Comfort Systems USA, Inc. — Q3 2011 Form 10-Q
Business and period: HVAC, plumbing, building-controls and related mechanical services provider, reporting the quarter and nine months ended September 30, 2011. The company operates as one mechanical-services segment. Financial amounts below are in millions unless stated otherwise.
Key financial results
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $328.1 | $307.6 | $922.3 | $793.7 |
| Gross profit / margin | $49.1 / 15.0% | $50.3 / 16.4% | $130.8 / 14.2% | $131.8 / 16.6% |
| Operating income (loss) | $(47.5) | $8.5 | $(50.2) | $12.9 |
| Net income (loss) | $(36.6) | $5.4 | $(38.6) | $8.9 |
| Diluted EPS | $(0.98) | $0.14 | $(1.03) | $0.24 |
| Operating cash flow | $1.5 | $(3.8) | $(22.0) | $(14.5) |
Q3 revenue grew 6.7%; nine-month revenue rose 16.2%. Growth reflected same-store increases and ColonialWebb, acquired in July 2010. ColonialWebb contributed $43.6 million of Q3 revenue and $126.3 million for the nine-month period. Despite higher revenue, gross profit fell and margins contracted, reflecting price competition, job write-downs and lower profitability in Maryland; nine-month results also included write-downs at Southern Alabama.
The company recorded a $55.1 million non-cash goodwill impairment in Q3, driving the operating loss. The impairment followed weaker results and revised forecasts at four reporting units in Virginia, Maryland and North Carolina. The second-step assessment was incomplete at filing; management said the charge could be adjusted in Q4. Changes in contingent earn-out fair value generated $5.1 million of income in Q3 and $5.6 million for nine months.
Liquidity, debt and capital
At September 30, cash was $43.7 million, down from $86.3 million at December 31, 2010. Nine-month operating cash use was $22.0 million, primarily reflecting a $7.4 million working-capital investment; defined free cash flow was negative $27.8 million. The company reported total debt of $28.2 million, including $25.5 million in notes to former owners; it had no revolver borrowings. Its amended $125 million credit facility runs to September 2016, with $42.7 million in letters of credit and $82.3 million of remaining availability. It reported compliance with covenants, a 0.65 leverage ratio and 12.95 fixed-charge coverage ratio.
Backlog was $636.1 million, flat year over year and up 2.4% sequentially; same-store backlog declined 3.5% year over year. Nine-month share repurchases totaled 0.6 million shares at an average $9.92 per share. The quarterly dividend was $0.05 per share.
Outlook, risks and notable items
- Management expected nonresidential construction weakness to continue into 2012, with industry activity likely flat over the next 12 months and price competition remaining strong. It expected 2011 profitability and modest profitability through 2012, emphasizing cost control, execution and efficient project performance.
- Management estimated a 15%–25% effective tax rate for 2011. The nine-month effective rate was 16.2%; the goodwill charge’s nondeductible portion and added valuation allowances affected the rate.
- Key risks include cyclical and seasonal demand, fixed-price project cost overruns, estimates used in percentage-of-completion accounting and goodwill valuation, self-insurance claims, and restricted availability of surety bonds. The company said 25%–35% of its business historically required bonds; a loss of bonding capacity could reduce revenue and profit.
- Customer backcharge accruals of $7.1 million at June 30 were resolved in Q3; the company reported a $4.8 million payment and a $0.2 million recovery, and no remaining accrual at September 30. Management said ordinary-course legal matters were not expected to materially affect results after recorded provisions.
- In October, the company received cash in a legal settlement expected to produce an approximately $1.0 million Q4 gain. On November 2, it acquired a 60% interest in Environmental Air Systems for approximately $30 million cash, plus working-capital adjustments and potential contingent consideration. EAS reported 2010 revenue of approximately $67.8 million and pretax income of $1.9 million.
- Disclosure controls were assessed as effective, with no material change in internal control reported for the quarter.
Important facts for investors to verify
- Final goodwill impairment amount and any further impairment after completion of the assessment and annual testing.
- Whether gross margins and job execution improve, particularly in Maryland, and whether backlog converts into profitable revenue.
- Working-capital trends, cash generation and liquidity following the EAS acquisition and ongoing repurchases and dividends.
- Environmental Air Systems’ final purchase accounting, contingent consideration and contribution to results.
- Renewal of letters of credit and continued access to surety bonding, alongside compliance with credit-facility covenants.