fix_Current_Folio_10Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10‑Q

 

 

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13, OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018

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: 1‑13011

COMFORT SYSTEMS USA, INC.

(Exact name of registrant as specified in its charter)

 

 

DELAWARE
(State or other jurisdiction of
Incorporation or Organization)

76‑0526487
(I.R.S. Employer
Identification No.)

675 Bering Drive
Suite 400
Houston, Texas 77057
(Address of Principal Executive Offices) (Zip Code)

Registrant’s telephone number, including area code: (713) 830‑9600

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. Yes ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes ☒  No ☐

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.

 

 

 

 

 

Large accelerated filer 

Accelerated filer 

Non‑accelerated filer 
(Do not check if a
smaller reporting company)

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 ☐  No ☒

The number of shares outstanding of the issuer’s common stock as of April 19, 2018 was 37,109,941 (excluding treasury shares of 4,013,424).

 

 

 

 


 

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COMFORT SYSTEMS USA, INC.

INDEX TO FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2018

 

 

 

 

 

    

Page

Part I—Financial Information

 

 

Item 1—Financial Statements

 

 

Consolidated Balance Sheets 

 

1

Consolidated Statements of Operations 

 

2

Consolidated Statements of Stockholders’ Equity 

 

3

Consolidated Statements of Cash Flows 

 

4

Condensed Notes to Consolidated Financial Statements 

 

5

Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations 

 

18

Item 3—Quantitative and Qualitative Disclosures about Market Risk 

 

27

Item 4—Controls and Procedures 

 

28

Part II—Other Information 

 

28

Item 1—Legal Proceedings 

 

28

Item 1A—Risk Factors 

 

28

Item 2—Unregistered Sales of Equity Securities and Use of Proceeds 

 

28

Item 6—Exhibits 

 

30

Signatures 

 

31

 

 

 

 

 


 

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COMFORT SYSTEMS USA, INC.

CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share Amounts)

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

    

2018

    

2017

 

 

 

(Unaudited)

 

 

 

 

ASSETS

 

 

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

25,219

 

$

36,542

 

Billed accounts receivable, less allowance for doubtful accounts of $3,516 and $3,400, respectively

 

 

392,998

 

 

382,867

 

Unbilled accounts receivable

 

 

36,634

 

 

 —

 

Other receivables

 

 

17,685

 

 

21,235

 

Inventories

 

 

11,029

 

 

10,303

 

Prepaid expenses and other

 

 

6,135

 

 

8,294

 

Costs and estimated earnings in excess of billings

 

 

2,093

 

 

30,116

 

Total current assets

 

 

491,793

 

 

489,357

 

PROPERTY AND EQUIPMENT, NET

 

 

88,298

 

 

87,591

 

GOODWILL

 

 

203,199

 

 

200,584

 

IDENTIFIABLE INTANGIBLE ASSETS, NET

 

 

78,332

 

 

76,044

 

DEFERRED TAX ASSETS

 

 

16,890

 

 

22,966

 

OTHER NONCURRENT ASSETS

 

 

4,206

 

 

4,578

 

Total assets

 

$

882,718

 

$

881,120

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

 

Current maturities of long-term debt

 

$

1,113

 

$

613

 

Accounts payable

 

 

128,249

 

 

132,011

 

Accrued compensation and benefits

 

 

56,199

 

 

69,217

 

Billings in excess of costs and estimated earnings

 

 

107,939

 

 

106,005

 

Accrued self-insurance

 

 

32,099

 

 

32,228

 

Other current liabilities

 

 

40,437

 

 

33,654

 

Total current liabilities

 

 

366,036

 

 

373,728

 

LONG-TERM DEBT

 

 

64,880

 

 

59,926

 

DEFERRED TAX LIABILITIES

 

 

4,835

 

 

2,263

 

OTHER LONG-TERM LIABILITIES

 

 

17,829

 

 

27,258

 

Total liabilities

 

 

453,580

 

 

463,175

 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

 

 

Preferred stock, $.01 par, 5,000,000 shares authorized, none issued and outstanding

 

 

 —

 

 

 —

 

Common stock, $.01 par, 102,969,912 shares authorized, 41,123,365 and 41,123,365 shares issued, respectively

 

 

411

 

 

411

 

Treasury stock, at cost, 4,035,263 and 3,936,291 shares, respectively

 

 

(69,322)

 

 

(63,519)

 

Additional paid-in capital

 

 

315,907

 

 

312,784

 

Retained earnings

 

 

182,142

 

 

168,269

 

Total stockholders’ equity

 

 

429,138

 

 

417,945

 

Total liabilities and stockholders’ equity

 

$

882,718

 

$

881,120

 

 

The accompanying notes are an integral part of these consolidated financial statements.

