Comfort Systems USA Inc (FIX) 2005 Q3 法說會逐字稿

Welcome to the third quarter earnings call.

All participants will be able to listen only until the question-and-answer session. Today's conference is being recorded. If anyone has any objections, you may disconnect at this time.

Now, I will turn the meeting to your host, Mr. Bill George, Chief Financial Officer.

Sir, you may begin.

Thanks, [Meralee].

Good morning, everyone. Welcome to Comfort Systems USA's third quarter earnings call.

To begin, we want to remind everyone that 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 say 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 list of specific risks in our form 10-K and in our press release covering these earnings.

On our call this morning are Bill Murdy, Comfort's Chairman and CEO, and Tom Tanner, our Chief Operating Officer. Bill Murdy is going to open our remarks.

Bill.

Thank you, Bill, and welcome, everyone.

We reported last night quarterly earnings from continuing operations of $6.5 million or $0.16 a share versus 3.4 million or $0.09 a share in last year's third quarter. Revenues in the quarter of $243 million, up about 18% versus Q3 last year. Significantly, our free cashflow in this quarter was $6.6 million. Bill George will have some comments on that in a moment.

Our backlog was up slightly as it reached another record high of $651 million versus a backlog of 479 million at the end of Q3 '04. That's a 36% increase. On a nine months to-date basis, we show revenues of $682 million and fully diluted earnings of $0.28 a share, versus 594 million and $0.22 a share for the comparable nine months of '04. Those are increases of 15% in revenues and 27% in earnings respectively.

As we indicated in our release last evening, we are also initiating a modest dividend evidencing our proven track record of cash generation, our stability, and our confidence in Comfort's future. We believe we've made, and continue to make, significant progress toward our general goal of achieving consistent top-core top performance in our sector, and while not all of our operation are yet operating in that fashion, the efforts they are making indicate very substantial progress towards that end. Tom Tanner, our Chief Operating Officer will have words on that later in the call.

Before passing the mic back to Bill for some financial comments, I want to add that we continue to rely on the very high quality and technical expertise and the energy of our people across the Company who have produce the positive results that we're reporting here, and that we believe -- results that we believe we will sustain into the future. Without those people, what we are achieving simply would not be possible.

Bill, I'd like to turn it back over to you for some financial comments.

Thanks, Bill.

Although Bill's already reviewed our third quarter results, I would like to comment on a few items. As those of you who have followed us for years already know, the third quarter has always been our seasonally strongest quarter. As you can see from the press release and Bill's remarks, our improvement during the third quarter was broad-based, including progress in earnings, revenues, and margins.

I do want to note the difference between earnings per share for all operations during the quarter, which was $0.15, and earnings per share from continuing operations, which was $0.16. The difference arises from the fact that during the quarter, we closed two small operations in upstate Michigan, and it primarily reflects some of the costs we incurred as those operations were wound down. The companies we closed were not core HVAC or service operations, and we continue to have a strong presence in that area, including one of our largest and most successful operations in Grand Rapids. One of the most encouraging statistics on the quarter for me was our positive free cashflow of over $6 million. That was a nice accomplishment for our operations in an extremely busy quarter, during which we also made a big investment in working capital as we purchased materials and funded payrolls, to support high levels of activities. After two successive quarters, in which we have been able to flow solid cashflow even as activity increased significantly, we are happy to see indications that the effective cash management practices we instituted and challenging circumstances in the past are also leading to good efficient use of capital in more robust times.

We continue to have zero indebtedness for borrowed money. I also want to note, for those of you who may not have had time to read 100 or so pages of our credit agreement, that our new dividend fits well inside all of our financial convenants, and it leaves substantial additional flexibility to pursue other opportunities that may arise.

That's it on financials, so I'll now introduce Tom Tanner, our Chief Operating Officer.

Tom.

Thanks, Bill.

Good morning, everyone.

Let me start by saying how much we appreciate the effort and results achieved by our team members this quarter. We were very pleased with the financial results from a significant number of our operating locations.

We believe part of the reason for the positive results this quarter relates to our focus over the last 18 months, on project selection and project execution. We have improved our project selection because we have a better understanding of both our resource and geographical strengths and limitations. We continue to invest in process improvements and labor productivity to strengthen our project execution by providing productivity training at specific operations, as well as providing industry-specific project management and project superintendent training.

