Comfort Systems USA, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. Unless noted otherwise, dollar amounts are in millions. Comfort Systems provides HVAC installation, maintenance, repair and replacement, along with related mechanical services. It operates in one industry segment. About 46% of 2015 revenue was from new-facility installation and 54% from maintenance, repair and replacement; by service type, HVAC accounted for 77% of revenue.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $410.6 | $370.1 | $1,196.7 | $1,054.3 |
| Gross profit / margin | $87.5 / 21.3% | $66.5 / 18.0% | $234.2 / 19.6% | $180.5 / 17.1% |
| Operating income / margin | $29.9 / 7.3% | $14.8 / 4.0% | $65.9 / 5.5% | $27.3 / 2.6% |
| Net income attributable to Comfort Systems | $17.7 | $7.6 | $36.1 | $12.4 |
| Diluted EPS | $0.46 | $0.20 | $0.96 | $0.33 |
- Cash flow: Nine-month operating cash flow was $74.6, versus $37.5 in 2014. Free cash flow, as defined by the company, was $60.3 versus $23.3. Capital expenditures were $15.2. Cash increased $13.0 to $45.1.
- Liquidity and debt: At September 30, 2015, current assets were $437.9 and current liabilities $309.1. Total debt obligations, including capital leases and a note to former owners, were $11.7, down from $40.3 at year-end 2014. The $250.0 revolving facility had $10.0 drawn, $46.4 in letters of credit and $193.6 available. The company reported compliance with all financial covenants.
- Other capital returns: Dividends were $0.065 per share in Q3 and $0.185 per share for the nine months. The company repurchased about 0.2 million shares for $4.9 during the nine-month period.
Material changes versus prior comparable periods
- Q3 revenue rose 10.9%; nine-month revenue rose 13.5%. Management attributed growth primarily to higher project activity, particularly in industrial markets, and reported nine-month same-store revenue growth of 11.6%.
- Gross margin expanded 3.3 percentage points in Q3 and 2.5 points for the nine months. Management cited better margins across many locations, improved project execution and recovery from prior-year underperformance at Southern California operations.
- SG&A rose 10.9% in Q3 and 10.3% for the nine months, mainly reflecting higher compensation accruals and expanded service activity. SG&A as a share of revenue was flat at 14.1% in Q3 and improved to 14.1% from 14.5% for the nine months.
- Operating income more than doubled in both comparison periods. The 2014 nine-month period included a $0.7 goodwill impairment; 2015 had none. Management also disclosed a prior-year contract-estimate revision on a loss-position project that reduced pretax results by $2.2 in Q3 and $4.4 for the nine months.
- Backlog was $666.3 at September 30, up 1.4% year over year but down 6.4% from June 30; management cautioned that backlog covers only a portion of future revenue and is not a reliable indicator of results over multiple quarters.
Outlook, risks and unusual items
- Management said industry conditions improved during 2015 and expected activity to gradually improve over the next 12 months, particularly in new construction. It expected revenue and profitability above levels experienced in recent years, emphasizing execution, cost control, labor development and investment in service and small projects. No specific full-year revenue or earnings guidance was provided.
- The company estimated a 2015 effective tax rate of 33%–37%; the nine-month rate was 34.3%.
- After quarter-end, approved change orders on multiple jobs were expected to add $3.0–$3.5 of project gain in Q4 2015, with minimal additional costs.
- Key operating risks include construction cyclicality and seasonality, price competition, fixed-price contract cost overruns and working-capital timing. Management noted that 25%–35% of business historically required surety bonds; a loss of bonding capacity could reduce revenue and profit. The company is substantially self-insured and exposed to claims development, and its revolving borrowings carry floating interest rates.
- Legal and regulatory claims arise in the ordinary course. Management said recorded accruals were made for probable losses and did not expect the matters, individually or together, to materially affect results, cash flows or financial condition. Letters of credit and surety guarantees are off-balance-sheet commitments; no claims resulting in payments were reported.
- The filing reports effective disclosure controls and no material change in internal control over financial reporting during the quarter. A post-quarter amendment to a senior vice president’s change-in-control agreement provided immediate acceleration of outstanding equity upon a change in control.
Important facts for investors to verify
- Whether margin gains reflect sustainable project execution and pricing, rather than timing or recovery from prior-year underperforming jobs.
- Whether the 1.4% year-over-year backlog growth converts to revenue and profit, given the sequential backlog decline and management’s caution about its predictive value.
- Whether the expected $3.0–$3.5 Q4 project gain is recognized as anticipated and whether similar change-order gains recur.
- How working-capital movements, self-insurance accrual estimates and fixed-price project estimates affect future cash conversion and reported margins.
- Whether surety capacity and credit-facility availability remain adequate as activity and project volumes change.