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COMFORT SYSTEMS USA, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Data)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

    

2018

    

2017

 

REVENUE

 

$

464,941

 

$

380,588

 

COST OF SERVICES

 

 

375,888

 

 

304,634

 

Gross profit

 

 

89,053

 

 

75,954

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

 

70,023

 

 

63,247

 

GOODWILL IMPAIRMENT

 

 

 —

 

 

1,105

 

GAIN ON SALE OF ASSETS

 

 

(211)

 

 

(154)

 

Operating income

 

 

19,241

 

 

11,756

 

OTHER INCOME (EXPENSE):

 

 

 

 

 

 

 

Interest income

 

 

14

 

 

11

 

Interest expense

 

 

(713)

 

 

(390)

 

Changes in the fair value of contingent earn-out obligations

 

 

153

 

 

(26)

 

Other

 

 

38

 

 

18

 

Other income (expense)

 

 

(508)

 

 

(387)

 

INCOME BEFORE INCOME TAXES

 

 

18,733

 

 

11,369

 

PROVISION FOR INCOME TAXES

 

 

2,074

 

 

3,892

 

NET INCOME

 

$

16,659

 

$

7,477

 

 

 

 

 

 

 

 

 

INCOME PER SHARE:

 

 

 

 

 

 

 

Basic

 

$

0.45

 

$

0.20

 

Diluted

 

$

0.44

 

$

0.20

 

 

 

 

 

 

 

 

 

SHARES USED IN COMPUTING INCOME PER SHARE:

 

 

 

 

 

 

 

Basic

 

 

37,192

 

 

37,225

 

Diluted

 

 

37,628

 

 

37,724

 

DIVIDENDS PER SHARE

 

$

0.075

 

$

0.070

 

The accompanying notes are an integral part of these consolidated financial statements.

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COMFORT SYSTEMS USA, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In Thousands, Except Share Amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Total

 

 

    

Common Stock

    

Treasury Stock

    

Paid-In

 

Retained

    

Stockholders’

 

 

    

Shares

    

Amount

    

Shares

    

Amount

    

Capital

    

Earnings

    

Equity

 

BALANCE AT DECEMBER 31, 2016

 

41,123,365

 

$

411

 

(3,914,251)

 

$

(57,387)

 

$

309,625

 

$

123,984

 

$

376,633

 

Net income

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

55,272

 

 

55,272

 

Issuance of Stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of shares for options exercised

 

 —

 

 

 —

 

145,746

 

 

2,257

 

 

(205)

 

 

 —

 

 

2,052

 

Issuance of restricted stock & performance stock

 

 —

 

 

 —

 

134,646

 

 

2,037

 

 

(421)

 

 

 —

 

 

1,616

 

Shares received in lieu of tax withholding payment on vested restricted stock

 

 —

 

 

 —

 

(39,335)

 

 

(1,419)

 

 

 —

 

 

 —

 

 

(1,419)

 

Stock-based compensation

 

 —

 

 

 —

 

 —

 

 

 —

 

 

3,785

 

 

 —

 

 

3,785

 

Dividends

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

(10,987)

 

 

(10,987)

 

Share repurchase

 

 —

 

 

 —

 

(263,097)

 

 

(9,007)

 

 

 —

 

 

 —

 

 

(9,007)

 

BALANCE AT DECEMBER 31, 2017

 

41,123,365

 

 

411

 

(3,936,291)

 

 

(63,519)

 

 

312,784

 

 

168,269

 

 

417,945

 

Net income (unaudited)

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

16,659

 

 

16,659

 

Issuance of Stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of shares for options exercised (unaudited)

 

 —

 

 

 —

 

19,124

 

 

326

 

 

(88)

 

 

 —

 

 

238

 

Issuance of restricted stock & performance stock (unaudited)

 

 —

 

 

 —

 

52,306

 

 

892

 

 

1,331

 

 

 —

 

 

2,223

 

Shares received in lieu of tax withholding payment on vested restricted stock (unaudited)

 

 —

 

 

 —

 

(19,921)

 

 

(846)

 

 

 —

 

 

 —

 

 

(846)

 

Stock-based compensation (unaudited)

 

 —

 

 

 —

 

 —

 

 

 —

 

 

1,880

 

 

 —

 

 

1,880

 

Dividends (unaudited)

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

(2,786)

 

 

(2,786)

 

Share repurchase (unaudited)

 

 —

 

 

 —

 

(150,481)

 

 

(6,175)

 

 

 —

 

 

 —

 

 

(6,175)

 

BALANCE AT MARCH 31, 2018 (unaudited)

 

41,123,365

 

$

411

 

(4,035,263)

 

$

(69,322)

 

$

315,907

 

$

182,142

 

$

429,138

 

The accompanying notes are an integral part of these consolidated financial statements.

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COMFORT SYSTEMS USA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

    

2018

    

2017

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net income

 

$

16,659

 

$

7,477

 

Adjustments to reconcile net income to net cash provided by operating activities—

 

 

 

 

 

 

 

Amortization of identifiable intangible assets

 

 

3,827

 

 

1,562

 

Depreciation expense

 

 

5,413

 

 

4,577

 

Goodwill impairment

 

 

 —

 

 

1,105

 

Bad debt expense

 

 

261

 

 

219

 

Deferred tax provision (benefit)

 

 

8,648

 

 

(1,077)

 

Amortization of debt financing costs

 

 

94

 

 

94

 

Gain on sale of assets

 

 

(211)

 

 

(154)

 

Changes in the fair value of contingent earn-out obligations

 

 

(153)

 

 

26

 

Stock-based compensation

 

