Good day and thank you for standing by. Welcome to the second quarter 2021 Comfort Systems USA earnings conference call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [[Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to turn the call to Julie Shaeff, Chief Accounting Officer. Please go ahead, ma'am.

Thanks Charlie. 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 upon the current plans and expectations of Comfort Systems USA. Those plans and expectations include risks and uncertainties that might cause actual future activities and results of our operations to be materially different from those set forth in our comments. You can read a 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 has been provided as a companion to our remarks. The presentation is posted on the Investor Relations section of the company's website found at comfortsystemsusa.com. Joining me on the call today are Brian Lane, President and Chief Executive Officer, Trent McKenna, Chief Operating Officer and Bill George, Chief Financial Officer. Brian will open our remarks.

Okay. Thank you Julie. Good morning everyone and thank you for joining us on the call today. We are happy to report an excellent second quarter. We earned $0.90 per share despite some revenue headwinds arising from pandemic-related delays in some areas and projects. Our sequential backlog increased by $180 million this quarter on a same-store basis and our year-over-year same-store backlog also increased by $200 million. And this is the first time since the pandemic declined that we have seen a same-store increase in our backlog from the prior year. These increases support our belief that direct pandemic effects are abating. Our free cash flow continues to be strong and yesterday we increased our dividend. Our essential workforce proved its mettle during the recent challenges and they continue to excel as circumstances improve. We are grateful for their strength and perseverance. We are optimistic about our prospects for the next several quarters. We recently announced that Amteck will be joining Comfort Systems USA and that acquisition is expected to close in the third quarter. Amteck provides electrical contracting solutions and services, including core electric and low-voltage systems as well as services for planned of maintenance, retrofit and emergency work. Amteck is headquartered in Kentucky and focuses on the Southeastern United States, including Kentucky, Tennessee and the Carolinas. Amteck brings experienced professionals and a fantastic reputation for electrical contracting and services in industrial markets such as food processing. Amteck will add world-class capabilities in complex projects, deep customer relationships, design-build confidence and opportunities for synergy. I will discuss our business and outlook in a few minutes, but first I will turn this call over to Bill to review our financial performance. Bill?

Thanks Brian. Before I review second quarter details, I want to discuss the impact of COVID and how that has affected the composition and timing of earnings and revenues so far this year and in the comparable period last year. Our first quarter results in 2020 were lowered by COVID. As we closed that quarter last year in the midst of governmental orders in building and job shutdowns, we were very concerned about how the pandemic and work precautions would affect our productivity. Accordingly, the judgments we made to close the first quarter last year led us to expect higher cost on jobs and reduced margins and we also reserved certain receivables. Three months later, by the time we were closing our second quarter, it had become clear that our activities were deemed essential and that we could work at good productivity levels or would be paid for lost productivity in most cases. As a result, we reassessed some cautious estimates and partially as a result of those judgments, the second quarter of 2020 was particularly robust. We continued to benefit from those factors in last year's second quarter as well and the third quarter of 2020 also benefited from a very discrete gain relating to the settlement of open issues with the IRS for our 2014 and 2015 tax years. As a result, although underlying trends are strengthening, we continue to face tough comparables in the third quarter. Now during the first half of this year and a year later, we have good execution and productivity. However, we have had some revenue softness due to delays in work preparation and pre-construction due to the pandemic. We are also towards the end of closing out some work that was performed under the worst conditions of the pandemic. And so the…

Okay. Thanks Bill. I am going to spend a few minutes discussing our backlog and markets. I will also comment on our outlook for the remainder of 2021. New bookings significantly exceeded backlog performed during the second quarter. Backlog at the end of the second quarter of 2021 was $1.84 billion. We believe that the business impacts relating to COVID-19 have now stabilized and as a result same-store backlog increased sequentially by 11% or $180 million. That is a strong increase, particularly for the second quarter. The increase is broad based with strength across our markets, most notably, in industrial projects. Although delays might modestly impact activity levels for the third quarter, we see strong underlying trends in the coming quarters and we are comfortable with the backlog we have across our operating locations. Our industrial activities were 42% of total revenue in the first half of 2021. We think this sector will continue growing as the majority of the revenues at our new companies of TAS and TEC are industrial and because industrial is heavily represented in new backlog. Institutional markets, which include education, healthcare and the government, are strong and were 33% of our revenue. The commercial sector is also solid but with our changing mix, it is now about 25% of our revenue. For the first six months of 2021, construction was 77% of our revenue with 46% from construction projects for new buildings and 31% from construction projects in existing buildings. Service was a great story this quarter and service revenue was 23% of year-to-date revenue with service projects providing 9% of revenue and pure service, including hourly work, providing 14% of revenue. Year-to-date service revenue is up approximately 12% with improved profitability. Service has now rebounded to full activity levels. Buildings are open. Profitable small…

[Operator Instructions]. Your first question comes from the line of Sean Eastman with KeyBanc Capital Markets. Your line is now open.

