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 Commissionfor the year ended December 31, 2020(the "Form 10-K"). This discussion contains "forward-looking statements" regarding our business and industry within the meaning of applicable securities laws and regulations. These statements are based on our current plans and expectations and involve risks and uncertainties that could cause our actual future activities and results of operations to be materially different from those set forth in the forward-looking statements. Important factors that could cause actual results to differ include risks set forth in "Item 1A. Risk Factors" included in our Form 10-K. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. The terms "Comfort Systems," "we," "us," or the "Company," refer to Comfort Systems USA, Inc.or Comfort Systems USA, Inc.and its consolidated subsidiaries, as appropriate in the context.
Introduction and overview
We are a national provider of comprehensive mechanical and electrical installation, renovation, maintenance, repair and replacement services within the mechanical and electrical services industries. We operate primarily in the commercial, industrial and institutional markets and perform most of our work in industrial, healthcare, education, office, technology, retail and government facilities. We operate our business in two business segments: mechanical and electrical.
Nature and economy of our business
In our mechanical business segment, customers hire us to ensure HVAC systems deliver specified or generally expected heating, cooling, conditioning and circulation of air in a facility. This entails installing core system equipment such as packaged heating and air conditioning units, or in the case of larger facilities, separate core components such as chillers, boilers, air handlers, and cooling towers. We also typically install connecting and distribution elements such as piping and ducting.
In our electrical business segment, our main activity is electrical construction and engineering in the commercial and industrial field. We also perform electrical logistics services, electrical maintenance work, and electrical construction and engineering services.
In both our mechanical and electrical business segments, our responsibilities usually require conforming the systems to pre-established engineering drawings and equipment and performance specifications, which we frequently participate in establishing. Our project management responsibilities include staging equipment and materials to project sites, deploying labor to perform the work, and coordinating with other service providers on the project, including any subcontractors we might use to deliver our portion of the work. Approximately 86.3% of our revenue is earned on a project basis for installation services in newly constructed facilities or for replacement of systems in existing facilities. When competing for project business, we usually estimate the costs we will incur on a project, and then propose a bid to the customer that includes a contract price and other performance and payment terms. Our bid price and terms are intended to cover our estimated costs on the project and provide a profit margin to us commensurate with the value of the installed system to the customer, the risk that project costs or duration will vary from estimate, the schedule on which we will be paid, the opportunities for other work that we might forego by committing capacity to this project, and other costs that we incur to support our operations but which are not specific to the project. Typically, customers will seek pricing from competitors for a given project. While the criteria on which customers select a provider vary widely and include factors such as quality, technical expertise, on-time performance, post-project support and service, and company history and financial strength, we believe that price for value is the most influential factor for most customers in choosing a mechanical or electrical installation and service provider. 22 Table of Contents After a customer accepts our bid, we generally enter into a contract with the customer that specifies what we will deliver on the project, what our related responsibilities are, and how much and when we will be paid. Our overall price for the project is typically set at a fixed amount in the contract, although changes in project specifications or work conditions that result in unexpected additional work are usually subject to additional payment from the customer via what are commonly known as change orders. Project contracts typically provide for periodic billings to the customer as we meet progress milestones or incur cost on the project. Project contracts in our industry also frequently allow for a small portion of progress billings or contract price to be withheld by the customer until after we have completed the work. Amounts withheld under this practice are known as retention or retainage. Labor, materials and overhead costs account for the majority of our cost of service. Accordingly, labor management and utilization have the most impact on our project performance. Given the fixed price nature of much of our project work, if our initial estimate of project costs is wrong or we incur cost overruns that cannot be recovered in change orders, we can experience reduced profits or even significant losses on fixed price project work. We also perform some project work on a cost-plus or a time and materials basis, under which we are paid our costs incurred plus an agreed-upon profit margin, and such projects are sometimes subject to a guaranteed maximum cost. These margins are frequently less than fixed-price contract margins because there is less risk of unrecoverable cost overruns in cost-plus or time and materials work. As of
September 30, 2021, we had 6,606 projects in process. Our average project takes six to nine months to complete, with an average contract price of approximately $841,000. 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 consider to be a well-diversified distribution of revenue across end-use sectors that we believe reduces our exposure to negative developments in any given sector. Because of the integral nature of our services to most buildings, we have the legal right in almost all cases to attach liens to buildings or related funding sources when we have not been fully paid for installing systems, except with respect to some government buildings. The service work that we do, which is discussed further below, usually does not
give rise to lien rights. We also perform larger projects. Taken together, projects with contract prices of
$1 millionor more totaled $4.8 billionof aggregate contract value as of September 30, 2021, or approximately 87% of a total contract value for all projects in progress, totaling $5.6 billion. Generally, projects closer in size to $1 millionwill be completed in one year or less. It is unusual for us to work on a project that exceeds two years in length. A stratification of projects in progress as of September 30, 2021, by contract price, is as follows: Aggregate Contract No. of Price Value Contract Price of Project Projects (millions) Under $1 million5,761 $ 711.2 $1 million- $5 million599 1,340.2 $5 million- $10 million128 891.2 $10 million- $15 million45 551.7 Greater than $15 million73 2,059.8 Total 6,606 $ 5,554.1