 

2,793

 

 

1,333

 

Changes in operating assets and liabilities, net of effects of acquisitions and divestitures—

 

 

 

 

 

 

 

(Increase) decrease in—

 

 

 

 

 

 

 

Receivables, net

 

 

(3,542)

 

 

24,525

 

Inventories

 

 

(537)

 

 

(750)

 

Prepaid expenses and other current assets

 

 

3,388

 

 

659

 

Costs and estimated earnings in excess of billings and unbilled accounts receivable

 

 

(8,065)

 

 

(6,605)

 

Other noncurrent assets

 

 

296

 

 

465

 

Increase (decrease) in—

 

 

 

 

 

 

 

Accounts payable and accrued liabilities

 

 

(15,663)

 

 

(16,299)

 

Billings in excess of costs and estimated earnings

 

 

(293)

 

 

(7,151)

 

Other long-term liabilities

 

 

(9,064)

 

 

47

 

Net cash provided by operating activities

 

 

3,851

 

 

10,053

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(5,588)

 

 

(5,077)

 

Proceeds from sales of property and equipment

 

 

366

 

 

292

 

Cash paid for acquisitions, net of cash acquired

 

 

(6,719)

 

 

(313)

 

Net cash used in investing activities

 

 

(11,941)

 

 

(5,098)

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Proceeds from revolving line of credit

 

 

20,000

 

 

 —

 

Payments on revolving line of credit

 

 

(15,000)

 

 

 —

 

Payments on other debt

 

 

(546)

 

 

(25)

 

Payments on capital lease obligations

 

 

 —

 

 

(57)

 

Payments of dividends to stockholders

 

 

(2,786)

 

 

(2,608)

 

Share repurchase

 

 

(4,293)

 

 

(2,197)

 

Shares received in lieu of tax withholding

 

 

(846)

 

 

(632)

 

Proceeds from exercise of options

 

 

238

 

 

736

 

Deferred acquisition payments

 

 

 —

 

 

(802)

 

Net cash used in financing activities

 

 

(3,233)

 

 

(5,585)

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

 

 

(11,323)

 

 

(630)

 

CASH AND CASH EQUIVALENTS, beginning of period

 

 

36,542

 

 

32,074

 

CASH AND CASH EQUIVALENTS, end of period

 

$

25,219

 

$

31,444

 

 

The accompanying notes are an integral part of these consolidated financial statements.

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COMFORT SYSTEMS USA, INC.

 

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

March 31, 2018

 

(Unaudited)

1. Business and Organization

 

Comfort Systems USA, Inc., a Delaware corporation, provides comprehensive mechanical contracting services, which principally includes heating, ventilation and air conditioning (“HVAC”), plumbing, piping and controls, as well as off-site construction, electrical, monitoring and fire protection. We install, maintain, repair and replace products and systems throughout the United States. Approximately 39% of our consolidated 2018 revenue is attributable to installation of systems in newly constructed facilities, with the remaining 61% attributable to maintenance, repair and replacement services. 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

 

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, 2017 (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.

 

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, the allowance for doubtful accounts, self-insurance accruals, deferred tax assets, warranty accruals, fair value accounting for acquisitions and the quantification of fair value for reporting units in connection with our goodwill impairment testing.

 

Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” Topic 606 supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605)” and requires entities to recognize revenue when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We adopted Topic 606 as of January 1, 2018.

 

In accordance with Topic 606, we applied the modified retrospective method to those contracts which were not completed as of January 1, 2018. Under the modified retrospective method, the cumulative effect of applying the standard is recognized at the date of initial application. Results for reporting periods beginning after January 1, 2018 are

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presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

 

In implementing Topic 606, we were required to recalculate the revenue earned on any work in process at the implementation date and to restate the revenue and cost of services as if Topic 606 had been followed from the inception of the contract.  In recalculating costs and revenue under Topic 606 guidelines, we identified no material difference in the account balances.  Since a material difference was not found, no retrospective analysis of account balance changes was required.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)”. The standard requires lessees to recognize assets and liabilities for most leases. ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted. ASU 2016-02’s transition provisions are applied using a modified retrospective approach at the beginning of the earliest comparative period presented in the financial statements. Full retrospective application is prohibited. We are currently evaluating the potential impact of this authoritative guidance on our consolidated financial statements.

 

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments”. This standard provides guidance on how certain cash receipts and cash payments are presented and classified in the statement of cash flows and is intended to reduce diversity in practice with respect to these items.  The standard is applied using a retrospective transition method and is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. We adopted this standard on January 1, 2018 and the adoption did not have any impact on our consolidated financial statements.

 

Revenue Recognition

 

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 comprehensive mechanical contracting services, which principally includes HVAC, plumbing, piping and controls, as well as off‑site construction, electrical, monitoring and fire protection. We 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.

