COMFORT SYSTEMS USA, INC. 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 theSecurities and Exchange Commission for the year endedDecember 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 toComfort Systems USA, Inc. orComfort 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 Economics of Our Business
In our mechanical business segment, customers hire us to ensure HVAC systems deliver specified or generally expected heating, cooling, conditioning and circulation of air in a facility. This entails installing core system equipment such as packaged heating and air conditioning units, or in the case of larger facilities, separate core components such as chillers, boilers, air handlers, and cooling towers. We also typically install connecting and distribution elements such as piping and ducting.
In our electrical business segment, our principal business activity is electrical construction and engineering in the commercial and industrial field. We also perform electrical logistics services, electrical service work, and electrical construction and engineering services.
In both our mechanical and electrical business segments, our responsibilities
usually require conforming the systems to pre-established engineering drawings
and equipment and performance specifications, which we frequently participate in
establishing. Our project management responsibilities include staging equipment
and materials to project sites, deploying labor to perform the work, and
coordinating with other service providers on the project, including any
subcontractors we might use to deliver our portion of the work.
Approximately 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.
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After a customer accepts our bid, we generally enter into a contract with the
customer that specifies what we will deliver on the project, what our related
responsibilities are, and how much and when we will be paid. Our overall price
for the project is typically set at a fixed amount in the contract, although
changes in project specifications or work conditions that result in unexpected
additional work are usually subject to additional payment from the customer via
what are commonly known as change orders. Project contracts typically provide
for periodic billings to the customer as we meet progress milestones or incur
cost on the project. Project contracts in our industry also frequently allow for
a small portion of progress billings or contract price to be withheld by the
customer until after we have completed the work. Amounts withheld under this
practice are known as retention or retainage.
Labor, materials and overhead costs account for the majority of our cost of
service. Accordingly, labor management and utilization have the most impact on
our project performance. Given the fixed price nature of much of our project
work, if our initial estimate of project costs is wrong or we incur cost
overruns that cannot be recovered in change orders, we can experience reduced
profits or even significant losses on fixed price project work. We also perform
some project work on a cost-plus or a time and materials basis, under which we
are paid our costs incurred plus an agreed-upon profit margin, and such projects
are sometimes subject to a guaranteed maximum cost. These margins are frequently
less than fixed-price contract margins because there is less risk of
unrecoverable cost overruns in cost-plus or time and materials work.
As of September 30, 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 notgive rise to lien rights. We also perform larger projects. Taken together, projects with contract prices of$1 million or more totaled$4.8 billion of aggregate contract value as ofSeptember 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 million will be completed in one year or less. It is unusual for us to work on a project that exceeds two years in length. A stratification of projects in progress as ofSeptember 30, 2021 , by contract price, is as follows: Aggregate Contract No. of Price Value Contract Price of Project Projects (millions) Under$1 million 5,761$ 711.2 $1 million -$5 million 599 1,340.2$5 million -$10 million 128 891.2$10 million -$15 million 45 551.7 Greater than$15 million 73 2,059.8 Total 6,606$ 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.
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A relatively small portion of our revenue comes from national and regional account customers. These customers typically have multiple sites and contract with us to perform maintenance and repair service. These contracts may also provide for us to perform new or replacement systems installation. We operate a national call center to dispatch technicians to sites requiring service. We perform the majority of this work with our own employees, with the balance being subcontracted to third parties that meet our performance qualifications.
Profile and Management of Our Operations
We manage our 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 Industry Factors
As a mechanical and electrical services provider, we operate in the broader nonresidential construction services industry and are affected by trends in this sector. While we do not have operations in all major cities ofthe United States , we believe our national presence is sufficiently large that we experience trends in demand for and pricing of our services that are consistent with trends in the national nonresidential construction sector. As a result, we monitor the views of major construction sector forecasters along with macroeconomic factors they believe drive the sector, including trends in gross domestic product, interest rates, business investment, employment, demographics and the fiscal condition of federal, state and local governments. Spending decisions for building construction, renovation and system replacement are generally made on a project basis, usually with some degree of discretion as to when and if projects proceed. With larger amounts of capital, time, and discretion involved, spending decisions are affected to a significant degree by uncertainty, particularly concerns about economic and financial conditions and trends. We have experienced periods of time when economic weakness caused a significant slowdown in decisions to proceed with installation and replacement project work.
