filings.toolsItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and related notes included elsewhere in this annual report on Form 10-K. Also see "Forward-Looking Statements" discussion.
Introduction and Overview
We are a national provider of comprehensive mechanical installation, renovation, maintenance, repair and replacement services within the mechanical services industry. We operate primarily in the commercial, industrial and institutional HVAC markets and perform most of our services within office buildings, retail centers, apartment complexes, manufacturing plants, and healthcare, education and government facilities.
Nature and Economics of Our Business
Approximately 82% of our revenue is earned on a project basis for installation of mechanical systems in newly constructed facilities or for replacement of systems in existing facilities. Customers hire us to ensure such systems deliver specified or generally expected heating, cooling, conditioning and circulation of air in a facility. This entails installing core system equipment such as packaged heating and air conditioning units, or in the case of larger facilities, separate core components such as chillers, boilers, air handlers, and cooling towers. We also typically install connecting and distribution elements such as piping and ducting. Our responsibilities usually require conforming the systems to pre-established engineering drawings and equipment and performance specifications, which we frequently participate in establishing. Our project management responsibilities include staging equipment and materials to project sites, deploying labor to perform the work, and coordinating with other service providers on the project, including any subcontractors we might use to deliver our portion of the work.
When competing for project business, we usually estimate the costs we will incur on a project, and then propose a bid to the customer that includes a contract price and other performance and payment terms. Our bid price and terms are intended to cover our estimated costs on the project and provide a profit margin to us commensurate with the value of the installed system to the customer, the risk that project costs or duration will vary from estimate, the schedule on which we will be paid, the opportunities for other work that we might forego by committing capacity to this project, and other costs that we incur more broadly to support our operations but which are not specific to the project. Typically customers will seek bids from competitors for a given project. While the criteria on which customers select the winning bid vary widely and include factors such as quality, technical expertise, on-time performance, post-project support and service, and company history and financial strength, we believe that price is the most influential factor for most customers in choosing a mechanical installation and service provider.
After a customer accepts our bid, we generally enter into a contract with the customer that specifies what we will deliver on the project, what our related responsibilities are, and how much and when we will be paid. Our overall price for the project is typically set at a fixed amount in the contract, although changes in project specifications or work conditions that result in unexpected additional work are usually subject to additional payment from the customer via what are commonly known as change orders. Project contracts typically provide for periodic billings to the customer as we meet progress milestones or incur cost on the project. Project contracts in our industry also frequently allow for a small portion of progress billings or contract price to be withheld by the customer until after we have completed the work, typically for six months. Amounts withheld under this practice are known as retention or retainage.
Labor and overhead costs account for the majority of our cost of service. Accordingly, labor management and utilization have the most impact on our project performance. Given the fixed price nature of much of our project work, if our initial estimate of project costs is wrong or we incur cost overruns that cannot be recovered in change orders, we can experience reduced profits or even significant losses on fixed price project work. We also perform some project work on a cost-plus or a time and materials basis, under which we are paid our costs incurred plus an agreed-upon profit
margin, although such projects are sometimes subject to a guaranteed maximum cost. These margins are frequently less than fixed-price contract margins because there is less risk of unrecoverable cost overruns in cost-plus or time and materials work.
As of December 31, 2015, we had 3,843 projects in process. Our average project takes six to nine months to complete, with an average contract price of approximately $512,000. Our projects generally require working capital funding of equipment and labor costs. Customer payments on periodic billings generally do not recover these costs until late in the job. Our average project duration together with typical retention terms as discussed above generally allow us to complete the realization of revenue and earnings in cash within one year. We have what we believe is a well-diversified distribution of revenue across end-use sectors that we believe reduces our exposure to negative developments in any given sector. Because of the integral nature of HVAC and related controls systems to most buildings, we have the legal right in almost all cases to attach liens to buildings or related funding sources when we have not been fully paid for installing systems, except with respect to some government buildings. The service work that we do, which is discussed further below, usually does not give rise to lien rights.
We also perform larger projects. As of December 31, 2015, we had 12 projects in process with a contract price greater than $15 million, 21 projects between $10 million and $15 million, 64 projects between $5 million and $10 million, and 286 projects between $1 million and $5 million. Taken together, projects with contract prices of $1 million or more totaled $1,565.0 million of aggregate contract value as of December 31, 2015, or approximately 80%, out of a total contract value for all projects in progress of $1,966.4 million. Generally, projects closer in size to $1 million will be completed in one year or less. It is unusual for us to work on a project that exceeds two years in length.
In addition to project work, approximately 18% of our revenue represents maintenance and repair service on already installed HVAC and controls systems. This kind of work usually takes from a few hours to a few days to perform. Prices to the customer are usually based on the equipment and materials used in the service as well as technician labor time. We usually bill the customer for service work when it is complete, typically with payment terms of up to thirty days. We also provide maintenance and repair service under ongoing contracts. Under these contracts, we are paid regular monthly or quarterly amounts and provide specified service based on customer requirements. These agreements typically cover periods ranging from one to three years with thirty- to sixty-day cancellation notice periods.
A relatively small portion of our revenue comes from national and regional account customers. These customers typically have multiple sites, and contract with us to perform maintenance and repair service. These contracts may also provide for us to perform new or replacement systems installation. We operate a national call center to dispatch technicians to sites requiring service. We perform the majority of this work with our own employees, with the balance being subcontracted to third parties that meet our performance qualifications. We will also typically use proprietary information systems to maintain information on the customer's sites and equipment, including performance and service records, and related cost data. These systems track the status of ongoing service and installation work, and may also monitor system performance data. Under these contractual relationships, we usually provide consolidated billing and credit payment terms to the customer.
Profile and Management of Our Operations
We manage our 35 operating units based on a variety of factors. Financial measures we emphasize include profitability, and use of capital as indicated by cash flow and by other measures of working capital principally involving project cost, billings and receivables. We also monitor selling, general, administrative and indirect project support expense, backlog, workforce size and mix, growth in revenue and profits, variation of actual project cost from original estimate, and overall financial performance in
comparison to budget and updated forecasts. Operational factors we emphasize include project selection, estimating, pricing, management and execution practices, labor utilization, safety, training, and the make-up of both existing backlog as well as new business being pursued, in terms of project size, technical application and facility type, end-use customers and industries, and location of the work.
Most of our operations compete on a local or regional basis. Attracting and retaining effective operating unit managers is an important factor in our business, particularly in view of the relative uniqueness of each market and operation, the importance of relationships with customers and other market participants such as architects and consulting engineers, and the high degree of competition and low barriers to entry in most of our markets. Accordingly, we devote considerable attention to operating unit management quality, stability, and contingency planning, including related considerations of compensation, and non-competition protection where applicable.
