Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This discussion and analysis of our financial condition and results of operations is intended to assist in understanding and assessing the trends and significant changes in our results of operations and financial condition. Historical results may not be indicative of future performance. This discussion includes forward-looking statements that reflect our plans, estimates and beliefs. Such statements involve risks and uncertainties. Our actual results may differ materially from those contemplated by these forward-looking statements as a result of various factors, including those set forth under the headings “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements.” This discussion should be read in conjunction with our audited consolidated financial statements and the notes thereto included elsewhere in this report. In this discussion, we use certain non-GAAP financial measures. An explanation of these non-GAAP financial measures and a reconciliation to the most directly comparable GAAP financial measures are included in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Investors should not consider non-GAAP financial measures in isolation or as substitutes for financial information presented in compliance with GAAP.
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Overview
We are a civil infrastructure company that specializes in the building and maintenance of transportation networks. Our operations leverage a highly-skilled workforce, strategically located HMA plants, substantial construction assets and select material deposits. We provide construction products and services to both public and private infrastructure projects, with an emphasis on highways, roads, bridges, airports and commercial and residential sites in the southeastern United States.
Our public projects are funded by federal, state and local governments and include roads, highways, bridges, airports and other forms of infrastructure. Public transportation infrastructure projects historically have been a relatively stable portion of state and federal budgets and represent a significant share of the United States construction market. Federal funds are allocated on a state-by-state basis, and each state is required to match a portion of the federal funds that it receives. Federal highway spending uses funds predominantly from the Highway Trust Fund, which derives its revenues from fuel taxes and other user fees.
In addition to public infrastructure projects, we provide a wide range of large site work construction and HMA paving services to private construction customers, including commercial and residential developers and local businesses.
Fiscal 2021 Developments
COVID-19
We did not incur significant disruptions from the COVID-19 pandemic during the fiscal year ended September 30, 2021. However, we continue to closely monitor the impact of the pandemic on all aspects of our business, including its impact on our customers, employees, suppliers and vendors. Among the primary risks to our business from the pandemic are (i) employee absences, which could adversely affect our productivity and our ability to complete projects in accordance with our contractual obligations, and could require us to temporarily close our facilities or project sites, (ii) potential disruptions in our supply chains for raw materials or equipment, whether as a result of facility closures or otherwise, which could increase our labor and materials costs and impair our ability to manufacture HMA or the ability of our subcontractors to complete their required tasks, and (iii) the impact of the COVID-19 pandemic on our customers, which could cause these customers to cancel or delay current or prospective projects or become delinquent in their payments to us for work that we have performed. These risks materialized in varying degrees during fiscal 2021, but none of these risks, individually or in the aggregate, have significantly impacted our operations to date. In addition, the extent to which our operations may be impacted by the COVID-19 pandemic going forward will also depend on the duration of the pandemic, the emergence of different COVID-19 variants, the efficacy and adoption rates of vaccines, and actions by government authorities to contain the outbreak or mitigate the impact of the pandemic. For example, we continue to monitor the impact of vaccination requirements imposed by our customers or governmental authorities on our workforce, which could increase employee turnover and thereby impair our ability to perform our construction projects.
Business Acquisitions
We completed eight acquisitions during the fiscal year, through which we added eighteen HMA plants and five aggregates facilities located in North Carolina and Alabama. As a result of these acquisitions, we entered into several new markets, while also securing crushed stone and aggregates sources for certain of our markets as part of our vertical integration strategy and adding a diverse fleet of trucks and construction equipment to support our operations. For more information about our acquisitions during fiscal 2021, see Note 4 - Business Acquisitions to our consolidated financial statements included elsewhere in this report.
Amended and Restated Credit Agreement
In June 2021, we amended and restated our existing Credit Agreement to, among other things, increase the amount of our Term Loan to an initial aggregate principal amount of $200 million (the full amount of which was drawn immediately) and the amount of our Revolving Credit Facility to an initial aggregate principal amount of $225 million. We used a portion of the proceeds advanced to us to refinance our indebtedness outstanding on the restatement date and to pay fees and expenses incurred in connection with the transaction, with the remainder available for our general corporate purposes, including permitted acquisitions. For more information about the Credit Agreement, see Note 11 - Debt to our consolidated financial statements included elsewhere in this report.
Inflation, Supply Chain and Labor
During fiscal 2021, we began to experience an upward trend in several inflation-sensitive inputs necessary for us to provide our products and services, including upward pressure on wages and increases in the cost of raw materials used to produce HMA and other items that are critical to our business, including fuel, concrete and steel. In addition, we experienced some disruptions from various participants in our supply chain, including subcontractors, materials suppliers and equipment manufacturers, who provide the raw materials, equipment, vehicles, construction supplies and other services we require in order to manufacture HMA and perform our construction projects. To date, we have been able to mitigate some of the effects of inflation, supply chain disruptions and labor constraints on our business by increasing prices for our products and including the anticipated cost increases in the construction
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projects we bid. However, we are limited in our ability to pass through increased costs for projects already in our backlog and, under those circumstances, may be unable to recoup losses or diminished profit margins by passing these costs through to our customers.
