Comfort Systems USA, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020; comparison is with the corresponding 2019 periods. The company provides mechanical and electrical contracting, installation, maintenance, and repair services across U.S. commercial, industrial, and institutional markets.
Financial performance and liquidity
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $714.1 million | $706.9 million | $2,157.7 million | $1,895.7 million |
| Gross profit / margin | $147.2 million / 20.6% | $142.7 million / 20.2% | $410.0 million / 19.0% | $369.4 million / 19.5% |
| Operating income / margin | $56.7 million / 7.9% | $53.4 million / 7.6% | $142.4 million / 6.6% | $117.1 million / 6.2% |
| Net income | $50.1 million | $36.2 million | $107.3 million | $80.3 million |
| Diluted EPS | $1.36 | $0.98 | $2.92 | $2.16 |
- Revenue rose 1.0% in Q3 and 13.8% for the first nine months. Q3 same-store revenue declined 5.8%; acquisitions contributed to reported growth. Nine-month same-store revenue increased 0.3%.
- Q3 net income increased about 38%; nine-month net income increased about 34%. Q3 gross margin improved year over year, while the nine-month margin declined, reflecting lower margins at Walker and COVID-related protective measures and inefficiencies.
- Operating cash flow for the first nine months was $216.4 million, compared with $99.7 million in 2019. Company-defined free cash flow was $198.8 million versus $78.5 million. Management attributed the operating cash flow increase chiefly to stronger collections and working-capital timing; approximately $20.9 million also reflected CARES Act payroll-tax deferrals.
- September 30 cash was $70.5 million. Debt principal was $222.6 million ($222.3 million net of issuance costs); lease liabilities were $98.0 million. The company had $332.9 million of available credit after $55.6 million of letters of credit. Leverage ratio was 0.8 and fixed-charge coverage was 6.6; the company reported compliance with all covenants.
- Backlog was $1.43 billion, down 11.2% year over year and 6.7% from June 30, 2020. Remaining performance obligations were $1.43 billion; the company expected to recognize approximately 80–85% over the next 12 months.
Material changes and unusual items
- The April 2020 TAS acquisition added a modular construction business and was recorded in mechanical services. The company also acquired a North Carolina electrical contractor; Walker, acquired in 2019, contributed to year-over-year comparisons. Acquisition cash payments were $112.9 million in the first nine months.
- Q3 revenue rose in mechanical services, partly due to TAS, but declined in electrical services amid COVID-19 effects and comparison with higher prior-year Walker project volume. Electrical segment gross profit was $8.5 million in Q3 versus $14.2 million a year earlier.
- Q3 results included an $8.3 million reduction in income-tax provision following IRS approval of amended 2014 and 2015 returns. The company also recorded $3.4 million of income from changes in contingent earn-out fair value, versus $2.0 million of expense in Q3 2019. The earn-out change was noncash and estimate-sensitive.
- COVID-19 drove higher credit-loss allowances and bad-debt expense during the first nine months. The company reported total credit-loss allowances of $11.6 million at September 30, compared with $6.9 million at year-end 2019.
- The company repurchased approximately 0.4 million shares for $18.8 million during the first nine months, temporarily suspending repurchases from March 27 to May 26 amid pandemic uncertainty.
Outlook, risks, and contingencies
- Management said service activity had largely returned to near-normal levels by quarter-end, but some construction projects experienced temporary closures, delayed awards or starts, and limited cancellations or delays affecting less than 5% of backlog. COVID-19 precautions added costs and inefficiencies.
- Management said the pandemic’s future effects were not quantifiable and anticipated that project award or start delays in some markets could affect activity in coming quarters, particularly the first half of 2021. Assuming conditions did not materially worsen, it expected substantial positive earnings and cash flow in Q4 2020 and 2021; no numerical earnings or revenue guidance was provided.
- Management estimated a 2020 full-year effective tax rate of 22–25%, including the IRS settlement benefits, and expected a 25–30% rate starting in 2021. Tax benefits claimed for 2016–2018 were largely offset by reserves for uncertain outcomes of future IRS examinations.
- Key operating risks include economic and construction cyclicality, labor availability and project cost-estimation risk, customer credit and collections, COVID-related disruptions, and dependence on surety bonding. Historically, 15–25% of business required bonds; interruption of bonding capacity could reduce revenue and profit.
- Routine litigation was accrued where losses were considered probable; management did not expect the matters, after recorded provisions, to materially affect results, cash flows, or financial condition. No material impairment was recorded in 2020, though management noted Walker’s goodwill was more susceptible to impairment if adverse conditions worsened.
Important facts for investors to verify
- Whether backlog converts to revenue as expected, given the year-over-year decline and COVID-related award and start delays.
- Whether strong operating cash flow is sustainable after considering collections, working-capital timing, and deferred payroll taxes.
- Credit quality and customer collections, particularly in industries more affected by COVID-19, and the adequacy of credit-loss reserves.
- Acquisition performance and integration, including Walker and TAS margins, contingent earn-out estimates, and goodwill impairment sensitivity.
- IRS examination outcomes and the assumptions behind the stated tax-rate outlook.
- Ongoing liquidity, covenant headroom, and access to surety bonds and letters of credit as project and market conditions evolve.