ENERGY SERVICES OF AMERICA CORPORATION You should read the following discussion of the financial condition and results of operations of Energy Services in conjunction with the historical financial statements and related notes contained elsewhere herein. Among other things, those historical consolidated financial statements include more detailed information regarding the basis of presentation for the following information. Understanding Gross Margins Our gross margin is gross profit expressed as a percentage of revenues. Cost of revenues consists primarily of salaries, wages and some benefits to employees, depreciation, fuel and other equipment costs, equipment rentals, subcontracted services, portions of insurance, facilities expense, materials and parts and supplies. Factors affecting gross margin include:
Seasonal. As discussed above, seasonal patterns can have a significant impact on gross margins. Usually, business is slower in the winter months versus the warmer months.
Weather. Adverse or favorable weather conditions can impact gross margin in each period. Periods of wet weather, snow or rainfall, as well as severe temperature extremes can severely impact production and therefore negatively impact revenues and margins. Conversely, periods of dry weather with moderate temperatures can positively impact revenues and margins due to the opportunity for increased production and efficiencies. Revenue Mix. The mix of revenues between customer types and types of work for various customers will impact gross margins. Some projects will have greater margins while others that are extremely competitive in bidding may have narrower margins.
Service and Maintenance versus Installation. In general, installation work has a higher gross margin than maintenance work. This is because installation work usually is of a fixed price nature and therefore has higher risks involved. Accordingly, a higher portion of the revenue mix from installation work typically will result in higher margins.
Subcontract Work. Work that is subcontracted to other service providers generally has lower gross margins. Increases in subcontract work as a percentage of total revenues in each period may contribute to a decrease in gross margin.
Materials versus Labor. Typically, materials supplied on projects have lower margins than labor. Accordingly, projects with a higher material cost in relation to the entire job will have a lower overall margin.
Depreciation. Depreciation is included in our cost of revenue. This is a common practice in our industry but can make comparability to other companies difficult.
Margin Risk. Failure to properly execute a job including failure to properly manage and supervise a job could decrease the profit margin.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of compensation
and related benefits to management, administrative salaries and benefits,
marketing, communications, office and utility costs, professional fees, bad debt
expense, letter of credit fees, general liability insurance and miscellaneous
other expenses.
17
Results of Operations for the Year Ended
Revenue. Revenue decreased by$55.3 million or 31.7% to$119.2 million for the year endedSeptember 30, 2020 from$174.5 million for the year endedSeptember 30, 2019 . The decrease was primarily attributable to a$48.5 million revenue decrease in petroleum and gas work, a$5.2 million revenue decrease in electrical and mechanical services and a$1.6 million revenue decrease in water and sewer and other ancillary services. The primary reason for the decrease in revenue from petroleum and gas projects was due to a$74.0 million gas transmission project completed in fiscal year 2019, and we had no similar project in fiscal year 2020. Even before the COVID-19 pandemic, many gas transmission projects had been cancelled or delayed in 2020. While the gas and petroleum revenue decreased in fiscal year 2020, the Company continued to perform the projects that were awarded. The decrease in revenue from electrical and mechanical services and water and sewer and ancillary services was primarily due to projects suspended, delayed, or cancelled due to the COVID-19 pandemic. Cost of Revenues. Cost of revenues decreased by$56.2 million or 34.7% to$105.7 million for the year endedSeptember 30, 2020 from$161.9 million for the year endedSeptember 30, 2019 . The decrease was primarily attributable to a$52.3 million cost decrease in petroleum and gas work, a$5.3 million cost decrease in electrical and mechanical services and a$361,000 cost decrease in water and sewer and other ancillary services, partially offset by a$1.8 million costs increase in equipment and tool shop operations not allocated to projects. The primary reason for the decrease in costs from petroleum and gas projects was due to a$74.0 million gas transmission project completed in fiscal year 2019, and we had no similar project in fiscal year 2020. Even before the COVID-19 pandemic, many gas transmission projects had been cancelled or delayed in 2020. The decrease in costs from electrical and mechanical services and water and sewer and other ancillary services was primarily due to projects suspended, delayed, or cancelled due to the COVID-19 pandemic. The increase in shop costs was primarily due to a lower volume of projects and less internal equipment and tool costs allocated to projects in fiscal year 2020 as compared to fiscal