On the service side, we continue to focus our efforts on sales training and improving our operational efficiencies. Our service group has spent considerable time and resources this year to develop training programs specifically to designed to develop our sales force and to effectively HVA service to our customers. We have just begun to implement these training programs, and we believe we will begin to see positive results from these efforts beginning late in the second quarter of next year.

As we mentioned last quarter, we continue to see our companies working together to share special expertise, manpower resources, and project opportunities. We are continuing to focus on our SG&A cost, and we were pleased that, as a percentage of revenue, our SG&A costs decreased in the third quarter and year to-date as compared to 2004. The good portion of the actual increase in the current year relates to increased incentive compensation because of our improved operating results.

Bill mentioned that we divested two small companies this quarter. The sale and closing of the two companies in the Michigan market, was the result of our strategy to sell or close non-core companies to stop spending our resources both human and financial, on small, unprofitable companies, which we concluded had very little future upside. Both of these companies had year-to-date losses for 2005, and both companies had sustained losses or had been marginally profitable in 2003 and 2004.

Even with our improved results, there are operations that we need to have -- that need to have better financial performance. Of the operations we mentioned last quarter, our Utah operation and one of our California operations were slightly profitable this quarter, while our other California operation had a nominal loss. These results, although not acceptable, were a significant improvement from our prior quarters. We are optimistic these companies will continue to show improvement in the fourth quarter, and then be profitable in 2006.

In addition, we experienced project earned performance at one of our larger operations. However, we believe the issues relative to the underperforming projects have been addressed by the operations management, and thus, future results will be much improved. We will continue to focus our efforts on improving our operational execution in both our construction and service division, while paying special attention to any underperforming operations. Even as we move into the historically slower part of our year, we are optimistic about our future given the size of our current backlog, our promising project pipeline, and our focused efforts to increase our service business.

With that, I will turn it back to Bill for his wrap-up, and then Q-&-A.

Thank you, Tom and Bill, for your comments.

We, as I mentioned before, we continued to see improvement, and that's not by accident. Our operations have worked for those productivity increases, and our efforts in areas like project management, superintendent training, service operations training, service sales training, have really started to show the importance of those kind of things.

At this point, I'd like to open it for questions out there, and, [Meralee], I'll turn it back to you to re-issue the instructions on how to do that.

Thank you, sir.

[OPERATOR INSTRUCTIONS]

Our first question is from David Yuschak.

Your line is open.

Thank you, and congratulations, gentlemen. You're operating margin in the quarter, Bill, the best under your watch and the best in all my six years, so you're moving that needle in the right direction. I think a lot of it has to do with your productivity initiatives for sure, but let me ask a few questions on the backlog.

Could you give a sense at to the bookings? Where you're seeing a strength in the bookings in the third quarter? Was there anything that maybe you took a backlog for whatever reasons, and just give us a sense as to what's happening there as far as current activity across your different markets?

We see strong backlog in our San Diego operation, our Phoenix operation, our Houston multi-family operation, including our offices in the Florida Pan Handle, Washington D.C. and Los Angeles, California. We have strong backlog in our Midwest group in Madison, Wisconsin, also another of our full-service mechanical in Washington D.C. So we have seen a broad-based increase in backlog throughout the great majority of our companies.

As far as the where you've had disappointments as far as operating performance is concerned, are you seeing backlogs building there, bookings coming in, enough to maybe support the optimism you expressed by how well they can do in the fourth quarter into next year, or are you constraining that operation from booking yet until you are satisfied with the productivity improvements?

Good question.

We certainly believe that we have addressed operational issues in those companies, and so they are moving forward in those companies that have experienced some under-performance so far in '05. Do have strong backlogs, and we have spent a great deal of attention with them and their management team, and their management teams are very focused to move forward. So we believe that their backlog is appropriate for their resources moving forward.

Okay.

And Bill -- Bill George -- give us some idea of where the business has been as far as multi-family versus education, health care. Do you have those numbers at all?

We continue to see strength in the institutional work with governments and hospitals. Multi-family is still very, very strong. I'd say it's similar to what we have experienced in the recent past, some signs of life, although they are not terribly -- they're not statistical so much as anecdotal, and forecast by McGraw-Hill, but some signs of life of life in office buildings. We'd like to see that -- we'd like to see that pick up for us.

Okay.

Couple other quick questions then -- as far as the billings in excess, that had a nice performance in the third quarter, does that reflect maybe a current business being a lot stronger going into the seasonally slower period, but there's more owners who want to get projects started sooner that waiting until next year?

