Item 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

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 81% 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 to support our operations but which are not specific to the project. Typically, customers will seek pricing from competitors for a given project. While the criteria on which customers select a service provider vary widely and include factors such as quality, technical expertise, on‑time performance, post‑project support and service, and company history and financial strength, we believe that price for value is the most influential factor for most customers in choosing a mechanical 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. 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, and such projects are sometimes subject to a guaranteed maximum cost. These margins are frequently less than fixed‑price contract margins because there is less risk of unrecoverable cost overruns in cost‑plus or time and materials work.

As of December 31, 2017, we had 4,690 projects in process. Our average project takes six to nine months to complete, with an average contract price of approximately $504,000. 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. Taken together, projects with contract prices of $1 million or more totaled $1.83 billion of aggregate contract value as of December 31, 2017, or approximately 80%, out of a total contract value for all projects in progress of $2.36 billion. Generally, projects closer in size to $1 million will be completed in one year or less. It is unusual for us to work on a project that exceeds two years in length.

A stratification of projects in progress as of December 31, 2017, by contract price, is as follows:


		Aggregate
		Contract
	No. of	Price Value
Contract Price of Project	Projects	(millions)
Under $1 million	4,221	$	529.8
$1 million - $5 million	368		828.6
$5 million - $10 million	70		464.7
$10 million - $15 million	18		221.3
Greater than $15 million	13		319.6
Total	4,690	$	2,364.0

In addition to project work, approximately 19% 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 based on the equipment and materials used in the service as well as technician labor time. We usually bill the customer for service work when it is complete, typically with payment terms of up to thirty days. We also provide maintenance and repair service under ongoing contracts. Under these contracts, we are paid regular monthly or quarterly amounts and provide specified service based on customer requirements. These agreements typically are for one or more years and frequently contain thirty‑ to sixty‑day cancellation notice periods.

A relatively small portion of our revenue comes from national and regional account customers. These customers typically have multiple sites, and contract with us to perform maintenance and repair service. These contracts may also provide for us to perform new or replacement systems installation. We operate a national call center to dispatch technicians to sites requiring service. We perform the majority of this work with our own employees, with the balance being subcontracted to third parties that meet our performance qualifications.

Profile and Management of Our Operations

We manage our 36 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 steeply 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. During the three-year period from 2015 to 2017, there was an increase in overall activity levels and we currently expect that activity will continue at these improved levels during 2018.

As a result of our continued strong emphasis on cash flow, at December 31, 2017 we had modest indebtedness under our revolving credit facility, with positive 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 February 2021. 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 nineteen 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 improved market conditions. We will continue to invest in our service business, to pursue the more active sectors in our markets, and to emphasize our regional and national account business. Our primary emphasis for 2018 will be on execution and cost control, but we are seeking growth based on our belief that industry conditions will continue to be strong in the near term, and we believe that activity levels will permit us to continue to earn solid profits while preserving and developing our workforce. We continue to focus on project qualification, estimating, pricing and management; and we are investing in 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 81% of our revenue was earned on a project basis and recognized through the percentage of completion method of accounting during 2017. 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, 2017.

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 are estimated and accrued based upon known facts, historical trends and industry averages. Estimated losses in excess of our deductible, which have not already been paid, are included in our accrual with a corresponding receivable from our insurance carrier. 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 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 a market approach 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 approach utilized market multiples of invested capital from comparable publicly traded companies (“public company approach”). The market multiples from invested capital include revenue, book equity plus debt and earnings before interest, provision for income 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,
	2017				2016				2015
Revenue	$	1,787,922	100.0	%	$	1,634,340	100.0	%	$	1,580,519	100.0	%
Cost of services		1,421,641	79.5	%		1,290,331	79.0	%		1,262,390	79.9	%
Gross profit		366,281	20.5	%		344,009	21.0	%		318,129	20.1	%
Selling, general and administrative expenses		266,586	14.9	%		243,201	14.9	%		228,965	14.5	%
Goodwill impairment		1,105	0.1	%		—	—			—	—
Gain on sale of assets		(670)	—			(761)	—			(880)	(0.1)	%
Operating income		99,260	5.6	%		101,569	6.2	%		90,044	5.7	%
Interest income		70	—			9	—			72	—
Interest expense		(3,156)	(0.2)	%		(2,345)	(0.1)	%		(1,753)	(0.1)	%
Changes in the fair value of contingent earn-out obligations		3,715	0.2	%		731	—			225	—
Other income (expense)		1,049	0.1	%		1,097	0.1	%		76	—
Income before income taxes		100,938	5.6	%		101,061	6.2	%		88,664	5.6	%
Provision for income taxes		45,666				36,165				31,224
Net income including noncontrolling interests		55,272	3.1	%		64,896	4.0	%		57,440	3.6	%
Less: Net income attributable to noncontrolling interests		—				—				8,076
Net income attributable to Comfort Systems USA, Inc.	$	55,272			$	64,896			$	49,364

