Limbach Holdings, Inc. (LMB) FY 2023 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 should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from its management’s expectations. Factors that could cause such differences are discussed in “Forward-Looking Statements”, “Risk Factor Summary” and “Risk Factors” in this Annual Report. The Company assumes no obligation to update any of these forward-looking statements, unless required to do so by applicable law.
Overview
The Company is a building systems solution firm that partners with building owners and facilities managers who have mission critical mechanical (heating, ventilation and air conditioning), electrical, and plumbing infrastructure. The Company strives to be an indispensable partner to its customers by providing services that are essential to the operation of their businesses. The Company has more than 1,400 team members in 19 offices across the eastern United States. The Company’s team members uniquely combine engineering expertise with field installation skills to provide custom solutions that leverage its full life-cycle capabilities, which allows it to address both the operational and capital projects needs of its customers.
The Company’s core market sectors consist of the following customer base with mission-critical systems:
•Healthcare, including research, acute care and inpatient hospitals for regional and national hospital groups, and pharmaceutical and biotech laboratories and manufacturing facilities;
•Industrial and manufacturing, including automotive, energy and general manufacturing plants;
•Data Centers, including facilities composed of networked computers, storage systems and computing infrastructure that organizations use to assemble, process, store and disseminate large amounts of data;
•Life sciences, including organizations and companies whose work is centered around research and development focused on living things;
•Higher Education, including both public and private colleges, universities and research centers; and
•Cultural and entertainment, including sports arenas, entertainment facilities (including casinos) and amusement rides and parks.
The Company operates in two segments, (i) GCR, in which the Company generally manages new construction or renovation projects that involve primarily mechanical, plumbing, or electrical services awarded to the Company by general contractors or construction managers, and (ii) ODR, in which the Company performs owner direct projects and/or provides maintenance or
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service primarily on mechanical, plumbing or electrical systems, building controls and specialty contracting projects direct to, or assigned by, building owners or property managers.
Key Components of Consolidated Statements of Operations
Revenue
The Company generates revenue principally from fixed-price construction contracts to deliver mechanical, plumbing, and electrical construction services to its customers. The duration of the Company’s contracts generally ranges from three months to two years. Revenue from fixed price contracts is recognized on the cost-to-cost method, measured by the relationship of total cost incurred to total estimated contract costs. Revenue from time and materials service contracts is recognized as services are performed. The Company believes that its extensive experience in mechanical, plumbing, and electrical projects, and its internal cost review procedures during the bidding process, enable it to reasonably estimate costs and mitigate the risk of cost overruns on fixed price contracts.
The Company generally invoices customers monthly based on a schedule of values that breaks down the contract amount into discrete billing items. Costs and estimated earnings in excess of billings are recorded as a contract asset until billable under the contract terms. Billings in excess of costs and estimated earnings are recorded as a contract liability until the related revenue is recognizable.
Cost of Revenue
Cost of revenue primarily consists of the labor, equipment, material, subcontract and other job costs in connection with fulfilling the terms of the Company’s contracts. Labor costs consist of wages plus taxes, fringe benefits and insurance. Equipment costs consist of the ownership and operating costs of company-owned assets, in addition to outside-rented equipment. If applicable, job costs include estimated contract losses to be incurred in future periods. Due to the varied nature of the Company's services, and the risks associated therewith, contract costs as a percentage of contract revenue have historically fluctuated, and this fluctuation is expected to continue in future periods.
Selling, General and Administrative
Selling, general and administrative (“SG&A”) expenses consist primarily of personnel costs for its administrative, estimating, human resources, safety, information technology, legal, finance and accounting employees and executives. Also included are non-personnel costs, such as travel-related expenses, legal and other professional fees and other corporate expenses to support the growth of the Company's business and to meet the compliance requirements associated with operating as a public company. Those costs include accounting, human resources, information technology, legal personnel, additional consulting, legal and audit fees, insurance costs, board of directors’ compensation and the costs of achieving and maintaining compliance with Section 404 of the Sarbanes-Oxley Act of 2002.
Change in fair value of contingent consideration
The change in fair value of contingent consideration relates to the remeasurement of the contingent consideration arrangements resulting from each of the Jake Marshall, LLC (“JMLLC”), Coating Solutions, LLC (“CSLLC”) (together with JMLLC, the Jake Marshall Transaction), the ACME Transaction and the Industrial Air Transaction. As a part of the total consideration for the Jake Marshall, ACME and Industrial Air transactions, the Company initially recognized $3.1 million, $1.5 million and $3.2 million, respectively, in contingent consideration associated with their respective earnout payments. The carrying values of the Jake Marshall, ACME and IA Earnout Payments are subject to remeasurement at fair value at each reporting date through the end of the respective earnout periods with any changes in the fair value reported as a separate component of operating income in the condensed consolidated statements of operations. See Note 9 – Fair Value Measurements in the accompanying notes to the Company’s consolidated financial statements for further information.
Amortization of Intangibles
Amortization expense represents periodic non-cash charges that consist of amortization of various intangible assets primarily including favorable leasehold interests and certain customer relationships in the ODR segment. As a result of the Jake Marshall Transaction, the Company recognized, in the aggregate, an additional $5.7 million of intangible assets associated with customer relationships with third-party customers, the acquired trade name and acquired backlog. In addition, as a result of the ACME Transaction, the Company recognized, in the aggregate, an additional $2.8 million of intangible assets associated with customer relationships with third-party customers and the acquired trade name, inclusive of the impact of certain measurement period adjustments. Lastly, as a result of the Industrial Air Transaction, the Company recognized, in the aggregate, an additional $8.7 million of intangible assets associated with customer relationships with third-party customers, the acquired trade name, trademarks and intellectual property and the acquired backlog. Each of the Jake Marshall, ACME and Industrial Air-related
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intangible assets were recorded under the acquisition method of accounting at their estimated fair values at the acquisition date. See Note 3 – Acquisitions in the accompanying notes to the Company’s consolidated financial statements for further discussion of the Company’s acquired intangible assets as a result of the ACME Transaction and the Industrial Air Transaction. In addition, see Note 5 – Goodwill and Intangible Assets for further information on the Company’s intangible assets.
Other (Expenses) Income
Other (expenses) income consists primarily of interest expense incurred in connection with the Company's debt, a loss associated with the early termination of an operating lease, gains or losses associated with the disposition of property, equipment, changes in fair value of interest rate swaps, losses associated with the early extinguishment of debt and interest income earned from its overnight repurchase agreements, money market investments, U.S. Treasury Bills and the Company's interest rate swap agreement. Deferred financing costs are amortized to interest expense using the effective interest method.
Provision for Income Taxes
The Company is taxed as a C corporation and its financial results include the effects of federal income taxes, which will be paid at the parent level.
The Company’s provision for income taxes (including federal, state and local taxes) is calculated based on the estimated annual effective tax rate. The Company accounts for income taxes in accordance with ASC Topic 740 - Income Taxes, which requires the use of the asset and liability method. Under this method, deferred tax assets and liabilities and income or expense are recognized for the expected future tax consequences of temporary differences between the financial statement carrying values and their respective tax bases, using enacted tax rates expected to be applicable in the years in which the temporary differences are expected to reverse. Changes in deferred tax assets and liabilities are recorded in the provision for income taxes.
