Comfort Systems USA, Inc. — Q2 2020 Form 10-Q
Business context and reporting period
Comfort Systems provides mechanical and electrical contracting services, including HVAC, plumbing, electrical, installation, maintenance and repair. This unaudited filing covers the three and six months ended June 30, 2020; comparisons are to the corresponding 2019 periods. Amounts below are in millions unless stated otherwise.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $743.5 | $650.3 | $1,443.6 | $1,188.8 |
| Gross profit / margin | $145.7 / 19.6% | $120.0 / 18.5% | $262.8 / 18.2% | $226.7 / 19.1% |
| Operating income / margin | $61.0 / 8.2% | $35.7 / 5.5% | $85.7 / 5.9% | $63.7 / 5.4% |
| Net income | $39.5 | $24.2 | $57.2 | $44.0 |
| Diluted EPS | $1.08 | $0.65 | $1.55 | $1.18 |
| Cash from operations | Not stated quarterly | Not stated quarterly | $163.8 | $26.6 |
| Free cash flow | Not stated quarterly | Not stated quarterly | $150.6 | $11.6 |
Q2 revenue rose 14.3% year over year and net income rose about 63%. For the first half, revenue increased 21.4% and net income increased about 30%. Q2 gross margin improved, while first-half gross margin declined year over year.
- At June 30, cash was $53.3; total assets were $1,675.4 and stockholders’ equity was $628.4. Current assets of $792.5 exceeded current liabilities of $681.5.
- Debt principal was $231.8 ($231.5 net of issuance costs), including $55.0 outstanding on the revolver and $138.8 on the term loan. The company reported $339.4 of remaining credit availability, including the effect of outstanding letters of credit.
- Leverage ratio was 0.9 and fixed-charge coverage was 7.3; the company reported compliance with all financial covenants. Revolver and term-loan rates were approximately 2.2% and 1.7%, respectively.
- Backlog was $1,531.2 at June 30, down 5.4% from March 31 and up 2.4% from June 2019. Remaining performance obligations were $1.53 billion; the company expected to recognize approximately 80–85% over the next 12 months.
Material changes versus prior comparable periods
- Acquisitions contributed materially to growth. TAS, acquired April 1, 2020, added $55.7 of Q2 revenue; the North Carolina electrical contractor and prior-year Walker acquisition also contributed to first-half growth. TAS consideration was preliminarily valued at $168.8, including $106.0 cash paid at closing, a $14.0 note and contingent consideration.
- Management attributed Q2 same-store gross-profit gains mainly to improved project execution. First-half gross margin was lower partly because of lower Walker margins and COVID-related safety measures and inefficiencies.
- First-half SG&A increased 8.9% to $178.0, including higher amortization and bad-debt expense. The allowance for credit losses was $11.6 at June 30, versus $6.9 at year-end 2019; first-half bad-debt expense was $4.6 versus $0.8.
- Operating cash flow increased substantially, helped by working-capital timing and approximately $10.5 of deferred payroll taxes and $8.5 of deferred federal and state tax payments. Investing outflows included $102.0 for acquisitions; financing activities included debt repayments, dividends and share repurchases.
Outlook, risks and unusual items
- Management said it could not quantify the pandemic’s potential second-half impact. Assuming COVID-19 does not materially worsen market conditions, it expected substantial positive earnings in Q3 and Q4 and believed full-year 2020 earnings would be at least comparable to 2019 profitability.
- COVID-19 affected service work through building closures and restricted customer access; by quarter-end, most service operations were near normal. Some construction jobs were temporarily closed or delayed, and work delays or cancellations affected less than 5% of backlog. Safety requirements added cost or inefficiency.
- The company cited potential collectability issues, particularly among customers in industries more affected by COVID-19. A pandemic-related prolonged downturn could also weaken demand, delay projects or affect liquidity and cash flows.
- Q2 included $3.9 of expense from changes in the fair value of contingent earn-out obligations. Such estimates are remeasured each period and can vary with assumptions and market conditions.
- Walker had $96.8 of goodwill and an estimated fair-value cushion of approximately 29% over carrying value. The filing said further adverse operating or economic changes could increase impairment risk.
- The company estimated its full-year 2020 effective tax rate at 25%–30%. Routine legal claims were not expected by management to materially affect results, cash flows or financial condition after recorded accruals. Surety-bond availability remains important; historically, 15%–25% of business required bonds.
Most important facts for investors to verify
- Whether the stated full-year earnings outlook is achieved as the pandemic and customer activity evolve.
- Backlog conversion, new project awards and the reported delays or cancellations affecting less than 5% of backlog.
- Receivables collection trends, bad-debt allowances and exposure to affected customer industries.
- Cash flow quality, including the contribution from working-capital timing and temporary tax-payment deferrals.
- Acquisition integration and returns, including TAS purchase-accounting estimates, earn-out liabilities and Walker goodwill impairment headroom.
- Available revolver capacity, covenant compliance, debt repayment requirements and continued access to surety bonding.