | /s/ Brian E. Lane |
| Brian E. Lane |
Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, William George, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Comfort Systems USA, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c. evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d. disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
| /s/ William George |
Date: October 26, 2023 | William George |
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002*
In connection with the Quarterly Report of Comfort Systems USA, Inc. (the “Company”) on Form 10-Q for the quarter ended September 30, 2023, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Brian E. Lane, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
Date: October 26, 2023 | /s/ Brian E. Lane |
| Brian E. Lane |
* A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002*
In connection with the Quarterly Report of Comfort Systems USA, Inc. (the “Company”) on Form 10-Q for the quarter ended September 30, 2023, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, William George, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
Date: October 26, 2023 | /s/ William George |
| William George |
* A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.
CONSOLIDATED BALANCE SHEETS (Parenthetical) - USD ($) $ in Thousands |
Sep. 30, 2023 |
Dec. 31, 2022 |
---|---|---|
CONSOLIDATED BALANCE SHEETS | ||
Billed accounts receivable, allowance for credit losses (in dollars) | $ 10,343 | $ 10,640 |
Unbilled accounts receivable, allowance for credit losses (in dollars) | 1,093 | 1,011 |
Other receivables, allowance for credit losses (in dollars) | 514 | 510 |
Costs and estimated earnings in excess of billings, allowance for credit losses (in dollars) | $ 94 | $ 80 |
Preferred stock, par value (in dollars per share) | $ 0.01 | $ 0.01 |
Preferred stock, shares authorized | 5,000,000 | 5,000,000 |
Preferred stock, shares issued | 0 | 0 |
Preferred stock, shares outstanding | 0 | 0 |
Common stock, par value (in dollars per share) | $ 0.01 | $ 0.01 |
Common stock, shares authorized | 102,969,912 | 102,969,912 |
Common stock, shares issued | 41,123,365 | 41,123,365 |
Treasury stock, shares | 5,363,300 | 5,362,224 |
CONSOLIDATED STATEMENTS OF OPERATIONS - USD ($) shares in Thousands, $ in Thousands |
3 Months Ended | 9 Months Ended | ||
---|---|---|---|---|
Sep. 30, 2023 |
Sep. 30, 2022 |
Sep. 30, 2023 |
Sep. 30, 2022 |
|
CONSOLIDATED STATEMENTS OF OPERATIONS | ||||
REVENUE | $ 1,378,124 | $ 1,120,012 | $ 3,849,194 | $ 3,023,176 |
COST OF SERVICES | 1,100,625 | 917,788 | 3,138,370 | 2,492,816 |
Gross profit | 277,499 | 202,224 | 710,824 | 530,360 |
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES | 142,935 | 121,194 | 414,397 | 357,694 |
GAIN ON SALE OF ASSETS | (579) | (406) | (1,683) | (1,112) |
Operating income | 135,143 | 81,436 | 298,110 | 173,778 |
OTHER INCOME (EXPENSE): | ||||
Interest income | 952 | 5 | 2,441 | 14 |
Interest expense | (1,886) | (3,609) | (9,880) | (8,764) |
Changes in the fair value of contingent earn-out obligations | (8,727) | (3,443) | (14,207) | 530 |
Other | (44) | 46 | 1 | 101 |
Other income (expense) | (9,705) | (7,001) | (21,645) | (8,119) |
INCOME BEFORE INCOME TAXES | 125,438 | 74,435 | 276,465 | 165,659 |
PROVISION (BENEFIT) FOR INCOME TAXES | 20,313 | 12,920 | 44,648 | (24,864) |
NET INCOME | $ 105,125 | $ 61,515 | $ 231,817 | $ 190,523 |
INCOME PER SHARE: | ||||
Basic | $ 2.93 | $ 1.72 | $ 6.47 | $ 5.30 |
Diluted | $ 2.93 | $ 1.71 | $ 6.46 | $ 5.28 |
SHARES USED IN COMPUTING INCOME PER SHARE: | ||||
Basic | 35,820 | 35,853 | 35,819 | 35,966 |
Diluted | 35,917 | 35,972 | 35,910 | 36,078 |
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Parenthetical) - $ / shares |
3 Months Ended | |||||
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Mar. 31, 2023 |
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Mar. 31, 2022 |
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY | ||||||
Dividends (per share) | $ 0.225 | $ 0.20 | $ 0.175 | $ 0.14 | $ 0.14 | $ 0.13 |
Business and Organization |
9 Months Ended |
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Sep. 30, 2023 | |
Business and Organization | |
Business and Organization | 1. Business and Organization Comfort Systems USA, Inc., a Delaware corporation, provides comprehensive mechanical and electrical contracting services, which principally includes heating, ventilation and air conditioning (“HVAC”), plumbing, electrical, piping and controls, as well as off-site construction, monitoring and fire protection. We build, install, maintain, repair and replace mechanical, electrical and plumbing (“MEP”) systems throughout the United States. The terms “Comfort Systems,” “we,” “us,” or the “Company,” refer to Comfort Systems USA, Inc. or Comfort Systems USA, Inc. and its consolidated subsidiaries, as appropriate in the context.
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Summary of Significant Accounting Policies and Estimates |
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Summary of Significant Accounting Policies and Estimates | |
Summary of Significant Accounting Policies and Estimates | 2. Summary of Significant Accounting Policies and Estimates Basis of Presentation These interim statements should be read in conjunction with the historical Consolidated Financial Statements and related notes of Comfort Systems included in the Annual Report on Form 10-K as filed with the Securities and Exchange Commission (“SEC”) for the year ended December 31, 2022 (the “Form 10-K”). The accompanying unaudited consolidated financial statements were prepared using generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and applicable rules of Regulation S-X of the SEC. Accordingly, these financial statements do not include all the footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the Form 10-K. We believe all adjustments necessary for a fair presentation of these interim statements have been included and are of a normal and recurring nature. The results of operations for interim periods are not necessarily indicative of the results for the full fiscal year. Certain amounts in prior periods have been reclassified to conform to the current period presentation. The effects of the reclassifications were not material to the consolidated financial statements. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and assumptions by management in determining the reported amounts of assets and liabilities, revenue and expenses and disclosures regarding contingent assets and liabilities. Actual results could differ from those estimates. The most significant estimates used in our financial statements affect revenue and cost recognition for construction contracts, self-insurance accruals, accounting for income taxes, fair value accounting for acquisitions and the quantification of fair value for reporting units in connection with our goodwill impairment testing. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements In October 2021, the FASB issued ASU 2021-08, “Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers.” This standard requires an acquirer to apply Accounting Standards Codification Topic 606 to recognize and measure contract assets and contract liabilities in a business combination. ASU 2021-08 is effective for fiscal years beginning after December 15, 2022 and interim periods within that year. We adopted this standard on January 1, 2023, and the impact on our consolidated financial statements was not material. Revenue Recognition We recognize revenue over time for all of our services as we perform them because (i) control continuously transfers to that customer as work progresses, and (ii) we have the right to bill the customer as costs are incurred. The customer typically controls the work in process, as evidenced either by contractual termination clauses or by our rights to payment for work performed to date, plus a reasonable profit, for delivery of products or services that do not have an alternative use to the Company. For the reasons listed above, revenue is recognized based on the extent of progress towards completion of the performance obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. We generally use a cost-to-cost input method to measure our progress towards satisfaction of the performance obligation for our contracts, as it best depicts the transfer of assets to the customer that occurs as we incur costs on our contracts. Under the cost-to-cost input method, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenue, including estimated fees or profits, is recorded proportionally as costs are incurred. Costs to fulfill include labor, materials, subcontractors’ costs, other direct costs and an allocation of indirect costs. For a small portion of our business in which our services are delivered in the form of service maintenance agreements for existing systems to be repaired and maintained, as opposed to constructed, our performance obligation is to maintain the customer’s mechanical system for a specific period of time. Similar to construction jobs, we recognize revenue over time; however, for service maintenance agreements in which the full cost to provide services may not be known, we generally use an input method to recognize revenue, which is based on the amount of time we have provided our services out of the total time we have been contracted to perform those services. Our revenue recognition policy is further discussed in Note 3 “Revenue from Contracts with Customers.” Accounts Receivable and Allowance for Credit Losses We are required to estimate and record the expected credit losses over the contractual life of our financial assets measured at amortized cost, including billed and unbilled accounts receivable, other receivables and contract assets. Accounts receivable include amounts from work completed in which we have billed or have an unconditional right to bill our customers. Our trade receivables are contractually due in less than a year. We estimate our credit losses using a loss-rate method for each of our identified portfolio segments. Our portfolio segments are construction, service and other. While our construction and service financial assets are often with the same subset of customers and industries, our construction financial assets will generally have a lower loss-rate than service