In addition to project work, approximately 13.7% of our revenue represents maintenance and repair service on already installed HVAC, electrical, and controls systems. This kind of work usually takes from a few hours to a few days to perform. Prices to the customer are based on the equipment and materials used in the service as well as technician labor time. We usually bill the customer for service work when it is complete, typically with payment terms of up to thirty days. We also provide maintenance and repair service under ongoing contracts. Under these contracts, we are paid regular monthly or quarterly amounts and provide specified service based on customer requirements. These agreements typically are for one or more years and frequently contain thirty- to sixty-day cancellation notice periods. 23 Table of Contents
A relatively small portion of our revenue comes from national and regional account customers. These customers typically have multiple sites and contract with us to perform maintenance and repair service. These contracts may also provide for us to perform new or replacement systems installation. We operate a national call center to dispatch technicians to sites requiring service. We perform the majority of this work with our own employees, with the balance being subcontracted to third parties that meet our performance qualifications.
Profile and management of our operations
We manage our 38 operating units based on a variety of factors. Financial measures we emphasize include profitability and use of capital as indicated by cash flow and by other measures of working capital principally involving project cost, billings and receivables. We also monitor selling, general, administrative and indirect project support expense, backlog, workforce size and mix, growth in revenue and profits, variation of actual project cost from original estimate, and overall financial performance in comparison to budget and updated forecasts. Operational factors we emphasize include project selection, estimating, pricing, management and execution practices, labor utilization, safety, training, and the make-up of both existing backlog as well as new business being pursued, in terms of project size, technical application, facility type, end-use customers and industries and location of the work. Most of our operations compete on a local or regional basis. Attracting and retaining effective operating unit managers is an important factor in our business, particularly in view of the relative uniqueness of each market and operation, the importance of relationships with customers and other market participants, such as architects and consulting engineers, and the high degree of competition and low barriers to entry in most of our markets. Accordingly, we devote considerable attention to operating unit management quality, stability, and contingency planning, including related considerations of compensation and non-competition protection where applicable.
Economic and industrial factors
As a mechanical and electrical services provider, we operate in the broader nonresidential construction services industry and are affected by trends in this sector. While we do not have operations in all major cities of
the United States, we believe our national presence is sufficiently large that we experience trends in demand for and pricing of our services that are consistent with trends in the national nonresidential construction sector. As a result, we monitor the views of major construction sector forecasters along with macroeconomic factors they believe drive the sector, including trends in gross domestic product, interest rates, business investment, employment, demographics and the fiscal condition of federal, state and local governments. Spending decisions for building construction, renovation and system replacement are generally made on a project basis, usually with some degree of discretion as to when and if projects proceed. With larger amounts of capital, time, and discretion involved, spending decisions are affected to a significant degree by uncertainty, particularly concerns about economic and financial conditions and trends. We have experienced periods of time when economic weakness caused a significant slowdown in decisions to proceed with installation and replacement project work.
Operating environment and focus on management
During the five-year period from 2015 to 2019, there was an increase in nonresidential building construction and renovation activity levels. In early 2020, the advent of a global pandemic led to some delays in service and construction, including the potential for delayed project starts and air pockets during 2020 and early 2021, and we believe those effects are now abating. We have a credit facility in place with terms we believe are favorable that does not expire until
January 2025. As of September 30, 2021, we had $285.5 millionof credit available to borrow under our credit facility. We have strong surety relationships to support our bonding needs, and we believe our relationships with the surety markets are strong and benefit from our operating history and financial position. We have generated positive free cash flow in each of the last twenty-two calendar years and will continue our emphasis in this area. We believe that the relative size and strength of our Balance Sheet and surety relationships, as compared to most companies in our industry, represent competitive advantages for us. 24 Table of Contents
As discussed at greater length in "Results of Operations" below, we expect price competition to continue as local and regional industry participants compete for customers. We will continue to invest in our service business, to pursue the more active sectors in our markets, and to emphasize our regional and national account business. Cyclicality and Seasonality The construction industry is subject to business cycle fluctuation. As a result, our volume of business, particularly in new construction projects and renovation, may be adversely affected by declines in new installation and replacement projects in various geographic regions of
the United Statesduring periods of economic weakness. The mechanical and electrical contracting industries are also subject to seasonal variations. The demand for new installation and replacement is generally lower during the winter months (the first quarter of the year) due to reduced construction activity during inclement weather and less use of air conditioning during the colder months. Demand for our services is generally higher in the second and third calendar quarters due to increased construction activity and increased use of air conditioning during the warmer months. Accordingly, we expect our revenue and operating results generally will be lower in the first calendar quarter.