Operating Environment and Management Emphasis
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 untilJanuary 2025 . As ofSeptember 30, 2021 , we had$285.5 million of credit available to borrow under our credit facility. We have strong surety relationships to support our bonding needs, and we believe our relationships with the surety markets are strong and benefit from our operating history and financial position. We have generated positive free cash flow in each of the last 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 ofthe United States during periods of economic weakness. The mechanical and electrical contracting industries are also subject to seasonal variations. The demand for new installation and replacement is generally lower during the winter months (the first quarter of the year) due to reduced construction activity during inclement weather and less use of air conditioning during the colder months. Demand for our services is generally higher in the second and third calendar quarters due to increased construction activity and increased use of air conditioning during the warmer months. Accordingly, we expect our revenue and operating results generally will be lower in the first calendar quarter.
Results of Operations (dollars in thousands):
Three Months Ended September 30 , Nine
Months Ended
2021 2020 2021 2020
Revenue $ 833,896 100.0 % $ 714,099 100.0 % $ 2,217,552 100.0 % $ 2,157,698 100.0 %
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 $ 46,297 5.6 % $ 50,088 7.0 % $ 105,753 4.8 % $ 107,299 5.0 %
We had 37 operating locations as ofDecember 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 inUtah , which reports as a separate operating location. In the third quarter of 2021, we completed the acquisition ofAmteck , which also reports as a separate operating location. As ofSeptember 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 inNorth Carolina , which was acquiredFebruary 1, 2020 and reports together with our existingNorth Carolina operation, three months of results for TAS, which was acquired onApril 1, 2020 , nine months of results for TEC, which was acquired onDecember 31, 2020 and two months of results forAmteck , which was acquired onAugust 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 inNorth Carolina was integrated with our existingNorth Carolina operation, 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 increased
The following table presents our operating segment revenue (in thousands, except
percentages):
Three Months Ended September 30,
2021 2020
Revenue:
Mechanical Services $ 690,680 82.8 % $ 625,660 87.6 %
Electrical Services 143,216 17.2 % 88,439 12.4 %
Total $ 833,896 100.0 % $ 714,099 100.0 %
Revenue for our mechanical services segment increased $65.0 million , or 10.4%,
to $690.7 million for 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 Texas operations ($64.8 million ) and in the
education sector at one of our Utah operations ($9.8 million ), partially offset
by a reduction in activity in the education sector at one of our Florida
operations ($9.1 million ).
Revenue for our electrical services segment increased $54.8 million , or 61.9%,
to $143.2 million for 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 Amteck in August 2021 ($34.6 million ), partially offset
by expected decreases driven by a higher volume of large jobs in the prior
period at our Texas electrical operation ($5.4 million ).
Revenue for the first nine months of 2021 increased $59.9 million , or 2.8%, to
$2.22 billion compared to the same period in 2020. The increase included a 5.9%
increase related to the North Carolina electrical contractor, TEC, TAS and
Amteck acquisitions, 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 $ 1,868,096 84.2 % $ 1,823,117 84.5 %
Electrical Services 349,456 15.8 % 334,581 15.5 %
Total $ 2,217,552 100.0 % $ 2,157,698 100.0 %
Revenue for our mechanical services segment increased $45.0 million , or 2.5%, to
$1.87 billion for the first nine months of 2021 compared to the same period in
2020. The increase included a $90.5 million increase related to TAS, of which
$60.5 million resulted from an increase in activity in the industrial sector and
$30.0 million resulted 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 Texas operations ($24.3 million )
and in the education sector at one of our Virginia operations ($19.4 million ).
Revenue for our electrical services segment increased $14.9 million , or 4.4%, to
$349.5 million for the first nine months of 2021 compared to the same period in
2020. The increase primarily resulted from the acquisitions of the North
Carolina electrical contractor in February 2020 ($8.3 million ), TEC in December
2020 ($53.3 million ) and Amteck in August 2021 ($34.6 million ), as well as an
increase in same-store activity for our North Carolina electrical contractor
($13.5 million ), partially offset by expected decreases driven by a higher
volume of large jobs in the prior period at our Texas electrical 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
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results over the next six to twelve months. As a result, we believe the predictive value of backlog information is limited to indications of general revenue direction over the near term, and should not be interpreted as indicative of ongoing revenue performance over several quarters.