year 2019. Gross Profit. Gross profit increased by$821,000 or 6.5% to$13.5 million for the year endedSeptember 30, 2020 from$12.7 million for the year endedSeptember 30, 2019 . The increase was primarily attributable to a$3.8 million gross profit increase in petroleum and gas work, and a$38,000 gross profit increase in electrical and mechanical services, partially offset by a$1.8 million gross profit decrease in equipment and tool shop operations not allocated to projects and a$1.2 million gross profit decrease in water and sewer and other ancillary services. The gross profit percentage was 11.4% for the year endedSeptember 30, 2020 and 8.6% for the year endedSeptember 30, 2019 . The primary reason for the gross profit increase in gas and petroleum work was projects started late in the Company's third quarter and early fourth quarter that exceeded profit expectations. The Company's familiarity with the customer, project scope and location allowed for greater productivity. The increase in gross profit from electrical and mechanical services was primarily due to several projects that performed better than expected in the Company's fourth quarter of fiscal year 2020. The gross profit from those projects was offset by the gross profit lost due to the revenue decrease related to the COVID-19 pandemic. The decrease in gross profit related to equipment and tool shop operations was primarily due to a lower volume of projects and less internal equipment and tool costs allocated to projects in fiscal year 2020 as compared to fiscal year 2019. The gross profit decrease in water and sewer and other ancillary services was primarily due to fewer and smaller projects and decreased productivity related to the COVID-19 pandemic. 18
A table comparing the Company's revenue and gross profit for the three and
twelve months ended
Revenue
Three Months Ended Three Months Ended Twelve Months Ended Twelve Months Ended
September 30, 2020
$ 26,596,388 $ 21,571,994 $ 56,961,211 $ 105,507,626 Electrical and Mechanical
15,269,997 13,914,560 51,661,974 56,900,121
Water, Sewer, and other 2,649,623 2,797,040 10,571,255 12,133,408
Total $ 44,516,008 $ 38,283,594 $ 119,194,440 $ 174,541,155
Gross Profit
Three Months Ended ThreeMonths Ended Twelve Months Ended Twelve Months Ended
September 30, 2020
$ 7,161,318 $ 4,041,014 $ 12,610,530 $ 8,832,394
Electrical and Mechanical 1,359,106 915,006 3,186,630 3,148,966
Water, Sewer, and other 577,657 1,052,026 2,453,283 3,654,015
Unallocated equipment an tool shop (850,238 ) (1,005,539 ) (4,749,212 ) (2,955,577 )
Total $ 8,247,843 $ 5,002,507 $ 13,501,231 $ 12,679,798
Gross profit percentage 18.5 % 13.1 % 11.3 % 7.3 % Selling and administrative expenses. Selling and administrative expenses increased by$974,000 or 11.0% to$9.8 million for the year endedSeptember 30, 2020 from$8.9 million for the year endedSeptember 30, 2019 . The increase was primarily due to the addition of several key employees in an effort to expand the Company's customer base and market the services the Company performs, to manage the gas distribution services and to enhance the Company's technological ability to track productivity and streamline reporting. The Company also had increased labor expense related to the COVID-19 pandemic. Expenses for employees that utilized the Families First Coronavirus Response Act were charged to selling and administrative expenses even if they were normally charged to projects. Income from operations. Income from operations decreased by$153,000 or 4.0% to$3.7 million for the year endedSeptember 30, 2020 from$3.8 million for the year endedSeptember 30, 2019 . The decrease was primarily due to the items mentioned above. Interest Expense. Interest expense decreased by$578,000 or 54.3% to$486,000 for the year endedSeptember 30, 2020 from$1.1 million for the year endedSeptember 30, 2019 . This decrease was primarily due to reduced line of credit borrowings and the repayment of long-term debt in early fiscal year 2020.
Net Income. Income before income tax expense was
Income tax expense for fiscal year 2020 was$1.1 million compared to$969,000 for fiscal year 2019. The effective tax expense rate for fiscal year 2020 was 32.0% as compared to 32.7% for fiscal year 2019. Effective income tax rates are estimates and may vary from period to period due to changes in the amount of taxable income and non-deductible expenses. Per diem paid to the Company's production personnel, where required by contract and federal law, are the Company's major source of non-deductible expenses. The non-deductible portion of per diem was$530,000 and$879,000 in fiscal years 2020 and 2019, respectively. 19
Dividends on preferred stock for fiscal years ended
The net income available to common shareholders was
Comparison of Financial Condition at
The Company had total assets of$58.2 million atSeptember 30, 2020 , an increase of$2.3 million from the prior fiscal year end balance of$55.9 million . Cash and cash equivalents totaled$11.2 million atSeptember 30, 2020 , an increase of$6.6 million from the prior fiscal year end balance of$4.6 million . The increase was primarily related to the receipt of$9.8 million in operating funds, a$4.5 million decrease in accounts receivable and retention, partially offset by a$3.7 million decrease in total debt and a$3.5 million investment in equipment. Prepaid expenses and other totaled$3.3 million atSeptember 30, 2020 , an increase of$600,000 from the prior fiscal year end balance of$2.7 million . The increase was primarily due to the increase of various prepaid insurance accounts based on labor cost expensed or standard monthly charges. The aggregate balance of accounts receivable, retainages receivable, allowance for doubtful accounts and other receivables totaled$20.7 million atSeptember 30, 2020 , a decrease of$4.4 million from the combined prior fiscal year end balance of$25.1 million . The decreases of$3.4 million in accounts receivable and other receivables and$1.0 million in retainages receivable were due to collections under contractual terms. Net property, plant and equipment totaled$16.4 million atSeptember 30, 2020 , a decrease of$423,000 from the prior fiscal year end balance of$16.8 million . Property, plant and equipment acquisitions totaled$4.2 million for fiscal year 2020 while depreciation expense was$4.4 million , and the net impact of disposals was$189,000 . Contract assets totaled$6.5 million atSeptember 30, 2020 , a decrease of$114,000 from the prior fiscal year end balance of$6.7 million . This decrease was primarily due to the decrease in costs and estimated earnings in excess of billings