How We Assess Performance of Our Business
Revenues
We derive our revenues predominantly by providing construction products and services for both public and private infrastructure projects, with an emphasis on highways, roads, bridges, airports and commercial and residential sites. Our projects represent a mix of federal, state, municipal and private customers. We also derive revenues from the sale of HMA, aggregates, and liquid asphalt cement to customers. We recognize revenues derived from projects as we satisfy our performance obligations over time (formerly known as the percentage-of-completion method), measured by the relationship of total cost incurred compared to total estimated contract costs (cost-to-cost input method). Changes in job performance, job conditions and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to estimated costs and income, and are recognized in the period in which the revisions are determined. Revenues derived from the sale of HMA, aggregates, and liquid asphalt cement are recognized when the risks associated with ownership have passed to the customer.
Gross Profit
Gross profit represents revenues less cost of revenues. Cost of revenues consists of all direct and indirect costs associated with construction contracts, including raw materials, labor, equipment costs, depreciation, lease expenses, subcontract costs and other expenses at our HMA plants, aggregates mining facilities, and liquid asphalt cement terminal. Our cost of revenues is directly affected by fluctuations in commodity prices, primarily liquid asphalt and diesel fuel. From time to time, when appropriate, we limit our exposure to changes in commodity prices by entering into forward purchase commitments. In addition, our public infrastructure contracts often provide for price adjustments based on fluctuations in certain commodity-related product costs. These price adjustment provisions are in place for most of our public infrastructure contracts, and we seek to include similar provisions in our private contracts.
Depreciation, Depletion, Accretion and Amortization
Property, plant and equipment are initially recorded at cost or, if acquired as a business combination, at fair value. Depreciation on property, plant and equipment is computed on a straight-line basis over the estimated useful life of the asset. Amortization expense is the periodic expense related to leasehold improvements and intangible assets. Leasehold improvements are amortized over the lesser of the life of the underlying asset or the remaining lease term. Our intangible assets were recognized as a result of certain acquisitions and are generally amortized on a straight-line basis over the estimated useful lives of the assets. Mineral reserves are depleted in accordance with the units-of-production method as aggregates are extracted, using the initial allocation of cost based on proven and probable reserves.
General and Administrative Expenses
General and administrative expenses include costs related to our operational offices that are not allocated to direct contract costs and expenses related to our corporate offices. These expenses consist primarily of salaries and personnel costs for our administration, finance and accounting, legal, information systems, human resources and certain managerial employees. General and administrative expenses also include acquisition expenses, audit, consulting and professional fees, stock-based compensation expense, travel, insurance, office space rental costs, property taxes and other corporate and overhead expenses.
Gain on Sale of Equipment, Net
In the normal course of business, we sell construction equipment for various reasons, including when the cost of maintaining the asset exceeds the cost of replacing it. The gain or loss on the sale of equipment reflects the difference between the carrying value at the date of disposal and the net consideration received from the sale of equipment during the period.
Interest Expense, Net
Interest expense, net primarily represents interest incurred on our long-term debt, such as the Term Loan and the Revolving Credit Facility, as well as the changes in fair values of interest swap agreements and amortization of deferred debt issuance costs. These amounts are partially offset by interest income earned on short-term investments of cash balances in excess of our current operating needs.
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Other Key Performance Indicators — Adjusted EBITDA, Adjusted EBITDA Margin, and Adjusted Net Income
Adjusted EBITDA represents net income before, as applicable from time to time, (i) interest expense, net, (ii) provision (benefit) for income taxes, (iii) depreciation, depletion, accretion and amortization, (iv) equity-based compensation expense, (v) loss on the extinguishment of debt, (vi) certain management fees and expenses and (vii) nonrecurring legal settlement costs and associated legal expenses unrelated to the Company’s core operations. Adjusted EBITDA Margin represents Adjusted EBITDA as a percentage of revenues for each period. Adjusted net income represents net income before nonrecurring legal settlement costs and associated legal expenses unrelated to the Company’s core operations. These metrics are supplemental measures of our operating performance that are neither required by, nor presented in accordance with, GAAP. These measures have limitations as analytical tools and should not be considered in isolation or as an alternative to net income or any other performance measure derived in accordance with GAAP as an indicator of our operating performance. We present Adjusted EBITDA, Adjusted EBITDA Margin and Adjusted net income because management uses these measures as key performance indicators, and we believe that securities analysts, investors and others use these measures to evaluate companies in our industry. Our calculation of Adjusted EBITDA, Adjusted EBITDA Margin and Adjusted net income may not be comparable to similarly named measures reported by other companies. Potential differences may include differences in capital structures, tax positions and the age and book depreciation of intangible and tangible assets.