The following table presents our operating segment backlog (in thousands, except
percentages):
September 30, December 31, September 30,
2021 2020 2020
Backlog:
Mechanical Services $ 1,458,652 75.1 % $ 1,267,200 83.8 % $ 1,240,482 86.8 %
Electrical Services 482,725 24.9 % 244,214 16.2 %
188,105 13.2 %
Total $ 1,941,377 100.0 % $ 1,511,414 100.0 % $ 1,428,587 100.0 %
Backlog as of September 30, 2021 was $1.94 billion , a 5.5% increase from June
30, 2021 backlog of $1.84 billion , and a 35.9% increase from September 30, 2020
backlog 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 Carolina operation ($47.2 million ), TEC ($40.3
million ), our Colorado operation ($35.5 million ) and our Arizona operation
($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 Carolina operation ($73.9 million ),
one of our Virginia operations ($37.9 million ), our Texas electrical operation
($34.2 million ) and another one of our Texas operations ($20.6 million ).
Gross Profit-Gross profit increased $12.0 million , or 8.2%, to $159.2 million
for 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 Amteck acquisitions, 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 Texas electrical operation ($3.3 million ), partially offset by
a decrease at our Arizona operation ($4.5 million ) and our Indiana operation
($2.4 million ) compared to the prior year. Additionally, we had decreased
volumes at one of our Florida operations ($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 Arizona and Indiana
operations and one of our Florida operations.
Gross profit decreased $0.8 million , or 0.2%, to $409.1 million for 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, Amteck and North Carolina electrical
contractor acquisitions. The same-store decrease in gross profit was primarily
due to stronger project execution in the prior year at one of our Florida
operations ($10.7 million ) and our Indiana operation ($6.6 million ).
Additionally, we had decreased volumes at one of our Virginia operations ($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 million for 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
million during the period, primarily as a result of the TEC and Amteck
acquisitions. As a percentage of revenue, SG&A for the third quarter decreased
from 12.7% in 2020 to 11.4% in 2021.
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SG&A increased$2.2 million , or 0.8%, to$271.1 million for 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 million in 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 million as compared to the same period in 2020. Amortization expense increased$2.4 million during the period, primarily as a result of the TAS, TEC andAmteck acquisitions. 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 $ 249,261
Interest Expense-Interest expense decreased $0.1 million , or 8.5%, to
$1.6 million for the third quarter of 2021 as compared to the same period in
2020. Interest expense decreased $2.5 million for 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 million as compared to the same period in 2020.
This increase in expense was primarily the result of our lowering the obligation
related to our Texas electrical 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 million as 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, 2021 was $33.6 million with an effective tax rate of 24.1%
as compared to a provision for income taxes of $30.1 million with 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 our effective tax rate for the full year 2021 will be between 23% and 26%. Starting in 2022, we expect our effective tax rate will be between 25% and 30%. However, our effective tax rates could be on the
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low end of these ranges, or lower, as we continue to pursue claims for the credit for increasing research activities (the "R&D tax credit") 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. InMarch 2020 , theWorld Health Organization categorized COVID-19 as a pandemic, andthe United States declared 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 ofSeptember 30, 2021 and 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, theDepartment of Labor's Occupational Safety and Health Administration is drafting an emergency regulation pursuant to a vaccine policy that was announced byPresident Biden onSeptember 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 $ 216,400
Investing activities (119,605) (130,514)
Financing activities (20,224) (66,134)Net increase (decrease) in cash and cash equivalents$ 12,825 $ 19,752 Free cash flow: Cash provided by operating activities$ 152,654 $
216,400
Purchases of property and equipment (15,864)
(19,459)
Proceeds from sales of property and equipment 1,802
1,890 Free cash flow$ 138,592 $ 198,831 Cash Flow Our business does not require significant amounts of investment in long-term fixed assets. The substantial majority of the capital used in our business is working capital that funds our costs of labor and installed equipment deployed in project work until our customer pays us. Customary terms in our industry allow customers to withhold a 29
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small portion of the contract price until after we have completed the work, typically for six months. Amounts withheld under this practice are known as retention or retainage. Our average project duration, together with typical retention terms, generally allow us to complete the realization of revenue and earnings in cash within one year.