Economic and Industry Factors
As a mechanical and building controls services provider, we operate in the broader nonresidential construction services industry and are affected by trends in this sector. While we do not have operations in all major cities of the United States, we believe our national presence is sufficiently large that we experience trends in demand for and pricing of our services that are consistent with trends in the national nonresidential construction sector. As a result, we monitor the views of major construction sector forecasters along with macroeconomic factors they believe drive the sector, including trends in gross domestic product, interest rates, business investment, employment, demographics, and the general fiscal condition of federal, state and local governments.
Spending decisions for building construction, renovation and system replacement are generally made on a project basis, usually with some degree of discretion as to when and if projects proceed. With larger amounts of capital, time, and discretion involved, spending decisions are affected to a significant degree by uncertainty, particularly concerns about economic and financial conditions and trends. We have experienced periods of time when economic weakness caused a significant slowdown in decisions to proceed with installation and replacement project work.
Operating Environment and Management Emphasis
Nonresidential building construction and renovation activity, as reported by the federal government, declined over the four year period from 2009 to 2012, and 2013 and 2014 activity levels were relatively stable at the low levels of the preceding years. While we expect that activity levels and the underlying environment for nonresidential construction activity will remain below prior peaks, we have seen industry conditions improve during 2015.
As a result of our continued strong emphasis on cash flow, at December 31, 2015 we had modest indebtedness under our revolving credit facility and substantial uncommitted cash balances, as discussed further in "Liquidity and Capital Resources" below. We have a credit facility in place with considerably less restrictive terms than those of our previous facilities; this facility does not expire until October 2019. We have strong surety relationships to support our bonding needs, and we believe our relationships with the surety markets are strong and benefit from our solid current results and financial position. We have generated positive free cash flow in each of the last seventeen calendar years and will continue our emphasis in this area. We believe that the relative size and strength of our balance sheet and surety support as compared to most companies in our industry represent competitive advantages for us.
As discussed at greater length in "Results of Operations" below, we expect price competition to continue as our customers and local and regional competitors respond cautiously to changing conditions. We will continue our efforts to expand and improve our service business, to find the more active sectors in our markets, and to increase our regional and national account business. Our primary
emphasis for 2016 will be on execution and cost control, but we are seeking growth based on our belief that industry conditions are beginning to improve, and we believe that activity levels will permit us to earn improved profits while preserving and developing our workforce. We continue to focus on project qualification, estimating, pricing and management; and we are investing in service growth and improved performance.
Critical Accounting Policies
Our critical accounting policies are based upon the significance of the accounting policy to our overall financial statement presentation, as well as the complexity of the accounting policy and our use of estimates and subjective assessments. Our most critical accounting policy is revenue recognition. As discussed elsewhere in this annual report on Form 10-K, our business has two service functions: (i) installation, which we account for under the percentage of completion method, and (ii) maintenance, repair and replacement, which we account for as the services are performed, or in the case of replacement, under the percentage of completion method. In addition, we identified other critical accounting policies related to our allowance for doubtful accounts receivable, the recording of our self-insurance liabilities, valuation of deferred tax assets, accounting for acquisitions and the recoverability of goodwill and identifiable intangible assets. These accounting policies, as well as others, are described in Note 2 to the Consolidated Financial Statements included elsewhere in this annual report on Form 10-K.
Percentage of Completion Method of Accounting
Approximately 82% of our revenue was earned on a project basis and recognized through the percentage of completion method of accounting during 2015. Under this 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 at any time to total estimated contract costs. More specifically, as part of the negotiation and bidding process in connection with obtaining installation contracts, we estimate our contract costs, which include all direct materials (exclusive of rebates), labor and subcontract costs and indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation costs. These contract costs are included in our results of operations under the caption "Cost of Services." Then, as we perform under those contracts, we measure costs incurred, compare them to total estimated costs to complete the contract, and recognize a corresponding proportion of contract revenue. Labor costs are considered to be incurred as the work is performed. Subcontractor labor is recognized as the work is performed, 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 our projects is substantially produced to job specifications and is a value added element to our work. The costs are considered to be incurred when title is transferred to us, which typically is upon delivery to the worksite. Prefabricated materials, such as ductwork and piping, are generally performed at our shops and recognized as contract costs when fabricated for the unique specifications of the job. Other materials costs are 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.
We generally do not incur significant costs prior to receiving a contract, and therefore, these costs are expensed as incurred. In limited circumstances, when significant pre-contract costs are incurred, they are deferred if the costs can be directly associated with a specific contract and if their recoverability from the contract is probable. Upon receiving the contract, these costs are included in contract costs. Deferred costs associated with unsuccessful contract bids are written off in the period that we are informed that we will not be awarded the contract.
Project contracts typically provide for a schedule of billings or invoices to the customer based on reaching agreed upon milestones or as we incur 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 our balance sheet under the caption "Costs and estimated earnings in excess of billings." Amounts by which cumulative billings to the customer under a contract as of a given date exceed cumulative contract revenue recognized on the contract are reflected as a current liability in our balance sheet under the caption "Billings in excess of costs and estimated earnings."
The percentage of completion 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 percentage of completion 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 can also result in claims we might make against the customer to recover project variances that have not been satisfactorily addressed through change orders with the customer. Except in certain circumstances, we do not recognize revenue or margin based on change orders or claims until they have been agreed upon with the customer. The amount of revenue associated with unapproved change orders and claims was immaterial for the year ended December 31, 2015.
Variations from estimated project costs could have a significant impact on our operating results, depending on project size, and the recoverability of the variation via additional customer payments.
Accounting for Allowance for Doubtful Accounts
We are required to estimate the collectability of accounts receivable and provide an allowance for doubtful accounts for receivable amounts we believe we will not ultimately collect. This requires us to make certain judgments and estimates involving, among others, the creditworthiness of our customers, prior collection history with our customers, ongoing relationships with our customers, the aging of past due balances, our lien rights, if any, in the property where we performed the work, and the availability, if any, of payment bonds applicable to the contract. These estimates are evaluated and adjusted as needed when additional information is received.
Accounting for Self-Insurance Liabilities
We are 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 we absorb under our insurance arrangements for these risks. Losses up to deductible amounts are estimated and accrued based upon known facts, historical trends and industry averages. Loss estimates associated with the larger and longer-developing risks—workers' compensation, auto liability and general liability—are reviewed by a third party actuary quarterly.
We believe these accruals are adequate. However, insurance liabilities are difficult to estimate due to unknown factors, including the severity of an injury, the determination of our 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.
Accounting 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. In assessing the realizability of deferred tax assets, we must consider whether it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. We consider 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.
Acquisitions
We recognize assets acquired and liabilities assumed in business combinations, including contingent assets and liabilities, based on fair value estimates as of the date of acquisition.