Impact of Acquisitions
In order to provide a more meaningful period-over-period discussion of the Company’s operating results, the Company may discuss amounts generated or incurred (revenues, gross profit, selling, general and administrative expenses, and operating income) from companies acquired. The amounts discussed reflect the acquired companies’ operating results in the current reported period only for the time period these entities were not owned by the Company in the comparable prior reported period.
During 2023, the Company acquired two companies for total consideration of $15.3 million, net of cash acquired and inclusive of certain measurement period adjustments. On July 3, 2023, the Company completed an acquisition of Chattanooga, TN-based specialty industrial contractor, ACME, for a purchase price at closing of $5.0 million in cash. The transaction also provides for an earnout of up to $2.5 million potentially being paid out over the next two years. ACME specializes in performing industrial maintenance, capital project work, and emergency services for specialty chemical and manufacturing clients, and is a leading mechanical solutions provider for hydroelectric producers. On November 1, 2023, the Company completed an acquisition of Greensboro, NC-based specialty mechanical contractor, Industrial Air, for a purchase price at closing of $13.5 million in cash. The transaction also provides for an earnout of up to $6.5 million potentially being paid out over the next two years. Industrial Air serves industrial customers throughout the Southeast United States and along the Eastern seaboard, focusing on delivering engineered air handling systems, including air condition and air filtration, along with controls systems and maintenance work. In addition, Industrial Air manufactures a wide range of components for air conditioning and filtration systems.
Based on the timing of these transactions, the post-acquisition results of the acquired companies did not have a material impact on the Company’s consolidated results for the year-ended December 31, 2023.
Divestitures
In February 2022, the Company announced its strategic decision to wind down its Southern California GCR and ODR operations. The decision was made to better align the Company’s customer geographic focus and to reduce losses related to unprofitable locations. During 2023, the Company executed the closeout phases on its remaining Southern California business unit projects and has fully exited the Southern California region aside from certain operational warranty obligations. However, the Company is party to the terms of a sublease agreement for its leased premises in Southern California through April 2027 and remains obligated under the original lease for such office space in the event the sublessee fails to satisfy its obligations under the sublease agreement. See Note 14 – Leases in the accompanying notes to the Company’s consolidated financial statements for further information on the Southern California Sublease.
Operating Segments
The Company manages and measures the performance of its business in two operating segments: GCR and ODR. These segments are reflective of how the Company’s Chief Operating Decision Maker (“CODM”) reviews operating results for the
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purposes of allocating resources and assessing performance. The Company’s CODM comprises its President and Chief Executive Officer and Executive Vice President and Chief Financial Officer.
In accordance with ASC Topic 280 – Segment Reporting, the Company has elected to aggregate all GCR work performed at branches into one GCR reportable segment and all ODR work performed at branches into one ODR reportable segment. All transactions between segments are eliminated in consolidation.
As previously discussed, on January 17, 2023, the Company announced its planned transition succession, pursuant to which Charles A. Bacon III stepped down as President and Chief Executive Officer on March 28, 2023, and Michael M. McCann, the Company’s former Executive Vice President and Chief Operating Officer, was appointed President and Chief Executive Officer. Following the transition, the Company revised its segment presentation to align with how Mr. McCann assesses performance and makes resource allocation decisions for its operating segments, which is based on segment revenue and segment gross profit. SG&A expenses are no longer reported on a segment basis as the Company's current CODM does not review discrete segment financial information for SG&A in order to assess performance. Interest expense is not allocated to segments because of the corporate management of debt service.
The Company restated segment information for the historical periods presented herein to conform to the current presentation. This change in segment presentation does not affect the Company’s consolidated statements of operations, balance sheets or statements of cash flows.
Comparison of Results of Operations for the years ended December 31, 2023 and 2022
The following table presents operating results for the years ended December 31, 2023 and 2022 in dollars and expressed as a percentage of total revenue (except as indicated below):
| For the Years Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands except for percentages) | 2023 | 2022 | ||||||||||||
| Statement of Operations Data: | ||||||||||||||
| Revenue: | ||||||||||||||
| GCR | $ | 254,392 | 49.3 | % | $ | 280,379 | 56.4 | % | ||||||
| ODR | 261,958 | 50.7 | % | 216,403 | 43.6 | % | ||||||||
| Total revenue | 516,350 | 100.0 | % | 496,782 | 100.0 | % | ||||||||
| Gross profit: | ||||||||||||||
| GCR | 43,200 | 17.0 | % | (1) | 38,622 | 13.8 | % | (1) | ||||||
| ODR | 76,090 | 29.0 | % | (2) | 55,119 | 25.5 | % | (2) | ||||||
| Total gross profit | 119,290 | 23.1 | % | 93,741 | 18.9 | % | ||||||||
| Selling, general and administrative(3) | 87,397 | 16.9 | % | 77,879 | 15.7 | % | ||||||||
| Change in fair value of contingent consideration | 729 | 0.1 | % | 2,285 | 0.5 | % | ||||||||
| Amortization of intangibles | 1,880 | 0.4 | % | 1,567 | 0.3 | % | ||||||||
| Total operating income | 29,284 | 5.7 | % | 12,010 | 2.4 | % | ||||||||
| Other income (expenses) | (1,184) | (0.2) | % | (2,402) | (0.5) | % | ||||||||
| Total consolidated income before income taxes | 28,100 | 5.4 | % | 9,608 | 1.9 | % | ||||||||
| Income tax provision | 7,346 | 1.4 | % | 2,809 | 0.6 | % | ||||||||
| Net income | $ | 20,754 | 4.0 | % | $ | 6,799 | 1.4 | % |
(1)As a percentage of GCR revenue.
(2)As a percentage of ODR revenue.
(3)Included within selling, general and administrative expenses was $4.9 million and $2.7 million of stock based compensation expense for the year ended December 31, 2023 and 2022, respectively.
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Revenue
| For the Years Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Increase/(Decrease) | ||||||||||||
| (in thousands except for percentages) | ||||||||||||||
| Revenue: | ||||||||||||||
| GCR: | $ | 254,392 | $ | 280,379 | $ | (25,987) | (9.3) | % | ||||||
| ODR: | 261,958 | 216,403 | 45,555 | 21.1 | % | |||||||||
| Total revenue | $ | 516,350 | $ | 496,782 | $ | 19,568 | 3.9 | % |
Revenue for the year ended December 31, 2023 increased by $19.6 million compared to the year ended December 31, 2022. GCR revenue decreased by $26.0 million, or 9.3%, while ODR revenue increased by $45.6 million, or 21.1%. The decrease in year-over-year GCR segment revenue primarily was due to the Company’s continued focus on improving project execution and profitability by pursuing GCR opportunities are smaller in size (based on contract value) and shorter in duration. The increase in period over period ODR segment revenue primarily was due to the Company's continued focus on the accelerated growth of its ODR business. In addition, ODR segment revenue increased by approximately $8.1 million due to the ACME and Industrial Air transactions.