Results of operations (dollars in thousands):
Three Months Ended
September 30, Nine
2021 2020 2021 2020 Revenue
$ 833,896100.0 % $ 714,099100.0 % $ 2,217,552100.0 % $ 2,157,698100.0 % Cost of services 674,684 80.9 % 566,903 79.4 % 1,808,416 81.6 % 1,747,714 81.0 % Gross profit 159,212 19.1 % 147,196 20.6 % 409,136 18.4 % 409,984 19.0 % Selling, general and administrative expenses 95,287 11.4 % 90,888 12.7 % 271,050 12.2 % 268,857 12.5 % Gain on sale of assets (180) - (377) (0.1) % (1,021) - (1,243) (0.1) % Operating income 64,105 7.7 % 56,685 7.9 % 139,107 6.3 % 142,370 6.6 % Interest income 1 - 7 - 7 - 99 - Interest expense (1,586) (0.2) % (1,733) (0.2) % (4,443) (0.2) % (6,904) (0.3) % Changes in the fair value of contingent earn-out obligations (1,244) (0.1) % 3,423 0.5 % 4,523 0.2 % 1,824 0.1 % Other income (expense) 20 - (15) - 112 - 10 - Income before income taxes 61,296 7.4 % 58,367 8.2 % 139,306 6.3 % 137,399 6.4 % Provision for income taxes 14,999 8,279 33,553 30,100 Net income $ 46,2975.6 % $ 50,0887.0 % $ 105,7534.8 % $ 107,2995.0 %
We had 37 operating locations as of
December 31, 2020. In the first quarter of 2021, we combined two operating locations into one. Additionally, we completed an immaterial acquisition of a mechanical contractor in Utah, which reports as a separate operating location. In the third quarter of 2021, we completed the acquisition of Amteck, which also reports as a separate operating location. As of September 30, 2021, we had 38 operating locations. Acquisitions are included in our results of operations from the respective acquisition date. The same-store comparison from 2021 to 2020, as described below, excludes one month of results for our electrical contractor in North Carolina, which was acquired February 1, 2020and reports together with our existing North Carolinaoperation, three months of results for TAS, which was acquired on April 1, 2020, nine months of results for TEC, which was acquired on December 31, 2020and two months of results for Amteck, which was acquired on August 1, 2021. An operating location is included in the same-store comparison on the first day it has comparable prior year operating data, except for immaterial acquisitions that are often absorbed and integrated with existing operations. While the electrical contractor in North Carolinawas integrated with our existing North Carolinaoperation, due to the size of the acquired operations, we have elected to exclude their results from our same-store comparison. 25 Table of Contents
Revenue-Revenue for the third quarter of 2021 up
The following table presents our operating segment revenue (in thousands, except percentages): Three Months Ended September 30, 2021 2020 Revenue: Mechanical Services
$ 690,68082.8 % $ 625,66087.6 % Electrical Services 143,216 17.2 % 88,439 12.4 % Total $ 833,896100.0 % $ 714,099100.0 % Revenue for our mechanical services segment increased $65.0 million, or 10.4%, to $690.7 millionfor the third quarter of 2021 compared to the same period in 2020. The increase consisted primarily of an increase in activity in the industrial sector at one of our Texasoperations ( $64.8 million) and in the education sector at one of our Utahoperations ( $9.8 million), partially offset by a reduction in activity in the education sector at one of our Floridaoperations ( $9.1 million). Revenue for our electrical services segment increased $54.8 million, or 61.9%, to $143.2 millionfor the third quarter of 2021 compared to the same period in 2020. The increase primarily resulted from the acquisitions of TEC in December 2020( $22.4 million) and Amteckin August 2021( $34.6 million), partially offset by expected decreases driven by a higher volume of large jobs in the prior period at our Texaselectrical operation ( $5.4 million). Revenue for the first nine months of 2021 increased $59.9 million, or 2.8%, to $2.22 billioncompared to the same period in 2020. The increase included a 5.9% increase related to the North Carolinaelectrical contractor, TEC, TAS and Amteckacquisitions, partially offset by a 3.1% decrease in revenue related
to same-store activity. The following table presents our operating segment revenue (in thousands, except percentages): Nine Months Ended September 30, 2021 2020 Revenue: Mechanical Services
$ 1,868,09684.2 % $ 1,823,11784.5 % Electrical Services 349,456 15.8 % 334,581 15.5 % Total $ 2,217,552100.0 % $ 2,157,698100.0 % Revenue for our mechanical services segment increased $45.0 million, or 2.5%, to $1.87 billionfor the first nine months of 2021 compared to the same period in 2020. The increase included a $90.5 millionincrease related to TAS, of which $60.5 millionresulted from an increase in activity in the industrial sector and $30.0 millionresulted from an additional three months of revenue for TAS in 2021 as compared to 2020. This increase was partially offset by a reduction in activity in the industrial sector at one of our Texasoperations ( $24.3 million) and in the education sector at one of our Virginiaoperations ( $19.4 million). Revenue for our electrical services segment increased $14.9 million, or 4.4%, to $349.5 millionfor the first nine