financial assets due to lien rights, which we are more likely to have on construction jobs. These lien rights result in lower credit loss expenses on average compared to receivables that do not have lien rights. Financial assets classified as Other include receivables that are not related to our core revenue producing activities, such as receivables related to our acquisition activity from former owners, our vendor rebate program or receivables for estimated losses in excess of our insurance deductible, which are accrued with a corresponding accrued insurance liability. Loss rates for our portfolios are based on numerous factors, including our history of credit loss expense by portfolio, the financial strength of our customers and counterparties in each portfolio, the aging of our receivables, our expectation of likelihood of payment, macroeconomic trends in the U.S. and the current and forecasted nonresidential construction market trends in the U.S. In addition to the loss-rate calculations discussed above, we also record allowance for credit losses for specific receivables that are deemed to have a higher risk profile than the rest of the respective pool of receivables (e.g., when we hold concerns about a specific customer going bankrupt and no longer being able to pay the receivables due to us). Unbilled Accounts Receivable Unbilled accounts receivable are amounts due to us that we have earned under a contract where our right to payment is unconditional. A right to consideration is unconditional if only the passage of time is required before payment of the consideration is due. Income Taxes We conduct business throughout the United States in virtually all fifty states. Our effective tax rate changes based upon our relative profitability, or lack thereof, in the federal and various state jurisdictions with differing tax rates and rules. In addition, discrete items such as tax law changes, judgments and legal structures, can impact our effective tax rate. These items can also include the tax treatment for impairment of goodwill and other intangible assets, changes in fair value of acquisition-related assets and liabilities, uncertain tax positions, and accounting for losses associated with underperforming operations. Following an Internal Revenue Service (“IRS”) survey of previously filed refund claims for the 2016, 2017 and 2018 tax years, the Joint Committee on Taxation approved such refunds in late January 2022. As a result, our benefit for income taxes in the first quarter of 2022 included a $28.8 million reduction in unrecognized tax benefits plus approximately $1.6 million of net interest income on the refunds. Our benefit for income taxes in the first quarter of 2022 was further increased by $26.8 million for the expected refunds due to our intention to claim the credit for increasing research activities (“the R&D tax credit”) for the 2019, 2020 and 2021 tax years. In the third quarter of 2022, we claimed the R&D tax credit on our originally filed 2021 federal return and recognized an additional $1.7 million benefit for the 2019, 2020 and 2021 tax years. Additionally, we filed amended federal returns for 2019 and 2020 requesting refunds primarily from claiming the R&D tax credit. The Inflation Reduction Act was enacted on August 16, 2022. This law, among other provisions, provides a corporate alternative minimum tax on adjusted financial statement income over $1 billion, which is effective for tax years beginning after December 31, 2022, and a 1% excise tax on net corporate stock repurchases after December 31, 2022. The impact of the excise tax is recorded in “Treasury Stock” within our Consolidated Balance Sheet. These provisions were not material to our current year overall financial results, financial position and cash flows. In early September 2023, the IRS issued interim guidance addressing, together with other topics, the treatment of research and experimental (“R&E”) expenditures for taxpayers using the percentage of completion method to account for taxable income from long-term contracts. We have chosen to rely on such guidance beginning with the 2022 tax year, and the resultant reduction in taxable revenue offsets the deferral of tax deductions for R&E expenditures pursuant to the Tax Cuts and Jobs Act (2017). We recently filed our 2022 federal return requesting a refund of our $107.1 million overpayment. Financial Instruments Our financial instruments consist of cash and cash equivalents, accounts receivable, other receivables, accounts payable and life insurance policies, for which we deem the carrying values approximate their fair value due to the short-term nature of these instruments, as well as notes to former owners and a revolving credit facility. Investments We have a $3.7 million investment with a fair value that is not readily determinable and is recorded at cost. This investment is included in “Other Noncurrent Assets” in our Consolidated Balance Sheet and is reviewed quarterly for impairment. We did not recognize any impairments in the current year related to this investment. |
Revenue from Contracts with Customers |
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Revenue from Contracts with Customers | 3. Revenue from Contracts with Customers Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. Sales-based taxes are excluded from revenue. We provide mechanical and electrical contracting services. Our mechanical segment principally includes HVAC, plumbing, piping and controls, as well as off-site construction, monitoring and fire protection. Our electrical segment includes installation and servicing of electrical systems. We build, install, maintain, repair and replace products and systems throughout the United States. All of our revenue is recognized over time as we deliver goods and services to our customers. Revenue can be earned based on an agreed-upon fixed price or based on actual costs incurred, marked up at an agreed-upon percentage. We account for a contract when: (i) it has approval and commitment from both parties, (ii) the rights of the parties are identified, (iii) payment terms are identified, (iv) the contract has commercial substance, and (v) collectability of consideration is probable. We consider the start of a project to be when the above criteria have been met and we either have written authorization from the customer to proceed or an executed contract. We generally do not incur significant incremental costs related to obtaining or fulfilling a contract prior to the start of a project. On rare occasions, when significant pre-contract costs are incurred, they are capitalized and amortized over the life of the contract using a cost-to-cost input method to measure progress towards contract completion. We do not currently have any capitalized obtainment or fulfillment costs in our Consolidated Balance Sheet and have not incurred any impairment loss on such costs in the current year. Due to the nature of the work required to be performed on many of our performance obligations, the estimation of total revenue and cost at completion (the process described below in more detail) is complex, subject to many variables and requires significant judgment. The consideration to which we are entitled on our long-term contracts may include both fixed and variable amounts. Variable amounts can either increase or decrease the transaction price. A common example of variable amounts that can either increase or decrease contract value are pending change orders that represent contract modifications for which a change in scope has been authorized or acknowledged by our customer, but the final adjustment to contract price is yet to be negotiated. Other examples of positive variable revenue include amounts awarded upon achievement of certain performance metrics, program milestones or cost of completion date targets and can be based upon customer discretion. Variable amounts can result in a deduction from contract revenue if we fail to meet stated performance requirements, such as complying with the construction schedule. We include estimated amounts of variable consideration in the contract price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Our estimates of variable consideration and determination of whether to include estimated amounts in the contract price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available to us. We reassess the amount of variable consideration each accounting period until the uncertainty associated with the variable consideration is resolved. Changes in the assessed amount of variable consideration are accounted for prospectively as a cumulative adjustment to revenue recognized in the current period. Contracts are often modified to account for changes in contract specifications and requirements. We consider contract modifications to exist when the modification either creates new, or changes the existing, enforceable rights and obligations. Most of our contract modifications are for goods or services that are not distinct from the existing performance obligation(s). The effect of a contract modification on the transaction price, and our measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase or decrease) on a cumulative catch-up basis. We have a Company-wide policy requiring periodic review of the Estimate at Completion in which management reviews the progress and execution of our performance obligations and estimated remaining obligations. As part of this process, management reviews information including, but not limited to, any outstanding key contract matters, progress towards completion and the related program schedule, identified risks and opportunities and the related changes in estimates of revenue and costs. The risks and opportunities include management's judgment about the ability and cost to achieve the schedule (e.g., the number and type of milestone events), technical requirements (e.g., a newly developed product versus a mature product) and other contract requirements. Management must make assumptions and estimates regarding labor productivity and availability, the complexity of the work to be performed, the availability of materials, the length of time to complete the performance obligation (e.g., to estimate increases in wages and prices for materials and related support cost allocations), execution by