Gross Profit
| For the Years Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Increase/(Decrease) | ||||||||||||
| (in thousands except for percentages) | ||||||||||||||
| Gross profit: | ||||||||||||||
| GCR | $ | 43,200 | $ | 38,622 | $ | 4,578 | 11.9 | % | ||||||
| ODR | 76,090 | 55,119 | 20,971 | 38.0 | % | |||||||||
| Total gross profit | $ | 119,290 | $ | 93,741 | $ | 25,549 | 27.3 | % | ||||||
| Total gross profit as a percentage of consolidated total revenue | 23.1 | % | 18.9 | % |
The Company's gross profit for the year ended December 31, 2023 increased by $25.5 million, or 27.3% compared to the year ended December 31, 2022. GCR gross profit increased $4.6 million, or 11.9%, primarily due to higher margins despite lower revenue. ODR gross profit increased $21.0 million, or 38.0%, due to the combination of an increase in revenue and higher margins driven by contract mix. The total gross profit percentage increased from 18.9% for the year ended December 31, 2022 to 23.1% for the year ended December 31, 2023, mainly driven by the mix of higher margin ODR segment work and being more selective in GCR work. In addition, for the year ended December 31, 2023, total gross profit generated by the entities acquired in the ACME Transaction and the Industrial Air Transaction was approximately $2.1 million, which was attributable to the ODR segment.
The Company recorded revisions in its contract estimates for certain GCR and ODR projects. During the year ended December 31, 2023, the Company recorded material gross profit write-ups on two GCR projects for a total of $2.2 million and two material GCR project gross profit write-downs for a total of $1.3 million that had a net gross profit impact of $0.5 million or more. During the year ended December 31, 2023, the Company recorded a material gross profit write-down on one ODR segment project for a total of $1.0 million. During the year ended December 31, 2022, the Company recorded material gross profit write-ups of $3.0 million on three GCR projects and four material GCR project gross profit write-downs for a total of $2.8 million that had a net gross profit impact of $0.5 million or more. There were no material write-ups or write-downs within the ODR segment during the year ended December 31, 2022.
Selling, General and Administrative
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| For the Years Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Increase/(Decrease) | ||||||||||||
| (in thousands except for percentages) | ||||||||||||||
| Selling, general and administrative | $ | 87,397 | $ | 77,879 | $ | 9,518 | 12.2 | % | ||||||
| Total selling, general and administrative expenses as a percentage of consolidated total revenue | 16.9 | % | 15.7 | % |
The Company's SG&A expense for the year ended December 31, 2023 increased by approximately $9.5 million, or 12.2% compared to the year ended December 31, 2022. The increase in SG&A primarily was due to a $6.8 million increase associated with payroll and incentive related expenses, a $2.2 million increase in stock-based compensation expense, a $1.5 million increase associated with costs incurred by the entities acquired in the ACME and Industrial Air transactions, $1.0 million related to CEO transition costs and $0.8 million related to acquisition-related costs, partially offset by a $1.2 million decrease in rent related expenses and a $1.5 million decrease related to certain legal accruals. Additionally, SG&A as a percentage of revenue was 16.9% for the year ended December 31, 2023 and 15.7% for the year ended December 31, 2022.
Change in Fair Value of Contingent Consideration
The change in fair values of the Company’s earnout payment contingent consideration was a loss of $0.7 million and $2.3 million for the years ended December 31, 2023 and 2022, respectively. These increases to the contingent liability were primarily attributable to the probability of meeting the gross profit margins associated with the contingent consideration arrangements as of December 31, 2023 and 2022.
Amortization of Intangibles
| For the Years Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Increase/(Decrease) | ||||||||||||
| (in thousands except for percentages) | ||||||||||||||
| Amortization of intangibles | $ | 1,880 | $ | 1,567 | $ | 313 | 20.0 | % |
Total amortization expense for the year ended December 31, 2023 increased by approximately $0.3 million compared to the year ended December 31, 2022. As a result of the ACME and Industrial Air transactions, the Company acquired certain intangible assets in which it recognized approximately $0.7 million of amortization expense for the year ended December 31, 2023. See Note 3 – Acquisitions in the accompanying notes to the Company’s consolidated financial statements for further discussion of the Company’s acquired intangible assets due to the ACME Transaction and the Industrial Air Transaction.
Other Income (Expenses)
| For the Years Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Increase/(Decrease) | ||||||||||||
| (in thousands except for percentages) | ||||||||||||||
| Other (expenses) income: | ||||||||||||||
| Interest expense | $ | (2,046) | $ | (2,144) | $ | 98 | 4.6 | % | ||||||
| Interest income | 1,217 | — | 1,217 | 100.0 | % | |||||||||
| Loss on early termination of operating lease | — | (849) | 849 | 100.0 | % | |||||||||
| Loss on debt extinguishment | (311) | — | (311) | (100.0) | % | |||||||||
| (Loss) gain on change in fair value of interest rate swap | (124) | 310 | (434) | (140.0) | % | |||||||||
| Gain on sale of property and equipment | 80 | 281 | (201) | (71.5) | % | |||||||||
| Total other expenses | $ | (1,184) | $ | (2,402) | $ | 1,218 | 50.7 | % |
Total other expenses for the year ended December 31, 2023 was $1.2 million as compared to $2.4 million for the year ended December 31, 2022. The decrease in total other expenses primarily was driven by a $1.2 million increase in interest income related to the Company's overnight repurchase agreements, investments in U.S. Treasury Bills and money market funds, as well as a $0.1 million offset to interest expense as a result of the Company's interest rate swap agreement. In addition, during 2022, the Company recognized a $0.8 million loss because of the early termination of its Pittsburgh operating lease. See Note 14 – Leases in the accompanying notes to the Company’s consolidated financial statements for further information. The decrease in
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total other expenses was partially offset by a $0.3 million loss on early debt extinguishment recognized during 2023 and a loss on the sale of certain property and equipment compared to a gain recognized in 2022.
Income Taxes
The Company’s income tax provision was $7.3 million and $2.8 million for the years ended December 31, 2023 and 2022, respectively, and it had a 26.1% and 29.2% effective tax rate over those same periods, respectively. The Company’s effective tax rate changes based upon its relative profitability, or lack thereof, in states with varying tax rates and rules. In addition, discrete items, such as tax law changes, judgments and legal structures can impact its effective tax rate. See also Note 11 – Income Taxes in the accompanying notes to the Company’s consolidated financial statements.
GCR and ODR Backlog Information
The Company refers to its estimated revenue on uncompleted contracts, including the amount of revenue on contracts for which work has not begun, less the revenue it had recognized under such contracts, as “backlog.” Backlog includes unexercised contract options. The Company’s backlog includes projects that have a written award, a letter of intent, a notice to proceed or an agreed upon work order to perform work on mutually accepted terms and conditions. Additionally, the difference between the Company’s backlog and remaining performance obligations is due to the portion of unexercised contract options that are excluded, under certain contract types, from the Company’s remaining performance obligations as these contracts can be canceled for convenience at any time by the Company or the customer without considerable cost incurred by the customer. Additional information related to the Company’s remaining performance obligations is provided in Note 4 — Revenue from Contracts with Customers in the accompanying notes to its consolidated financial statements. See also “Item 1A. Risk Factors — Our contract backlog is subject to unexpected adjustments and cancellations and could be an uncertain indicator of our future earnings.”