months of 2021 compared to the same period in 2020. The increase primarily resulted from the acquisitions of the North Carolinaelectrical contractor in February 2020( $8.3 million), TEC in December 2020( $53.3 million) and Amteckin August 2021( $34.6 million), as well as an increase in same-store activity for our North Carolinaelectrical contractor ( $13.5 million), partially offset by expected decreases driven by a higher volume of large jobs in the prior period at our Texaselectrical operation ( $94.8 million). Backlog reflects revenue still to be recognized under contracted or committed installation and replacement project work. Project work generally lasts less than one year. Service agreement revenue, service work and short duration projects, which are generally billed as performed, do not flow through backlog. Accordingly, backlog represents only a portion of our revenue for any given future period, and it represents revenue that is likely to be reflected in
our operating 26 Table of Contents
results over the next six to twelve months. Therefore, we believe that the predictive value of backlog information is limited to guidance on the general direction of short-term revenue and should not be interpreted as an indication of continued revenue performance over multiple quarters.
The following table presents our operating segment backlog (in thousands, except percentages): September 30, December 31, September 30, 2021 2020 2020 Backlog: Mechanical Services
$ 1,458,65275.1 % $ 1,267,20083.8 % $ 1,240,48286.8 % Electrical Services 482,725 24.9 % 244,214 16.2 %
188,105 13.2 % Total
$ 1,941,377100.0 % $ 1,511,414100.0 % $ 1,428,587100.0 % Backlog as of September 30, 2021was $1.94 billion, a 5.5% increase from June 30, 2021backlog of $1.84 billion, and a 35.9% increase from September 30, 2020backlog of $1.43 billion. Sequential backlog included the acquisition of Amteck( $89.8 million) and a same-store increase of $11.6 million, or 0.6%. The sequential same-store backlog increase was primarily a result of increased project bookings at our North Carolinaoperation ( $47.2 million), TEC ( $40.3 million), our Coloradooperation ( $35.5 million) and our Arizonaoperation ( $22.3 million). The sequential backlog increase was partially offset by completion of project work at TAS ( $127.6 million). The year-over-year backlog increase included the acquisitions of TEC ( $152.9 million) and Amteck( $89.8 million), as well as a same-store increase of $270.1 million, or 18.9%. Same-store year-over-year backlog was broad-based, and increased primarily due to increased project bookings at our North Carolinaoperation ( $73.9 million), one of our Virginiaoperations ( $37.9 million), our Texaselectrical operation ( $34.2 million) and another one of our Texasoperations ( $20.6 million). Gross Profit-Gross profit increased $12.0 million, or 8.2%, to $159.2 millionfor the third quarter of 2021 as compared to the same period in 2020. The increase included a 4.4% increase related to the TEC and Amteckacquisitions, as well as a 3.8% increase in same-store activity. The same-store increase in gross profit was primarily due to improvements in project execution at TAS ( $11.9 million) and our Texaselectrical operation ( $3.3 million), partially offset by a decrease at our Arizonaoperation ( $4.5 million) and our Indianaoperation ( $2.4 million) compared to the prior year. Additionally, we had decreased volumes at one of our Floridaoperations ( $4.0 million). As a percentage of revenue, gross profit for the third quarter decreased from 20.6% in 2020 to 19.1% in 2021 primarily due to lower margins at our Arizonaand Indianaoperations and one of our Floridaoperations. Gross profit decreased $0.8 million, or 0.2%, to $409.1 millionfor the first nine months of 2021 as compared to the same period in 2020. The decrease included a 3.7% decrease in same-store activity, partially offset by a 3.5% increase related to the TAS, TEC, Amteckand North Carolinaelectrical contractor acquisitions. The same-store decrease in gross profit was primarily due to stronger project execution in the prior year at one of our Floridaoperations ( $10.7 million) and our Indianaoperation ( $6.6 million). Additionally, we had decreased volumes at one of our Virginiaoperations ( $6.3 million), which was offset by increased volumes on a same-store basis at TAS ( $11.9 million). As a percentage of revenue, gross profit for the nine-month period decreased slightly from 19.0% in 2020 to 18.4% in 2021 due to the factors explained above. Selling, General and Administrative Expenses ("SG&A")-SG&A increased $4.4 million, or 4.8%, to $95.3 millionfor the third quarter of 2021 as compared to 2020. On a same-store basis, excluding amortization expense, SG&A decreased $1.8 million, or 2.1%. The same-store decrease is primarily due to a decrease in tax consulting fees ( $2.5 million), as well as a decrease in bad debt expense ( $2.1 million) driven by reserves recorded in the prior year for certain receivables due to the business interruptions caused by COVID-19, specifically with respect to receivables with retail, restaurants and entertainment companies. Additionally, in the current quarter, we collected some of these reserve amounts and lowered our assessed risk on collectability as business impacts relating to COVID-19 have stabilized. These decreases were partially offset by increases as a result of higher same-store revenue as well as an increase in travel related expenses ( $0.8 million), which were lower in the prior year as a result of COVID-19. Amortization expense increased $0.9 millionduring the period, primarily as a result of the TEC and Amteckacquisitions. As a percentage of revenue, SG&A for the third quarter decreased from 12.7% in 2020 to 11.4% in 2021. 27 Table of Contents