atSeptember 30, 2020 as compared to atSeptember 30, 2019 . Liabilities totaled$32.3 million atSeptember 30, 2020 , an increase of$1.0 million from the prior fiscal year end balance of$31.3 million . Accounts payable totaled$5.2 million as ofSeptember 30, 2020 , an increase of$2.3 million from the prior fiscal year end balance of$2.9 million . The increase was due to the timing of payments to material and equipment providers. Contract liabilities totaled$4.9 million atSeptember 30, 2020 , an increase of$1.4 million from the prior fiscal year end balance of$3.5 million . This increase was due to a larger number of overbillings when comparing the billed revenue and percentage of cost completed on construction projects in 2020 as compared to 2019. Net deferred income tax payable totaled$2.3 million atSeptember 30, 2020 , an increase of$330,000 from the prior fiscal year end balance of$1.9 million . The increase was primarily due to deferred income tax payable resulting from bonus depreciation on fiscal year 2020 property, plant and equipment acquisitions. Accrued expenses and other current liabilities totaled$4.2 million atSeptember 30, 2020 , an increase of$728,000 from the prior fiscal year end balance of$3.5 million . The increase was primarily due to higher labor expenses incurred towards the end of fiscal year 2020 compared to 2019. Lines of credit and short-term borrowings totaled$510,000 atSeptember 30, 2020 , a decrease of$3.5 million from the prior fiscal year end balance of$4.0 million . This decrease was primarily due to repayments against the Company's operating line of credit. The aggregate balance of current maturities of long-term debt and long-term debt totaled$15.3 million atSeptember 30, 2020 , a decrease of$165,000 from the prior fiscal year end balance of$15.4 million . The decrease was primarily due to repayment of the$10.0 million refinanced from line of credit borrowings to long-term debt, partially offset by$9.8 million in proceeds from PPP loans. Shareholders' equity totaled$25.8 million atSeptember 30, 2020 , an increase of$1.1 million from the prior fiscal year end balance of$24.7 million . This increase was primarily due to the$2.4 million net income generated by the Company in fiscal year 2020,$696,000 in dividends paid on common stock,$309,000 in dividends paid on preferred stock and$268,000 from the repurchase of common shares of Company stock. 20
Liquidity and Capital Resources
Indebtedness
OnDecember 16, 2014 , the Company's Nitro subsidiary entered into a 20-year$1.2 million loan agreement withFirst Bank of Charleston, Inc. (West Virginia ) to purchase the office building and property it had previously been leasing for$6,300 monthly. The interest rate on this loan agreement is 4.82% with monthly payments of$7,800 . The interest rate on this note is subject to change from time to time based on changes in TheU.S. Treasury yield, adjusted to a constant maturity of three years as published by theFederal Reserve weekly. As ofSeptember 30, 2020 , the Company had made principal payments of$232,000 . The loan is collateralized by the building purchased under this agreement. OnSeptember 16, 2015 , the Company entered into a$2.5 million Non-Revolving Note agreement withUnited Bank, Inc. This six-year agreement gave the Company access to a$2.5 million line of credit ("Equipment Line of Credit"), specifically for the purchase of equipment, for the period of one year with an interest rate of 5.0%. After the first year, all borrowings against the Equipment Line of Credit were converted to a five-year term note agreement with an interest rate of 5.0%. As ofSeptember 30, 2020 , the Company had borrowed$2.46 million against this note and made principal payments of$2.0 million . The loan is collateralized by the equipment purchased under this agreement. OnNovember 13, 2015 , the Company entered into a 10-year$1.1 million loan agreement withUnited Bank, Inc. to purchase the fabrication shop and property Nitro had previously been leasing for$12,900 each month. The interest rate on the new loan agreement is 4.25% with monthly payments of$11,602 . As ofSeptember 30, 2020 , the Company had made principal payments of$456,000 . The loan is collateralized by the building and property purchased under this agreement. OnJune 28, 2017 , the Company entered into a$5.0 million Non-Revolving Note agreement withUnited Bank, Inc. This five-year agreement gave the Company access to a$5.0 million line of credit ("Equipment Line of Credit 2017"), specifically for the purchase of equipment, for a period of three months with an interest rate of 4.99%. After three months, all borrowings against the Equipment Line of Credit 2017 were converted to a five-year term note agreement with an interest rate of 4.99%. As ofSeptember 30, 2020 , the Company had borrowed$5.0 million against this note and made principal payments of$3.0 million . The loan is collateralized by the equipment purchased under this agreement. OnMay 30, 2019 , the Company entered into Term Note 2019 withUnited Bank which refinanced the$10.0 million borrowed on Operating Line of Credit (2019) to a five-year term note with a fixed interest rate of 5.50%. The purpose of this note was to finance a specific construction project completed inSeptember 2019 . The loan was collateralized by the Company's equipment. The refinancing effectively reset the Company's line of credit borrowings to zero as ofMay 30, 2019 and did not affect the conditions of subsequent borrowings. The Company paid off Term Note 2019 inJanuary 2020 . OnApril 15, 2020 ,Energy Services of America Corporation and subsidiariesC.J. Hughes Construction Company ,Contractors Rental Corporation andNitro Construction Services, Inc. entered into separate Paycheck Protection Program Notes effectiveApril 7, 2020 withUnited Bank, Inc. as the lender in an aggregate principal amount of$13,139,100 pursuant to the PPP (collectively, the "PPP Loan"). In a special meeting held onApril 27, 2020 , the Board of Directors of the Company unanimously voted to return$3.3 million of the PPP Loan funds after discussing the financing needs of the Company and subsidiaries. That left the Company and subsidiaries with$9.8 million in PPP Loans to fund operations. The Company had used all the available PPP Loan funds as ofSeptember 30, 2020 and is in the process of filing for loan forgiveness with its Lender. 21 Operating Line of Credit