The following table presents a reconciliation of net income, the most directly comparable measure calculated in accordance with GAAP, to Adjusted EBITDA and the calculation of Adjusted EBITDA Margin for the periods presented (in thousands, except percentages):
For the Fiscal Year
Ended September 30,
2021 2020
Net income $ 20,177 $ 40,297
Interest expense, net 2,404 3,113
Provision for income taxes 8,349 12,760
Depreciation, depletion, accretion and amortization 49,806 39,301
Equity-based compensation expense 3,549 1,570
Management fees and expenses (1)
1,935 1,403
Settlement of legal claim and associated legal expenses (2)
4,362 434
Adjusted EBITDA $ 90,582 $ 98,878
Revenues $ 910,739 $ 785,679
Adjusted EBITDA Margin 9.9 % 12.6 %
(1) Reflects fees and reimbursement of certain out-of-pocket expenses under a management services agreement with SunTx Capital Partners, the Company’s controlling stockholder (see Note 17 - Related Parties to the consolidated financial statements included elsewhere in this report).
(2) Reflects $3.2 million legal settlement and associated legal expenses (see Note 26 - Legal Settlement to the consolidated financial statements included elsewhere in this report).
The following table presents a reconciliation of net income, the most directly comparable measure calculated in accordance with GAAP, to adjusted net income for the periods presented (in thousands):
For the Fiscal Year
Ended September 30,
2021 2020
Net income $ 20,177 $ 40,297
Settlement of legal claim and associated legal expenses (1)
4,362 434
Tax impact due to above reconciling items $ (570) $ (109)
Adjusted net income $ 23,969 $ 40,622
(1) Reflects $3.2 million legal settlement and associated legal expenses (see Note 26 - Legal Settlement to the consolidated financial statements included elsewhere in this report).
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Results of Operations — Fiscal Year Ended September 30, 2021 Compared to Fiscal Year Ended September 30, 2020
The following table sets forth selected financial data for the fiscal years ended September 30, 2021 (“fiscal 2021”) and September 30, 2020 (“fiscal 2020”) (in thousands, except percentages). Refer to the Annual Report on Form 10-K for the fiscal year ended September 30, 2020, filed with the SEC on December 11, 2020, for a discussion of results for the fiscal year ended September 30, 2019.
For the Fiscal Year Ended September 30, Change from Fiscal
2020 to Fiscal 2021
2021 2020
Dollars % of
Revenues Dollars % of
Revenues $ Change %
Change
Revenues $ 910,739 100.0 % $ 785,679 100.0 % $ 125,060 15.9 %
Cost of revenues 790,803 86.8 % 663,467 84.4 % 127,336 19.2 %
Gross profit 119,936 13.2 % 122,212 15.6 % (2,276) (1.9) %
General and administrative expenses (91,878) (10.1) % (68,597) (8.7) % (23,281) 33.9 %
Gain on sale of equipment, net 2,043 0.2 % 1,616 0.2 % 427 26.4 %
Operating income 30,101 3.3 % 55,231 7.1 % (25,130) (45.5) %
Interest expense, net (2,404) (0.3) % (3,113) (0.4) % 709 (22.8) %
Other income 819 0.1 % 336 — % 483 143.8 %
Income before provision for income taxes and earnings from investment in joint venture 28,516 3.1 % 52,454 6.7 % (23,938) (45.6) %
Provision for income taxes 8,349 0.9 % 12,760 1.6 % (4,411) (34.6) %
Earnings from investment in
joint venture 10 — % 603 — % (593) (98.3)
Net income $ 20,177 2.2 % $ 40,297 5.1 % $ (20,120) (49.9) %
Adjusted EBITDA $ 90,582 9.9 % $ 98,878 12.6 % $ (8,296) (8.4) %
Adjusted net income $ 23,969 2.6 % $ 40,622 5.2 % $ (16,653) (41.0) %
Revenues. Revenues for fiscal 2021 increased $125.0 million, or 15.9%, to $910.7 million from $785.7 million for fiscal 2020. The increase included $87.0 million of revenues attributable to acquisitions completed during or subsequent to fiscal 2020 and an increase of approximately $38.0 million of revenues in our remaining markets from contract work and sales of HMA and aggregates to third parties.
Gross Profit. Gross profit for fiscal 2021 decreased $2.3 million, or 1.9%, to $119.9 million from $122.2 million for fiscal 2020. The lower gross profit was the result of a decrease in gross profit margin to 13.2% for fiscal 2021 from 15.6% for fiscal 2020, primarily due to (i) lower margins on construction projects in the fourth quarter of fiscal 2021 due to delays related to weather, labor and trucking and supply chain issues, and (ii) lower profit margins on the projects we assumed in connection with the North Carolina acquisitions we completed during fiscal 2021 and low utilization of the asphalt plants and equipment acquired in those acquisitions.