Contingent Consideration—In certain acquisitions, we agree to pay additional amounts to sellers contingent upon achievement by the acquired businesses of certain predetermined profitability targets. We have recognized liabilities for these contingent obligations based on their estimated fair value at the date of acquisition with any differences between the acquisition-date fair value and the ultimate settlement of the obligations being recognized in income from operations.
Contingent Assets and Liabilities—Assets and liabilities arising from contingencies are recognized at their acquisition date fair value when their respective fair values can be determined. If the fair values of such contingencies cannot be determined, they are recognized at the acquisition date if the contingencies are probable and an amount can be reasonably estimated. Acquisition date fair value estimates are revised as necessary if, and when, additional information regarding these contingencies becomes available to further define and quantify assets acquired and liabilities assumed.
Recoverability of Goodwill and Identifiable Intangible Assets
Goodwill is the excess of purchase price over the fair value of the net assets of acquired businesses. We assess 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.
We perform our annual impairment testing as of October 1 and any impairment charges resulting from this process are reported in the fourth quarter. We segregate our operations into reporting units based on the degree of operating and financial independence of each unit and our related management of them. We perform our annual goodwill impairment testing at the reporting unit level. Each of our operating units represents an operating segment, and our operating segments are our reporting units.
In the evaluation of goodwill for impairment, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of one of our reporting units is greater than its carrying value. If,
after completing such assessment, we determine it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, then there is no need to perform any further testing. If we conclude otherwise, then we perform the first step of a two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying value of the reporting unit.
We estimate the fair value of the reporting unit based on two market approaches and an income approach, which utilizes discounted future cash flows. Assumptions critical to the fair value estimates under the discounted cash flow model include discount rates, cash flow projections, projected long-term growth rates and the determination of terminal values. The market approaches utilized market multiples of invested capital from comparable publicly traded companies ("public company approach") and comparable transactions ("transaction approach"). The market multiples from invested capital include revenue, book equity plus debt and earnings before interest, taxes, depreciation and amortization ("EBITDA").
There are significant inherent uncertainties and management judgment involved in estimating the fair value of each reporting unit. While we believe we have made reasonable estimates and assumptions to estimate the fair value of our reporting units, it is possible that a material change could occur. If actual results are not consistent with our current estimates and assumptions, or the current economic outlook worsens, goodwill impairment charges may be recorded in future periods.
We amortize identifiable intangible assets with finite lives over their useful lives. Changes in strategy and/or market condition, may result in adjustments to recorded intangible asset balances or their useful lives.
Results of Operations (in thousands):
| Year Ended December 31, | |||||||||||||||||||
| 2015 | 2014 | 2013 | |||||||||||||||||
| Revenue | $ | 1,580,519 | 100.0 | % | $ | 1,410,795 | 100.0 | % | $ | 1,357,272 | 100.0 | % | |||||||
| Cost of services | 1,262,390 | 79.9 | % | 1,161,024 | 82.3 | % | 1,117,389 | 82.3 | % | ||||||||||
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| Gross profit | 318,129 | 20.1 | % | 249,771 | 17.7 | % | 239,883 | 17.7 | % | ||||||||||
| Selling, general and administrative expenses | 228,965 | 14.5 | % | 207,652 | 14.7 | % | 194,214 | 14.3 | % | ||||||||||
| Goodwill impairment | — | — | 727 | 0.1 | % | — | — | ||||||||||||
| Gain on sale of assets | (880 | ) | (0.1 | )% | (830 | ) | (0.1 | )% | (589 | ) | — | ||||||||
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| Operating income | 90,044 | 5.7 | % | 42,222 | 3.0 | % | 46,258 | 3.4 | % | ||||||||||
| Interest income | 72 | — | 18 | — | 23 | — | |||||||||||||
| Interest expense | (1,753 | ) | (0.1 | )% | (1,858 | ) | (0.1 | )% | (1,351 | ) | (0.1 | )% | |||||||
| Changes in the fair value of contingent earn-out obligations | 225 | — | (245 | ) | — | 1,646 | 0.1 | % | |||||||||||
| Other income | 76 | — | 91 | — | 204 | — | |||||||||||||
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| Income before income taxes | 88,664 | 5.6 | % | 40,228 | 2.9 | % | 46,780 | 3.4 | % | ||||||||||
| Income tax expense | 31,224 | 11,614 | 18,148 | ||||||||||||||||
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| Income from continuing operations | 57,440 | 3.6 | % | 28,614 | 2.0 | % | 28,632 | 2.1 | % | ||||||||||
| Loss from discontinued operations, net of tax | — | (15 | ) | (76 | ) | ||||||||||||||
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| Net income including noncontrolling interests | 57,440 | 28,599 | 28,556 | ||||||||||||||||
| Less: Net income attributable to noncontrolling interests | 8,076 | 5,536 | 1,287 | ||||||||||||||||
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| Net income attributable to Comfort Systems USA, Inc. | $ | 49,364 | $ | 23,063 | $ | 27,269 | |||||||||||||
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2015 Compared to 2014
We had 37 operating locations as of December 31, 2014. During 2015, we completed two acquisitions in the first quarter, one in the third quarter and one in the fourth quarter. These acquisitions were not material and were "tucked-in" with existing operations. In addition, we merged two operating locations during the first quarter and closed one operating location during the third quarter. As of December 31, 2015, we had 35 operating locations. Acquisitions are included in our results of operations from the respective acquisition date. The same-store comparison from 2015 to 2014, as described below, excludes four months of results for our Northern Texas operation, which was acquired in May 2014. An operating location is included in the same-store comparison on the first day it has comparable prior year operating data. An operating location is excluded from the same-store comparison in the current year and comparable prior years when it is properly characterized as a discontinued operation under applicable accounting standards.
Revenue—Revenue increased $169.7 million, or 12.0% to $1,580.5 million in 2015 compared to 2014. The increase included a 10.6% increase in revenue related to same-store activity and a 1.4% increase related to the acquisition of our Northern Texas operation. The same-store revenue increase is primarily due to our Environmental Air Systems, LLC ("EAS") operation ($61.3 million), our Arizona operation ($17.7 million), our large operation headquartered in Virginia ($12.2 million) and one of our Maryland operations ($12.1 million). These operations, as well as many of our other operating
locations, experienced increased project work compared to the prior year in multiple markets, but primarily the industrials sector due to improved market conditions.
Backlog reflects revenue still to be recognized under contracted or committed installation and replacement project work. Project work generally lasts less than one year. Service agreement revenue and service work and short duration projects, which are generally billed as performed, do not flow through backlog. Accordingly, backlog represents only a portion of our revenue for any given future period, and it represents revenue that is likely to be reflected in our operating results over the next six to twelve months. As a result, we believe the predictive value of backlog information is limited to indications of general revenue direction over the near term, and should not be interpreted as indicative of ongoing revenue performance over several quarters.