OnJuly 30, 2020 , the Company received a one-year extension on its line of credit ("Operating Line of credit (2020)") effectiveJune 28, 2020 . The$15.0 million revolving line of credit has a$12.5 million component and a$2.5 million component, each with separate borrowing requirements. The interest rate on the line of credit is the "Wall Street Journal " Prime Rate (the index) with a floor of 4.99%. The line of credit expires onJune 28, 2021 . Based on the borrowing base calculation, the Company was able to borrow up to$11.1 million as ofSeptember 30, 2020 . The Company had no borrowings on the line of credit, leaving$11.1 million available on the line of credit as ofSeptember 30, 2020 . Based on the borrowing base calculation, the Company was able to borrow up to$11.5 million as ofSeptember 30, 2019 . The Company had borrowed$3.5 million on the line of credit, leaving$8.0 million available on the line of credit as
ofSeptember 30, 2019 . Major items excluded from the borrowing base calculation are receivables from bonded jobs and retainage as well as all items greater than ninety (90) days old. Line of credit borrowings are collateralized by the Company's accounts receivable. Cash available under the line is calculated based on 70.0% of the Company's eligible accounts receivable.
Under the terms of the agreement, the Company must meet the following loan
covenants to access the first
1. Minimum tangible net worth of$19.0 million to be measured quarterly
2. Minimum traditional debt service coverage of 1.25x to be measured quarterly
on a rolling twelve- month basis
3. Minimum current ratio of 1.50x to be measured quarterly
4. Maximum debt to tangible net worth ratio ("TNW") of 2.0x to be measured
semi-annually
5. Full review of accounts receivable aging report and work in progress. The
results of the review shall be satisfactory to the lender in its sole and
unfettered discretion.
Under the terms of the agreement, the Company must meet the following additional
requirements for draw requests causing the borrowings to exceed
1. Minimum traditional debt service coverage of 2.0x to be measured quarterly on
a rolling twelve-month basis
2. Minimum tangible net worth of
The Company was in compliance with all covenants for the
As ofSeptember 30, 2020 , the Company had$11.2 million in cash and$22.9 million in working capital. The maturities of long-term and short-term debt, which includes line of credit borrowings, term notes payable to banks, and notes payable on various equipment purchases, were as follows: 2021$ 4,538,743 2022 3,417,031 2023 2,287,389 2024 2,259,381 2025 2,278,986 Thereafter 990,918$ 15,772,448 22
Off-Balance Sheet Transactions
Due to the nature of our industry, we often enter into certain off-balance sheet arrangements in the ordinary course of business that result in risks not directly reflected on our balance sheets. Though for the most part not material in nature, some of these are: Leases InFebruary 2016 , the FASB issued ASU 2016-02, "Leases (Topic 842)". ASU 2016-02 is effective for public business entities for fiscal years beginning afterDecember 15, 2018 including interim periods within those fiscal years. Among other things, lessees are required to recognize the following for all leases (except for short-term leases) at the commencement date: a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. It is the Company's preference to acquire equipment needed for long-term use through purchase, by cash or finance. For equipment needed on a short-term basis, the Company will enter into short-term rental agreements with the equipment provider where the agreement is cancellable at any time. The adoption of ASU 2016-02 had an immaterial impact, if any, on its consolidated financial statements.
The Company rents equipment for use on construction projects with rental
agreements being week to week or month to month. Rental expense can vary by
fiscal year due to equipment requirements on construction projects and the
availability of Company owned equipment. Rental expense was
Letters of Credit
Certain of our customers or vendors may require letters of credit to secure
payments that the vendors are making on our behalf or to secure payments to
subcontractors, vendors, etc. on various customer projects. At
Performance Bonds
Some customers, particularly new ones or governmental agencies require the Company to post bid bonds, performance bonds and payment bonds (collectively, performance bonds). These bonds are obtained through insurance carriers and guarantee to the customer that we will perform under the terms of a contract and that we will pay subcontractors and vendors. If the Company fails to perform under a contract or to pay subcontractors and vendors, the customer may demand that the insurer make payments or provide services under the bond. The Company must reimburse the insurer for any expenses or outlays it is required to make. Currently, the Company has an agreement with a surety company to provide bonding which will suit the Company's immediate needs. The ability to obtain bonding for future contracts is an important factor in the contracting industry with respect to the type and value of contracts that can be bid. Depending upon the size and conditions of a particular contract, the Company may be required to post letters of credit or other collateral in favor of the insurer. Posting of these letters or other collateral will reduce our borrowing capabilities. The Company does not anticipate any claims in the foreseeable future. AtSeptember 30, 2020 , the Company had$3.2 million in performance
bonds
outstanding.