Hi team. Thanks for taking my questions.

Good morning Sean.

Good morning guys. So Brian, in your prepared remarks there, you are talking about being confident in the second half and then even more confident in 2022. It's kind of unusual for you guys to speak about the out-year so bullishly, right. So obviously we saw a great bookings in the second quarter but maybe beyond that, what's really underpinning that confidence, especially considering we have got some of the supply chain and labor availability uncertainty here?

Yes. Well, I think, first of all, Sean we are seeing a lot of opportunity still throughout the country. It's work we like, work we are good at. So that gives me a lot of confidence that we will be able to execute well in the field. And as far as we can see, that's going to continue for the rest of this year into next year. There's multitude of opportunities. Particularly, if you look at the industrial sector, data centers, pharma, medical facilities, labs, food processing, medical in general on the retrofit side and some new buildings and education. So I am pretty confident what we are seeing and I think the momentum will continue. I guess your question about the materials and labor. I am sure it's well documented. But I think we are doing a really good job managing it on the material front, in particular. We have really good relationships with our vendors, a long history with them which we pay them fairly and we pay them on time. And we will let them know what's coming as early as we can and all of us are on the phone with them. So I mean, we are going to manage our way through. We have been through tight times before. None of us are new at this. And of course on the labor front, you do everything you can. I think stuff like pre-fabrication and modular helps us reduce our dependence a little bit on labor. But we recruit and bringing them in, training them. But I am pretty optimistic. We have got a lot of well-seasoned professionals out there doing the work and we will get through it.

Okay. That's helpful Brian. And another high-level one from me is, you pointed out this big shift in mix we have seen over the past several years with industrial overtaking commercial in a big way. I think that's been deliberate with acquisitions being a big part of that. You have also invested heavily in service over the past several years. So just in that context, as we are looking at our forecasts into a positive inflection in activity, I mean, what do we really need to consider in our models considering that big shift in the profile and mix of business?

As far as your model goes, I don't know, but the most important things about those changes are, in the complex space you have a much better opportunity to get reliable margins and to charge for the labor that we have that's really what you invest in when you buy Comfort Systems stock is group of people who can do hard things. I am not sure it really changes the modeling. I do think that industrial will go up for the rest of this year, but almost certainly just because we will have a full year of two companies that are virtually 100% industrial. And as Amteck comes in, they have a richer industrial mix than we have on average. And they have particular expertise in things like food processing and certain types of industrial facilities that really we didn't have a lot of exposure to. And a really great sort of it shaped the geography where we are really excellent at this stuff, a little bit to the chasing our sweet spot of the greater Southeast but shades us a little more to the west of the Southeast in some areas that we think are just really, really attractive in the coming years.

Okay. That's helpful. And last one for me is, this is the one of the lower gross margin prints we have seen in some time from you guys. Could you just walk us through some of the moving pieces there? It sounds like no real change in margin expectations on a go-forward is my sense.

Yes. If you look at where we are at the year-to-date, we are over 18%, Sean. I mean, you look at the three month timeframe, I think we are really executing really well in the field. I think we will be back to our normal spot. I think this is just a one quarter decline in my opinion.

Yes. You think about it a year with all the craziness over the last year, right. One of the things that happened last year was people had to work out on job sites with masks on and they could flow fewer people in an elevator and just more distance and longer timeframe to just get on to the job site as you were getting your temperature taken. So even though a year ago, we found out we could still work with good productivity, that doesn't mean it doesn't affect somebody. If they have to wait 10 extra minutes to get in and we are paying them, that's 10 minutes of lost productivity. So I think that on many of our jobs, we had some lost productivity. It's just that we had money in our cost codes to cover it. But when you get to the end of the job, we are finishing a lot of those jobs, that's still going to affect how much of a pickup you are going to have at the end, right. And also, we are in a period of time when we have a little bit, we have some sporadic air pockets in places where they are about to get really busy. And as you might imagine, if you have got, well, there isn't pipe fitters and plumbers and master electricians, you are going to usually pretty slow to lay those guys off when you are facing a giant amount of work. So I think what you are seeing is an amazing outcome as our guys are managing through an inflection point a little bit and a little bit of an air pocket. And we are thrilled to make a ton of money and be positioned the way we are.