our subcontractors, the availability and timing of funding from our customer, and overhead cost rates, among other variables. Based on this analysis, any adjustments to revenue, cost of services, and the related impact to operating income are recognized as necessary in the quarter when they become known. These adjustments may result from positive program performance if we determine we will be successful in mitigating risks surrounding the technical, schedule and cost aspects of those performance obligations or realizing related opportunities and may result in an increase in operating income during the performance of individual performance obligations. Likewise, if we determine we will not be successful in mitigating these risks or realizing related opportunities, these adjustments may result in a decrease in operating income. Changes in estimates of revenue, cost of services and the related impact to operating income are recognized quarterly on a cumulative catch-up basis, meaning we recognize in the current period the cumulative effect of the changes on current and prior periods based on our progress towards complete satisfaction of a performance obligation. A significant change in one or more of these estimates could affect the profitability of one or more of our performance obligations. For projects in which estimates of total costs to be incurred on a performance obligation exceed total estimates of revenue to be earned, a provision for the entire loss on the performance obligation is recognized in the period the loss is determined. In the first nine months of 2023 and 2022, net revenue recognized from our performance obligations partially satisfied in previous periods was not material. Disaggregation of Revenue Our consolidated 2023 revenue was derived from contracts to provide service activities in the mechanical and electrical segments we serve. Refer to Note 11 “Segment Information” for additional information on our reportable segments. We disaggregate our revenue from contracts with customers by activity, customer type and service provided, as we believe it best depicts how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors. See details in the following tables (dollars in thousands):
Contract Assets and Liabilities Contract assets include unbilled amounts typically resulting from sales under long term contracts when the cost-to-cost method of revenue recognition is used, revenue recognized exceeds the amount billed to the customer and right to payment is conditional or subject to completing a milestone, such as a phase of the project. Contract assets are not considered to have a significant financing component, as they are intended to protect the customer in the event that we do not perform our obligations under the contract. Contract liabilities consist of advance payments and billings in excess of revenue recognized. Advanced payments from customers related to work not yet started are classified as “Deferred Revenue.” Contract liabilities are not considered to have 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 are intended to protect us from the other party failing to meet its obligations under the contract. Our contract assets and liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period. Contract assets and liabilities in the Consolidated Balance Sheet consisted of the following amounts as of September 30, 2023 and December 31, 2022 (in thousands):
In the first nine months of 2023 and 2022, we recognized revenue of $482.9 million and $277.5 million related to our contract liabilities at January 1, 2023 and January 1, 2022, respectively. We did not have any impairment losses recognized on our receivables or contract assets in the first nine months of 2023 and 2022. Remaining Performance Obligations Remaining construction performance obligations represent the remaining transaction price of firm orders for which work has not been performed and exclude unexercised contract options. As of September 30, 2023, the aggregate amount of the transaction price allocated to remaining performance obligations was $4.29 billion. The Company expects to recognize revenue on approximately 65-75% of the remaining performance obligations over the next 12 months, with the remaining recognized thereafter. Our service maintenance agreements are generally one-year renewable agreements. We have adopted the practical expedient that allows us to not include service maintenance contracts with a total term of one year or less; therefore, we do not report unfulfilled performance obligations for service maintenance agreements. |
Fair Value Measurements |
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Fair Value Measurements | 4. Fair Value Measurements Interest Rate Risk Management and Derivative Instruments In April 2020, we entered into interest rate swap agreements to reduce our exposure to variable interest rates on our revolving credit facility. The interest rate swap agreements terminated on September 30, 2022. At times, we use derivative instruments to manage exposure to market risk, including interest rate risk. Unsettled amounts under our interest rate swaps, if any, are recorded in the Consolidated Balance Sheet at fair value in “Other Receivables” or “Other Current Liabilities.” Gains and losses on our interest rate swaps are recorded in the Consolidated Statement of Operations in “Interest Expense.” For each period three and nine months ended September 30, 2022, we recognized a net gain of $0.3 million for each period related to our interest rate swaps. We currently do not have any derivatives that are accounted for as hedges under ASC 815. Fair Value Measurement We classify and disclose assets and liabilities carried at fair value in one of the following three categories:
The following table summarizes the fair values, and levels within the fair value hierarchy in which the fair value measurements are included, for assets and liabilities measured on a recurring basis as of September 30, 2023 and December 31, 2022 (in thousands):
Cash and cash equivalents consist primarily of highly rated money market funds at a variety of well-known institutions with original maturities of three months or less. The original cost of these assets approximates fair value due to their short-term maturity. We believe the carrying value of our debt associated with our revolving credit facility approximates its fair value due to the variable rate on such debt. We believe the carrying values of our notes to former owners approximate their fair values due to the relatively short remaining terms on these notes. We have life insurance policies covering 132 employees with a combined face value of $87.8 million. The policies are invested in several investment vehicles, and the fair value measurement of the cash surrender balance associated with these policies is determined using Level 2 inputs within the fair value hierarchy and will vary with investment performance. The cash surrender value of these policies is included in “Other Noncurrent Assets” in our Consolidated Balance Sheets. We value contingent earn-out obligations using a probability weighted discounted cash flow method. This fair value measurement is based on significant unobservable inputs in the market and thus represents a Level 3 measurement within the fair value hierarchy. This analysis reflects the contractual terms of the purchase agreements (e.g., minimum and maximum payments, length of earn-out periods, manner of calculating any amounts due, etc.) and utilizes assumptions with regard to future cash flows and operating income, probabilities of achieving such future cash flows and operating income and a weighted average cost of capital. Significant changes in any of these assumptions could result in a significantly higher or lower potential liability. The contingent earn-out obligations are measured at fair value each reporting period, and changes in estimates of fair value are recognized in earnings. As of September 30, 2023, cash flows were discounted using a weighted average cost of capital ranging from 11.0% - 18.0%. The table below presents a reconciliation of the fair value of our contingent earn-out obligations that use significant unobservable inputs (Level 3) (in thousands):
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Acquisitions | |
Acquisitions | 5. Acquisitions On February 1, 2023, we acquired all of the issued and outstanding shares of capital stock of Eldeco, Inc. (“Eldeco”), headquartered in South Carolina, for a total preliminary purchase price of $74.0 million, which included $60.8 million of cash paid on the closing date, $8.0 million in notes payable to the former owners, an earn-out that will be paid if certain financial targets are met after the acquisition date and a working capital adjustment. Eldeco performs electrical design and construction services in the Southeastern region of the United States. As a result of the acquisition, Eldeco is a wholly owned subsidiary of the Company reported in our electrical segment. On April 1, 2022, we acquired Atlantic Electric, LLC and its related subsidiary (“Atlantic”), headquartered in Charleston, South Carolina, and with operations in South Carolina and Western North Carolina, for a total purchase price of $48.1 million, which included $34.1 million of cash paid on the closing date, $5.3 million in notes payable to former owners and a working capital adjustment. Atlantic performs electrical contracting for customers in various South Carolina markets, as well as installation of airport runway lighting in the Southeast. As a result of the acquisition, Atlantic is a wholly owned subsidiary of the Company reported in our electrical segment. The results of operations of acquisitions are included in our consolidated financial statements from their respective acquisition dates. Our Consolidated Balance Sheet includes preliminary allocations of the purchase price to the assets acquired and liabilities assumed for the applicable acquisitions pending the completion of the final valuation of intangible assets and accrued liabilities. The acquisitions completed in the current and prior year were not material, individually or in the aggregate. Additional contingent purchase price (“earn-out”) has been or will be paid if certain acquisitions achieve predetermined profitability targets. Such earn-outs, when they are not subject to the continued employment of the sellers, are estimated as of the purchase date and included as part of the consideration paid for the acquisition. If we have an earn-out under which continued employment is a condition to receipt of payment, then the earn-out is recorded as compensation expense over the period earned. |
