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
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our historical consolidated financial statements and related notes included elsewhere in Item 8. Financial Statements and Supplementary Data. The discussion below contains forward-looking statements that are based upon our current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from these expectations due to inaccurate assumptions and known or unknown risks and uncertainties, including those identified in Uncertainty of Forward-Looking Statements and Information below and Item 1A. Risk Factors.
Introduction
We are a leading provider of specialty contracting services, delivering comprehensive infrastructure solutions for the electric power, energy and communications industries in the United States, Canada, Australia, Latin America and select other international markets. The services we provide include the design, installation, upgrade, repair and maintenance of infrastructure within each of the industries we serve, such as electric power transmission and distribution networks; substation facilities; pipeline transmission and distribution systems and facilities; refinery, petrochemical and industrial facilities; and telecommunications and cable multi-system operator networks.
Our customers include many of the leading companies in the industries we serve. We have developed strong strategic alliances with numerous customers and strive to develop and maintain our status as a preferred service provider to our customers. Our services are typically provided pursuant to master service agreements, repair and maintenance contracts and fixed price and non-fixed price installation contracts.
We report our results under two reportable segments: (1) Electric Power Infrastructure Services and (2) Pipeline and Industrial Infrastructure Services. This structure is generally focused on broad end-user markets for our services. As of December 31, 2018, we changed the name of our Oil and Gas Infrastructure Services segment to the Pipeline and Industrial Infrastructure Services segment. There was no change to the composition of the segment, and the name change was made to better reflect the work performed within the segment and the diversity of its service offerings. Our consolidated revenues for the year ended December 31, 2018 were $11.17 billion, of which 57% was attributable to the Electric Power Infrastructure Services segment and 43% was attributable to the Pipeline and Industrial Infrastructure Services segment.
The Electric Power Infrastructure Services segment provides comprehensive network solutions to customers in the electric power industry. Services performed by the Electric Power Infrastructure Services segment generally include the design, installation, upgrade, repair and maintenance of electric power transmission and distribution infrastructure and substation facilities along with other engineering and technical services. This segment also provides emergency restoration services, including the repair of infrastructure damaged by inclement weather, the energized installation, maintenance and upgrade of electric power infrastructure utilizing unique bare hand and hot stick methods and our proprietary robotic arm technologies, and the installation of “smart grid” technologies on electric power networks. In addition, this segment provides services that support the development of renewable energy generation, including solar, wind and certain types of natural gas generation facilities, and related switchyards and transmission infrastructure. This segment also provides comprehensive communications infrastructure services to wireline and wireless telecommunications companies, cable multi-system operators and other customers within the communications industry; services in connection with the construction of electric power generation facilities; and the design, installation, maintenance and repair of commercial and industrial wiring. This segment also includes our postsecondary educational institution, which specializes in pre-apprenticeship training, apprenticeship training and specialized utility task training for electric workers, and has been recently expanded to include curriculum for the gas distribution and communications industries.
The Pipeline and Industrial Infrastructure Services segment provides comprehensive infrastructure solutions to customers involved in the development, transportation, storage and processing of natural gas, oil and other products. Services performed by the Pipeline and Industrial Infrastructure Services segment generally include the design, installation, repair and maintenance of pipeline transmission and distribution systems, gathering systems, production systems, storage systems and compressor and pump stations, as well as related trenching, directional boring and mechanized welding services. In addition, this segment’s services include pipeline protection, integrity testing, rehabilitation and replacement, and the fabrication of pipeline support systems and related structures and facilities for natural gas utilities and midstream companies. We also provide high-pressure and critical-path turnaround services to the downstream and midstream energy markets and instrumentation and electrical services, piping, fabrication and storage tank services. To a lesser extent, this segment serves the offshore and inland water energy markets and designs, installs and maintains fueling systems and water and sewer infrastructure.
For internal management purposes, we are also organized into two internal divisions: the Electric Power Infrastructure Services Division and the Pipeline and Industrial Infrastructure Services Division. These internal divisions are closely aligned with the reportable segments and are based on the predominant type of work provided by the operating units within each division.
Reportable segment information, including revenues and operating income by type of work, is gathered from each operating unit for the purpose of evaluating segment performance in support of our market strategies. These classifications of our operating unit revenues by type of work for segment reporting purposes can at times require judgment on the part of management. Our operating units may perform joint projects for customers in multiple industries, deliver multiple types of services under a single customer contract or provide service offerings to various industries. For example, we perform joint trenching projects to install distribution lines for electric power and natural gas customers. Our integrated operations and common administrative support for our operating units requires that certain allocations be made to determine segment profitability, including allocations of shared and indirect costs, such as facility costs, indirect operating expenses (e.g., depreciation), and general and administrative costs. Certain corporate costs are not allocated, including payroll and benefits, employee travel expenses, facility costs, professional fees, acquisition costs, non-cash stock-based compensation and amortization related to intangible assets.
We operate primarily in the United States; however, we derived $2.60 billion, $2.48 billion and $1.59 billion of our revenues from foreign operations during the years ended December 31, 2018, 2017 and 2016, respectively. Of our foreign revenues, 76%, 79% and 75% were earned in Canada during the years ended December 31, 2018, 2017 and 2016, respectively. In addition, we held property and equipment of $304.0 million and $330.4 million in foreign countries, primarily Canada, as of December 31, 2018 and 2017. See Note 2 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data for a further disaggregation of revenues by geographic location.
Recent Acquisitions, Investments and Divestitures
Acquisitions
On January 24, 2019, we acquired an electric power specialty contracting business located in the United States. The purchase price for this acquisition was approximately $47.0 million, which included the repayment of certain indebtedness of the acquired business. The results of the acquired business will generally be included in our Electrical Power Infrastructure Services segment and consolidated financial statements beginning on the acquisition date.
During the year ended December 31, 2018, we acquired an electrical infrastructure services business specializing in substation construction and relay services, a postsecondary educational institution that provides pre-apprenticeship training and programs for experienced linemen and two communications infrastructure services businesses, all of which are located in the United States. The aggregate consideration for these acquisitions was $106.8 million paid or payable in cash, subject to certain adjustments, and 679,668 shares of Quanta common stock, which had a fair value of approximately $22.9 million as of the respective acquisition dates. Additionally, the acquisitions of the postsecondary educational institution and one of the communications infrastructure services businesses include the potential payment of up to $18.0 million of contingent consideration, payable if the acquired businesses achieve certain performance objectives over three-year and five-year post-acquisition periods. Based on the estimated fair value of this contingent consideration, we recorded $16.5 million of liabilities as of the respective acquisition dates. The results of the acquired businesses have generally been included in our Electric Power Infrastructure Services segment and have been included in our consolidated financial statements beginning on the respective acquisition dates.
On July 20, 2017, we acquired Stronghold, Ltd. and Stronghold Specialty, Ltd. (collectively Stronghold), a specialized services business located in the United States that provides high-pressure and critical-path solutions to the downstream and midstream energy markets. The aggregate consideration included $351.0 million in cash, subject to certain adjustments, and 2,693,680 shares of Quanta common stock, which had a fair value of $81.3 million as of the acquisition date. Additionally, the acquisition includes the potential payment of up to $100.0 million of contingent consideration, payable if the acquired business achieves certain performance objectives over a three-year post-acquisition period. Based on the estimated fair value of this contingent consideration, we recorded a $51.1 million liability as of the acquisition date. The results of the acquired business have generally been included in our Pipeline and Industrial Infrastructure Services segment and have been included in our consolidated financial statements since the acquisition date.
During the year ended December 31, 2017, we also acquired a communications infrastructure services business and an electrical and communications business, both of which are located in the United States. The aggregate consideration for these acquisitions consisted of $12.0 million paid or payable in cash, subject to certain adjustments, and 288,666 shares of Quanta common stock, which had a fair value of $8.3 million as of the acquisition date of the applicable acquired business. The results of the acquired businesses have generally been included in our Electric Power Infrastructure Services segment and have been included in our consolidated financial statements since the respective acquisition dates.
During 2016, we completed five acquisitions. The results of four of the acquired businesses have been generally included in our Electric Power Infrastructure Services segment and have been included in our consolidated financial statements since their respective acquisition dates. These businesses included an electrical infrastructure services business located in Australia, a utility contracting business located in Canada, a full service medium- and high-voltage powerline contracting business located in the United States and a communications services business located in Canada. We also acquired a pipeline services contractor located in the United States, the results of which have generally been included in our Pipeline and Industrial Infrastructure Services segment
since the acquisition date. The aggregate consideration for these acquisitions consisted of $75.9 million paid or payable in cash, subject to certain adjustments, 70,840 shares of Quanta common stock, which had a fair value of $1.5 million as of the settlement date of the applicable acquisition, and contingent consideration payments of up to $39.5 million, payable if certain of the acquired businesses achieve performance objectives over a four to five-year post-acquisition period. Based on the estimated fair value of this contingent consideration, we recorded a total of $18.7 million in liabilities as of the applicable acquisition dates.
Investments
During the year ended December 31, 2018, we acquired a 30% equity interest in a water and gas pipeline infrastructure contractor located in Australia for $22.2 million. This investment includes an option through 2020 to acquire the remaining equity of the company and provides for certain additional earnings and distribution participation rights during a designated 25-month post-investment period, as well as preferential liquidation rights. This investment has been recorded at cost and will be adjusted for impairment, if any, plus or minus observable changes in the value of the company’s equity. Earnings on this investment are recognized as dividends are received and are reported in “Other expense, net” in the accompanying consolidated statements of operations. We received and recognized $3.9 million of cash dividends from this investment during 2018. Additionally, during the year ended December 31, 2018, we acquired a 49% equity interest in an electric power infrastructure services company together with certain related customer relationship and other intangible assets for $12.3 million in total.
We also enter into strategic partnerships and investment arrangements with customers and infrastructure investors to provide fully integrated infrastructure services on certain projects, including planning and feasibility analysis, engineering, design, procurement, construction and project operation and maintenance. These projects include public-private partnerships and concessions, along with private infrastructure projects such as build, own, operate (and in some cases transfer) and build-to-suit arrangements. As part of this strategy, we formed a partnership with select investors that provides up to $1.0 billion of capital, including approximately $80.0 million from us, available to invest in certain of these infrastructure projects through August 2024. Wholly owned subsidiaries of Quanta serve as the general partner of this partnership and as a separately operated registered investment adviser that manages the invested capital. Through February 2019, we had contributed $15.1 million to this partnership in connection with certain investments and the payment of management fees.
Seasonality; Fluctuations of Results; Economic Conditions
Our revenues and results of operations can be subject to seasonal and other variations. These variations are influenced by weather, customer spending patterns, bidding seasons, receipt of required regulatory approvals, permits and rights of way, project timing and schedules, and holidays. Typically, our revenues are lowest in the first quarter of the year because cold, snowy or wet conditions can cause delays on projects. In addition, many of our customers develop their annual capital budgets during the first quarter, and therefore do not begin infrastructure projects in a meaningful way until their capital budgets are finalized. Second quarter revenues are typically higher than those in the first quarter, as some projects begin, but continued cold and wet weather can often impact second quarter productivity. Third quarter revenues are typically the highest of the year, as a greater number of projects are underway, and weather is normally more accommodating. Generally, revenues during the fourth quarter of the year are lower than the third quarter but higher than the second quarter. Many projects are completed in the fourth quarter, and revenues are often impacted positively by customers seeking to spend their capital budgets before the end of the year. However, the holiday season and inclement weather can sometimes cause delays during the fourth quarter, reducing revenues and increasing costs. Productivity and operating activity in any quarter may be positively or negatively affected by atypical weather patterns in the areas we serve, such as severe weather, excessive rainfall or unusual winter weather. The timing of project awards and unanticipated changes in project schedules as a result of delays or accelerations can also create variations in the level of operating activity from quarter to quarter.
These seasonal impacts are typical for our U.S. operations, but as our foreign operations grow, this pattern may have a lesser impact on our quarterly revenues. For example, revenues in Canada are typically higher in the first quarter because projects are often accelerated in order to complete work while the ground is frozen and prior to the break up, or seasonal thaw, as productivity is adversely affected by wet ground conditions during the warmer spring and summer months. Also, although revenues from Australia and other international operations have not been significant relative to our overall revenues to date, their seasonal patterns may differ from those in North America and may impact our seasonality more in the future.
Additionally, our industry can be highly cyclical. Our volume of business may be adversely affected by declines or delays in new projects due to cyclicality, which may vary by geographic region. Project schedules, particularly in connection with larger, longer-term projects, can also create fluctuations in the amount of work performed in a given period. For example, in connection with larger and more complicated projects, the timing of obtaining permits and other approvals may be delayed, and we may need to maintain a portion of our workforce and equipment in an underutilized capacity to ensure we are strategically positioned to deliver on such projects when they move forward. Examples of other items that may cause our results or demand for our services
to fluctuate materially from quarter to quarter include: the financial condition of our customers and their access to capital; margins of ongoing projects; economic and political conditions on a regional, national or global scale, including changes in U.S. trade relationships with other countries; our customers’ capital spending, including on larger pipeline and electrical infrastructure projects; oil, natural gas and natural gas liquids prices; liabilities and costs that are not covered by, or that are in excess of, third party insurance coverage; the timing of and costs associated with acquisitions; changes in the fair value of acquisition-related contingent consideration liabilities; dispositions; equity in earnings (losses) of unconsolidated affiliates; impairments of goodwill, intangible assets, long-lived assets or investments; effective tax rates; and interest rates. Accordingly, our operating results in any particular period may not be indicative of the results that can be expected for any other period. Please read Outlook and Understanding Margins for additional discussion of trends and challenges that may affect our financial condition, results of operations and cash flows.
Understanding Margins
Our gross margin is gross profit expressed as a percentage of revenues, and our operating margin is operating income expressed as a percentage of revenues. Cost of services, which is subtracted from revenues to obtain gross profit, consists primarily of salaries, wages and benefits to employees; depreciation; fuel and other equipment expenses; equipment rental expense; and costs related to subcontracted services, insurance, facilities, materials, parts and supplies. Selling, general and administrative expenses, amortization of intangible assets and change in fair value of contingent consideration liabilities are then subtracted from gross profit to obtain operating income. Various factors, only some of which are within our control, can impact our margins on a quarterly or annual basis.
Seasonal and geographical. Seasonal weather patterns can have a significant impact on margins. Generally, business is slower in the colder months versus the warmer months of the year, resulting in lower productivity and consequently reducing our ability to cover fixed costs. This can be offset somewhat by increased demand for electrical service and repair work resulting from infrastructure damaged by severe weather during the colder months, and increased demand in certain northern climates during the winter months due to the adverse operating conditions during the spring seasonal thaw. Additionally, project schedules, including when projects begin and are completed, may impact margins. The mix of business conducted in the areas we serve will also affect margins, as some areas offer the opportunity for higher margins due to their geographic characteristics. For example, margins may be negatively impacted by unexpected difficulties that can arise in challenging operating conditions such as urban settings or mountainous and other difficult terrain. Site conditions, including unforeseen underground conditions, can also impact margins.
