IES Holdings, Inc. (IESC) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and the notes thereto, set forth in Item 8.“Financial Statements and Supplementary Data” of this Annual Report on Form 10-K. For additional information, see “Disclosure Regarding Forward Looking Statements” in Part I of this Annual Report on Form 10-K.
OVERVIEW
Executive Overview
Please refer to Item 1. “Business” of this Annual Report on Form 10-K for a discussion of the Company’s services and corporate strategy. IES Holdings, Inc., a Delaware corporation, designs and installs integrated electrical and technology systems and provides infrastructure products and services to a variety of end markets, including data centers, residential housing, and commercial and industrial facilities. Our operations are organized into four business segments: Communications, Residential, Infrastructure Solutions and Commercial & Industrial.
Industry Trends
Our performance is affected by a number of trends that drive the demand for our services. In particular, the markets in which we operate are exposed to many regional and national trends such as the demand for single and multi-family housing, the need for mission
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critical facilities as a result of technology-driven advancements, capital spending on data centers, distribution centers, and high-tech manufacturing facilities, demand for back-up power, output levels and equipment utilization at heavy industrial facilities, demand for our rail and infrastructure services and custom engineered products, and changes in commercial, institutional, public infrastructure and electric utility spending. Over the long term, we believe that there are numerous factors that could positively drive demand and affect growth within the industries in which we operate, including (i) population growth, which will increase the need for commercial and residential facilities, (ii) aging public infrastructure, which must be replaced or repaired, (iii) an increasing demand for data storage, and (iv) increased emphasis on environmental and energy efficiency, which may lead to increased public and private spending. However, there can be no assurance that we will not experience a decrease in demand for our services due to economic, technological or other factors beyond our control, including interest rate changes, increases in the price of copper, aluminum, steel, fuel, electrical components, certain plastics, and other commodity prices and other economic factors, which may reduce the demand for housing in the regions where our Residential division operates, and may impact levels of construction. For a further discussion of the industries in which we operate, please see Item 1. “Business - Operating Segments” of this Annual Report on Form 10-K.
Business Outlook
While there are differences among the Company’s segments, on an overall basis, increased demand for the Company’s services and the Company’s previous investment in growth initiatives and other business-specific factors discussed below resulted in aggregate year-over-year revenue growth in fiscal 2022 as compared to fiscal 2021. In addition, revenue growth during fiscal 2022 at our Residential and Infrastructure Solutions segments reflects the contribution of acquisitions completed during fiscal 2021.
Our business segments each have their own unique set of factors influencing demand for our services, While we are entering the year with strong backlog levels in each of our business segments, we are also closely monitoring weakness in the residential construction market and, more generally, heightened uncertainty regarding the future direction of the overall economy. Based on current trends in demand for housing heading into fiscal 2023, we expect that a revenue decline in our single-family housing business, where we typically do not enter into long-term contracts, will offset, or more than offset, revenue growth from our multi-family housing and other backlog-driven businesses during the year. Nevertheless, we remain focused on monitoring costs, improving margins, and capitalizing on opportunities to expand our service lines and gain market share, as many of our markets continue to experience highly competitive margins and increasing costs. Further, we believe our strong balance sheet and flexible operating model position us to navigate challenges we may encounter in a more uncertain economy.
To continue to grow our business, including through acquisitions and the funding of working capital, we may require a significant amount of cash. Our ability to generate cash depends on many externally influenced factors, including demand for our services, the availability of projects at margins acceptable to us, the ultimate collectability of our receivables, our ability to borrow on our credit facility, and our ability to raise funds in the capital markets, among many other factors. We anticipate that the combination of cash on hand, cash flows from operations and available capacity under our credit facility will provide sufficient cash to enable us to meet our working capital needs, debt service requirements and capital expenditures for property and equipment through the next 12 months. We expect our capital expenditures will range from $12.0 million to $17.0 million for the year ending on September 30, 2023.
Current Market and Operating Conditions
The Federal Reserve has raised the target federal funds rate six times since the beginning of calendar 2022 and has announced an expectation that it will continue to raise the target rate through the end of 2022 and into 2023. This has resulted in higher mortgage rates, which when combined with elevated materials and labor costs, have had a substantial impact on the affordability of housing. There continue to be several trends, such as rising household formation and population growth in our key markets, that we expect will drive long-term demand for our services in the single-family housing market. However, going into fiscal 2023, we do expect housing affordability to cause a near-term decrease in demand for our services in this market.
The COVID-19 pandemic and its impact on markets, the supply chain and the labor force continued to influence trends affecting our business throughout fiscal 2022. While commodity prices for some of the materials we procure recently have begun to stabilize, concerns remain around limited availability or delays in deliveries for certain materials necessary for our projects, notably copper, steel, aluminum, electronic components, and certain plastics. Reduced availability of certain materials has resulted in a continuing need to take actions such as carrying higher levels of inventory than we typically hold, or, in some cases, substituting higher-cost materials or sourcing materials from new suppliers which may offer less favorable terms or pricing than our usual suppliers. Such actions have resulted in elevated levels of working capital throughout fiscal 2022. We seek to mitigate supply chain risk by maintaining relationships with multiple vendors, and to recoup higher materials costs through adjusted pricing. However, we are not able to pass on all increased costs, and our suppliers are facing challenges in providing the materials we require. We have also experienced, and may continue to experience, workforce disruptions related to exposure to, or illness from, COVID-19, resulting in production inefficiencies and delays, higher overtime costs, and the need to outsource activities or use more expensive contract labor. An inability to procure materials in a timely manner, to complete work on schedule, and to reflect higher materials or labor costs in our pricing to customers has had, and could continue to have, a significant impact on our operating results.
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RESULTS OF OPERATIONS
We report our operating results across our four operating segments: Communications, Residential, Infrastructure Solutions and Commercial & Industrial. Expenses associated with our corporate office are classified separately. The following table presents selected historical results of operations of IES, as well as the results of acquired businesses from the dates acquired.
