Comfort Systems USA, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; financial comparisons are against Q1 2018 unless otherwise stated. The company provides U.S. mechanical contracting and related HVAC, plumbing, controls, electrical, and service work. Results are unaudited and interim results may not indicate full-year performance.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change / context |
|---|---|---|---|
| Revenue | $538.5 million | $464.9 million | Up 15.8%; 9.8% same-store growth and 6.0% from the Indiana acquisition |
| Gross profit / margin | $106.7 million / 19.8% | $89.1 million / 19.2% | Margin improved 0.6 percentage points |
| Operating income / margin | $28.0 million / 5.2% | $19.2 million / 4.1% | Improved year over year |
| Net income | $19.9 million | $16.7 million | Up 19.3%; diluted EPS was $0.53 vs. $0.44 |
| Operating cash flow | $1.0 million | $3.9 million | Lower, principally reflecting working-capital timing |
| Free cash flow | $(7.5) million | $(1.4) million | Operating cash flow less capital expenditures, plus asset-sale proceeds |
| Cash and debt, March 31 | $29.1 million cash; $77.2 million debt | — | Debt includes $51.0 million drawn on revolver and $26.2 million in notes to former owners |
SG&A was $78.9 million, or 14.7% of revenue, compared with $70.0 million, or 15.1%. The effective tax rate was 25.9%, versus 11.1% in Q1 2018; the prior-year rate benefited from a $2.8 million tax benefit related to an accounting-method change. The Q1 2019 dividend was $0.095 per share.
At March 31, current assets were $557.3 million and current liabilities were $409.8 million. The company had $315.4 million of available revolver capacity after $51.0 million of borrowings and $33.6 million of letters of credit. It reported compliance with credit covenants: total leverage ratio 0.4 against a maximum of 3.0, and fixed-charge coverage ratio 22.6 against a minimum of 2.0.
Changes, operations, and outlook
- Revenue gains were broad-based; industrial and healthcare customer revenue increased notably, while education revenue declined. Gross margin improvement was attributed primarily to better project execution, including at North Carolina operations.
- Backlog was $1.14 billion, down 2.0% from December 2018 and up 5.9% year over year. The company expected to recognize about 85% of remaining performance obligations within 12 months. Backlog excludes much service and short-duration work and is not a reliable multi-quarter revenue forecast.
- Management expected 2019 revenue and net earnings to remain at favorable 2018 levels, citing backlog and improved industry conditions. Priorities included cost discipline, project execution, workforce development, and investment in service and small projects. Management anticipated continued price competition and noted normal first-quarter seasonal weakness.
- After quarter-end, on April 1, the company acquired Walker, a Texas electrical contracting and network infrastructure business, for $178 million cash, a $25 million note, and potential earn-out payments; it also funded a $20.5 million advance. The transaction was primarily financed through the revolver.
- A ransomware incident beginning around April 14 disrupted access to systems at most operating locations, including accounting, payroll, billing, and job-reporting systems. Q1 results were not affected; management expected second-quarter costs, inefficiencies, delays, and possible near- to intermediate-term cash-flow timing effects, some potentially uninsured.
Risks and unusual items
Fixed-price project profitability depends on estimates of labor, materials, subcontractor costs, and completion timing; estimate changes can affect revenue and profit through cumulative adjustments, and anticipated contract losses are recognized when identified. Construction cyclicality, seasonal demand, labor availability, working-capital needs, interest-rate exposure on variable-rate borrowings, and the availability of surety bonds are also risks. Historically, 20%–30% of business required bonds; the company reported adequate bonding capacity and no known bond losses. Routine claims and lawsuits were accrued where considered probable; management did not expect them to have a material financial effect after recorded provisions.
Adoption of lease accounting on January 1, 2019 added $75.9 million of right-of-use assets and lease liabilities at adoption, without a material income-statement or cash-flow impact. Q1 cash flow was affected by seasonal working-capital movements. No impairment was recorded in the quarter.
Important facts for investors to verify
- Whether the Walker acquisition delivers expected performance and how its financing affects debt, interest expense, and covenant headroom.
- The operational and financial impact, insurance coverage, and recovery status related to the ransomware incident.
- Whether backlog converts into revenue and earnings as expected, given project timing, execution, pricing, and cost-estimate risks.
- Whether Q1 working-capital patterns reverse seasonally and support improved operating and free cash flow.
- How the 25%–30% full-year tax-rate expectation and the higher post-2018 tax baseline affect net income.