Comfort Systems USA, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. The company provides mechanical and electrical contracting, installation, maintenance, repair, and replacement services across the United States. Unless noted, amounts are in millions of dollars.
Financial performance
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Revenue | $706.9 | $594.5 | $1,895.7 | $1,594.5 |
| Gross profit / margin | $142.7 / 20.2% | $127.9 / 21.5% | $369.4 / 19.5% | $328.1 / 20.6% |
| Operating income / margin | $53.4 / 7.6% | $52.8 / 8.9% | $117.1 / 6.2% | $112.2 / 7.0% |
| Net income | $36.2 | $38.5 | $80.3 | $87.7 |
| Diluted EPS | $0.98 | $1.02 | $2.16 | $2.33 |
- Q3 revenue rose 18.9% year over year, while operating income increased 1.2% and net income declined 6.0%. Nine-month revenue rose 18.9%, but net income fell 8.5%.
- For the first nine months, operating cash flow was $99.7 versus $68.0; capital spending was $22.6. Company-defined free cash flow was $78.5 versus $47.0.
- At September 30, cash was $40.4; total debt was $242.0, including $193.0 outstanding on the revolver and $49.0 in notes to former owners. Net debt was approximately $201.7. Revolver capacity available was $173.4, with $33.6 of letters of credit outstanding.
- Current assets were $750.4 and current liabilities $577.7 (current ratio approximately 1.30). The company reported total assets of $1,467.5 and stockholders’ equity of $557.6.
- Backlog was $1.61 billion, up 7.6% from June 30 and 28.2% year over year. The company expected to recognize approximately 80–85% of remaining performance obligations over the following 12 months.
Material changes and notable items
- The April 2019 Walker acquisition contributed $203.1 of revenue in its first six months and substantially expanded electrical services. The company attributed 18.6 percentage points of Q3 revenue growth to Walker; same-store activity contributed 0.3 percentage points. Nine-month growth included acquisition contributions and 2.8% same-store growth.
- Gross margin declined year over year in both comparison periods. Management cited lower Walker margins and acquisition-related backlog amortization, including $1.2 in Q3 and $2.8 for the nine-month period, as contributing factors.
- Interest expense rose to $2.8 in Q3 and $6.9 for nine months, reflecting higher acquisition-related borrowings and seller notes. Fair-value expense on contingent earn-outs was $2.0 in Q3 and $3.9 for nine months; the nine-month increase primarily reflected a higher estimated BCH acquisition obligation.
- Nine-month 2018 results included a $4.0 gain from BP Deepwater Horizon claim settlements, which did not recur in 2019. The company also recorded a $4.6 R&D tax credit benefit in Q3, fully offset by an increase in unrecognized tax benefits; it therefore had no effective-tax-rate impact.
- Adoption of lease accounting on January 1, 2019 added $75.9 of right-of-use assets and lease liabilities at adoption, without a material income-statement or cash-flow effect or a retained-earnings adjustment. At September 30, lease liabilities totaled $86.8.
- Acquisition spending increased investing cash outflow; net cash paid for acquisitions was $196.5. Financing cash inflow included net revolver borrowing, principally to fund Walker. Cash declined $5.3 during the nine months.
Outlook, risks, and contingencies
- Management expected strong industry activity through 2019 and the first half of 2020, and anticipated Q4 2019 and 2020 revenue and net earnings would remain at favorable levels, based on backlog and economic conditions. Priorities included cost discipline, project execution, workforce development, and growth in service and small projects.
- Management estimated a 2019 full-year effective tax rate of 24–27%, including the 179D deduction, and expected 25–30% beginning in 2020. These are estimates, not earnings guidance.
- The company described construction as cyclical and seasonal, with project activity typically lower in winter. Fixed-price work exposes results to inaccurate cost estimates, labor availability and utilization, project delays, and unrecoverable overruns. Pricing competition and customer decisions to defer projects are also risks.
- About 20–30% of business historically required surety bonds. Management reported adequate bonding capacity and strong relationships, but a reduction in surety availability could constrain work and reduce near-term revenue and profit. The company reported no resulting surety losses to date.
- Legal and regulatory claims arise in the ordinary course; management believed recorded provisions were adequate and that remaining exposure would not materially affect results, cash flows, or financial condition. The company was in compliance with debt covenants; leverage ratio was 1.2 against a 3.0 maximum, and fixed-charge coverage was 13.1 against a 2.0 minimum.
- Operating cash flow benefited from working-capital timing, including receivable movements. Results may vary with project timing, billings, collections, weather, and seasonal working-capital needs. The company uses floating-rate revolver debt and does not use derivatives to manage interest-rate exposure.
Important facts for investors to verify
- Whether Walker and other acquisitions deliver expected growth and margins, and how much of reported growth is organic versus acquired.
- Whether gross-margin pressure persists and whether backlog converts to revenue and cash on expected terms.
- Receivables, contract assets and liabilities, collections, and working-capital movements underlying operating cash flow.
- Debt, interest expense, acquisition-related earn-out revaluations, and continued covenant headroom.
- Assumptions behind management’s activity outlook and estimated effective tax rates, as well as exposure to project execution, labor, bonding, and ordinary-course claims.