| Year Ended September 30, | |||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2020 | |||||||||||||||||||
| $ | % | $ | % | $ | % | ||||||||||||||||
| (Dollars in thousands, Percentage of revenues) | |||||||||||||||||||||
| Revenues | $ | 2,166,808 | 100.0 | % | $ | 1,536,493 | 100.0 | % | $ | 1,190,856 | 100.0 | % | |||||||||
| Cost of services | 1,847,878 | 85.3 | % | 1,248,495 | 81.3 | % | 962,897 | 80.9 | % | ||||||||||||
| Gross profit | 318,930 | 14.7 | % | 287,998 | 18.7 | % | 227,959 | 19.1 | % | ||||||||||||
| Selling, general and administrative expenses | 262,714 | 12.1 | % | 202,251 | 13.2 | % | 170,911 | 14.4 | % | ||||||||||||
| Goodwill impairment expense | — | — | % | — | — | % | 6,976 | 0.7 | % | ||||||||||||
| Contingent consideration | 277 | — | % | 211 | — | % | (11) | — | % | ||||||||||||
| Gain on sale of assets | (69) | — | % | (47) | — | % | — | — | % | ||||||||||||
| Operating income | 56,008 | 2.6 | % | 85,583 | 5.6 | % | 50,083 | 4.2 | % | ||||||||||||
| Interest and other expense, net | 3,007 | 0.1 | % | 676 | — | % | 789 | 0.1 | % | ||||||||||||
| Operating income before income taxes | 53,001 | 2.4 | % | 84,907 | 5.5 | % | 49,294 | 4.1 | % | ||||||||||||
| Provision for income taxes | 12,815 | 0.6 | % | 16,231 | 1.1 | % | 8,740 | 0.7 | % | ||||||||||||
| Net income | 40,186 | 1.9 | % | 68,676 | 4.5 | % | 40,554 | 3.4 | % | ||||||||||||
| Net (income) loss attributable to noncontrolling interest | (5,424) | (0.3) | % | (2,018) | (0.1) | % | 1,045 | 0.1 | % | ||||||||||||
| Net income attributable to IES Holdings, Inc. | $ | 34,762 | 1.6 | % | $ | 66,658 | 4.3 | % | $ | 41,599 | 3.5 | % |
2022 Compared to 2021
Consolidated revenues for the year ended September 30, 2022, were $630.3 million higher than for the year ended September 30, 2021, an increase of 41.0%, with increases at all four of our operating segments, driven by strong demand and the contribution of businesses acquired in fiscal 2021.
Our overall gross profit percentage decreased to 14.7% during the year ended September 30, 2022, as compared to 18.7% during the year ended September 30, 2021. Gross profit as a percentage of revenue decreased at all four of our operating segments. See further discussion below of changes in gross margin for our individual segments.
Selling, general and administrative expenses include costs not directly associated with performing work for our customers. These costs consist primarily of compensation and benefits related to corporate, business segment and branch management (including incentive-based compensation), occupancy and utilities, training, professional services, information technology costs, consulting fees, travel and certain types of depreciation and amortization. We allocate certain corporate selling, general and administrative costs across our segments as we believe this more accurately reflects the costs associated with operating each segment.
During the year ended September 30, 2022, our selling, general and administrative expenses were $262.7 million, an increase of $60.5 million, or 29.9% over the year ended September 30, 2021, driven by increased personnel costs, primarily at our Residential operating segment, in connection with its growth, and the impact of businesses acquired during fiscal 2021, including amortization of intangible assets. Selling, general and administrative expenses as a percentage of revenue decreased to 12.1% for the year ended September 30, 2022 from 13.2% for the year ended September 30, 2021, as we benefited from the increased scale of our operations.
2021 Compared to 2020
Consolidated revenues for the year ended September 30, 2021, were $345.6 million higher than for the year ended September 30, 2020, an increase of 29.0% with increases across all segments, driven by strong demand and the contribution of acquired businesses.
Our overall gross profit percentage decreased to 18.7% during the year ended September 30, 2021, as compared to 19.1% during the year ended September 30, 2020. Gross profit as a percentage of revenue increased at our Infrastructure Solutions and Commercial & Industrial segments, but decreased at our Communications and Residential segments, as discussed in further detail with respect to each segment below.
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During the year ended September 30, 2021, our selling, general and administrative expenses were $202.3 million, an increase of $31.3 million, or 18.3% over the year ended September 30, 2020, driven by increased personnel costs at our Communications and Residential operating segments in connection with their growth, increased incentive compensation in connection with improved results at those segments, and the impact of businesses acquired during fiscal 2021. Selling, general and administrative expenses as a percentage of revenue decreased to 13.2% for the year ended September 30, 2021 from 14.4% for the year ended September 30, 2020.
For the year ended September 30, 2020, we recognized a non-cash goodwill impairment charge of $7.0 million relating to our Commercial & Industrial segment.
Communications
2022 Compared to 2021
| Year Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | ||||||||||||
| $ | % | $ | % | ||||||||||
| (Dollars in thousands, Percentage of revenues) | |||||||||||||
| Revenues | $ | 559,777 | 100.0 | % | $ | 445,968 | 100.0 | % | |||||
| Cost of services | 490,959 | 87.7 | % | 361,197 | 81.0 | % | |||||||
| Gross Profit | 68,818 | 12.3 | % | 84,771 | 19.0 | % | |||||||
| Selling, general and administrative expenses | 46,717 | 8.3 | % | 41,373 | 9.3 | % | |||||||
| (Gain)/Loss on sale of assets | 12 | — | % | (4) | — | % | |||||||
| Operating Income | 22,089 | 3.9 | % | 43,402 | 9.7 | % |
Revenue. Our Communications segment’s revenues increased by $113.8 million, or 25.5%, during the year ended September 30, 2022, compared to the year ended September 30, 2021. This increase primarily resulted from increased demand from our data center customers.
Gross Profit. Our Communications segment’s gross profit during the year ended September 30, 2022, decreased $16.0 million, or 18.8%, as compared to the year ended September 30, 2021. Gross profit as a percentage of revenue decreased from 19.0% for the year ended September 30, 2021 to 12.3% for the year ended September 30, 2022. During fiscal 2022, we expanded our offerings to our data center customers into a new, adjacent service area; however, we had execution issues and recorded a combined loss of $19.9 million on a series of these projects for the year ended September 30, 2022. As a result of this loss, we are no longer pursuing work in this service area. As of September 30, 2022, our work on such projects was substantially complete. Our operating margins for the year ended September 30, 2022 were also negatively impacted by a shift in our mix of customers, as well as a more competitive bidding environment in the distribution center and warehouse market, which has experienced slowing activity following a period of significant pandemic-related growth. Supply chain challenges and workforce disruptions related to COVID-19 have also continued to affect project efficiency. Finally, we continue to invest in hiring and training personnel, particularly in estimating and project management, to grow the business.
Selling, General and Administrative Expenses. Our Communications segment’s selling, general and administrative expenses increased $5.3 million, or 12.9% during the year ended September 30, 2022, as compared to the year ended September 30, 2021. The increase is a result of higher personnel cost in connection with the growth of our business, as well as higher wages in an increasingly competitive labor market. We also experienced a more typical level of selling expense for the year ended September 30, 2022 as compared to the year ended September 30, 2021, when travel and other activities were curtailed due to the pandemic. Selling, general and administrative expenses as a percentage of revenue in the Communications segment were 8.3% during the year ended September 30, 2022, compared to 9.3% for the year ended September 30, 2021, as we have benefited from the scale of our operations.