2017 Compared to 2016

We had 35 operating locations as of December 31, 2016. During 2017, we completed one acquisition in the second quarter of 2017, known as “BCH”, that reports as a separate operating location in the Tampa, Florida area. Other than the addition of BCH, we did not make any changes to operating locations. As of December 31, 2017, we had 36 operating locations. Acquisitions are included in our results of operations from the respective acquisition date. The

same‑store comparison from 2017 to 2016, as described below, excludes nine months of results for BCH, which was acquired in April 2017 as well as the first month of 2017 for Shoffner, which was acquired in February 2016. An operating location is included in the same‑store comparison on the first day it has comparable prior year operating data.

Revenue—Revenue increased $153.6 million, or 9.4% to $1.79 billion in 2017 compared to 2016. The increase included a 6.4% increase related to the acquisitions of BCH and Shoffner and a 3.0% increase in revenue related to same‑store activity. The same‑store revenue increase was primarily due to one of our Virginia operations ($24.1 million) and our Wisconsin operation ($22.9 million), which experienced increased large project work compared to the prior year, specifically in the industrial sector.

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, 2017 was $948.4 million, a 5.2% increase from September 30, 2017 backlog of $901.2 million and a 24.2% increase from December 31, 2016 backlog of $763.4 million. Sequential backlog increased primarily due to increased project bookings at our North Carolina operation ($43.0 million). The year‑over‑year backlog increase included the acquisition of BCH ($30.0 million or 3.9%). Same-store backlog increased 20.3% primarily due to increased project bookings at our North Carolina operation ($63.3 million), one of our Virginia operations ($39.0 million) and our Colorado operation ($37.3 million).

Gross Profit—Gross profit increased $22.3 million, or 6.5%, to $366.3 million in 2017 as compared to 2016. The increase included a $18.3 million, or 5.3%, increase related to the acquisitions of BCH and Shoffner and a $4.0 million, or 1.2%, increase on a same‑store basis. The same‑store increase in gross profit was primarily due to increased volumes at our Wisconsin operation ($6.9 million) and our New Hampshire operation ($3.7 million). This was partially offset by a decrease at our North Carolina operation ($6.4 million), which has experienced lower project activity when compared to the same period in 2016. As a percentage of revenue, gross profit decreased from 21.0% in 2016 to 20.5% in 2017 primarily due to a $3.6 million increase in amortization expense, primarily related to the BCH acquisition, as well as the factors discussed above.

Selling, General and Administrative Expenses (“SG&A”)—SG&A increased $23.4 million, or 9.6%, to $266.6 million for 2017 as compared to 2016. On a same‑store basis, excluding amortization expense, SG&A increased $7.3 million, or 3.1%. This increase is primarily due to $0.8 million in compensation costs related to leadership changes and the increase in same-store revenue. Additionally, we incurred $0.4 million in expenses in the first quarter of 2017 related to the acquisition of BCH completed on April 1, 2017. Amortization expense increased $5.6 million during the period primarily as a result of the BCH acquisition. As a percentage of revenue, SG&A was 14.9% in both 2017 and 2016.

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,
	2017		2016
	(in thousands)
SG&A	$	266,586	$	243,201
Less: SG&A from companies acquired		(10,493)		—
Less: Amortization expense		(11,759)		(6,165)
Same-store SG&A, excluding amortization expense	$	244,334	$	237,036

Interest Expense—Interest expense increased $0.8 million, or 34.6%, in 2017. The increase reflects the increased borrowings on the revolving credit facility as well as notes to former owners used to fund the BCH acquisition during the second quarter of 2017.