The Company’s GCR backlog was $186.9 million and $302.9 million as of December 31, 2023 and 2022, respectively. Projects are brought into backlog once the Company has been provided with a written confirmation of award and the contract value has been established. At any point, the Company has a substantial volume of projects that are specifically identified and advanced in negotiations and/or documentation, however those projects are not booked as backlog until the Company has received written confirmation from the owner or the general contractor / construction manager of their intention to award it the contract and they have directed the Company to begin engineering, designing, incurring construction labor costs or procuring needed equipment and material. The Company’s GCR projects tend to be built over a 12- to 24-month schedule depending upon scope and complexity. Most major projects have a preconstruction planning phase, which may require months of planning before actual construction commences. The Company is occasionally employed to deliver a “fast-track” project, where construction commences as the preconstruction planning work continues. As work on the Company’s projects progress, it increases or decreases backlog to take into account its estimate of the effects of changes in estimated quantities, changes in conditions, change orders and other variations from initially anticipated contract revenue, and the percentage of completion of the Company’s work on the projects. Based on historical trends, the Company currently estimates that 83% of its GCR backlog as of December 31, 2023 will be recognized as revenue during 2024. Additionally, the reduction in GCR backlog has been intentional as the Company looks to focus on higher margin projects than historically, as well as its focus on smaller, higher margin owner direct projects.
The Company’s ODR backlog was $147.0 million and $108.2 million as of December 31, 2023 and 2022, respectively. These amounts reflect unrecognized revenue expected to be recognized over the remaining terms of its service contracts and projects. Based on historical trends, the Company currently estimates that 95% of its ODR backlog as of December 31, 2023 will be recognized as revenue during 2024. The Company believes its ODR backlog increased due to its continued focus on the accelerated growth of its ODR business. In addition, as of December 31, 2023, ODR backlog included approximately $1.2 million and $26.6 million of backlog associated with the operations of ACME and Industrial Air, respectively.
Market Update
Although the Company has been experiencing strong demand, certain events continue to impact its business, including global economic conditions, the inflationary cost environment, elevated labor costs, disruption in its supply chain, continued uncertainty around the COVID-19 pandemic and ongoing geopolitical instability caused by conflicts in Ukraine and the Middle East. The Company continued to experience elevated levels of cost inflation during 2023, which is expected to persist through 2024, although at lower levels than experienced in 2023. These headwinds have been partially mitigated in 2023 by pricing actions taken in response to the inflationary cost environment, supply chain productivity improvements and cost savings initiatives. The effects of inflation also have resulted in central banks raising short-term interest rates and, therefore, the Company has experienced an increase in its interest expense relative to its outstanding borrowings. While the impacts of COVID-19 on the Company's business have moderated, there still remains uncertainty around the pandemic, its effect on labor or other macroeconomic factors, its severity and duration, the continued availability and effectiveness of vaccines and actions
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taken by third parties or by government authorities in response, including restrictions, laws or regulations, or other responses. Also, the ongoing conflict between Russia and Ukraine, and the sanctions imposed in response to this conflict, have increased global economic and political uncertainty and the conflict in the Middle East may add to these issues.
While the impact of these factors remains uncertain, the Company continues to evaluate the extent to which they may impact its business, financial condition or results of operations. There can be no assurance that the Company's actions will serve to mitigate such impacts in future periods. Further, while the Company believes its remaining performance obligations are firm, and its customers have not provided the Company with indications that they no longer wish to proceed with planned projects, prolonged delays in the receipt of critical equipment could result in the Company's customers seeking to terminate existing or pending agreements. Any of these events could have a material adverse effect on the Company’s business, financial condition and/or results of operations.
Outlook for 2024
The Company continues to focus on creating value for building owners by targeting opportunities for long-term relationships with the vision of becoming an indispensable partner to building owners with mission-critical systems. For 2024, the key objectives of the Company’s strategy are to improve profitability and generate quality growth in its operations, to enable sustainable and efficient building environments, to continue investing in its workforce and to acquire strategically synergistic businesses.
In focusing on improved profitability and generating quality growth in its operation, the Company has dedicated and continues to dedicate, its resources toward the growth of its ODR segment as the scope of services provided within the Company’s ODR segment typically yield higher margins when compared to its GCR segment work. During fiscal year 2023, the Company eclipsed its ODR-related revenue target, generating a 50/50 segment revenue mix. For 2024, the Company reaffirms its focus on expanding the number and breadth of owner relationships that it serves on a direct basis and leveraging these expanded owner-direct relationships to deliver a broad suite of services. The Company believes it maintains a disciplined approach, capable of providing a full life-cycle of engineered solutions and craft expertise enabling it to be a one-stop-shop for building owners to maximize their investments in their mission-critical assets. In addition, the Company continues to make investments to expand its ODR revenue by increasing the value it can offer to building owners and continues to evaluate areas in which it could expand the breadth of its service offerings to better serve its clients. Employee development underpins the Company’s efforts to execute its 2024 strategy. The Company is actively concentrating managerial and sales resources on training and hiring experienced employees to sell and profitably perform ODR-related services. In many locations, the Company has added or upgraded its capabilities and the Company believes its investments and efforts have provided customer value and stimulated growth. The Company’s team members uniquely combine engineering expertise with field installation skills to provide custom solutions that leverage its full life-cycle capabilities, which allows it to address both the operational and capital projects needs of its customers.
In the Company’s GCR segment, its efforts continue to focus on improving project execution and profitability by pursuing opportunities that are smaller in size and shorter in duration than historically, and where it can leverage its captive design and engineering services. The Company believes that it is appropriate in the current contracting environment to reduce risk and exposure to large, complex, non-owner direct projects where the trend has been for such jobs to provide risks that are difficult to mitigate. Currently, management believes the historical industry pricing and associated risks for this type of work does not align with the Company’s stakeholders’ expectations, and therefore, the Company continues to take steps to actively reduce these risks as it looks at future job selection and as it completes current jobs.
Additionally, the Company believes that it can further increase its cash flow and operating income by acquiring strategically synergistic companies that will increase the Company’s geographic footprint, supplement the Company’s current business model, address capability gaps and enhance the breadth of its service offerings to better serve its clients. The Company has dedicated and continues to dedicate its resources to seek opportunities to acquire and integrate businesses that have attractive market positions, supports the Company ODR growth strategy, expands and/or supplements the Company’s current breadth of service offerings and is culturally compatible.
Given the broad suite of services offered to customers within the Company’s market concentrations, management uses a variety of factors to attempt to predict the outlook for the Company. The Company monitors key competitors and customers in order to gauge relative performance and the outlook for the future. The Company regularly performs detailed evaluations of the different market verticals in which it serves to proactively detect trends and to adapt its strategies accordingly, including potential triggers and actions to be taken under recessionary scenarios. In addition, the Company believes its backlog is indicative of future revenue and thus are a key measure of anticipated performance.
The Company continues to monitor the impact that the inflationary cost environment has on its cost structure. Although global supply chain and resource constraints have improved throughout the year, the Company’s performance may be impacted by
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future developments that are uncertain. In addition, geopolitical risks and macroeconomic events could cause disruptions to operations, supply chains and end markets, tightening credit conditions, higher interest rates, global banking uncertainty and the possibility of deteriorating overall economic conditions which could negatively impact the Company’s business.