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2021 Compared to 2020
| Year Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | ||||||||||||
| $ | % | $ | % | ||||||||||
| (Dollars in thousands, Percentage of revenues) | |||||||||||||
| Revenues | $ | 445,968 | 100.0 | % | $ | 395,141 | 100.0 | % | |||||
| Cost of services | 361,197 | 81.0 | % | 317,013 | 80.2 | % | |||||||
| Gross Profit | 84,771 | 19.0 | % | 78,128 | 19.8 | % | |||||||
| Selling, general and administrative expenses | 41,373 | 9.3 | % | 37,674 | 9.5 | % | |||||||
| (Gain)/Loss on sale of assets | (4) | — | % | 8 | — | % | |||||||
| Operating Income | 43,402 | 9.7 | % | 40,446 | 10.2 | % |
Revenue. Our Communications segment’s revenues increased by $50.8 million, or 12.9%, during the year ended September 30, 2021, compared to the year ended September 30, 2020. This increase primarily resulted from increased demand from our data center and distribution center customers. Revenues in our Communications segment can vary from period to period based on the capital spending cycles of our customers.
Gross Profit. Our Communications segment’s gross profit during the year ended September 30, 2021, increased $6.6 million, or 8.5%, as compared to the year ended September 30, 2020. Gross profit as a percentage of revenue decreased from 19.8% for the year ended September 30, 2020 to 19.0% for the year ended September 30, 2021, as we invested in hiring and training personnel, particularly in estimating and project management, to grow the business. Additionally, during the fourth fiscal quarter of 2020, we benefited from some larger than typical efficiency gains from strong project execution.
Selling, General and Administrative Expenses. Our Communications segment’s selling, general and administrative expenses increased $3.7 million, or 9.8% during the year ended September 30, 2021, as compared to the year ended September 30, 2020. The increase was a result of higher personnel cost, particularly related to continuing investment to support the growth of the business, along with higher incentive compensation expense in connection with improved profitability and cash flows. Selling, general and administrative expenses as a percentage of revenues in the Communications segment decreased from 9.5% for the year ended September 30, 2020 to 9.3% of segment revenue during the year ended September 30, 2021, as we benefited from the increased scale of our operations.
Residential
2022 Compared to 2021
| Year Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | ||||||||||||
| $ | % | $ | % | ||||||||||
| (Dollars in thousands, Percentage of revenues) | |||||||||||||
| Revenues | $ | 1,131,414 | 100.0 | % | $ | 687,347 | 100.0 | % | |||||
| Cost of services | 928,161 | 82.0 | % | 553,546 | 80.5 | % | |||||||
| Gross Profit | 203,253 | 18.0 | % | 133,801 | 19.5 | % | |||||||
| Selling, general and administrative expenses | 144,100 | 12.7 | % | 92,761 | 13.5 | % | |||||||
| Contingent consideration | 277 | — | % | 211 | — | % | |||||||
| Loss on sale of assets | 20 | — | % | 86 | — | % | |||||||
| Operating Income | 58,856 | 5.2 | % | 40,743 | 5.9 | % |
Revenue. Our Residential segment’s revenues increased by $444.1 million, or 64.6%, during the year ended September 30, 2022, as compared to the year ended September 30, 2021, reflecting a full year of revenue contribution from businesses acquired in fiscal 2021, strong demand for single-family and multi-family housing and the impact of price increases in connection with a higher cost of materials. Businesses acquired in fiscal 2021 contributed $233.1 million of the total increase for the year ended September 30, 2022 compared to the year ended September 30, 2021. Inclusive of these acquired businesses, revenue in our single-family business increased by $371.1 million for the year ended September 30, 2022, compared to the year ended September 30, 2021, while multi-family and other revenue increased by $73.0 million.
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Gross Profit. During the year ended September 30, 2022, our Residential segment gross profit increased by $69.5 million, or 51.9%, as compared to the year ended September 30, 2021. The increase in gross profit was driven primarily by contributions from the businesses acquired in fiscal 2021 and higher volumes, partly offset by increased commodity prices. Gross margin as a percentage of revenue decreased to 18.0% during the year ended September 30, 2022 from 19.5% for the year ended September 30, 2021, primarily as a result of increased commodity prices and a reduction in project efficiency related to supply-chain challenges and the COVID-19 pandemic.
Selling, General and Administrative Expenses. Our Residential segment's selling, general and administrative expenses increased by $51.3 million, or 55.3%, during the year ended September 30, 2022, compared to the year ended September 30, 2021. Selling, general and administrative expenses incurred at the businesses acquired during fiscal 2021, including amortization of intangible assets, contributed $21.3 million of the increase. The remaining increase was driven by higher personnel cost in connection with business growth, including incentive profit sharing for division management. Selling, general and administrative expenses as a percentage of revenues in the Residential segment decreased to 12.7% during the year ended September 30, 2022, from 13.5% during the year ended September 30, 2021, as we benefited from the increased scale of our operations.
2021 Compared to 2020
| Year Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | ||||||||||||
| $ | % | $ | % | ||||||||||
| (Dollars in thousands, Percentage of revenues) | |||||||||||||
| Revenues | $ | 687,347 | 100.0 | % | $ | 411,790 | 100.0 | % | |||||
| Cost of services | 553,546 | 80.5 | % | 318,034 | 77.2 | % | |||||||
| Gross Profit | 133,801 | 19.5 | % | 93,756 | 22.8 | % | |||||||
| Selling, general and administrative expenses | 92,761 | 13.5 | % | 63,668 | 15.5 | % | |||||||
| Contingent consideration | 211 | — | % | — | — | % | |||||||
| Loss on sale of assets | 86 | — | % | 2 | — | % | |||||||
| Operating Income | 40,743 | 5.9 | % | 30,086 | 7.3 | % |
Revenue. Our Residential segment’s revenues increased by $275.6 million, or 66.9%, during the year ended September 30, 2021, as compared to the year ended September 30, 2020, reflecting the revenue contribution of businesses acquired in fiscal 2021, strong demand for single-family and multi-family housing and the impact of price increases in connection with a higher cost of materials. Businesses acquired in fiscal 2021 contributed $172.6 million of revenue for the year ended September 30, 2021. Inclusive of these acquired businesses, revenue in our single-family business increased by $215.3 million for the year ended September 30, 2021, compared to the year ended September 30, 2020, while multi-family and other revenue increased by $60.2 million. Excluding the impact of the businesses acquired during fiscal 2021, our Residential segment's revenues grew by 25.0% for the year ended September 30, 2021.
Gross Profit. During the year ended September 30, 2021, our Residential segment experienced a $40.0 million, or 42.7%, increase in gross profit as compared to the year ended September 30, 2020. The increase in gross profit was driven primarily by $27.9 million contributed by the businesses acquired in fiscal 2021, as well as higher volumes, partly offset by increased commodity prices. Gross margin as a percentage of revenue decreased from 22.8% for the year ended September 30, 2020 to 19.5% during the year ended September 30, 2021, primarily as a result of higher commodity prices.
