Comfort Systems USA, Inc. (FIX) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2015 Comfort Systems USA Earnings Conference Call. My name is Towanda, and I will be your coordinator for today. At this time, all participants are in a listen-only model. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Ms. Julie Shaeff, Chief Accounting Officer. Please proceed.

Thanks, Towanda. Good morning. Welcome to Comfort Systems USA's Second Quarter Earnings Call. Our comments this morning, as well as our press releases contain forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. What we will say today is based on the current plans and expectations of Comfort Systems USA. Those plans and expectations involve risks and uncertainties that could cause actual future activities and results of our operations to be materially different from those set forth in our comments. You can read a more detailed listing and commentary concerning our specific risk factors in our most recent Form 10-K and Form 10-Q, as well as in our press release covering these earnings. A slide presentation will accompany the prepared remarks and has been posted on the Investor Relations section of the company's website found at www.comfortsystemsusa.com. Joining me on the call today is Brian Lane, our President and Chief Executive Officer; and Bill George, our Chief Financial Officer. Brian will open our remarks.

Thanks, Julie, and good morning, everyone. Welcome to our second quarter earnings call. First of all, I'd like to thank all of our employees for their hard work and another great quarter. I'll start with the highlights, Bill will cover the financial results, and then I will discuss our operations and outlook. We are very pleased to report significant year-over-year improvement in our second quarter revenues and earnings. We had good top line growth and we are very happy with our construction backlog and ongoing small projects and service opportunities. As we mentioned during our last call, we had several large fast-paced projects that have contributed to our same-store revenue increase for the first half of the year. Our earnings for the quarter was $0.35 per diluted share, as compared to the $0.12 per share in second quarter of 2014. The year-over-year improvement is the result of broad-based strength and strong individual performances at several of our operating companies. Our emphasis on execution, combined with the investments in workforce and growth initiatives during the recent challenging condition, have positioned us to take advantage of improved demand in our industry. Cash flow in the second quarter and through the first six months has been outstanding, and gives us additional confidence to invest and return capital to our shareholders. As you may have noted, we increased our dividend this quarter. All right, with that, I'll turn the call over to Bill, and he’ll take it through the financials. Bill?

Thanks Brian. You can refer to Slides 2 through 6 as I review our results. Second quarter revenue increased to $470 million, as compared to $363 million last year. During the second quarter of last year, we owned Dyna Ten for two of the three months, so the one additional month of Dyna Ten’s results this year contributed $5 million of the $54 million overall revenue increase. The same-store revenue increased $49 million or 14% in this quarter. Approximately one-third of our same-store revenue increase resulted from a high level of profitable project activity at Environmental Air System or EAS, which is our majority owned subsidiary in North Carolina. We also had a strong increase at ColonialWebb. Although we expect the continued upward trend in revenue in the coming quarter, it's not likely that in the next few quarters the increase will be as high as the 12% same-store increase of our first six months, and that was partly driven by some large revenue at simultaneous jobs in the mid-Atlantic that are not likely to be duplicated to that extent that can have. Our best estimate is that we'll have high single-digit growth in the second half of 2015, probably more weighted to the third quarter, given the comparison with our strong fourth quarter results in 2014. Gross profit was 19.7% for the second quarter of 2015, and this was an improvement from the 17.1% in the second quarter of 2014. The significant increase was driven by a combination of broad-based improvement at a majority of our locations, most notably ColonialWebb, combined with improved results from our Southern California operation, which negatively impacted our results in the second quarter of last year. SG&A expense was $57.4 million for the second quarter of 2015, compared to $50.6 million for the second quarter of 2014. The increase is due to increased compensation accruals, as a result of improved results, and also reflects expanded service activities at certain locations. SG&A as a percentage of revenue was 13.8% in the second quarter of 2015, a bit lower than 13.9% a year ago. Our year-to-date tax rate was 35.7% and benefited from our strong performance at EAS, as the 40% minority interests is treated as a partnership for tax purposes. Net income for the second quarter was $13.4 million or $0.35 per share, compared to $4.4 million or $0.12 per share last year. As mentioned, we had strong performance at a majority of our operating locations, and absence of significant write-downs and downsized revenues and earnings at the large mid-Atlantic operations that we added to Comfort Systems during the recent recession. It's great to see the acquisitions that we made during tough times making such a strong contribution as demand improves. We had another quarter of outstanding free cash flow. For the quarter, our free cash flow was $24.8 million, as compared to $18.3 million a year ago. On a year-to-date basis, our free cash flow is a remarkable $41.8 million versus $5.8 million for the first six months of 2014. This improvement is largely due to improved operating results as well as good cash practices relating to our project work at a number of our operating companies. With proportionately more service and small project business, we are realizing cash flow earlier in the year as a result of our very strong cash flow. And even during a busy summer months, our net cash increased to over $20 million and we have retired half of the debt that we carried at the end of 2014. Yesterday, we also announced that we've increased our dividend starting this quarter. Our cash performance definitely supports increasing that return to our shareholders. I also want to update you on our stock buyback program. We have been carefully and faithfully repurchasing our shares since 2007. During the second quarter of 2015, we purchased 73,000 shares for an average price of $20.88 per share. On a cumulative basis, since our program began, we've repurchased 6.6 million shares at an average price of $11.40 per share, and that also contributed to this quarter’s stronger per share results. Overall our operating and cash flow performance have been very strong for the first half of 2015. We’re optimistic that the underlying trends for new constructions in a majority of our markets are seeing improvements, and we're seeing good progress in our service business. That's all I have on financials. Brian?

