Comfort Systems USA, Inc. — 2019 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2019; it is not a standalone fourth-quarter filing. Comfort Systems provides mechanical and electrical contracting, installation, maintenance and repair services across the United States. Revenue is primarily project-based, with 54.1% from work in existing buildings and 45.9% from new construction. Mechanical services generated 86.1% of 2019 revenue; electrical services generated 13.9%.
Financial performance and liquidity
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Revenue | $2.615 billion | $2.183 billion | +19.8% |
| Gross profit | $501.9 million | $446.3 million | +12.5% |
| Gross margin | 19.2% | 20.4% | Down 1.2 percentage points |
| Operating income | $163.6 million | $150.2 million | +8.9% |
| Net income | $114.3 million | $112.9 million | +1.3% |
| Diluted EPS | $3.08 | $3.00 | +2.7% |
| Cash from operations | $142.0 million | $147.2 million | Down $5.2 million |
| Free cash flow | $112.4 million | $121.6 million | Down $9.2 million |
Fourth quarter: Revenue was $719.6 million versus $588.4 million in Q4 2018; gross profit was $132.6 million versus $118.2 million; net income was $34.1 million versus $25.2 million; and diluted EPS was $0.92 versus $0.67.
Balance sheet and debt: At year-end, cash was $50.8 million, working capital $182.2 million, total assets $1.505 billion and stockholders’ equity $585.3 million. Total debt, net, was $226.1 million, up from $76.9 million. The company had $381.1 million of available credit under its $600 million facility, including $40.9 million of letters of credit. Leverage was 1.0x against a 3.0x covenant limit; the company reported compliance with all covenants.
Material changes versus the prior year
- Revenue growth reflected acquisitions and modest same-store expansion: the Indiana and Walker acquisitions contributed 18.2 percentage points of the 19.8% increase, while same-store revenue rose 1.6%.
- The Walker electrical contracting acquisition closed April 1, 2019 for consideration valued at $235.4 million. It contributed $343.2 million of revenue over the nine months after acquisition and drove most of the increase in electrical services.
- Gross margin declined despite higher revenue, reflecting lower margins at Walker, including $3.6 million of backlog amortization, and other mix and execution factors. SG&A fell as a share of revenue, from 13.6% to 13.0%.
- Interest expense rose to $9.3 million from $3.7 million, principally due to acquisition-related borrowings and notes to former owners. Investing cash outflow increased to $224.5 million, mainly due to acquisitions.
- Backlog was $1.60 billion at year-end, up 37.4% year over year, including the Walker acquisition; same-store backlog increased 16.8%. Management said approximately 85% of remaining performance obligations were expected to be recognized over the next 12 months.
Outlook, commentary, risks and unusual items
- Management expected strong industry activity to continue in 2020 and was optimistic that revenue and net earnings would remain at favorable levels. Priorities included execution, cost control, productivity, workforce development, service, small projects and modular construction. This is management’s outlook as of the filing date, not a guarantee.
- The company recorded $4.8 million of insurance proceeds in Q4 related to an April 2019 ransomware attack: approximately $3.2 million reduced cost of services and $1.6 million reduced SG&A. The attack disrupted systems at most operating locations; the company said it expected no further recovery proceeds.
- Other comparability item: 2018 included a $4.0 million gain from settlements related to BP Deepwater Horizon claims; no such claims remained outstanding.
- Key operating risks include economic and construction cyclicality, price competition, skilled-labor availability and cost, fixed-price project overruns, subcontractor and supplier performance, customer payment delays, backlog cancellation or changes, and dependence on surety bonding. Revenue and profit estimates rely substantially on percentage-of-completion accounting and estimated costs to complete projects.
- Other exposures include self-insured claims, contingent acquisition earn-outs, variable-rate debt and tax uncertainties. The company reported $10.2 million of unrecognized tax benefits and an IRS examination of amended 2014 and 2015 returns. Normal-course litigation was not expected by management to have a material effect after recorded provisions.
- Effective January 2020, the company acquired Starr Electric; management expected annualized revenue contribution of approximately $90–$100 million. The filing also disclosed adoption of lease accounting in 2019, adding $84.1 million of right-of-use assets and $86.7 million of lease liabilities at year-end, with no significant effect on operations or cash flows.
Important facts for investors to verify
- Whether project execution and pricing can restore gross margin after the 2019 decline, and whether the Q4 insurance recovery makes reported results less comparable.
- How much of backlog converts to revenue and profit, given project timing, cancellation and cost-estimation risks.
- Walker and Starr integration, acquired-business margins, contingent earn-out obligations and the resulting debt and interest burden.
- Cash conversion, working-capital needs, customer collections and the sustainability of dividends and repurchases.
- Potential consequences of the ransomware incident, ongoing tax examinations and exposure from self-insurance and bonding commitments.
The independent auditor issued an unqualified opinion on the financial statements and on internal control over financial reporting. The auditor identified percentage-of-completion revenue estimates and Walker purchase accounting as critical audit matters.