Selling, General and Administrative Expenses. Our Residential segment's selling, general and administrative expenses increased $29.1 million, or 45.7%, during the year ended September 30, 2021, compared to the year ended September 30, 2020. Selling, general and administrative expenses incurred at the businesses acquired during fiscal 2021, including amortization of intangible assets, contributed $20.1 million of the increase. The remaining increase was driven by higher personnel cost in connection with business growth, including incentive profit sharing for division management. Selling, general and administrative expenses as a percentage of revenues in the Residential segment decreased from 15.5% during the year ended September 30, 2020 to 13.5% during the year ended September 30, 2021, as we benefited from the increased scale of our operations.
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Infrastructure Solutions
2022 Compared to 2021
| Year Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | ||||||||||||
| $ | % | $ | % | ||||||||||
| (Dollars in thousands, Percentage of revenues) | |||||||||||||
| Revenues | $ | 167,113 | 100.0 | % | $ | 146,980 | 100.0 | % | |||||
| Cost of services | 138,444 | 82.8 | % | 106,048 | 72.2 | % | |||||||
| Gross Profit | 28,669 | 17.2 | % | 40,932 | 27.8 | % | |||||||
| Selling, general and administrative expenses | 25,129 | 15.0 | % | 23,966 | 16.3 | % | |||||||
| Gain on sale of assets | (46) | — | % | (10) | — | % | |||||||
| Operating Income | 3,586 | 2.1 | % | 16,976 | 11.5 | % |
Revenue. Revenues in our Infrastructure Solutions segment increased by $20.1 million, or 13.7% during the year ended September 30, 2022 compared to the year ended September 30, 2021. The increase in revenue was driven primarily by increased demand at our generator enclosure business as well as the acquisition of Wedlake Fabricating, Inc. ("Wedlake") during the first quarter of fiscal 2021, which contributed $16.9 million of the increase.
Gross Profit. Our Infrastructure Solutions segment’s gross profit for the year ended September 30, 2022, decreased by $12.3 million, as compared to the year ended September 30, 2021, reflecting the impact of supply chain disruptions on our generator enclosure business, COVID-19 related labor inefficiencies, and operating inefficiencies in connection with the relocation of the Wedlake business to a new, larger facility that expands capacity while allowing for improved workflow and process efficiency. The transition to and setup of the new facility were completed during the third quarter of fiscal 2022. Gross profit as a percent of revenue decreased to 17.2% for the year ended September 30, 2022 compared to 27.8% for the year ended September 30, 2021. Additionally, during the year ended September 30, 2021, we benefited from workers' compensation refunds received from the State of Ohio.
Selling, General and Administrative Expenses. Our Infrastructure Solutions segment’s selling, general and administrative expenses during the year ended September 30, 2022, increased $1.2 million compared to the year ended September 30, 2021, primarily as a result of expenses incurred at the Wedlake business acquired during the first fiscal quarter of 2021. Selling, general and administrative expenses as a percentage of revenue decreased from 16.3% for the year ended September 30, 2021, to 15.0% for the year ended September 30, 2022.
2021 Compared to 2020
| Year Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | ||||||||||||
| $ | % | $ | % | ||||||||||
| (Dollars in thousands, Percentage of revenues) | |||||||||||||
| Revenues | $ | 146,980 | 100.0 | % | $ | 128,379 | 100.0 | % | |||||
| Cost of services | 106,048 | 72.2 | % | 93,358 | 72.7 | % | |||||||
| Gross Profit | 40,932 | 27.8 | % | 35,021 | 27.3 | % | |||||||
| Selling, general and administrative expenses | 23,966 | 16.3 | % | 20,418 | 15.9 | % | |||||||
| (Gain)/Loss on sale of assets | (10) | — | % | 35 | — | % | |||||||
| Operating Income | 16,976 | 11.5 | % | 14,568 | 11.3 | % |
Revenue. Revenues in our Infrastructure Solutions segment increased by $18.6 million, or 14.5% during the year ended September 30, 2021 compared to the year ended September 30, 2020. Increased demand for our custom power solutions was partially offset by lower revenue from our industrial services business. The demand for our motor repair services continues to be affected by reduced demand from customers in the steel and rail industries. During the year ended September 30, 2021, the Wedlake business acquired during the first fiscal quarter 2021 contributed $7.1 million of revenue for the year ended September 30, 2021.
Gross Profit. Our Infrastructure Solutions segment’s gross profit for the year ended September 30, 2021, increased by $5.9 million, as compared to the year ended September 30, 2020, reflecting improved overall operational efficiencies. Gross profit as a percent of revenue increased to 27.8% for the year ended September 30, 2021 compared to 27.3% for the year ended September 30, 2020, largely as the result of those efficiencies, as management has continued to focus on procurement, engineering, and quality.
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Selling, General and Administrative Expenses. Our Infrastructure Solutions segment’s selling, general and administrative expenses during the year ended September 30, 2021, increased $3.5 million compared to the year ended September 30, 2020. The increase in fiscal 2021 includes $1.6 million of expenses incurred, including amortization of intangible assets, at our acquired Wedlake business. The selling, general and administrative expenses as a percentage of revenue increased from 15.9% for the year ended September 30, 2020, to 16.3% for the year ended September 30, 2021, primarily as a result of the increase in expenses, including amortization expense, related to Wedlake.
Commercial & Industrial
2022 Compared to 2021
| Year Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | ||||||||||||
| $ | % | $ | % | ||||||||||
| (Dollars in thousands, Percentage of revenues) | |||||||||||||
| Revenue | $ | 308,504 | 100.0 | % | $ | 256,198 | 100.0 | % | |||||
| Cost of services | 290,314 | 94.1 | % | 227,704 | 88.9 | % | |||||||
| Gross Profit | 18,190 | 5.9 | % | 28,494 | 11.1 | % | |||||||
| Selling, general and administrative expenses | 30,557 | 9.9 | % | 28,172 | 11.0 | % | |||||||
| Gain on sale of assets | (55) | — | % | (92) | — | % | |||||||
| Operating Income | (12,312) | (4.0) | % | 414 | 0.2 | % |
Revenue. Revenues in our Commercial & Industrial segment increased $52.3 million, or 20.4%, during the year ended September 30, 2022, compared to the year ended September 30, 2021. During the year ended September 30, 2022, we benefited from the start-up of projects that were delayed in fiscal 2021. While activity in this segment was curtailed earlier in the COVID-19 pandemic, many customers have returned to more typical levels of activity. However, this market remains highly competitive.
Gross Profit. Our Commercial & Industrial segment’s gross profit during the year ended September 30, 2022 decreased by $10.3 million, or 36.2%, as compared to the year ended September 30, 2021. During the year ended September 30, 2022, one of our Commercial & Industrial branches experienced execution issues on a large contract, resulting in significant project rework. As a result, we incurred additional expense related to this project including the accrual of estimated costs to complete the project, including demolition, purchase of replacement materials, and performance of the rework. Additionally, a second job at that same branch was affected by costs associated with a delay in receiving materials from a supplier. These two projects collectively impacted gross profit for the year ended September 30, 2022 by $16.7 million. As a result, gross profit as a percentage of revenue decreased from 11.1% for the year ended September 30, 2021, to 5.9% for the year ended September 30, 2022.