 

For fixed price agreements, we use the percentage of completion method of accounting under which contract revenue recognizable at any time during the life of a contract is determined by multiplying expected total contract revenue by the percentage of contract costs incurred at any time to total estimated contract costs. More specifically, as part of the negotiation and bidding process to obtain installation contracts, we estimate our contract costs, which include all direct materials, labor and subcontract costs and indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation costs. These contract costs are included in our results of operations under the caption “Cost of Services.” Then, as we perform under those contracts, we measure costs incurred, compare them to total estimated costs to complete the contract and recognize a corresponding proportion of contract revenue. Labor costs are considered to be incurred as the work is performed. Subcontractor labor is recognized as the work is performed. Non‑labor project costs consist of purchased equipment, prefabricated materials and other materials. Purchased equipment on our projects is substantially produced to job specifications and is a value-added element to our work. The costs are considered to be incurred when title is transferred to us, which typically is upon delivery to the work site. Prefabricated materials, such as ductwork and piping, are generally performed at our shops and recognized as contract costs when fabricated for the unique specifications of the job. Other materials costs are generally recorded when delivered to the work site. This measurement and comparison process requires updates to the estimate of total costs to complete the contract, and these updates may include subjective assessments and judgments.

 

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

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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.

 

Selling, marketing and estimation costs incurred in relation to selling contracts are expensed as incurred.  On rare occasions, we may incur significant expense related to selling a contract that we only incurred because we sold that contract.  If this occurs, we capitalize that cost and amortize it on a straight-line basis over the expected life of the job.  We do not currently have any capitalized selling, marketing, or estimation costs on our Balance Sheet and did not incur any impairment loss in the current year.

 

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 on a percentage of completion basis over the life of the contract. We do not currently have any capitalized obtaining or fulfillment costs on our Balance Sheet and did not incur any impairment loss on such costs in the current year.

 

Project contracts typically provide for a schedule of billings or invoices to the customer based on our job to date percentage of completion of specific tasks inherent in the fulfillment of our performance obligation(s). The schedules for such billings usually do not precisely match the schedule on which costs are incurred. As a result, contract revenue recognized in the statement of operations can and usually does differ from amounts that can be billed or invoiced to the customer at any point during the contract. Amounts by which cumulative contract revenue recognized on a contract as of a given date exceed cumulative billings and unbilled receivables to the customer under the contract are reflected as a current asset in our balance sheet under the caption “Costs and estimated earnings in excess of billings” and “Unbilled accounts receivable.” Amounts by which cumulative billings to the customer under a contract as of a given date exceed cumulative contract revenue recognized on the contract are reflected as a current liability in our balance sheet under the caption “Billings in excess of costs and estimated earnings.”

We typically invoice our customers with payment terms of net due in 30 days.  It is common in the construction industry for a contract to specify specific more lenient payment terms allowing the customer 45 to 60 days to make their payment.  It is also common for the contract in the construction industry to specify that a general contractor is not required to submit payments to a subcontractor until it has received those funds from the owner or funding source.  In most instances we receive payment of our invoices between 30 to 90 days of the date of the invoice.

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied.

 

To determine the proper revenue recognition method for contracts, we evaluate whether two or more contracts should be combined and accounted for as one performance obligation and whether the combined or single contract should be accounted for as more than one performance obligation. This evaluation requires significant judgment and the decision to combine a group of contracts or separate the combined or single contract into multiple performance obligations could change the amount of revenue and profit recorded in a given period. For most of our contracts, the customer contracts with us to provide a significant service of integrating a complex set of tasks and components into a single project or capability (even if that single project results in the delivery of multiple units). Hence, the entire contract is accounted for as one performance obligation. Less commonly, however, we may promise to provide distinct goods or services within a contract in which case we separate the contract into more than one performance obligation. If a contract is separated into more than one performance obligation, we allocate the total transaction price to each performance obligation in an amount based on the estimated relative standalone selling prices of the promised goods or services underlying each performance obligation. We infrequently sell standard products with observable standalone sales. In cases where we do, the observable standalone sales are used to determine the standalone selling price. More frequently, we sell a customized customer specific solution, and in these cases we typically use the expected cost plus a margin approach to estimate the standalone selling price of each performance obligation. 

 

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

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payment for work performed to date plus a reasonable profit to deliver products or services that do not have an alternative use to the Company.

 

Because of control transferring over time, 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 the cost to cost measure of progress 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 measure of progress, 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 and subcontractors’ costs, other direct costs and an allocation of indirect costs.

 

For a small portion of our business where our services are delivered in the form 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 jobs, we recognize revenue over time; however, for service maintenance agreements where the full cost to provide services may not be known, we generally use an output 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.

 

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. On rare occasions, our long-term contracts may contain incentive fees or other provisions that can either increase or decrease the transaction price. These variable amounts generally are 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 additional revenue to us or can be a deduction from contract revenue if we fail to meet stated performance requirements.  We include estimated amounts in the transaction 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 transaction price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available to us.

 

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 catchup 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 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

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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 catchup basis, which recognizes in the current period the cumulative effect of the changes on current and prior periods based on a performance obligation's percentage of completion. A significant change in one or more of these estimates could affect the profitability of one or more of our performance obligations. For projects where 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.

 

The Company typically does not incur any returns, refunds, or similar obligations after the completion of the performance obligation since any deficiencies are corrected during the course of the work or are included as a modification to revenue.  The Company does offer an industry standard warranty on our work, which is most commonly for a one-year period.  The vendors providing the equipment and materials are responsible for any failures in their product unless installed incorrectly.  We include an estimated amount to cover estimated warranty expense in our Cost of Services and record a liability on our Balance Sheet to cover our current estimated outstanding warranty obligations.

