fix_Current_Folio_10Q

Table of Contents

 

 

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 June 30, 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 July 19, 2018 was 37,245,109 (excluding treasury shares of 3,878,256).

 

 

 

 


 

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COMFORT SYSTEMS USA, INC.

INDEX TO FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 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 

 

28

Item 4—Controls and Procedures 

 

28

Part II—Other Information 

 

29

Item 1—Legal Proceedings 

 

29

Item 1A—Risk Factors 

 

29

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

 

29

Item 6—Exhibits 

 

31

Signatures 

 

32

 

 

 

 

 


 

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COMFORT SYSTEMS USA, INC.

CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share Amounts)

 

 

 

 

 

 

 

 

 

 

June 30,

 

December 31,

 

 

    

2018

    

2017

 

 

 

(Unaudited)

 

 

 

 

ASSETS

 

 

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

28,001

 

$

36,542

 

Billed accounts receivable, less allowance for doubtful accounts of $4,202 and $3,400, respectively

 

 

455,596

 

 

382,867

 

Unbilled accounts receivable

 

 

42,237

 

 

 —

 

Other receivables

 

 

11,572

 

 

21,235

 

Inventories

 

 

11,986

 

 

10,303

 

Prepaid expenses and other

 

 

5,183

 

 

8,294

 

Costs and estimated earnings in excess of billings

 

 

7,248

 

 

30,116

 

Total current assets

 

 

561,823

 

 

489,357

 

PROPERTY AND EQUIPMENT, NET

 

 

91,898

 

 

87,591

 

GOODWILL

 

 

205,162

 

 

200,584

 

IDENTIFIABLE INTANGIBLE ASSETS, NET

 

 

77,968

 

 

76,044

 

DEFERRED TAX ASSETS

 

 

17,138

 

 

22,966

 

OTHER NONCURRENT ASSETS

 

 

5,177

 

 

4,578

 

Total assets

 

$

959,166

 

$

881,120

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

 

Current maturities of long-term debt

 

$

1,113

 

$

613

 

Accounts payable

 

 

145,374

 

 

132,011

 

Accrued compensation and benefits

 

 

66,128

 

 

69,217

 

Billings in excess of costs and estimated earnings

 

 

133,962

 

 

106,005

 

Accrued self-insurance

 

 

32,524

 

 

32,228

 

Other current liabilities

 

 

39,211

 

 

33,654

 

Total current liabilities

 

 

418,312

 

 

373,728

 

LONG-TERM DEBT

 

 

57,864

 

 

59,926

 

DEFERRED TAX LIABILITIES

 

 

4,835

 

 

2,263

 

OTHER LONG-TERM LIABILITIES

 

 

17,180

 

 

27,258

 

Total liabilities

 

 

498,191

 

 

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, 3,877,756 and 3,936,291 shares, respectively

 

 

(67,386)

 

 

(63,519)

 

Additional paid-in capital

 

 

316,235

 

 

312,784

 

Retained earnings

 

 

211,715

 

 

168,269

 

Total stockholders’ equity

 

 

460,975

 

 

417,945

 

Total liabilities and stockholders’ equity

 

$

959,166

 

$

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

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

    

2018

    

2017

    

2018

    

2017

 

REVENUE

 

$

535,043

 

$

465,411

 

$

999,984

 

$

845,999

 

COST OF SERVICES

 

 

423,860

 

 

369,673

 

 

799,748

 

 

674,307

 

Gross profit

 

 

111,183

 

 

95,738

 

 

200,236

 

 

171,692

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

 

71,208

 

 

66,599

 

 

141,231

 

 

129,846

 

GOODWILL IMPAIRMENT

 

 

 —

 

 

 —

 

 

 —

 

 

1,105

 

GAIN ON SALE OF ASSETS

 

 

(200)

 

 

(126)

 

 

(411)

 

 

(280)

 

Operating income

 

 

40,175

 

 

29,265

 

 

59,416

 

 

41,021

 

OTHER INCOME (EXPENSE):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

14

 

 

28

 

 

28

 

 

39

 

Interest expense

 

 

(736)

 

 

(1,041)

 

 

(1,449)

 

 

(1,431)

 

Changes in the fair value of contingent earn-out obligations

 

 

(94)

 

 

(598)

 

 

59

 

 

(624)

 

Other

 

 

3,985

 

 

29

 

 

4,023

 

 

47

 

Other income (expense)

 

 

3,169

 

 

(1,582)

 

 

2,661

 

 

(1,969)

 

INCOME BEFORE INCOME TAXES

 

 

43,344

 

 

27,683

 

 

62,077

 

 

39,052

 

PROVISION FOR INCOME TAXES

 

 

10,797

 

 

9,711

 

 

12,871

 

 

13,603

 

NET INCOME

 

$

32,547

 

$

17,972

 

$

49,206

 

$

25,449

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INCOME PER SHARE:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.87

 

$

0.48

 

$

1.32

 

$

0.68

 

Diluted

 

$

0.87

 

$

0.48

 

$

1.31

 

$

0.67

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SHARES USED IN COMPUTING INCOME PER SHARE:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