Backlog as of December 31, 2015 was $711.6 million, a 6.8% increase from September 30, 2015 backlog of $666.3 million and a 6.1% decrease from December 31, 2014 backlog of $757.8 million. Sequential backlog increased primarily due to increased project bookings at our EAS operation ($16.8 million), our Michigan operation ($13.6 million) and one of our Florida operations ($12.0 million). The year-over-year backlog decrease was primarily due to our EAS operation ($22.2 million), which had unusually large jobs booked in the fourth quarter of 2014, and due to completion of project work during the year at our California operation ($19.7 million) and our Arkansas operation ($17.9 million). This was partially offset by increased project bookings at our Michigan operation ($16.8 million).
Gross Profit—Gross profit increased $68.4 million, or 27.4%, to $318.1 million in 2015 as compared to 2014. The increase included a $3.4 million, or 1.3%, increase related to the acquisition of our Northern Texas operation and a $65.0 million, or 26.1%, increase on a same-store basis. The same-store increase in gross profit was due to overall increased margins at a majority of operating locations. Specifically, increases were due to job underperformance at our Southern California operation in 2014 ($9.0 million), improved project execution at our large operation headquartered in Virginia ($7.0 million), and improved market conditions, which resulted in an increase in volumes at our EAS operation ($5.8 million). In addition, in the fourth quarter of 2015, we came to an agreement with customers on multiple jobs and received approved change orders, which resulted in additional revenue with minimal additional costs. The resulting impact to the current year was an increase to gross profit of approximately $3.4 million. As a percentage of revenue, gross profit increased from 17.7% in 2014 to 20.1% in 2015 primarily due to the factors discussed above.
Selling, General and Administrative Expenses ("SG&A")—SG&A increased $21.3 million, or 10.3%, to $229.0 million for 2015 as compared to 2014. On a same-store basis, excluding amortization expense, SG&A increased $19.4 million, or 9.7%. This increase is primarily due to increased compensation accruals based on operating results ($13.3 million) and expanded service activities at certain locations ($4.8 million). Amortization expense remained relatively flat. As a percentage of revenue, SG&A decreased from 14.7% in 2014 to 14.5% in 2015, primarily due to the higher revenue base caused by the increase in market activity in 2015.
We have included same-store SG&A, excluding amortization, because we believe it is an effective measure of comparative results of operations. However, same-store SG&A, excluding amortization, is not considered under generally accepted accounting principles to be a primary measure of an entity's
financial results, and accordingly, should not be considered an alternative to SG&A as shown in our consolidated statements of operations.
| Year Ended December 31, | |||||||
| 2015 | 2014 | ||||||
| (in thousands) | |||||||
| SG&A | $ | 228,965 | $ | 207,652 | |||
| Less: SG&A from companies acquired | (1,843 | ) | — | ||||
| Less: Amortization expense | (6,897 | ) | (6,825 | ) | |||
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| Same-store SG&A, excluding amortization expense | $ | 220,225 | $ | 200,827 | |||
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Interest Expense—Interest expense decreased $0.1 million, or 5.7%, in 2015. The decrease is due to lower net borrowings on the revolving credit facility in 2015.
Goodwill Impairment—No goodwill impairment was recorded in 2015. We recorded a goodwill impairment charge of $0.7 million during the second quarter of 2014. Based on market activity declines and write-downs incurred on several jobs, we determined that the operating environment, conditions and performance at our operating unit based in Southern California could no longer support the related goodwill balance.
Changes in the Fair Value of Contingent Earn-out Obligations—The contingent earn-out obligations are measured at fair value each reporting period and changes in estimates of fair value are recognized in earnings. Income from changes in the fair value of contingent earn-out obligations increased $0.5 million in 2015 compared to 2014. Based on updated measurements of estimated future cash flows for our contingent obligations, we decreased our obligations related to prior year acquisitions resulting in the current year gain of $0.2 million. The $0.3 million loss from changes in the fair value of contingent earn-out obligations in the prior year was due to updated measurements of estimated future cash flows for our contingent obligation related to the EAS acquisition.
Income Tax Expense—We perform work throughout the United States in virtually all of the fifty states. Our effective tax rate varies based upon our relative profitability, or lack of profitability, in states with varying state tax rates and rules. In addition, discrete events, judgments and legal structures can affect our effective tax rate. These items can include the tax treatment for impairment of goodwill and other intangible assets and changes in fair value of acquisition related assets and liabilities, tax reserves associated with regulatory audits, accounting for losses associated with underperforming operations and the partial ownership of consolidated entities.
Our effective tax rate for 2015 was 35.2%, as compared to 28.9% in 2014. The effective rate for 2015 is slightly higher than the federal statutory rate of 35.0% primarily due to an increase in state income taxes (3.9%) which was partially offset by a decrease from the impact of the noncontrolling interest of EAS which for tax purposes is treated as a partnership (3.2%). The effective rate for 2014 is lower than the federal statutory rate of 35.0% primarily due to a decrease in the valuation allowance primarily associated with our operations in Maryland and Virginia (4.8%), by the impact of the noncontrolling interest of EAS which for tax purposes is treated as a partnership (4.8%) and the effect of the production activity deduction (1.7%). Refer to Note 10 in the Consolidated Financial Statements for a reconciliation of the federal statutory income tax rate to the effective tax rate reflected in our financial statements. The increase in the effective tax rate from 2014 to 2015 is primarily due to the impact on the rate from state income taxes and the valuation allowance, which is partially offset by the impact of our noncontrolling interests. We currently estimate our effective tax rate for 2016 will be between 36% and 42%. We generally expect our tax rate in 2016 to be higher than 2015 due to our
purchase of the noncontrolling interest in EAS on January 1, 2016 since the noncontrolling interest was treated as a partnership for tax purposes.
Net Income Attributable to Noncontrolling Interests—Net income attributable to noncontrolling interests increased $2.5 million in 2015 to income of $8.1 million as compared to $5.5 million in 2014. This increase reflects the impact of higher earnings at EAS, our non-wholly owned consolidated subsidiary, which was due primarily to increased revenue in the current year resulting from large project work at this location in 2015. Due to our acquisition of the remaining 40% noncontrolling interest in EAS on January 1, 2016, we do not expect to continue to have income attributable to noncontrolling interests in 2016. EAS was the only entity in which we reported a noncontrolling interest for financial statement purposes as of December 31, 2015.
