Comfort Systems USA, Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014; financial statements are unaudited. The company provides HVAC installation, maintenance, repair and replacement services, plus plumbing, building automation and related services, primarily in commercial, industrial and institutional markets.
Financial performance and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $370.1M | $350.0M | $1,054.3M | $1,026.9M |
| Gross profit / margin | $66.5M / 18.0% | $67.0M / 19.1% | $180.5M / 17.1% | $178.5M / 17.4% |
| Operating income / margin | $14.8M / 4.0% | $17.7M / 5.1% | $27.3M / 2.6% | $37.2M / 3.6% |
| Net income attributable to Comfort Systems | $7.6M | $11.4M | $12.4M | $21.7M |
| Diluted EPS | $0.20 | $0.30 | $0.33 | $0.58 |
| Cash from operations | $23.9M | $27.4M | $37.5M | $23.8M |
Q3 revenue increased 5.8%, including 0.7% same-store growth and 5.1% from the Northern Texas acquisition. Nine-month revenue rose 2.7%, driven by the acquisition; same-store activity was flat. Q3 net income attributable to the company fell 33% year over year; nine-month net income fell 43%.
Cash and debt at September 30: Cash was $43.9M, down from $52.1M at December 31, 2013. Total current assets were $410.0M and current liabilities $279.0M. Revolver borrowings were $42.0M; credit availability was $129.5M, with $50.6M of letters of credit outstanding. The amended revolving facility has $250M stated capacity and expires in October 2019. Leverage ratio was 0.68 versus a 2.75 maximum; fixed-charge coverage was 18.15 versus a 2.00 minimum. The company reported covenant compliance.
Nine-month free cash flow, as defined by the company, was $23.3M versus $11.9M a year earlier. Investing cash use was $68.3M, primarily reflecting $54.2M for acquisitions, earn-outs and intangible assets. Financing provided $22.7M, including $42.0M net revolver borrowings. Nine-month dividends were $0.165 per share.
Material changes and notable items
- Q3 gross profit declined $0.6M despite higher revenue; gross margin contracted 1.1 percentage points. The 2013 quarter included a $2.5M prior-period accounting adjustment; excluding it, the prior-year gross margin was 18.6%.
- A Southern California operation recorded project estimate write-downs of $2.2M in Q3 and $4.4M year to date. The company also recorded a $0.7M goodwill impairment in Q2, citing lower market activity and project write-downs.
- SG&A rose 5.7% in Q3 and 8.1% year to date. Management attributed the increase mainly to compensation and investment in service growth and information technology, as well as higher training costs year to date.
- Backlog was $656.8M, up 15.0% year over year but down 2.5% from June 30. The year-over-year increase included the Northern Texas acquisition and same-store growth.
- Three acquisitions were completed in the first half of 2014; none were completed in Q3. The Northern Texas acquisition had $40.2M of acquisition-date consideration.
- The board authorized an additional 1.0M shares for repurchase on October 24, 2014, after quarter-end. During the first nine months, the company repurchased 0.4M shares for $6.3M.
Outlook, risks and contingencies
Management expected nonresidential construction activity to remain weak and broadly similar to recent years through 2014 and early 2015. It expected revenue to remain near recent levels, the company to be solidly profitable in 2014, and net profitability to be below 2013. Management highlighted execution, cost discipline, efficient project performance and investment in service growth. The filing estimated a 2014 effective tax rate of 35%–40%.
- Project work is often fixed-price and uses percentage-of-completion estimates; inaccurate cost forecasts, overruns, delays or unrecoverable change orders can reduce margins or create losses. The filing says estimate revisions are recognized when identified.
- Construction demand is cyclical and seasonal, and price competition remains strong. Backlog is concentrated in contracted installation/replacement work and management cautions that it is only a limited indicator of future revenue.
- Historically, 25%–35% of business required surety bonds. Restrictive surety-market conditions or reduced bonding capacity could lower revenue and profits or require cash or letter-of-credit collateral.
- The company is substantially self-insured for several liability and employee health risks; actual claims may differ from recorded estimates. It also has floating-rate debt exposure.
- Ordinary-course lawsuits and claims were accrued where considered probable; management did not expect them, individually or together, to materially affect results, cash flows or financial condition. No letter-of-credit claims had resulted in payments as of the filing.
Important facts for investors to verify
- Whether project execution and margins improve, particularly at the Southern California operation, and whether further contract losses or goodwill impairment arise.
- How much of reported growth and backlog reflects acquired operations versus same-store demand; Q3 same-store revenue rose only 0.7% and nine-month same-store revenue was flat.
- Whether the $42.0M revolver balance, $129.5M reported availability and $50.6M letters of credit remain consistent with acquisition, repurchase and working-capital needs.
- Whether backlog converts to revenue and cash as expected, given project timing, customer billing and collection cycles, and retainage.
- The filing describes approximately 43% of 2014 revenue as new-construction installation and 57% as maintenance, repair and replacement, while MD&A describes approximately 82% as project-based. Verify the differing classifications and definitions.