Cash Provided by (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 million during the first nine months of 2021 compared with$216.4 million during the same period in 2020. This decrease was primarily driven by a$59.1 million change in receivables, net driven by strong collections in the prior year and a$13.2 million change 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 million from the deferral of payroll taxes allowed by the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") that normally would have been paid bySeptember 30, 2020 . This was partially offset by a$31.1 million change 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 million compared to$130.5 million during the same period in 2020. The$10.9 million decrease 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 million for the first nine months of 2021 compared to$66.1 million during the same period in 2020. The$45.9 million decrease 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 OnMarch 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. OnDecember 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 ofSeptember 30, 2021 , we have repurchased a cumulative total of 9.7 million shares at an average price of$21.57 per share under the repurchase program. The share repurchases will be made from time to time at our discretion in the open market or privately negotiated transactions as permitted by securities laws and other legal requirements, and subject to market conditions and 30
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other factors. The Board may modify, suspend, extend or terminate the program at any time. During the nine months endedSeptember 30, 2021 , we repurchased 0.3 million shares for approximately$25.5 million at an average price of$73.69 per share. Debt
Revolving Credit Facility and Term Loan
We have a$600.0 million senior 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 million and a$150.0 million term loan, and the Facility provides for a$150.0 million accordion or increase option for the revolving portion of the Facility. As ofSeptember 30, 2021 , the Facility capacity was$570.0 million , as the term loan was paid down by$30.0 million since the inception of the Facility. The Facility also includes a sublimit of up to$160.0 million issuable in the form of letters of credit. The Facility expires inJanuary 2025 and is secured by a first lien on substantially all of our personal property except for assets related to projects subject to surety bonds and 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 ofSeptember 30, 2021 , we had$115.0 million of outstanding borrowings on the revolving credit facility,$49.5 million in letters of credit outstanding and$285.5 million of credit available. There are two interest rate options for borrowings under the Facility, the Base Rate Loan option and the Eurodollar Rate Loan option. These rates are floating rates determined by the broad financial markets, meaning they can and do move up and down from time to time. Additional margins are then added to these two rates. 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 ofSeptember 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 million as ofSeptember 30, 2021 . In conjunction with the acquisition ofAmteck in the third quarter of 2021, we issued a promissory note to former owners with an outstanding balance of$10.0 million as ofSeptember 30, 2021 that bears interest, payable quarterly, at a stated interest rate of 2.5%. The principal is due in equal installments inOctober 2024 andOctober 2025 . In conjunction with the acquisition of theUtah mechanical contractor in the first quarter of 2021, we issued a promissory note to former owners with an outstanding balance of$3.5 million as ofSeptember 30, 2021 that bears interest, payable quarterly, at a stated interest rate of 2.5%. The principal is due inApril 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 million as ofSeptember 30, 2021 that bears interest, payable quarterly, at a stated interest rate of 2.5%. The principal is due inDecember 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 million as ofSeptember 30, 2021 that bears interest, payable quarterly, at a stated interest rate of 3.5%. The principal is due inApril 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 million as ofSeptember 30, 2021 that bears interest, payable quarterly, at a stated interest rate of 3.0%. The principal is due in installments inFebruary 2023 andFebruary 2024 . In conjunction with the acquisition of aTexas electrical contractor in the second quarter of 2019, we issued a promissory note to former owners with an outstanding balance of$6.0 million as ofSeptember 30, 2021 that bears interest, payable quarterly, at a stated interest rate of 4.0%. The remaining principal is due inApril 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 vendorswho provided goods or services under a contract, the customer may demand that the surety make payments or provide services under the bond. We must reimburse the sureties for any expenses or outlays they incur. 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 ofSeptember 30, 2021 , we have$49.5 million in letter of credit commitments, of which$16.1 million will expire in 2021 and$33.4 million will expire in 2022. The substantial majority of these letters of credit are posted with insurerswho disburse funds on our behalf in connection with our workers' compensation, auto liability and general liability insurance program. These letters of credit provide additional security to the insurers that sufficient financial resources will be available to fund claims on our behalf, many of which develop over long periods of time, should we 32
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ever encounter financial duress. Posting of letters of credit for this purpose is a common practice for entities that manage their self-insurance programs through third-party insurers as we do. While some of these letter of credit commitments expire in the next twelve months, we expect nearly all of them, particularly those supporting our insurance programs, will be renewed annually.
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