Comfort Systems USA, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; compared with Q1 2019. Comfort Systems provides mechanical and electrical contracting, installation, maintenance and repair services across U.S. commercial, industrial and institutional markets. Figures below are in millions, except per-share data and percentages.
Financial performance and liquidity
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Revenue | $700.1 | $538.5 |
| Gross profit / margin | $117.1 / 16.7% | $106.7 / 19.8% |
| Operating income / margin | $24.7 / 3.5% | $28.0 / 5.2% |
| Net income / margin | $17.7 / 2.5% | $19.9 / 3.7% |
| Diluted EPS | $0.48 | $0.53 |
| Cash from operating activities | $21.9 | $1.0 |
| Free cash flow* | $15.1 | ($7.5) |
- Revenue increased 30.0%; management attributed approximately 24 percentage points of growth to acquisitions and 6 points to same-store activity. Electrical revenue rose substantially with the Walker and North Carolina acquisitions; mechanical revenue increased 5.8%.
- Gross margin contracted 3.1 percentage points. Management cited lower-margin Walker work, project mix and some March COVID-19-related inefficiency. SG&A rose 17.8% to $92.9 million, including acquisition costs and a $4.3 million increase in bad debt expense.
- Interest expense increased to $2.6 million from $1.1 million, reflecting higher acquisition-related borrowings. A $2.3 million fair-value gain on contingent earn-out obligations partly offset other expense; the filing attributes the decrease in the liability mainly to wider credit spreads.
- Cash and equivalents were $133.3 million at March 31, versus $50.8 million at year-end. Management noted this balance was higher than usual because it borrowed in late March to fund the April 1 TAS Energy purchase. Debt, net of issuance costs, was $334.0 million, versus $226.1 million at year-end. Cash flow benefited from timing of project billings and payments; working-capital movements were significant.
- The $600 million credit facility had $150 million drawn on the revolver, $55.6 million of letters of credit and $244.4 million available. The leverage ratio was 1.5 versus a maximum of 3.0; fixed-charge coverage was 10.7 versus a minimum of 1.5. The company reported compliance with covenants.
- Backlog was $1.62 billion, up 1.0% sequentially and 41.7% year over year; the year-over-year increase included acquisitions and same-store growth. Remaining performance obligations were also $1.62 billion, with 80–85% expected to be recognized over the next 12 months.
*Company-defined non-GAAP measure: operating cash flow less property and equipment purchases, plus asset-sale proceeds.
Outlook, risks and notable items
- COVID-19 disrupted operations in the latter half of March through building closures, restricted site access, temporary project stoppages, delayed awards and added safety-related inefficiency. Management expected a more pronounced impact in Q2, particularly April and May. It anticipated positive earnings if conditions did not materially worsen, but far below Q2 2019; Q3 and Q4 were expected to improve from Q2, but not reach the record levels of 2019. The company said the full impact could not be quantified.
- Management estimated a 25–30% full-year 2020 effective tax rate, potentially toward the low end because of the extended 179D deduction. The filing provides no full-year revenue or earnings guidance.
- COVID-related credit concerns led to higher expected-loss reserves and $4.6 million of bad debt expense, compared with $0.2 million in Q1 2019. Walker’s goodwill fair-value cushion declined to about 21% from 27% at the 2019 annual test; no impairment was recorded, but further deterioration could increase impairment risk.
- On April 1, the company completed the TAS Energy acquisition and expected it to contribute annualized revenue of approximately $170–190 million. It also completed a North Carolina electrical contractor acquisition in February. April interest-rate swaps initially covered $225 million of debt, declining to $80 million by November 2021, with termination scheduled for September 2022.
- Share repurchases were suspended beginning March 27 amid pandemic uncertainty; $9.0 million of shares had been repurchased during the quarter. Management described ordinary-course legal claims as not expected to have a material effect after recorded provisions. Surety bonding availability, self-insurance obligations, fixed-price project execution, seasonality and economic cyclicality remain relevant risks.
Most important facts for investors to verify
- Whether COVID-19 effects on customer access, project timing, service demand, margins and collections matched or exceeded management’s Q2 expectations.
- Whether receivables and expected-credit-loss reserves adequately reflect customer credit deterioration, especially in retail, restaurants and entertainment.
- Whether backlog converts to revenue and cash as expected, given its limited predictive value and project timing risks.
- Post-acquisition performance, purchase accounting and debt impact for TAS Energy and the North Carolina contractor; also confirm acquisition-related cash use and financing.
- Whether margin pressure persists and whether Walker’s goodwill fair-value cushion remains adequate.
- Facility availability, covenant headroom, floating-rate exposure and the effectiveness of the announced interest-rate swaps.