Comfort Systems USA, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. The company provides mechanical contracting and related HVAC, plumbing, controls, installation, maintenance, repair and replacement services across the United States. It reported one industry segment.
Financial performance
Amounts below are in millions, except per-share data and percentages.
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Revenue | $427.5 | $416.6 | $813.5 | $786.1 |
| Gross profit | $89.4 | $82.0 | $162.9 | $146.7 |
| Gross margin | 20.9% | 19.7% | 20.0% | 18.7% |
| Operating income | $28.6 | $24.8 | $44.1 | $36.0 |
| Operating margin | 6.7% | 6.0% | 5.4% | 4.6% |
| Net income attributable to Comfort Systems | $17.7 | $13.4 | $27.6 | $18.5 |
| Basic / diluted EPS | $0.47 / $0.47 | $0.36 / $0.35 | $0.74 / $0.73 | $0.49 / $0.49 |
- Cash flow: First-half operating cash flow was $36.4 million, versus $50.7 million; free cash flow, as defined by the company, was $26.0 million versus $41.8 million. Cash declined $18.2 million to $38.3 million.
- Liquidity and debt: Current assets were $434.5 million and current liabilities $326.6 million. Revolver borrowings were $36.0 million; total debt including notes, other debt and capital leases was $39.5 million, compared with $11.5 million at year-end 2015. The amended facility provides $325 million of capacity plus a $100 million accordion; $247.5 million remained available after $41.5 million of letters of credit. The company reported covenant compliance, a 0.3 leverage ratio and a 29.3 fixed-charge coverage ratio.
- Other metrics: Backlog was $724.3 million, up 1.7% year over year but down 6.8% from March 31. The company had 4,415 projects in process, with an aggregate contract value of $2.05 billion.
Changes versus prior-year periods
- Q2 revenue rose 2.6%; first-half revenue rose 3.5%. Shoffner acquisition revenue contributed to growth, while same-store revenue declined 2.5% in Q2 and 1.1% for the first half. Management attributed much of the same-store decline to lower large-project activity at Environmental Air Systems (EAS), particularly in manufacturing.
- Gross margin expanded 1.2 percentage points in Q2 and 1.3 points for the first half, reflecting improved project execution and volume at several locations; lower EAS volume partially offset improvement.
- SG&A increased 6.4% in Q2 and 7.3% for the first half. As a share of revenue, it rose to 14.3% and 14.7%, respectively, mainly reflecting compensation costs and expanded service activity.
- Reported attributable net income benefited from the January 2016 purchase of EAS’s remaining 40% noncontrolling interest; no noncontrolling-interest income was deducted in 2016, versus $2.4 million in Q2 2015 and $4.2 million in the first half of 2015.
- First-half operating cash flow fell primarily due to timing-related decreases in accounts payable/accruals and billings in excess of costs. Investing cash use increased substantially, largely due to acquisitions.
Outlook, risks and notable items
- Outlook: Management expected 2016 revenue to be similar to 2015 and profitability to exceed 2015, citing improved industry conditions and backlog. Its stated priorities were execution, cost discipline, labor development, and growth in service and small projects. Management estimated a 2016 effective tax rate of 35%–38%.
- Acquisitions: The company bought the remaining EAS interest for stated consideration of $47.0 million and acquired Shoffner for preliminary consideration of $19.2 million. Shoffner contributed $36.0 million of revenue from its acquisition date; purchase-price allocations remained preliminary.
- Business risks: Fixed-price work exposes results to estimating errors, labor availability and cost overruns. Management also cited construction cyclicality, seasonality, price competition, project delays, working-capital demands and the possibility that sureties could reduce bonding capacity. About 20%–30% of business historically required bonds.
- Contingencies and unusual items: Management said recorded legal claims were not expected to materially affect results, cash flows or financial condition. Self-insurance estimates and contingent acquisition earn-outs involve judgment; a $0.3 million Q2 earn-out fair-value expense was recorded. Early adoption of stock-compensation guidance had small reported effects, including a $0.1 million tax benefit.
- Disclosure controls were deemed effective, and management reported no material change in internal control over financial reporting during the quarter.
Key facts investors should verify
- Whether higher gross margins and improved project execution persist as EAS large-project volume remains lower.
- Backlog conversion, including the sequential decline and 4.9% same-store year-over-year decrease.
- Cash conversion and working-capital trends, given lower first-half operating cash flow and acquisition-related borrowing.
- Acquisition performance and final purchase-price allocations for Shoffner, as well as earn-out obligations.
- Progress against management’s full-year expectation of revenue near 2015 levels and profitability above 2015.
- Exposure to floating interest rates, bonding availability, self-insurance claims and fixed-price project cost overruns.