Comfort Systems USA, Inc. — 2018 Form 10-K Summary
Business context and reporting period
For the fiscal year ended December 31, 2018, Comfort Systems USA (NYSE: FIX) provided mechanical contracting services, principally HVAC and plumbing, across 36 operating units and 128 locations. About 99% of revenue came from commercial, industrial, institutional and large multi-family customers. Revenue mix was 38% new construction and 62% existing-building work; maintenance, service calls and monitoring represented 16% of revenue.
Financial performance and liquidity
| Metric | 2018 | 2017 |
|---|---|---|
| Revenue | $2.183 billion | $1.788 billion |
| Gross profit / margin | $446.3 million / 20.4% | $366.3 million / 20.5% |
| Operating income / margin | $150.2 million / 6.9% | $99.3 million / 5.5% |
| Net income | $112.9 million | $55.3 million |
| Diluted EPS | $3.00 | $1.47 |
| Cash from operations | $147.2 million | $114.1 million |
| Free cash flow (company-defined) | $121.6 million | $80.0 million |
Revenue rose 22.1%; management attributed 17.0 percentage points to same-store activity and 5.1 percentage points to acquisitions. Gross margin was nearly unchanged, while lower SG&A as a share of revenue helped lift operating margin. The effective tax rate fell to 24.1% from 45.2%, principally reflecting the lower federal corporate rate; 2017 included a $9.5 million tax expense from remeasuring deferred tax assets.
At year-end, cash was $45.6 million, working capital was $142.6 million, and total debt was $76.9 million, including $50.0 million drawn on the revolving facility and $26.8 million in notes to former owners. The $400 million facility matures in April 2023; $316.4 million was available after borrowings and letters of credit. The company reported a 0.4 total leverage ratio, a 21.9 fixed-charge coverage ratio, and compliance with its covenants.
Year-end backlog was $1.17 billion, up 23.0% from December 2017. Separate from backlog, remaining performance obligations were also reported as $1.17 billion; the company expected to recognize approximately 85% over the following 12 months.
Fourth-quarter 2018 revenue was $588.4 million, gross profit $118.2 million, and net income $25.2 million, compared with $461.1 million, $93.7 million, and $7.5 million, respectively, in fourth-quarter 2017.
Material changes and notable items
- 2018 included seven acquisitions with a preliminary total purchase price of $95.6 million; the Indiana acquisition was the principal separately reported operating location. Acquisition-related revenue contributed to growth.
- Cash used in investing was $95.7 million, primarily reflecting acquisition spending and $27.3 million of property and equipment purchases. Cash used in financing was $42.4 million, including $28.5 million of share repurchases and $12.3 million of dividends.
- Bad-debt expense increased by $3.4 million, including charges related to three retail customer bankruptcies and the California operation.
- The company recorded a $4.0 million gain from settlements of BP Deepwater Horizon-related claims; it reported no remaining subsidiary claims related to that matter.
- Management adopted ASC 606 in 2018; it reported no material effect on account balances. The company expected adoption of the new lease standard to add right-of-use assets and liabilities of less than $75 million, without a significant expected impact on operating results or cash flows.
Outlook, risks and contingencies
Management expected improved industry activity to continue in 2019 and forecast revenue and net earnings to remain at the favorable levels experienced in 2018. Priorities included cost discipline, project execution, workforce development, and investment in service and small projects. Management estimated a 2019 effective tax rate of 25%–30%. This is outlook, not a guarantee.
Key risks include cyclical construction demand, seasonal and severe-weather disruption, fixed-price project cost overruns, labor availability and costs, price competition, project delays or cancellations, collection risk, and reliance on subcontractors, suppliers and surety bonding. Revenue and profit depend partly on estimates of costs to complete projects; estimate revisions can reduce or reverse previously recorded results. The company substantially self-insures several liability and employee-health risks. It reported ordinary-course legal claims with accruals for probable losses and did not expect them, after recorded provisions, to have a material effect.
After year-end, the company signed an agreement to acquire Walker TX Holding Company for $178 million cash at closing, a $25 million seller note, and a potential earn-out, subject to customary closing conditions. The transaction was expected to close early in the second quarter of 2019. Management reported effective internal controls, and the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether 2019 revenue and earnings meet management’s outlook, and whether backlog converts on schedule and at expected margins.
- Project-level cost estimates, underperforming jobs, and the company’s exposure to customer insolvencies, particularly in retail.
- Walker acquisition closing, financing, integration, and the effect of its cash, note and earn-out consideration on leverage and liquidity.
- Cash conversion and receivables trends, including retention balances and unbilled receivables; year-end retention receivables were $80.8 million.
- Availability and terms of surety bonds, insurance coverage, and revolving-credit capacity as acquisition and working-capital needs evolve.
- Tax-rate assumptions, contingent acquisition earn-outs, and the actual balance-sheet effect of lease-standard adoption.