Comfort Systems USA, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Financial statement amounts below are in millions of dollars, except per-share data. The company provides mechanical contracting and HVAC, plumbing, controls, and related services across the United States.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $535.0 | $465.4 | $1,000.0 | $846.0 |
| Gross profit / margin | $111.2 / 20.8% | $95.7 / 20.6% | $200.2 / 20.0% | $171.7 / 20.3% |
| Operating income / margin | $40.2 / 7.5% | $29.3 / 6.3% | $59.4 / 5.9% | $41.0 / 4.8% |
| Net income / margin | $32.5 / 6.1% | $18.0 / 3.9% | $49.2 / 4.9% | $25.4 / 3.0% |
| Diluted EPS | $0.87 | $0.48 | $1.31 | $0.67 |
- Q2 revenue rose 15.0%; six-month revenue rose 18.2%, including 3.0% from BCH acquisition activity and 15.2% from same-store growth.
- Q2 gross margin improved, helped by stronger project execution in North Carolina. Six-month gross margin declined year over year, reflecting weaker project performance at New York and California operations.
- SG&A was $71.2 million in Q2 and $141.2 million for six months; as a share of revenue it fell to 13.3% and 14.1%, respectively, from 14.3% and 15.3%.
- Six-month provision for income taxes was $12.9 million, an effective rate of 20.7% versus 34.8% in 2017. The lower 2018 rate included a $2.8 million first-quarter benefit from a federal accounting-method change application.
Cash flow, balance sheet and liquidity
- Six-month operating cash flow was $37.5 million versus $21.2 million; free cash flow, as defined by the company, was $24.1 million versus $10.1 million.
- Cash was $28.0 million at June 30, down from $36.5 million at year-end 2017. Total debt was $59.0 million, including $42.0 million drawn on the revolving facility; approximate net debt was $31.0 million.
- The amended revolving facility provides $400 million of capacity plus a $100 million accordion option, matures in April 2023, and had $324.4 million of availability after borrowings and letters of credit. The weighted average borrowing rate was approximately 3.4%.
- Leverage and fixed-charge coverage ratios were 0.3 and 24.3, respectively; the company reported compliance with all financial covenants.
- Receivables and unbilled accounts increased amid growth and project timing. Six-month cash flow was also supported by higher billings in excess of costs and estimated earnings.
Material changes and operating developments
- Backlog was $1.23 billion at June 30, up 13.8% sequentially and 30.9% year over year. The company expects to recognize about 85% of remaining construction performance obligations over the following 12 months.
- The revenue mix for the first half was 37% new construction, 36% existing-building construction, 9% service projects, and 18% service calls, maintenance, and monitoring.
- Five acquisitions were completed in the first half for a total purchase price of $18.1 million. A further acquisition closed July 1, 2018; that business reported approximately $85 million of 2017 revenue.
- On April 18, the company increased revolving-facility capacity from $325 million to $400 million and incurred approximately $0.8 million of amendment-related financing and professional costs.
Outlook, risks and unusual items
- Management expected improved industry activity to continue during 2018 and anticipated improvement in full-year revenue and net earnings, citing backlog and economic conditions. Priorities included cost discipline, project execution, workforce development, and growth in service and small projects.
- Management estimated a 22%–26% effective tax rate for full-year 2018 and 25%–30% beginning in 2019. Tax effects recorded for the Tax Cuts and Jobs Act remained provisional.
- Q2 and first-half other income included a $4.0 million gain from settlements of two BP Deepwater Horizon-related claims. No related subsidiary claims remained. This is an unusual, non-operating item that boosted reported pretax and net income.
- Key business exposures include cyclicality and seasonality in construction, competitive pricing, fixed-price project cost overruns, labor availability and utilization, estimates of contract costs and revenue, and working-capital timing. About 20%–30% of business historically required surety bonds; loss of bonding capacity could reduce revenue and profits.
- The company is substantially self-insured and has ordinary-course legal claims; management said recorded litigation matters were not expected to materially affect results, cash flows, or financial condition. Letters of credit totaled $33.6 million; operating leases and surety guarantees are additional commitments.
- The company adopted revenue-recognition Topic 606 on January 1, 2018 using the modified retrospective method and reported no material effect. It was evaluating the impact of the new lease standard, effective for it after December 15, 2018.
Important facts for investors to verify
- Whether backlog converts to revenue and cash as anticipated, and whether project execution sustains margins amid the six-month gross-margin decline at certain locations.
- Receivables, unbilled balances, contract assets and liabilities, and related cash conversion as revenue and project activity grow.
- How much earnings growth reflects underlying operations versus the $4.0 million BP settlement gain and the tax benefit, and the resulting full-year tax rate.
- The integration, purchase price allocation, and financial contribution of first-half acquisitions and the July 1 acquisition.
- Continued covenant compliance, borrowing availability, floating-rate exposure, and access to surety bonding.