Selling, General and Administrative Expenses. Our Commercial & Industrial segment’s selling, general and administrative expenses during the year ended September 30, 2022 increased $2.4 million, or 8.5%, compared to the year ended September 30, 2021. The increase was driven primarily by higher pay rates in an increasingly competitive labor market, as well as $2.3 million of reserves in connection with legal matters related to certain contractual disputes. Selling, general and administrative expenses as a percentage of revenue decreased from 11.0% for the year ended September 30, 2021 to 9.9% for the year ended September 30, 2022.
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2021 Compared to 2020
| Year Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | ||||||||||||
| $ | % | $ | % | ||||||||||
| (Dollars in thousands, Percentage of revenues) | |||||||||||||
| Revenues | $ | 256,198 | 100.0 | % | $ | 255,546 | 100.0 | % | |||||
| Cost of services | 227,704 | 88.9 | % | 234,492 | 91.8 | % | |||||||
| Gross Profit | 28,494 | 11.1 | % | 21,054 | 8.2 | % | |||||||
| Selling, general and administrative expenses | 28,172 | 11.0 | % | 32,128 | 12.6 | % | |||||||
| Goodwill impairment expense | — | — | % | 6,976 | 2.7 | % | |||||||
| Contingent consideration | — | — | % | (11) | — | % | |||||||
| Gain on sale of assets | (92) | — | % | (45) | — | % | |||||||
| Operating Income (Loss) | 414 | 0.2 | % | (17,994) | (7.0) | % |
Revenue. Revenues in our Commercial & Industrial segment increased $0.7 million, or 0.3%, during the year ended September 30, 2021, compared to the year ended September 30, 2020. The market for our Commercial & Industrial segment's services remains highly competitive, and disruptions caused by the COVID-19 pandemic resulted in some delays in the awarding of new projects and the progress of certain existing projects, as well as decreased demand for new construction in certain sectors we serve, particularly through the first six months of fiscal 2021.
Gross Profit. Our Commercial & Industrial segment’s gross profit during the year ended September 30, 2021 increased by $7.4 million, or 35.3%, as compared to the year ended September 30, 2020. We have improved project efficiency, enhanced our procurement process, and focused on controlling costs. As a result, gross profit as a percent of revenues increased from 8.2% for the year ended September 30, 2020, to 11.1% for the year ended September 30, 2021.
Selling, General and Administrative Expenses. Our Commercial & Industrial segment’s selling, general and administrative expenses during the year ended September 30, 2021 decreased $4.0 million, or 12.3%, compared to the year ended September 30, 2020. The higher expense in fiscal 2020 primarily reflected a write-off recorded in 2020 related to a commercial dispute, as well as costs incurred in 2020 to improve our procurement process. Selling, general and administrative expenses as a percentage of revenue decreased from 12.6% for the year ended September 30, 2020 to 11.0% for the year ended September 30, 2021.
INTEREST AND OTHER EXPENSE, NET
| Year Ended September 30, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2020 | ||||||||
| (In thousands) | ||||||||||
| Interest expense | $ | 2,771 | $ | 764 | $ | 625 | ||||
| Deferred financing charges | 199 | 198 | 152 | |||||||
| Total interest expense | 2,970 | 962 | 777 | |||||||
| Other (income) expense, net | 37 | (286) | 12 | |||||||
| Total interest and other expense, net | 3,007 | 676 | 789 |
During the year ended September 30, 2022, we incurred interest expense of $3.0 million primarily comprised of interest expense from our revolving credit facility and fees on an average letter of credit balance of $4.5 million under our revolving credit facility and an average unused line of credit balance of $49.2 million. This compares to interest expense of $1.0 million for the year ended September 30, 2021 primarily comprised of interest expense from our revolving credit facility and fees on an average letter of credit balance of $5.7 million under our revolving credit facility and an average unused line of credit balance of $77.4 million.
During the year ended September 30, 2020, we incurred interest expense of $0.8 million primarily comprised of interest expense from our revolving credit facility and fees on an average letter of credit balance of $6.9 million under our revolving credit facility and an average unused line of credit balance of $89.6 million.
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PROVISION FOR INCOME TAXES
For the year ended September 30, 2022, we recorded income tax expense of $12.8 million, which reflects a $0.8 million benefit related to the recognition of previously unrecognized tax benefits.
For the year ended September 30, 2021, we recorded income tax expense of $16.2 million, which reflects a $5.1 million benefit related to the recognition of previously unrecognized tax benefits.
For the year ended September 30, 2020, we recorded income tax expense of $8.7 million, which reflects a $3.2 million benefit related to the recognition of previously unrecognized tax benefits as well as a $3.3 million benefit related to the release of valuation allowance on certain state net operating loss carryforwards.
WORKING CAPITAL
During the year ended September 30, 2022, working capital exclusive of cash increased by $48.2 million from September 30, 2021, reflecting a $138.5 million increase in current assets excluding cash and a $90.3 million increase in current liabilities during the period.
During the year ended September 30, 2022, our current assets exclusive of cash increased to $599.6 million, as compared to $461.1 million as of September 30, 2021. An increase in business activity drove an $84.0 million increase in trade accounts receivable. Days sales outstanding increased to 58 at September 30, 2022 from 57 at September 30, 2021. While the rate of collections may vary, our typically secured position, resulting from our ability in general to secure liens against our customers’ overdue receivables, offers some protection that collection will occur eventually to the extent that our security retains value. Retainage increased by $23.7 million as a result of growth in the Residential multi-family business, as well as the timing of projects in the Commercial & Industrial business. Additionally, inventory increased by $27.8 million in connection with rising commodity prices as well as growth of our business. Further, we have increased the quantity of inventory we are currently carrying to manage procurement risks. Costs and estimated earnings in excess of billings increased by $8.7 million as a result of increased levels of activity at our Communications business, as well as supply chain disruptions in our Infrastructure Solutions business.
During the year ended September 30, 2022, our total current liabilities increased by $90.3 million to $401.9 million, compared to $311.6 million as of September 30, 2021, driven by increased levels of business activity, offset in part by remittance of payroll taxes deferred under the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act").
Surety
Many customers, particularly in connection with new construction, require us to post performance and payment bonds issued by a surety. These bonds provide a guarantee to the customer that we will perform under the terms of our contract and that we will pay our subcontractors and vendors. If we fail to perform under the terms of our contract or to pay subcontractors and vendors, 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 on our behalf. To date, we have not been required to make any reimbursements to our sureties for bond-related costs.