Weather. Adverse or favorable weather conditions can impact gross margins in a given period. For example, snowfall, rainfall or other severe weather may negatively impact our revenues and margins due to reduced productivity, as projects may be terminated, deferred or delayed until weather conditions improve or an affected area recovers from a severe weather event. Conversely, in periods when weather remains dry and temperatures are accommodating, more work can be done, sometimes at a lower cost. In some cases, severe weather, such as hurricanes, ice storms and wildfires, can provide us with emergency restoration service work, which typically yields higher margins due in part to better equipment utilization rates and absorption of fixed costs.
Revenue mix. The mix of revenues derived from the industries we serve and the types of services we provide within an industry will impact margins, as certain industries and services provide higher margin opportunities. Additionally, changes in our customers’ spending patterns can cause an imbalance in supply and demand and, therefore, affect margins and the mix of revenues.
Service and maintenance versus installation. Installation work is often performed on a fixed price basis, while maintenance work is often performed under pre-established or negotiated prices or cost-plus pricing arrangements. Margins for installation work may vary from project to project, and may be higher than maintenance work, as work obtained on a fixed price basis has higher risk than other types of pricing arrangements. We typically derive approximately 30% of our annual revenues from maintenance work, but a higher portion of installation work in any given period may affect our gross margins for that period.
Subcontract work. Work that is subcontracted to other service providers generally yields lower margins. An increase in subcontract work in a given period may contribute to a decrease in margins. In recent years, we have subcontracted approximately 15% to 20% of our work to other service providers.
Materials versus labor. Typically our customers are responsible for supplying the materials for their projects; however, for some of our contracts we may agree to procure all or part of the required materials. Margins may be lower on projects where we furnish a significant amount of materials, including projects where we provide engineering, procurement and construction (EPC) services, as our markup on materials is generally lower than our markup on labor costs. Furthermore, fluctuations in the price of materials we are required to procure, including as a result of changes in U.S. trade relationships with other countries or other economic or political conditions, may impact our margins. In a given period, an increase in the percentage of work with higher materials procurement requirements may decrease our overall margins.
Size, scope and complexity of projects. We may experience a decrease or fluctuations in margins when larger, more complex electric transmission and pipeline projects experience significant delays or other difficulties impacting performance. Larger projects
with higher voltage capacities, larger diameter throughput capacities, increased engineering, design or construction complexities, more difficult terrain requirements or longer distance requirements typically yield opportunities for higher margins as we assume a greater degree of performance risk and there is greater utilization of our resources for longer construction timeframes. Conversely, smaller or less complex electric transmission and pipeline projects typically provide lower margin opportunities as there are a greater number of competitors capable of performing in this market, and competitors at times may more aggressively pursue available volumes of work to absorb fixed costs. A greater percentage of smaller scale or less complex electric transmission and pipeline work also could negatively impact margins due to the inefficiency of transitioning between a greater number of smaller projects versus continuous production on fewer larger projects. Our margins may be further impacted by delays in the timing of larger projects, extended bidding procedures for more complex EPC projects or temporary decreases in capital spending by our customers. Also, during these periods we may choose to maintain a portion of our workforce and equipment in an underutilized capacity to ensure we are strategically positioned to deliver on larger, more complicated electric transmission or pipeline projects when they move forward.
Depreciation. We include depreciation in cost of services, which is common practice in our industry. However, this can make comparability of our margins to those of other companies difficult and must be taken into consideration when comparing us to other companies.
Insurance. As discussed in Contractual Obligations — Insurance, we are insured for employer’s liability, workers’ compensation, auto liability and general liability claims. We also have employee health care benefit plans for most employees not subject to collective bargaining agreements. Margins could be impacted by fluctuations in insurance accruals as additional claims arise and as circumstances and conditions of existing claims change.
Project Variability and Performance. Margins for a single project may fluctuate quarter to quarter due to changes in the volume or type of work performed, the pricing structure under the project contract or job productivity. Productivity can be influenced by many factors, including unexpected project difficulties or site conditions; project locations, including locations with challenging operating conditions; whether the work is on an open or encumbered right of way; inclement weather or severe weather events; environmental restrictions or regulatory delays; protests, other political activity or legal challenges related to a project; and the performance of third parties. These types of factors are not practicable to quantify through accounting data but may individually or in the aggregate have a direct impact on the gross margin of a specific project.
Foreign currency risk. Our financial performance is reported on a U.S. dollar-denominated basis but is partially subject to fluctuations in foreign currency exchange rates. Fluctuations in exchange rates relative to the U.S. dollar, primarily the Canadian and Australian dollars, could cause material fluctuations in comparisons of our results of operations between periods.
Change in fair value of contingent consideration liabilities. We anticipate fluctuations in operating income margins as a result of changes in the fair value of contingent consideration liabilities associated with prior acquisitions, which occur as we obtain additional information on the likelihood that the acquired businesses will achieve their post-acquisition performance objectives. See Note 2 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data for more information about the valuation methodologies and assumptions related to the determination of the fair value of these liabilities.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of compensation and related benefits, marketing and communication costs, office rent and utilities, professional fees, bad debt expense, acquisition costs, gains and losses on the sale of property and equipment, letter of credit fees and maintenance, training and conversion costs related to information technology systems.
Results of Operations
As previously discussed, the results of acquired businesses have been included in the following results of operations beginning on their respective acquisition dates. The following table sets forth selected statements of operations data and such data as a percentage of revenues for the years indicated (dollars in thousands):
Consolidated Results
| Year Ended December 31, | |||||||||||||||||||||
| 2018 | 2017 | 2016 | |||||||||||||||||||
| Revenues | $ | 11,171,423 | 100.0 | % | $ | 9,466,478 | 100.0 | % | $ | 7,651,319 | 100.0 | % | |||||||||
| Cost of services (including depreciation) | 9,691,459 | 86.8 | 8,224,618 | 86.9 | 6,637,519 | 86.7 | |||||||||||||||
| Gross profit | 1,479,964 | 13.2 | 1,241,860 | 13.1 | 1,013,800 | 13.3 | |||||||||||||||
| Selling, general and administrative expenses | 857,574 | 7.7 | 777,920 | 8.2 | 653,338 | 8.5 | |||||||||||||||
| Amortization of intangible assets | 43,994 | 0.4 | 32,205 | 0.4 | 31,685 | 0.5 | |||||||||||||||
| Asset impairment charges | 49,375 | 0.4 | 58,057 | 0.6 | 7,964 | 0.1 | |||||||||||||||
| Change in fair value of contingent consideration liabilities | (11,248 | ) | (0.1 | ) | (5,171 | ) | (0.1 | ) | — | — | |||||||||||
| Operating income | 540,269 | 4.8 | 378,849 | 4.0 | 320,813 | 4.2 | |||||||||||||||
| Interest expense | (36,945 | ) | (0.3 | ) | (20,946 | ) | (0.2 | ) | (14,887 | ) | (0.2 | ) | |||||||||
| Interest income | 1,555 | — | 832 | — | 2,423 | — | |||||||||||||||
| Other expense, net | (47,213 | ) | (0.4 | ) | (4,978 | ) | (0.1 | ) | (663 | ) | — | ||||||||||
| Income from continuing operations before income taxes | 457,666 | 4.1 | 353,757 | 3.7 | 307,686 | 4.0 | |||||||||||||||
| Provision for income taxes | 161,659 | 1.5 | 35,532 | 0.3 | 107,246 | 1.4 | |||||||||||||||
| Net income from continuing operations | 296,007 | 2.6 | 318,225 | 3.4 | 200,440 | 2.6 | |||||||||||||||
| Net loss from discontinued operations | — | — | — | — | (342 | ) | — | ||||||||||||||
| Net income | 296,007 | 2.6 | 318,225 | 3.4 | 200,098 | 2.6 | |||||||||||||||
| Less: Net income attributable to non-controlling interests | 2,661 | — | 3,247 | 0.1 | 1,715 | — | |||||||||||||||
| Net income attributable to common stock | $ | 293,346 | 2.6 | % | $ | 314,978 | 3.3 | % | $ | 198,383 | 2.6 | % | |||||||||
| Amounts attributable to common stock: | |||||||||||||||||||||
| Net income from continuing operations | $ | 293,346 | 2.6 | % | $ | 314,978 | 3.3 | % | $ | 198,725 | 2.6 | % | |||||||||
| Net loss from discontinued operations | — | — | — | — | (342 | ) | — | ||||||||||||||
| Net income attributable to common stock | $ | 293,346 | 2.6 | % | $ | 314,978 | 3.3 | % | $ | 198,383 | 2.6 | % |
2018 compared to 2017
Revenues. Revenues increased $1.70 billion, or 18.0%, to $11.17 billion for the year ended December 31, 2018. Contributing to the overall increase were an $889.2 million increase in revenues from our Pipeline and Industrial Infrastructure Services segment and an $815.7 million increase in revenues from our Electric Power Infrastructure Services segment. The increase in Pipeline and Industrial Infrastructure Services segment revenues was primarily due to an increase in revenues from gas distribution and smaller diameter pipeline transmission services work and approximately $385 million of increased revenues from Stronghold during 2018, which was acquired in late July 2017. The increase in Electric Power Infrastructure Services segment revenues was primarily the result of increased spending by our customers associated with transmission and distribution services and to a lesser extent an increase in customer spending associated with larger electric transmission projects, including progress on a large transmission project in Canada.
Gross profit. Gross profit increased $238.1 million, or 19.2%, to $1.48 billion for the year ended December 31, 2018. Gross profit as a percentage of revenues increased slightly to 13.2% for the year ended December 31, 2018 from 13.1% for the year ended December 31, 2017. The increased gross profit was primarily due to the increased revenues described above, including the impact of continued favorable progress on a large transmission project in Canada. Partially offsetting the increases were project losses associated with two projects within the Pipeline and Industrial Infrastructure Services segment and one project within the Electric Power Infrastructure Services segment. Additionally, gross profit during 2017 was negatively impacted by work disruptions,
project suspensions or deferrals, and employee support costs due to Hurricanes Harvey and Irma. See Segment Results below for additional information and discussion related to segment revenues and operating income (loss).
Selling, general and administrative expenses. Selling, general and administrative expenses increased $79.7 million, or 10.2%, to $857.6 million for the year ended December 31, 2018. The increase was primarily due to a $56.7 million increase in expenses associated with acquired businesses, including incremental acquisition and integration costs of $6.7 million; and a $25.3 million increase in compensation expenses, largely associated with higher salaries due to increased personnel to support business growth, annual and incentive compensation increases and increased stock-based compensation expense related to improved forecasted achievement of multi-year performance metrics. Also contributing to the increase were a $7.9 million increase in travel and entertainment expenses; a $6.8 million increase in bad debt expense; and $1.3 million of severance and restructuring costs incurred during 2018, which were associated with the closure of certain operations within the Pipeline and Industrial Infrastructure Services segment. These increases were partially offset by a $12.5 million decrease in legal costs, partially due to certain legal costs incurred in 2017 that were related to a matter involving our prior disposition of certain communications operations, and a $6.0 million decrease in liabilities associated with deferred compensation plans. Selling, general and administrative expenses as a percentage of revenues decreased to 7.7% for the year ended December 31, 2018 from 8.2% for the year ended December 31, 2017, primarily due to the increase in revenues described above.
Amortization of intangible assets. Amortization of intangible assets increased $11.8 million to $44.0 million for the year ended December 31, 2018. This increase was primarily due to increased amortization of intangible assets associated with recently acquired businesses, partially offset by reduced amortization expense from previously acquired intangible assets as certain of these assets became fully amortized.
Asset impairment charges. Asset impairment charges were $49.4 million for the year ended December 31, 2018 compared to $58.1 million for the year ended December 31, 2017. During the fourth quarter of 2018, we recorded a $49.4 million asset impairment charge related to the winding down of certain oil-influenced operations and assets. During the fourth quarter of 2017, we recorded a $57.0 million goodwill impairment and a $1.1 million impairment related to a customer relationship intangible asset.
Change in fair value of contingent consideration liabilities. An $11.2 million decrease in the fair value of contingent consideration liabilities was recognized for the year ended December 31, 2018, which resulted in a corresponding increase in operating income, as compared to a $5.2 million decrease in fair value of contingent consideration liabilities recognized for the year ended December 31, 2017. The decreases in fair value were primarily due to changes in forecasted performance for certain acquired businesses, and we anticipate that additional changes in fair value will be recorded periodically until the contingent consideration liabilities are settled. See Contractual Obligations — Contingent Consideration Liabilities for more information.
Interest expense. Interest expense increased $16.0 million to $36.9 million for the year ended December 31, 2018, as compared to the year ended December 31, 2017, due to increased borrowing activity, primarily related to outstanding amounts borrowed in connection with the acquisition of Stronghold and common stock repurchases, as well as a higher weighted average interest rate.
Other expense, net. Other expense, net was $47.2 million for the year ended December 31, 2018, as compared to $5.0 million for the year ended December 31, 2017. The increase was primarily due to an increase in construction activity on a large electric transmission project in Canada for an entity in which we have an equity investment. Due to such equity investment, a portion of our construction earnings for the project are deferred, which is recognized by a decrease to the recorded value of the equity investment and a charge to equity in earnings (losses) of unconsolidated affiliates within “Other expense, net.” As of December 31, 2018, the project was approximately 88% complete, and additional profit deferrals are anticipated through the first half of 2019 as the project progresses toward completion. Upon completion of the project and transfer of the constructed asset to the customer, the amount of profit deferral will be recognized in equity in earnings (losses) of unconsolidated affiliates. The positive net impact of this equity investment on equity in earnings (losses) of unconsolidated affiliates is expected to be approximately $60 million for 2019. Also included for the year ended December 31, 2018 were $3.9 million in dividends received from our 30% equity interest in a water and gas pipeline infrastructure contractor located in Australia.
Provision for income taxes. The provision for income taxes was $161.7 million for the year ended December 31, 2018, with an effective tax rate of 35.3%. The provision for income taxes was $35.5 million for the year ended December 31, 2017, with an effective tax rate of 10.0%. Our effective tax rates for 2018 and 2017 were impacted by the enactment of the Tax Act on December 22, 2017, which, lowered the U.S. federal corporate tax rate from 35% to 21% as of January 1, 2018 and resulted in the recognition of a $70.1 million provisional benefit during 2017 associated with the enactment of the Tax Act and an additional benefit of $6.3 million recognized during 2018 as an adjustment to the provisional amount. Also during 2017, $26.7 million of tax benefits were recognized associated with entity restructuring and recapitalization efforts. As a result of the tax reform regulations issued during 2018, the 2018 effective tax rate was impacted by a $37.2 million provision to record a valuation allowance against certain tax benefits recognized during 2017 associated with the Tax Act and other entity restructuring and recapitalization efforts. Additionally,
the effective tax rates in 2018 and 2017 were impacted by tax benefits of $8.0 million and $7.2 million related to decreases in reserves for uncertain tax positions, which resulted from the expiration of certain federal and state statute of limitations periods, and $1.4 million and $5.1 million related to vesting of stock-based compensation awards, which were primarily impacted by changes in the weighted average vesting date stock prices. As described above, the Tax Act significantly revised the U.S. corporate tax regime and is anticipated to significantly impact our future effective tax rate, which we expect to be approximately 29.5% to 30.0% for 2019. For additional information regarding the Tax Act, refer to Note 9 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data.