23
Concentration of Credit Risk
In the ordinary course of business, the Company grants credit under normal payment terms, generally without collateral, to our customers, which include natural gas and oil companies, general contractors, and various commercial and industrial customers located withinthe United States . Consequently, the Company is subject to potential credit risk related to business and economic factors that would affect these companies. However, the Company generally has certain statutory lien rights with respect to services provided. Under certain circumstances such as foreclosure, the Company may take title to the underlying assets in lieu of cash in settlement of receivables. Please see the tables below for customers that represent 10.0% or more of the Company's revenue or accounts receivable net of retention for fiscal years
2020 and 2019: Revenue FY 2020 FY 2019 TransCanada Corporation 24.7 % 11.8 % Marathon Petroleum 11.1 % * Goff Connector LLC * 29.0 % All other 64.2 % 59.2 % Total 100.0 % 100.0 %
* Less than 10.0% and included in "All other" if applicable
Accounts receivable net of retention FY 2020 FY 2019 Marathon Petroleum 19.7 % * TransCanada Corporation 18.4 % 12.2 % Shimizu North American LLC 11.9 % * Goff Connector LLC * 22.0 % All other 50.0 % 65.8 % Total 100.0 % 100.0 %
* Less than 10.0% and included in "All other" if applicable
Litigation InFebruary 2018 , the Company filed a lawsuit against a former customer related to a dispute over changes on a pipeline construction project. The Company is seeking$10.0 million in the lawsuit, none of which has been recognized in the Company's financial statements. Although no trial date has been set, the Company expects the case to go to trial in fiscal year 2021 barring a mediation settlement between the parties. Other than described above, atSeptember 30, 2020 , the Company was not involved in any legal proceedings other than in the ordinary course of business. The Company is a party from time to time 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, punitive damages, civil penalties or other losses, or injunctive or declaratory relief. With respect to all such lawsuits, claims, and proceedings, we record reserves when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. AtSeptember 30, 2020 , the Company does not believe that any of these proceedings, separately or in aggregate, would be expected to have a material adverse effect on our financial position, results of operations or cash flows. Related Party Transactions We intend that all transactions between us and our executive officers, directors, holders of 10% or more of the shares of any class of our common stock and affiliates thereof, will be on terms no less favorable than those terms given to unaffiliated third parties and will be approved by a majority of our independent outside directors not having any interest in the transaction. OnDecember 16, 2014 , the Company's Nitro subsidiary entered into a 20-year$1.2 million loan agreement withFirst Bank of Charleston, Inc. (West Virginia ) to purchase the office building and property it had previously been leasing for$6,300 each month. Mr.Douglas Reynolds , President of Energy Services, was a director and secretary ofFirst Bank of Charleston . Mr.Samuel Kapourales , a director of Energy Services, was also a director ofFirst Bank of Charleston . OnOctober 15, 2018 ,First Bank of Charleston was merged intoPremier Bank, Inc. , a wholly owned subsidiary of Premier Financial Bancorp, Inc. Mr.Marshall Reynolds , Chairman of theBoard of Energy Services , holds the same position with Premier Financial Bancorp Inc. Mr.Neal Scaggs is a director of Energy Services and holds the same position with Premier Financial Bancorp, Inc. Mr.Douglas Reynolds is the president and a director of Energy Services and a director of Premier Financial Bancorp, Inc. The interest rate on the loan agreement is 4.82% with monthly payments of$7,800 . As ofSeptember 30, 2020 , we have paid approximately$232,000 in principal and approximately$306,000 in interest since the beginning of the loan. There were no new material related party transactions entered into during the fiscal year endedSeptember 30, 2020 . 24 Certain Energy Services subsidiaries routinely engage in transactions in the normal course of business with each other, including sharing employee benefit plan coverage, payment for insurance and other expenses on behalf of other affiliates, and other services incidental to business of each of the affiliates. All revenue and related expense transactions, as well as the related accounts payable and accounts receivable have been eliminated in consolidation. Inflation
Due to relatively low levels of inflation during the years ended
Critical Accounting Policies
The discussion and analysis of the Company's financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States . 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 at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. We evaluate our estimates on an ongoing basis, based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. There can be no assurance that actual results will not differ from those estimates. Management believes the following accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. Revenue Recognition OnOctober 1, 2018 , the Company adopted an Accounting Standard Update, Revenue from Contracts with Customers (Topic 606). The core principle of Topic 606 is that revenue will be recognized when promised goods or services are transferred to customers in an amount that reflects consideration for which entitlement is expected in exchange for those goods or services. We adopted Topic 606 using a modified retrospective transition approach and elected to apply Topic 606 to contracts with customers that are not substantially complete, i.e. less than 90% complete, as ofOctober 1, 2018 . The adoption of Topic 606 did not have a material impact on the Company's financial statements. In addition, as ofOctober 1, 2018 , we began to separately present contract assets and liabilities on the Company's consolidated balance sheet. Contract assets may include costs and estimated earnings in excess of billings that were previously separately presented. Contract liabilities may include billings in excess of costs and estimated earnings that were previously separately presented as well as provisions for losses, when occurred, that were previously included in accrued expenses and other current liabilities.