37,220

 

 

37,296

 

 

37,206

 

 

37,272

 

Diluted

 

 

37,605

 

 

37,705

 

 

37,617

 

 

37,714

 

DIVIDENDS PER SHARE

 

$

0.080

 

$

0.075

 

$

0.155

 

$

0.145

 

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)

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

49,206

 

 

49,206

 

Issuance of Stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of shares for options exercised (unaudited)

 

 —

 

 

 —

 

131,740

 

 

2,276

 

 

(117)

 

 

 —

 

 

2,159

 

Issuance of restricted stock & performance stock (unaudited)

 

 —

 

 

 —

 

129,569

 

 

2,227

 

 

(4)

 

 

 —

 

 

2,223

 

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

 

 —

 

 

 —

 

(36,967)

 

 

(1,540)

 

 

 —

 

 

 —

 

 

(1,540)

 

Stock-based compensation (unaudited)

 

 —

 

 

 —

 

 —

 

 

 —

 

 

3,572

 

 

 —

 

 

3,572

 

Dividends (unaudited)

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

(5,760)

 

 

(5,760)

 

Share repurchase (unaudited)

 

 —

 

 

 —

 

(165,807)

 

 

(6,830)

 

 

 —

 

 

 —

 

 

(6,830)

 

BALANCE AT JUNE 30, 2018 (unaudited)

 

41,123,365

 

$

411

 

(3,877,756)

 

$

(67,386)

 

$

316,235

 

$

211,715

 

$

460,975

 

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)

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

    

2018

    

2017

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net income

 

$

49,206

 

$

25,449

 

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

 

 

 

 

 

 

 

Amortization of identifiable intangible assets

 

 

8,753

 

 

7,302

 

Depreciation expense

 

 

10,969

 

 

9,597

 

Goodwill impairment

 

 

 —

 

 

1,105

 

Bad debt expense (benefit)

 

 

1,186

 

 

(62)

 

Deferred tax provision (benefit)

 

 

8,400

 

 

(2,547)

 

Amortization of debt financing costs

 

 

192

 

 

188

 

Gain on sale of assets

 

 

(411)

 

 

(280)

 

Changes in the fair value of contingent earn-out obligations

 

 

(59)

 

 

624

 

Stock-based compensation

 

 

4,874

 

 

3,447

 

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

 

 

 

 

 

 

 

(Increase) decrease in—

 

 

 

 

 

 

 

Receivables, net

 

 

(55,675)

 

 

(38,886)

 

Inventories

 

 

(1,435)

 

 

(924)

 

Prepaid expenses and other current assets

 

 

4,549

 

 

4,043

 

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

 

 

(18,711)

 

 

(8,781)

 

Other noncurrent assets

 

 

61

 

 

420

 

Increase (decrease) in—

 

 

 

 

 

 

 

Accounts payable and accrued liabilities

 

 

9,470

 

 

13,422

 

Billings in excess of costs and estimated earnings

 

 

24,831

 

 

6,835

 

Other long-term liabilities

 

 

(8,682)

 

 

228

 

Net cash provided by operating activities

 

 

37,518

 

 

21,180

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(14,123)

 

 

(11,646)

 

Proceeds from sales of property and equipment

 

 

661

 

 

605

 

Cash paid for acquisitions, net of cash acquired

 

 

(13,668)

 

 

(83,710)

 

Net cash used in investing activities

 

 

(27,130)

 

 

(94,751)

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Proceeds from revolving line of credit

 

 

34,000

 

 

110,000

 

Payments on revolving line of credit

 

 

(37,000)

 

 

(21,500)

 

Payments on other debt

 

 

(1,069)

 

 

(287)

 

Payments on capital lease obligations

 

 

 —

 

 

(105)

 

Debt financing costs

 

 

(844)

 

 

 —

 

Payments of dividends to stockholders

 

 

(5,760)

 

 

(5,405)

 

Share repurchase

 

 

(6,830)

 

 

(3,816)

 

Shares received in lieu of tax withholding

 

 

(1,540)

 

 

(1,419)

 

Proceeds from exercise of options

 

 

2,159

 

 

1,296

 

Deferred acquisition payments

 

 

 —

 

 

(2,802)

 

Payments for contingent consideration arrangements

 

 

(2,045)

 

 

 —

 

Net cash provided by (used in) financing activities

 

 

(18,929)

 

 

75,962

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

 

(8,541)

 

 

2,391

 

CASH AND CASH EQUIVALENTS, beginning of period

 

 

36,542

 

 

32,074

 

CASH AND CASH EQUIVALENTS, end of period

 

$

28,001

 

$

34,465

 

 

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

 

June 30, 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 37% of our consolidated 2018 revenue is attributable to installation of systems in newly constructed facilities, with the remaining 63% 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 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 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. 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 being in compliance with the construction schedule.