Seasonality, Cyclicality and Quarterly Trends
Severe weather can impact the Company’s operations. In the northern climates where it operates, and to a lesser extent the southern climates as well, severe winters can slow the Company’s productivity on construction projects, which shifts revenue and gross profit recognition to a later period. The Company’s maintenance operations may also be impacted by mild or severe weather. Mild weather tends to reduce demand for its maintenance services, whereas severe weather may increase the demand for its maintenance and time-and-materials services. The Company’s operations also experience mild cyclicality, as building owners typically work through maintenance and capital projects at an increased level during the third and fourth calendar quarters of each year.
Effect of Inflation and Tariffs
The prices of products such as steel, pipe, copper and equipment from manufacturers are subject to fluctuation and increases. It is difficult to accurately measure the impact of inflation, tariffs and price escalation due to the imprecise nature of the estimates required. However, these effects are, at times, material to the Company’s results of operations and financial condition. During fiscal years 2023 and 2022, the Company experienced higher cost of materials on specific projects and delays in its supply chain for equipment and service vehicles from the manufacturers, and it expects these higher costs and delays in its supply chain to persist in 2024. When appropriate, the Company includes cost escalation factors into its bids and proposals, as well as limit the acceptance time of its bid. In addition, the Company is often able to mitigate the impact of future price increases by entering into fixed price purchase orders for materials and equipment and subcontracts on its projects. Notwithstanding these efforts, if the Company experiences significant disruptions to its supply chain, it may need to delay certain projects that would otherwise be accretive to its business, and this may also impact the conversion rate of its current backlog into revenue.
Liquidity and Capital Resources
Cash Flows
The Company’s liquidity needs relate primarily to the provision of working capital (defined as current assets less current liabilities) to support operations, funding of capital expenditures, and investment in strategic opportunities. Historically, liquidity has been provided by operating activities and borrowings from commercial banks and institutional lenders.
The following table presents summary cash flow information for the periods indicated:
| For the Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| (in thousands) | 2023 | 2022 | ||||
| Net cash provided by (used in): | ||||||
| Operating activities | $ | 57,366 | $ | 35,373 | ||
| Investing activities | (17,092) | (495) | ||||
| Financing activities | (16,490) | (13,353) | ||||
| Net increase in cash, cash equivalents and restricted cash | $ | 23,784 | $ | 21,525 | ||
| Noncash investing and financing transactions: | ||||||
| Earnout liability associated with the ACME Transaction | $ | 1,514 | $ | — | ||
| Earnout liability associated with the Industrial Air Transaction | 3,165 | — | ||||
| Right of use assets obtained in exchange for new operating lease liabilities | 3,135 | — | ||||
| Right of use assets obtained in exchange for new finance lease liabilities | 5,219 | 2,634 | ||||
| Right of use assets disposed or adjusted modifying operating lease liabilities | 1,112 | 2,455 | ||||
| Right of use assets disposed or adjusted modifying finance lease liabilities | (93) | (77) | ||||
| Interest paid | 1,908 | 2,005 | ||||
| Cash paid for income taxes | $ | 9,156 | $ | 1,979 |
The Company's cash flows are primarily impacted period to period by fluctuations in working capital. Factors such as the Company’s contract mix, commercial terms, days sales outstanding (“DSO”) and delays in the start of projects may impact its working capital. In line with industry practice, the Company accumulates costs during a given month then bills those costs in
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the current month for many of its contracts. While labor costs associated with these contracts are paid weekly and salary costs associated with the contracts are paid bi-weekly, certain subcontractor costs are generally not paid until the Company receives payment from its customers (contractual “pay-if-paid” terms). The Company has not historically experienced a large volume of write-offs related to its receivables and contract assets. The Company regularly assesses its receivables for collectability and provides allowances for credit losses where appropriate. The Company believes that its reserves for its expected credit losses are appropriate as of December 31, 2023, but adverse changes in the economic environment may impact certain of its customers’ ability to access capital and compensate the Company for its services, as well as impact project activity for the foreseeable future.
The Company’s existing current backlog is projected to provide substantial coverage of forecasted GCR revenue for one year from the date of the financial statement issuance. The Company’s current cash balance, together with cash it expects to generate from future operations along with borrowings available under its credit facility, are expected to be sufficient to finance its short- and long-term capital requirements (or meet working capital requirements) for the next twelve months. In addition to the future operating cash flows of the Company, along with its existing borrowing availability and access to financial markets, the Company currently believes it will be able to meet any working capital and future operating requirements, and capital investment forecast opportunities for the next twelve months.
The following table represents the Company’s summarized working capital information:
| As of December 31, | ||||||
|---|---|---|---|---|---|---|
| (in thousands, except ratios) | 2023 | 2022 | ||||
| Current assets | $ | 217,000 | $ | 225,990 | ||
| Current liabilities | (145,148) | (159,085) | ||||
| Net working capital | $ | 71,852 | $ | 66,905 | ||
| Current ratio(1) | 1.50 | 1.42 |
(1) Current ratio is calculated by dividing current assets by current liabilities.
As discussed above and in Note 7 – Debt in the accompanying notes to the Company’s consolidated financial statements, as of December 31, 2023, the Company was in compliance with all financial maintenance covenants as required by its credit facility.
Cash Flows Provided by Operating Activities
The following is a summary of the significant sources (uses) of cash from operating activities:
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| For the Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands) | 2023 | 2022 | Cash Inflow (Outflow) | |||||||
| Cash flows from operating activities: | ||||||||||
| Net income | $ | 20,754 | $ | 6,799 | $ | 13,955 | ||||
| Non-cash operating activities(1) | 18,222 | 17,634 | 588 | |||||||
| Changes in operating assets and liabilities: | ||||||||||
| Accounts receivable | 32,607 | (35,407) | 68,014 | |||||||
| Contract assets | 10,397 | 22,410 | (12,013) | |||||||
| Other current assets | (1,486) | 1,128 | (2,614) | |||||||
| Accounts payable, including retainage | (10,909) | 11,282 | (22,191) | |||||||
| Contract liabilities | (9,121) | 17,296 | (26,417) | |||||||
| Income tax receivable | 95 | 19 | 76 | |||||||
| Accrued taxes payable | (1,442) | 1,387 | (2,829) | |||||||
| Accrued expenses and other current liabilities | 2,867 | (2,934) | 5,801 | |||||||
| Operating lease liabilities | (3,795) | (4,133) | 338 | |||||||
| Payment of contingent consideration liability in excess of acquisition-date fair value | (1,224) | — | (1,224) | |||||||
| Other long-term liabilities | 401 | (108) | 509 | |||||||
| Cash provided by working capital | 18,390 | 10,940 | 7,450 | |||||||
| Net cash provided by operating activities | $ | 57,366 | $ | 35,373 | $ | 21,993 |
(1)Represents non-cash activity associated with depreciation and amortization, provision for credit losses / doubtful accounts, stock-based compensation expense, operating lease expense, amortization of debt issuance costs, deferred income tax provision, gain or loss on sale of property and equipment, loss on early termination of operating lease, changes in fair value of contingent consideration and changes in the fair value of the Company’s interest rate swap.