Okay. Thanks Bill. I am going to spend a few minutes discussing our backlog and activity in various sectors and markets. These are covered in Slide 7 through 9. I will also discuss our prospects for the rest of this year. Backlog at the end of the second quarter was $712 million, a 6% increase from last year. Backlog was essentially flat compared to the first quarter. The underlying demand for our services has strengthened, and small and mid-size projects are available in virtually all of our markets. We still see a lack of large project awards since the people whole build and invest in nonresidential buildings have hesitated to commit to long-term capital projects. However, we remain focused and disciplined to project bidding and execution. Let's look at what we’re seeing across the country, starting with the Northeast. This region, which includes our companies in the upper Midwest, continues to be very profitable. The majority of the operating companies in this region have strong backlog and are operating near capacity. The Southeast is stable, but continues to face a competitive pricing environment in many of our key markets. In the West, we have improving activity levels in some markets like Colorado, but overall our Western markets are mixed. Our operation in Southern California experienced job underperformance during the first half of 2014, but the challenging work is nearing completion and is tracking as expected. As a result, we saw improved results from California in the first half of this year. Overall, we are encouraged by the improving conditions in nonresidential construction in our geographic markets. Many of our markets are getting closer to full capacity and we are benefiting from tough decisions that we made during the downturn to maintain our labor force. We believe that the investments we've made in our workforce, most notably in our national training programs, will continue to help attract and develop the best workforce in this industry. Our end-user sectors are shown on Slide 8. The institutional sector, which includes education, government and healthcare, comprises 36% of our revenues. The proportion of our work in the institutional sector has declined in the recent years, but we’ve seen a spike in industrial, which was 32% of our revenues for the first half 2015. Industrial for us includes projects and industrial plants, food production facilities, datacenters and pharmaceutical projects. Overall, we are pleased with trends for our work in various sectors. Please turn to Slide 9 for our current revenue mix. We feel good about our current mix, where new construction made up 48% of revenue as the nonresidential markets strengthened. US Service, which is maintenance and repair, remains strong at 17% of our increased revenue for the first six months of 2015. Together service, repair and retrofit, was 52% of revenue. Our service businesses are executing and growing as planned and our maintenance base has increased approximately 10% this year. The investments we've made in growing our sales force and building out service capabilities over the past few years are providing the improved earnings and growth we expected for 2015. In addition to the investments we've made in service, we've also redoubled our commitment and increased our investments in safety. Our OSHA recordable rate has improved 21% compared to last year, and is 35% below the industry average. While we’re seeing the positive financial impact with the improved safety results, the important thing is to get our people home safely at the end of the day. Finally, let's discuss the outlook. We have seen industry conditions improve during the first half of 2015, and we expect these positive trends to continue in the near-term. As markets get busier, our challenges shift towards pricing, execution and staffing. The investments we've made in growing our service business and improving our construction operations are beginning to pay off. We believe that we are well positioned to benefit as the nonresidential construction markets strengthen. Before I turn to questions, I want to thank all of our 1,700 team members for their efforts. I'll now turn it back over to Towanda for questions. Thank you.