I think billings in excess are strong -- based on strong activity levels, and the culture that the Company has of making sure that our schedules of values don't result in us financing somebody else's building. As far as where we are in the cycle affecting that, I can't say that I've thought about that, but I could see that being a factor. It really is a direct factor of a large backlog, a lot of the work having recently started in the third quarter, and our training efforts to get people to correctly bill these projects, and as Bill said, we're not in a position where we're financing the developers going forward and the owners.

It's likely though the fourth quarter may not be, because of the strength of the nonresidential right now in your marketplace, it's very conceivable that the fourth quarter may not be as seasonally slow when you get around the holidays. Is that a possibility given the weather conditions stay fairly moderate?

I think it is, David.

We've got sort of a continuing summer here in many parts of the company -- country, and we've got the backlog, the work-in-progress is already there, recognize, though, that we've got fewer workdays in this fourth quarter than in any other quarter of the year.

Right.

So, yes, I think there's reason for optimism about fourth quarter not being as seasonal -- your words -- as it has been in the past.

One last quick question -- on the tax rates, still relatively high -- what conditions would we need to see that tax rate come down, maybe like 40, 42?

One of the things that really drives our tax rate is our mix of work, and we've been doing really well in some high-tech states like Michigan and haven't been doing so well in unitary states where the taxes would have been spread over other operations.

Another thing that really emphasizes our tax rates, actually makes it larger than it would be, is the way that -- generally accepted accounting principles, the way that you have to calculate your tax rate is you have to make assumptions about the taxes that you'll pay in various states entities, and those assumptions essentially -- they assume that you would be audited. You have to apply a standard that assumes you would be audited, and our company is new enough, having been formed initially in 1997, and having taken on its current characteristics much more recently than that, we're new enough that we have a lot of tax positions out there that are established on our books as reserves, but that -- we may never be audited. We may never need that money, and so they will come off as our company ages and we begin to see the statute of limitations expire. There's a -- I think there's a factor in our tax rate that just has to do with our youth. We have a higher tax rate because we're a newer company, and we're making provisions, but we're not relieving them.

Fine.

I'll go back in the queue.

Thanks, David.

[OPERATOR INSTRUCTIONS]

Our next question is from John Rogers.

Your line is open.

Hi.

Good morning.

Hi, John.

I was just wondering could you talk a little bit about the pricing environment? I mean, with the market picking up, is it enough that you're able to start pushing up pricing as you bid new work?

Let me address that first, John.

Tom's comments, and he ought to follow me here, we are in to a period of selectivity in projects, clearly to the extent we can see forward on these things. We're going to select those where we can get the price -- the best price -- that we can. We're not -- we don't have infinite resources to take on everything, and so that lends -- I think, additionally, there is a general supply, demand imbalance, where there's a lot of -- there's good amount of work. This is not 1999, 2000 here, but there's a lot of work out there, and there's work resultant from Katrina, Rita, and Wilma, those three ladies have provided some work across the South, which has taken some assets, not all cases ours, there. I would say that those elements allow us to get a little pricing traction, if you will.

Tom, I don't know if you want to add to that.

Well, our operators and company presidents are -- deal with pricing issues every day. We believe that on certain projects, we have special expertise. We have special resources. We have bonding capabilities that some of our competitors don't have. In every case, we try to take advantage of that to get some marginal increase in pricing. I think our operations have done that pretty successful, especially as their backlog grows, people are raising prices in those markets where people still want them to perform work, but they already have a large backlog, and they're not that hungry for work. So we're seeing that in certain markets.

Okay.

Just following up on, Bill, your comment relative to the storms, were they a net negative, positive in the quarter, and what's your thoughts on the fourth quarter?

Well, we don't have real good data, but to the extent we do, I think they were probably a net negative. We lost workdays. We closed down Houston for three days. Fortunately, Rita did not hit here, but we closed down three of our operations for three days. We didn't let people go, so that -- that's a negative effect. Wilma, obviously had some affect in Florida, just in terms of that.

Now going forward, how much work will those storms spawn? Certainly some. We are not in Louisiana, South Mississippi to any great extent. Our Mobile, Alabama operation does some work on the coast there, and we're not in South Florida where there was damage, but as I said, there will be some assets that are used up, some construction and service assets in our sector that are used up by those activities, which will leave us work in other places. That's why it's really hard to get a definite handle on it. In summary, I think it's a net slight negative to Q3, and might be a positive in some way to Q4, Q1.

Okay. Great.

Thank you.