As is common in the surety industry, sureties issue bonds on a project-by-project basis and can decline to issue bonds at any time. We believe that our relationships with our sureties will allow us to provide surety bonds as they are required. However, current market conditions, as well as changes in our sureties' assessment of our operating and financial risk, could cause our sureties to decline to issue bonds for our work. If our sureties decline to issue bonds for our work, our alternatives would include posting other forms of collateral for project performance, such as letters of credit or cash, seeking bonding capacity from other sureties, or engaging in more projects that do not require surety bonds. In addition, if we are awarded a project for which a surety bond is required but we are unable to obtain a surety bond, the result could be a claim for damages by the customer for the costs of replacing us with another contractor.
We believe the bonding capacity currently provided by our sureties is adequate for our current operations and will be adequate for our operations for the foreseeable future. As of September 30, 2022, the estimated cost to complete our bonded projects was approximately $107.6 million.
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LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2022, we had cash and cash equivalents of $24.8 million and $63.3 million of availability under our revolving credit facility. We anticipate that the combination of cash on hand, cash flows from operations and available capacity under our revolving credit facility will provide sufficient cash to enable us to meet our working capital needs, debt service requirements and capital expenditures for property and equipment through the next twelve months. Our ability to generate cash flow is dependent on many factors, including demand for our services, the availability of projects at margins acceptable to us, the ultimate collectability of our receivables, and our ability to borrow on our revolving credit facility or raise funds in the capital markets, if needed.
The Revolving Credit Facility
On April 28, 2022, we entered into a Third Amended and Restated Credit and Security Agreement (the "Amended Credit Agreement"), which increased our maximum borrowing amount from $125 million to $150 million. The Amended Credit Agreement also removed the aggregate cap on our investments in certain securities and the cap on our ability to make stock repurchases, in each case subject to the satisfaction of certain liquidity requirements. All other customary affirmative, negative and financial covenants and events of default were unchanged by the amendment.
Borrowings under the Amended Credit Agreement may not exceed a "Borrowing Base,” as defined in the Amended Credit Agreement, determined monthly based on available collateral, primarily certain accounts receivables, inventories, and equipment. Amounts outstanding bear interest at a per annum rate equal to the Daily Three Month Secured Overnight Financing Rate ("SOFR"), plus an interest rate margin, which is determined quarterly, based on the following thresholds:
| Level | Thresholds | Interest Rate Margin | ||
|---|---|---|---|---|
| I | If Liquidity is less than 35% of the Maximum Revolver Amount (each as defined in the Amended Credit Agreement) at any time during the period | 2.00 percentage points | ||
| II | If Liquidity is greater than or equal to 35% of the Maximum Revolver Amount at all times during the period and less than 50% of the Maximum Revolver Amount at any time during the period | 1.75 percentage points | ||
| III | If Liquidity is greater than or equal to 50% of the Maximum Revolver Amount at all times during the period | 1.50 percentage points |
In addition, we are charged monthly in arrears for (1) an unused commitment fee of 0.25% per annum, (2) a collateral monitoring fee of $5 thousand per quarter, (3) a letter of credit fee based on the then-applicable interest rate margin (4) appraisal fees, costs and expenses and (5) certain other fees and charges as specified in the Amended Credit Agreement.
As of September 30, 2022, we were in compliance with the financial covenants under the Amended Credit Agreement, requiring that we maintain:
• a Fixed Charge Coverage Ratio (as defined in the Amended Credit Agreement), measured quarterly on a trailing
four-quarter basis at the end of each quarter, of at least 1.1 to 1.0; and
• minimum Liquidity of at least 10% of the Maximum Revolver Amount, or $15.0 million; with, for purposes of this covenant, at least 50% of our Liquidity comprised of Excess Availability (as defined in the Amended Credit Agreement).
At September 30, 2022, our Liquidity was $88.1 million, our Excess Availability was $63.3 million (or greater than 50% of minimum Liquidity), and our Fixed Charge Coverage Ratio was 1.6:1.0.
Our Fixed Charge Coverage Ratio is calculated as follows (with capitalized terms as defined in the Amended Credit Agreement): (i) our trailing twelve month EBITDA, less Non-Financed Capital Expenditures (other than capital expenditures financed by means of an advance under the credit facility), cash taxes and all Restricted Junior Payments consisting of certain Pass-Through Tax Liabilities, divided by (ii) the sum of our cash interest (other than interest paid-in-kind, amortization of financing fees, and other non-cash interest expense) and principal debt payments (other than repayment of principal on advances under the credit facility and including cash payments with respect to capital leases), any management, consulting, monitoring, and advisory fees paid to an affiliate, and all Restricted Junior Payments (other than Pass-Through Tax Liabilities) and other cash distributions; provided, that if we make an acquisition consented to by our lenders, the components of the Fixed Charge Coverage Ratio will be calculated for such fiscal period after giving pro forma effect to the acquisition assuming that such transaction has occurred on the first day of such period (including pro forma adjustments arising out of events which are directly attributable to such acquisition, are factually supportable, and are expected to have a continuing impact, in each case to be reasonably agreed to by our lenders).
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As defined in the Amended Credit Agreement, EBITDA is calculated as consolidated net income (or loss), less extraordinary gains, interest income, non-operating income and income tax benefits and decreases in any change in LIFO reserves, plus stock compensation expense, non-cash extraordinary losses (including, but not limited to, a non-cash impairment charge or write-down), Interest Expense, income taxes, depreciation and amortization, and increases in any change in LIFO reserves for such period, determined on a consolidated basis in accordance with GAAP.
If in the future our Liquidity falls below $15.0 million (or Excess Availability falls below 50% of our minimum Liquidity), our Fixed Charge Coverage Ratio is less than 1.1:1.0, or if we otherwise fail to perform or otherwise comply with certain of our covenants or other agreements under the Amended Credit Agreement, it would result in an event of default under the Amended Credit Agreement, which could result in some or all of our then-outstanding indebtedness becoming immediately due and payable.
At September 30, 2022, we had $4.1 million in outstanding letters of credit and $82.7 million of outstanding borrowings under our revolving credit facility.
Investments
From time to time, the Company invests in non-controlling positions in the debt or equity securities of other businesses. Our Board of Directors has approved an investment policy that permits the Company to invest our cash in liquid and marketable securities that include equities and fixed income securities, subject to size limits on investments individually and in the aggregate. Equity securities may include unrestricted, publicly traded stock that is listed on a major exchange or a national, over-the-counter market and that is appropriate for our portfolio objectives, and fixed income securities are required to have an investment grade credit quality at the time of purchase.
Operating Activities
Our cash flow from operations is not only influenced by cyclicality, demand for our services, operating margins and the type of services we provide, but can also be influenced by working capital needs such as the timing of our receivable collections. Working capital needs are generally lower during our fiscal first and second quarters due to the seasonality that we experience in many regions of the country; however, a seasonal decline in working capital may be offset by needs associated with higher growth or acquisitions. Currently, our working capital needs are higher than they have been historically, as a result of growth of our business, elevated commodity prices,and the steps taken to mitigate the impact of supply chain disruptions.