Goodwill and Identifiable Intangible Assets, Net |
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Goodwill and Identifiable Intangible Assets, Net | 6. Goodwill and Identifiable Intangible Assets, Net Goodwill The changes in the carrying amount of goodwill are as follows (in thousands):
Identifiable Intangible Assets, Net At September 30, 2023, future amortization expense of identifiable intangible assets is as follows (in thousands):
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Debt Obligations |
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Debt Obligations | 7. Debt Obligations Debt obligations consist of the following (in thousands):
Revolving Credit Facility On May 25, 2022, we amended our senior credit facility (as amended, the “Facility”) arranged by Wells Fargo Bank, National Association, as administrative agent, and provided by a syndicate of banks, increasing our borrowing capacity to $850 million. As amended, the Facility is composed of a revolving credit line guaranteed by certain of our subsidiaries, in the amount of $850.0 million. The amended Facility also provides for an accordion or increase option not to exceed the greater of (a) $250 million and (b) 1.0x Credit Facility Adjusted EBITDA (as defined below), as well as a sublimit of up to $175.0 million issuable in the form of letters of credit. The Facility expires in July 2027 and is secured by a first lien on substantially all of our personal property except for assets related to projects subject to surety bonds and the equity of, and assets held by, certain unrestricted subsidiaries and our wholly owned captive insurance company, and a second lien on our assets related to projects subject to surety bonds. In 2022, we incurred approximately $2.3 million in financing and professional costs in connection with the amendment to the Facility, which, combined with previously unamortized costs of $1.2 million, are being amortized on a straight-line basis as a non-cash charge to interest expense over the remaining term of the Facility. As of September 30, 2023, we had no outstanding borrowings on the revolving credit facility, $70.0 million in letters of credit outstanding and $780.0 million of credit available. There are two interest rate options for borrowings under the Facility, the Base Rate Loan (as defined in the Facility) option and the Secured Overnight Financing Rate (“SOFR”) Loan option. These rates are floating rates determined by the broad financial markets, meaning they can and do move up and down from time to time. Additional margins are then added to these two rates:
The weighted average interest rate applicable to the borrowings under the revolving credit facility was approximately 5.7% as of December 31, 2022. There were no outstanding borrowings on the revolving credit facility as of September 30, 2023. Certain of our vendors require letters of credit to ensure reimbursement for amounts they are disbursing on our behalf, such as to beneficiaries under our self-funded insurance programs. We have also occasionally used letters of credit to guarantee performance under our contracts and to ensure payment to our subcontractors and vendors under those contracts. Our lenders issue such letters of credit through the Facility. A letter of credit commits the lenders to pay specified amounts to the holder of the letter of credit if the holder demonstrates that we have failed to perform specified actions. If this were to occur, we would be required to reimburse the lenders for amounts they fund to honor the letter of credit holder’s claim. Absent a claim, there is no payment or reserving of funds by us in connection with a letter of credit. However, because a claim on a letter of credit would require immediate reimbursement by us to our lenders, letters of credit are treated as a use of Facility capacity. The letter of credit fees range from 1.00% to 2.00% per annum, based on the Net Leverage Ratio. Commitment fees are payable on the portion of the revolving loan capacity not in use for borrowings or letters of credit at any given time. These fees range from 0.15% to 0.25% per annum, based on the Net Leverage Ratio. The Facility contains financial covenants defining various financial measures and the levels of these measures with which we must comply. Covenant compliance is assessed as of each quarter end. We were in compliance with all of our financial covenants as of September 30, 2023. Notes to Former Owners As part of the consideration used to acquire eleven companies, we have outstanding notes to the former owners. Together, these notes had an outstanding balance of $47.1 million as of September 30, 2023. At September 30, 2023, future principal payments of notes to former owners by maturity year are as follows (dollars in thousands):
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Leases |
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Leases | 8. Leases We lease certain facilities, vehicles and equipment primarily under noncancelable operating leases. The most significant portion of these noncancelable operating leases is for the facilities occupied by our corporate office and our operating locations. Leases with an initial term of 12 months or less are not recorded in the Consolidated Balance Sheet. We do not separate lease components from their associated non-lease components pursuant to lease accounting guidance. We have certain leases with variable payments based on an index as well as some short-term leases on equipment and facilities. Variable lease expense and short-term lease expense aggregated to $17.0 million and $6.3 million for the three months ended September 30, 2023 and 2022, respectively. Variable lease expense and short-term lease expense aggregated to $38.8 million and $14.4 million in the first nine months of 2023 and 2022, respectively. These expenses were primarily related to short-term equipment rentals. Lease right-of-use assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The weighted average discount rate for our operating leases as of September 30, 2023 and December 31, 2022 was 5.8% and 4.3%, respectively. We recognize operating lease expense, including escalating lease payments and lease incentives, on a straight-line basis over the lease term. Operating lease expense for the three months ended September 30, 2023 and 2022 was $25.7 million and $13.1 million, respectively. Operating lease expense for the nine months ended September 30, 2023 and 2022 was $61.7 million and $34.3 million, respectively. The lease terms generally range from to ten years. Some leases include one or more options to renew, which may be exercised to extend the lease term. We include the exercise of lease renewal options in the lease term when it is reasonably certain that we will exercise the option and such exercise is at our sole discretion. In the third quarter of 2023, we commenced two large real estate leases to support our expected growth in off-site construction, with lease terms longer than our typical terms. The weighted average remaining lease term for our operating leases was 11.0 years at September 30, 2023 and 8.1 years at December 31, 2022.A majority of the Company’s real property leases are with individuals or entities with whom we have no other business relationship. However, in certain instances the Company enters into real property leases with current or former employees. Rent paid to related parties for the three months ended September 30, 2023 and 2022 was approximately $1.9 million and $1.7 million, respectively. Rent paid to related parties for the nine months ended September 30, 2023 and 2022 was approximately $5.6 million and $5.2 million, respectively. If we decide to cancel or terminate a lease before the end of its term, we would typically owe the lessor the remaining lease payments under the term of the lease. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. On rare occasions, we rent or sublease certain real estate assets that we no longer use to third parties. The following table summarizes the operating lease assets and liabilities included in the Consolidated Balance Sheet as follows (in thousands):
The maturities of operating lease liabilities are as follows (in thousands):
Supplemental information related to operating leases was as follows (in thousands):
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Commitments and Contingencies |
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Sep. 30, 2023 | |
Commitments and Contingencies | |