Other comprehensive income. Other comprehensive income (loss), net of taxes, was a loss of $82.7 million in the year ended December 31, 2018 compared to a gain of $68.3 million in the year ended December 31, 2017. The loss in the year ended December 31, 2018 was due to the strengthening of the U.S. dollar against foreign currencies associated with our international operations, primarily the Canadian and Australian dollars, as of December 31, 2018 when compared to December 31, 2017. The gain in year ended December 31, 2017 was due to the strengthening of foreign currencies associated with our international operations, primarily the Canadian and Australian dollars, against the U.S. dollar as of December 31, 2017 when compared to December 31, 2016.
2017 compared to 2016
Revenues. Revenues increased $1.82 billion, or 23.7%, to $9.47 billion for the year ended December 31, 2017. Contributing to the overall increase were a $1.07 billion increase in revenues from pipeline and industrial infrastructure services and a $749.3 million increase in revenues from electric power infrastructure services. The increase in revenues from pipeline and industrial infrastructure services was primarily the result of increased capital spending by our customers on larger gas pipeline transmission projects and approximately $190 million of incremental revenues during 2017 from the acquisition of Stronghold. The increase in revenues from electric power infrastructure services was primarily due to increased customer spending associated with larger electric transmission projects and an increase in emergency restoration services revenues.
Gross profit. Gross profit increased $228.1 million, or 22.5%, to $1.24 billion for the year ended December 31, 2017. Gross profit as a percentage of revenues decreased slightly to 13.1% for the year ended December 31, 2017 from 13.3% for the year ended December 31, 2016. Gross profit and gross profit as a percentage of revenues for the year ended December 31, 2017 were positively impacted by greater contributions from emergency restoration services and midstream gas pipeline transmission projects, which typically yield higher margins. However, these increases were partially offset by the negative impact of work disruptions, deferrals, cancellations and employee support costs due to Hurricanes Harvey and Irma. Gross profit and gross profit as a percentage of revenues for the year ended December 31, 2016 were negatively impacted by project losses related to a power plant project in Alaska, which was substantially completed in the fourth quarter of 2016. See Segment Results below for additional information and discussion related to segment revenues and operating income (loss).
Selling, general and administrative expenses. Selling, general and administrative expenses increased $124.6 million, or 19.1%, to $777.9 million for the year ended December 31, 2017. This increase was primarily due to a $62.8 million increase in compensation costs, largely associated with higher incentive compensation based on increased profitability, increased annual compensation and increased personnel to support business growth; a $38.3 million increase in expenses associated with acquired businesses, including acquisition and integration costs; and a $6.9 million increase in legal costs, $4.2 million of which was associated with a matter involving our prior disposition of certain communications operations. These increases were partially offset by $6.3 million of incremental costs incurred during 2016 that were related to severance costs for our former president and chief executive officer and severance and restructuring costs primarily associated with certain operations within the Pipeline and Industrial Infrastructure Services segment. Selling, general and administrative expenses as a percentage of revenues decreased to 8.2% for the year ended December 31, 2017 from 8.5% for the year ended December 31, 2016, primarily due to the increase in revenues described above.
Amortization of intangible assets. Amortization of intangible assets increased $0.5 million to $32.2 million for the year ended December 31, 2017. This increase was primarily due to increased amortization of intangible assets associated with recently acquired companies, partially offset by reduced amortization expense from previously acquired intangible assets as certain of these assets became fully amortized.
Asset impairment charges. Asset impairment charges were $58.1 million for the year ended December 31, 2017 compared to $8.0 million for the year ended December 31, 2016. During the fourth quarter of 2017, we recorded a $57.0 million goodwill impairment and a $1.1 million impairment related to a customer relationship intangible asset, as a result of an extended low commodity price environment that significantly impacted certain reporting units within our Pipeline and Industrial Infrastructure Services Division. Specifically, a reporting unit that provides material handling services experienced lower operating margins and was expected to continue to face a highly competitive environment in its select markets and a reporting unit that provides marine and offshore services experienced prolonged periods of reduced revenues and operating margins and was expected to continue to experience lower levels of activity in the U.S. Gulf of Mexico and other offshore markets. During the fourth quarter of 2016, we
also recorded an asset impairment of $8.0 million related to certain international renewable energy services operations as a result of a pending disposition of these operations, which was completed in 2017.
Change in fair value of contingent consideration liabilities. A $5.2 million decrease in fair value of contingent consideration liabilities was recognized for the year ended December 31, 2017, which resulted in a corresponding increase in operating income during 2017, as compared to no change in fair value for the year ended December 31, 2016. The decrease in fair value was primarily due to changes in the timing and amounts of forecasted operating results of certain acquired businesses.
Interest expense. Interest expense increased $6.1 million to $20.9 million for the year ended December 31, 2017 as compared to the year ended December 31, 2016 due to increased borrowing activity, primarily related to the acquisition of Stronghold, as well as a higher weighted average interest rate.
Provision for income taxes. The provision for income taxes was $35.5 million for the year ended December 31, 2017, with an effective tax rate of 10.0%. The provision for income taxes was $107.2 million for the year ended December 31, 2016, with an effective tax rate of 34.9%. Our effective tax rate for 2017 was impacted by a $70.1 million provisional benefit related to the enactment of the Tax Act; $26.7 million of tax benefits recognized associated with entity restructuring and recapitalization efforts; and a $5.1 million discrete income tax benefit associated with the adoption of an accounting update addressing share-based payments. Also impacting the 2017 effective tax rate were an increased proportion of income before taxes from international jurisdictions, which are generally taxed at lower statutory rates, and an $8.5 million decrease of the production activity related tax benefit due to the acceleration of certain temporary deductions and the loss of a permanent deduction. For additional information regarding the Tax Act and income before taxes from international versus domestic jurisdictions, refer to Note 9 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. Additionally, the effective tax rates in 2017 and 2016 were impacted by tax benefits of $7.2 million and $20.5 million related to decreases in reserves for uncertain tax positions, which resulted from the expiration of certain federal and state statute of limitations periods.
Other comprehensive income. Other comprehensive income, net of taxes was a gain of $68.3 million in the year ended December 31, 2017 compared to a gain of $23.0 million in the year ended December 31, 2016. These gains were due to a strengthening of foreign currencies associated with our international operations, primarily the Canadian and Australian dollars, against the U.S. dollar as of December 31, 2017 when compared to December 31, 2016 and as of December 31, 2016 when compared to December 31, 2015.
Segment Results
The following table sets forth segment revenues and segment operating income (loss) for the years indicated (dollars in thousands):
| Year Ended December 31, | |||||||||||||||||||||
| 2018 | 2017 | 2016 | |||||||||||||||||||
| Revenues: | |||||||||||||||||||||
| Electric Power Infrastructure Services | $ | 6,415,562 | 57.4 | % | $ | 5,599,836 | 59.2 | % | $ | 4,850,495 | 63.4 | % | |||||||||
| Pipeline and Industrial Infrastructure Services | 4,755,861 | 42.6 | 3,866,642 | 40.8 | 2,800,824 | 36.6 | |||||||||||||||
| Consolidated revenues from external customers | $ | 11,171,423 | 100.0 | % | $ | 9,466,478 | 100.0 | % | $ | 7,651,319 | 100.0 | % | |||||||||
| Operating income (loss): | |||||||||||||||||||||
| Electric Power Infrastructure Services | $ | 628,286 | 9.8 | % | $ | 518,130 | 9.3 | % | $ | 395,745 | 8.2 | % | |||||||||
| Pipeline and Industrial Infrastructure Services | 204,178 | 4.3 | 184,083 | 4.8 | 149,502 | 5.3 | |||||||||||||||
| Corporate and non-allocated costs | (292,195 | ) | N/A | (323,364 | ) | N/A | (224,434 | ) | N/A | ||||||||||||
| Consolidated operating income | $ | 540,269 | 4.8 | % | $ | 378,849 | 4.0 | % | $ | 320,813 | 4.2 | % |
2018 compared to 2017
Electric Power Infrastructure Services Segment Results
Revenues for this segment increased $815.7 million, or 14.6%, to $6.42 billion for the year ended December 31, 2018. This change in revenues was primarily due to increased spending by our customers associated with transmission and distribution services and to a lesser extent an increase in customer spending associated with larger electric transmission projects, including favorable progress on a large transmission project in Canada during 2018, an approximate $85 million increase in revenues from acquired
businesses, and an approximate $58 million increase in communications infrastructure services revenues. These increases were partially offset by an approximate $24 million decrease in emergency restoration services, primarily attributable to the significant impact of Hurricanes Harvey and Irma during 2017.
Operating income increased $110.2 million, or 21.3%, to $628.3 million for the year ended December 31, 2018. Operating income as a percentage of segment revenues increased to 9.8% for the year ended December 31, 2018 from 9.3% for the year ended December 31, 2017. These increases were primarily due to the increase in revenues described above, including favorable progress on a large transmission project in Canada that successfully executed through project procurement, winter schedule and productivity risks resulting in a decrease in cost contingencies. Operating income for 2017 included the impact of a $17.3 million project loss on an electric transmission project that experienced road access, subcontractor and labor issues and which was completed during 2018. Operating income for 2018 was negatively impacted by a $21.8 million project loss on an electric power project that was approximately 86% complete as of December 31, 2018 and that experienced unexpected site conditions, adverse weather conditions and material delivery delays, as well as reduced operating income from emergency restoration services, which typically yield higher margins due in part to higher equipment utilization and absorption of fixed costs.
Pipeline and Industrial Infrastructure Services Segment Results
Revenues for this segment increased $889.2 million, or 23.0%, to $4.76 billion for the year ended December 31, 2018. This increase was primarily due to an increase in revenues from gas distribution and pipeline transmission services and an approximate $385 million increase in revenues from Stronghold, which was acquired in late July 2017. These increases were partially offset by a decrease in revenues from larger pipeline transmission projects during 2018, the timing of construction of which is highly variable due to potential permitting delays, worksite access limitations related to environmental regulations and seasonal weather patterns. Also contributing to the year over year increase was the negative impact during 2017 related to the temporary suspension or deferral of several projects as a result of Hurricane Harvey.
Operating income increased $20.1 million, or 10.9%, to $204.2 million for the year ended December 31, 2018. Operating income as a percentage of segment revenues decreased to 4.3% for the year ended December 31, 2018 from 4.8% for the year ended December 31, 2017. The overall increase in operating income was primarily due to the increase in revenues as described above from gas distribution and pipeline transmission services; partially offset by the decrease in revenues from larger pipeline transmission projects and the negative impact in 2017 related to the temporary suspension or deferral of projects as a result of Hurricane Harvey. The decrease in operating income as a percentage of segment revenues in 2018 was primarily due to the recognition of $52.7 million of asset impairment and other charges related to the winding down of certain oil-influenced operations and assets, including a write-down of certain long-lived assets held for sale, and a loss on the disposition of a long-lived asset. Additionally, operating income during 2018 was negatively impacted by $49.8 million of project losses associated with two projects, including engineering and production delays on a processing facility construction project in Texas that was 88% complete at December 31, 2018 and production issues and the impact of severe weather conditions on a large gas transmission project in West Virginia that was 99% complete at December 31, 2018. Operating income during 2017 was negatively impacted by lower margins on two distribution MSAs that resulted from unexpected delays in the release of work after crews were mobilized and also by increased costs associated with certain Canadian pipeline transmission projects resulting from adverse weather conditions, delays and other production issues.
Corporate and Non-allocated Costs
Certain selling, general and administrative expenses and amortization of intangible assets are not allocated to segments. Corporate and non-allocated costs for the year ended December 31, 2018 decreased $31.2 million to $292.2 million compared to the year ended December 31, 2017. This decrease was primarily due to a $58.1 million decrease in goodwill and intangible asset impairment charges and a $6.0 million decrease in liabilities associated with deferred compensation plans. These decreases were partially offset by a $21.8 million increase in compensation expenses, largely associated with increased personnel to support business growth, annual and incentive compensation increases and increased stock-based compensation expense related to improved forecasted achievement of multi-year performance metrics; an $11.8 million increase in intangible amortization, primarily related to the Stronghold acquisition; and a $6.7 million increase in acquisition-related costs.
2017 compared to 2016
Electric Power Infrastructure Services Segment Results
Revenues for this segment increased $749.3 million, or 15.4%, to $5.60 billion for the year ended December 31, 2017. This increase was primarily due to increased customer spending associated with larger electric transmission projects, which primarily resulted from interconnections with new generation facilities and modernization of the North American electric power grid; a $143.8 million increase in emergency restoration services revenues, which primarily resulted from Hurricanes Harvey and Irma and winter storms across the United States and Canada; an approximate $40 million increase in revenues from acquired companies; and an approximate $27 million increase in revenues due to favorable foreign currency exchange rates, primarily attributable to
the relationship between the U.S. dollar and the Canadian and Australian dollars. These items were partially offset by delays on certain projects during 2017, including as a result of work disruptions, deferrals and cancellations related to Hurricanes Harvey and Irma; a decrease in renewable energy services revenues; and a decrease in revenues associated with a power plant project in Alaska, as the project was substantially completed in the fourth quarter of 2016.
Operating income increased $122.4 million, or 30.9%, to $518.1 million for the year ended December 31, 2017. Operating income as a percentage of segment revenues increased to 9.3% for the year ended December 31, 2017 from 8.2% for the year ended December 31, 2016. These increases were primarily due to $54.8 million of project losses on a power plant project in Alaska that were recognized during 2016 and an increase in emergency restoration services revenues, which typically yield higher margins due in part to higher equipment utilization and absorption of fixed costs. These items were partially offset by $17.3 million of project losses on an electric transmission project that were recognized during 2017 due to road access, subcontractor and labor production issues; delays on certain projects during 2017, including as a result of work disruptions, deferrals, cancellations and employee support costs due to Hurricanes Harvey and Irma; and an increase in expenses incurred to support the growth of our communications services operations.
Pipeline and Industrial Infrastructure Services Segment Results
Revenues for this segment increased $1.07 billion, or 38.1%, to $3.87 billion for the year ended December 31, 2017. This increase was primarily due to an increase in capital spending by our customers on larger gas pipeline transmission projects, the timing of which is highly variable due to delays associated with obtaining permits, worksite access limitations related to environmental regulations and seasonality of weather patterns; an approximate $190 million increase in revenues from acquired businesses; an approximate $26 million increase in revenues due to favorable foreign currency exchange rates, primarily attributable to the relationship between the U.S. dollar and the Canadian dollar; and project delays due to forest fires in Alberta, Canada during 2016.
Operating income increased $34.6 million, or 23.1%, to $184.1 million for the year ended December 31, 2017. Operating income as a percentage of segment revenues decreased to 4.8% for the year ended December 31, 2017 from 5.3% for the year ended December 31, 2016. These changes were positively impacted by an increase in the proportion of larger gas pipeline transmission projects, which typically yield higher margins. In addition, overall higher revenues in the segment allowed for better coverage of fixed and overhead costs. These increases were offset by higher costs associated with adverse weather conditions, including delays and other production issues on certain Canadian pipeline transmission projects during 2017, and the temporary suspension or deferral of several projects as a result of Hurricane Harvey during 2017.