The accounting policies that were affected by Topic 606 and the changes thereto are as follows:
Revenue Recognition:
Our revenue is primarily derived from construction contracts that can span several quarters. We recognize revenue in accordance with Topic 606. Topic 606 provides for a five-step model for recognizing revenue from contracts with customers as follows:
1. Identify the contract
2. Identify performance obligations
3. Determine the transaction price
4. Allocate the transaction price
5. Recognize revenue
25
Identify the Contract
The first step in applying Accounting Standards Codification (ASC) 606 is to identify the contract(s) with the customer. To do so, the Company evaluates indicators of the existence of the contract.
Certain conditions must be present for there to be a contract with a customer:
· The parties to the contract have approved the contract (in writing, orally, or
in accordance with other customary business practices) and are committed to
perform their respective obligations.
· The Company can identify each party's rights regarding the goods or services
to be transferred.
· The Company can identify the payment terms for the goods or services to be
transferred.
· The contract has commercial substance (that is, the risk, timing, or amount of
the entity's future cash flows is expected to change as a result of the
contract).
It is probable that the Company will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. In evaluating whether collectability of an amount of consideration is probable, the Company shall consider only the customer's ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession.
Identify Performance Obligations
Once the Company has determined that it has a contract with a customer as defined in Accounting Standards Codification (ASC) 606, the Company must determine what the performance obligations are. A performance obligation is defined in the ASC Master Glossary as:
A promise in a contract with a customer to transfer to the customer either:
· A good or service (or a bundle of goods or services) that is distinct;
· A series of distinct goods or services that are substantially the same and
that have the same pattern of transfer to the customer.
Generally, performance obligations are clearly stated in the contract. The Company's contracts usually contain one performance obligation that is satisfied over time because our performance typically creates or enhances an asset that the customer controls as the asset is created or enhanced.
In assessing whether promises to transfer goods or service to the customer are separately identifiable, a company considers the following factors:
· The entity provides a significant service of integrating the goods or services
with other goods or services promised in the contract into a bundle of goods
or services that represent the combined output or outputs for which the
customer has contracted. In other words, the entity is using the goods or
services as inputs to produce or deliver the combined output or outputsspecified by the customer. Combined output or outputs might include more than
one phase, element, or unit.
· One or more of the goods or services significantly modifies or customizes, or
are significantly modified or customized by, one or more of the other goods or
services promised in the contract.
26
· The goods or services are highly interdependent or highly interrelated. In
other words, each of the goods or services is significantly affected by one or
more of the other goods or services in the contract. For example, in some
cases, two or more goods or services are significantly affected by each other
because the entity would not be able to fulfill its promise by transferring
each of the goods or services independently.
Under ASC 606, contracts will be required to be combined when certain criteria
are met. The new accounting standard requires contracts be combined prior to
further assessment of the five elements, if one or more of the following
criteria are met:
· Negotiated at the same time with the same customer (or related party) with a
single commercial objective in mind;
· The consideration to be paid for one contract is dependent on another
contract;
· The promised goods and services in the contracts are a single performance
obligation in accordance with the guidance.
If the promises do not meet the requirements for separating, the performance
obligations shall be combined into one performance obligation. A contract could
have several performance obligations which in themselves include sets of
promises that are not distinct and cannot be separated.
Management has made the assessment that the company is acting as a principal
rather than as an agent (i.e., the company integrates the materials, labor and
equipment into the deliverables promised to the customer) in all contract
performed by the Company.
Determine Transaction Price
The transaction price is the amount of consideration to which the Company
expects to be entitled in exchange for transferring goods and services to the
customer. The consideration promised in a contract with customers may include
both fixed amounts and variable amounts (e.g. bonuses/incentives or
penalties/liquidated damages) to the extent that a significant reversal of
cumulative revenue recognized will not occur when the uncertainty associated
with the variable consideration is subsequently resolved (i.e., probable and
estimable).
Variable consideration is defined broadly and can take many forms, such as incentives, penalty provisions, price concessions, rebates or refunds. Consideration is also considered variable if the amount the Company will receive is contingent on a future event occurring or not occurring, even though the amount itself is fixed.
The following are examples of variable considerations within a contract:
· Claims and pending change orders;
· Unpriced change orders;
· Incentive and penalty provisions within the contract;
· Shared savings;
· Price concessions;
· Liquidating damages; and
· Unit price contracts with variable consideration.
Subsequent to the inception of a contract, the transaction price could change
for various reasons, including the executed or estimated amount of change orders
and unresolved contract modifications and claims to or from owners. Changes that
are accounted for as an adjustment to existing performance obligations are
allocated on the same basis at contract inception. Otherwise, changes are
accounted for as separate performance obligation(s) and the separate transaction
price is allocated as discussed above. Changes are made to the transaction price
from unapproved change orders to the extent the amount can be reasonably
estimated, and recovery is probable. On certain projects we have submitted and
have pending unresolved contract modifications and affirmative claims
("affirmative claims") to recover additional costs and the associated profit, if
applicable, to which the Company believes it is entitled under the terms of
contracts with customers, subcontractors, vendors or others. The owners or their
authorized representatives and/or other third parties may be in partial or full
agreement with the modifications or affirmative claims or may have rejected or
disagree entirely or partially as to such entitlement.
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Allocate Transaction Price
When a contract has a single performance obligation, the entire transaction price is attributed to that performance obligation. When a contract has more than one performance obligation, the transaction price is allocated to each performance obligation based on estimated relative standalone selling prices of the goods or services at the inception of the contract, which typically is determined using cost plus an appropriate margin.
