Comfort Systems USA, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; comparisons are with Q1 2022 unless stated otherwise. The company provides mechanical and electrical contracting, installation, maintenance and repair services across the United States.
Financial performance
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Revenue | $1,174.6 million | $885.2 million | +32.7% |
| Gross profit / margin | $205.4 million / 17.5% | $153.1 million / 17.3% | Gross profit +34.1% |
| Operating income / margin | $70.9 million / 6.0% | $35.7 million / 4.0% | +98.6% |
| Income before taxes | $65.8 million | $37.7 million | +74.6% |
| Net income / diluted EPS | $57.2 million / $1.59 | $86.8 million / $2.40 | Net income -34.1% |
| Operating cash flow | $126.9 million | $63.7 million | +$63.2 million |
| Free cash flow, as defined by company | $111.0 million | $55.6 million | +$55.4 million |
Revenue growth reflected 30.0% same-store growth and a 2.7% contribution from Eldeco and Atlantic acquisitions. Mechanical revenue grew 34.6% and electrical revenue 26.3%. Technology-sector work was a notable growth driver. Reported 2023 tax expense was $8.6 million (13.1% effective rate), versus a $49.1 million tax benefit in Q1 2022 (negative 130.1% rate), when tax settlements and R&D credits generated substantial discrete benefits. Thus, the year-over-year decline in net income does not reflect the increase in pretax income.
Balance sheet, liquidity and capital
- At March 31, cash was $48.6 million; total debt was $209.2 million, comprising $160.0 million drawn on the revolver and $49.0 million in notes to former owners.
- The $850 million revolving facility had $638.1 million available after $51.9 million of letters of credit; it matures in July 2027. The weighted-average revolver rate was approximately 6.2%. The company reported compliance with all financial covenants.
- Total current assets were $1,459.0 million and current liabilities $1,406.7 million. Receivables were $1,299.4 million, while billings in excess of costs and deferred revenue were $717.3 million.
- Operating cash flow benefited from a $159.1 million increase in billings in excess of costs and deferred revenue, including large customer advance payments; the company said this benefit reverses as project costs are incurred. Receivables also used cash as revenue grew.
- Investing cash outflow was $68.9 million, including $53.0 million of net acquisition cash payments and $16.5 million of capital expenditures. Financing cash outflow was $66.6 million, including net revolver repayments, dividends of $6.3 million and share repurchases of $3.6 million.
Backlog, material changes and unusual items
- Backlog was $4.445 billion at March 31, up 9.4% from year-end 2022 and 62.6% year over year. Management expects to recognize approximately 65%–75% of remaining performance obligations over the next 12 months. The filing cautions that backlog is not a reliable measure of results beyond the near term.
- Gross margin rose to 17.5% from 17.3%, while SG&A declined to 11.5% of revenue from 13.3%. Management attributed the SG&A ratio improvement primarily to revenue growth and operating leverage.
- Q1 included a $6.8 million pretax gain from legal developments and settlements, recorded across gross profit, SG&A, interest income and contingent earn-out expense. Management said unresolved legal accruals were not material, while noting actual outcomes could differ from estimates.
- Eldeco, an electrical design and construction business, was acquired February 1 for a preliminary purchase price of $73.9 million. The filing also includes Atlantic, acquired in April 2022, in the year-over-year acquisition comparison.
Outlook and principal risks
Management reported strong demand, a good opportunity pipeline and generally successful productivity and material procurement. It anticipated solid earnings and cash flow in 2023 and expected supportive industry conditions to continue, while preparing for a possible recession. Labor costs, supply constraints, material and equipment cost increases, reduced availability and delivery delays remained challenges. The company said it was addressing these through planning, earlier ordering and collaboration with customers.
- Management estimated that, absent Congressional action restoring immediate deductibility of research and experimental expenditures, related tax payments could reduce cash flow by approximately $120 million–$140 million during the last nine months of 2023.
- Most project work is fixed-price, making profitability sensitive to labor availability and productivity, material costs, scheduling, subcontractor execution and estimates of costs to complete. Losses on a contract are recognized when identified.
- Construction demand is cyclical and seasonal, with first-quarter activity typically lower. Higher interest rates may affect customers’ discretionary project decisions and increase borrowing costs.
- Bonding is required on historically 10%–20% of business. A reduction in surety capacity could constrain work and hurt near-term revenue and profits. Letters of credit and self-insurance claims are additional liquidity exposures.
Most important facts for investors to verify
- Whether backlog converts into revenue and margin as expected, and whether same-store growth and project execution remain strong.
- How much Q1 operating cash flow reflected customer advances and whether collections and working capital normalize as projects proceed.
- The timing and cash impact of the projected $120 million–$140 million tax payments, and any Congressional action affecting R&E tax deductions.
- Whether the Q1 legal gain and favorable project items are nonrecurring, and how acquisition-related earn-out liabilities and purchase accounting develop.
- Whether labor, supply, inflation, interest-rate and surety conditions affect costs, project schedules, credit availability or customer demand.