Comfort Systems USA, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. The company provides commercial, industrial and institutional HVAC installation, maintenance, repair and replacement, plus plumbing, building controls and related services. It reported one operating segment.
Financial performance
Amounts below are in millions of dollars, except per-share data. Comparisons are with the corresponding 2013 period.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $362.8 | $351.1 | $684.2 | $676.9 |
| Gross profit / margin | $61.9 / 17.1% | $60.0 / 17.1% | $114.0 / 16.7% | $111.4 / 16.5% |
| Operating income / margin | $10.6 / 2.9% | $14.4 / 4.1% | $12.5 / 1.8% | $19.5 / 2.9% |
| Net income attributable to Comfort Systems | $4.4 | $7.8 | $4.8 | $10.3 |
| Diluted EPS | $0.12 | $0.21 | $0.13 | $0.28 |
| Operating cash flow | $22.4 | $6.7 | $13.6 | $(3.7) |
| Free cash flow | $18.3 | $3.0 | $5.8 | $(10.4) |
- Revenue rose 3.3% in Q2 and 1.1% year to date. Q2 growth reflected 0.5% same-store growth and 2.8% from acquisitions; first-half growth reflected 1.5% from acquisitions, partly offset by a 0.4% same-store decline.
- Q2 gross margin was unchanged, but higher SG&A—up 10.7% to $50.6 million—contributed to lower operating income. First-half SG&A rose 9.5% to $101.0 million, and operating margin fell to 1.8% from 2.9%.
- Management attributed higher SG&A to compensation and investment in service growth and information technology, training costs, and bad-debt expense. Q2 included a $0.7 million goodwill impairment.
- Cash and cash equivalents were $49.8 million at June 30, versus $52.1 million at year-end 2013. Current assets were $423.5 million and current liabilities $280.2 million. The company had $52.0 million drawn on its revolving facility, versus no revolver debt at year-end; it repaid $2.0 million of former-owner notes. The reported leverage ratio was 0.77 and fixed-charge coverage ratio 24.84; the company reported compliance with covenants.
Material changes and business developments
- Three acquisitions were completed in the first half, including two in Q2. The Northern Texas acquisition, completed in May, had $40.2 million of acquisition-date consideration; preliminary purchase-price allocations included $30.4 million allocated to goodwill and identifiable intangibles. Acquisition-related cash outflows were $51.4 million for the first half.
- Backlog was $673.7 million at June 30, up 14.1% year over year and 10.0% from March 31. Management cautioned that backlog covers only contracted or committed project work and is a limited indicator of near-term revenue direction.
- Q2 operating cash flow improved year over year, primarily with collections on project receivables and timing of vendor payments. First-half investing outflows and revolver borrowings largely reflected acquisition spending; first-half cash declined by $2.3 million.
- On July 22, after quarter-end, the company amended its credit facility, increasing capacity from $175 million to $250 million and extending maturity to October 2019. At June 30, it had $50.6 million of letters of credit outstanding and $72.4 million of facility availability under the prior facility.
Outlook, risks and unusual items
- Management expected nonresidential construction activity to remain weak and broadly flat, with revenue continuing near recent years’ levels. It expected to be solidly profitable in 2014, but full-year net profitability below 2013. Its stated priorities were execution, cost discipline, efficient project performance and investment in service growth. The estimated 2014 effective tax rate was 35%–40%.
- Management cited continued price competition, construction cyclicality and seasonality, and project execution risk. Most project work is fixed-price; inaccurate cost estimates, overruns or delays can reduce margins or cause losses. Revenue recognition relies on percentage-of-completion estimates, which may be revised as project conditions change.
- Surety capacity is a notable risk: historically, 25%–35% of business required bonds, and constrained or more restrictive surety markets could reduce revenue and profits in the near term. The company also disclosed substantial self-insurance exposure, operating lease commitments, letters of credit and surety guarantees.
- The company recorded a $0.7 million goodwill impairment at a California location following market activity declines and job write-downs. Litigation accruals were recorded; management did not expect pending claims to materially affect results, cash flows or financial condition. A Delaware operation remained in discontinued operations, with a first-half after-tax loss below $0.1 million.
Important facts for investors to verify
- Whether higher SG&A and weaker operating income persist, and whether the stated full-year profitability outlook is achieved.
- Backlog conversion, project execution and margin trends, particularly at the California operation and in light of fixed-price contract estimates.
- Acquisition performance and final purchase-price allocations, including contingent earn-out assumptions and the Northern Texas contribution.
- Liquidity and borrowing capacity after the facility amendment, including variable-rate exposure, letters of credit and covenant compliance.
- The filing describes revenue mix using different classifications: the note cites approximately 45% from new construction and 55% from maintenance, repair and replacement, while MD&A describes approximately 82% as project-based work and 18% as maintenance and repair. Verify the definitions and reconciliation when assessing revenue mix.