$2.2 million, or 0.8%, to $271.1 millionfor the first nine months of 2021 as compared to 2020. On a same-store basis, excluding amortization expense, SG&A decreased $12.1 million, or 4.8%. This same-store decrease is primarily due to a decrease of $7.1 millionin bad debt expense in the first nine months of 2021 as compared to the same period in 2020 driven by reserves recorded in the prior year for certain receivables due to the business interruptions caused by COVID-19, specifically with respect to receivables with retail, restaurants and entertainment companies. Additionally, in the current year, we collected some of these reserve amounts and lowered our assessed risk on collectability as business impacts relating to COVID-19 have stabilized. Furthermore, tax consulting fees decreased $2.4 millionas compared to the same period in 2020. Amortization expense increased $2.4 millionduring the period, primarily as a result of the TAS, TEC and Amteckacquisitions. As a percentage of revenue, SG&A for the nine-month period decreased from 12.5% in 2020 to
12.2% in 2021. We have included same-store SG&A, excluding amortization, because we believe it is an effective measure of comparative results of operations. However, same-store SG&A, excluding amortization, is not considered under generally accepted accounting principles to be a primary measure of an entity's financial results, and accordingly, should not be considered an alternative to SG&A as shown in our consolidated statements of operations. Three Months Ended Nine Months Ended September 30, September 30, 2021 2020 2021 2020 (in thousands) (in thousands) SG&A
$ 95,287 $ 90,888 $ 271,050 $ 268,857
Less: SG&A from companies acquired (5,329) - (11,889)
- Less: Amortization expense (7,751) (6,889) (21,967) (19,596) Same-store SG&A, excluding amortization expense
$ 82,207 $ 83,999 $ 237,194 $ 249,261Interest Expense-Interest expense decreased $0.1 million, or 8.5%, to $1.6 millionfor the third quarter of 2021 as compared to the same period in 2020. Interest expense decreased $2.5 millionfor the first nine months of 2021 as compared to the same period in 2020. The decrease in interest expense is due to a reduction in our average interest rate on our outstanding borrowings in 2021 compared to the prior year as well as a lower average outstanding debt balance as compared to the prior year. Changes in the Fair Value of Contingent Earn-out Obligations-The contingent earn-out obligations are measured at fair value each reporting period, and changes in estimates of fair value are recognized in earnings. Expense from changes in the fair value of contingent earn-out obligations for the third quarter of 2021 increased $4.7 millionas compared to the same period in 2020. This increase in expense was primarily the result of our lowering the obligation related to our Texaselectrical operation due to a downward adjustment of their forecasts in the third quarter of 2020. Income from changes in the fair value of contingent earn-out obligations for the first nine months of 2021 increased $2.7 millionas compared to the same period in 2020. This increase was primarily caused by lower than previously forecasted earnings at TAS in the first earnout period ended June 30, 2021, partially offset by higher expenses at TAS related to the second earnout period driven by higher than previously forecasted earnings at TAS in the third quarter of 2021. Provision for Income Taxes-Our provision for income taxes for the nine months ended September 30, 2021was $33.6 millionwith an effective tax rate of 24.1% as compared to a provision for income taxes of $30.1 millionwith an effective tax rate of 21.9% for the same period in 2020. The effective tax rate for 2021 was higher than the 21% federal statutory rate primarily due to net state income taxes (4.0%) and nondeductible expenses, including nondeductible expenses related to TAS (1.0%), partially offset by deductions for stock-based compensation (1.2%) and benefits from claiming the energy efficient commercial buildings deduction (the "179D deduction") allocated to us (0.7%). The effective tax rate for 2020 was higher than the 21% federal statutory rate primarily due to net state income taxes (4.8%) and nondeductible expenses, including nondeductible expenses related to TAS (2.2%), partially offset by a decrease in unrecognized tax benefits as a result of settlement with the Internal Revenue Service upon completion of its examination of our amended federal returns for 2014 and 2015 (6.0%).