Corporate and Non-allocated Costs
Certain selling, general and administrative expenses and amortization of intangible assets are not allocated to segments. Corporate and non-allocated costs for the year ended December 31, 2017 increased $98.9 million to $323.4 million compared to the year ended December 31, 2016. The increase was primarily due to $58.1 million of goodwill and intangible asset impairment charges recognized in 2017; an increase in compensation costs, which were largely associated with higher incentive compensation based on profitability; an increase in acquisition and integration costs; an increase in costs associated with ongoing technology and business development initiatives; $4.2 million of legal costs during 2017 that were associated with our prior disposition of certain communications operations; and a $2.4 million charitable contribution during 2017 that was associated with the formation of a non-profit line training school. These items were partially offset by a $5.2 million decrease in the fair value of certain contingent consideration liabilities that was recognized during 2017 and $4.0 million associated with the departure of our former president and chief executive officer that was recognized during 2016.
Liquidity and Capital Resources
Cash Requirements
Amounts related to our cash and cash equivalents based on geographic location of the bank accounts were as follows (in thousands):
| December 31, | ||||||||
| 2018 | 2017 | |||||||
| Cash and cash equivalents held in domestic bank accounts | $ | 62,495 | $ | 83,074 | ||||
| Cash and cash equivalents held in foreign bank accounts | 16,192 | 55,211 | ||||||
| Total cash and cash equivalents | $ | 78,687 | $ | 138,285 |
Cash and cash equivalents held by joint ventures, which are either consolidated or proportionately consolidated, are available to support joint venture operations, but we cannot utilize those assets to support our other operations. We generally have no right to the joint ventures’ cash and cash equivalents other than participating in distributions and in the event of dissolution. Amounts related to cash and cash equivalents held by joint ventures, which are included in our total cash and cash equivalents balances, were as follows (in thousands):
| December 31, | ||||||||
| 2018 | 2017 | |||||||
| Cash and cash equivalents held by domestic joint ventures | $ | 8,544 | $ | 10,042 | ||||
| Cash and cash equivalents held by foreign joint ventures | 441 | 6,615 | ||||||
| Total cash and cash equivalents held by joint ventures | 8,985 | 16,657 | ||||||
| Cash and cash equivalents not held by joint ventures | 69,702 | 121,628 | ||||||
| Total cash and cash equivalents | $ | 78,687 | $ | 138,285 |
At December 31, 2018, we were in compliance with the covenants under the credit agreement for our senior secured credit facility. We anticipate that our cash and cash equivalents on hand, existing borrowing capacity under our senior secured credit facility, and future cash flows from operations will provide sufficient funds to enable us to meet our debt repayment obligations, future operating needs and planned capital expenditures during 2019, as well as facilitate our ability to grow through acquisitions or otherwise in the foreseeable future.
Our industry is capital intensive, and we expect the need for substantial capital expenditures to continue into the foreseeable future to meet the anticipated demand for our services, all of which may require cash. Total capital expenditures are expected to be approximately $260 million to $275 million for 2019.
We also evaluate opportunities for strategic acquisitions, stock repurchases under our authorized stock repurchase programs and opportunities to invest in strategic partnerships with customers and infrastructure investors. These investment opportunities exist in the markets and industries we serve and may require the use of cash to purchase debt or equity investments.
Management monitors financial markets and national and global economic conditions for factors that may affect our liquidity and capital resources. We consider our investment policies related to cash and cash equivalents to be conservative in that we maintain a diverse portfolio of what we believe to be high-quality cash and cash equivalent investments with short-term maturities. Accordingly, we do not anticipate that any weakness in the capital markets will have a material impact on the principal amounts of our cash and cash equivalents or our ability to rely upon our senior secured credit facility for funds. To date, we have not experienced a loss of or lack of access to our cash or cash equivalents or funds under our senior secured credit facility; however, our access to invested cash and cash equivalents or availability under our senior secured credit facility could be impacted in the future by adverse conditions in financial markets.
We generally do not provide for taxes related to undistributed earnings of our foreign subsidiaries because such earnings either would not be taxable when remitted or they are considered to be indefinitely reinvested. We could also be subject to additional foreign withholding taxes if we were to repatriate cash that is indefinitely reinvested outside the United States, but we do not expect such amounts to be material.
Sources and Uses of Cash
As of December 31, 2018, we had cash and cash equivalents of $78.7 million and working capital of $1.52 billion. We had $1.07 billion of outstanding loans under our senior secured credit facility, which included $592.5 million outstanding under the term loan facility and $477.8 million of outstanding revolving loans. Of the total outstanding borrowings, $883.8 million were denominated in U.S. dollars, $102.6 million were denominated in Canadian dollars and $83.9 million were denominated in Australian dollars. We also had $412.9 million of outstanding letters of credit and bank guarantees under our senior secured credit facility, $242.2 million of which were denominated in U.S. dollars and $170.7 million of which were denominated in currencies other than the U.S. dollar, primarily Australian or Canadian dollars. As of December 31, 2018, our senior secured credit facility had $1.09 billion available for loans or issuing new letters of credit or bank guarantees.
In summary, our cash flows for each period were as follows (in thousands):
| Year Ended December 31, | ||||||||||||
| 2018 | 2017 | 2016 | ||||||||||
| Net cash provided by operating activities of continuing operations | $ | 358,789 | $ | 371,891 | $ | 390,749 | ||||||
| Net cash used in investing activities of continuing operations | (402,670 | ) | (572,084 | ) | (264,379 | ) | ||||||
| Net cash provided by (used in) financing activities of continuing operations | (16,570 | ) | 227,764 | (133,836 | ) |
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 labor, equipment and subcontractors, are required to be paid before the associated receivables are billed and collected. Accordingly, changes within working capital in accounts receivable, contract assets and contract liabilities are normally related and are typically affected on a collective basis by changes in revenue due to the timing and volume of work performed and variability in the timing of customer billings and payments. Additionally, working capital needs are generally higher during the summer and fall months due to increased demand for our services when favorable weather conditions exist in many of our operating regions. Conversely, working capital assets are typically converted to cash during the winter months. These seasonal trends can be offset by changes in project timing due to delays or accelerations and other economic factors that may affect customer spending.
Net cash provided by operating activities during 2018 and 2017 were favorably impacted by increases in earnings from continuing operations. However, we had higher working capital requirements during 2018 driven by the increase in 2018 revenues, particularly the increased activity in the fourth quarter of 2018 when compared to the fourth quarter of 2017, and higher working capital requirements during 2017 primarily related to variability in billing and payment terms across various projects and an increase in accounts receivable associated with emergency restoration services work performed late in 2017. Also impacting cash provided by operating activities during 2017 was a $25.5 million payment related to the settlement of certain multiemployer pension plan withdrawal liabilities associated with the Central States, Southeast and Southwest Areas Pension Plan and a reduction in cash tax payments due to the acceleration of certain tax deductions.
Days sales outstanding (DSO) as of December 31, 2018 was 74 days, as compared to 76 days as of December 31, 2017. DSO is calculated by using the sum of current accounts receivable, net of allowance (which includes retainage and unbilled balances), plus contract assets less contract liabilities, divided by average revenues per day during the quarter.
Investing Activities
Net cash used in investing activities of continuing operations during 2018 included $293.6 million used for capital expenditures; $94.9 million used for acquisitions; $36.9 million of cash paid for investments in unconsolidated affiliates and other entities, including $18.5 million for our acquisition of a 30% interest in a water and gas pipeline infrastructure contractor located in Australia and $14.9 million related to a limited partnership that is involved in an engineering, procurement and construction electric transmission project in Canada; and $14.4 million of cash paid for intangible assets. These items were partially offset by $31.8 million of proceeds from the sale of property and equipment.
Net cash used in investing activities of continuing operations during 2017 included $361.2 million used for acquisitions, $347.5 million of which was associated with the Stronghold acquisition; $244.7 million used for capital expenditures; and $56.5 million of cash paid related to investments in unconsolidated affiliates and other entities, primarily associated with the limited partnership mentioned above. These items were partially offset by $65.8 million of cash distributions from investments in unconsolidated affiliates and other entities, primarily from the limited partnership mentioned above and $23.3 million of proceeds from the sale of property and equipment.
Net cash used in investing activities of continuing operations during 2016 included $212.6 million used for capital expenditures and $68.8 million used for acquisitions. These items were partially offset by $22.0 million of proceeds from the sale of property and equipment.
Our industry is capital intensive, and we expect the need for substantial capital expenditures to continue into the foreseeable future to meet the anticipated demand for our services. We also have various contractual obligations related to investments in unconsolidated affiliates and other capital commitments that are detailed in Contractual Obligations below. In addition, we expect to continue to pursue strategic acquisitions and investments, although we cannot predict the timing or magnitude of the potential cash outlays for these initiatives.
Additionally, certain of our acquisitions included the potential payment of contingent consideration, payable in the event certain performance objectives are achieved by the acquired businesses. The majority of these contingent consideration liabilities are subject to a maximum payment amount, which totaled $157.2 million as of December 31, 2018. Included within this maximum amount is approximately $18.0 million related to certain 2018 acquisitions, payable if the acquired businesses achieve certain performance objectives over three-year and five-year post-acquisition periods, and approximately $100.0 million related to the 2017 acquisition of Stronghold, payable at the end of a three-year post-acquisition period if the acquired business achieves certain performance objectives. The significant majority of these liabilities would be paid at least 70% to 85% in cash, and the aggregate fair value of all of our contingent consideration liabilities was $70.8 million as of December 31, 2018.
Financing Activities
Net cash used in financing activities of continuing operations during 2018 included $443.2 million of common stock repurchases under our stock repurchase programs and $15.2 million of payments to satisfy tax withholding obligations associated with share-based compensation. These items were mostly offset by $415.3 million of net borrowings under our senior secured credit facility and $33.8 million of net short-term debt borrowings.
Net cash provided by financing activities of continuing operations during 2017 included $307.9 million of net borrowings under our senior secured credit facility. This cash provided was partially offset by $50.0 million of common stock repurchases under our stock repurchase programs and $18.5 million of payments to satisfy tax withholding obligations associated with share-based compensation. Net borrowings during 2017 were primarily utilized to fund the cash portion of the consideration paid at closing for the Stronghold acquisition and additional working capital requirements associated with increases in emergency restoration services projects and the number and size of ongoing pipeline and industrial infrastructure projects.
Net cash used in financing activities of continuing operations during 2016 included $116.2 million of net repayments under our senior secured credit facility and $8.3 million of payments to satisfy tax withholding obligations associated with share-based compensation.
Stock Repurchases
During the years ended December 31, 2018 and 2017, we repurchased 13.9 million and 1.4 million shares of our common stock in the open market at a cost of $451.3 million and $50.0 million, respectively. Our policy is to record a stock repurchase as of the trade date; however, the payment of cash related to a repurchase is made on the settlement date of the trade. During the years ended December 31, 2018 and 2017, cash payments related to stock repurchases were $443.2 million and $50.0 million. At December 31, 2018, $298.7 million remained under our current repurchase program. In January and February 2019, we have repurchased an additional 0.3 million shares of our common stock in the open market at a cost of $8.0 million. For additional detail about our stock repurchases, refer to Note 10 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data.
Dividends
On December 6, 2018, we declared a cash dividend of $0.04 per share of our common stock, which was paid on January 16, 2019 to stockholders of record as of January 2, 2019. Holders of restricted stock units on the record date received a cash dividend equivalent payment on the payment date, and holders of unearned and unvested performance units are entitled to cash dividend equivalent payments to the extent such performance units become earned and vest. Cash dividend equivalents related to certain vested and unvested equity awards that have been deferred pursuant to the terms of a deferred compensation plan maintained by Quanta are recorded as liabilities in such plans until the deferred awards are distributed. Additionally, holders of exchangeable shares of certain of our Canadian subsidiaries on the record date were paid a cash dividend of $0.04 per exchangeable share as of the payment date. At December 31, 2018, we accrued $5.8 million for cash dividends and cash dividend equivalents, and in January 2019, we paid the substantial majority of this amount.
The declaration, payment and amount of future cash dividends, if any, will be at the discretion of our Board of Directors after taking into account various factors, including our financial condition, results of operations, cash flows from operations, current and anticipated capital requirements and expansion plans, the income tax laws then in effect and the requirements of Delaware law. In addition, as discussed below, our credit agreement restricts the payment of cash dividends unless certain conditions are met.
Debt Instruments
Senior Secured Credit Facility
We have a credit agreement with various lenders that, as amended on October 10, 2018, provides for (i) a $1.99 billion revolving credit facility and (ii) a term loan facility with total term loan commitments of $600.0 million. In addition, subject to the conditions specified in the credit agreement, we have the option to increase the capacity of the credit facility, in the form of
an increase in the revolving credit facility, incremental term loans or a combination thereof, by up to an additional $400.0 million, from time to time, upon receipt of additional commitments from new or existing lenders. Borrowings under the credit agreement are to be used to refinance existing indebtedness and for working capital, capital expenditures and other general corporate purposes. The maturity date for both the revolving credit facility and the term loan facility is October 31, 2022, and we are required to make quarterly principal payments on the term loan facility as described below.
With respect to the revolving credit facility, the entire amount available may be used by us for revolving loans and letters of credit in U.S. dollars and certain alternative currencies. Up to $600.0 million may be used by certain of our subsidiaries for revolving loans and letters of credit in certain alternative currencies, up to $100.0 million may be used for swing line loans in U.S. dollars, up to $50.0 million may be used for swing line loans in Canadian dollars and up to $50.0 million may be used for swing line loans in Australian dollars.
On October 10, 2018, we borrowed the full amount of the term loan facility and used all of such proceeds to repay outstanding revolving loans. As of December 31, 2018, we had $1.07 billion of outstanding borrowings under the credit agreement, which included $592.5 million borrowed under the term loan facility and $477.8 million of outstanding revolving loans. Of the total outstanding borrowings, $883.8 million were denominated in U.S. dollars, $102.6 million were denominated in Canadian dollars and $83.9 million were denominated in Australian dollars. We also had $412.9 million of letters of credit and bank guarantees issued under our revolving credit facility, of which $242.2 million were denominated in U.S. dollars and $170.7 million were denominated in currencies other than the U.S. dollar, primarily Canadian and Australian dollars. The remaining $1.09 billion of available commitments under the credit facility was available for loans or issuing new letters of credit and bank guarantees.