During the year ended December 31, 2023, the Company generated $57.4 million in cash in its operating activities, which consisted of cash provided by working capital of $18.4 million, non-cash adjustments of $18.2 million (primarily depreciation and amortization, stock-based compensation expense, operating lease expense, loss on early debt extinguishment and the change in fair value of contingent consideration) and net income for the period of $20.8 million. During the year ended December 31, 2022, the Company generated $35.4 million in cash in its operating activities, which consisted of cash provided by working capital of $10.9 million, non-cash adjustments of $17.6 million (primarily depreciation and amortization, stock-based compensation expense, operating lease expense, loss on early termination of an operating lease and the change in fair value of contingent consideration) and net income for the period of $6.8 million.
The increase in operating cash flows during the year ended December 31, 2023 compared to the year ended December 31, 2022 was primarily attributable to a $68.0 million period-over-period cash inflow related to the change in accounts receivable, which was due to the timing of cash receipts, inclusive of an aggregate $25.6 million in cash receipts associated with certain outstanding claim resolutions. This cash inflow was partially offset by a $38.4 million cash outflow period-over-period related to the aggregate change in the Company’s contract assets and liabilities and a $22.2 million change in accounts payable, including retainage. The increase in the Company’s overbilled position was due to the timing of contract billings and the recognition of contract revenue, as well as the successful resolution of certain outstanding claims. The cash outflows associated with its accounts payable were due to the timing of cash receipts and payments.
Cash Flows Used in Investing Activities
Cash flows used in investing activities were $17.1 million for the year ended December 31, 2023 as compared to $0.5 million for the year ended December 31, 2022. Cash used in investing activities for the year ended December 31, 2023 of $4.9 million and $10.4 million cash outflows associated with the ACME Transaction and Industrial Air Transaction, respectively, net of cash acquired and inclusive of certain measurement period adjustments. In addition, cash used in investing activities for the year ended December 31, 2023 represented $2.3 million of cash outflows for capital additions pertaining to purchased property and equipment, offset by $0.4 million in cash proceeds from the sale of property and equipment. Cash used in investing activities for the year ended December 31, 2022 of $0.5 million was primarily due to $1.0 million of cash outflows for capital additions pertaining to additional non-leased vehicles, tools and equipment, computer software and hardware purchases, office furniture and office related leasehold improvements, offset by $0.5 million in cash proceeds from the sale of property and equipment.
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For the years ended December 31, 2023 and 2022, the Company obtained the use of various assets through operating and finance leases, which reduced the level of capital expenditures that would have otherwise been necessary to operate its business.
Cash Flows Used in Financing Activities
Cash flows used in financing activities were $16.5 million for the year ended December 31, 2023 as compared to cash flows provided by financing activities of $13.4 million for the year ended December 31, 2022. For the year ended December 31, 2023, as a result of the execution of the Second A&R Wintrust Credit Agreement, the Company paid off the remaining principal portion of the A&R Wintrust Term Loan of $19.0 million. Prior to the termination of the A&R Wintrust Term Loan, the Company made principal payments of $2.4 million, consisting of monthly installment payments of $0.6 million. In addition, the Company paid approximately $0.8 million in taxes related to net share settlement of equity awards, $2.7 million for payments on finance leases and made a $3.0 million payment to the former owners of JMLLC and CSLLC related to the 2022 Jake Marshall Earnout Period, of which $1.7 million was recognized as a cash outflow from financing activities. These cash financing outflows were partially offset by $10.0 million in proceeds from borrowings under the Second A&R Wintrust Revolving Loan and $0.4 million associated with proceeds from contributions to the Company’s Employee Stock Purchase Plan (“ESPP”).
For the year ended December 31, 2022, the Company made principal payments of $13.4 million, consisting of monthly installment payments of $0.6 million, an Excess Cash Flow payment of $3.3 million and total Net Claim Proceeds payments of $2.7 million, The Company also borrowed and repaid $15.2 million under the A&R Wintrust Revolving Loan of $15.2 million, made payments of $2.7 million on finance leases, repurchased $2.0 million in common stock under the Company’s Share Repurchase Program (defined below), paid $0.4 million in taxes related to net share settlement of equity awards and incurred $0.4 million in payments for debt issuance costs. These financing cash outflows were partly offset by $5.4 million in proceeds from the Company’s sale-leaseback financing transaction and $0.3 million associated with proceeds from contributions to the Company’s ESPP.
The following table reflects the Company’s available funding capacity as of December 31, 2023:
| (in thousands) | ||||
|---|---|---|---|---|
| Cash & cash equivalents | $ | 59,833 | ||
| Credit agreement: | ||||
| Second A&R Wintrust Revolving Loan | 50,000 | |||
| Outstanding borrowings on the Second A&R Wintrust Revolving Loan | (10,000) | |||
| Outstanding letters of credit | (4,065) | |||
| Net credit agreement capacity available | 35,935 | |||
| Total available funding capacity | $ | 95,768 |
Share Repurchase Program
In September 2022, the Company announced that its Board of Directors approved the Share Repurchase Program to repurchase shares of its common stock for an aggregate purchase price not to exceed $2.0 million. The share repurchase authority was valid through September 29, 2023. Share repurchases may be executed through various means, including, without limitation, open market transactions, privately negotiated transactions or by other means in accordance with federal securities laws. The Share Repurchase Program does not obligate the Company to acquire any particular amount of common stock, and the program may be suspended or terminated by the Company at any time at its discretion without prior notice. Through September 29, 2023, approximately $2.0 million of common stock was repurchased under its Share Repurchase Program, which was funded from the Company’s available cash on hand. There were no shares repurchased during 2023.
Debt and Related Obligations
Long-term debt consists of the following obligations as of:
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| (in thousands) | December 31, 2023 | December 31, 2022 | ||||
|---|---|---|---|---|---|---|
| A&R Wintrust Term Loan | $ | — | $ | 21,453 | ||
| Wintrust Revolving Loans | 10,000 | — | ||||
| Finance leases – collateralized by vehicles, payable in monthly installments of principal, plus interest ranging from 3.96% to 8.60% through 2030 | 7,347 | 4,954 | ||||
| Financing liability | 5,351 | 5,351 | ||||
| Total debt | $ | 22,698 | $ | 31,758 | ||
| Less – Current portion of long-term debt | (2,680) | (9,564) | ||||
| Less – Unamortized discount and debt issuance costs | (387) | (666) | ||||
| Long-term debt | $ | 19,631 | $ | 21,528 |
See Note 7 – Debt in the accompanying notes to the Company’s consolidated financial statements for further discussion.
Surety Bonding
In connection with its business, the Company is occasionally required to provide various types of surety bonds that provide an additional measure of security to its customers for its performance under certain government and private sector contracts. The Company’s ability to obtain surety bonds depends upon its capitalization, working capital, past performance, management expertise and external factors, including the capacity of the overall surety market. Surety companies consider such factors in light of the amount of the Company’s backlog that it has currently bonded and their current underwriting standards, which may change from time-to-time. The bonds, if any, the Company provides typically reflect the contract value. As of December 31, 2023 and 2022, the Company has approximately $90.9 million and $129.6 million in surety bonds outstanding, respectively. The Company believes that its $800 million bonding capacity provides it with a significant competitive advantage relative to many of its competitors which have limited bonding capacity. See Note 13 – Commitments and Contingencies in the accompanying notes to the Company’s consolidated financial statements for further discussion.