Thank you. [Operator Instructions] Your first question comes from the line of Tahira Afzal with KeyBanc Capital Markets. Please proceed.

Hi, Brian and team. Congrats. Fantastic quarter.

Thanks Tahira.

So Brian as you said, you guys have done the right thing. You’ve strategically bought for the whole down cycle. As you look at the problem you have now which is a nice problem, you've got a lot of cash coming in the door. Apart from buybacks, what do you do, given you our expectation so that the cycle doesn't peak till 2017? Do you keep investing in organically as well? I would love to get some thoughts around capital allocation.

So we paid down half our debt. We still have some debt we can pay down, which is an unaccustomed position for us to be in. During the last expansion, we built up a couple of hundred million dollars of cash, that turned out to been a good thing during the recession. So we're not really - it doesn't bother us if cash builds up. But having said that, we’re definitely actively looking at acquisitions. It's just that we’re talking to people actively, but they are experiencing some of what we are experiencing. So whether - when we can get people to join us, the timing is questionable. So I think there is a chance of us doing some acquisitions. I think there is a chance that will just build our cash, but I think we’ve proven that we’ll eventually put the money to work.

And Tahira, we’ll also continue to buy back stock to at least offset dilution, and we did raise a dividend $0.065 a share for the quarter we announced yesterday.

Got it. Okay, Brian. And I guess the next question I have and then I’ll hop back in the queue. The question I get a lot is, what happens - how do your customers behave on the private commercial side if interest rates were to go up? And if it's tepid increase versus a more sizable increase, and I guess the more sizable increase doesn’t seem to be the case right now, but would love to get your thoughts around that.

Tahira, I think that most of the factors that would lead to an interest rate increase in the United States will be very bullish for us, right. The reason United States might be the only market that has, I think probably some measured interest rate increases is because it's a good market. It's a market where everybody wants to be in. We do 100% of our work in the United States. So I think - I don't see much chance of bad ambient conditions and interest rate increases. I think most scenarios where there is interest rate increases because things are going well in exactly the positioning we have.

Got it. Okay, Bill. And that does make sense. And I’ll hop back in the queue.

Thank you.

Your next question comes from the line of Adam Thalhimer with BB&T Capital Markets. Please proceed.

Hi, good morning guys. Congrats.

Thanks Adam.

I wanted to first ask about margins because gross margin is near 20%, operating margin at 6%. Those are numbers that are more reminiscent of prior peak periods. As I hear you guys talk, I don’t think we’re in a peak-ish environment. So can you comment a little bit on the margin strength in the first half of the year, and what are your expectations if demand continues to improve?

Adam, it’s Brian. So I’ll move first. I think those are exceptional margins. I just said we [indiscernible] peak. I think we’ve really had a good first half of being selective on the type of work we've taken and executing really well. I think it's probably high on a go-forward basis. We'll keep that level. But I think the average in the first half of the year was more likely what we'll see going forward in the second half. But Bill, what are your thoughts on that?

Yes. So, as far as whether we can improve on our historical peak margins, we had - I think you’ve been around, Adam, long enough to know. When we were peaking in the 2007 through 2009 timeframe, we had a subpart of our business that was doing very poorly, that I think kept that peak from being higher. I think there is room to improve as the pick-up in demand is just beginning.

Okay. How concerned should we be, if at all, about the datacenter jobs that rolled in at the end of December, and then you were into the first half of the year, you said those won't repeat in full. Is that - how cautionary should we take that comment?

