Comfort Systems USA, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. The company provides mechanical and electrical contracting services, including HVAC, plumbing, electrical, piping, controls, maintenance and repair, primarily for commercial, industrial and institutional customers.
Financial performance
- Second quarter: Revenue was $650.3 million, up 21.5% year over year. Gross profit was $120.0 million, up 7.9%, while gross margin declined to 18.5% from 20.8%. Operating income fell 11.1% to $35.7 million; net income fell 25.7% to $24.2 million. Diluted EPS was $0.65 versus $0.87.
- First six months: Revenue was $1.189 billion, up 18.9%; gross profit increased 13.2% to $226.7 million, with gross margin down to 19.1% from 20.0%. Operating income rose 7.2% to $63.7 million. Net income declined 10.5% to $44.0 million, and diluted EPS was $1.18 versus $1.31.
- Cash flow: First-half operating cash flow was $26.6 million, versus $37.5 million a year earlier. Capital spending net of asset-sale proceeds was $15.0 million, producing reported free cash flow of $11.6 million versus $24.1 million. Investing activities used $211.3 million, mainly reflecting acquisition spending.
- Liquidity and debt: June 30 cash was $36.8 million. Current assets were $726.6 million and current liabilities were $527.1 million. Total debt was $295.0 million, including $246.0 million drawn on the revolving facility and $49.0 million in notes to former owners. The company reported $120.4 million of remaining facility availability, after letters of credit, and was in compliance with covenants; leverage and fixed-charge coverage ratios were 1.4 and 8.7, respectively.
- Other metrics: Backlog was $1.50 billion, up 21.8% year over year. The company reported 6,021 projects in process. Dividends per share were $0.10 for Q2, compared with $0.08 in Q2 2018.
Material changes and drivers
- Growth was substantially acquisition-related. Q2 revenue included a 22.1% contribution from the Indiana and Walker acquisitions, offset by a 0.6% decline in same-store revenue. First-half revenue included 14.6% acquisition growth and 4.3% same-store growth.
- The April 2019 Walker acquisition added an electrical contracting and network infrastructure business. Walker contributed $92.6 million of revenue in Q2; consideration was valued at $235.6 million, including $178.0 million paid at closing, notes and contingent earn-out consideration. The purchase-price allocation remains preliminary.
- Management attributed lower gross margin primarily to lower margins at Walker, including $1.7 million of backlog amortization, and unusually high Q2 2018 margins. Acquisition-related borrowing increased interest expense; remeasurement of contingent earn-outs also increased expense.
- Q2 2018 included a $4.0 million gain from BP Deepwater Horizon claim settlements, which did not recur. The Q2 2019 tax provision benefited by $1.4 million from expected amended returns claiming the energy-efficient buildings deduction.
Outlook, risks and contingencies
- Management expected strong industry activity to continue during 2019 and anticipated favorable revenue and net earnings for the year, but said earnings for the remainder of 2019 were expected to be below the comparable 2018 period. The filing gives no specific full-year revenue or earnings guidance.
- Management estimated a 2019 effective tax rate of 24%–28%, including the expected energy-efficiency deduction; it expected 25%–30% beginning in 2020.
- Key operating risks include the cyclical and seasonal nature of construction, price competition, labor availability and utilization, and cost overruns on fixed-price projects. Project revenue and profit depend on estimates of costs to complete, which may change and require cumulative adjustments.
- The company had $33.6 million of letters of credit outstanding and historically bonds 20%–30% of its business. A reduction in bonding capacity could constrain work and reduce near-term revenue and profits. Its revolving debt has floating rates, creating interest-rate exposure.
- The company reported ordinary-course legal claims and lawsuits, with accruals for probable losses; management did not expect the matters, after recorded provisions, to materially affect results, cash flows or financial condition. No material surety losses or letter-of-credit claims had occurred.
Important facts for investors to verify
- Whether Walker and other acquisitions deliver expected earnings and cash flow, given preliminary purchase accounting, earn-out exposure and added debt.
- Whether gross-margin pressure persists and how much reflects Walker’s lower margins and backlog amortization versus underlying project execution.
- Whether the $1.50 billion backlog converts to revenue and cash as expected; the company estimates 80%–85% of remaining performance obligations will be recognized within 12 months.
- Whether working-capital timing continues to weigh on operating cash flow and free cash flow despite higher revenue.
- Whether the stated outlook that remaining-2019 earnings will be below the prior-year period is consistent with subsequent results; the filing provides no quantified earnings forecast.