2014 Compared to 2013
We had 36 operating locations as of December 31, 2013. We completed one acquisition in the first quarter of 2014. This acquisition was not material and was "tucked-in" with existing operations. We completed two acquisitions in the second quarter of 2014, one of which was "tucked-in" with existing operations and the second reports as a separate operating location in northern Texas. No acquisitions were completed in the third quarter of 2014. An immaterial acquisition was completed and "tucked-in" with existing operations in the fourth quarter of 2014. As of December 31, 2014, we had 37 operating locations. Acquisitions are included in our results of operations from the respective acquisition date. The same-store comparison from 2014 to 2013, as described below, excludes eight months of results for our Northern Texas operation, which was acquired in May 2014. An operating location is included in the same-store comparison on the first day it has comparable prior year operating data. An operating location is excluded from the same-store comparison in the current year and comparable prior years when it is properly characterized as a discontinued operation under applicable accounting standards.
Revenue—Revenue increased $53.5 million, or 3.9% to $1,410.8 million in 2014 compared to 2013. The increase included a 0.6% increase in revenue related to same-store activity and a 3.3% increase related to the acquisition of our Northern Texas operation. The same-store revenue increase is primarily due to our Arkansas operation ($16.1 million) and one of our Virginia operations ($12.9 million), both of which performed a significant amount of project work for the institutional sector during 2014. This increase was partially offset by lower revenues at our Arizona operation ($23.8 million), which performed a significant amount of project work during 2013 that did not reoccur in 2014 due to its completion.
Backlog reflects revenue still to be recognized under contracted or committed installation and replacement project work. Project work generally lasts less than one year. Service agreement revenue and service work and short duration projects, which are generally billed as performed, do not flow through backlog. Accordingly, backlog represents only a portion of our revenue for any given future period, and it represents revenue that is likely to be reflected in our operating results over the next six to twelve months. As a result, we believe the predictive value of backlog information is limited to indications of general revenue direction over the near term, and should not be interpreted as indicative of ongoing revenue performance over several quarters.
Backlog as of December 31, 2014 was $757.8 million, a 15.4% increase from September 30, 2014 backlog of $656.8 million and a 25.5% increase from December 31, 2013 backlog of $603.6 million. Sequential backlog increased primarily due to our EAS operation ($37.3 million) and one of our Virginia operations ($17.2 million), which had increased project bookings. The year-over-year backlog increase was primarily due to a same-store increase of 17.1% largely related to increased project bookings at many of our operating locations, including our EAS operation ($30.6 million) and one of our Maryland operations ($25.4 million). In addition, an 8.4% increase was due to the aforementioned acquisition of our Northern Texas operation ($50.8 million) during the current year.
Gross Profit—Gross profit increased $9.9 million, or 4.1%, to $249.8 million in 2014 as compared to 2013. The increase included a $5.6 million, or 2.3%, increase related to the acquisition of our Northern Texas operation and a $4.3 million, or 1.8%, increase on a same-store basis. The same-store increase in gross profit was primarily due to a $9.8 million increase in profitability at our EAS operation due to improved project execution. This was partially offset by a decrease in project volumes at our Arizona operation ($4.2 million) and job underperformance at our Southern California operation ($3.9 million), which included a revision in contract estimate on a project in a loss position resulting in a $4.4 million writedown. As a percentage of revenue, gross profit was stable at 17.7% in 2014 compared to 2013 primarily due to the factors discussed above.
Selling, General and Administrative Expenses ("SG&A")—SG&A increased $13.4 million, or 6.9%, to $207.7 million for 2014 as compared to 2013. On a same-store basis, excluding amortization expense, SG&A increased $9.4 million, or 5.0%. This increase was primarily due to higher compensation expense ($6.5 million) primarily as a result of our increased investment in service growth and information technology, higher training costs ($2.6 million) and a $1.3 million increase in bad debt expense as a result of a $0.8 million gain recorded in the prior year as a result of a receivable settlement. Amortization expense decreased $0.2 million, or 2.4%. As a percentage of revenue, SG&A increased from 14.3% in 2013 to 14.7% in 2014, primarily due to the factors discussed above.
We have included same-store SG&A, excluding amortization, because we believe it is an effective measure of comparative results of operations. However, same-store SG&A, excluding amortization, is not considered under generally accepted accounting principles to be a primary measure of an entity's financial results, and accordingly, should not be considered an alternative to SG&A as shown in our consolidated statements of operations.
| Year Ended December 31, | |||||||
| 2014 | 2013 | ||||||
| (in thousands) | |||||||
| SG&A | $ | 207,652 | $ | 194,214 | |||
| Less: SG&A from companies acquired | (4,204 | ) | — | ||||
| Less: Amortization expense | (6,825 | ) | (6,992 | ) | |||
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| Same-store SG&A, excluding amortization expense | $ | 196,623 | $ | 187,222 | |||
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Interest Expense—Interest expense increased $0.5 million, or 37.5%, in 2014. The increase was due to the increase in borrowings on the revolving credit facility.
Goodwill Impairment—We recorded a goodwill impairment charge of $0.7 million during the second quarter of 2014. Based on market activity declines and write-downs incurred on several jobs, we determined that the operating environment, conditions and performance at our operating unit based in Southern California could no longer support the related goodwill balance. No goodwill impairment was recorded in 2013.
Changes in the Fair Value of Contingent Earn-out Obligations—The contingent earn-out obligations are measured at fair value each reporting period and changes in estimates of fair value are recognized in earnings. Income from changes in the fair value of contingent earn-out obligations decreased $1.9 million in 2014 compared to 2013. The primary reason for the decrease was an overall reduction of estimated future cash flows in 2013 related to the 2010 acquisition of ColonialWebb and the 2011 acquisition of EAS. This change in estimate was the result of a writedown of $1.6 million, which did not reoccur in the current year. In addition, based on updated measurements of estimated future cash flows in the current year, primarily for our EAS location, we recorded a $0.3 million increase to the earn-out obligation.
Income Tax Expense—We perform work throughout the United States in virtually all of the fifty states as well as in Puerto Rico. Our effective tax rate varies based upon our relative profitability, or lack of profitability, in states with varying state tax rates and rules. In addition, discrete events, judgments and legal structures can affect our effective tax rate. These items can include the tax treatment for impairment of goodwill and other intangible assets and changes in fair value of acquisition related assets and liabilities, tax reserves associated with regulatory audits, accounting for losses associated with underperforming operations and the partial ownership of consolidated entities.
Our effective tax rate for 2014 was 28.9%, as compared to 38.8% in 2013. The effective rate for 2014 was lower than the federal statutory rate of 35.0% primarily due to a decrease in the valuation allowance primarily associated with our operations in Maryland and Virginia (4.8%), by the impact of the noncontrolling interest of EAS, which for tax purposes is treated as a partnership (4.8%), and the effect of the production activity deduction (1.7%). The effective rate for 2013 was higher than the federal statutory rate of 35.0% primarily due to state income taxes (4.1%), the effect of non-deductible expenses (1.3%) and an increase in the valuation allowance primarily associated with our operations in Puerto Rico (3.1%). These increases were partially offset by the impact of the noncontrolling interest of EAS, which for tax purposes is treated as a partnership (1.0%), the effect of the production activity deduction (1.1%) and the effect of purchase accounting adjustments (1.0%). Refer to Note 10 in the Consolidated Financial Statements for a reconciliation of the federal statutory income tax rate to the effective tax rate reflected in our financial statements. The decrease in the effective tax rate from 2013 to 2014 was primarily due to impact on the rate from valuation allowance and from noncontrolling interests.
