Comfort Systems USA, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. The company provides commercial, industrial and institutional HVAC installation, maintenance, repair and replacement, along with related mechanical services. Figures below are in millions of dollars except per-share data.
Financial results and liquidity
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Revenue | $335.5 | $328.1 | $1,019.7 | $922.3 |
| Gross profit / margin | $55.7 / 16.6% | $49.1 / 15.0% | $152.9 / 15.0% | $130.8 / 14.2% |
| Operating income (loss) | $9.7 | $(47.5) | $14.0 | $(50.2) |
| Net income (loss) attributable to Comfort Systems | $5.7 | $(36.6) | $9.1 | $(38.6) |
| Diluted EPS | $0.15 | $(0.98) | $0.24 | $(1.03) |
| Operating cash flow | $16.5 | $1.5 | $3.4 | $(22.0) |
| Free cash flow | $13.8 | $(0.8) | $(5.0) | $(27.8) |
- Q3 SG&A was $46.0 million, or 13.7% of revenue, versus $41.5 million, or 12.6%, a year earlier. Nine-month SG&A was $139.5 million, or 13.7% of revenue, versus $126.0 million, or 13.7%.
- Cash was $35.7 million at September 30, down from $51.2 million at December 31, 2011. Total debt, including notes to former owners, was $24.3 million, versus $15.4 million at year-end. Working capital was approximately $116.2 million.
- The $125 million credit facility had $14.0 million drawn, $45.2 million in letters of credit and $65.8 million available. The company reported covenant compliance; leverage and fixed-charge coverage ratios were 0.52 and 15.94, respectively.
- Dividends were $0.05 per share in Q3 and $0.15 per share for the first nine months.
Changes versus the prior comparable periods
- Q3 revenue rose 2.3%; management attributed this to EAS, acquired in 2011, contributing about $19.9 million, partly offset by a 3.8% decline in same-store revenue. Nine-month revenue rose 10.6%, reflecting EAS and 3.4% same-store growth.
- Same-store demand varied by sector: Q3 weakness included healthcare; nine-month growth included manufacturing, notably a large, short-duration data-center project substantially completed in the first half, partly offset by healthcare declines.
- Gross margin improved in both comparisons. Management cited better performance in certain operations and prior-year job underperformance. Nine-month results also included a first-quarter project write-down after owner-accelerated work created more than $3 million of additional costs; the company was pursuing a claim and had not recognized additional contract price.
- The prior-year periods included a $55.1 million goodwill impairment charge. Its absence in 2012 is a major reason for the swing from operating and net losses to profits. Prior-year other income also included gains from changes in contingent earn-out fair values ($5.1 million in Q3 and $5.6 million for nine months), versus small expenses in 2012.
- Backlog was $623.1 million at September 30: up 0.9% sequentially but down 2.0% year over year. Management attributed the year-over-year same-store decline partly to completion of the large data-center project; EAS lifted reported backlog.
Outlook, risks and unusual items
- Management expected industry activity to remain flat over the next 12 months, with weakness in nonresidential construction continuing through the rest of 2012. It expected current profitability levels to persist for the remainder of 2012 and, absent industry improvement, into 2013. Price competition was described as noticeable; priorities were execution, cost control and efficient project and service performance.
- Management estimated a 2012 annual effective tax rate of 43%–48%. The nine-month effective rate was 47.5%, with increases in tax reserves and variation among local jurisdictions cited as factors.
- Construction contracts are often fixed-price and use percentage-of-completion accounting. Cost-estimate revisions, labor execution, project overruns and collection timing can affect results and working capital. Backlog is not a complete forecast of future revenue.
- Surety capacity and terms were described as challenging; historically, 25%–35% of business required bonds. A loss of bonding availability could reduce near-term revenue and profits. Letters of credit totaled $45.2 million, largely supporting insurance programs.
- The company disclosed ordinary-course litigation and an unresolved matter involving approximately 29,000 potentially mislabeled gaskets that may contain asbestos; it said no reasonable estimate of any liability was then possible. Management did not expect known litigation, after recorded provisions, to materially affect results or financial condition.
- Other exposures include substantial self-insurance, operating leases, variable-rate debt, and potential goodwill impairment if operating performance or recovery assumptions deteriorate. No goodwill impairment was recorded in the current quarter. Management reported effective disclosure controls and no material change in internal control during the quarter.
Key facts for investors to verify
- Whether project margins and same-store activity can hold up amid flat demand and continued pricing pressure.
- How much of revenue and backlog growth reflects EAS or the completed data-center project, and the trajectory of healthcare-related work.
- Conversion of operating cash flow to free cash flow, including working-capital movements and acquisition spending.
- Project-cost estimates and recovery prospects for the accelerated project’s additional costs; collectability and adequacy of bad-debt and self-insurance reserves.
- Tax-reserve developments, the unresolved gasket matter, surety availability, and headroom under credit-facility covenants and letters-of-credit commitments.