 

Prior to implementing ASC 606 on January 1, 2018, our methods for recognizing revenue were very similar to our current method under ASC 606.  We used the actual cost as a percent of total expected cost at completion to estimate our percentage complete on fixed price jobs, a mark-up of costs for jobs where revenue was based on time and materials incurred and elapsed time for those service maintenance contracts where the full cost to provide the services cannot be reasonably estimated. Furthermore, our process for allocating transaction price to performance obligations is also substantially similar to prior years where, in most cases, a contract is one performance obligation.  In those cases where a contract is determined to have more than one performance obligation, the contract price is allocated to each performance obligation based on its standalone sales price.

 

In the first quarter of 2018, net revenue recognized from our performance obligations satisfied in previous periods was not material.  

 

Disaggregation of Revenue

 

We disaggregate our revenue from contracts with customers by activity, customer type and contract type, as we believe it best depicts how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors. Our consolidated 2018 revenue was derived from the following service activities, all of which are in the mechanical services industry, the single industry segment we serve.  See details in the following tables (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

Revenue by Service Provided

 

2018

 

 

2017

 

HVAC and Plumbing

 

$

424,017

 

91

%

 

$

338,723

 

89

%

Building Automation Control Systems

 

 

20,045

 

 4

%

 

 

22,835

 

 6

%

Other

 

 

20,879

 

 5

%

 

 

19,030

 

 5

%

Total

 

$

464,941

 

100

%

 

$

380,588

 

100

%

 

 

 

 

 

 

 

 

 

 

 

 

 

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Three Months Ended March 31,

 

Revenue by Type of Customer

    

2018

 

 

2017

 

Industrial

 

$

100,100

 

22

%

 

$

87,614

 

23

%

Education

 

 

88,203

 

19

%

 

 

61,588

 

16

%

Office Buildings

 

 

69,120

 

15

%

 

 

52,434

 

14

%

Healthcare

 

 

63,183

 

14

%

 

 

51,767

 

14

%

Government

 

 

36,147

 

 8

%

 

 

36,236

 

10

%

Retail, Restaurants and Entertainment

 

 

52,787

 

11

%

 

 

45,225

 

12

%

Multi-Family and Residential

 

 

33,052

 

 7

%

 

 

26,870

 

 7

%

Other

 

 

22,349

 

 4

%

 

 

18,854

 

 4

%

Total

 

$

464,941

 

100

%

 

$

380,588

 

100

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

Revenue by Activity Type

    

2018

 

 

2017

 

New Construction

 

$

183,437

 

39

%

 

$

148,511

 

39

%

Existing Building Construction

 

 

155,197

 

33

%

 

 

118,266

 

31

%

Service Projects

 

 

40,175

 

 9

%

 

 

42,609

 

11

%

Service Calls, Maintenance and Monitoring

 

 

86,132

 

19

%

 

 

71,202

 

19

%

Total

 

$

464,941

 

100

%

 

$

380,588

 

100

%

 

Accounts Receivables

 

Accounts Receivable, include amounts billed and billable from work completed in which we have billed or have an unconditional right to bill our customers. The amounts due are stated at their net estimated realizable value. We maintain an allowance for doubtful accounts to provide for the estimated amount of receivables that will not be collected. The allowance is based upon an assessment of customer creditworthiness, historical payment experience, the age of outstanding receivables and collateral to the extent applicable.

 

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 and revenue recognized exceeds the amount billed to the customer and right to payment is conditional, subject to completing a milestone, such as a phase of the project.  Contract assets are generally classified as current.

 

Contract liabilities consist of advance payments and billings in excess of revenue recognized.  Our contract assets and liabilities are reported in a net position on a contract by contract basis at the end of each reporting period. We classify advance payments and billings in excess of revenue recognized as current. It is very unusual for us to have advanced payments with a term of greater than one year; therefore, our contract assets are usually all current.  If we have advanced payments with a term greater than one year, the noncurrent portion of advanced payments would be included in other long-term liabilities in our consolidated balance sheets.

 

The following table presents the changes in contract assets and contract liabilities (in thousands):

 

 

 

 

 

 

 

 

 

Contract

    

Contract

 

 

Assets

 

Liabilities

 

Balance at beginning of period

$

30,116

 

$

106,005

 

Change due to acquisitions

 

546

 

 

2,227

 

Change due to conditional versus unconditional

 

411

 

 

 —

 

Reclassified to unbilled accounts receivable

 

(28,980)

 

 

 —

 

Change in timing for performance obligation to be satisfied

 

 —

 

 

(293)

 

Balance at March 31, 2018

$

2,093

 

$

107,939

 

 

In the first quarters of 2018 and 2017, we recognized revenue of $85.5 million and $69.9 million related to our contract liabilities at January 1, 2018 and January 1, 2017, respectively.

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We did not have any impairment losses recognized on our receivables or contract assets in the first quarters of 2018 and 2017.