I think we gave really much - for us very clear guidance on that. We think we’ll see high single-digit growth. That’s better than anybody expected, better than we expected a couple of months ago. But we just don’t think we can get into the teams like we were in this quarter. The datacenter market is still very good. And the biggest people for whom we've done datacenters were finishing some phases, but they got more phases to come. We think we're well positioned to get at least our fair share of that work. And overall the industrial markets look pretty good. It’s just that when we comment, hey, the first half had a lot of simultaneous jobs - number of jobs simultaneously, then we’re just filling a lot of revenue and we won't quite see that, but it’s going to be good.

Adam, I’m optimistic about the mix. Datacenter is one of them, but pharmaceutical, the other things I mentioned in my script. We got some broad-based improvement in a lot of sectors. I’m very encouraged.

Okay. And then along those lines in terms of the bidding activity you’re seeing across sectors, are you getting asked to bid on things for early ‘16 that will give you confidence that the recovery continues into next year?

Absolutely. We’re looking at work. We’re in pretty good shape for the foreseeable future but we’re looking now back into this year, beginning of next year, the visibilities are pretty good and we’re looking at stuff clearly into 2016 right now.

Okay. And then just, Bill, lastly on the tax rate. You got a little help in the first half you said. What will be the expectation going forward?

So the tax rate will trend in the 36% to 38% range, not quite as low as it has been, only because of the disproportionate earnings of the company that we have, a minority holder in. So I think they will continue to pull down our tax rates, but not quite as much as they have in the first couple of months. So I’d say it will be under - our historical averages are like 38%, 39%. We just recorded something in the high 35% range. We’ll a little above that, but still lower than our historical average for the rest of the year for the full-year.

Okay, perfect. Thank you.

Thank you.

[Operator Instructions] Your next question comes from the line of John Rogers with D.A. Davidson. Please proceed.

Hi, good morning.

Hi John.

Good morning, John.

Again congratulations on the quarter and the first half. I just want to follow-up I guess a little bit on Adam’s question relative to margins. I guess, Bill or Brian, is there a point in terms of revenue that is a significant tipping point that’s adding to those margins in the quarter, getting over certain fixed costs that - because just the magnitude of the uptake, or was it just particular projects that got it there, when you highlighted some of that in terms of impact on revenue. I just want to understand maybe, I don't know, maybe what he the margin range was across companies. Was it extraordinary, or maybe a little more color there?

You pulled the numbers apart. There is not a single driver. Margins were higher across the board, very few exceptions. We did have at the same time a couple of outliers. We had a couple of companies in the mid-Atlantic really have a special quarter. So it really - and then honestly, we’re doing more service, especially on the gross margin side. Service has better margins. We just had a big jump in revenues as the percentage of work that we were doing, the same for service. So that means service jumped as well, and service has certainly higher gross margins, even though we continue to invest in service, it's a lift. And I will say the investments in service over the last couple of years were at the parent level, those our leveling off and even coming down a little bit, but then in the field we have some subsidiaries who perceive a really good opportunity in their market and they are investing to take advantage of it. So it really - I look to see if it was a single driver, and really across - if you look at cash, if you look at all the things that went well this quarter, it's a broad-based story.

John, just to follow-on, having the absence of bad news that I used to have in my script is a huge help not to be minimized, but also the service front for me personally has exceeded my expectations of where we are today. This is not to be minimized how much help we're getting from it.

And did you also anniversaried some of that investment in building out the service that we've talked about over the last year or so?

So you mean has it come down?

Yes, exactly. Because you used to talk about $1 million a quarter I think.

Yes, it’s probably - so some of that investment we continued, but it's down to 0.5 million bucks probably, not enough to really matter, not enough to make it into the MD&A but it's not going up. But we are still - we still think it's a good area to invest in, and we’re putting some incremental dollars into things like mobile technology, and it’s earned keeping the investment level reasonably robust.

As you know, John, as you go along you tweak things here and there when you get the most bang for the buck. I think the leadership on the service front has done a great job of picking where we think we’re going to get the most mileage of our investment dollar.

Okay. I guess that would imply then if the mix is hold steady and assuming no problem projects, these margins then should be at least sustainable over the near-term?