Commitments and Contingencies | 9. Commitments and Contingencies Claims and Lawsuits We are subject to certain legal and regulatory claims, including lawsuits arising in the normal course of business. We maintain various insurance coverages to minimize financial risk associated with these claims. We have estimated and provided accruals for probable losses and related legal fees associated with certain litigation in the accompanying consolidated financial statements. While we cannot predict the outcome of these proceedings, in management’s opinion and based on reports of counsel, any liability arising from these matters individually and in the aggregate will not have a material effect on our operating results, cash flows or financial condition, after giving effect to provisions already recorded. During the first quarter of 2023, we recorded a pre-tax gain of $6.8 million from legal developments and settlements that primarily relate to disputes with customers regarding the outcome of completed projects as well as an obligation to perform subcontract work under two executed letters of intent for subsequent projects that we believed were not enforceable. The pre-tax gain of $6.8 million has been recorded as an increase in gross profit of $6.6 million, a reduction in SG&A of $0.7 million, an increase in interest income of $1.3 million and an increase in the change in fair value of contingent earn-out obligations expense of $1.8 million in our Consolidated Statements of Operations. During the third quarter of 2022, we recorded a net gain of $4.5 million related to legal matters that merited changes to our assessments of the related accruals in the ordinary course of our business based on information received in the third quarter of 2022. The largest change in the third quarter resulted from favorable developments related to a dispute with a customer regarding the outcome of a completed project as well as the obligation to perform subcontract work under two executed letters of intent for subsequent projects that we believed were not enforceable. The net gain of $4.5 million was recorded primarily as an increase in gross profit in our Consolidated Statements of Operations. As of September 30, 2023, we recorded an accrual for unresolved matters, which is not material to our financial statements, based on our analysis of likely outcomes related to the respective matters; however, it is possible that the ultimate outcome and associated costs will deviate from our estimates and that, in the event of an unexpectedly adverse outcome, we may experience additional costs and expenses in future periods. Surety Many customers, particularly in connection with new construction, require us to post performance and payment bonds issued by a financial institution known as a surety. If we fail to perform under the terms of a contract or to pay subcontractors and vendors who provided goods or services under a contract, the customer may demand that the surety make payments or provide services under the bond. We must reimburse the surety for any expenses or outlays it incurs. Current market conditions for surety markets and bonding capacity are adequate, with acceptable terms and conditions. Historically, approximately 10% to 20% of our business has required bonds. While we currently have strong surety relationships to support our bonding needs, future market conditions or changes in the sureties’ assessment of our operating and financial risk could cause the sureties to decline to issue bonds for our work. If that were to occur, the alternatives include doing more business that does not require bonds, posting other forms of collateral for project performance, such as letters of credit or cash, and seeking bonding capacity from other sureties. We would likely also encounter concerns from customers, suppliers and other market participants as to our creditworthiness. While we believe our general operating and financial characteristics would enable us to ultimately respond effectively to an interruption in the availability of bonding capacity, such an interruption would likely cause our revenue and profits to decline in the near term. Self-Insurance We are substantially self-insured for workers’ compensation, employer’s liability, auto liability, general liability and employee group health claims, in view of the relatively high per-incident deductibles we absorb under our insurance arrangements for these risks. Losses are estimated and accrued based upon known facts, historical trends and industry averages. Estimated losses in excess of our deductible, which have not already been paid, are included in our accrual with a corresponding receivable from our insurance carrier. Loss estimates associated with the larger and longer-developing risks, such as workers’ compensation, auto liability and general liability, are reviewed by a third-party actuary quarterly.
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Stockholders' Equity |
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Stockholders' Equity | 10. Stockholders’ Equity Earnings Per Share Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Diluted EPS is computed considering the dilutive effect of stock options, restricted stock, restricted stock units and performance stock units. The vesting of unvested, contingently issuable performance stock units is based on the achievement of certain earnings per share targets and total shareholder return. These shares are considered contingently issuable shares for purposes of calculating diluted earnings per share. These shares are not included in the diluted earnings per share denominator until the performance criteria are met, if it is assumed that the end of the reporting period was the end of the contingency period. Unvested restricted stock, restricted stock units and performance stock units are included in diluted earnings per share, weighted outstanding until the shares and units vest. Upon vesting, the vested restricted stock, restricted stock units and performance stock units are included in basic earnings per share weighted outstanding from the vesting date. There were zero anti-dilutive stock options excluded from the calculation of diluted EPS for the three and nine months ended September 30, 2023 and 2022. The following table reconciles the number of shares outstanding with the number of shares used in computing basic and diluted earnings per share for each of the periods presented (in thousands):
Share Repurchase Program On March 29, 2007, our Board of Directors (the “Board”) approved a stock repurchase program to acquire up to 1.0 million shares of our outstanding common stock. Subsequently, the Board has from time to time increased the number of shares that may be acquired under the program and approved extensions of the program. On May 17, 2022, the Board approved an extension to the program by increasing the shares authorized for repurchase by 0.7 million shares. Since the inception of the repurchase program, the Board has approved 10.9 million shares to be repurchased. As of September 30, 2023, we have repurchased a cumulative total of 10.2 million shares at an average price of $25.21 per share under the repurchase program. The share repurchases will be made from time to time at our discretion in the open market or privately negotiated transactions, as permitted by securities laws and other legal requirements, and subject to market conditions and other factors. The Board may modify, suspend, extend or terminate the program at any time. During the nine months ended September 30, 2023, we repurchased 0.1 million shares for approximately $8.6 million at an average price of $134.53 per share. |
Segment Information |
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Segment Information | 11. Segment Information Our activities are within the mechanical services industry and the electrical services industry, which represent our two reportable segments. We aggregate our operating segments into two reportable segments, as the operating segments meet all of the aggregation criteria. The following tables present information about our reportable segments (in thousands):
The electrical segment included a benefit in the third quarter of 2022 related to favorable developments from a dispute with a customer. See Note 9 “Commitments and Contingencies” for further information. |
Subsequent Event |
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Subsequent Event. | |
Subsequent Event | 12. Subsequent Event On October 2, 2023, we acquired all of the issued and outstanding equity interests of DECCO, Inc. (“DECCO”). DECCO is headquartered in Nashua, New Hampshire, and performs mechanical and plumbing services with specialties in piping systems, steam, power, biotechnical processes and conveying systems, in addition to turnkey tool and equipment installation and critical equipment handling services and associated maintenance and support services, in the Northeastern United States. We expect DECCO to initially contribute annualized revenues of approximately $55 to $65 million. DECCO will be included in our mechanical segment.
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Summary of Significant Accounting Policies and Estimates (Policies) |
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Summary of Significant Accounting Policies and Estimates | |
Basis of Presentation | Basis of Presentation These interim statements should be read in conjunction with the historical Consolidated Financial Statements and related notes of Comfort Systems included in the Annual Report on Form 10-K as filed with the Securities and Exchange Commission (“SEC”) for the year ended December 31, 2022 (the “Form 10-K”). The accompanying unaudited consolidated financial statements were prepared using generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and applicable rules of Regulation S-X of the SEC. Accordingly, these financial statements do not include all the footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the Form 10-K. We believe all adjustments necessary for a fair presentation of these interim statements have been included and are of a normal and recurring nature. The results of operations for interim periods are not necessarily indicative of the results for the full fiscal year. Certain amounts in prior periods have been reclassified to conform to the current period presentation. The effects of the reclassifications were not material to the consolidated financial statements. |
Use of Estimates | Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and assumptions by management in determining the reported amounts of assets and liabilities, revenue and expenses and disclosures regarding contingent assets and liabilities. Actual results could differ from those estimates. The most significant estimates used in our financial statements affect revenue and cost recognition for construction contracts, self-insurance accruals, accounting for income taxes, fair value accounting for acquisitions and the quantification of fair value for reporting units in connection with our goodwill impairment testing.
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Recent Accounting Pronouncements | Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements In October 2021, the FASB issued ASU 2021-08, “Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers.” This standard requires an acquirer to apply Accounting Standards Codification Topic 606 to recognize and measure contract assets and contract liabilities in a business combination. ASU 2021-08 is effective for fiscal years beginning after December 15, 2022 and interim periods within that year. We adopted this standard on January 1, 2023, and the impact on our consolidated financial statements was not material.
