Comfort Systems USA, Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Financial amounts below are in millions unless otherwise noted. The company provides commercial, industrial and institutional HVAC installation, maintenance, repair and replacement, plus related plumbing and building-control services.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $350.0 | $335.2 | $1,026.9 | $1,015.3 |
| Gross profit / margin | $67.0 / 19.1% | $55.5 / 16.6% | $178.5 / 17.4% | $152.5 / 15.0% |
| Operating income / margin | $17.7 / 5.1% | $9.8 / 2.9% | $37.2 / 3.6% | $14.2 / 1.4% |
| Net income attributable to Comfort Systems | $11.4 | $5.7 | $21.7 | $9.1 |
| Diluted EPS | $0.30 | $0.15 | $0.58 | $0.24 |
| Cash from operating activities | $27.4 | $16.5 | $23.8 | $3.4 |
| Free cash flow | $22.3 | $13.8 | $11.9 | $(5.0) |
Q3 revenue increased 4.4% year over year; nine-month revenue rose 1.1%. Profitability improved more sharply, with higher gross margins and operating income. Management attributed improvement to stronger results at EAS and Arizona, improved profitability at a Virginia operation, and fewer prior-year job problems in Maryland. SG&A increased 7.7% in Q3, including higher bonus accruals and medical claims.
Balance sheet, debt and liquidity
- At September 30, cash was $45.3, versus $40.8 at December 31, 2012. Current assets were $389.2 and current liabilities $266.6.
- Total debt, including notes to former owners, was $7.0: $5.0 drawn on the revolving facility and $2.0 due to former owners in July 2014. The company paid off $2.4 of other debt during July.
- The amended credit facility has $175.0 of capacity and expires in July 2018. At quarter-end, $50.7 of letters of credit were outstanding and $119.3 of capacity remained available. The company reported covenant compliance; leverage and fixed-charge coverage ratios were 0.10 and 11.14, respectively.
- Nine-month capital expenditures were $12.5. Cash generation improved, but working-capital movements—including the timing of customer billings and vendor payments—materially affected operating cash flow.
Material changes and unusual items
- Gross profit included approximately $2.5 from a correction of prior-period accounting errors, which added approximately $1.3 of after-tax income in the first nine months. The errors primarily affected years before 2010; management concluded they were not material to prior financial statements and did not restate them. Investors should consider this benefit when assessing reported growth.
- Nine-month gross profit also included approximately $1.6 from settlement of a claim on a large data-center project. A $0.75 Q3 gain (and $0.696 for nine months) from remeasurement of contingent earn-out obligations reflected a reduced estimated liability.
- Backlog was $570.9 at September 30, down 3.3% from June 30 and 8.3% year over year. No acquisitions were completed during the first nine months of 2013.
Outlook, commentary and risks
- Management described nonresidential construction as subdued and expected industry activity to remain broadly flat over the next 12 months. It expected 2013 revenue to remain near the lower levels of recent years, while profitability would improve from 2012. Its then-current expectation was for 2014 revenue and profitability to be comparable to improved 2013 levels.
- Management estimated a 2013 effective tax rate of 38%–42%. Its main priorities for the rest of 2013 were project execution, cost discipline, efficient service performance and preserving the core workforce.
- Risks include cyclical construction demand, strong price competition, fixed-price project cost overruns, and estimates used for percentage-of-completion revenue recognition. Surety capacity was constrained across the market; about 25%–35% of the company’s business historically required bonds, and an interruption could reduce near-term revenue and profit.
- The company is substantially self-insured for several liability and employee-health risks, making results sensitive to claim estimates and actual loss experience. Legal claims were accrued where considered probable; management did not expect pending matters to have a material effect. The filing also identifies operating leases and letters of credit as off-balance-sheet commitments.
Key facts for investors to verify
- How much of the reported 2013 earnings improvement is recurring, given the accounting correction, project-claim settlement and earn-out remeasurement?
- Whether backlog trends and project bookings support management’s flat-market and 2014 outlook assumptions.
- Whether operating cash flow remains strong after the favorable timing effects from receivables, payables and accrued expenses.
- Whether surety availability, project cost estimates and self-insurance claims develop as management expects.
- Whether the company maintains covenant compliance and liquidity as the $2.0 former-owner note comes due in July 2014.