I think that the margins that we averaged out to in the first half, it’s certainly our goal plan to do better than that in the second half. Now you just isolate the margin in the second quarter, that's going to be a tough thing to maintain. If demand keeps picking up, hopefully we can surpass it. But for the second half, I think our margins are somewhere between the full first half and the second quarter. I think there is some - there is upside to what we averaged in the first half.

Okay. And in terms of - I appreciate the comments on revenue growth, but how much visibility do you have into the second half, or is that just based on what you know you have? And are there call-out - is there a call-out work or opportunities there to improve that?

John, the visibility in the second half is pretty good.

Okay.

We talk regularly to our regional teams in each company in what they are bidding, so we get pretty granular - especially this week, we did about with the back half of this year looks like probably a little bit clear in the early 2016 than we normally have. But for sure the back-end of this year, I think we are pretty confident what we are saying.

Okay. And sorry, one of the - couple of the things just on revenue then. I think I saw it in the Q but commented a lot - I can't remember whether it was the quarter or the six months that you talked about industrial activity in generally being stronger. And is that still the case, only because I've heard on some other conference calls and comments on second quarter earnings that there is some industrial slowing as it relates to some delays and in oil projects rolling through the system?

Yes, for us John, the industrial front has not slowed down. And as you know, we don't really have oil and gas exposure at all. We live in Houston city but we are still very busy here. But we have not seen a slowdown on the industrial front.

Okay. And the commercial office I assume is still holding up pretty well.

It's actually picked up.

Yes, Main Street [ph] looks pretty good as well.

Okay.

The institutional is flat to retracting, and healthcare will kick in at some point but right now the hospital construction is the lowest I can remember.

Okay. And one other thing, if I could, is - then I’ll get back in queue. But acquisitions - in this kind of a market environment, are people more eager to sell less, or does it just still work in the pipeline? What does that look like?

I think on an immediate basis, they are less eager to sell. You've been in the desert for five or six years and you finally get signs of life, you want to enjoy that a little bit. We got some really good people we’re talking to, but they’re in a more planned kind of - yes, they are in a more planned kind of a change. And I think that it’s hard to get sizable acquisitions to let go of the opportunity that they think they are seeing right now.

But we’re still out there and engaging in discussions like - so we’ll see.

And there is always the opportunity to maybe make an investment in something if it really is worth that, we’ll just find out right [ph].

Okay. Thank you very much.

Thanks John.

Your next question is a follow-up from the line of Tahira Afzal with KeyBanc Capital Markets. Please proceed.

Thanks a lot. So folks just wanted to ask you one question. I know you’re really focusing still on keeping your good people and your workforce. So I just wanted to sort of gather or try to figure out that how should we think about leverage on your SG&A line going forward? Your revenues are growing, at least in the second half in the high single-digit. We saw a bit of a jump up in G&A, but how should we think about that from sort of 18 months perspective?

I want to say two things about that. One, I think we could do better if we can get Brian [Technical Difficulty].

He is trying to put back [ph] some work.

But that’s not likely to happen. I think that historically at this point in the cycle, we’ve gotten about 50% G&A leverage. In other words, as we make more money in this industry, people expect to be paid better. They don’t get paid very well in recessions. Project managers and corpsman and superintendents and even estimators, but when the company starts to make money, the shares of the profit that those people get, which by the way drive the profits we give you guys, go up some. So historically unless we’re making a conscious incremental investment in upsize, we get about 50%. Our SG&A goes up about half as fast as our revenues at the moments of inflection. That’s what we’ve averaged in the past at my best guess for the future.

That’s very helpful. Thanks a lot, Bill.

[Operator Instructions] Please standby. And with no further questions in queue, I would now like to turn the conference over to Mr. Brian Lane for closing remarks.

Okay. Thank you. Thank you everyone for listening to the call and your interest in Comfort Systems. We’re very pleased with the first half of the year, particularly with the second quarter, and are very optimistic about the back half of 2015. So with that, I hope you all have a safe and [Technical Difficulty]. Thank you.

Thank you for joining today’s conference. That concludes the presentation. You may now disconnect, and have a wonderful day.