General and Administrative Expenses. General and administrative expenses for fiscal 2021 increased $23.3 million, or 33.9%, to $91.9 million from $68.6 million for fiscal 2020. The increase in general and administrative expenses for fiscal 2021 compared to fiscal 2020 was primarily the result of (i) a $2.0 million increase in equity-based compensation expense, (ii) a $3.2 million legal settlement, as described in Note 26 - Legal Settlement, and an increase of $0.7 million for legal fees associated with this settlement, (iii) a $7.8 million increase in management personnel payroll and benefits, (iv) a $3.5 million increase attributable to general and administrative expenses of businesses acquired subsequent to September 30, 2020, and (v) a $3.5 million increase in other professional fees, primarily driven by expenses incurred in support of acquisition activities, information technology expenses and increased accounting and consulting fees.
Interest Expense, Net. Interest expense, net for fiscal 2021 decreased $0.7 million, or 22.8%, to $2.4 million compared to $3.1 million for fiscal 2020. The decrease in interest expense, net reflects a $1.2 million decrease in interest expense and a decrease of $0.5 million in interest income. The decrease was primarily due to $0.9 million of unrealized gain on interest rate swaps for fiscal 2021, compared to an unrealized loss on interest rate swaps of $1.4 million for fiscal 2020. This change was offset by an increase in interest paid due to
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the increase in long-term debt at September 30, 2021 compared to September 30, 2020. The decrease in interest income was due to a decrease in interest rates earned on our deposits.
Provision for Income Taxes. Our effective tax rate increased to 29.3% for fiscal 2021, from 24.0% for fiscal 2020. Our higher effective tax rate was due to the unfavorable impact of a non-deductible legal settlement and related legal expenses, as described in Note 26 - Legal Settlement, and other fiscal 2021 permanent non-deductible expenses.
Earnings from Investment in Joint Venture. Earnings from investment in joint venture decreased $0.6 million during fiscal 2021 compared to fiscal 2020, as the construction project from which these earnings were derived had a lower level of activity during fiscal 2021.
Net Income. Net income decreased $20.1 million, or 49.9%, to $20.2 million for fiscal 2021 compared to $40.3 million for fiscal 2020. The decrease in net income was primarily a result of lower gross profit and higher general and administrative expenses, partially offset by a decrease in interest expense, net, all as described above.
Adjusted EBITDA and Adjusted EBITDA Margin. Adjusted EBITDA and Adjusted EBITDA Margin were $90.6 million and 9.9%, respectively, for fiscal 2021, compared to $98.9 million and 12.6%, respectively, for fiscal 2020. The decrease in Adjusted EBITDA primarily resulted from lower gross profit and an increase in general and administrative expenses. The lower Adjusted EBITDA Margin was primarily the result of a decrease in Adjusted EBITDA and increase in revenues, all as described above. For a description of Adjusted EBITDA and Adjusted EBITDA Margin, as well as a reconciliation of Adjusted EBITDA to net income, see “How We Assess Performance of Our Business.”
Adjusted Net Income . Adjusted net income decreased $16.7 million to adjusted net income of $24.0 million for fiscal 2021, compared to adjusted net income of $40.7 million for fiscal 2020. The decrease in adjusted net income was primarily a result of lower gross profit and higher general and administrative expenses, all as described above.
Inflation and Price Changes
Except as described above in Item 1 of this report under the heading “2021 Fiscal Year Developments — Inflationary Trends,” inflation had an immaterial impact on our results of operations for fiscal years 2021 and 2020 due to relatively low inflation in the United States in recent years and our ability to recover increasing costs by charging higher prices for our products, including through sale price escalator clauses in most of our public infrastructure sector contracts. Inflation risk varies with the level of activity in our industry, the number, size and strength of competitors and the availability of products to supply a local market. For more information, see the discussion under the heading “Inflation Risk” included in Item 7A of this report.
Liquidity and Capital Resources
Cash Flows Analysis
The following table sets forth our cash flows for the periods indicated (in thousands):
For the Fiscal Year
Ended September 30,
2021 2020
Net cash provided by operating activities, net of acquisitions $ 48,500 $ 105,173
Net cash used in investing activities (263,412) (79,363)
Net cash provided by financing activities 123,847 41,887
Net change in cash and cash equivalents $ (91,065) $ 67,697
Operating Activities
During fiscal 2021, cash provided by operating activities, net of acquisitions, was $48.5 million, primarily as a result of:
• net income of $20.2 million, including $49.8 million of depreciation, depletion and amortization of long-lived assets, unrealized gains on derivative instruments of $3.2 million and equity-based compensation expense of $3.5 million;
• an increase in contracts receivable including retainage, net of $27.1 million as a result of higher overall revenues due to acquisitions and growth in existing markets;
• an increase in other assets of $2.9 million primarily due to capitalized costs related to the amended Revolving Credit Facility and deposits on property, plant and equipment assets;
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• an increase in inventories of $3.9 million due to increased inventories from acquisitions and normal fluctuations in our inventory cycle;
• an increase in accounts payable and accrued expenses and other current liabilities of $24.0 million due to an increase in construction activity; and
• a net decrease in the difference between costs and estimated earnings in excess of billings on uncompleted contracts and billings in excess of costs and estimated earnings on uncompleted contracts of $15.1 million due to the timing of performing and closing projects.
