Comfort Systems USA, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; comparative periods ended September 30, 2016. The company provides mechanical contracting services, including HVAC, plumbing, controls, maintenance, repair and replacement, through one reportable industry segment. It had 36 operating locations at quarter-end.
Financial performance
| Metric | Q3 2017 | Q3 2016 | First nine months 2017 | First nine months 2016 |
|---|---|---|---|---|
| Revenue | $480.9 million | $428.8 million | $1,326.9 million | $1,242.2 million |
| Gross profit / margin | $100.9 million / 21.0% | $92.8 million / 21.6% | $272.6 million / 20.5% | $255.7 million / 20.6% |
| Operating income / margin | $34.3 million / 7.1% | $32.0 million / 7.5% | $75.4 million / 5.7% | $76.0 million / 6.1% |
| Net income / margin | $22.3 million / 4.6% | $20.5 million / 4.8% | $47.7 million / 3.6% | $48.0 million / 3.9% |
| Diluted EPS | $0.59 | $0.54 | $1.27 | $1.27 |
- Q3 revenue grew 12.1%, including 8.0% from BCH and 4.1% same-store growth. Q3 gross profit rose 8.7%, while gross margin declined 0.6 percentage point, primarily due to BCH-related backlog amortization.
- Nine-month revenue increased 6.8%, including 6.4% from acquisitions and 0.4% same-store growth. Gross profit rose 6.6%, but operating income declined 0.9% and net income declined 0.6% year over year.
- Q3 SG&A was $66.7 million (13.9% of revenue), versus $61.0 million (14.2%) a year earlier. Nine-month SG&A was $196.6 million (14.8%), versus $180.2 million (14.5%).
Cash flow, liquidity and balance sheet
- Nine-month operating cash flow was $65.7 million, versus $49.8 million in 2016. Management-defined free cash flow was $49.6 million, versus $33.3 million. The increase in operating cash flow reflected higher payables and billings in excess of costs, partly offset by a $33.8 million increase in receivables.
- Investing activities used $110.9 million, including $94.9 million of acquisition cash payments. Financing activities provided $42.6 million, largely reflecting net revolving-credit borrowings. Cash declined $2.6 million to $29.5 million from year-end 2016.
- At September 30, 2017, total debt was $81.7 million, including $66.0 million drawn on the revolving facility and $15.3 million in notes to former owners. The $325 million facility had $219.4 million available after borrowings and letters of credit. The weighted-average facility rate was approximately 2.6%.
- Leverage and fixed-charge coverage ratios were 0.5 and 29.5, respectively; the company reported compliance with all financial covenants. Current assets were $495.4 million and current liabilities $373.8 million.
- Backlog was $901.2 million, down 3.9% sequentially but up 25.3% year over year, including $31.8 million from BCH and a 20.9% same-store increase.
Material changes and notable items
- The April 2017 BCH acquisition had preliminary consideration fair value of $122.6 million; its results contributed $73.2 million of revenue from acquisition through September. Acquisitions contributed to higher goodwill and intangible assets, and to increased amortization and interest expense.
- A $1.1 million goodwill impairment was recorded in Q1 for a California reporting unit following a change in market strategy and revised projected earnings.
- Q3 included $2.5 million of income from changes in contingent earn-out fair value, primarily from reducing the BCH obligation after results were below initial estimates, including effects attributed to Hurricane Irma and lower project activity. This valuation gain is not equivalent to operating cash flow.
- Nine-month interest expense rose to $2.4 million from $1.9 million, reflecting acquisition-related borrowing and notes. The effective tax rate was 36.3%, versus 36.0% in 2016.
- The company repurchased approximately 0.3 million shares for $8.9 million during the first nine months and paid $8.2 million in dividends.
Outlook, risks and contingencies
- Management expected 2017 revenue to exceed 2016 levels, citing recent acquisitions, and expected profitability to remain strong at levels similar to 2016. It emphasized execution, cost control, labor development, and investment in service and small projects. Estimated full-year 2017 effective tax rate was 35%–38%.
- Management described industry conditions as improved, while cautioning that price competition would continue. Construction demand is cyclical and seasonal; fixed-price project work carries risk of cost overruns, and working-capital requirements can vary with project timing and collections.
- Approximately 20%–30% of business historically required surety bonds. Bonding capacity was described as adequate, but loss of surety support could reduce near-term revenue and profit. The company also has self-insurance exposures and $39.6 million of letters of credit outstanding.
- Ordinary-course legal claims were accrued where losses were considered probable; management did not expect them, after recorded provisions, to materially affect results, cash flows or financial condition. The filing also identifies operating leases and surety guarantees as off-balance-sheet arrangements.
- Hurricane Harvey relief permitted approximately $6.0 million of income tax payments to be postponed without penalty, supporting reported payables and accrued liabilities. Management stated liquidity was sufficient for the foreseeable future.
Important facts for investors to verify
- How much of revenue and backlog growth is sustainable on a same-store basis versus acquisition-driven, and how BCH performs relative to acquisition estimates.
- Whether gross-margin pressure from backlog amortization and project execution persists, and whether operating income recovers despite higher SG&A.
- Receivables, billing timing, and working-capital conversion, given the significant receivables increase and reliance on project cash flows.
- Revolving-credit utilization, interest-rate exposure, covenant headroom, and contingent earn-out obligations as acquisition-related balances change.
- Potential developments in surety capacity, self-insurance estimates, legal contingencies, and the impact of new accounting standards, particularly revenue recognition.