Operating activities provided net cash of $16.3 million during the year ended September 30, 2022, as compared to $37.9 million of net cash provided in the year ended September 30, 2021. The decrease in operating cash flow resulted from lower earnings and an increase in working capital, particularly due to increased trade accounts receivable and inventory during the year ended September 30, 2022 in support of the growth of the business. We also remitted $7.0 million of payroll taxes previously deferred under the CARES Act.
Operating activities provided net cash of $37.9 million during the year ended September 30, 2021, as compared to $76.7 million of net cash provided in the year ended September 30, 2020. The decrease in operating cash flow resulted from an increase in working capital, particularly related to inventory. As commodity prices increased, we also experienced longer lead times for deliveries, and reduced availability for certain products we procure, particularly copper wire. As a result, we increased the amount of inventory carried in an effort to ensure the availability of materials to serve our customers. This increase in working capital was partly offset by higher earnings during the year ended September 30, 2021.
Investing Activities
Net cash used in investing activities was $29.5 million for the year ended September 30, 2022, compared to $99.6 million of net cash used in investing activities in the year ended September 30, 2021. We used $29.3 million for capital expenditures in the year ended September 30, 2022, primarily related to the acquisition of a new operating facility for our Wedlake business, as well as an additional facility to support the growth of our Residential business in Florida. Investing activities for the year ended September 30, 2021 include $7.4 million of capital expenditures and $92.5 million for the acquisition of businesses.
In the year ended September 30, 2021, net cash used in investing activities was $99.6 million, as compared to $33.6 million of net cash used in investing activities in the year ended September 30, 2020. Investing activities for the year ended September 30, 2021 include $7.4 million of capital expenditures and $92.5 million for the acquisition of businesses. Investing activities for the year ended September 30, 2020 include $4.7 million of capital expenditures and $29.0 million for the acquisition of businesses.
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Financing Activities
Net cash provided by financing activities was $15.0 million in the year ended September 30, 2022, compared to $31.2 million in the year ended September 30, 2021. Net cash provided by financing activities for the year ended September 30, 2022 included net borrowing on our credit facility of $42.3 million, partly offset by $18.6 million used for repurchase of our common stock, including repurchases to satisfy statutory withholding requirements upon the vesting of employee stock compensation. Additionally, we distributed $7.0 million to noncontrolling interests under operating agreements in connection with certain acquisitions.
Net cash provided by financing activities was $31.2 million in the year ended September 30, 2021, compared to $8.5 million used in the year ended September 30, 2020. For the year ended September 30, 2021, we borrowed a net $40.0 million on our revolving credit facility. In addition, we used $7.0 million to repurchase our shares under our stock repurchase program, as well as to satisfy statutory withholding requirements upon the vesting of employee stock compensation.
CONTROLLING SHAREHOLDER
Tontine Associates, L.L.C. ("Tontine Associates"), together with its affiliates (collectively, "Tontine") is the Company's controlling stockholder, owning approximately 57 percent of the Company’s outstanding common stock based on the Form 4 filed by Tontine with the SEC on December 3, 2021 and the Company's shares outstanding as of December 2, 2022. Accordingly, Tontine has the ability to exercise significant control over our affairs, including the election of directors and most actions requiring the approval of shareholders.
We are a party to a sublease agreement with Tontine Associates for corporate office space in Greenwich, Connecticut. The sublease extends through February 27, 2023, with monthly payments due in the amount of approximately $8 thousand. The lease has terms at market rates, and payments by the Company are at a rate consistent with that paid by Tontine Associates to its landlord.
On December 6, 2018, the Company entered into a Board Observer Letter Agreement (the "Observer Agreement") with Tontine Associates in order to assist Tontine in managing its investment in the Company. Subject to the terms and conditions set forth in the Observer Agreement, the Company granted Tontine the right, at any time that Tontine holds at least 20% of the outstanding common stock of the Company, to appoint a representative to serve as an observer to the Board (the “Board Observer”). The Board Observer, who shall serve at the discretion of and must be reasonably acceptable to those members of the Board who are not affiliates of Tontine, shall have no voting rights or other decision making authority. Subject to the terms and conditions set forth in the Observer Agreement, so long as Tontine has the right to appoint a Board Observer, the Board Observer will have the right to attend and participate in meetings of the Board and the committees thereof, subject to confidentiality requirements, and to receive reimbursement for reasonable out-of-pocket expenses incurred in his or her capacity as a Board Observer and such rights to coverage under the Company’s directors’ and officers’ liability insurance policy as are available to directors.
Jeffrey L. Gendell was appointed Chief Executive Officer of the Company effective October 1, 2020, having served as the Company's Interim Chief Executive Officer since July 31, 2020. Mr. Gendell also serves as Chairman of the Board of Directors, a position he has held since November 2016. He is the managing member and founder of Tontine, and the brother of David B. Gendell, who has served as a member of our Board of Directors since February 2012, and who previously served as Interim Director of Operations from November 2017 to January 2019, as Vice Chairman of the Board from November 2016 to November 2017 and as Chairman of the Board from January 2015 to November 2016. David B. Gendell was an employee of Tontine from 2004 until January 2018.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
As is common in our industry, we have entered into certain off-balance sheet arrangements that expose us to increased risk. Our significant off-balance sheet transactions include letter of credit obligations, firm commitments for materials and surety guarantees.
Some of our customers and vendors may require us to post letters of credit as a means of guaranteeing performance under our contracts and ensuring payment by us to subcontractors and vendors. If our customer has reasonable cause to effect payment under a letter of credit, we would be required to reimburse our creditor for the letter of credit.
Some of the underwriters of our casualty insurance program require us to post letters of credit as collateral, as is common in the insurance industry. To date, we have not had a situation where an underwriter has had reasonable cause to effect payment under a letter of credit. At September 30, 2022, $3.9 million of our outstanding letters of credit were to collateralize our insurance programs.
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From time to time, we may enter into firm purchase commitments for materials such as copper wire and aluminum wire, which we expect to use in the ordinary course of business. These commitments are typically for terms of less than one year and require us to buy minimum quantities of materials at specified intervals at a fixed price over the term. As of September 30, 2022, we had commitments of $9.7 million outstanding under such agreements to purchase copper wire and other materials over the next 12 months in the ordinary course of business.
Many of our customers require us to post performance and payment bonds issued by a surety. Those bonds guarantee the customer that we will perform under the terms of a contract and that we will pay subcontractors and vendors. In the event that we fail to perform under a contract or pay subcontractors and vendors, the customer may demand the surety to pay or perform under our bond. Our relationship with our sureties is such that we will indemnify the sureties for any expenses they incur in connection with any of the bonds they issue on our behalf and may be required to post collateral to support the bonds. To date, we have not incurred any material costs to indemnify our sureties for expenses they incurred on our behalf.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of operations are based on our Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of our Consolidated Financial Statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities known to exist as of the date the Consolidated Financial Statements, and the reported amounts of revenues and expenses recognized during the periods presented. We review all significant estimates affecting our Consolidated Financial Statements on a recurring basis and record the effect of any necessary adjustments prior to their publication. Judgments and estimates are based on our beliefs and assumptions derived from information available at the time such judgments and estimates are made. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of financial statements. There can be no assurance that actual results will not differ from those estimates.