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 $3.0 million in 2017 compared to 2016. This increase was the result of reducing our obligation related to the BCH acquisition primarily due to results being below the initial estimate as a result of the impact of Hurricane Irma and less project activity than previously estimated. In 2016, based on updated measurements of estimated future cash flows for our contingent obligations, we reduced our obligation related to the EAS acquisition resulting in a gain of $0.8 million.

Other Income—Other income remained relatively flat in 2017 compared to 2016. In the fourth quarter of 2017, we entered into settlement agreements with British Petroleum (“BP”) related to two claims from one of our subsidiaries regarding the April 2010 BP Deepwater Horizon oil spill. We recorded a $1.0 million gain in the fourth quarter of 2017 in “Other Income” as a result of these settlements. Additionally, in the fourth quarter of 2016, we entered into a separate settlement agreement with BP related to a claim from another one of our subsidiaries and recorded a $0.6 million gain in the fourth quarter of 2016 in “Other Income”. While we still have other subsidiaries with outstanding claims against BP related to this matter, we cannot predict when or if we will receive any further settlement compensation as a result of these outstanding claims.

Provision for Income Taxes—We conduct business throughout the United States in virtually all fifty states. Our effective tax rate changes based upon our 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 our effective tax rate. These items can also include the tax treatment for impairment of goodwill and other intangible assets, changes in fair value of acquisition-related assets and liabilities, tax reserves for uncertain tax positions, accounting for losses associated with underperforming operations and noncontrolling interests.

Our effective tax rate for 2017 was 45.2%, as compared to 35.8% in 2016. The effective rate for 2017 was higher than the 35% federal statutory rate primarily due to the remeasurement of net deferred tax assets for the corporate tax rate reduction to 21% (9.4%), net state income taxes (2.8%) partially offset by the domestic production activities deduction (2.1%) and deductions for stock-based compensation (1.3%). The effective rate for 2016 was higher than the 35% federal statutory rate primarily due to net state income taxes (4.2%) partially offset by the domestic production activities deduction (2.0%) and a decrease in valuation allowances (1.2%). Refer to Note 9 in the Consolidated Financial Statements for a reconciliation of the federal statutory rate to the effective tax rate reflected in our financial statements.

The increase in the effective tax rate from 2016 to 2017 was primarily due to the impact from the remeasurement of net deferred tax assets for the corporate tax rate reduction to 21% pursuant to the recently enacted Tax Cuts and Jobs Act. While we believe we were able to make reasonable estimates of the impact of the Tax Cuts and Jobs Act in these financial statements, the amounts recorded are provisional and the final impact may differ from these estimates due to, among other things, changes in our interpretations and assumptions and additional guidance that may be issued by regulatory authorities.

We currently estimate our effective tax rate for 2018 will be between 22% and 27%. This includes the impact of a decrease in unrecognized tax benefits of up to $8.7 million that is expected within the next twelve months due to the

filing of a federal income tax automatic accounting method change application. Approximately $3.0 million of the decrease is expected to impact our effective tax rate. Starting in 2019, we currently estimate our effective tax rate will be between 25% and 30%. We expect our future tax rates to be lower than 2017 primarily due to the corporate tax rate reduction to 21% effective January 1, 2018. These estimates also reflect the repeal of the domestic production activities deduction and other items of the Tax Cuts and Jobs Act that partially offset the benefit from the reduction in the corporate tax rate.

2016 Compared to 2015

We had 35 operating locations as of December 31, 2015. During 2016, we completed one acquisition in the first quarter of 2016, known as “Shoffner”, that reports as a separate operating location in the Knoxville, Tennessee area. In addition, we merged four operating locations into two operating locations during the first quarter, and created two operating locations out of one existing operating location. As of December 31, 2016, we had 35 operating locations. Acquisitions are included in our results of operations from the respective acquisition date. The same‑store comparison from 2016 to 2015, as described below, excludes eleven months of results for Shoffner, which was acquired in February 2016. 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 $53.8 million, or 3.4% to $1,634.3 million in 2016 compared to 2015. The increase included a 4.6% increase related to the acquisition of Shoffner, which was partially offset by a 1.1% decrease in revenue related to same‑store activity. The same‑store revenue decrease was primarily due to our Environmental Air Systems, LLC (“EAS”) operation ($48.0 million), which experienced decreased large project work compared to the prior year, specifically in the manufacturing sector. This decrease was partially offset by increased activity at our Michigan operation ($16.8 million) and our Northern Texas operation ($13.1 million).

