Comfort Systems USA, Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods. Unless stated otherwise, figures below are in millions of dollars. The company provides commercial, industrial and institutional HVAC installation, maintenance, repair and replacement services, plus plumbing, building controls and related work.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $416.6 | $362.8 | $786.1 | $684.2 |
| Gross profit | $82.0 | $61.9 | $146.7 | $114.0 |
| Gross margin | 19.7% | 17.1% | 18.7% | 16.7% |
| Operating income | $24.8 | $10.6 | $36.0 | $12.5 |
| Net income attributable to Comfort Systems | $13.4 | $4.4 | $18.5 | $4.8 |
| Diluted EPS | $0.35 | $0.12 | $0.49 | $0.13 |
| Operating cash flow | $30.2 | $22.4 | $50.7 | $13.6 |
| Free cash flow | $24.8 | $18.3 | $41.8 | $5.8 |
Free cash flow is a company-defined non-GAAP measure: operating cash flow less property and equipment purchases, plus asset-sale proceeds.
Balance sheet and liquidity
- At June 30, cash and cash equivalents were $40.7, current assets $446.8 and current liabilities $324.5.
- Long-term debt was $19.0; total debt obligations including capital leases and the note to former owners were $19.7. Revolver borrowings were $18.0, down from $38.5 at December 31, 2014.
- The $250 million credit facility had $48.0 of letters of credit outstanding and $184.0 of borrowing capacity available. The weighted-average rate on revolver borrowings was approximately 1.4%. The company reported compliance with covenants; leverage ratio was 0.23 versus a 2.75 maximum, and fixed-charge coverage was 24.05 versus a 2.00 minimum.
- Cash increased $8.7 in the first half. Investing used $14.7, including $5.9 for acquisitions and $9.3 for capital expenditures; financing used $27.3, principally reflecting net revolver repayments.
Changes versus prior comparable periods
- Q2 revenue rose 14.8%; first-half revenue rose 14.9%. Management attributed the increases mainly to same-store activity, with Northern Texas acquisition contributions also included.
- Gross margin improved 2.6 percentage points in Q2 and 2.0 points in the first half. Management cited stronger project execution and improved margins at several operating locations. SG&A increased in dollars, but declined as a share of revenue in the first half, to 14.1% from 14.8%.
- Operating income and attributable earnings increased substantially. The prior-year comparison included a $0.7 goodwill impairment charge; no impairment was recorded in 2015.
- First-half operating cash flow improved year over year, supported by higher earnings and increases in accounts payable, accrued liabilities and billings in excess of costs. Higher receivables partially offset those sources.
- Backlog was $712.3 at June 30, up 5.7% year over year but down 0.8% from March 31. It comprised 4,208 projects with aggregate contract value of $2.089 billion.
Outlook, commentary and risks
- Management said industry conditions had gradually improved in the first half of 2015 and expected gradual activity improvement over the next 12 months, particularly in new construction. It expected 2015 revenue to exceed levels experienced in recent years and profitability to improve versus 2014; no specific numerical forecast was provided.
- For the rest of 2015, management emphasized execution, cost discipline, project performance, workforce development and investment in service and small-project growth. It also noted continuing price competition and that construction activity remained below prior peaks.
- Management estimated the 2015 effective tax rate at 35%–40%; the first-half rate was 35.7%.
- Fixed-price project work exposes results to estimating errors, cost overruns, labor utilization and delays. The business is cyclical and seasonal, with demand generally higher in the second and third quarters. Receivables, project costs and collection timing can cause working-capital swings.
- Historically, 25%–35% of business required bonds. Management reported adequate bonding capacity and strong surety relationships, but warned that reduced access to surety support could constrain revenue and profits. The company is substantially self-insured for several liability and employee-health risks.
- Routine legal claims and lawsuits were reported; management did not expect them, individually or collectively, to materially affect results, cash flows or financial condition after recorded accruals. The company also disclosed operating leases, letters of credit and surety guarantees as off-balance-sheet arrangements.
- Two small acquisitions were completed in Q1 2015; none were completed in Q2. The 2015 balance sheet included preliminary purchase-price allocations for the acquisitions. A $0.1 gain from remeasurement of contingent earn-out obligations was recorded in Q2, and the obligation stood at $0.3 at quarter-end.
Important facts for investors to verify
- Whether the improvement in project execution and gross margin is sustainable, particularly as revenue and backlog convert to completed work.
- How receivables, billings, collections and customer retainage affect cash generation; first-half operating cash flow benefited from liability and billing timing.
- Backlog conversion, project mix and pricing, including the filing’s descriptions of revenue mix: the notes report 48% from new-facility installations and 52% from maintenance, repair and replacement, while MD&A describes about 83% as project work and 17% as maintenance and repair.
- Exposure to fixed-price project overruns, bonding availability, self-insurance claims and variable interest rates.
- Acquisition purchase-price adjustments, earn-out estimates and the expected effective tax rate.