Yes,. I couldn't be happier with the way we are performing in construction and service right now.

Okay. That's really helpful. Thanks guys.

All right. Thanks Sean.

Your next question comes from the line of Adam Thalhimer with Thompson Davis. Your line is now open.

Hi. Good morning guys.

Good morning Adam.

Bill or Brian, how are building owners or people thinking about building a building thinking about rising materials prices?

So as far as we can tell, when you talk to virtually any of our companies, there's still a ton of planning going on, right. So I think, nobody likes it when they have to pay more for something. There are certainly places where people were budgeting something and they are seeing a little bit of sticker shock and they are happy to talk a little bit more. But the reality is, for most of these businesses, the capital expense of building a building is spread over the next 40 years or 60 years. If it's a good investment, a 10% or 15% increase in the total price is very unlikely to turn something into a bad investment. Especially if you think about it this is the second time in my career in this industry where we are facing a big very quick increase in material costs. The last time was 2005. The summer of 2005 there was an awakening where people said, China is here to stay and they are going to use a lot of the world's resources and building supplies doubled over about a six months period. We managed through that with just a, I mean, this was a $1 million I think of effect. But also the biggest reason I feel much, much better this time is, last time this big "problem" was a real problem because that was going to happen in a place I don't do work. Very hard as the CFO of a company that build things that to say, oh, this factor that's raising cost, that's driven by the fact that people really want to build things is a problem net net. I think at some point, you have to accept the fact that if you are going to be in a really robust market, you are going to move a little bit on the supply curve. So I don't know, I think it's good news.

And Adam, it's interesting. We have a very collaborative discussions throughout everybody on a project, customers, subs everybody else about the issue. So it's not like it's affecting a few sectors, right. It's broad based. So everybody is trying to work together to get these jobs built.

And its self correcting. If people stop wanting buildings, what will happen to the material prices?

Yes. We don't want that. Can you comment a little bit on pricing? I mean, it sounds like obviously good bookings in Q2. It sounds like the bidding is still steady. What are you seeing on pricing?

I think pricing is good. I mean, it's been pretty stable, new opportunities that we are looking at. So I think it will be okay.

And then, Bill, can you repeat those Amteck numbers? And were those rest of year numbers?

No. So we basically, in our press release, we said that once Amteck is a part of Comfort Systems, you could expect a $175 million to $200 million of revenue and $14 million to $17 million of EBITDA. And we did that with each one of our acquisitions, is just to get people an idea of what we bought. Obviously, we try to put numbers in that we think are very fair and achievable. But I will say also those are numbers that we expect them to average in years to come. There will be years when they do much better than that. And like all companies, if we have a company in Little Rock, Arkansas and nobody's building a building in Little Rock, Arkansas, the greatest company in the world might have a soft year too. So it is, we are a portfolio. But I never felt more comfortable with sort of my view of the prospects of some acquisitions that we have done.

Great. Okay. Thanks guys.

All right. Adam, take care.

Your next question comes from the line of Brent Thielman with D.A. Davidson. Your line is now open.

Hi guys. Thanks. Hi Bill. Does the cash flow get better from here in the second half? I know you are going to have some working capital requirements, but I wonder --

If I were guessing, we can do better than, we will probably do better than $20 million. The fourth quarter is usually a good cash flow quarter for us. But the one thing I would say is, if we were to go back to that eye-popping cash flow, it wouldn't necessarily be good news. It's actually, cash flow less than our earnings for the next three or four quarters if our revenues are going up the way we expect them to, because definitionally, in general, we pay people their wages before we, on a weighted average, get paid for the work we do. So it's good news, I think that. But the good news is, I think we have very good cash flow. I don't know if we can match the first half, but the second quarter was just a low number. There is one factor that's just out there that's math. And that is, last year they gave us permission not to pay our payroll taxes. And we aren't a simple workforce. We have a lot of payroll taxes. And we have to make up half of that in the fourth quarter of this year and we have to make up the other half of that in the fourth quarter of the next year. So that's definitionally going to knock, I think $20 million off or something in the fourth quarter as we just do a catch-up on that.

Okay. And I think the electrical profitability over the last couple of quarters is a pretty interesting story. Your revenue is down a lot, but obviously much improved. I wanted to get your thoughts. I mean, can you build on these levels as you start to accelerate some of this new work? I am not asking about timing but just more whether this is kind of the baseline we ought to think about for that side of the business that you can build out as things get more active?