During fiscal 2020, cash provided by operating activities, net of acquisitions, was $105.2 million, primarily as a result of:
• net income of $40.3 million, including $39.3 million of depreciation, depletion and amortization of long-lived assets, unrealized losses on derivative instruments of $1.9 million and equity-based compensation expense of $1.6 million;
• a decrease in prepaid expenses and other current assets of $8.1 million, primarily reflecting the $7.7 million payment received by certain of our subsidiaries from January 2020 to July 2020 in connection with a settlement agreement we entered into in April 2018 related to a business interruption event; and
• a decrease in contracts receivable including retainage, net of $7.4 million due to a reduction in fiscal year 2020 fourth quarter job activity in certain of our markets, including North Carolina, compared to the prior year.
Investing Activitie s
During fiscal 2021, cash used in investing activities was $263.4 million, of which $210.7 million related to acquisitions completed in the period and $56.3 million of which was invested in property, plant and equipment. These amounts were partially offset by $3.7 million of proceeds from the sale of equipment.
During fiscal 2020, cash used in investing activities was $79.4 million, of which $30.2 million related to acquisitions completed in the period and $52.6 million of which was invested in property, plant and equipment, which included $11.5 million for the buyout of equipment leases. These amounts were partially offset by $3.0 million of proceeds from the sale of equipment.
Financing Activities
During fiscal 2021, cash provided by financing activities was $123.8 million. We received $219.2 million from proceeds on long-term debt, net of debt issuance costs and discounts, which was offset by $95.4 million of principal payments on long-term debt.
During fiscal 2020, cash provided by financing activities was $41.9 million. We received $72.3 million from proceeds on long-term debt, net of debt issuance costs and discounts, which was offset by $30.4 million of principal payments on long-term debt.
Credit Agreement
We and each of our subsidiaries are parties to the Credit Agreement, which provides for the Term Loan and the Revolving Credit Facility. At September 30, 2021 and 2020, we had $197.5 million and $92.9 million, respectively, of principal outstanding under the Term Loan, $20.0 million and $0.0 million, respectively, of principal outstanding under the Revolving Credit Facility, and availability of $193.7 million and $39.3 million, respectively, under the Revolving Credit Facility, including reduction for outstanding letters of credit. The obligations of our subsidiaries under the Term Loan and the Revolving Credit Facility are secured by a first priority security interest in substantially all of our assets.
The Credit Agreement requires the Company to satisfy certain financial covenants, including a minimum fixed charge coverage ratio of 1.20-to-1.00 and a maximum consolidated leverage ratio of 3.00-to-1.00, subject to certain adjustments. At September 30, 2021 and 2020, our fixed charge coverage ratio was 3.29-to-1.00 and 2.85-to-1.00, respectively, and our consolidated leverage ratio was 1.99-to-1.00 and 1.08-to-1.00, respectively.
From time to time, the Company has entered into interest rate swap agreements to hedge against the risk of changes in interest rates. At September 30, 2021 and 2020, the aggregate notional value of these interest rate swap agreements was $198.3 million and $46.5 million, respectively, and the fair value was $(0.8) million and $(1.7) million, respectively, which is included within other current liabilities or other long-term liabilities on the Company’s Consolidated Balance Sheets.
For more information about the Credit Amendment, see Note 11 - Debt to the consolidated financial statements included elsewhere in this report.
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Capital Requirements and Sources of Liquidity
During fiscal 2021 and fiscal 2020, our capital expenditures were approximately $56.3 million and $52.6 million, respectively. Our capital expenditures are typically made during the same fiscal year in which they are approved. At September 30, 2021, our commitments for capital expenditures were not material to our financial condition or results of operations on a consolidated basis. For fiscal 2022, we expect total capital expenditures to be $60.0 million to $65.0 million. Our capital expenditure budget is an estimate and is subject to change.
Historically, we have required significant amounts of cash in order to make capital expenditures, purchase materials and fund our organic expansion into new markets. Our working capital needs are driven by the seasonality and growth of our business, with our cash requirements increasing in periods of growth. Additional cash requirements resulting from our growth include the costs of additional personnel, production and distribution facilities, enhancements to our information systems, integration costs related to any acquisitions and our compliance with laws and rules applicable to public companies.
We have historically relied on cash available through credit facilities, in addition to cash from operations, to finance our working capital requirements and to support our growth. We regularly monitor potential capital sources, including equity and debt markets, in an effort to meet our planned capital expenditures and liquidity requirements. Our future success will depend on our ability to access outside sources of capital.