 

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 successful in mitigating these risks or realizing related opportunities these adjustments may result in a decrease in

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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 six months 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 June 30,

 

 

Six Months Ended June 30,

 

Revenue by Service Provided

 

2018

 

 

2017

 

 

2018

 

 

2017

 

HVAC and Plumbing

 

$

484,011

 

90

%

 

$

422,676

 

91

%

 

$

908,028

 

91

%

 

$

761,399

 

90

%

Building Automation Control Systems

 

 

26,261

 

 5

%

 

 

27,925

 

 6

%

 

 

46,306

 

 5

%

 

 

50,760

 

 6

%

Other

 

 

24,771

 

 5

%

 

 

14,810

 

 3

%

 

 

45,650

 

 4

%

 

 

33,840

 

 4

%

Total

 

$

535,043

 

100

%

 

$

465,411

 

100

%

 

$

999,984

 

100

%

 

$

845,999

 

100

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

Revenue by Type of Customer

    

2018

 

    

2017

 

    

2018

 

    

2017

 

Industrial

 

$

114,077

    

21

%

 

$

97,756

    

21

%

 

$

214,177

    

21

%

 

$

185,370

    

22

%

Education

 

 

109,447

 

20

%

 

 

89,274

 

19

%

 

 

197,650

 

20

%

 

 

150,862

 

18

%

Office Buildings

 

 

79,309

 

15

%

 

 

76,470

 

16

%

 

 

148,429

 

15

%

 

 

128,904

 

15

%

Healthcare

 

 

71,930

 

13

%

 

 

59,322

 

13

%

 

 

135,113

 

14

%

 

 

111,089

 

13

%

Government

 

 

37,285

 

 7

%

 

 

35,323

 

 8

%

 

 

73,432

 

 7

%

 

 

71,559

 

 8

%

Retail, Restaurants and Entertainment

 

 

56,204

 

11

%

 

 

54,669

 

12

%

 

 

108,991

 

11

%

 

 

99,894

 

12

%

Multi-Family and Residential

 

 

36,040

 

 7

%

 

 

30,260

 

 7

%

 

 

69,092

 

 7

%

 

 

57,130

 

 7

%

Other

 

 

30,751

 

 6

%

 

 

22,337

 

 4

%

 

 

53,100

 

 5

%

 

 

41,191

 

 5

%

Total

 

$

535,043

 

100

%

 

$

465,411

 

100

%

 

$

999,984

 

100

%

 

$

845,999

 

100

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

Revenue by Activity Type

    

2018

 

 

2017

 

    

2018

 

 

2017

 

New Construction

 

$

183,998

 

34

%

 

$

178,392

 

38

%

 

$

367,435

 

37

%

 

$

326,903

 

39

%

Existing Building Construction

 

 

207,775

 

39

%

 

 

146,980

 

32

%

 

 

362,972

 

36

%

 

 

265,246

 

31

%

Service Projects

 

 

51,586

 

10

%

 

 

46,428

 

10

%

 

 

91,761

 

 9

%

 

 

89,037

 

11

%

Service Calls, Maintenance and Monitoring

 

 

91,684

 

17

%

 

 

93,611

 

20

%

 

 

177,816

 

18

%

 

 

164,813

 

19

%

Total

 

$

535,043

 

100

%

 

$

465,411

 

100

%

 

$

999,984

 

100

%

 

$

845,999

 

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.

 

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

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

June 30, 2018

 

 

Contract

    

Contract

 

 

Assets

 

Liabilities

 

Balance at beginning of period

$

30,116

 

$

106,005

 

Change due to acquisitions

 

658

 

 

3,126

 

Change due to conditional versus unconditional

 

5,454

 

 

 —

 

Reclassified to unbilled accounts receivable

 

(28,980)

 

 

 —

 

Change in timing for performance obligation to be satisfied

 

 —

 

 

24,831

 

Balance at June 30, 2018

$

7,248

 

$

133,962

 

 

In the first six months of 2018 and 2017, we recognized revenue of $94.2 million and $83.5 million related to our contract liabilities at January 1, 2018 and January 1, 2017, respectively.

 

We did not have any impairment losses recognized on our receivables or contract assets in the first six months 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 June 30, 2018, the aggregate amount of the transaction price allocated to remaining performance obligations was $1.23 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 in virtually all fifty 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.

 

While we believe we were able to make reasonable estimates of the impact of the Tax Cuts and Jobs Act in our financial statements, the amounts recorded are provisional and the final impact may differ from these estimates due to, among other things, changes in our interpretations and assumptions and additional guidance that may be issued by regulatory authorities.

 

Other Income

 

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 recorded a gain of $4.0 million in the second quarter of 2018 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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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.

 

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 June 30, 2018 and December 31, 2017 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at June 30, 2018

 

    

Level 1

    

Level 2

    

Level 3

    

Total

Cash and cash equivalents

 

$

28,001

 

$

 —

 

$

 —

 

$

28,001

Life insurance—cash surrender value

 

$

 —

 

$

3,096

 

$

 —

 

$

3,096

Contingent earn-out obligations

 

$

 —

 

$

 —

 

$

6,591

 

$

6,591

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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.

 

We have life insurance policies covering 49 employees with a combined face value of $35.5 million. The policy is 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 was $3.1 million as of June 30, 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.

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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).