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Revenue Recognition | Revenue Recognition We recognize revenue over time for all of our services as we perform them because (i) control continuously transfers to that customer as work progresses, and (ii) we have the right to bill the customer as costs are incurred. The customer typically controls the work in process, as evidenced either by contractual termination clauses or by our rights to payment for work performed to date, plus a reasonable profit, for delivery of products or services that do not have an alternative use to the Company. For the reasons listed above, revenue is recognized based on the extent of progress towards completion of the performance obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. We generally use a cost-to-cost input method to measure our progress towards satisfaction of the performance obligation for our contracts, as it best depicts the transfer of assets to the customer that occurs as we incur costs on our contracts. Under the cost-to-cost input method, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenue, including estimated fees or profits, is recorded proportionally as costs are incurred. Costs to fulfill include labor, materials, subcontractors’ costs, other direct costs and an allocation of indirect costs. For a small portion of our business in which our services are delivered in the form of service maintenance agreements for existing systems to be repaired and maintained, as opposed to constructed, our performance obligation is to maintain the customer’s mechanical system for a specific period of time. Similar to construction jobs, we recognize revenue over time; however, for service maintenance agreements in which the full cost to provide services may not be known, we generally use an input method to recognize revenue, which is based on the amount of time we have provided our services out of the total time we have been contracted to perform those services. Our revenue recognition policy is further discussed in Note 3 “Revenue from Contracts with Customers.” |
Accounts Receivable and Allowance for Credit Losses | Accounts Receivable and Allowance for Credit Losses We are required to estimate and record the expected credit losses over the contractual life of our financial assets measured at amortized cost, including billed and unbilled accounts receivable, other receivables and contract assets. Accounts receivable include amounts from work completed in which we have billed or have an unconditional right to bill our customers. Our trade receivables are contractually due in less than a year. We estimate our credit losses using a loss-rate method for each of our identified portfolio segments. Our portfolio segments are construction, service and other. While our construction and service financial assets are often with the same subset of customers and industries, our construction financial assets will generally have a lower loss-rate than service financial assets due to lien rights, which we are more likely to have on construction jobs. These lien rights result in lower credit loss expenses on average compared to receivables that do not have lien rights. Financial assets classified as Other include receivables that are not related to our core revenue producing activities, such as receivables related to our acquisition activity from former owners, our vendor rebate program or receivables for estimated losses in excess of our insurance deductible, which are accrued with a corresponding accrued insurance liability. Loss rates for our portfolios are based on numerous factors, including our history of credit loss expense by portfolio, the financial strength of our customers and counterparties in each portfolio, the aging of our receivables, our expectation of likelihood of payment, macroeconomic trends in the U.S. and the current and forecasted nonresidential construction market trends in the U.S. In addition to the loss-rate calculations discussed above, we also record allowance for credit losses for specific receivables that are deemed to have a higher risk profile than the rest of the respective pool of receivables (e.g., when we hold concerns about a specific customer going bankrupt and no longer being able to pay the receivables due to us).
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Unbilled Accounts Receivable | Unbilled Accounts Receivable Unbilled accounts receivable are amounts due to us that we have earned under a contract where our right to payment is unconditional. A right to consideration is unconditional if only the passage of time is required before payment of the consideration is due. |
Income Taxes | Income Taxes We conduct business throughout the United States in virtually all fifty states. Our effective tax rate changes based upon our relative profitability, or lack thereof, in the federal and various state jurisdictions with differing tax rates and rules. In addition, discrete items such as tax law changes, judgments and legal structures, can impact our effective tax rate. These items can also include the tax treatment for impairment of goodwill and other intangible assets, changes in fair value of acquisition-related assets and liabilities, uncertain tax positions, and accounting for losses associated with underperforming operations. Following an Internal Revenue Service (“IRS”) survey of previously filed refund claims for the 2016, 2017 and 2018 tax years, the Joint Committee on Taxation approved such refunds in late January 2022. As a result, our benefit for income taxes in the first quarter of 2022 included a $28.8 million reduction in unrecognized tax benefits plus approximately $1.6 million of net interest income on the refunds. Our benefit for income taxes in the first quarter of 2022 was further increased by $26.8 million for the expected refunds due to our intention to claim the credit for increasing research activities (“the R&D tax credit”) for the 2019, 2020 and 2021 tax years. In the third quarter of 2022, we claimed the R&D tax credit on our originally filed 2021 federal return and recognized an additional $1.7 million benefit for the 2019, 2020 and 2021 tax years. Additionally, we filed amended federal returns for 2019 and 2020 requesting refunds primarily from claiming the R&D tax credit. The Inflation Reduction Act was enacted on August 16, 2022. This law, among other provisions, provides a corporate alternative minimum tax on adjusted financial statement income over $1 billion, which is effective for tax years beginning after December 31, 2022, and a 1% excise tax on net corporate stock repurchases after December 31, 2022. The impact of the excise tax is recorded in “Treasury Stock” within our Consolidated Balance Sheet. These provisions were not material to our current year overall financial results, financial position and cash flows. In early September 2023, the IRS issued interim guidance addressing, together with other topics, the treatment of research and experimental (“R&E”) expenditures for taxpayers using the percentage of completion method to account for taxable income from long-term contracts. We have chosen to rely on such guidance beginning with the 2022 tax year, and the resultant reduction in taxable revenue offsets the deferral of tax deductions for R&E expenditures pursuant to the Tax Cuts and Jobs Act (2017). We recently filed our 2022 federal return requesting a refund of our $107.1 million overpayment. |
Financial Instruments | Financial Instruments Our financial instruments consist of cash and cash equivalents, accounts receivable, other receivables, accounts payable and life insurance policies, for which we deem the carrying values approximate their fair value due to the short-term nature of these instruments, as well as notes to former owners and a revolving credit facility. |
Investments | Investments We have a $3.7 million investment with a fair value that is not readily determinable and is recorded at cost. This investment is included in “Other Noncurrent Assets” in our Consolidated Balance Sheet and is reviewed quarterly for impairment. We did not recognize any impairments in the current year related to this investment. |