We currently estimate that our effective tax rate for the full year 2021 will be between 23% and 26%. From 2022, we expect our effective tax rate to be between 25% and 30%. However, our effective tax rates could be
lower of these ranges, or lower, as we continue to claim the credit for increasing research activities (the âR&D tax creditâ) and the 179D deduction.
Outlook At the beginning of 2020, we were experiencing good ongoing market conditions; however, beginning at the end of the first quarter of 2020, we experienced negative impacts to our business due to the business disruption caused by COVID-19. In
March 2020, the World Health Organizationcategorized COVID-19 as a pandemic, and the United Statesdeclared the COVID-19 outbreak a national emergency. Since the start of the pandemic, our activities have generally been classified as essential services, although from time to time certain jobs and service sites have temporarily or partially closed due to government action, decisions by owners, or upon positive tests for COVID-19. We have also experienced delays in the award of new construction work, instances of delayed starts, as well as increased cost and reduced availability or delays in delivery of some materials and equipment. Across our operations, we have implemented safety precautions and other COVID-19 related working guidelines that have added cost or inefficiency as we strive to create a safe environment for our team members and our communities. The Company considered the ongoing impact of COVID-19 on the assumptions and estimates used to determine our results and asset valuations as of September 30, 2021and determined that there were no material or systematic adverse impacts on the Company except for previously disclosed delays, cost and availability constraints for labor and materials, and operational inefficiency.
The initial business impacts relating to COVID-19 have stabilized, although we continue to experience sporadic delays in the award or commencement of some projects and increased cost or lead times for materials and equipment. Current vaccine mandates by certain customers or authorities have also hindered our ability to pursue certain work, or to staff or maintain scheduling on work that is subject to such mandates. In addition, the
Department of Labor's Occupational Safety and Health Administrationis drafting an emergency regulation pursuant to a vaccine policy that was announced by President Bidenon September 9, 2021, and the scope, timing and impact of the new regulation is currently unclear. It is impossible to predict what impact the regulation might have on our business
and industry. Despite the ongoing effects from COVID-19, we have a good pipeline of opportunities and potential backlog, and we have been generally successful in maintaining activity levels and productivity and in procuring needed materials despite ongoing challenges. Considering all these factors, we currently anticipate solid earnings and cash flow for the remainder of 2021, and we feel that we have good prospects in 2022. We continue to prepare for a wide range of pandemic-related challenges and economic circumstances; however, despite challenges, we currently expect supportive conditions for our industry are likely to continue in 2022.
Liquidity and capital resources (in thousands):
Nine Months Ended September 30, 2021 2020 Cash provided by (used in): Operating activities
$ 152,654 $ 216,400Investing activities (119,605) (130,514) Financing activities (20,224) (66,134)
Net increase (decrease) in cash and cash equivalents
$ 12,825 $ 19,752Free cash flow: Cash provided by operating activities $ 152,654$
Purchases of property and equipment (15,864)
Proceeds from sales of property and equipment 1,802
1,890 Free cash flow
$ 138,592 $ 198,831Cash Flow Our business does not require significant amounts of investment in long-term fixed assets. The substantial majority of the capital used in our business is working capital that funds our costs of labor and installed equipment deployed in project work until our customer pays us. Customary terms in our industry allow customers to withhold a 29
small portion of the contract price until we have completed the work, usually for six months. Amounts withheld under this practice are called withholding or withholding. The average duration of our projects, along with typical retention conditions, generally allow us to complete the realization of income and cash benefits within one year.