Yes. So hi Brent, this is Brian. Yes. There has been a marked improvement in the profitability of electrical. And as we announced early, when we got into electrical that we probably shrink it before we grew it again. But I am very optimistic about the possibilities of improving margins in electrical, particularly with Amteck joining us. We have got a good critical mass, sharing best practices, et cetera, using pre-fabrication. So I think for modeling sake, there's probably a good baseline, but I am optimistic we will get better.

Okay. I appreciate it guys. Thank you.

Thanks.

Your next question comes from the line of Julio Romero with Sidoti & Company. Your line is now open.

Hi. Good morning. Thanks for taking the questions.

Hi. Good morning.

So I guess, I wanted to start on the services side. You are seeing a nice rebound there sequentially. Is that rebound in service mirroring your increase in some of the sub-sectors, industrial, government or multifamily? Or is there other sub-sectors that may be driving that?

No. Our sweet spot for service, unlike construction is commercial. So we do an awful lot of service in commercial buildings. We do a lot of projects across our portfolio. But where we get in there and do a lot of demand service, where we have a lot of our preventive maintenance agreements is in commercial. If you think about it, somebody like Duke University or the Methodist Hospital System, they have their own facilities management teams. And so they kind of call us when they plan to do something hard like a project. It's really in our commercial that we do a lot of service.

Got it. So I guess the implication would be, on the construction side and commercial that's something where the air pocket maybe affecting you?

I don't know if you are asking if the air pocket has affected us in the second quarter in service. I think the answer is no. I think our service was up 12% or something.

No. I am sorry. Yes. I meant to say that because the commercial and other was down year-over-year on the revenue side. And if service is up, I guess the implication is that the construction side of commercial is down. Okay.

Yes. Absolutely. And it's really improved on the industrial and the others as we mentioned. But also on the service front, right, we have got some help with the excessive heat we are having too. So we have an HVAC business. And there's no question that that does help us. But we are full tilt in service right now.

And by the way, I would also say commercial is not as strong, I would say in the United States today as industrial or even institutional. But our commercial numbers coming down is not just indicative of like weakness in commercial. It is indicative of decisions being made by our subsidiaries to take work that's more complex and better for them. It's indicative of us moving up the food chain really.

Got it. That's helpful. I guess if you can talk about the mix of what you are seeing in backlog now. I know you mentioned some improvement, particularly in industrial. But I am curious if education or any other sub-sectors might be increasing year-over-year, making a bigger portion of your backlog, but not at the current revenue mix?

Yes. I know if you look at our backlog today, industrial is very commensurate with our revenues. So that's strong and growing. We are hitting growth out of medical for sure, both in new build hospitals, retrofits and medical facilities and also a fair bit of what I call laboratory research facilities and vaccine development facilities. And education has been pretty stable for us, doing a little bit of work with air quality in schools, et cetera. But universities is still pretty strong for us, Julio. So of all other sectors in the backlog, that had a majority of it.

Understood.

Yes. Believe it or not, lodging and entertainment also was up. We had a couple of nice bookings in that area this quarter.

Yes. We got some hotels going up, which is not what we expected.

Yes. I haven't seen that much on other companies either. I guess just last one for me here is, what do you think Tennessee Electrical does in the back half of the year from a revenue run rate standpoint?

What did you say, Tennessee Electric, TEC?

Tennessee, correct, TEC.

That's probably a little too granular. Their revenues were very light in the first half and we knew it. Like, three months before we did the deal, he was telling me that he had this period and they are picking up. They have got some jobs starting. So I think they will be up considerably, but it's hard for me to, I just don't have at my fingertips have a number I can put on that.

But I will tell you, I was at TEC there recently and their workload, they will be full tilt the back end of this year for sure.

Okay. Fair enough. Thanks for taking the questions.

All right. Thank you.

And that concludes our question-and-answer session for today. I will now turn the call back to Brian Lane for closing remarks.

Okay. Well thanks, Charlie. In closing, I really want to once again thank our wonderful employees and I really want to give a shout out to our analysts this morning for their preparation. They had a lot of calls going on today. We know it. We really appreciate you joining in the call today and your questions as well. So we are also glad and hopeful to see everybody here in the near future in-person. We are looking forward to it. In the meantime, everybody, be safe and have a good upcoming weekend, a good rest of your summer. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.