 

Remaining Performance Obligations

 

Remaining construction performance obligations represent the remaining transaction price of firm orders for which work has not been performed and excludes unexercised contract options.  As of March 31, 2018, the aggregate amount of the transaction price allocated to remaining performance obligations was $1.08 billion. The Company expects to recognize revenue on approximately 85% 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 less than one year, therefore we do not report unfulfilled performance obligations for service maintenance agreements. 

 

Income Taxes

 

We conduct business throughout the United States. Our effective tax rate changes based upon our relative profitability, or lack thereof, in states with varying 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, tax reserves for uncertain tax positions, accounting for losses associated with underperforming operations and noncontrolling interests.

 

Our provision for income taxes was reduced by $2.8 million in the first quarter of 2018 due to a decrease in unrecognized tax benefits from the filing of a federal income tax automatic accounting method change application.

 

Financial Instruments

 

Our financial instruments consist of cash and cash equivalents, accounts receivable, other receivables, accounts payable, life insurance policies, notes to former owners, capital leases and a revolving credit facility. We believe that the carrying values of these instruments on the accompanying balance sheets approximate their fair values.

 

Segment Disclosure

 

Our activities are within the mechanical services industry, which is the single industry segment we serve. Each operating unit represents an operating segment and these segments have been aggregated, as the operating units meet all of the aggregation criteria.

 

 

 

3. Fair Value Measurements

 

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.

 

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The following table summarizes the 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 as of March 31, 2018 and December 31, 2017 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at March 31, 2018

 

    

Level 1

    

Level 2

    

Level 3

    

Total

Cash and cash equivalents

 

$

25,219

 

$

 —

 

$

 —

 

$

25,219

Life insurance—cash surrender value

 

$

 —

 

$

2,950

 

$

 —

 

$

2,950

Contingent earn-out obligations

 

$

 —

 

$

 —

 

$

8,542

 

$

8,542

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at December 31, 2017

 

    

Level 1

    

Level 2

    

Level 3

    

Total

Cash and cash equivalents

 

$

36,542

 

$

 —

 

$

 —

 

$

36,542

Life insurance—cash surrender value

 

$

 —

 

$

3,128

 

$

 —

 

$

3,128

Contingent earn-out obligations

 

$

 —

 

$

 —

 

$

7,993

 

$

7,993

 

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. The carrying value of our borrowings associated with the Revolving Credit Facility approximate its fair value due to the variable rate on such debt.

 

One of our operations has life insurance policies covering 42 employees with a combined face value of $31.3 million. The policy is invested in mutual funds 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 was $3.0 million as of March 31, 2018 and $3.1 million as of December 31, 2017. These assets are 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, probabilities of achieving such future cash flows and a discount rate. The contingent earn-out obligations are measured at fair value each reporting period and changes in estimates of fair value are recognized in earnings.

 

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).

 

 

 

 

 

 

Balance at beginning of year

    

$

7,993

 

Issuances

 

 

1,000

 

Settlements

 

 

(298)

 

Adjustments to fair value

 

 

(153)

 

Balance at March 31, 2018

 

$

8,542

 

 

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. During the first quarter of 2017, we recorded a goodwill impairment charge of $1.1 million based on Level 3 measurements. See Note 5 “Goodwill” for further discussion. We did not recognize any impairments, in the current year, on those assets required to be measured at fair value on a nonrecurring basis.

 

4. Acquisitions

 

On April 1, 2017, we acquired all of the issued and outstanding stock of BCH Holdings, Inc. and each of its wholly-owned subsidiaries (collectively “BCH”) for $121.3 million of which $97.0 million was allocated to goodwill

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and identifiable intangible assets. The total purchase price included $95.4 million in cash, $14.3 million in notes payable to former owners and an $11.6 million contingent earn-out obligation.  BCH is an integrated, single-source provider of mechanical service, maintenance and construction with headquarters in Tampa, Florida and operations throughout the southeastern region of the United States, which reports as a separate operating location.

 

We completed two acquisitions in the first quarter of 2018 with a total purchase price of $10.6 million for the three months ended March 31, 2018.  In addition to the BCH acquisition, we completed four additional acquisitions in 2017.  The total purchase price for these acquisitions, including earn-outs, was $9.4 million.  These acquisitions were not material and were “tucked-in” with existing operations.

 

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 acquisition 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 are not subject to the continued employment of the sellers.

 

5. Goodwill

 

The changes in the carrying amount of goodwill are as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

    

2018

    

2017

 

Balance at beginning of year

 

$

200,584

 

$

149,208

 

Additions (See Note 4)

 

 

2,615

 

 

52,481

 

Impairment adjustment

 

 

 —

 

 

(1,105)

 

Balance at end of period

 

$

203,199

 

$

200,584

 

 

We recorded a goodwill impairment charge of $1.1 million during the first quarter of 2017. Based on changes to our market strategy that occurred in March 2017 related to our reporting unit based in California, we reevaluated our projected future earnings for this operating location. When the carrying value of a given reporting unit exceeds its fair value, a goodwill impairment loss is recorded for this difference, not to exceed the carrying amount of goodwill. Based upon our projected future earnings for this location, we could no longer support the related goodwill balance and therefore the goodwill associated with this location was fully impaired. The fair value was estimated using a discounted cash flow model.