Discontinued Operations—During the fourth quarter of 2012, we substantially completed the shutdown of our operation located in Delaware. The after tax loss of less than $0.1 million for the year ended December 31, 2014 and the after tax loss of $0.1 million for the year ended December 31, 2013 have been recorded in discontinued operations under "Operating income (loss), net of tax expense (benefit)."
Net Income (Loss) Attributable to Noncontrolling Interests—Net income (loss) attributable to noncontrolling interests increased $4.2 million in 2014 to income of $5.5 million as compared to income of $1.3 million in 2013. This increase reflects the impact of higher earnings at EAS, our non-wholly owned consolidated subsidiary, which was due primarily to increased margins on jobs performed in the current year.
Outlook
We have seen industry conditions improve during 2015. Our emphasis for 2016 will be on execution, including a focus on cost discipline and efficient project performance, labor force development, and investing in growth, particularly in service and small projects. Based on our backlog, and in light of economic conditions for our industry, we expect that revenue and profitability in 2016 will be similar to or above the levels that we experienced in 2015.
Liquidity and Capital Resources
| Year Ended December 31, | ||||||||||
| 2015 | 2014 | 2013 | ||||||||
| (in thousands) | ||||||||||
| Cash provided by (used in): | ||||||||||
| Operating activities | $ | 97,867 | $ | 42,552 | $ | 38,423 | ||||
| Investing activities | (25,628 | ) | (74,142 | ) | (16,253 | ) | ||||
| Financing activities | (47,839 | ) | 11,600 | (10,873 | ) | |||||
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| Net increase (decrease) in cash and cash equivalents | $ | 24,400 | $ | (19,990 | ) | $ | 11,297 | |||
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| Free cash flow: | ||||||||||
| Cash provided by operating activities | $ | 97,867 | $ | 42,552 | $ | 38,423 | ||||
| Purchases of property and equipment | (20,808 | ) | (19,183 | ) | (17,403 | ) | ||||
| Proceeds from sales of property and equipment | 1,338 | 1,355 | 1,107 | |||||||
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| Free cash flow | $ | 78,397 | $ | 24,724 | $ | 22,127 | ||||
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Cash Flow
Our business does not require significant amounts of investment in long-term fixed assets. The substantial majority of the capital used in our business is working capital that funds our costs of labor and installed equipment deployed in project work until our customer pays us. Customary terms in our industry allow customers to withhold a small portion of the contract price until after we have completed the work, typically for six months. Amounts withheld under this practice are known as retention or retainage. Our average project duration together with typical retention terms generally allow us to complete the realization of revenue and earnings in cash within one year.
2015 Compared to 2014
Cash Provided by Operating Activities—Cash flow from operations is primarily influenced by demand for our services and operating margins, but can also be influenced by working capital needs associated with the various types of services that we provide. In particular, working capital needs may increase when we commence large volumes of work under circumstances where project costs, primarily associated with labor, equipment and subcontractors, are required to be paid before the receivables resulting from the work performed are billed and collected. Working capital needs are generally higher during the late winter and spring months as we prepare and plan for the increased project demand when favorable weather conditions exist in the summer and fall months. Conversely, working capital assets are typically converted to cash during the late summer and fall months as project completion is underway. These seasonal trends are sometimes offset by changes in the timing of major projects, which can be impacted by the weather, project delays or accelerations and other economic factors that may affect customer spending.
We generated $97.9 million of cash flow from operating activities during 2015 compared with $42.6 million during 2014. The $55.3 million increase primarily relates to higher net income in the current year ($57.4 million) compared to the prior year ($28.6 million). In addition, there was an increase in accounts payable and accrued liabilities of $15.7 million compared to the prior year, primarily caused by higher compensation accruals and a decrease in net receivables of $14.8 million compared to the prior year, primarily due to the timing of customer billings and payments. This was partially offset by an increase in costs and estimated earnings in excess of billings of $6.4 million compared to the prior year due to the timing of customer billings.
Cash Used in Investing Activities—Cash used in investing activities was $25.6 million for 2015 compared to $74.1 million during 2014. The $48.5 million decrease in cash used primarily relates to cash paid for the four acquisitions that were completed in 2014.
Cash Provided by (Used in) Financing Activities—Cash used in financing activities was $47.8 million for 2015 compared to cash provided by financing activities of $11.6 million during 2014. The $59.4 million decrease in cash provided by financing activities primarily relates to $28.5 million of net payments on the revolving line of credit in 2015 compared to $38.5 million of net borrowings in 2014. This decrease in cash provided was partially offset by increases due to decreased distributions to noncontrolling interests of $3.7 million, increased proceeds from options exercised of $2.5 million and a $2.0 million payment of other debt that occurred in 2014.
2014 Compared to 2013
Cash Provided by Operating Activities—We generated $42.6 million of cash flow from operating activities during 2014 compared with $38.4 million during 2013. The $4.1 million increase was primarily due to billings in excess of costs and estimated earnings, which had a positive impact of $16.8 million on the comparison of cash flows due to the achievement of contract milestones that affected the timing of customer billings. This was partially offset by a $10.9 million negative impact related to on accounts payables and accrued liabilities. During the year ended December 31, 2014, accounts payable balances decreased due to timing of payments as compared to accrued compensation due to higher earnings for the year ended December 31, 2013.
Cash Used in Investing Activities—Cash used in investing activities was $74.1 million for 2014 compared to $16.3 million during 2013. The $57.9 million increase in cash used primarily relates to cash paid for four acquisitions that were completed in 2014 ($52.1 million) and deferred purchase price costs related to previous acquisitions that were completed in 2012 and 2011 ($4.3 million).
Cash Provided by (Used in) Financing Activities—Cash provided by financing activities was $11.6 million for 2014 compared to cash used in financing activities of $10.9 million during 2013. The $22.5 million increase in cash provided by financing activities primarily related to $38.5 million of net borrowings on the revolving line of credit in 2014 compared to no net borrowings in 2013. This was partially offset by cumulative cash distributions of $8.6 million to our noncontrolling partners as well as an incremental increase of $6.1 million related to share repurchases.