Accordingly, we have identified the accounting principles which we believe are most critical to our reported financial status by considering accounting policies that involve the most complex or subjective decisions or assessments. We identified our most critical accounting policies to be those related to revenue recognition, accounting for business combinations, the assessment of goodwill and asset impairment, our allowance for credit losses, the recording of our insurance liabilities and estimation of the valuation allowance for deferred tax assets, and unrecognized tax benefits. These accounting policies, as well as others, are described in Note 2, “Summary of Significant Accounting Policies” in the notes to our Consolidated Financial Statements and at relevant sections in this discussion and analysis.
Revenue Recognition. We enter into contracts principally on the basis of competitive bids. We frequently negotiate the final terms and prices of those contracts with the customer. Although the terms of our contracts vary considerably, approximately 90% of our revenues are based on either a fixed price or unit price basis in which we agree to do the work for a fixed amount for the entire project (fixed price) or for units of work performed (unit price). Approximately 10% of our revenues are earned from contracts where we are paid on a time and materials basis. Our most significant cost drivers are the cost of labor and materials. These costs may vary from the costs we originally estimated. Variations from estimated contract costs along with other risks inherent in performing fixed price and unit price contracts may result in actual revenue and gross profits or interim projected revenue and gross profits for a project differing from those we originally estimated and could result in losses on projects. Depending on the size of a particular project, variations from estimated project costs could have a significant impact on our operating results for any fiscal quarter or year.
We complete most of our projects within one year. We frequently provide service and maintenance work under open-ended, unit price master service agreements which are renewable annually. We recognize revenue on service, time and material work when services are performed. Work performed under a construction contract generally provides that the customers accept completion of progress to date and compensate us for services rendered, measured in terms of units installed, hours expended or some other measure of progress. Revenues from construction contracts are recognized on the percentage-of-completion method. Revenues recognized on a percentage-of-completion basis, all of which are fixed price or cost plus arrangements, comprised approximately 49% of our total revenue for the year ended September 30, 2022. The percentage-of-completion method for construction contracts is measured principally by the percentage of costs incurred and accrued to date for each contract to the estimated total costs for each contract at completion. We generally consider contracts substantially complete upon departure from the work site and acceptance by the customer. Contract costs include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation costs. Changes in job performance, job conditions, estimated contract costs, profitability and final contract settlements may result in revisions to costs and income, and the effects of such revisions are recognized in the period in which the revisions are determined. Provisions for total estimated losses on uncompleted contracts are made in the period in which such losses are determined.
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We generally do not incur significant costs related to obtaining contracts, or initial set-up or mobilization costs, prior to the start of a project. When significant pre‑contract costs are incurred, they will be capitalized and amortized on a percentage of completion basis over the life of the contract.
The current asset “Costs and estimated earnings in excess of billings” represents revenues recognized in excess of amounts billed that management believes will be billed and collected within the next twelve months. The current liability “Billings in excess of costs and estimated earnings” represents billings in excess of revenues recognized. Costs and estimated earnings in excess of billings are amounts considered recoverable from customers based on different measures of performance, including achievement of specific milestones, completion of specified units or completion of the contract. Also included in this asset, from time to time, are claims and unapproved change orders, which include amounts that we are in the process of collecting from our customers or agencies for changes in contract specifications or design, contract change orders in dispute or unapproved as to scope and price, or other related causes of unanticipated additional contract costs. Claims and unapproved change orders are recorded at estimated realizable value when collection is probable and can be reasonably estimated. We do not recognize profits on construction costs incurred in connection with claims. Claims made by us involve negotiation and, in certain cases, litigation. Such litigation costs are expensed as incurred.
Business Combinations. In accounting for business combinations, certain assumptions and estimates are employed in determining the fair value of assets acquired, evaluating the fair value of liabilities assumed, as well as in determining the allocation of goodwill to the appropriate reporting unit. These estimates may be affected by factors such as changing market conditions affecting the industries in which we operate. The most significant assumptions requiring judgment involve identifying and estimating the fair value of intangible assets and the associated useful lives for establishing amortization periods. To finalize purchase accounting for significant intangible assets and liabilities, we utilize the services of independent valuation specialists to assist in the determination of the fair value.
Valuation Allowance for Deferred Tax Assets. We regularly evaluate valuation allowances established for deferred tax assets for which future realization is uncertain. We perform this evaluation quarterly. The estimation of required valuation allowances includes estimates of future taxable income. In assessing the realizability of deferred tax assets at September 30, 2022, we concluded, based upon the assessment of positive and negative evidence, that it is more likely than not that the Company will generate sufficient taxable income within the applicable NOL carryforward periods to realize its $20.5 million of deferred tax assets. We considered the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.
An inability to generate sufficient taxable income in future periods to realize our deferred tax assets may lead to a future need for a valuation allowance and a corresponding reduction in GAAP net income. In addition, any reduction in the federal statutory tax rate in the future could also cause a reduction in the economic benefit of the NOL available to us and a corresponding charge to reduce the book value of the deferred tax asset recorded on our Consolidated Balance Sheets.
Income Taxes. GAAP specifies the methodology by which a company must identify, recognize, measure and disclose in its financial statements the effects of any uncertain tax return reporting positions that it has taken or expects to take. GAAP requires financial statement reporting of the expected future tax consequences of uncertain tax return reporting positions on the presumption that all relevant tax authorities possess full knowledge of those tax reporting positions, as well as all of the pertinent facts and circumstances, but it prohibits discounting of any of the related tax effects for the time value of money.
The evaluation of a tax position is a two-step process. The first step is the recognition process to determine if it is more likely than not that a tax position will be sustained upon examination by the appropriate taxing authority, based on the technical merits of the position. The second step is a measurement process whereby a tax position that meets the more likely than not recognition threshold is calculated to determine the amount of benefit/expense to recognize in the financial statements. The tax position is measured at the largest amount of benefit/expense that is more likely than not of being realized upon ultimate settlement.
The tax years ended September 30, 2019 and forward are subject to federal audit as are prior tax years, to the extent of unutilized net operating losses generated in those years.
We anticipate that approximately $0.2 million in liabilities for unrecognized tax benefits, including accrued interest, may be reversed in the next twelve months. This reversal is predominantly due to the expiration of the statutes of limitation for unrecognized tax benefits.
New Accounting Pronouncements. Recent accounting pronouncements are described in Note 2, “Summary of Significant Accounting Policies — New Accounting Pronouncements” in the notes to our Consolidated Financial Statements and at relevant sections in this discussion and analysis.
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