Insurance and Self-Insurance
The Company purchases workers’ compensation and general liability insurance under policies with per-incident deductibles of $250,000 per occurrence. Losses incurred over primary policy limits are covered by umbrella and excess policies up to specified limits with multiple excess insurers. The Company accrues for the unfunded portion of costs for both reported claims and claims incurred but not reported. The liability for unfunded reported claims and future claims is reflected on the consolidated balance sheets as current and non-current liabilities. The liability is computed by determining a reserve for each reported claim on a case-by-case basis based on the nature of the claim and historical loss experience for similar claims plus an allowance for the cost of incurred but not reported claims. The current portion of the liability is included in accrued expenses and other current liabilities on the consolidated balance sheets. The non-current portion of the liability is included in other long-term liabilities on the consolidated balance sheets.
The Company is self-insured related to medical and dental claims under policies with annual per-claimant and annual aggregate stop-loss limits. The Company accrues for the unfunded portion of costs for both reported claims and claims incurred but not reported. The liability for unfunded reported claims and future claims is reflected on the consolidated balance sheets as a current liability in accrued expenses and other current liabilities. See Note 13 – Commitments and Contingencies in the accompanying notes to the Company’s consolidated financial statements for further discussion.
Multiemployer Plans
The Company participates in approximately 40 MEPPs that provide retirement benefits to certain union employees in accordance with various collective bargaining agreements (“CBAs”). As one of many participating employers in these MEPPs, the Company is responsible with the other participating employers for any plan underfunding. The Company’s contributions to a particular MEPP are established by the applicable CBAs; however, required contributions may increase based on the funded status of an MEPP and legal requirements of the Pension Protection Act of 2006 (the “PPA”), which requires substantially underfunded MEPPs to implement a funding improvement plan (“FIP”) or a rehabilitation plan (“RP”) to improve its funded status. Factors that could impact funded status of an MEPP include, without limitation, investment performance, changes in the participant demographics, decline in the number of contributing employers, changes in actuarial assumptions and the utilization of extended amortization provisions. Assets contributed to the MEPPs by the Company may be used to provide benefits to employees of other participating employers. If a participating employer stops contributing to an MEPP, the unfunded obligations of the MEPP may be borne by the remaining participating employers.
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An FIP or RP requires a particular MEPP to adopt measures to correct its underfunding status. These measures may include, but are not limited to an increase in a company’s contribution rate as a signatory to the applicable CBA, or changes to the benefits paid to retirees. In addition, the PPA requires that a 5.0% surcharge be levied on employer contributions for the first year commencing shortly after the date the employer receives notice that the MEPP is in critical status and a 10.0% surcharge on each succeeding year until a CBA is in place with terms and conditions consistent with the RP.
The Company could also be obligated to make payments to MEPPs if it either ceases to have an obligation to contribute to the MEPP or significantly reduces its contributions to the MEPP because it reduces the number of employees who are covered by the relevant MEPP for various reasons, including, but not limited to, layoffs or closure of a subsidiary assuming the MEPP has unfunded vested benefits. The amount of such payments (known as a complete or partial withdrawal liability) would equal the Company’s proportionate share of the MEPPs’ unfunded vested benefits. The Company believes that certain of the MEPPs in which it participates may have unfunded vested benefits. Due to uncertainty regarding future factors that could trigger withdrawal liability, the Company is unable to determine (a) the amount and timing of any future withdrawal liability, if any, and (b) whether its participation in these MEPPs could have a material adverse impact on its financial condition, results of operations or liquidity.
Recent Accounting Pronouncements
The Company reviews new accounting standards to determine the expected financial impact, if any, that the adoption of such standards will have on its financial position and/or results of operations. See Note 2 – Significant Accounting Policies in the accompanying notes to the Company’s consolidated financial statements for further information regarding new accounting standards, including the anticipated dates of adoption and the effects on its consolidated financial position, results of operations, or liquidity.
Critical Accounting Policies
The Company’s critical accounting policies are based upon the significance of the accounting policy to its overall financial statement presentation, as well as the complexity of the accounting policy and its use of estimates and subjective assessments. The Company’s most critical accounting policy is revenue recognition. As discussed elsewhere in this Annual Report on Form 10-K, the Company’s business has two operating segments: (i) GCR, for which it accounts for using the cost-to-cost method and (ii) ODR, for which it accounts for using the cost-to-cost method and for certain projects when revenue is recognized as services are provided. In addition, the Company believes that some of the more critical judgment areas in the application of accounting policies that affect its financial condition and results of operations are the impact of changes in the estimates and judgments pertaining to: (a) collectability or valuation of accounts receivable; (b) the recording of its self-insurance liabilities; (c) valuation of deferred tax assets; and (d) recoverability of goodwill and identifiable intangible assets. These accounting policies, as well as others, are described in Note 2 – Significant Accounting Policies in the accompanying notes to the Company’s consolidated financial statements.
Revenue and Cost Recognition
The Company believes its most significant accounting policy is revenue recognition from construction contracts for which it uses the cost-to-cost method of accounting. Under the cost-to-cost method, contract revenue recognizable at any time during the life of a contract is determined by multiplying expected total contract revenue by the percentage of contract costs incurred to total estimated contract costs. Revenue from fixed price and modified fixed price contracts are recognized on the cost-to-cost method, measured by the relationship of total cost incurred to total estimated contract costs.
Contract costs include direct labor, material, and subcontractor costs, and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs, depreciation, and insurance. These contract costs are included in the Company’s results of operations under the caption “Cost of revenue.” Then, as the Company performs under those contracts, it measures costs incurred, compares them to total estimated costs to complete the contract, and recognizes a corresponding proportion of contract revenue. Labor costs are considered to be incurred as the work is performed. Subcontractor labor is recognized as the work is performed but is generally subjected to approval as to milestones or other evidence of completion. Non-labor project costs consist of purchased equipment, prefabricated materials and other materials. Purchased equipment on the Company’s projects is substantially produced to job specifications and is a value-added element to its work. The costs are considered to be incurred when title is transferred to the Company, which typically is upon delivery to the worksite. Prefabricated materials, such as ductwork and piping, are generally performed at the Company’s shops and recognized as contract costs when fabricated for the unique specifications of the job. Other materials costs are not significant and are generally recorded when delivered to the worksite. This measurement and comparison process requires updates to the estimate of total costs to complete the contract, and these updates may include subjective assessments.
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The Company generally does not incur significant costs prior to receiving a contract, and therefore, these costs are expensed as incurred. Upon receiving the contract, these costs are included in contract costs. Selling, general, and administrative costs are charged to expense as incurred. Bidding and proposal costs are also recognized as an expense in the period in which such amounts are incurred. Total estimated contract costs are based upon management’s current estimate of total costs at completion. As changes in estimates of contract costs at completion and/or estimated total losses on projects are identified, appropriate earnings adjustments are recorded during the period that the change or loss is identified. Contract revenue for construction contracts is based upon management’s estimate of contract prices at completion, including revenue for additional work on which contract pricing has not been finalized (claims). Changes in job performance, job conditions and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to estimated costs and income, and are recognized in the period in which the revisions are determined. Provisions for estimated losses on uncompleted contracts are recognized in the period in which such losses are determined.
