Comfort Systems USA, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Dollar figures below are in millions unless stated otherwise. The company provides mechanical contracting services, including HVAC, plumbing, controls, installation, maintenance, repair and replacement, across the United States.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $594.5 | $480.9 | $1,594.5 | $1,326.9 |
| Gross profit | $127.9 | $100.9 | $328.1 | $272.6 |
| Gross margin | 21.5% | 21.0% | 20.6% | 20.5% |
| Operating income | $52.8 | $34.3 | $112.2 | $75.4 |
| Operating margin | 8.9% | 7.1% | 7.0% | 5.7% |
| Net income | $38.5 | $22.3 | $87.7 | $47.7 |
| Diluted EPS | $1.02 | $0.59 | $2.33 | $1.27 |
Cash flow: Nine-month operating cash flow was $68.0 million, compared with $65.7 million a year earlier. Free cash flow, as defined by the company, was $47.0 million versus $49.6 million. Investing used $86.3 million, including $65.3 million net cash paid for acquisitions; financing provided $1.0 million. Cash declined $17.3 million during the period to $19.2 million.
Liquidity and debt: At September 30, cash was $19.2 million and total debt was $97.0 million, up from $60.5 million at year-end 2017. Debt included $70.0 million drawn on the revolving facility and $26.8 million in notes to former owners. The amended facility provides $400 million of borrowing capacity, with $296.4 million available after borrowings and letters of credit. The company reported a 0.5 total leverage ratio, an 18.6 fixed-charge coverage ratio, and compliance with its covenants.
Other metrics: Backlog was $1.25 billion, up 39.3% year over year; management expected to recognize approximately 85% within 12 months. The company completed seven acquisitions in the first nine months, at a preliminary aggregate purchase price of $94.0 million. Dividends were $0.085 per share in Q3.
Changes versus the prior comparable period
- Q3 revenue increased 23.6%; management attributed 17.9% growth to same-store activity and 5.7% to the Indiana acquisition. Nine-month revenue increased 20.2%, including 16.2% same-store growth.
- Profitability improved: Q3 gross margin rose 0.5 percentage points and operating margin 1.8 points. Management cited higher volume and better project execution, particularly at its North Carolina operation. Nine-month gross margin improved slightly; California job underperformance partly offset gains.
- SG&A increased in dollars but declined as a share of revenue: 12.7% versus 13.9% in Q3, and 13.6% versus 14.8% year to date.
- Nine-month net income included a $4.0 million gain from settlement of two BP Deepwater Horizon-related claims and a $2.8 million first-quarter tax benefit from a decrease in unrecognized tax benefits. The 2017 comparison included a $1.1 million goodwill impairment charge.
- Receivables and unbilled amounts used cash: management cited project timing and billing schedules, including a $42.7 million increase in accounts receivable as a partial offset to higher earnings and billings.
Outlook, commentary and risks
- Management expected year-over-year improvement in revenue and net earnings in Q4 2018 and continued favorable industry conditions in 2019. It emphasized project execution, cost control, workforce development and growth investment.
- Management estimated a 22%–25% full-year 2018 effective tax rate and 25%–30% for 2019; the 2018 estimate includes the tax benefit described above. Tax amounts related to the Tax Cuts and Jobs Act remained provisional.
- Construction is cyclical and seasonal; HVAC demand and results are generally lower in Q1. Fixed-price project profitability depends on cost estimates, labor utilization, execution and change-order recovery. Revenue and margins can be affected by project delays, cost overruns and changing estimates.
- Approximately 20%–30% of business historically required surety bonds. Reduced bonding availability could constrain work and lower near-term revenue and profits. The company also bears substantial self-insured exposure and has floating-rate debt.
- Ordinary-course legal claims were accrued where losses were considered probable; management did not expect remaining exposure to materially affect results, cash flows or financial condition. Disclosure controls were assessed as effective, with no material changes in internal control reported.
Important facts for investors to verify
- Whether strong backlog converts to revenue and cash on expected schedules, and whether receivables and unbilled balances remain collectible.
- Whether project execution and margins sustain improvement, especially given disclosed California underperformance and the company’s reliance on fixed-price work.
- Acquisition integration, purchase-price allocations, earn-out obligations and the increase in debt associated with acquisitions.
- Cash generation after capital spending, acquisitions, dividends and repurchases; confirm the company’s non-GAAP free-cash-flow definition when comparing results.
- Effects of provisional tax estimates, floating interest rates, self-insurance claims and continued access to surety bonding.