Leases | We lease certain facilities, vehicles and equipment primarily under noncancelable operating leases. The most significant portion of these noncancelable operating leases is for the facilities occupied by our corporate office and our operating locations. Leases with an initial term of 12 months or less are not recorded in the Consolidated Balance Sheet. We do not separate lease components from their associated non-lease components pursuant to lease accounting guidance. We have certain leases with variable payments based on an index as well as some short-term leases on equipment and facilities. Variable lease expense and short-term lease expense aggregated to $17.0 million and $6.3 million for the three months ended September 30, 2023 and 2022, respectively. Variable lease expense and short-term lease expense aggregated to $38.8 million and $14.4 million in the first nine months of 2023 and 2022, respectively. These expenses were primarily related to short-term equipment rentals. Lease right-of-use assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The weighted average discount rate for our operating leases as of September 30, 2023 and December 31, 2022 was 5.8% and 4.3%, respectively. We recognize operating lease expense, including escalating lease payments and lease incentives, on a straight-line basis over the lease term. Operating lease expense for the three months ended September 30, 2023 and 2022 was $25.7 million and $13.1 million, respectively. Operating lease expense for the nine months ended September 30, 2023 and 2022 was $61.7 million and $34.3 million, respectively. The lease terms generally range from to ten years. Some leases include one or more options to renew, which may be exercised to extend the lease term. We include the exercise of lease renewal options in the lease term when it is reasonably certain that we will exercise the option and such exercise is at our sole discretion. In the third quarter of 2023, we commenced two large real estate leases to support our expected growth in off-site construction, with lease terms longer than our typical terms. The weighted average remaining lease term for our operating leases was 11.0 years at September 30, 2023 and 8.1 years at December 31, 2022.A majority of the Company’s real property leases are with individuals or entities with whom we have no other business relationship. However, in certain instances the Company enters into real property leases with current or former employees. Rent paid to related parties for the three months ended September 30, 2023 and 2022 was approximately $1.9 million and $1.7 million, respectively. Rent paid to related parties for the nine months ended September 30, 2023 and 2022 was approximately $5.6 million and $5.2 million, respectively. If we decide to cancel or terminate a lease before the end of its term, we would typically owe the lessor the remaining lease payments under the term of the lease. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. On rare occasions, we rent or sublease certain real estate assets that we no longer use to third parties. |
Revenue from Contracts with Customers (Tables) |
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Revenue from Contracts with Customers | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Schedule of disaggregation of revenue | See details in the following tables (dollars in thousands):
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Schedule of contract assets and liabilities | Contract assets and liabilities in the Consolidated Balance Sheet consisted of the following amounts as of September 30, 2023 and December 31, 2022 (in thousands):
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Fair Value Measurements (Tables) |
9 Months Ended | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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Sep. 30, 2023 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Fair Value Measurements | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Summary of fair values and levels within the fair value hierarchy in which the fair value measurements fall for assets and liabilities measured on a recurring basis | The following table summarizes the fair values, and levels within the fair value hierarchy in which the fair value measurements are included, for assets and liabilities measured on a recurring basis as of September 30, 2023 and December 31, 2022 (in thousands):
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Schedule of reconciliation of the fair value of contingent earn-out obligations that use significant unobservable inputs (Level 3) | The table below presents a reconciliation of the fair value of our contingent earn-out obligations that use significant unobservable inputs (Level 3) (in thousands):
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Goodwill and Identifiable Intangible Assets, Net (Tables) |
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Sep. 30, 2023 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Goodwill and Identifiable Intangible Assets, Net | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Schedule of changes in the carrying amount of goodwill | The changes in the carrying amount of goodwill are as follows (in thousands):
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Schedule of future amortization expense of identifiable intangible assets | At September 30, 2023, future amortization expense of identifiable intangible assets is as follows (in thousands):
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Debt Obligations (Tables) |
9 Months Ended | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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Sep. 30, 2023 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Schedule of components of debt obligations | Debt obligations consist of the following (in thousands):
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Summary of additional margins |
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Notes to Former Owners | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Schedule of future principal payments of notes to former owners | At September 30, 2023, future principal payments of notes to former owners by maturity year are as follows (dollars in thousands):
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Leases (Tables) |
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Sep. 30, 2023 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Leases | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Schedule of operating lease assets and liabilities | The following table summarizes the operating lease assets and liabilities included in the Consolidated Balance Sheet as follows (in thousands):
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Schedule of maturities of lease liabilities | The maturities of operating lease liabilities are as follows (in thousands):
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Schedule of supplemental information related to leases | Supplemental information related to operating leases was as follows (in thousands):
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Stockholders' Equity (Tables) |
9 Months Ended | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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Stockholders' Equity | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Reconciliation of number of shares outstanding with the number of shares used in computing basic and diluted earnings per share | The following table reconciles the number of shares outstanding with the number of shares used in computing basic and diluted earnings per share for each of the periods presented (in thousands):
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Segment Information (Tables) |
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Sep. 30, 2023 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Segment Information | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Summary of information about reportable segments | The following tables present information about our reportable segments (in thousands):
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Summary of Significant Accounting Policies and Estimates - Income Taxes (Details) - USD ($) $ in Millions |
1 Months Ended | 3 Months Ended | |
---|---|---|---|
Sep. 30, 2023 |
Sep. 30, 2022 |
Mar. 31, 2022 |
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Summary of Significant Accounting Policies and Estimates | |||
Reduced provision for income taxes | $ 28.8 | ||
Net interest income on the tax refunds | 1.6 | ||
Refund claim for overpayment | $ 107.1 | ||
Total Tax Years 2019-2021 | |||
Summary of Significant Accounting Policies and Estimates | |||
R&D tax credits | $ 1.7 | $ 26.8 |
Summary of Significant Accounting Policies and Estimates - Investments (Details) $ in Millions |
Sep. 30, 2023
USD ($)
|
---|---|
Summary of Significant Accounting Policies and Estimates | |
Investment fair value | $ 3.7 |
Revenue from Contracts with Customers - Contract Assets and Liabilities (Details) - USD ($) |
9 Months Ended | ||
---|---|---|---|
Sep. 30, 2023 |
Sep. 30, 2022 |
Dec. 31, 2022 |
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Contract Assets | |||
Costs and estimated earnings in excess of billings, less allowance for credit losses | $ 32,554,000 | $ 27,211,000 | |
Contract Liabilities | |||
Billings in excess of costs and estimated earnings and deferred revenue | 775,302,000 | $ 548,293,000 | |
Revenue related to our contract liabilities | 482,900,000 | $ 277,500,000 | |
Impairment losses | $ 0 | $ 0 |
Revenue from Contracts with Customers - Remaining Performance Obligations (Details) $ in Millions |
9 Months Ended |