Cash Provided by (Used in) Operating Activities-Cash flow from operations is primarily influenced by demand for our services and operating margins but can also be influenced by working capital needs associated with the various types of services that we provide. In particular, working capital needs may increase when we commence large volumes of work under circumstances where project costs, primarily associated with labor, equipment and subcontractors, are required to be paid before the receivables resulting from the work performed are billed and collected. Working capital needs are generally higher during the late winter and spring months as we prepare and plan for the increased project demand when favorable weather conditions exist in the summer and fall months. Conversely, working capital assets are typically converted to cash during the late summer and fall months as project completion is underway. These seasonal trends are sometimes offset by changes in the timing of major projects, which can be impacted by the weather, project delays or accelerations and other economic factors that may affect customer spending. Cash provided by operating activities was
$152.7 millionduring the first nine months of 2021 compared with $216.4 millionduring the same period in 2020. This decrease was primarily driven by a $59.1 millionchange in receivables, net driven by strong collections in the prior year and a $13.2 millionchange in billings in excess of costs, which was attributable to timing of payments and project billings. In addition, operating cash flows in the prior year benefited by approximately $20.9 millionfrom the deferral of payroll taxes allowed by the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") that normally would have been paid by September 30, 2020. This was partially offset by a $31.1 millionchange in accounts payable and accrued liabilities, which was driven by timing of payments. Cash Provided by (Used in) Investing Activities-During the first nine months of 2021, cash used in investing activities was $119.6 millioncompared to $130.5 millionduring the same period in 2020. The $10.9 milliondecrease in cash used primarily relates to cash paid (net of cash acquired) for acquisitions in 2021 compared to the same period in 2020. Cash Provided by (Used in) Financing Activities-Cash used in financing activities was $20.2 millionfor the first nine months of 2021 compared to $66.1 millionduring the same period in 2020. The $45.9 milliondecrease in cash used in financing activities is primarily due to an increase in net proceeds from debt, which was driven by fewer payments in the current year, partially offset by less borrowings to pay for acquisitions in 2021. Free Cash Flow-We define free cash flow as cash provided by operating activities, less customary capital expenditures, plus the proceeds from asset sales. We believe free cash flow, by encompassing both profit margins and the use of working capital over our approximately one year working capital cycle, is an effective measure of operating effectiveness and efficiency. We have included free cash flow information here for this reason, and because we are often asked about it by third parties evaluating us. However, free cash flow is not considered under generally accepted accounting principles to be a primary measure of an entity's financial results, and accordingly free cash flow should not be considered an alternative to operating income, net income, or amounts shown in our consolidated statements of cash flows as determined under generally accepted accounting principles. Free cash flow may be defined differently by other companies. Share Repurchase Program On March 29, 2007, our Board of Directors (the "Board") approved a stock repurchase program to acquire up to 1.0 million shares of our outstanding common stock. Subsequently, the Board has from time to time increased the number of shares that may be acquired under the program and approved extensions of the program. On December 8, 2020, the Board approved an extension to the program by increasing the shares authorized for repurchase by 0.7 million shares. Since the inception of the repurchase program, the Board has approved 10.3 million shares to be repurchased. As of September 30, 2021, we have repurchased a cumulative total of 9.7 million shares at an average price of $21.57per 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 30
other factors. The Board may modify, suspend, extend or terminate the program at any time. During the nine months ended
September 30, 2021, we repurchased 0.3 million shares for approximately $25.5 millionat an average price of $73.69per share. Debt
Revolving credit facility and term loan
We have a
$600.0 millionsenior credit facility (the "Facility") provided by a syndicate of banks. The Facility is composed of a revolving credit line in the amount of $450.0 millionand a $150.0 millionterm loan, and the Facility provides for a $150.0 millionaccordion or increase option for the revolving portion of the Facility. As of September 30, 2021, the Facility capacity was $570.0 million, as the term loan was paid down by $30.0 millionsince the inception of the Facility. The Facility also includes a sublimit of up to $160.0 millionissuable in the form of letters of credit. The Facility expires in January 2025and is secured by a first lien on substantially all of our personal property except for assets related to projects subject to surety bonds and assets held by certain unrestricted subsidiaries and our wholly owned captive insurance company and a second lien on our assets related to projects subject to surety bonds. As of September 30, 2021, we had $115.0 millionof outstanding borrowings on the revolving credit facility, $49.5 millionin letters of credit outstanding and $285.5 millionof 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. 