Backlog as of December 31, 2016 was $763.4 million, a 6.1% increase from September 30, 2016 backlog of $719.3 million and a 7.3% increase from December 31, 2015 backlog of $711.6 million. Sequential backlog increased primarily due to increased project bookings at our Colorado operation ($15.9 million), our New Hampshire operation ($13.3 million) and one of our Florida operations ($12.9 million). The year‑over‑year backlog increase was primarily due to the acquisition of Shoffner ($35.3 million or 5.0%). Same-store backlog increased 2.3% primarily due to increased project bookings at our New Hampshire operation ($28.1 million). This was partially offset by the completion of project work at our EAS operation ($21.0 million).

Gross Profit—Gross profit increased $25.9 million, or 8.1%, to $344.0 million in 2016 as compared to 2015. The increase included a $13.3 million, or 4.2%, increase related to the acquisition of Shoffner and a $12.6 million, or 3.9%, increase on a same‑store basis. The same‑store increase in gross profit was primarily due to broad based improvement in project execution, including our California operation ($4.0 million) and one of our New York operations ($3.5 million). Additionally, gross profit was higher due to increased volumes at our Michigan operation ($3.9 million) and one of our Alabama operations ($3.3 million). This was partially offset by a decrease at our EAS operation ($8.6 million), which has experienced a decrease in large project work when compared to the same period in 2015. As a percentage of revenue, gross profit increased from 20.1% in 2015 to 21.0% in 2016 primarily due to the factors discussed above.

Selling, General and Administrative Expenses (“SG&A”)—SG&A increased $14.2 million, or 6.2%, to $243.2 million for 2016 as compared to 2015. On a same‑store basis, excluding amortization expense, SG&A increased $4.2 million, or 1.9%. This increase was primarily due to increased compensation costs ($4.8 million), which are primarily related to an increase in operating results and expanded service activities at multiple locations. This was offset by a decrease in bad debt expense ($1.6 million) primarily due to collections of aged receivables. Amortization expense

decreased $0.7 million during 2016 compared to the prior year. As a percentage of revenue, SG&A increased from 14.5% in 2015 to 14.9% in 2016, 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,
	2016		2015
	(in thousands)
SG&A	$	243,201	$	228,965
Less: SG&A from companies acquired		(10,817)		—
Less: Amortization expense		(6,165)		(6,897)
Same-store SG&A, excluding amortization expense	$	226,219	$	222,068

Interest Expense—Interest expense increased $0.6 million, or 33.8%, in 2016. The increase is due to higher average net borrowings on the revolving credit facility in 2016 compared to 2015.

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 2016 compared to 2015. Based on updated measurements of estimated future cash flows for our contingent obligations, we reduced our obligation related to the EAS acquisition resulting in a gain of $0.8 million. This was partially offset by increases in the fair value of contingent earn-out obligations related to various acquisitions during 2016.

Other Income—Other income increased $1.0 million in 2016 compared to 2015. In the fourth quarter of 2016, we entered into a settlement agreement with British Petroleum (“BP”) related to a claim from one of our subsidiaries regarding the April 2010 BP Deepwater Horizon oil spill. We recorded a $0.6 million gain in the fourth quarter of 2016 in “Other Income” as a result of this settlement.

Our effective tax rate for 2016 was 35.8%, as compared to 35.2% in 2015. The effective rate for 2016 was higher than the 35% federal statutory rate primarily due to net state income taxes (4.2%) partially offset by the domestic production activities deduction (2.0%) and a decrease in valuation allowances (1.2%). The effective rate for 2015 was slightly higher than the 35% federal statutory rate primarily due to an increase in net state income taxes (3.9%) which was partially offset by a decrease from the impact of the noncontrolling interest of EAS which for federal tax purposes is treated as a partnership (3.2%). Refer to Note 9 in the Consolidated Financial Statements for a reconciliation of the federal statutory rate to the effective tax rate reflected in our financial statements. The increase in the effective tax rate from 2015 to 2016 was primarily due to the impact of our noncontrolling interests, which was partially offset by the impact on the rate from the benefits from deductions on stock-based compensation, valuation allowances and net state income taxes.