We believe that our operating cash flow and available borrowings under the Credit Agreement will be sufficient to fund our operations through September 30, 2022. However, future cash flows are subject to a number of variables, including the potential impacts of COVID-19, and significant additional capital expenditures will be required to conduct our operations. There can be no assurance that operations and other capital resources will provide sufficient cash to maintain planned or future levels of capital expenditures. In the event that we make one or more acquisitions and the amount of capital required is greater than the amount of cash on hand we have available for acquisitions at that time, we could be required to reduce the expected level of capital expenditures and/or seek additional capital. If we seek additional capital, we may do so through borrowings under the Credit Agreement, joint ventures, asset sales, offerings of debt or equity securities or other means. However, the unprecedented public health and governmental efforts to contain the spread of COVID-19 have created significant uncertainty as to general economic conditions for fiscal 2022 and beyond, and our ability to engage in any such transactions may be constrained by economic conditions and other factors outside of our control. We cannot guarantee that additional capital will be available on acceptable terms or at all. If we are unable to obtain the funds we need, we may not be able to complete acquisitions that may be favorable to us or finance the capital expenditures necessary to conduct our operations.
Off-Balance Sheet Arrangements
As of September 30, 2021, the Company had aggregate letters of credit outstanding in the amount of $11.3 million, future purchase commitments of $0.1 million for diesel fuel and $2.4 million of minimum royalty payments related to aggregates facilities. Other than the letters of credit, future purchase commitments and minimum royalty payments, we do not currently have any off-balance sheet arrangements that have, or are reasonably likely to have, a material current or future effect on our financial condition, changes in our financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources. See Note 18 - Commitments and Contingencies to our consolidated financial statements included elsewhere in this report for additional information.
Contractual Obligations
The following table summarizes our significant obligations outstanding as of September 30, 2021
Payments Due by Fiscal Year
Total 2022 2023 2024 2025 2026 2027 and Thereafter
Debt obligations $ 217,500 $ 10,000 $ 10,000 $ 11,250 $ 15,000 $ 171,250 $ —
Operating leases 8,104 1,614 1,223 929 623 600 3,115
Purchase commitments 51 51 — — — — —
Royalty payments 2,395 289 196 189 137 124 1,460
Asset retirement obligations 2,788 — — — — — 2,788
Total $ 230,838 $ 11,954 $ 11,419 $ 12,368 $ 15,760 $ 171,974 $ 7,363
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Critical Accounting Policies and Estimates
The discussion of our financial condition and results of operations is 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 judgments that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and assumptions on an ongoing basis. The results of our analysis form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and the impact of such differences may be material to our consolidated financial statements.
Critical accounting policies are those policies that, in management’s view, are the most important in the portrayal of our financial condition and results of operations. The notes to the consolidated financial statements also include disclosure of significant accounting policies. The methods, estimates and judgments that we use in applying our accounting policies have a significant impact on the results that we report in our consolidated financial statements. These critical accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. Those critical accounting policies and estimates that require the most significant judgment are discussed further below.
Revenue Recognition
The majority of our public construction contracts are fixed unit price contracts. Under fixed unit price contracts, we are committed to providing materials or services required by a contract at fixed unit prices (for example, dollars per ton of asphalt placed). Our private customer contracts are primarily fixed total price contracts, also known as lump sum contracts, which require that the total amount of work be performed for a single price. Revenues from fixed unit price and fixed total price construction contracts are recognized as performance obligations are satisfied over time (formerly known as the percentage-of-completion method), measured by the relationship of total cost incurred compared to total estimated contract costs (cost-to-cost input method). Under this method, revenues are recognized as costs are incurred in an amount equal to cost plus the related expected profit based on the ratio of costs incurred to estimated final costs. This cost-to-cost method is used because management considers it to be the best available measure of progress on these contracts. Contract costs consist of direct costs on contracts, including labor, materials, amounts payable to subcontractors and those indirect costs related to contract performance, such as equipment costs, insurance and employee benefits. Contract cost is recorded as incurred, and revisions in contract revenues and cost estimates are reflected in the accounting period when known. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability, including those changes arising from contract change orders, penalty provisions and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined.