 

 

 

6. Debt Obligations

 

Debt obligations consist of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

    

2018

    

2017

 

Revolving credit facility

 

$

50,000

 

$

45,000

 

Notes to former owners

 

 

15,813

 

 

15,325

 

Other debt

 

 

180

 

 

214

 

Total debt

 

 

65,993

 

 

60,539

 

Less—current portion

 

 

(1,113)

 

 

(613)

 

Total long-term portion of debt

 

$

64,880

 

$

59,926

 

 

Revolving Credit Facility

 

We have a $325.0 million senior credit facility (the “Facility”) provided by a syndicate of banks, with a $100 million accordion option. The Facility, which is available for borrowings and letters of credit, expires in February 2021 and is secured by a first lien on substantially all of our personal property except for assets related to projects subject to

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surety bonds and assets held by certain unrestricted subsidiaries and a second lien on our assets related to projects subject to surety bonds. As of March 31, 2018, we had $50.0 million of outstanding borrowings, $33.6 million in letters of credit outstanding and $241.4 million of credit available.

 

There are two interest rate options for borrowings under the Facility, the Base Rate Loan Option and the Eurodollar Rate 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 following is a summary of the additional margins:

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated Total Indebtedness to

 

 

 

Credit Facility Adjusted EBITDA

 

 

    

Less than 0.75

    

0.75 to 1.50

    

1.50 to 2.25

    

2.25 or greater

 

Additional Per Annum Interest Margin Added Under:

 

 

 

 

 

 

 

 

 

Base Rate Loan Option

 

0.25

%  

0.50

%  

0.75

%  

1.00

%

Eurodollar Rate Loan Option

 

1.25

%

1.50

%

1.75

%

2.00

%

 

The weighted average interest rate applicable to the borrowings under the Facility was approximately 3.1% as of March 31, 2018.

 

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 for a fee. We have never had a claim made against a letter of credit that resulted in payments by a lender or by us and believe such a claim is unlikely in the foreseeable future. The letter of credit fees range from 1.25% to 2.00% per annum, based on the ratio of Consolidated Total Indebtedness to Credit Facility Adjusted EBITDA, as defined in the credit agreement.

 

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 0.20% to 0.35% per annum, based on the ratio of Consolidated Total Indebtedness to Credit Facility Adjusted EBITDA, as defined in the credit agreement.

 

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.

 

The Facility’s principal financial covenants include:

 

Leverage Ratio—The Facility requires that the ratio of our Consolidated Total Indebtedness to our Credit Facility Adjusted EBITDA not exceed 2.75 to 1.00 as of the end of each fiscal quarter. The leverage ratio as of March 31, 2018 was 0.4.

 

Fixed Charge Coverage Ratio—The Facility requires that the ratio of (a) Credit Facility Adjusted EBITDA, less non-financed capital expenditures, provision for income taxes, dividends and amounts used to repurchase stock to (b) the sum of interest expense and scheduled principal payments of indebtedness be at least 2.00 to 1.00; provided that the calculation of the fixed charge coverage ratio excludes stock repurchases and the payment of dividends at any time that the Company’s Net Leverage Ratio does not exceed 1.50 to 1.00. The Facility also allows the fixed charge coverage ratio not to be reduced for stock repurchases through September 30, 2015 in an aggregate amount not to exceed $25 million and for stock repurchases made after February 22, 2016 but on or prior to December 31, 2017 in an aggregate amount not to exceed $25 million, if at the time of and after giving effect to such repurchase the Company’s Net Leverage Ratio was less than or equal to 1.50 to 1.00. Capital expenditures, provision for income taxes, dividends and stock repurchase payments are defined under the Facility for purposes of this covenant to be amounts for the four quarters ending as of any given quarterly covenant compliance measurement date. The fixed charge coverage ratio as of March 31, 2018 was 19.9.

 

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Other Restrictions—The Facility permits acquisitions of up to $30.0 million per transaction, provided that the aggregate purchase price of all such acquisitions in the same fiscal year does not exceed $65.0 million. However, these limitations only apply when the Company’s Total Leverage Ratio is greater than 2.00 to 1.00.

 

While the Facility’s financial covenants do not specifically govern capacity under the Facility, if our debt level under the Facility at a quarter-end covenant compliance measurement date were to cause us to violate the Facility’s leverage ratio covenant, our borrowing capacity under the Facility and the favorable terms that we currently have could be negatively impacted by the lenders.

 

We were in compliance with all of our financial covenants as of March 31, 2018.

 

Notes to Former Owners

 

As part of the consideration used to acquire three companies, we have outstanding notes to the former owners. These notes had an outstanding balance of $15.8 million as of March 31, 2018. In conjunction with a small acquisition in the first quarter of 2018, we issued a subordinated note to former owners with an outstanding balance of $1.0 million as of March 31, 2018 that bears interest, payable quarterly, at a weighted average interest rate of 2.5%.  The principal is due in equal installments in January 2019 and 2020.  In conjunction with the BCH acquisition in the second quarter of 2017, we issued a promissory note to former owners with an outstanding balance of $14.3 million as of March 31, 2018 that bears interest, payable quarterly, at a weighted average interest rate of 3.0%.  The principal is due in equal installments in April 2020 and 2021. In conjunction with the Shoffner acquisition in the first quarter of 2016, we issued a subordinated note to former owners with an outstanding balance of $0.5 million as of March 31, 2018 that bears interest, payable quarterly, at a weighted average interest rate of 3.0%. The principal is due in February 2019.

