Comfort Systems USA, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. The company provides mechanical contracting services, including HVAC, plumbing, piping, controls and related installation, maintenance, repair and replacement work. Unless otherwise noted, dollar amounts below are in millions.
Financial results and liquidity
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Revenue | $380.6 | $385.9 |
| Gross profit / margin | $76.0 / 20.0% | $73.5 / 19.0% |
| Operating income / margin | $11.8 / 3.1% | $15.5 / 4.0% |
| Net income | $7.5 | $9.8 |
| Diluted EPS | $0.20 | $0.26 |
| Operating cash flow | $10.1 | $13.1 |
| Free cash flow | $5.3 | $9.6 |
Revenue fell 1.4% year over year; gross profit rose 3.3%, but SG&A increased 8.7% to $63.2 million. Gross margin improved, while operating margin and net income declined. The effective tax rate was 34.2%, versus 35.4%.
At March 31, cash was $31.4 million and current assets were $396.5 million against current liabilities of $293.0 million. Total debt, including capital leases, was $2.0 million; there were no revolving-facility borrowings. The $325 million facility had $286.1 million available after $38.9 million of letters of credit. The company reported compliance with covenants, a 0.02 leverage ratio and a 25.24 fixed-charge coverage ratio.
Material changes and operating developments
- Same-store revenue declined 2.9%, partly offset by a 1.5% contribution from Shoffner, acquired in February 2016. Management attributed the same-store decrease mainly to lower activity at operations in Michigan and Virginia.
- Gross margin increased from 19.0% to 20.0%, reflecting improved project execution at New York and Wisconsin operations, partly offset by underperformance in California.
- SG&A rose partly due to leadership-related compensation, investment in service, and higher bad-debt expense. The company also incurred $0.4 million of costs related to the BCH acquisition.
- A $1.1 million goodwill impairment fully wrote off goodwill associated with a California reporting unit after a market-strategy change and revised projected earnings.
- Backlog was $863.0 million at quarter-end, up 13.1% from December 2016 and 11.1% from March 2016. Management cautions backlog covers only contracted or committed project work, generally expected to convert over six to twelve months, and is not a reliable indicator of results over multiple quarters.
- On April 1, 2017, the company acquired BCH Holdings for $100 million: $85.7 million cash at closing, a $14.3 million promissory note, subject to adjustments, and a potential earn-out.
Outlook, risks and other notable items
Management expected 2017 revenue to exceed 2016 levels, reflecting the BCH acquisition, and expected profitability to remain strong at levels similar to 2016. Priorities included execution, cost control, labor development and growth, particularly in service and small projects. The estimated full-year 2017 effective tax rate was 35%–40%. Management noted improved industry activity in 2015–2016 and expected activity to remain strong in 2017, while acknowledging continued price competition.
Risks include the cyclical and seasonal nature of construction demand, fixed-price project cost overruns, labor availability and utilization, and dependence on surety bonding. Historically, 20%–30% of business required bonds; reduced bonding capacity could pressure revenue and profits. The company is substantially self-insured and estimates related claims using actuarial and other assumptions. Ordinary-course litigation was not expected by management to have a material effect after recorded accruals. The filing also identifies operating leases, letters of credit and surety guarantees as off-balance-sheet arrangements. Q1 cash flow was affected by working-capital timing and is typically seasonally lower in the first quarter.
The company early adopted the revised goodwill impairment standard in Q1 2017. It was evaluating the expected effects of new revenue-recognition, lease and cash-flow accounting standards; it did not then expect revenue-standard adoption to have a material impact.
Investor verification priorities
- Track whether backlog converts to revenue and whether the improved gross margin is sustained as project mix and execution change.
- Assess the sources and persistence of higher SG&A, and whether operating profitability recovers from the year-over-year decline.
- Review BCH’s integration, performance, final purchase-price adjustments and earn-out exposure, including the effect of the cash payment on liquidity.
- Monitor California operations and any further goodwill impairment or other underperforming locations.
- Verify working-capital and cash-flow trends, covenant headroom, and continued access to letters of credit and surety bonding.