Comfort Systems USA, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017; balance-sheet figures are as of June 30, 2017. Amounts below are in millions except per-share data. The company provides mechanical contracting services, principally HVAC, plumbing, piping and controls, through one reported industry segment.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $465.4 | $427.5 | $846.0 | $813.5 |
| Gross profit / margin | $95.7 / 20.6% | $89.4 / 20.9% | $171.7 / 20.3% | $162.9 / 20.0% |
| Operating income / margin | $29.3 / 6.3% | $28.6 / 6.7% | $41.0 / 4.8% | $44.1 / 5.4% |
| Net income | $18.0 | $17.7 | $25.4 | $27.6 |
| Diluted EPS | $0.48 | $0.47 | $0.67 | $0.73 |
Q2 revenue rose 8.9% year over year, primarily due to BCH, acquired April 1; same-store revenue was down 0.1%. Six-month revenue grew 4.0%, while same-store revenue declined 1.5%. Q2 net income increased modestly, but six-month net income declined 7.7%. Six-month operating income fell despite higher revenue, reflecting higher SG&A and a $1.1 million goodwill impairment.
At June 30, cash was $34.5 million, current assets $497.2 million and current liabilities $375.4 million. Total assets were $893.2 million and stockholders’ equity $396.9 million. Total debt including capital leases was $104.7 million, versus $2.8 million at year-end 2016; this included $88.5 million outstanding on the revolving facility and $15.8 million in notes to former owners. The $325 million facility had $196.9 million available after $39.6 million of letters of credit; its weighted-average borrowing rate was 2.4%. The company reported compliance with all covenants, a 0.70 leverage ratio and 27.67 fixed-charge coverage ratio.
For the six months, operating cash flow was $21.2 million versus $36.4 million in 2016; free cash flow, as defined by the company, was $10.1 million versus $26.0 million. Investing used $94.8 million, mainly for acquisitions, and financing provided $76.0 million, primarily from net revolver borrowings. Cash increased $2.4 million to $34.5 million. Working-capital investment, particularly receivables, weighed on operating cash flow.
Material changes and notable items
- BCH was acquired on April 1 for stated consideration of $100 million (cash at closing and a seller note), plus earn-out and working-capital adjustments. Preliminary fair value of consideration was $122.6 million; the filing allocated $97.9 million to goodwill and identifiable intangible assets. BCH contributed $38.6 million of revenue after acquisition. Three additional small acquisitions were also completed in Q2; total purchase price for those and other 2017 acquisitions was $7.8 million.
- Backlog was $937.8 million, up 29.5% year over year and 8.7% from March 31. Management cautions that backlog covers contracted installation/replacement work and is only a limited indicator of near-term revenue.
- Q2 gross margin decreased from 20.9% to 20.6%, primarily due to increased backlog amortization related to BCH. Six-month gross margin improved from 20.0% to 20.3%. SG&A rose 9.1% in Q2 and 8.9% year to date; six-month SG&A was 15.3% of revenue versus 14.7%.
- The company fully impaired $1.1 million of goodwill for a California reporting unit after a market-strategy change and revised earnings projections. Changes in estimated BCH earn-out obligations generated $0.6 million of expense in the first half; total contingent earn-out obligations were $14.9 million at June 30.
- Six-month interest expense rose to $1.4 million from $1.3 million, reflecting borrowings and seller notes used to fund acquisitions. The effective tax rate was 34.8% for the first half versus 35.6% in 2016.
Outlook, risks and contingencies
Management expected 2017 revenue to exceed 2016 levels, citing acquisitions, and profitability to remain strong at levels similar to 2016. Priorities included execution, cost control, workforce development and investment in service and small projects. Management expected industry activity to remain at improved 2015–2016 levels during 2017 and estimated a full-year effective tax rate of 35%–40%. These are forward-looking expectations, not guarantees.
- Construction is cyclical and seasonal; first-quarter activity is typically lower. Price competition, project delays, labor utilization and fixed-price cost overruns may pressure results. Management noted Q2 same-store underperformance at certain locations and job underperformance in California in the first half.
- Historically, 20%–30% of business required bonds. Loss of surety capacity could reduce revenue and profits; the company reported adequate bonding capacity and no known losses to sureties. Letters of credit totaled $39.6 million and generally support self-insurance obligations.
- The company is substantially self-insured for several liability and employee-health risks. Legal claims arise in the normal course; management, based on counsel, did not expect them to have a material effect after recorded accruals.
- Borrowings use floating rates, exposing the company to rate changes. Facility covenants and borrowing availability are relevant if leverage rises. The company reported no derivative use.
- Management was evaluating new lease and cash-flow standards. It planned modified-retrospective adoption of revenue-recognition guidance effective in 2018 and did not then expect a material impact, though the ultimate effect depended partly on contracts in progress.
Key facts for investors to verify
- Whether same-store performance, project execution and margins improve as management expects, and how much reported growth reflects acquisitions.
- Backlog conversion, project profitability and the effects of BCH purchase accounting and amortization.
- Receivables, billings and working-capital trends given the decline in operating cash flow and free cash flow.
- Acquisition funding, earn-out exposure, seller-note obligations and debt capacity relative to covenant thresholds.
- Progress toward the stated revenue and profitability outlook, including the estimated 35%–40% full-year tax rate.