Subsequent to November 19, 2017, revolving loans borrowed in U.S. dollars bear interest, at our option, at a rate equal to either (i) the Eurocurrency Rate (as defined in the credit agreement) plus 1.125% to 2.000%, as determined based on our Consolidated Leverage Ratio (as described below), or (ii) the Base Rate (as described below) plus 0.125% to 1.000%, as determined based on our Consolidated Leverage Ratio. Revolving loans borrowed in any currency other than U.S. dollars bear interest at a rate equal to the Eurocurrency Rate plus 1.125% to 2.000%, as determined based on our Consolidated Leverage Ratio. Additionally, standby or commercial letters of credit issued under the credit agreement are subject to a letter of credit fee of 1.125% to 2.000%, based on our Consolidated Leverage Ratio, and Performance Letters of Credit (as defined in the credit agreement) issued under the credit agreement in support of certain contractual obligations are subject to a letter of credit fee of 0.675% to 1.150%, based on our Consolidated Leverage Ratio. From December 18, 2015 through November 19, 2017, interest rates for revolving loans and letter of credit fees were generally consistent with those set forth above, other than the maximum additional interest rates and fee percentages were 0.125% higher.
Term loans bear interest at rates generally consistent with the revolving loans borrowed in U.S. dollars, except that the additional amount over the Eurocurrency Rate is 1.125% to1.875%, based on our Consolidated Leverage Ratio. We are also required to make quarterly principal payments of $7.5 million on the last business day of each March, June, September and December, which began in December 2018. The aggregate outstanding principal amount of all outstanding term loans must be paid on the maturity date; however, we may voluntarily prepay that amount from time to time, in whole or in part, without premium or penalty.
We are also subject to a commitment fee of 0.20% to 0.40%, based on our Consolidated Leverage Ratio, on any unused availability under the revolving credit facility.
Consolidated Leverage Ratio is the ratio of our Consolidated Funded Indebtedness to Consolidated EBITDA (as those terms are defined in the credit agreement). For purposes of calculating our Consolidated Leverage Ratio, Consolidated Funded Indebtedness is reduced by available cash and cash equivalents (as defined in the credit agreement) in excess of $25.0 million. The Base Rate equals the highest of (i) the Federal Funds Rate (as defined in the credit agreement) plus 0.5%, (ii) the prime rate publicly announced by Bank of America, N.A. and (iii) the Eurocurrency Rate plus 1.00%. Consolidated Interest Coverage Ratio is the ratio of (i) Consolidated EBIT (as defined in the credit agreement) for the four fiscal quarters most recently ended to (ii) Consolidated Interest Expense (as defined in the credit agreement) for such period (excluding all interest expense attributable to capitalized loan costs and the amount of fees paid in connection with the issuance of letters of credit on our behalf during such period).
The credit agreement contains certain covenants, including (i) a maximum Consolidated Leverage Ratio of 3.0 to 1.0 (except that in connection with certain permitted acquisitions in excess of $200.0 million, such ratio is 3.5 to 1.0 for the fiscal quarter in which the acquisition is completed and the two subsequent fiscal quarters) and (ii) a minimum Consolidated Interest Coverage Ratio of 3.0 to 1.0. As of December 31, 2018, we were in compliance with all of the covenants under the credit agreement.
Subject to certain exceptions, (i) all borrowings under the credit agreement are secured by substantially all of our assets and the assets of our wholly owned U.S. subsidiaries and by a pledge of all of the capital stock of our wholly owned U.S. subsidiaries and 65% of the capital stock of direct foreign subsidiaries of our wholly owned U.S. subsidiaries and (ii) our wholly owned U.S. subsidiaries guarantee the repayment of all amounts due under the credit agreement. Subject to certain conditions, all collateral will automatically be released from the liens at any time we maintain an Investment Grade Rating (defined in the credit agreement
as two of the following three conditions being met: (i) a corporate credit rating that is BBB- or higher by Standard & Poor’s Rating Services, (ii) a corporate family rating that is Baa3 or higher by Moody’s Investors Services, Inc. or (iii) a corporate credit rating that is BBB- or higher by Fitch Ratings, Inc.).
The credit agreement also limits certain acquisitions, mergers and consolidations, indebtedness, asset sales and prepayments of indebtedness and, subject to certain exceptions, prohibits liens on our assets. The credit agreement allows cash payments for dividends and stock repurchases subject to compliance with the following requirements (after giving effect to the dividend or stock repurchase): (i) no default or event of default under the credit agreement; (ii) continued compliance with the financial covenants in the credit agreement; and (iii) at least $100.0 million of availability under the revolving credit facility and/or cash and cash equivalents on hand.
The credit agreement provides for customary events of default and contains cross-default provisions with our underwriting, continuing indemnity and security agreement with our sureties and certain other debt instruments exceeding $150.0 million in borrowings or availability. If an Event of Default (as defined in the credit agreement) occurs and is continuing, on the terms and subject to the conditions set forth in the credit agreement, the lenders may declare all amounts outstanding and accrued and unpaid interest immediately due and payable, require that we provide cash collateral for all outstanding letter of credit obligations, terminate the commitments under the credit agreement, and foreclose on the collateral.
Off-Balance Sheet Transactions
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 significant off-balance sheet transactions include certain obligations relating to our investments and joint venture arrangements, liabilities associated with non-cancelable operating leases, letters of credit obligations, surety guarantees related to performance bonds, committed expenditures to purchase equipment and certain multiemployer pension plan liabilities. See Contractual Obligations below and Note 14 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data for a description of these arrangements.
Contractual Obligations
The following table summarizes our future contractual obligations as of December 31, 2018, excluding amounts discussed below related to unrecognized tax benefits, multiemployer pension plan obligations, interest associated with letters of credit and bank guarantees, commitment fees under our senior secured credit facility, commitments associated with our insurance liabilities and acquisition-related contingent consideration liabilities (in thousands):
| Total | 2019 | 2020 | 2021 | 2022 | 2023 | Thereafter | ||||||||||||||||||||||
| Long-term debt - principal (1) | $ | 1,071,822 | $ | 31,522 | $ | 30,000 | $ | 30,000 | $ | 980,300 | $ | — | $ | — | ||||||||||||||
| Long-term debt - cash interest (2) | 6 | 6 | — | — | — | — | — | |||||||||||||||||||||
| Short-term debt (3) | 33,422 | 33,422 | — | — | — | — | — | |||||||||||||||||||||
| Operating lease obligations | 354,550 | 124,530 | 81,189 | 55,827 | 34,337 | 21,450 | 37,217 | |||||||||||||||||||||
| Capital lease obligations(4) | 934 | 702 | 112 | 112 | 8 | — | — | |||||||||||||||||||||
| Equipment purchase commitments (5) | 7,824 | 7,824 | — | — | — | — | — | |||||||||||||||||||||
| Capital commitment related to investments in unconsolidated affiliates (6) | 36,345 | 36,345 | — | — | — | — | — | |||||||||||||||||||||
| Total | $ | 1,504,903 | $ | 234,351 | $ | 111,301 | $ | 85,939 | $ | 1,014,645 | $ | 21,450 | $ | 37,217 |
| (1) | Amounts were recorded in our December 31, 2018 consolidated balance sheet. We had $1.07 billion of outstanding borrowings under the credit agreement, which included $592.5 million borrowed under the term loan facility and $477.8 million of outstanding revolving loans, both of which bear interest at variable market rates. Assuming the principal amount outstanding at December 31, 2018 remained outstanding and the interest rate in effect at December 31, 2018 remained the same, the annual cash interest expense with respect to our senior secured credit facility would be approximately $42.6 million, payable until October 31, 2022, the maturity date of the facility. In addition, we are required to make quarterly principal payments of $7.5 million on the term borrowings, which are due on the last business day of each March, June, September and December, and pay the remaining balance of the term borrowings at the maturity date for the facility. |
| (2) | Amount represents cash interest expense on our fixed-rate long-term debt, which excludes our senior secured credit facility. |
| (3) | Amount was recorded in our December 31, 2018 consolidated balance sheet. |
| (4) | Principal amounts of capital lease obligations were recorded in our December 31, 2018 consolidated balance sheet. |
| (5) | Amount represents capital committed for the expansion of our vehicle fleet in order to accommodate manufacturer lead times on certain types of vehicles. Although we have committed to the purchase of these vehicles at the time of their delivery, we expect that these orders will be assigned to third party leasing companies and be made available to us under certain of our master equipment lease agreements, which will release us from our capital commitment. |
| (6) | Amount represents outstanding capital commitments associated with investments in unconsolidated affiliates. An additional capital commitment of $0.7 million is anticipated to be paid by May 31, 2022; however we have excluded this capital commitment from the Contractual Obligations table because we are unable to determine the timing of this payment. Additionally, during the year ended December 31, 2017, we formed a partnership with select investors that provides up to $1.0 billion of capital, including approximately $80.0 million from us, available to invest in certain specified types of infrastructure projects through August 2024. Because we are not obligated to invest this amount and are unable to determine the timing of any such investments, we have excluded this capital commitment from the Contractual Obligations table other than $13.7 million that was contributed in February 2019. |
Unrecognized Tax Benefits
Quanta and certain subsidiaries remain under examination by various U.S. state, Canadian and other foreign tax authorities for multiple periods. We believe it is reasonably possible that within the next 12 months unrecognized tax benefits may decrease by up to $9.5 million as a result of settlement of these examinations or the expiration of certain statute of limitations periods. Because we are unable to accurately predict the timing and amounts of any obligations related to unrecognized tax benefits, we have excluded unrecognized tax benefits from the Contractual Obligations table.
Multiemployer Pension Plans
The previously presented table of estimated contractual obligations does not reflect the obligations under the multiemployer pension plans in which our union employees participate. Some of our operating units are parties to various collective bargaining agreements with unions that represent certain of their employees. The agreements require the operating units to pay specified wages, provide certain benefits to their union employees and contribute certain amounts to multiemployer pension plans and employee benefit trusts. Our multiemployer pension plan contribution rates generally are specified in the collective bargaining agreements (usually on an annual basis), and contributions are made to the plans on a “pay-as-you-go” basis based on our union employee payrolls. The location and number of union employees that we employ at any given time and the plans in which they may participate vary depending on the projects we have ongoing at any time and the need for union resources in connection with those projects. Therefore, we are unable to accurately predict our union employee payroll and the amount of the resulting multiemployer pension plan contribution obligations for future periods.
We may also be required to make additional contributions to our multiemployer pension plans if they become underfunded, and these additional contributions will be determined based on our union employee payrolls. The Pension Protection Act of 2006 added special funding and operational rules generally applicable to plan years beginning after 2007 for multiemployer plans that are classified as “endangered,” “seriously endangered” or “critical” status based on multiple factors (including, for example, the plan’s funded percentage, cash flow position and whether it is projected to experience a minimum funding deficiency). Plans in these classifications must adopt measures to improve their funded status through a funding improvement or rehabilitation plan, as applicable, which may require additional contributions from employers (which may take the form of a surcharge on benefit contributions) and/or modifications to retiree benefits. Certain multiemployer plans to which our operating units contribute or may contribute in the future are in “endangered,” “seriously endangered” or “critical” status. The amount of additional funds, if any, that we may be obligated to contribute to these plans in the future cannot be reasonably estimated and are not included in the above table due to uncertainty of the future levels of work that require the specific use of the union employees covered by these plans, as well as the future contribution levels and possible surcharges on contributions applicable to these plans.
We may be subject to additional liabilities imposed by law as a result of our participation in multiemployer defined benefit pension plans. The Employee Retirement Income Security Act of 1974, as amended by the Multiemployer Pension Plan Amendments Act of 1980, imposes certain liabilities upon an employer who is a contributor to a multiemployer plan if the employer withdraws from the plan or the plan is terminated or experiences a mass withdrawal. These liabilities include an allocable share of the unfunded vested benefits in the plan for all plan participants, not merely the benefits payable to a contributing employer’s own retirees. As a result, participating employers may bear a higher proportion of liability for unfunded vested benefits if other participating employers cease to contribute or withdraw, with the reallocation of liability being more acute in cases when a withdrawn employer is insolvent or otherwise fails to pay its withdrawal liability. We are not aware of any material amounts of withdrawal liability that have been incurred or asserted and that remain outstanding as a result of our withdrawal from a multiemployer defined benefit pension plan.
Letters of Credit and Bank Guarantee Fees and Commitment Fees
We have excluded from the Contractual Obligations table interest associated with letters of credit and bank guarantees and commitment fees under our senior secured credit facility because the outstanding letters of credit and bank guarantees, availability and applicable interest rates and fees are variable. Assuming that the amount of letters of credit and bank guarantees outstanding and the interest rate as of December 31, 2018 remained the same, the annual cash interest expense for our letters of credit and bank guarantees would be approximately $4.7 million. For additional information regarding our letters of credit and bank guarantees and the interest rates and fees associated with these items and our borrowings under our senior secured credit facility, see Liquidity and Capital Resources — Debt Instruments above.
Insurance
We are insured for employer’s liability, workers’ compensation, auto liability and general liability claims. Under these programs, the deductible for employer’s liability is $1.0 million per occurrence, the deductible for workers’ compensation is $5.0 million per occurrence, and the deductibles for auto liability and general liability are $10.0 million per occurrence. We manage and maintain a portion of our casualty risk through our wholly-owned captive insurance company, which insures all claims up to the amount of the applicable deductible of our third-party insurance programs. In connection with our casualty insurance programs, we are required to issue letters of credit to secure our obligations. We also have employee health care benefit plans for most employees not subject to collective bargaining agreements, of which the primary plan is subject to a deductible of $0.5 million per claimant per year.
Losses under all of these insurance programs are accrued based upon our estimate of the ultimate liability for claims reported and an estimate of claims incurred but not reported, with assistance from third-party actuaries. These insurance liabilities are difficult to assess and estimate due to unknown factors, including the severity of an injury, the extent of damage, the determination of our liability in proportion to other parties and the number of incidents not reported. The accruals are based upon known facts and historical trends, and management believes such accruals are adequate. As of December 31, 2018 and 2017, the gross amount accrued for insurance claims totaled $272.9 million and $254.7 million, with $210.1 million and $200.0 million considered to be long-term and included in “Insurance and other non-current liabilities.” Related insurance recoveries/receivables as of December 31, 2018 and 2017 were $56.5 million and $50.4 million, of which $0.3 million and $0.4 million were included in “Prepaid expenses and other current assets” and $56.2 million and $50.0 million were included in “Other assets, net.”
We renew our insurance policies on an annual basis, and therefore deductibles and levels of insurance coverage may change in future periods. In addition, insurers may cancel our coverage or determine to exclude certain items from coverage, or we may elect not to obtain certain types or incremental levels of insurance based on the potential benefits considered relative to the cost of such insurance. In any such event, our overall risk exposure would increase, which could negatively affect our results of operations, financial condition and cash flows. The Contractual Obligations table excludes commitments associated with our insurance liabilities, as we are unable to determine the timing of payments related to these obligations.
Contingent Consideration Liabilities
We have excluded from the Contractual Obligations table acquisition-related contingent consideration liabilities, which represent the estimated fair value of future amounts payable to the former owners of certain acquired businesses, because the amounts have not been earned and we are unable to determine the portion of the liabilities that will be settled in cash and the exact timing of any such payments as of December 31, 2018. Payment of such consideration is contingent upon achievement of certain performance objectives by the acquired businesses, and the fair value of such consideration is estimated by management based on entity-specific assumptions that are evaluated on an ongoing basis. As of December 31, 2018 and 2017, the aggregate fair value of these outstanding and unearned contingent consideration liabilities totaled $70.8 million and $65.7 million, all of which was included in “Insurance and other non-current liabilities” on our consolidated balance sheets. Because acquisition-related contingent consideration liabilities are contingent upon future events, we include these liabilities in the Contractual Obligations table when the contingencies are resolved. We expect a significant portion of these liabilities to be settled by late 2020 or early 2021.