 

Other Debt

 

As part of the Shoffner acquisition, we acquired debt with an outstanding balance at the acquisition date of $0.4 million with principal and interest due the last day of every month; ending on the December 30, 2019 maturity date. The interest rate is the one month LIBOR rate plus 2.25%. As of March 31, 2018, $0.2 million of the note was outstanding, of which $0.1 million was considered current.

 

7. 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.

 

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. To date, we are not aware of any losses to our sureties in connection with bonds the sureties have posted on our behalf, and do not expect such losses to be incurred in the foreseeable future.

 

Surety market conditions have seen some strengthening as the commercial construction markets have started to rebound. Bonding capacity remains adequate in the current market conditions along with acceptable terms and conditions. Historically, approximately 20% to 30% of our business has required bonds. While we currently have strong

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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.

 

8. 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 less than 0.1 million anti-dilutive stock options excluded from the calculation of diluted EPS for the three months ended March 31, 2018 and for the three months ended March 31, 2017.   

 

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

 

 

 

March 31,

 

 

    

2018

    

2017

 

Common shares outstanding, end of period

 

37,088

 

37,226

 

Effect of using weighted average common shares outstanding

 

104

 

(1)

 

Shares used in computing earnings per share—basic

 

37,192

 

37,225

 

Effect of shares issuable under stock option plans based on the treasury stock method

 

317

 

335

 

Effect of restricted and contingently issuable shares

 

119

 

164

 

Shares used in computing earnings per share—diluted

 

37,628

 

37,724

 

 

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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. Since the inception of the repurchase program, the Board has approved 8.1 million shares to be repurchased. As of March 31, 2018, we have repurchased a cumulative total of 7.8 million shares at an average price of $14.28 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 three months ended March 31, 2018, we repurchased 0.2 million shares for approximately $6.2 million at an average price of $41.04 per share.  Approximately 46,000 shares were purchased in March 2018, but were not paid for until April 2018.

 

9. Subsequent Events

 

On April 18, 2018, the Company entered into Amendment No. 5 to Second Amended and Restated Credit Agreement and Amendment to Other Loan Documents (the “Fifth Amendment” and, together with the Facility, the “Amended Facility”) with a syndicate of banks. The Amended Facility is secured by a first lien on substantially all of the Company’s personal property except for assets related to projects subject to surety bonds and assets held by certain unrestricted subsidiaries and a second lien on the Company’s assets related to projects subject to surety bonds. The Amended Facility provides an increased line of credit to the Company from $325 million to $400 million, with a $100 million accordion option. The line of credit includes up to $125 million issuable in the form of letters of credit. The Amended Facility will expire in April 2023.

 

In April 2018, we entered into settlement agreements with British Petroleum (“BP”) related to two claims from one of our subsidiaries regarding the April 2010 BP Deepwater Horizon oil spill.  We expect to record a gain of $3.5 million to $4.0 million in the second quarter of 2018 in “Other Income” as a result of these settlements.  We do not have any remaining subsidiaries with outstanding claims against BP related to this matter.

 

 

 

 

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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, 2017 (the “Form 10‑K”). This discussion contains “forward‑looking statements” regarding our business and industry within the meaning of the Private Securities Litigation Reform Act of 1995. 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 installation, renovation, maintenance, repair and replacement services within the mechanical services industry. We operate primarily in the commercial, industrial and institutional HVAC markets and perform most of our services within office buildings, retail centers, apartment complexes, manufacturing plants, and healthcare, education and government facilities.

 

Nature and Economics of Our Business

 

Approximately 81% of our revenue is earned on a project basis for installation of mechanical systems in newly constructed facilities or for replacement of systems in existing facilities. Customers hire us to ensure such 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. 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.

 

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 service 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 installation and service provider.

 

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.

 

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Labor 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 March 31, 2018 we had 4,419 projects in process. Our average project takes six to nine months to complete, with an average contract price of approximately $563,000. 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 believe is 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 HVAC and related controls systems 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.

 

A stratification of projects in progress as of March 31, 2018, by contract price, is as follows:

 

 

 

 

 

 

 

 

 

    

 

    

Aggregate

 

 

 

 

 

Contract

 

 

 

No. of

 

Price Value

 

Contract Price of Project

 

Projects

 

(millions)

 

Under $1 million

 

3,919

 

$

534.4

 

$1 million - $5 million

 

397

 

 

891.5

 

$5 million - $10 million

 

71

 

 

473.0

 

$10 million - $15 million

 

17

 

 

204.9

 

Greater than $15 million

 

15

 

 

386.3

 

Total

 

4,419

 

$

2,490.1

 

 

In addition to project work, approximately 19% of our revenue represents maintenance and repair service on already installed HVAC 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.