Net Income Attributable to Noncontrolling Interests— There was no net income attributable to noncontrolling interests for 2016 due to our January 1, 2016 purchase of the remaining 40% noncontrolling interest in Environmental Air Systems, LLC.

Outlook

Industry conditions improved during the three-year period from 2015 to 2017 and we currently expect that activity will continue at these improved levels during 2018. Our emphasis for 2018 will be 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, we currently expect improvement in our revenue and net earnings in 2018.

Liquidity and Capital Resources



	Year Ended December 31,
	2017		2016		2015
	(in thousands)
Cash provided by (used in):
Operating activities	$	114,090	$	91,188	$	97,867
Investing activities		(128,968)		(79,318)		(25,628)
Financing activities		19,346		(36,260)		(47,839)
Net increase (decrease) in cash and cash equivalents	$	4,468	$	(24,390)	$	24,400
Free cash flow:
Cash provided by operating activities	$	114,090	$	91,188	$	97,867
Purchases of property and equipment		(35,467)		(23,217)		(20,808)
Proceeds from sales of property and equipment		1,359		1,062		1,338
Free cash flow	$	79,982	$	69,033	$	78,397

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.

2017 Compared to 2016

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 $114.1 million of cash flow from operating activities during 2017 compared with $91.2 million during 2016. The $22.9 million increase is primarily due to the $22.3 million increase in gross profit, increases in billings in excess of costs of $21.6 million, primarily due to the timing of billings and various project work, and increases in accounts payable and accrued liabilities of $19.3 million due to increased activity and revenue as well as increased compensation accruals. These increases to operating cash flow were partially offset by the change in receivables of $44.8 million primarily related to the timing of customer billings and payments.

Cash Used in Investing Activities—Cash used in investing activities was $129.0 million for 2017 compared to $79.3 million during 2016. The $49.7 million increase in cash used primarily relates to cash paid (net of cash acquired)

for the BCH acquisition in 2017 of $86.1 million compared to the EAS and Shoffner acquisitions in 2016 ($56.3 million).

Cash Provided by (Used in) Financing Activities—Cash provided by financing activities was $19.3 million for 2017 compared to cash used in financing activities of $36.3 million during 2016. The $55.6 million increase in cash provided by financing activities primarily relates to $55.0 million of additional net proceeds from the revolving line of credit in 2017 compared to the prior year.

2016 Compared to 2015

Cash Provided by Operating Activities—We generated $91.2 million of cash flow from operating activities during 2016 compared with $97.9 million during 2015. The $6.7 million decrease is primarily due to decreases in billings in excess of costs of $16.3 million, primarily due to the timing of billings and various project work, and increases in prepaid expenses and other current assets of $9.2 million, primarily due to increases of insurance receivables. These uses of operating cash flow were partially offset by the change in receivables of $10.6 million primarily related to the timing of customer billings and payments and overall higher net income in 2016 compared to 2015.

Cash Used in Investing Activities—Cash used in investing activities was $79.3 million for 2016 compared to $25.6 million during 2015. The $53.7 million increase in cash used primarily relates to cash paid for the EAS and Shoffner acquisitions that were completed in 2016.

Cash Used in Financing Activities—Cash used in financing activities was $36.3 million for 2016 compared to $47.8 million during 2015. The $11.6 million decrease in cash used in financing activities primarily relates to $18.5 million less in net payments on the revolving line of credit in 2016. Additionally, we repurchased $4.8 million of incremental shares in 2016 and did not have distributions to noncontrolling interests after we acquired the remaining 40% noncontrolling interest in EAS.

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 increased the number of shares that may be acquired under the program and approved extensions of the program. Since the inception of the repurchase program, the Board has approved 8.1 million shares to be repurchased. As of December 31, 2017, we have repurchased a cumulative total of 7.6 million shares at an average price of $13.75 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, 2017, we repurchased 0.3 million shares for approximately $9.0 million at an average price of $34.23 per share.

Debt

Revolving Credit Facility

We have a $325.0 million senior credit facility (the “Facility”) provided by a syndicate of banks, with a $100 million accordion option. The Facility, which is available for borrowings and letters of credit, expires in February 2021 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. As of December 31, 2017, we had $45.0 million of outstanding borrowings, $39.6 million in letters of credit outstanding and $240.4 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 2.8% as of December 31, 2017.