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 claims are 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," which shall mean Consolidated EBITDA as such term is 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. The Facility contains financial covenants defining various financial measures and the levels of these measures with which we must comply. Covenant compliance is assessed as of each quarter end. We were in compliance with all of our financial covenants as of September 30, 2021. Notes to Former Owners As part of the consideration used to acquire six companies, we have outstanding notes to the former owners. Together, these notes had an outstanding balance of $35.5 millionas of September 30, 2021. In conjunction with the acquisition of Amteckin the third quarter of 2021, we issued a promissory note to former owners with an outstanding balance of $10.0 millionas of September 30, 2021that bears interest, payable quarterly, at a stated interest rate of 2.5%. The principal is due in equal installments in October 2024and October 2025. In conjunction with the acquisition of the Utahmechanical contractor in the first quarter of 2021, we issued a promissory note to former owners with an outstanding balance of $3.5 millionas of September 30, 2021that bears interest, payable quarterly, at a stated interest rate of 2.5%. The principal is due in April 2023. In conjunction with the acquisition of TEC in the fourth quarter of 2020, we issued a promissory note to former owners with an outstanding balance of $7.0 millionas of September 30, 2021that bears interest, payable quarterly, at a stated interest rate of 2.5%. The principal is due in December 2023. In conjunction with the acquisition of TAS in the second quarter of 2020, we issued a promissory note to former owners with an outstanding balance of $4.0 millionas of September 30, 2021that bears interest, payable quarterly, at a stated interest rate of 3.5%. The principal is due in April 2022. In conjunction with the acquisition of the electrical contractor in North 31 Table of Contents Carolina in the first quarter of 2020, we issued a promissory note to former owners with an outstanding balance of $5.0 millionas of September 30, 2021that bears interest, payable quarterly, at a stated interest rate of 3.0%. The principal is due in installments in February 2023and February 2024. In conjunction with the acquisition of a Texaselectrical contractor in the second quarter of 2019, we issued a promissory note to former owners with an outstanding balance of $6.0 millionas of September 30, 2021that bears interest, payable quarterly, at a stated interest rate of 4.0%. The remaining principal is due in April 2023. Outlook We have generated positive net free cash flow for the last twenty-two calendar years, much of which occurred during challenging economic and industry conditions. We also continue to have significant borrowing capacity under our credit facility, and we maintain what we feel are reasonable cash balances. We believe these factors will provide us with sufficient liquidity to fund our operations for the foreseeable future.
Off-balance sheet arrangements and other commitments
Certain of our vendors require letters of credit to ensure reimbursement for amounts they are disbursing on our behalf, such as to beneficiaries under our self-funded insurance programs. We have also occasionally used letters of credit to guarantee performance under our contracts and to ensure payment to our subcontractors and vendors under those contracts. The letters of credit we provide are actually issued by our lenders through the Facility as described above. A letter of credit commits the lenders to pay specified amounts to the holder of the letter of credit if the holder demonstrates that we have failed to perform specified actions. If this were to occur, we would be required to reimburse the lenders. Depending on the circumstances of such a reimbursement, we may also have to record a charge to earnings for the reimbursement. Absent a claim, there is no payment or reserving of funds by us in connection with a letter of credit. However, because a claim on a letter of credit would require immediate reimbursement by us to our lenders, letters of credit are treated as a use of the Facility's capacity just the same as actual borrowings. Claims against letters of credit are rare in our industry. To date, we have not had a claim made against a letter of credit that resulted in payments by a lender or by us. We believe that it is unlikely that we will have to fund claims under a letter of credit in the foreseeable future. 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
whoprovided goods or services under a contract, the customer may demand that the surety make payments or provide services under the bond. We must reimburse the sureties for any expenses or outlays they incur. To date, we are not aware of any losses to our sureties in connection with bonds the sureties have posted on our behalf, and we do not expect such losses to be incurred in the foreseeable future. Under standard terms in the surety market, sureties issue bonds on a project-by-project basis, and can decline to issue bonds at any time. Historically, approximately 15% to 25% of our business has required bonds. While we currently have strong surety relationships to support our bonding needs, future market conditions or changes in our sureties' assessment of our operating and financial risk could cause our sureties to decline to issue bonds for our work. If that were to occur, our alternatives include doing more business that does not require bonds, posting other forms of collateral for project performance, such as letters of credit or cash, and seeking bonding capacity from other sureties. We would likely also encounter concerns from customers, suppliers and other market participants as to our creditworthiness. While we believe our general operating and financial characteristics would enable us to ultimately respond effectively to an interruption in the availability of bonding capacity, such an interruption would likely cause our revenue and profits to decline in the near term. Contractual Obligations As of September 30, 2021, we have $49.5 millionin letter of credit commitments, of which $16.1 millionwill expire in 2021 and $33.4 millionwill expire in 2022. The substantial majority of these letters of credit are posted with insurers whodisburse funds on our behalf in connection with our workers' compensation, auto liability and general liability insurance program. These letters of credit provide additional security to the insurers that sufficient financial resources will be available to fund claims on our behalf, many of which develop over long periods of time, should we 32
never encounter financial constraints. Posting letters of credit for this purpose is standard practice for entities that operate their self-insurance programs through third party insurers as we do. While some of these letter of credit commitments expire within the next twelve months, we expect almost all of them, especially those that support our insurance programs, will be renewed each year.
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