Free Cash Flow
We define free cash flow as cash provided by operating activities, less customary capital expenditures, plus the proceeds from asset sales and taxes paid related to pre-acquisition equity transactions of an acquired company. We believe free cash flow, by encompassing both profit margins and the use of working capital over our approximately one year working capital cycle, is an effective measure of operating effectiveness and efficiency. We have included free cash flow information here for this reason, and because we are often asked about it by third parties evaluating us. However, free cash flow is not considered under generally accepted accounting principles to be a primary measure of an entity's financial results, and accordingly free cash flow should not be considered an alternative to operating income, net income, or amounts shown in our consolidated statements of cash flows as determined under generally accepted accounting principles. Free cash flow may be defined differently by other companies.
Share Repurchase Program
On March 29, 2007, our Board of Directors (the "Board") approved a stock repurchase program to acquire up to 1.0 million shares of our outstanding common stock. Subsequently, the Board has from
time to time approved extensions of the program to acquire additional shares. Since the inception of the repurchase program, the Board has approved 7.6 million shares to be repurchased. As of December 31, 2015, we have repurchased a cumulative total of 6.9 million shares at an average price of $11.99 per share under the repurchase program.
The share repurchases will be made from time to time at our discretion in the open market or privately negotiated transactions as permitted by securities laws and other legal requirements, and subject to market conditions and other factors. The Board may modify, suspend, extend or terminate the program at any time. During the twelve months ended December 31, 2015, we repurchased 0.3 million shares for approximately $8.3 million at an average price of $26.36 per share.
Debt
Revolving Credit Facility
We have a $250.0 million senior credit facility (the "Facility") provided by a syndicate of banks, which is available for borrowings and letters of credit. The Facility expires in October 2019 and is secured by a first lien on substantially all of our personal property except for assets related to projects subject to surety bonds and assets held by certain unrestricted subsidiaries and a second lien on our assets related to projects subject to surety bonds. In 2014, we incurred approximately $0.6 million in financing and professional costs in connection with an amendment to the Facility, which combined with the previous unamortized costs of $1.3 million, are being amortized on a straight-line basis as a non-cash charge to interest expense over the remaining term of the Facility. As of December 31, 2015, we had $10.0 million of outstanding borrowings, $41.5 million in letters of credit outstanding and $198.5 million of credit available.
There are two interest rate options for borrowings under the Facility, the Base Rate Loan option and the Eurodollar Rate Loan option. These rates are floating rates determined by the broad financial markets, meaning they can and do move up and down from time to time. Additional margins are then added to these two rates. The weighted average interest rate applicable to the borrowings under the Facility was approximately 1.7% as of December 31, 2015.
Certain of our vendors require letters of credit to ensure reimbursement for amounts they are disbursing on our behalf, such as to beneficiaries under our self-funded insurance programs. We have also occasionally used letters of credit to guarantee performance under our contracts and to ensure payment to our subcontractors and vendors under those contracts. Our lenders issue such letters of credit through the Facility for a fee. We have never had a claim made against a letter of credit that resulted in payments by a lender or by us and believe such claims are unlikely in the foreseeable future. The letter of credit fees range from 1.25% to 2.00% per annum, based on the ratio of Consolidated Total Indebtedness to Credit Facility Adjusted EBITDA, as defined in the credit agreement.
Commitment fees are payable on the portion of the revolving loan capacity not in use for borrowings or letters of credit at any given time. These fees range from 0.20%-0.35% per annum, based on the ratio of Consolidated Total Indebtedness to Credit Facility Adjusted EBITDA, as defined in the credit agreement.
Interest expense included the following primary elements (in thousands):
| Year Ended December 31, | ||||||||||
| 2015 | 2014 | 2013 | ||||||||
| Interest expense on notes to former owners | $ | 25 | $ | 38 | $ | 97 | ||||
| Interest expense on borrowings and unused commitment fees | 692 | 790 | 278 | |||||||
| Letter of credit fees | 719 | 747 | 731 | |||||||
| Amortization of debt financing costs | 317 | 283 | 245 | |||||||
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| Total | $ | 1,753 | $ | 1,858 | $ | 1,351 | ||||
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The Facility contains financial covenants defining various measures and the levels of these measures with which we must comply. Covenant compliance is assessed as of each quarter end. Credit Facility Adjusted EBITDA is defined under the Facility for financial covenant purposes as net earnings for the four quarters ending as of any given quarterly covenant compliance measurement date, plus the corresponding amounts for (a) interest expense; (b) income taxes; (c) depreciation and amortization; (d) other non-cash charges; and (e) pre-acquisition results of acquired companies. The following is a reconciliation of Credit Facility Adjusted EBITDA to net income for 2015 (in thousands):
| Net income including noncontrolling interests | $ | 57,440 | ||
| Income taxes—continuing operations | 31,224 | |||
| Interest expense, net | 1,681 | |||
| Depreciation and amortization expense | 23,416 | |||
| Stock compensation expense | 5,609 | |||
| Goodwill impairment | — | |||
| EBITDA attributable to noncontrolling interests | (9,027 | ) | ||
| Pre-acquisition results of acquired companies, as defined under the Facility | 373 | |||
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| Credit Facility Adjusted EBITDA | $ | 110,716 | ||
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The Facility's principal financial covenants include:
Leverage Ratio— The Facility requires that the ratio of our Consolidated Total Indebtedness to our Credit Facility Adjusted EBITDA not exceed 2.75 through maturity. The leverage ratio as of December 31, 2015 was 0.10.
Fixed Charge Coverage Ratio— The Facility requires that the ratio of Credit Facility Adjusted EBITDA, less non-financed capital expenditures, tax provision, dividends and amounts used to repurchase stock to the sum of interest expense and scheduled principal payments of indebtedness be at least 2.00; provided that the calculation of the fixed charge coverage ratio excludes stock repurchases and the payment of dividends at any time that the Company's Net Leverage Ratio does not exceed 1.50. The Facility also allows the fixed charge coverage ratio not to be reduced for stock repurchases through September 30, 2015 in an aggregate amount not to exceed $25 million if at the time of and after giving effect to such repurchase the Company's Net Leverage Ratio was less than or equal to 1.50. Capital expenditures, tax provision, dividends and stock repurchase payments are defined under the Facility for purposes of this covenant to be amounts for the four quarters ending as of any given quarterly covenant compliance measurement date. The fixed charge coverage ratio as of December 31, 2015 was 27.45.
Other Restrictions— The Facility permits acquisitions of up to $25.0 million per transaction, provided that the aggregate purchase price of such an acquisition and of acquisitions in the same
fiscal year does not exceed $60.0 million. However, these limitations only apply when the Company's Net Leverage Ratio is equal to or greater than 2.00.
While the Facility's financial covenants do not specifically govern capacity under the Facility, if our debt level under the Facility at a quarter-end covenant compliance measurement date were to cause us to violate the Facility's leverage ratio covenant, our borrowing capacity under the Facility and the favorable terms that we currently have could be negatively impacted by the lenders.