With respect to the Company’s service contracts, there are two basic types of service contracts: fixed price service contracts, which are signed in advance for maintenance, repair and retrofit work over a period, typically of one year, and service contracts not signed in advance for similar maintenance, repair and retrofit work on an as-needed basis. Fixed price service contracts are generally performed evenly over the contract period, and accordingly, revenue is recognized on a pro rata basis over the life of the contract. Revenue derived from other service contracts is recognized when the services are performed. Expenses related to all service contracts are recognized as services are provided.
Project contracts typically provide for a schedule of billings or invoices to the customer based on reaching agreed upon milestones or as the Company incurs costs. The schedules for such billings usually do not precisely match the schedule on which costs are incurred. As a result, contract revenue recognized in the statement of operations can and usually does differ from amounts that can be billed or invoiced to the customer at any point during the contract. Amounts by which cumulative contract revenue recognized on a contract as of a given date exceed cumulative billings to the customer under the contract are reflected as a current asset in the Company’s balance sheet under the caption “contract assets.” Amounts by which cumulative billings to the customer under a contract as of a given date exceed cumulative contract revenue recognized on the contract are reflected as a current liability in the Company’s balance sheet under the caption “contract liabilities.”
The cost-to-cost method of accounting is also affected by changes in job performance, job conditions, and final contract settlements. These factors may result in revisions to estimated costs and, therefore, revenue. Such revisions are frequently based on further estimates and subjective assessments. The effects of these revisions are recognized in the period in which revisions are determined. When such revisions lead to a conclusion that a loss will be recognized on a contract, the full amount of the estimated ultimate loss is recognized in the period such conclusion is reached, regardless of the percent complete of the contract.
Revisions to project costs and conditions can give rise to change orders under which the customer agrees to pay additional contract price. Revisions also can result in claims the Company might make against the customer to recover project variances that have not been satisfactorily addressed through change orders with the customer. Claims and unapproved change orders are recorded at estimated net realizable value when realization is probable and can be reasonably estimated. No profit is recognized on the construction costs incurred in connection with claim amounts. See Note 4 – Revenue from Contracts with Customers in the accompanying notes to the Company’s consolidated financial statements for information related to unresolved change orders and claims.
Variations from estimated project costs could have a significant impact on the Company’s operating results, depending on project size, and the recoverability of the variation via additional customer payments.
In accordance with industry practice, the Company classifies as current all assets and liabilities relating to the performance of long-term contracts. The term of the Company’s contracts generally ranges from three months to two years and, accordingly, collection or payment of amounts relating to these contracts may extend beyond one year.
Accounts Receivable and Allowance for Credit Losses
On January 1, 2023, the Company adopted Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. The Company develops its allowance for credit losses, which represents an estimate of expected losses over the remaining contractual life of its receivables, using an aging method. Under the aging method, the Company assigns its accounts receivable to a level of delinquency and apply loss rates to each class. The determination of its loss rates require it to make certain judgements and estimates involving, among others, the creditworthiness of its customers, historical loss experiences with customers, the aging of past due balances, the consideration of a customer’s financial condition, ongoing relationships with its customers, its lien rights, if any, in the property where it performed the work, the availability, if any, of payment bonds applicable to the contract, current market economic conditions
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and a forecast of future economic conditions when appropriate. These estimates are evaluated and adjusted as needed when additional information is received.
Self-insurance Liabilities
The Company is substantially self-insured for workers’ compensation, employer’s liability, auto liability, general liability and employee group health claims in view of the relatively high per-incident deductibles it absorbs under its insurance arrangements for these risks. Losses are estimated and accrued based upon known facts, historical trends and industry averages. Estimated losses in excess of the Company’s deductible, which have not already been paid, are included in the Company’s accrual with a corresponding receivable from its insurance carrier.
In addition, the Company is self-insured related to medical and dental claims under policies with annual per-claimant and annual aggregate stop-loss limits. The Company accrues for the unfunded portion of costs for both reported claims and claims incurred but not reported.
The Company believes the liabilities recognized on its balance sheets for these obligations are adequate. However, insurance liabilities are difficult to estimate due to unknown factors, including the severity of any injury, the determination of its liability in proportion to other parties, timely reporting of occurrences, ongoing treatment or loss mitigation, general trends in litigation recovery outcomes and the effectiveness of safety and risk management programs. Therefore, if actual experience differs from the assumptions and estimates used for recording the liabilities, adjustments may be required and would be recorded in the period that such experience becomes known.
Deferred Tax Assets
The Company regularly evaluates the need for valuation allowances related to deferred tax assets for which future realization is uncertain. The Company performs this evaluation quarterly. In assessing the realizability of deferred tax assets, it must consider whether it is more likely than not some portion, or all, of the deferred tax assets will not be realized. The Company considers all available evidence, both positive and negative, in determining whether a valuation allowance is required. Such evidence includes the scheduled reversal of deferred tax liabilities, projected future taxable income, taxable income in prior carryback years and tax planning strategies in making this assessment, and judgment is required in considering the relative weight of negative and positive evidence.
Goodwill and Identifiable Intangible Assets
Goodwill is the excess of purchase price over the fair value of the net assets of acquired businesses. The Company assesses goodwill for impairment each year, and more frequently if circumstances suggest an impairment may have occurred. When the carrying value of a given reporting unit exceeds its fair value, an impairment loss is recorded to the extent that the implied fair value of the goodwill of the reporting unit is less than its carrying value. If other reporting units have had increases in fair value, such increases may not be recorded. Accordingly, such increases may not be netted against impairments at other reporting units. The requirements for assessing whether goodwill has been impaired involve market-based information. This information, and its use in assessing goodwill, entails some degree of subjective assessment.
The Company performs its annual impairment testing as of October 1, and any impairment charges resulting from this process are reported in the fourth quarter. The Company segregates its operations into reporting units based on the degree of operating and financial independence of each unit and its related management of them. The Company performs its annual goodwill impairment analysis at the reporting unit level. Each of the Company’s operating units represents an operating segment, and its operating segments are its reporting units.
The Company also reviews intangible assets with definite lives subject to amortization whenever events or circumstances indicate that a carrying amount of an asset may not be recoverable. Events or circumstances that might require impairment testing include the identification of other impaired assets within a reporting unit, loss of key personnel, the disposition of a significant portion of a reporting unit, a significant decline in stock price or a significant adverse change in business climate or regulations. Changes in strategy and/or market condition may also result in adjustments to recorded intangible asset balances or their useful lives.
Off-Balance Sheet and Other Arrangements
Aside from the $4.1 million and $3.2 million in irrevocable letters of credit outstanding in connection with the Company’s self-insurance program, at December 31, 2023 and 2022, respectively, the Company did not have any relationships with any entities or financial partnerships, such as structured finance or special purpose entities established for the purpose of facilitating off-balance sheet arrangements or other purposes.
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