In accordance with Topic 606, the Company is required to estimate variable consideration when determining the contract transaction price by taking into account all the information (historical, current and forecasted) that is reasonably available and identifying a reasonable number of possible consideration amounts. Management must include an estimate of any variable consideration using either the "expected value" method or the "most likely amount" method.
The "expected value" method estimates variable consideration based on the range of possible outcomes and the probabilities of each outcome. This method might be most appropriate when the Company has a large number of contracts that have similar characteristics because it will likely have better information about the probabilities of various outcomes when there are a large number of similar transactions. The "most likely amount" method estimates variable consideration based on the single most likely amount in a range of possible consideration amounts. This method might be the most predictive if the Company will receive one of only
two possible amounts. The method used is not a policy choice and should be applied consistently throughout a contract, however, is subject to guidance on constraining estimates of variable consideration. The Company may only include variable consideration within the transaction price to the extent that it is probable that a significant reversal of revenue will not occur when the uncertainty is subsequently resolved. This assessment will require the application of judgment.
While no single factor is determinative, the revenue standard includes factors to consider when assessing whether variable consideration should be constrained.
The following factors may increase the likelihood or the magnitude of a revenue reversal:
· The amount of consideration is highly susceptible to factors outside the
entity's influence;
· The uncertainty is not expected to be resolved for a long period of time;
· The entity's experience with similar types of contracts is limited;
· The entity has a practice of offering a broad range of price concessions or
changing the payment terms frequently; and
· The contract has a broad range of possible consideration amounts.
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Recognize Revenue
The Company disaggregates revenue based on our operating groups and contract
types as it is the format that is regularly reviewed by management. Our
reportable operating groups are: Petroleum and Gas, Water, Sewer and other
services, and Electrical and Mechanical services. Our contract types are: Lump
Sum, Unit Price, and Cost Plus and Time and Material (T&M).
The Company recognizes revenue as performance obligations are satisfied and
control of the promised good and service is transferred to the customer. For
Lump Sum contracts, revenue is ordinarily recognized over time as control is
transferred to the customers by measuring the progress toward complete
satisfaction of the performance obligation(s) using an input (i.e., "cost to
cost") method. For Unit Price, Cost Plus and T&M contracts, revenue is
ordinarily recognized over time as control is transferred to the customers by
measuring the progress toward satisfaction of the performance obligation(s)
using an output method.
The Company does have certain service and maintenance contracts in which each
customer purchase order is considered its own performance obligation recognized
over time and would be recognized depending on the type of contract mentioned
above. The Company also does certain T&M service work that is generally
completed in a short duration and is recognized at a point in time.
All contract costs, including those associated with affirmative claims, change
orders and back charges, are recorded as incurred and revisions to estimated
total costs are reflected as soon as the obligation to perform is
determined. Contract costs consist of direct costs on contracts, including labor
and materials, amounts payable to subcontractors and outside equipment
providers, direct overhead costs and internal equipment expense (primarily
depreciation, fuel, maintenance and repairs).
The company recognizes revenue, but not profit, on certain uninstalled
materials. Revenue on these uninstalled materials is recognized when the cost is
incurred (when control is transferred), but the associated profit is not
recognized until the end of the project. The costs of uninstalled materials will
be tracked separately within the Company's accounting software.
Pre-contract and bond costs, if required, on projects are generally immaterial
to the total value of the Company's contracts and are expensed when incurred.
Project mobilization costs are also generally immaterial and charged to project
costs as incurred. As a practical expedient, the Company recognizes these
incremental costs as an expense when incurred if the amortization period of the
asset that the entity otherwise would have recognized is one year or less. For
projects expected to last greater than one year, mobilization costs will be
capitalized as incurred and amortized over the expected duration of the project.
For these projects, mobilization costs will be tracked separately in the
Company's accounting software. This includes costs associated with setting up a
project lot or lay-down yard, equipment, tool and supply transportation,
temporary facilities and utilities and worker qualification and safety training.
Contracts may require the Company to warranty that work is performed in
accordance with the contract; however, the warranty is not priced separately,
and the Company does not offer customers an option to purchase a warranty. As of
September 30, 2020 , the Company does not have a material amount of costs
expensed that would otherwise be capitalized and amortized.
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. 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;
29
• 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 from period to period. Significant changes in cost estimates,
particularly in our larger, more complex projects have had, and can in future
periods have, a significant effect on our profitability.