Change orders are modifications of an original contract that effectively change the existing provisions of the contract without adding new provisions or terms. Change orders may include changes in specifications or designs, manner of performance, facilities, equipment, materials, sites and period of completion of the work. Either we or our customers may initiate change orders. We consider unapproved change orders to be contract variations for which we have a change of scope for which we believe we are contractually entitled to a higher price, but where a price change associated with the scope change has not yet been agreed upon with the customer. Costs associated with unapproved change orders are included in the estimated cost to complete the contracts and are treated as project costs as incurred. We recognize revenues equal to costs incurred on unapproved change orders when realization of price approval is probable. Unapproved change orders involve the use of estimates, and it is reasonably possible that revisions to the estimated costs and recoverable amounts may be required in future reporting periods to reflect changes in estimates or final agreements with customers. Change orders that are unapproved as to both price and scope are evaluated as claims. We consider claims to be amounts in excess of agreed contract prices that we seek to collect from our customers or others for customer-caused delays, errors in specifications and designs, contract terminations, change orders that are either in dispute or are unapproved as to both scope and price, or other causes of unanticipated additional contract costs. Claims are included in the calculation of revenues when realization is probable and amounts can be reliably determined. To support these requirements, the existence of the following items must be satisfied: (i) the contract or other evidence provides a legal basis for the claim or a legal opinion has been obtained, stating that, under the circumstances, there is a reasonable basis to support the claim; (ii) additional costs are caused by circumstances that were unforeseen at the contract date and are not the result of deficiencies in our performance; (iii) costs associated with the claim are identifiable or otherwise determinable and are reasonable in view of the work performed; and (iv) the evidence supporting the claim is objective and verifiable, not based on management’s subjective evaluation of the situation or on unsupported representations. Revenues in excess of contract costs incurred on claims are recognized when an agreement is reached with the customer as to the value of the claim, which, in some instances, may not occur until after completion of work under the contract. Costs associated with claims are included in the estimated costs to complete the contracts and are treated as project costs when incurred.
For the majority of our contracts, upon completion and final acceptance of the services that we were contracted to perform, we receive our final payment upon completion of the necessary contract closing documents, and our obligations to the owner are complete at that point. The accuracy of our revenues and profit recognition in a given period depends on the accuracy of our estimates of the revenues
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and costs to finish uncompleted contracts. Our estimates for all of our significant contracts use a highly detailed “bottom up” approach. However, our projects can be highly complex and, in almost every case, the profit margin estimates for a contract will either increase or decrease to some extent from the amount that was originally estimated at the time of bid. Because we have a large number of projects of varying levels of size and complexity in process at any given time, these changes in estimates can sometimes offset each other without materially impacting our overall profitability. However, large changes in revenues or cost estimates can have a significant effect on profitability.
The accuracy of our revenue and profit recognition in a given period depends on the accuracy of our estimates of the cost to complete each project. Cost estimates for all of our projects use a detailed approach, and we believe our experience allows us to create materially reliable estimates. There are a number of factors that can contribute to changes in estimates of contract cost and profitability. The most significant of these include:
• the completeness and accuracy of the original bid;
• costs associated with scope changes;
• changes in costs of labor and/or materials;
• extended overhead and other costs due to owner, weather and other delays;
• subcontractor performance issues;
• changes in productivity expectations;
• site conditions that differ from those assumed in the original bid;
• changes from original design on design-build projects;
• the availability and skill level of workers in the geographic location of the project;
• a change in the availability and proximity of equipment and materials;
• our ability to fully and promptly recover on affirmative claims and back charges for additional contract costs; and
• the customer’s ability to properly administer the contract.
The foregoing factors, as well as the stage of completion of contracts in process and the mix of contracts at different margins, may cause fluctuations in gross profit between periods, and these fluctuations may be significant.
Contracts Receivable, Including Retainage
Contracts receivable are generally based on amounts billed to the customer and currently due in accordance with our contracts. Many of the contracts under which we perform work contain retainage provisions. Retainage refers to amounts that we have billed to the customer, but are being held for payment by the customer pending satisfactory completion of the project. Retainage on active contracts is classified as a current asset regardless of the term of the contract and is generally collected within one year of the completion of a contract. At September 30, 2021 and 2020, contracts receivable included $27.6 million and $21.0 million, respectively, of retainage, which was being contractually withheld by customers until completion of the associated contracts.
Because the majority of our construction contracts are entered into with federal, state or municipal government customers, credit risk is minimal. We confirm that funds have been appropriated by the government project owner prior to commencing work on such projects. While most of our public contracts are subject to termination at the election of the government entity, in the event of any such termination, we are entitled to receive the contract price for completed work and reimbursement of termination-related costs. Credit risk with private owners is minimized because of statutory mechanic’s liens, which give us high priority in the event of lien foreclosures following financial difficulties of private owners. We maintain an allowance for doubtful accounts, which has historically been sufficient to cover accounts that are not collected.
Valuation of Long-Lived Assets and Goodwill
Long-lived assets, which include property, equipment and acquired intangible assets, such as goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment evaluations involve fair values and management estimates of useful asset lives and future cash flows. Actual useful lives and cash flows could be different from those estimated by management, and this could have a material effect on our operating results and financial position. For the fiscal years ended September 30, 2021 and 2020, there were no events or changes in circumstances that would indicate a material impairment of our long-lived assets.