The fair values of the contingent consideration liabilities as of December 31, 2018 were primarily determined using a Monte Carlo simulation valuation methodology based on probability-weighted performance projections and other inputs, including a discount rate and an expected volatility factor for each acquisition. The expected volatility factors ranged from 22.2% to 30.0% based on historical asset volatility of selected guideline public companies. Depending on contingent consideration payment terms, the present values of the estimated payments are discounted based on a risk-free rate and/or our cost of debt, ranging from 2.1% to 3.8%. The fair value determinations incorporate significant inputs not observable in the market. Accordingly, the level of inputs used for these fair value measurements is the lowest level (Level 3), as further described in Note 2 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. Significant changes in any of these assumptions could result in a significantly higher or lower potential liability.
The majority of our contingent consideration liabilities are subject to a maximum payment amount, which totaled $157.2 million as of December 31, 2018. One contingent consideration liability is not subject to a maximum payout amount, and that liability had a fair value of $1.0 million as of December 31, 2018.
Our aggregate contingent consideration liabilities can change due to additional business acquisitions, payments to settle outstanding liabilities, changes in the fair value of amounts owed based on actual or forecasted performance, and foreign currency translation gains or losses. During the years ended December 31, 2018, 2017 and 2016, acquisitions increased our aggregate contingent consideration liabilities by $16.5 million, $51.1 million and $18.7 million. During the years ended December 31, 2018 and 2017, we recognized net decreases in the fair value of contingent consideration liabilities of $11.2 million and $5.2 million, which were reflected in “Change in fair value of contingent consideration liabilities” on our consolidated statements of operations.
Concentrations of Credit Risk
We are subject to concentrations of credit risk related primarily to our cash and cash equivalents and our net receivable position with customers, which includes amounts related to billed and unbilled accounts receivable and contract assets net of advanced billings with the same customer. Substantially all of our cash and cash equivalents are managed by what we believe to be high credit quality financial institutions. In accordance with our investment policies, these institutions are authorized to invest cash and cash equivalents in a diversified portfolio of what we believe to be high quality cash and cash equivalent investments, which consist primarily of interest-bearing demand deposits, money market investments and money market mutual funds. Although we do not currently believe the principal amount of these cash and cash equivalents is subject to any material risk of loss, changes in economic conditions could impact the interest income we receive from these investments. In addition, we grant credit under normal payment terms, generally without collateral, to our customers, which include electric power and energy companies, governmental entities, general contractors, and builders, owners and managers of commercial and industrial properties located primarily in the United States, Canada, Australia and Latin America. Consequently, we are subject to potential credit risk related to changes in business and economic factors throughout these locations, which may be heightened as a result of uncertain economic and financial market conditions. However, we generally have certain statutory lien rights with respect to services provided. Some of our customers have experienced significant financial difficulties (including bankruptcy), and customers may experience financial difficulties in the future. These difficulties expose us to increased risk related to collectability of billed and unbilled receivables and contract assets for services we have performed.
PG&E Bankruptcy. On January 29, 2019, one of our largest customers, PG&E, filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code, as amended. We are monitoring the bankruptcy proceeding and evaluating the treatment of, and potential claims related to, our pre-petition receivables, which we currently estimate total approximately $150 million as of the bankruptcy filing date. We currently believe we will ultimately collect the amounts owed, whether through assumption of certain executory contracts or through amounts approved by the bankruptcy court for payment to certain of PG&E’s safety and reliability suppliers. As with any bankruptcy, that belief is based on a number of assumptions that are potentially subject to change as the bankruptcy proceeding progresses. Should any of those assumptions change, the amount collected could be materially less than the amount of our pre-petition receivables. Additionally, we are continuing to perform services for PG&E while the bankruptcy matter is ongoing and believe that amounts billed for post-petition services will be collected in the ordinary course.
At December 31, 2018 and 2017, no customer represented 10% or more of our consolidated net receivable position. No customer represented 10% or more of our consolidated revenues for the years ended December 31, 2018, 2017 and 2016.
Project Insurance Claim
In June 2018, while performing a horizontal directional drill and installing an underground gas pipeline, one of our subsidiaries experienced a partial collapse of a borehole. Subsequent to the incident, we have been working with our customer to mitigate the impact of the incident and to complete the project, and have encountered additional challenges similar to those experienced previously. As required by the contract, the customer procured certain insurance coverage for the project, with our subsidiary as an additional insured. We believe the incident is covered under such insurance and are working collaboratively with the customer to pursue insurance claims with the customer’s insurance carriers. To the extent such claims are not successful, we could pursue contractual relief from the customer or seek partial recovery under our own insurance policies.
As of December 31, 2018, we recorded an insurance receivable of $26.7 million, which represents a portion of the insurance claims being pursued as of such date and management’s estimate of the amount of costs incurred through such date that are probable of recovery. We expect the insurance claims and the amount of insurance receivable to increase in future periods as additional mitigation costs are incurred, which could be significant. The plan and related work to mitigate the incident are not complete, may change and will be subject to inherent risks associated with underground pipeline installation, which could cause the costs to mitigate the incident to increase materially. To the extent we are unsuccessful in realizing insurance or contractual recoveries, additional charges to operating results, which could be material, would be required.
Legal Proceedings
We are from time to time party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of business. These actions typically seek, among other things, compensation for alleged personal injury, breach of contract and/or property damages, employment-related damages, punitive damages, civil penalties or other losses, or injunctive or declaratory relief. With respect to all such lawsuits, claims and proceedings, we record a reserve when it is probable that a loss has been incurred and the amount of loss can be reasonably estimated. In addition, we disclose matters for which management believes a material loss is at least reasonably possible. See Note 14 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data for additional information regarding litigation, claims and other legal proceedings.
Related Party Transactions
In the normal course of business, we enter into transactions from time to time with related parties. Our significant related party transactions typically involve real property and facility leases with prior owners of certain acquired companies.
Inflation
Due to relatively low levels of inflation experienced during the years ended December 31, 2018, 2017 and 2016, inflation did not have a significant effect on our results of operations, financial condition or cash flows.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities known to exist as of the date the consolidated financial statements are published and the reported amounts of revenues and expenses recognized during the periods presented. We review all significant estimates affecting our consolidated financial statements on a recurring basis and record the effect of any necessary adjustments prior to their publication. Judgments and estimates are based on our beliefs and assumptions derived from information available at the time such judgments and estimates are made. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of financial statements. There can be no assurance that actual results will not differ from those estimates. Management has reviewed its development and selection of critical accounting estimates with the audit committee of our Board of Directors. Our accounting policies are more fully described in Note 2 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. We believe the following accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:
Revenue Recognition
As discussed in Note 3 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data, effective January 1, 2018, we adopted new revenue recognition guidance using the modified retrospective transition method, applying the guidance to contracts with customers that were not substantially complete as of such date. Our financial results for reporting periods after January 1, 2018 are presented under the new guidance, while financial results for prior periods will continue to be reported in accordance with the prior guidance and our historical accounting policy. The net cumulative adjustment due to adoption of the new guidance was a $1.3 million reduction to retained earnings as of January 1, 2018, which represented a $1.8 million decrease to revenue recognized prior to adoption, net of $0.5 million in taxes. This adjustment primarily related to certain contracts that are now accounted for as a single performance obligation but were previously accounted for separately for revenue recognition purposes. We do not anticipate significant changes to the pattern of revenue recognition for contracts with customers and do not believe that the guidance surrounding the identification of contracts and performance obligations or the measurement of variable consideration will have a material impact on revenue recognition under our customary contractual arrangements.
Contracts
We design, install, upgrade, repair and maintain infrastructure for customers in the electric power, energy and communications industries. These services may be provided pursuant to master service agreements (MSAs), repair and maintenance contracts and fixed price and non-fixed price installation contracts. These contracts are classified into three categories based on how transaction prices are determined and revenue is recognized: unit-based contracts, cost-plus contracts and fixed price contracts. Transaction prices for unit-based contracts are determined on a per unit basis, transaction prices for cost-plus contracts are determined by applying a profit margin to costs incurred on the contracts and transaction prices for fixed price contracts are determined on a lump-sum basis. Among other considerations, revenue is not recognized unless collectability under the contract is considered
probable. This determination requires the use of judgment based on our beliefs and assumptions derived from information available at the time such judgments and estimates are made. These estimates may be adjusted as additional information is received.
Performance Obligations
A performance obligation is a promise in a contract with a customer to transfer a distinct good or service. Most of our contracts are considered to have a single performance obligation whereby we are required to integrate complex activities and equipment into a deliverable for the customer. For contracts with multiple performance obligations, we allocate the transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. The standalone selling price is estimated using the expected costs plus a margin approach for each performance obligation.
At December 31, 2018, the aggregate transaction price allocated to unsatisfied or partially satisfied performance obligations was estimated to be approximately $4.68 billion, of which 66.2% was expected to be recognized in the subsequent twelve months. This amount represents management’s estimate of the consolidated revenues that are expected to be realized from the remaining portion of firm orders under fixed price contracts not yet completed or for which work has not yet begun. For purposes of calculating remaining performance obligations, we include all estimated revenues attributable to consolidated joint ventures and VIEs, revenues from funded and unfunded portions of government contracts to the extent they are reasonably expected to be realized and revenues from change orders and claims to the extent management believes additional contract revenues will be earned and are deemed probable of collection. Excluded from remaining performance obligations were potential orders under MSAs and non-fixed price contracts expected to be completed within one year.
Recognition of Revenue Upon Satisfaction of Performance Obligations
A transaction price is determined for each contract, and that amount is allocated to each performance obligation within the contract and recognized as revenue when, or as, the performance obligation is satisfied. We generally recognize revenue over time as we perform our obligations because there is a continuous transfer of control of the deliverable to the customer. Under unit-based contracts with an insignificant amount of partially completed units, we recognize revenue as units are completed based on contractual pricing amounts. Under unit-based contracts with more than an insignificant amount of partially completed units and fixed price contracts, we recognize revenues as performance obligations are satisfied over time, with the percentage completion generally measured as the percentage of costs incurred to total estimated costs for such performance obligation. Under cost-plus contracts, we recognize revenue on an input basis, as labor hours are incurred, materials are utilized and services are performed.
Contract costs include all direct materials, labor and subcontract costs and indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation costs. The majority of the materials associated with our work are owner-furnished, and therefore not included in contract revenues and costs.
Contract Estimates
Actual revenues and project costs can vary, sometimes substantially, from previous estimates due to changes in a variety of factors, including unforeseen or changed circumstances not included in our cost estimates or covered by our contracts. The estimating process is based on the professional knowledge and experience of our engineers, project managers and financial professionals. Some of the factors that may lead to changes in estimates include concealed or unknown environmental conditions; changes in the cost of equipment, commodities, materials or labor; unanticipated costs or claims due to delays caused by customers or third parties; customer failure to provide required materials or equipment; errors in engineering, specifications or designs; project modifications or contract termination; weather conditions; changes in estimates related to the length of time to complete a performance obligation; and performance and quality issues requiring rework or replacement. These factors, along with other risks inherent in performing services under fixed price contracts, are routinely evaluated by management. Any changes in estimates could result in changes in profitability or losses associated with the related performance obligations. For example, estimated costs for a performance obligation may increase from the original estimate and contractual provisions may not allow for adequate compensation or reimbursement for such additional costs. Changes in estimated revenues, costs and profit are recorded in the period they are determined to be probable and can be reasonably estimated.
Changes in cost estimates on certain contracts may result in the issuance of change orders and/or claims, which may be approved or unapproved by the customer. We determine the probability that such costs will be recovered based on, among other things, contractual entitlement, past practices with the customer, specific discussions or preliminary negotiations with the customer or verbal approvals by the customer. We recognize amounts associated with change orders and claims as revenue if it is probable that the contract price will be adjusted and the amount of any such adjustment can be reliably estimated. Most of our change orders are for services that are not distinct from an existing contract and are accounted for as part of an existing contract on a cumulative catch-up basis. We account for a change order as a separate contract if the additional goods or services are distinct from and increase the scope of the contract, and the price of the contract increases by an amount commensurate to our standalone selling price for the additional goods or services.
As of December 31, 2018 and 2017, we had recognized revenues of $121.8 million and $144.0 million related to change orders and claims included as contract price adjustments and that were in the process of being negotiated in the normal course of business. These aggregate amounts, which were included in “Contract assets” in the accompanying consolidated balance sheets, represent management’s estimates of additional contract revenues that were earned and probable of collection. However, our estimates could be incorrect and the amount ultimately realized could be significantly higher or lower than the estimated amount.
Variable consideration amounts, including performance incentives, early pay discounts and penalties, may also cause changes in contract estimates. The amount of variable consideration is estimated based on the most likely amount that is deemed probable of realization. Contract consideration is adjusted for variable consideration when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur once the uncertainty related to the variable consideration is resolved.
Changes in contract estimates are recognized on a cumulative catch-up basis in the period in which the revisions to the estimates are made. Such changes in estimates can result in the recognition of revenue in a current period for performance obligations that were satisfied or partially satisfied in prior periods. Such changes in estimates may also result in the reversal of previously recognized revenue if the current estimate differs from the previous estimate. The impact of a change in estimate is measured as the difference between the revenue or gross profit recognized in the prior period as compared to the revenue or gross profit which would have been recognized had the revised estimate been used as the basis of recognition in the prior period. See Note 2 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data for information relating to our changes in estimates.
Current and Long-Term Accounts Receivable, Notes Receivable and Allowance for Doubtful Accounts
We provide an allowance for doubtful accounts when collection of an account or note receivable is considered doubtful, and receivables are written off against the allowance when deemed uncollectible. Inherent in the assessment of the allowance for doubtful accounts are certain judgments and estimates regarding, among other factors, our customer’s access to capital, our customer’s willingness or ability to pay, general economic and market conditions, the ongoing relationship with the customer and uncertainties related to the resolution of disputed matters. We consider accounts receivable delinquent after 30 days but do not generally include delinquent accounts in our analysis of the allowance for doubtful accounts unless the accounts receivable have been outstanding for at least 90 days. We also include accounts receivable balances that relate to customers in bankruptcy or with other known difficulties in our analysis of the allowance for doubtful accounts. Material changes to a customer’s business, cash flows or financial condition, which may be impacted by negative economic and market conditions, could affect our ability to collect amounts due. Should anticipated recoveries relating to receivables fail to materialize (including anticipated recoveries relating to existing bankruptcies or other workout situations), we could experience reduced cash flows and losses in excess of current allowances provided. Long-term accounts receivable are included within “Other assets, net” in our consolidated balance sheets.