Contract Assets:
Our contract assets may include cost and estimated earnings in excess of
billings that represent amounts earned and reimbursable under contracts,
including claim recovery estimates, but have a conditional right for billing and
payment such as achievement of milestones or completion of the project. With the
exception of customer affirmative claims, generally, such unbilled amounts will
become billable according to the contract terms and generally will be billed and
collected over the next three months. Settlement with the customer of
outstanding affirmative claims is dependent on the claims resolution process and
could extend beyond one year. Based on our historical experience, we generally
consider the collection risk related to billable amounts to be low. When events
or conditions indicate that it is probable that the amounts outstanding become
unbillable, the transaction price and associated contract asset is reduced.Contract Liabilities:
Our contract liabilities may consist of provisions for losses and billings in excess of costs and estimated earnings. Provisions for losses are recognized in the consolidated statements of income at the uncompleted performance obligation level for the amount of total estimated losses in the period that evidence indicates that the estimated total cost of a performance obligation exceeds its estimated total revenue. Billings in excess of costs and estimated earnings are billings to customers on contracts in advance of work performed, including advance payments negotiated as a contract condition. Generally, unearned project-related costs will be earned over the next twelve months. Income Taxes The Company and all subsidiaries file a consolidated federal and various state income tax returns on a fiscal year basis. With few exceptions, the Company is no longer subject toU.S. federal, state, or local income tax examinations for years ended prior toSeptember 30, 2017 . The Company follows the liability method of accounting for income taxes in accordance with the Income Taxes topic of the ASC 740. Under this method, deferred tax assets and liabilities are recorded for future tax consequences of temporary differences between 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. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that a portion of the deferred tax asset will
not be realized.U.S. GAAP also prescribes a comprehensive model for how companies should recognize, measure, present and disclose in their financial statements uncertain tax positions taken or to be taken on a tax return. This evaluation is a two-step process. First, the recognition process determines if it is more likely than not that a tax position will be sustained based on the merits of the tax position upon examination by the appropriate taxing authority. Second, a measurement process is calculated to determine the amount of benefit/expense to recognize in the financial statements if a tax position meets the more likely than not recognition threshold. The tax position is measured at the greatest amount of benefit/expense that is more likely than not of being realized upon ultimate settlement. Any interest and penalty related to the unrecognized tax benefits, as the result of recognition of tax obligations resulting from uncertain tax positions, are included in the provision for income taxes. The Company had not recognized any uncertain tax positions atSeptember 30, 2020 . 30 Claims
Claims are amounts in excess of the agreed contract price that a contractor seeks to collect from customers or others for customer-caused delays, errors in specifications and designs, contract terminations, change orders in dispute or unapproved as to both scope and price, or other causes of unanticipated additional costs. The Company records revenue on claims that have a high probability of success. Revenue from a claim is recorded only to the extent that contract costs relating to the claim have been incurred.Self-Insurance The Company has its workers' compensation, general liability and auto insurance through a captive insurance company. While the Company believes that this arrangement has been very beneficial in reducing and stabilizing insurance costs; the Company does have to maintain a surety deposit to guarantee payments of premiums. That account had a balance of$1.9 million as ofSeptember 30, 2020 . Should the captive insurance company experience severe losses over an extended period, it could have a detrimental effect on the Company.
Current and Non-Current Accounts Receivable and Provision for Doubtful Accounts
The Company provides an allowance for doubtful accounts when collection of an account is considered doubtful. Inherent in the assessment of the allowance for doubtful accounts are certain judgments and estimates relating to, among others, our customers' access to capital, our customers' willingness or ability to pay, general economic conditions and the ongoing relationship with the customers. While most of our customers are large well capitalized companies, should they experience material changes in their revenues and cash flows or incur other difficulties and not be able to pay the amounts owed, this could cause reduced cash flows and losses in excess of our current reserves. AtSeptember 30, 2020 , the management review deemed that the allowance for doubtful accounts was adequate. Operating Leases InFebruary 2016 , the FASB issued ASU 2016-02, "Leases (Topic 842)". ASU 2016-02 is effective for public business entities for fiscal years beginning afterDecember 15, 2018 including interim periods within those fiscal years. Among other things, lessees are required to recognize the following for all leases (except for short-term leases) at the commencement date: a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. It is the Company's preference to acquire equipment needed for long-term use through purchase, by cash or finance. For equipment needed on a short-term basis, the Company will enter into short-term rental agreements with the equipment provider where the agreement is cancellable at any time. The adoption of ASU 2016-02 had an immaterial impact, if any, on its consolidated financial statements.
The Company rents equipment for use on construction projects with rental
agreements being week to week or month to month. Rental expense can vary by
fiscal year due to equipment requirements on construction projects and the
availability of Company owned equipment. Rental expense was
New Accounting Pronouncements
InFebruary 2016 , the FASB issued ASU 2016-02, "Leases (Topic 842)". ASU 2016-02 is effective for public business entities for fiscal years beginning afterDecember 15, 2018 including interim periods within those fiscal years. Among other things, lessees will be required to recognize the following for all leases (except for short-term leases) at the commencement date: a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. The Company has adopted ASU 2016-02 and it did not have a material impact on its financial statements or disclosure. 31 Subsequent Events OnDecember 16, 2020 ,Energy Services of America Corporation's (the "Company") newly formed wholly owned subsidiary,West Virginia Pipeline Acquisition Company ("West Virginia Pipeline"), aWest Virginia corporation, entered into an Asset Purchase Agreement (the "Agreement") withWV Pipeline, Inc. ("WV Pipeline"), aWest Virginia corporation located inPrinceton, West Virginia . Pursuant to the Agreement, West Virginia Pipeline will acquire substantially all the assets of WV Pipeline for$3.5 million in cash and a$3.0 million seller note. The transaction closed onDecember 31, 2020 .David Bolton andDaniel Bolton will continue their roles as President and Vice President, respectively, of the Company's new subsidiary. Management has evaluated subsequent events throughJanuary 4, 2021 , the date which the financial statements were available for issue. There have been no other material events during the period, other than noted above, that would either impact the results reflected in the report or the Company's results going forward.
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