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Goodwill and indefinite-lived intangible assets must be tested for impairment at least annually. We performed our most recent annual impairment test on July 1, 2021. Our test indicated that there was no impairment of goodwill and indefinite-lived intangible assets. For our goodwill impairment test, we first evaluate our market capitalization compared to the net assets of the Company overall. Our final determination of valuation is impacted by a number of factors, but the key factors are the price of our common stock, recently completed transactions from both public companies and private transactions and our estimated forecast of future cash flows.
The valuation approaches contain uncertainty regarding the estimates used. Our market capitalization could be impacted because we are a controlled company, which impacts the control premium we apply to the market price of our common stock. One of the largest uncertainties relates to federal, state and local government spending, which management expects to increase in the upcoming years. There are a number of other uncertainties with respect to our future financial performance that could impact estimated future cash flows, including those discussed under the heading “Risk Factors” elsewhere in this report. Based on our valuation approaches, we determined that our one reporting unit substantially exceeded its carrying value, and thus concluded that the carrying value of goodwill was not impaired at July 1, 2021 or 2020. At September 30, 2021 and 2020, we had goodwill with a carrying amount of $85.4 million and $46.3 million, respectively.
For our indefinite-lived intangible asset impairment test, we performed a qualitative impairment assessment. The qualitative assessment did not identify indicators of impairment, and it was determined that is more likely than not the indefinite-lived name license fair value was more than its carrying amount. Accordingly, no further analysis was required or performed.
Income Taxes
Deferred tax assets and liabilities are recognized based on the differences between the financial statement carrying amounts and the tax basis of assets and liabilities. We regularly review our deferred tax assets for recoverability and, where necessary, establish a valuation allowance. Valuation allowances are established to reduce deferred tax assets if we determine that it is more likely than not that some or all of the deferred tax assets will not be realized in future periods.
To assess this likelihood, we use historical three-year results of operations, estimates and judgments regarding our future taxable income and consider the jurisdiction in which the taxable income is generated to determine whether a valuation allowance is required. Such evidence can include our current financial position, results of operations, actual and forecasted results, the reversal of deferred tax liabilities, tax planning strategies and the current and forecasted business economics of our industry. Additionally, we record uncertain tax positions at their net recognizable amount, based on the amount that management deems is more likely than not to be sustained upon ultimate settlement with the tax authorities in jurisdictions in which we operate.
On the basis of our evaluations, at September 30, 2021 and 2020, no valuation allowance was recorded on our net deferred tax assets, and we had no material uncertain tax positions. If our estimates or assumptions regarding our current and deferred tax items are inaccurate or are modified, these changes could have potentially material impacts on our earnings.
Accrued Insurance Cost
We carry insurance policies to cover various risks, primarily general liability, automobile liability and workers’ compensation, under which we are liable to reimburse the insurance company for a portion of each claim paid, ranging from $100,000 to $500,000 per occurrence. We accrue for probable losses, both reported and unreported, that are reasonably estimable using actuarial methods based on historic trends and modified, if necessary, by recent events. Changes in our loss assumptions caused by changes in actual experience would affect our assessment of the ultimate liability and could have an effect on our operating results and financial position up to $500,000 per occurrence for general liability, automobile liability and workers’ compensation claims.
We provide employee medical insurance under policies that are both fixed-premium, fully-insured policies and self-insured policies that are administered by the insurance company. Under the self-insured policies, we are liable to reimburse the insurance company for actual claims paid plus an administrative fee. We purchase separate stop-loss insurance, which limits the individual participant claim loss to amounts ranging from $100,000 to $160,000.
Share-Based Payments and Other Equity Transactions
Our equity incentive plans are administered by the Compensation Committee of our Board of Directors. We account for our equity-based compensation plans using a fair value-based method of accounting, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is typically the vesting period.
Other Accounting Policies and New Accounting Pronouncements
See Note 2 – Significant Accounting Policies and Note 3 – Accounting Standards, to the consolidated financial statements for the fiscal year ended September 30, 2021, which are contained in Part II, Item 8 of this report and are incorporated by reference herein.
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Seasonality
The activity of our business fluctuates due to seasonality because our business is primarily conducted outdoors. Therefore, seasonal changes and other weather-related conditions, in particular extended snowy, rainy or cold weather in the winter, spring or fall and major weather events, such as hurricanes, tornadoes, tropical storms and heavy snows, can adversely affect our business and operations through a decline in both the use of our products and the demand for our services. In addition, construction materials production and shipment levels follow activity in the construction industry, which typically occurs in the spring, summer and fall. Warmer and drier weather during our third and fourth fiscal quarters typically result in higher activity and revenues during those quarters. Our first and second fiscal quarters typically have lower levels of activity due to adverse weather conditions. Our third fiscal quarter varies greatly with spring rains and wide temperature variations. A cool, wet spring increases drying time on projects, which can delay sales in the third fiscal quarter, while a warm, dry spring may facilitate earlier project commencement dates.