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,
	2017		2016		2015
Interest expense on notes to former owners	$	365	$	70	$	25
Interest expense on borrowings and unused commitment fees		1,862		1,251		692
Letter of credit fees		553		657		719
Amortization of debt financing costs		376		367		317
Total	$	3,156	$	2,345	$	1,753

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) provision for income taxes; (c) depreciation and amortization; (d) stock compensation; (e) other non‑cash charges; and (f) pre‑acquisition results of acquired companies. The following is a reconciliation of Credit Facility Adjusted EBITDA to net income for 2017 (in thousands):


Net income including noncontrolling interests	$	55,272
Provision for income taxes		45,666
Interest expense, net		3,086
Depreciation and amortization expense		37,456
Stock-based compensation		6,377
Goodwill impairment		1,105
Pre-acquisition results of acquired companies, as defined under the Facility		4,597
Credit Facility Adjusted EBITDA	$	153,559

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 to 1.00 as of the end of each fiscal quarter. The leverage ratio as of December 31, 2017 was 0.4.

Fixed Charge Coverage Ratio— The Facility requires that the ratio of (a) Credit Facility Adjusted EBITDA, less non‑financed capital expenditures, provision for income taxes, dividends and amounts used to repurchase stock to (b) the sum of interest expense and scheduled principal payments of indebtedness be at least 2.00 to 1.00; 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 to 1.00. 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 and for stock repurchases made after February 22, 2016 but on or prior to December 31, 2017 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 to 1.00. Capital expenditures, provision for income taxes, 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, 2017 was 21.8.

Other Restrictions— The Facility permits acquisitions of up to $30.0 million per transaction, provided that the aggregate purchase price of all such acquisitions in the same fiscal year does not exceed $65.0 million. However, these limitations only apply when the Company’s Total Leverage Ratio is greater than 2.00 to 1.00.

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, 2017.

Notes to Former Owners

As part of the consideration used to acquire two companies, we have outstanding notes to the former owners. These notes had an outstanding balance of $15.3 million as of December 31, 2017. In conjunction with the BCH acquisition in the second quarter of 2017, we issued a promissory note to the former owners with an outstanding balance of $14.3 million as of December 31, 2017 that bears interest, payable quarterly, at a weighted average interest rate of 3.0%. The principal is due in equal installments in April 2020 and 2021. In conjunction with the Shoffner acquisition in the first quarter of 2016, we issued a subordinated note to former owners with an outstanding balance of $1.0 million as of December 31, 2017 that bears interest, payable quarterly, at a weighted average interest rate of 3.0%. The principal is due in equal installments in February 2018 and 2019.

Other Debt

As part of the Shoffner acquisition, we acquired debt with an outstanding balance at the acquisition date of $0.4 million with principal and interest due the last day of every month; ending on the December 30, 2019 maturity date. The interest rate is the one month LIBOR rate plus 2.25%. As of December 31, 2017, $0.2 million of the note was outstanding, of which $0.1 million was considered current.

Outlook

We have generated positive net free cash flow for the last nineteen 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, 2017 (in thousands):


	Twelve Months Ended December 31,
	2018		2019		2020		2021		2022		Thereafter		Total
Revolving credit facility	$	—	$	—	$	—	$	45,000	$	—	$	—	$	45,000
Notes to former owners		513		512		7,150		7,150		—		—		15,325
Other debt		100		114		—		—		—		—		214
Interest payable		1,716		1,697		1,533		264		—		—		5,210
Operating lease obligations		13,963		11,892		9,838		7,921		6,266		21,726		71,606
Total	$	16,292	$	14,215	$	18,521	$	60,335	$	6,266	$	21,726	$	137,355

As discussed in Note 9 “Income Taxes”, included in our Consolidated Balance Sheet at December 31, 2017 is approximately $8.9 million of unrecognized tax benefits. Due to the uncertain and complex application of tax

regulations, combined with the difficulty in predicting when tax audits may be concluded, we generally cannot make reliable estimates of the timing of cash outflows relating to these liabilities. We, however, expect to recognize a decrease in unrecognized tax benefits of up to $8.7 million within the next twelve months due to the filing of a federal income tax automatic accounting method change application. Approximately $3.0 million of the decrease is expected to impact our effective tax rate.

As of December 31, 2017, we also have $39.6 million in letter of credit commitments, of which $15.1 million will expire in 2018 and $24.5 million will expire in 2019. 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 2018, 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

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