We were in compliance with all of our financial covenants as of December 31, 2015.
Notes to Former Owners
In conjunction with an immaterial acquisition in the fourth quarter of 2014, we issued a subordinated note to the former owners of the acquired company as part of the consideration used to acquire the company. This note had an outstanding balance of $1.0 million as of December 31, 2015 and bears interest, payable quarterly, at a weighted average interest rate of 2.5%. The principal is due in equal installments on October 2016 and 2017.
Other Debt
In conjunction with one of our acquisitions, we acquired capital lease obligations. As of December 31, 2015, $0.5 million of capital lease obligations were outstanding, of which $0.3 million was considered current.
Our majority owned subsidiary, Environmental Air Systems, LLC, has a revolving $2.5 million credit line that is available for temporary working capital needs and expires May 31, 2016. As of December 31, 2015, we had no outstanding borrowings and, therefore, $2.5 million of credit available. We estimate that the weighted average interest rate applicable to borrowings under this variable rate credit line would be approximately 2.2% as of December 31, 2015.
Outlook
We have generated positive net free cash flow for the last seventeen calendar years, much of which occurred during challenging economic and industry conditions. We also continue to have significant borrowing capacity under our credit facility, and we maintain what we feel are reasonable cash balances. We believe these factors will provide us with sufficient liquidity to fund our operations for the foreseeable future.
Off-Balance Sheet Arrangements and Other Commitments
As is common in our industry, we have entered into certain off-balance sheet arrangements in the ordinary course of business that result in risks not directly reflected in our balance sheets. Our most significant off-balance sheet transactions include liabilities associated with noncancelable operating leases. We also have other off-balance sheet obligations involving letters of credit and surety guarantees.
We enter into noncancelable operating leases for many of our facility, vehicle and equipment needs. These leases allow us to conserve cash by paying a monthly lease rental fee for use of facilities, vehicles and equipment rather than purchasing them. At the end of the lease, we have no further obligation to the lessor. If we decide to cancel or terminate a lease before the end of its term, we would typically owe the lessor the remaining lease payments under the term of the lease.
Certain of our vendors require letters of credit to ensure reimbursement for amounts they are disbursing on our behalf, such as to beneficiaries under our self-funded insurance programs. We have also occasionally used letters of credit to guarantee performance under our contracts and to ensure
payment to our subcontractors and vendors under those contracts. The letters of credit we provide are actually issued by our lenders through the Facility as described above. A letter of credit commits the lenders to pay specified amounts to the holder of the letter of credit if the holder demonstrates that we have failed to perform specified actions. If this were to occur, we would be required to reimburse the lenders. Depending on the circumstances of such a reimbursement, we may also have to record a charge to earnings for the reimbursement. Absent a claim, there is no payment or reserving of funds by us in connection with a letter of credit. However, because a claim on a letter of credit would require immediate reimbursement by us to our lenders, letters of credit are treated as a use of the Facility's capacity just the same as actual borrowings. Claims against letters of credit are rare in our industry. To date we have not had a claim made against a letter of credit that resulted in payments by a lender or by us. We believe that it is unlikely that we will have to fund claims under a letter of credit in the foreseeable future.
Many customers, particularly in connection with new construction, require us to post performance and payment bonds issued by a financial institution known as a surety. If we fail to perform under the terms of a contract or to pay subcontractors and vendors who provided goods or services under a contract, the customer may demand that the surety make payments or provide services under the bond. We must reimburse the sureties for any expenses or outlays they incur. To date, we are not aware of any losses to our sureties in connection with bonds the sureties have posted on our behalf, and we do not expect such losses to be incurred in the foreseeable future.
Under standard terms in the surety market, sureties issue bonds on a project-by-project basis and can decline to issue bonds at any time. Historically, approximately 20% to 30% of our business has required bonds. While we currently have strong surety relationships to support our bonding needs, future market conditions or changes in our sureties' assessment of our operating and financial risk could cause our sureties to decline to issue bonds for our work. If that were to occur, our alternatives include doing more business that does not require bonds, posting other forms of collateral for project performance such as letters of credit or cash, and seeking bonding capacity from other sureties. We would likely also encounter concerns from customers, suppliers and other market participants as to our creditworthiness. While we believe our general operating and financial characteristics would enable us to ultimately respond effectively to an interruption in the availability of bonding capacity, such an interruption would likely cause our revenue and profits to decline in the near term.
Contractual Obligations
The following recaps the future maturities of our contractual obligations as of December 31, 2015 (in thousands):
| Twelve Months Ended December 31, | ||||||||||||||||||||||
| 2016 | 2017 | 2018 | 2019 | 2020 | Thereafter | Total | ||||||||||||||||
| Revolving credit facility | $ | — | $ | — | $ | — | $ | 10,000 | $ | — | $ | — | $ | 10,000 | ||||||||
| Notes to former owners | 500 | 500 | — | — | — | — | 1,000 | |||||||||||||||
| Interest payable | 195 | 182 | 170 | 142 | — | — | 689 | |||||||||||||||
| Capital lease obligations | 251 | 163 | 71 | 22 | — | — | 507 | |||||||||||||||
| Operating lease obligations | 11,819 | 10,647 | 9,066 | 7,004 | 4,949 | 6,068 | 49,553 | |||||||||||||||
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| Total | $ | 12,765 | $ | 11,492 | $ | 9,307 | $ | 17,168 | $ | 4,949 | $ | 6,068 | $ | 61,749 | ||||||||
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As discussed in Note 10 "Income Taxes", included in our Consolidated Balance Sheet at December 31, 2015 is approximately $0.2 million of liabilities associated with uncertain tax positions. Due to the uncertain and complex application of tax regulations, combined with the difficulty in predicting when tax audits may be concluded, we cannot make reliable estimates of the timing of cash outflows relating to these liabilities.
As of December 31, 2015, we also have $41.5 million in letter of credit commitments, of which $17.3 million will expire in 2016 and $24.2 million will expire in 2017. The substantial majority of these letters of credit are posted with insurers who disburse funds on our behalf in connection with our workers' compensation, auto liability and general liability insurance program. These letters of credit provide additional security to the insurers that sufficient financial resources will be available to fund claims on our behalf, many of which develop over long periods of time, should we ever encounter financial duress. Posting of letters of credit for this purpose is a common practice for entities that manage their self-insurance programs through third-party insurers as we do. While many of these letter of credit commitments expire in 2016, we expect nearly all of them, particularly those supporting our insurance programs, will be renewed annually.
Other than the operating and capital lease obligations noted above, we have no significant purchase or operating commitments outside of commitments to deliver equipment and provide labor in the ordinary course of performing project work.
Previous: Item 6. Selected Financial Data · Next: Item 7A. Quantitative and Qualitative Disclosures about Market Risk