Insurance
As discussed in Contractual Obligations — Insurance, we are insured for employer’s liability, workers’ compensation, auto liability, general liability, and group health claims, and have recognized certain liabilities and related recoveries associated with these insurance coverages. Losses under all of these insurance programs are accrued based upon our estimate of the ultimate liability for claims reported and an estimate of claims incurred but not reported, with assistance from third-party actuaries. These insurance liabilities are difficult to assess and estimate due to unknown factors, including the severity of an injury, the extent of damage, the determination of our liability in proportion to other parties and the number of incidents not reported. The accruals are based upon known facts and historical trends, and management believes such accruals are adequate. However, our assumptions may be incorrect and our actual liabilities may differ materially from our accruals. Any adjustments to our accrued amounts will be recorded in the period that the experience becomes known.
Valuation of Goodwill
Goodwill, net of accumulated impairment losses, which represents the excess of cost over the fair market value of net tangible and identifiable intangible assets of acquired businesses, is stated at cost. Goodwill is not amortized but instead is annually tested for impairment, or more frequently if events or circumstances indicate that the carrying amount of goodwill may be impaired. We have recorded goodwill in connection with our historical acquisitions of businesses. Upon acquisition, these businesses were either combined into one of our existing operating units or managed on a stand-alone basis as an individual operating unit. Our operating units are organized into one of two internal divisions: the Electric Power Infrastructure Services Division and the Pipeline and Industrial Infrastructure Services Division. As most of the companies acquired by us provide multiple types of services for multiple types of customers, these divisional designations are based on the predominant type of work performed by an operating unit at the point in time the divisional designation is made. Goodwill is required to be measured for impairment at the reporting unit level, which represents the operating segment level or one level below the operating segment level for which discrete financial information is available. We have determined that our individual operating units represent our reporting units for the purpose of assessing goodwill impairment. An annual assessment for impairment is performed for each reporting unit that carries a balance of goodwill.
Our goodwill impairment assessment is performed during the fourth quarter of our fiscal year, or more frequently if events or circumstances arise which indicate that goodwill may be impaired. An assessment can be performed by first completing a qualitative assessment on none, some or all of our reporting units. We can also bypass the qualitative assessment for any reporting unit in any period and proceed directly to the quantitative impairment test, and then resume the qualitative assessment in any subsequent period. Qualitative indicators that may trigger the need for annual or interim quantitative impairment testing include, among other things, deterioration in macroeconomic conditions, declining financial performance, deterioration in the operational environment, or an expectation of selling or disposing of a portion of a reporting unit. Additionally, a significant change in business climate, a loss of a significant customer, increased competition, a sustained decrease in share price, or a decrease in our market capitalization below book value may trigger the need for interim impairment testing of goodwill associated with one or more of our reporting units.
If we believe that, as a result of our qualitative assessment, it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. The quantitative test involves comparing the fair value of each of our reporting units with its carrying amount, including goodwill. We determine the fair value of our reporting units using a weighted combination of the income approach (discounted cash flow method) and market multiples valuation techniques (market guideline transaction method and market guideline public company method), with heavier weighting on the discounted cash flow method because management believes this method results in the most appropriate calculation of fair value and reflects an expectation of market value as determined by a “held and used” model.
Under the discounted cash flow method, we determine fair value based on the estimated future cash flows for each reporting unit, discounted to present value using a risk-adjusted industry weighted average cost of capital, which reflects the overall level of inherent risk for each reporting unit and the rate of return an outside investor would expect to earn. Cash flow projections are derived from budgeted amounts (typically a one-year model) and subsequent period cash flows are developed for each reporting unit using growth rates that management believes are reasonably likely to occur. All cash flow projections by reporting unit are evaluated by management. A terminal value is derived from a multiple of the reporting unit’s earnings before interest, taxes, depreciation and amortization (EBITDA). The EBITDA multiples for each reporting unit are based on observed purchase transactions for similar businesses adjusted for size, volatility and risk.
Under the market guideline transaction and market guideline public company methods, we determine the estimated fair value of each of our reporting units by applying transaction multiples and public company multiples, respectively, to each reporting unit’s projected EBITDA and then averaging that estimate with similar historical calculations using either a one, two or three year average. The transaction multiples are based on observed purchase transactions for similar businesses adjusted for size, volatility and risk. The public company multiples are based on peer group multiples adjusted for size, volatility and risk. For the market guideline public company method, we add a reasonable control premium, which is estimated as the premium that would be appropriate to convert the reporting unit value to a controlling interest basis.
The following table presents the significant estimates used by management in determining the fair values of our reporting units for which a quantitative assessment was performed at December 31, 2018, 2017 and 2016:
| 2018 | 2017 | 2016 | ||||
| Years of cash flows before terminal value | 5 years | 5 years | 5 years | |||
| Weighted average cost of capital | 12.0% to 15.0% | 12.0% to 14.0% | 12.5% to 14.5% | |||
| Transaction multiples applied to EBITDA | 6.5 to 9.0 | 5.5 to 7.0 | 5.5 to 7.0 | |||
| Guideline public company multiples applied to EBITDA | 6.5 to 9.5 | 6.5 to 8.0 | 5.5 to 7.0 | |||
| Five-year revenue compounded annual growth rates | -14% to 8% | -14% to 17% | -2% to 24% | |||
| Weighting of three methods: | ||||||
| Discounted cash flows | 70% | 70% | 70% | |||
| Market guideline transaction method | 15% | 15% | 15% | |||
| Market guideline public company method | 15% | 15% | 15% |
Although no goodwill impairment charges were recorded during the year ended December 31, 2018, the determination of a reporting unit’s fair value requires judgment and the use of significant estimates and assumptions. We believe the estimates and assumptions used in our impairment assessments are reasonable and based on available market information obtained from relevant industry sources; however, variations in any of the assumptions could result in materially different calculations of fair value and impairment determinations. Accordingly, management considered the sensitivity of its fair value estimates to changes in certain valuation assumptions. After taking into account a 10% decrease in the fair value of the reporting units for which a quantitative impairment test was performed, two reporting units within our Pipeline and Industrial Infrastructure Services Division would have fair values below their carrying amounts. One of the reporting units is the material handling services business for which a goodwill
impairment was recorded in 2017 as described in Note 2 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data and the other reporting unit operates within the midstream and smaller-scale pipeline market. Goodwill and intangible assets associated with these two reporting units were $48.0 million and $11.1 million at December 31, 2018.
If an operating unit experiences prolonged periods of declining revenues, operating margins or both, it may be at risk of failing the quantitative goodwill impairment test. The reporting units referenced above have experienced declines over the short-term due to challenging macroeconomic conditions in certain geographic areas and low oil and natural gas prices, which have negatively impacted customer spending and resulted in project cancellations and delays. Additionally, customer capital spending has been constrained as a result of an increasingly complex regulatory and permitting environment. We monitor these conditions and others to determine if it is necessary to perform the quantitative fair-value based impairment test for one or more operating units prior to the annual impairment assessment.
Due to the cyclical nature of our business, and the other factors described above and in Item 1A. Risk Factors, the profitability of our individual reporting units may suffer from decreases in customer demand and other factors. These factors may have a disproportionate impact on the individual reporting units as compared to Quanta as a whole and might adversely affect the fair value of individual reporting units. If material adverse conditions occur that impact our reporting units, our future estimates of fair value may not support the carrying amount of one or more of our reporting units, and the related goodwill would need to be written down to an amount considered recoverable.
Valuation of Other Intangible Assets
Our intangible assets include customer relationships, backlog, trade names, non-compete agreements, patented rights and developed technology and curriculum, all of which are subject to amortization, as well as an engineering license, which is not subject to amortization. The value of customer relationships is estimated as of the date a business is acquired based on the value-in-use concept utilizing the income approach, specifically the multi-period excess earnings method. This analysis discounts to present value the projected cash flows attributable to the customer relationships, with consideration given to customer contract renewals and estimated customer attrition rates. The following table presents the significant estimates used by management in determining the fair values of customer relationships associated with acquisitions in the years ended December 31, 2018, 2017 and 2016:
| 2018 | 2017 | 2016 | ||||
| Discount rates | 20% to 27% | 17% to 25% | 20% to 23% | |||
| Customer attrition rates | 20% to 33% | 15% to 78% | 10% to 70% |
We value backlog for acquired businesses as of the acquisition date based upon the contractual nature of the backlog within each service line, discounted to present value. The value of trade names and curriculum are estimated using the relief-from-royalty method of the income approach, which is based on the assumption that in lieu of ownership, a company would be willing to pay a royalty for use of the trade name and curriculum. The value of a non-compete agreement is estimated based on the difference between the present value of the prospective cash flows with the agreement in place and the present value of the prospective cash flows without the agreement in place. The value of the engineering license is based on cash paid to acquire the asset.
We amortize the intangible assets that are subject to amortization based upon the estimated consumption of their economic benefits, or on a straight-line basis if the pattern of economic benefit cannot otherwise be reliably estimated. Intangible assets are reviewed for impairment and tested for recoverability whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. For instance, a significant change in business climate or a loss of a significant customer, among other things, may trigger the need for interim impairment testing of intangible assets. An impairment loss is recognized if the carrying amount of an intangible asset is not recoverable and its carrying amount exceeds its fair value. Intangible asset impairments are included within “Asset impairment charges” on our consolidated statements of operations.
Valuation of Long-Lived Assets
We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be realizable. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset group are compared to the asset group’s carrying amount to determine if an impairment is necessary. This requires us to make long-term forecasts of the future revenues and costs related to the asset group. Forecasts require assumptions about demand for our products and future market conditions. Estimating future cash flows requires significant judgment, and our projections may vary from the cash flows eventually realized. When an impairment exists, the difference between the fair value of the asset group and its carrying amount is expensed and reflected in operating income (loss) in our consolidated statements of operations. In addition, we estimate the useful lives of our long-lived assets and periodically review these estimates to determine whether they are appropriate. Depreciation expense related to property and equipment is recognized on a straight-line basis over the estimated useful lives of the long-lived assets.
Contingent Consideration Liabilities
As more fully described in Contractual Obligations — Contingent Consideration Liabilities above, we have recorded liabilities related to contingent consideration associated with certain acquisitions, the payment of which is contingent upon the achievement of certain performance objectives by the acquired businesses during post-acquisition periods and, if earned, would be payable to the former owners of the acquired businesses. The liabilities recorded represent the estimated fair values of future amounts payable to the former owners and are estimated by management based on entity-specific assumptions that are evaluated on an ongoing basis.
The fair value of contingent consideration liabilities as of December 31, 2018 was primarily determined using a Monte Carlo simulation valuation methodology based on probability-weighted performance projections and other inputs, including a discount rate and an expected volatility factor for each acquisition. The expected volatility factors ranged from 22.2% to 30.0% based on historical asset volatility of selected guideline public companies. Depending on contingent consideration payment terms, the present value of the estimated payments are discounted based on a risk free rate and/or our cost of debt, ranging from 2.1% to 3.8%. The fair value determinations incorporate significant inputs not observable in the market. Accordingly, the level of inputs used for these fair value measurements is the lowest level (Level 3). Significant changes in any of these assumptions could result in a significantly higher or lower potential liability.
Income Taxes
We follow the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recorded based on future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the underlying assets or liabilities are recovered or settled.
We regularly evaluate valuation allowances established for deferred tax assets for which future realization is uncertain, including in connection with changes in tax laws. The estimation of required valuation allowances includes estimates of future taxable income. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider projected future taxable income and tax planning strategies in making this assessment. If actual future taxable income differs from our estimates, we may not realize deferred tax assets to the extent estimated.
We record reserves for income taxes related to certain tax positions in those instances where we consider it more likely than not that additional taxes may be due in excess of amounts reflected on income tax returns filed. When recording these reserves, we assume that taxing authorities have full knowledge of the position and all relevant facts. We continually review exposure to additional tax obligations, and as further information is known or events occur, changes in tax reserves may be recorded. To the extent interest and penalties may be assessed by taxing authorities on any underpayment of income tax, such amounts have been accrued and included in the provision for income taxes.
U.S. federal and state and foreign income tax laws and regulations are voluminous and are often ambiguous. As such, we are required to make many subjective assumptions and judgments regarding our tax positions that could materially affect amounts recognized in our future consolidated balance sheets, consolidated statements of operations and consolidated statements of comprehensive income. For example, the Tax Act significantly revised the U.S. corporate tax regime, which, among other things, resulted in a reduction of our current and estimated future effective tax rate and a remeasurement of our deferred tax assets and liabilities. For additional information on the Tax Act, refer to Results of Operations above and Note 9 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data.
Outlook
We believe there are growth opportunities across the industries we serve and continue to have a positive long-term outlook. Overall, favorable end-market drivers have spurred demand for infrastructure services in both our Electric Power Infrastructure Services and Pipeline and Industrial Infrastructure Services segments, and we believe both segments are generally in a multi-year up-cycle. Additionally, the traditional electric utility model has evolved since our inception, with many long-standing customers shifting their focus from fossil fuel-based electric power generation to an advanced integrated utility model that is primarily focused on electric transmission and distribution investment, and increasing their focus on gas distribution and ownership of pipeline infrastructure. We have strategically adapted our business over time to respond to these changes, which allows us to collaborate with our customers and create unique solutions that benefit end users. We are focused on long-term profitable growth and continuing to distinguish ourselves through safe execution and best-in-class field leadership. Although not without risks and challenges, including those discussed below and referenced in Item 1A. Risk Factors of Part I of this Annual Report and Uncertainty of Forward-Looking Statements and Information below, we believe we are well-positioned to capitalize on opportunities and trends in the industries we serve with our full-service operations, broad geographic reach, financial position and technical expertise.
Electric Power Infrastructure Services Segment
We expect demand for electricity in North America to grow over the long term and believe that certain segments of the North American electric power grid are not adequate to efficiently serve the power needs of the future. These factors have affected and will continue to affect reliability, requiring utilities to upgrade, modernize and expand their existing transmission and distribution systems. Furthermore, current federal legislation also requires the power industry to meet federal reliability standards for its transmission and distribution systems. In response to these dynamics, over the past several years, many utilities across North America have begun to implement plans to upgrade their transmission and distribution systems in order to improve reliability and reduce congestion.
As demand for power increases, we expect the need for new power generation facilities to also increase. The development of such facilities, expected to be powered by certain types of traditional energy sources and renewable energy sources such as solar and wind, would necessitate new or expanded transmission infrastructure to transport power to demand centers. Furthermore, we anticipate that the access to low cost natural gas resources from unconventional shale formations in the United States and Canada will continue to increase the amount of electricity generated by natural gas-powered plants. To the extent this dynamic continues, transmission and substation infrastructure will be needed to interconnect new natural gas-fired generation facilities. We also anticipate that modification and reengineering of existing transmission and substation infrastructure will be required as existing coal and nuclear generation facilities are retired or shut down.
With respect to distribution systems, a number of utilities are implementing system upgrades or hardening programs in response to severe weather events that have occurred over the past several years, which is increasing distribution investment in some regions of the United States. We also anticipate that utilities will continue to integrate smart grid technologies into their distribution systems over time to improve grid management and create efficiencies. Further, to the extent adoption of electrical vehicle technology increases, we believe upgrades to distribution and other electrical infrastructure will be required to accommodate increased load demand.