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Sep. 30, 2023
USD ($)
| |
Remaining Performance Obligations | |
The term of the renewable service maintenance agreements (in years) | 1 year |
Practical Expedient | true |
Revenue, Remaining Performance Obligation, Expected Timing of Satisfaction, Start Date [Axis]: 2023-10-01 | |
Remaining Performance Obligations | |
Remaining performance obligations | $ 4,290 |
Expected timing of performance obligations | 12 months |
Revenue, Remaining Performance Obligation, Expected Timing of Satisfaction, Start Date [Axis]: 2023-10-01 | Minimum | |
Remaining Performance Obligations | |
Expected percentage of remaining performance obligations | 65.00% |
Revenue, Remaining Performance Obligation, Expected Timing of Satisfaction, Start Date [Axis]: 2023-10-01 | Maximum | |
Remaining Performance Obligations | |
Expected percentage of remaining performance obligations | 75.00% |
Acquisitions (Details) - USD ($) $ in Millions |
Feb. 01, 2023 |
Apr. 01, 2022 |
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Atlantic | ||
Consideration transferred: | ||
Fair value of consideration transferred | $ 48.1 | |
Cash paid at closing | 34.1 | |
Notes issued to former owners | $ 5.3 | |
Eldeco Inc | ||
Consideration transferred: | ||
Fair value of consideration transferred | $ 74.0 | |
Cash paid at closing | 60.8 | |
Notes issued to former owners | $ 8.0 |
Goodwill and Identifiable Intangible Assets, Net - Changes in Carrying Amount of Goodwill (Details) - USD ($) $ in Thousands |
9 Months Ended | 12 Months Ended |
---|---|---|
Sep. 30, 2023 |
Dec. 31, 2022 |
|
Changes in the carrying amount of goodwill | ||
Balance at beginning of year | $ 611,789 | $ 592,114 |
Acquisitions and purchase price adjustments (See Note 5) | 25,698 | 19,675 |
Balance at end of period | 637,487 | 611,789 |
Mechanical Segment [Member] | ||
Changes in the carrying amount of goodwill | ||
Balance at beginning of year | 363,929 | 361,320 |
Acquisitions and purchase price adjustments (See Note 5) | 2,609 | |
Balance at end of period | 363,929 | 363,929 |
Electrical Segment [Member] | ||
Changes in the carrying amount of goodwill | ||
Balance at beginning of year | 247,860 | 230,794 |
Acquisitions and purchase price adjustments (See Note 5) | 25,698 | 17,066 |
Balance at end of period | $ 273,558 | $ 247,860 |
Goodwill and Identifiable Intangible Assets, Net - Identifiable Intangible Assets, Net (Details) $ in Thousands |
Sep. 30, 2023
USD ($)
|
---|---|
Future amortization expense of identifiable intangible assets | |
2023 (remainder of the year) | $ 10,314 |
2024 | 37,006 |
2025 | 34,525 |
2026 | 33,681 |
2027 | 31,699 |
Thereafter | 126,903 |
Total | $ 274,128 |
Debt Obligations (Details) - USD ($) $ in Thousands |
Sep. 30, 2023 |
Dec. 31, 2022 |
---|---|---|
Debt Obligations | ||
Other debt | $ 159 | $ 205 |
Total debt | 47,265 | 256,245 |
Less-current portion | (13,333) | (9,000) |
Total long-term portion of debt | 33,932 | 247,245 |
Revolving Credit Facility | ||
Debt Obligations | ||
Revolving credit facility | 215,000 | |
Notes to Former Owners | ||
Debt Obligations | ||
Notes to former owners | $ 47,106 | $ 41,040 |
Leases (Details) $ in Millions |
3 Months Ended | 9 Months Ended | |||
---|---|---|---|---|---|
Sep. 30, 2023
USD ($)
lease
|
Sep. 30, 2022
USD ($)
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Sep. 30, 2023
USD ($)
lease
Option
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Sep. 30, 2022
USD ($)
|
Dec. 31, 2022 |
|
Leases | |||||
Variable lease expense and short-term lease expenses | $ 17.0 | $ 6.3 | $ 38.8 | $ 14.4 | |
Weighted average discount rate for operating leases | 5.80% | 5.80% | 4.30% | ||
Operating lease expense | $ 25.7 | 13.1 | $ 61.7 | 34.3 | |
Weighted average remaining lease term | 11 years | 11 years | 8 years 1 month 6 days | ||
Rent paid to related parties | $ 1.9 | $ 1.7 | $ 5.6 | $ 5.2 | |
Existence of option to extend | true | ||||
Number of off-site construction real estate leases commenced | lease | 2 | 2 | |||
Minimum | |||||
Leases | |||||
Lease term for operating lease | 3 years | 3 years | |||
Number of options to renew | Option | 1 | ||||
Maximum | |||||
Leases | |||||
Lease term for operating lease | 10 years | 10 years |
Leases - Summary of Operating Lease Assets and Liabilities (Details) - USD ($) $ in Thousands |
Sep. 30, 2023 |
Dec. 31, 2022 |
---|---|---|
Summary of lease asset and liabilities | ||
Operating lease right-of-use assets | $ 209,138 | $ 130,666 |
Operating lease liabilities: | ||
Other current liabilities | $ 23,346 | $ 21,151 |
Operating Lease, Liability, Current, Statement of Financial Position [Extensible List] | Other Liabilities, Current | Other Liabilities, Current |
Long-term operating lease liabilities | $ 191,451 | $ 111,744 |
Total operating lease liabilities | $ 214,797 | $ 132,895 |
Leases - Maturities of Lease Liabilities (Details) - USD ($) $ in Thousands |
3 Months Ended | 9 Months Ended | |||
---|---|---|---|---|---|
Sep. 30, 2023 |
Sep. 30, 2022 |
Sep. 30, 2023 |
Sep. 30, 2022 |
Dec. 31, 2022 |
|
Maturities of lease liabilities: | |||||
2023 (excluding the nine months ended September 30, 2023) | $ 8,058 | $ 8,058 | |||
2024 | 34,816 | 34,816 | |||
2025 | 33,412 | 33,412 | |||
2026 | 29,808 | 29,808 | |||
2027 | 25,817 | 25,817 | |||
Thereafter | 169,579 | 169,579 | |||
Total Lease Payments | 301,490 | 301,490 | |||
Less-Present Value Discount | (86,693) | (86,693) | |||
Present Value of Operating Lease Liabilities | 214,797 | 214,797 | $ 132,895 | ||
Supplemental information related to leases: | |||||
Cash paid for amounts included in the measurement of operating lease liabilities | 7,293 | $ 6,777 | 21,362 | $ 19,793 | |
Operating lease right-of-use assets obtained in exchange for lease liabilities | $ 82,352 | $ 6,191 | $ 98,102 | $ 24,560 |
Stockholders' Equity - Incentive and Other (Details) - USD ($) $ / shares in Units, $ in Thousands, shares in Millions |
3 Months Ended | 9 Months Ended | 198 Months Ended | ||||
---|---|---|---|---|---|---|---|
Sep. 30, 2023 |
Sep. 30, 2022 |
Sep. 30, 2023 |
Sep. 30, 2022 |
Sep. 30, 2023 |
May 17, 2022 |
Mar. 29, 2007 |
|
Share Repurchase Program | |||||||
Share repurchase | $ 8,563 | $ 36,427 | |||||
Anti-dilutive securities excluded from computation of earnings per share amount (in shares) | 0.0 | 0.0 | 0.0 | 0.0 | |||
Stock Repurchase Program 2007 | |||||||
Share Repurchase Program | |||||||
Number of shares of outstanding common stock authorized to be acquired under a stock repurchase program | 10.9 | 10.9 | 10.9 | 1.0 | |||
Additional number of shares authorized for repurchase | 0.7 | ||||||
Share repurchase (in shares) | 0.1 | 10.2 | |||||
Share repurchase | $ 8,600 | ||||||
Average price (in dollars per share) | $ 134.53 | $ 25.21 |
Stockholders' Equity - Number of Shares (Details) - shares shares in Thousands |
3 Months Ended | 9 Months Ended | ||
---|---|---|---|---|
Sep. 30, 2023 |
Sep. 30, 2022 |
Sep. 30, 2023 |
Sep. 30, 2022 |
|
Reconciliation of the number of shares outstanding with the number of shares used in computing basic and diluted earnings per share | ||||
Common shares outstanding, end of period | 35,760 | 35,774 | 35,760 | 35,774 |
Effect of using weighted average common shares outstanding | 60 | 79 | 59 | 192 |
Shares used in computing earnings per share-basic | 35,820 | 35,853 | 35,819 | 35,966 |
Effect of shares issuable under stock option plans based on the treasury stock method | 28 | 32 | 26 | 39 |
Effect of restricted and contingently issuable shares | 69 | 87 | 65 | 73 |
Shares used in computing earnings per share-diluted | 35,917 | 35,972 | 35,910 | 36,078 |
Segment Information (Details) $ in Thousands |
3 Months Ended | 9 Months Ended | ||
---|---|---|---|---|
Sep. 30, 2023
USD ($)
|
Sep. 30, 2022
USD ($)
|
Sep. 30, 2023
USD ($)
segment
|
Sep. 30, 2022
USD ($)
|
|
Segment Information | ||||
Number of reportable segments | segment | 2 | |||
Revenue | $ 1,378,124 | $ 1,120,012 | $ 3,849,194 | $ 3,023,176 |
Gross Profit | 277,499 | 202,224 | 710,824 | 530,360 |
Operating | Mechanical Segment [Member] | ||||
Segment Information | ||||
Revenue | 1,031,310 | 858,768 | 2,925,848 | 2,318,036 |
Gross Profit | 210,147 | 150,872 | 547,695 | 416,205 |
Operating | Electrical Segment [Member] | ||||
Segment Information | ||||
Revenue | 346,814 | 261,244 | 923,346 | 705,140 |
Gross Profit | $ 67,352 | $ 51,352 | $ 163,129 | $ 114,155 |
Subsequent Event (Details) - USD ($) $ in Thousands |
3 Months Ended | 9 Months Ended | |||
---|---|---|---|---|---|
Oct. 02, 2023 |
Sep. 30, 2023 |
Sep. 30, 2022 |
Sep. 30, 2023 |
Sep. 30, 2022 |
|
Subsequent Event [Line Items] | |||||
Revenues | $ 1,378,124 | $ 1,120,012 | $ 3,849,194 | $ 3,023,176 | |
Subsequent Event | DECCO | Minimum | |||||
Subsequent Event [Line Items] | |||||
Revenues | $ 55,000 | ||||
Subsequent Event | DECCO | Maximum | |||||
Subsequent Event [Line Items] | |||||
Revenues | $ 65,000 |
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