We believe that several existing, pending or proposed legislative or regulatory actions may also positively impact long-term demand for the services we provide, particularly in connection with electric power infrastructure and renewable energy spending. For example, legislative or regulatory action that alleviates some of the siting and right-of-way challenges that impact transmission projects would potentially accelerate future construction, and federal reliability standards for transmission and distribution systems could create incentives for system investment and maintenance. We also consider renewable energy, including solar and wind generation facilities, to be an ongoing opportunity for our engineering, project management and installation services; however, the economic feasibility of these projects may depend on the availability of tax incentive programs and there is no assurance that existing incentive programs will be extended or that new incentive programs will be implemented.
Despite these positive trends, the regulatory and environmental permitting processes remain a hurdle for some proposed transmission and renewable energy projects, and these factors continue to create uncertainty as to timing of projects and customer spending. In the near term, margins for our electric power infrastructure services operations have been impacted by regulatory and permitting delays and unfavorable economic and market conditions, particularly for larger transmission projects. We anticipate many of these issues to be resolved over the long term, as a number of these projects are currently underway, and we expect this segment’s backlog to remain strong during 2019.
Our customers are also seeking additional specialized labor resources to address an aging utility workforce and labor availability issues, increasing pressure to reduce costs and improve reliability, and increasing duration and complexity of customer capital programs. We believe these trends will continue, possibly to the point where customer demand for labor resources will outpace the supply of industry resources. Our ability to take advantage of available opportunities is limited by our ability to employ, train and retain the necessary skilled personnel. We are taking proactive steps to develop our workforce, including through strategic relationships with universities, the military and unions; the expansion and development of our training facility, which provides classroom and on-the-job training programs; and the acquisition and development of our postsecondary educational institution, which specializes in pre-apprenticeship training, apprenticeship training and specialized utility task training for electric workers, and has been recently expanded to include curriculum for the gas distribution and communications industries. Although we believe these initiatives will help address workforce needs, meeting our customers’ demand for labor resources could remain challenging.
With respect to our communications service offerings, consumer and commercial demand in North America and Latin America for communication and data-intensive, high-bandwidth wireline and wireless services and applications is driving significant investment in infrastructure and the deployment of new technologies. In particular, we believe there is increasing demand to upgrade or build fiber optic networks that are closer or connected to the end user. In North America, communications providers are in the early stages of developing new fifth generation wireless services (5G), which are intended to facilitate bandwidth-intensive services at high speeds for consumers and a wide range of commercial applications. These 5G networks
require significant fiber network development and the deployment of new small cells to provide 5G services. As a result of these near- and longer-term industry trends, we believe there will be meaningful demand for our services.
Pipeline and Industrial Infrastructure Services Segment
We continue to see growth opportunities in our Pipeline and Industrial Infrastructure Services segment, primarily with respect to services related to natural gas distribution, pipeline integrity, downstream industrial services, the installation and maintenance of larger pipeline systems and associated facilities and horizontal directional drilling.
We have experienced an increase in demand for our natural gas distribution services as a result of improved economic conditions, lower natural gas prices and a significant need to upgrade and replace aging infrastructure. We believe there are also growth opportunities for our pipeline integrity, rehabilitation and replacement services. Regulatory measures have increased and could continue to increase the frequency or stringency of pipeline integrity testing requirements, which we expect to result in increased capital expenditures by our customers.
We have also expanded our industrial services offerings, including high-pressure and critical-path turnaround services to the downstream and midstream energy markets, and enhanced our capabilities with respect to instrumentation and electrical services, piping, fabrication and storage tank services. While these services can be negatively impacted by severe weather events along the U.S. Gulf Coast region, we believe, looking at trends and estimates for process facility utilization rates and overall refining capacity, North America will be the largest downstream maintenance market in the world over the next several years. Furthermore, we believe processing facilities located along the U.S. Gulf Coast region should have certain strategic advantages due to their access and proximity to affordable hydrocarbon resources.
A number of larger pipeline projects from the North American shale formations and Canadian oil sands to power plants, refineries and other demand centers are in various stages of development. While there is risk the projects will not move forward or could be delayed, we believe many of our customers remain committed to them given the cost and time required to move from conception to construction.
Due to its abundant supply and current low price, we believe demand for North American natural gas will continue to increase in the future and that natural gas will remain a fuel of choice for both primary power generation and backup power generation for renewable-driven power plants. In certain areas of North America, the existing pipeline system infrastructure is insufficient to support this expected future development. Furthermore, the abundance of affordable natural gas in the United States, Canada and Australia has also resulted in efforts to develop liquefied natural gas (LNG) export facilities to serve higher-price international markets, which could provide pipeline and related facilities development opportunities for us. Although fluctuating commodity prices, regulatory issues and changing economic conditions may impact the number of projects that ultimately move forward, we believe our comprehensive service offerings and broad geographic presence enable us to competitively pursue opportunities that become available.
Despite these positive trends, a challenging regulatory and permitting environment has caused the delay of some larger pipeline projects during the past several years. These dynamics negatively impacted our segment margins, in part as a result of our inability to adequately cover certain fixed costs. Margins for larger pipeline projects are also subject to significant performance risk, which can arise from adverse weather conditions, challenging geography, customer decisions and crew productivity. Specific opportunities for larger pipeline projects are also sometimes difficult to predict because of the seasonality of bidding and construction cycles.
Although much of this segment’s services are influenced by hydrocarbon production volume rather than shorter-term changes in commodity prices, the broader oil and gas industry is highly cyclical and subject to volatility as a result of fluctuations in natural gas, natural gas liquids and oil prices. Certain of our end markets remain challenged as the broader energy market has not fully recovered from the significant decline in oil prices that began in mid-2014. Exploration and production companies and midstream companies significantly reduced capital spending in response to the price decline, and demand in certain areas where the price of oil is influential, such as Australia, the Canadian Oil Sands, certain oil-driven U.S. shale formations and the Gulf of Mexico, has been adversely impacted by low oil prices. If oil and natural gas prices decline or remain at lower levels over the long term, our outlook may change and demand for our services could be materially impacted.
Overall, we remain optimistic about this segment’s operations. Over several years we have taken steps to diversify and expand our operations in this segment through services such as pipeline integrity, natural gas distribution, and downstream industrial services, to better withstand various end-market cyclicality. Additionally, from a near- and medium-term perspective, we continue to believe that larger pipeline opportunities can provide significant profitability, although these projects are often subject to more cyclicality and execution risk than our other service offerings.
Strategic Acquisitions and Investments
We continue to evaluate potential strategic acquisitions and investments to broaden our customer base, expand our geographic area of operations, grow our portfolio of services and increase opportunities across our operations. We believe that attractive growth opportunities exist primarily due to the highly fragmented and evolving nature of the industries in which we operate and adjacent industries, along with the inability of many companies to expand and modernize due to capital or liquidity constraints. We will pursue opportunities designed to enhance our core business and leadership position in the industries we serve and provide innovative solutions to our customers. We also believe our unique operating model and entrepreneurial mindset will continue to be attractive to acquisition candidates.
Uncertainty of Forward-Looking Statements and Information
This Annual Report includes “forward-looking statements” reflecting assumptions, expectations, projections, intentions or beliefs about future events that are intended to qualify for the “safe harbor” from liability established by the Private Securities Litigation Reform Act of 1995. You can identify these statements by the fact that they do not relate strictly to historical or current facts. They use words such as “anticipate,” “estimate,” “project,” “forecast,” “may,” “will,” “should,” “could,” “expect,” “believe,” “plan,” “intend” and other words of similar meaning. In particular, these include, but are not limited to, statements relating to the following:
| • | Projected revenues, net income, earnings per share, margins, weighted average shares outstanding, capital expenditures, tax rates and other projections of operating or financial results; |
| • | Expectations regarding our business or financial outlook, growth, trends or opportunities in particular markets; |
| • | The expected value of contracts or intended contracts with customers; |
| • | Future capital allocation initiatives; |
| • | The scope, services, term and results of any projects awarded or expected to be awarded for services to be provided by us; |
| • | The development of larger electric transmission and pipeline projects, as well as the level of oil, natural gas and natural gas liquids prices and their impact on our business or demand for our services; |
| • | Future capital allocation initiatives, including the amount, timing and strategies with respect to any future stock repurchases, and expectations regarding the declaration, amount and timing of any future cash dividends; |
| • | The impact of existing or potential legislation or regulation; |
| • | Potential opportunities that may be indicated by bidding activity or similar discussions with customers; |
| • | The future demand for and availability of labor resources in the industries we serve; |
| • | The expected realization of remaining performance obligations or backlog; |
| • | The potential benefits from investments or acquisitions; |
| • | The expected outcome of pending or threatened litigation; |
| • | Beliefs and assumptions about the collectability of receivables; |
| • | The business plans or financial condition of our customers; |
| • | Our plans and strategies; |
| • | Possible recovery of pending or contemplated insurance claims or change orders or claims against customers or third parties; and |
| • | The current economic and regulatory conditions and trends in the industries we serve. |
These forward-looking statements are not guarantees of future performance, involve or rely on a number of risks, uncertainties, and assumptions that are difficult to predict or beyond our control, and reflect management’s beliefs and assumptions based on information available at the time the statements are made. We caution you that actual outcomes and results may differ materially from what is expressed, implied or forecasted by our forward-looking statements and that any or all of our forward-looking statements may turn out to be inaccurate or incorrect. Those statements can be affected by inaccurate assumptions and by known or unknown risks and uncertainties, including the following:
| • | Market conditions; |
| • | The effects of industry, economic, financial or political conditions outside our control, including weakness in the capital markets or any actual or potential shutdown, sequester, default or similar event or occurrence involving the U.S. federal government; |
| • | Quarterly variations in our operating and financial results, liquidity, financial condition, capital requirements, and reinvestment opportunities; |
| • | Trends and growth opportunities in relevant markets; |
| • | Delays, reductions in scope or cancellations of anticipated, pending or existing projects, including as a result of weather, regulatory or permitting issues, environmental processes, project performance issues, claimed force majeure events, protests or other political activity, legal challenges or customer capital constraints; |
| • | The successful negotiation, execution, performance and completion of anticipated, pending and existing contracts, including the ability to obtain future project awards; |
| • | Our dependence on suppliers, subcontractors, equipment manufacturers and other third-party contractors; |
| • | Our ability to attract and the potential shortage of skilled employees and our ability to retain key personnel and qualified employees; |
| • | Our dependence on fixed price contracts and the potential to incur losses with respect to these contracts; |
| • | Estimates relating to revenue recognition and costs associated with contracts; |
| • | Adverse weather conditions or significant weather events, including hurricanes, tropical storms and floods; |
| • | Risks associated with operational hazards that arise due to the nature of the services we provide and the conditions in which we operate; |
| • | Our ability to generate internal growth; |
| • | Competition in our business, including our ability to effectively compete for new projects and market share; |
| • | The effect of natural gas, natural gas liquids and oil prices on our operations and growth opportunities and on our customers’ capital programs and demand for our services; |
| • | The future development of natural resources; |
| • | The failure of existing or potential legislative actions and initiatives to result in demand for our services; |
| • | Fluctuations of prices of certain materials used in our business, including as a result of the imposition of tariffs or changes in U.S. trade relationships with other countries; |
| • | Unexpected costs or liabilities that may arise from pending or threatened litigation, indemnity obligations or other claims or actions asserted against us, including liabilities, costs, fines or penalties for which we are not covered by, or are in excess of, our third-party insurance; |
| • | The outcome of pending or threatened litigation; |
| • | Risks relating to the potential unavailability or cancellation of third-party insurance, the exclusion of coverage for certain losses, and potential increases in premiums for coverage deemed beneficial to us; |
| • | Damage to our brand or reputation arising as a result of cyber-security or data privacy breaches, environmental and occupational health and safety matters, or other negative corporate incidents; |
| • | Cancellation provisions within our contracts and the risk that contracts expire and are not renewed or are replaced on less favorable terms; |
| • | Loss of customers with whom we have long-standing or significant relationships; |
| • | The potential that participation in joint ventures or similar structures exposes us to liability and/or harm to our reputation for acts or omissions by our partners; |
| • | Our inability or failure to comply with the terms of our contracts, which may result in additional costs, unexcused delays, warranty claims, failure to meet performance guarantees, damages or contract terminations; |
| • | The inability or refusal of our customers to pay for services, including failure to collect our outstanding receivables; |
| • | The failure to recover on payment claims against project owners or third-party contractors or to obtain adequate compensation for customer-requested change orders; |
| • | The failure of our customers to comply with regulatory requirements applicable to their projects, which may result in project delays and cancellations; |
| • | Budgetary or other constraints that may reduce or eliminate tax incentives or government funding for projects, which may result in project delays or cancellations; |
| • | Estimates and assumptions in determining our financial results, remaining performance obligations and backlog; |
| • | Our ability to successfully complete our remaining performance obligations or realize our backlog; |
| • | Risks associated with operating in international markets, including instability of foreign governments, currency exchange fluctuations, and compliance with unfamiliar foreign legal systems and cultural practices, the U.S. Foreign Corrupt Practices Act and other applicable anti-bribery and anti-corruption laws, and complex U.S. and foreign tax regulations and international treaties; |
| • | Our ability to successfully identify, complete, integrate and realize synergies from acquisitions; |
| • | The potential adverse impact resulting from uncertainty surrounding acquisitions and investments, including the ability to retain key personnel from acquired businesses, the potential increase in risks already existing in our operations and poor performance or decline in value of our investments; |
| • | The adverse impact of impairments of goodwill, other intangible assets, receivables, long-lived assets or investments; |
| • | Our growth outpacing our decentralized management and infrastructure; |
| • | Requirements relating to governmental regulation and changes thereto; |
| • | Inability to enforce our intellectual property rights or the obsolescence of such rights; |
| • | Risks related to the implementation of new information technology solutions; |
| • | The impact of our unionized workforce on our operations, including labor stoppages or interruptions due to strikes or lockouts; |
| • | The cost of borrowing, availability of cash and credit, fluctuations in the price and volume of our common stock, debt covenant compliance, interest rate fluctuations and other factors affecting our financing and investing activities; |
| • | The ability to access sufficient funding to finance desired growth and operations; |
| • | Our ability to obtain performance bonds; |
| • | Our ability to meet the regulatory requirements applicable to us and our subsidiaries, including the Sarbanes-Oxley Act of 2002; |
| • | Rapid technological and other structural changes that could reduce the demand for our services; |
| • | New or changed tax laws, treaties or regulations; |
| • | Legislative or regulatory changes that result in increased costs, including with respect of labor and healthcare costs; |
| • | Significant fluctuations in foreign currency exchange rates; and |
| • | The other risks and uncertainties described elsewhere herein and in Item 1A. Risk Factors in this Annual Report and as may be detailed from time to time in our other public filings with the SEC. |
All of our forward-looking statements, whether written or oral, are expressly qualified by these cautionary statements and any other cautionary statements that may accompany such forward-looking statements or that are otherwise included in this report. In addition, we do not undertake and expressly disclaim any obligation to update or revise any forward-looking statements to reflect events or circumstances after the date of this report or otherwise.
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