Our next question from Rich Wesolowski .

Your line is open.

Thanks.

Tom, you mentioned surety bonding and advantage of 32. You added another surety provider. Do you think that will have an effect on the pricing you pay for your bonds, or will it influence the proportion of work that you go after that will require bonds?

It probably won't impact the pricing to a great extent. We have reasonable pricing in all cases. The cost of the bond is added in to our bid, so it's not a significant factor. What's critical to us, vise-a-vie our competitors, is that we have availability for bonding.

We're seeing in the marketplace more people requiring different types of work to be bonded that may have not been in the past. Also, we're seeing as our companies develop expertise, they're working on larger projects, and often times, those larger projects require bonds, so that's what's driving the marketplace. It is a very positive competitive advantage for us in the market -- in our local marketplace.

Okay.

Bill Murdy, there's a blurb in the 10-Q that our primary emphasis in on internal execution and margin improvement rather than on revenue growth. Assume the market environment stays the way it is for the next one or two years, which is, of course, the easiest assumption, but what are the realizable goals that you guys have for growth or operating margins? Have your goals ever changed?

We haven't changed really. We've always said that -- first of all, let me back up. We're not just interested in achievable margins, it's achievable and sustainable, and we're not taking advantage of a boom, bust situation here. And we're trying mightily to build our service revenues, which when we get them, are -- it's not an annuity, but it's certainly recurring, and they're very reasonable margin revenues. Things will expand almost regardless our efforts, and then with our efforts, I think they'll expand more.

We're high-grading our opportunities and that should help. We have announced and talked about in the past, there are certain very nice markets out there where we are currently not represented, but we have customers that might want to work with us there, and there might be market opportunities, so we may grow by prudent acquisition into those markets where we are not currently.

That whole combination, Rich, would indicate some definite growth on the top line.

Okay.

How much variability is there, qualitatively speaking, to internal sales or projections for next year?

I don't --

I'm trying to get an idea the visibility you have into your markets.

I can make two comments about that -- one is we're in the budgeting process, so that's a developing issue for us, but also, we're a fairly -- we're a company, we're experiencing a tail-wind for the first time. The configuration that we are in, that we've created ourselves into over the last few years, is a very good vehicle, but we're seeing it for the first time, and so there's a broad range of possible outcomes. That's why execution is our focus. We think this industry responds to management, but we have to go out, and we have to get the results.

I don't think, I said in my prepared remarks, revenues in the quarter were up 18%, Q-on-Q. That's not sustainable, the 18% increase, I don't think is a realistic thing to look at, but nor is normal inflation. We've always grown faster than the industry, somewhere in between. We are working, refining that, and some of it's resource-oriented.

And just a note, about 4.5% of that 18% came from our acquisition in New Hampshire earlier this year, so about 14% of it was same-store growth.

Okay.

Thanks, guys.

Thank you.

[OPERATOR INSTRUCTIONS]

Our next question is from [Jon] Morrissey.

Your line is open.

Thank you.

Bill Murdy, we've had some -- a lot of talk about the higher energy prices, and we're now starting to see articles about green buildings and energy-compliant buildings. I know in some of the discussions that you've had, you've talked about retrofits of old buildings having pay-backs as quick as three years. Have you starting to see a pick-up in that kind of business, and are you -- are you addressing the potential for that?

The answer is, yes, we have seen a pick-up in interest in that, higher energy prices cause that. The pay-back period decreases with every ratchet in the cost of fuel oil or natural gas that produces electricity, which is consumed by mechanical HVAC systems in the building. As John as I have said before, it's not a perfect supply, demand equation that you can put on a piece of paper and rely on because it takes a commercial building, you've got an owner that has to be convinced to improve that building with an HVAC retrofit, and he may have the building entirely leased and can pass on whatever increase in energy consumption are. He's got to have an extra incentive to go forward.

Interesting enough, in the new tax bill, there is, at least, what appears to be a tax incentive to that. We're trying to sort through that to see if it really is because it's got some standards that may not be realistic.

To answer to your question, yes, quantifiable is hard to do because of the disconnect at the various stages of making decisions here. We are -- we have definite efforts in this area, trying to do this. It's certainly coming, and it's certainly a major driver in the decision making, vise-a-vie, HVAC retrofit, then indeed, in new construction. I think people are real cognizant of that as they design what they do, and energy efficiency certainly becomes part of that design, and our design-builds capability and our editing allows us to work with the end-user, architect, et cetera, to capitalize on it.

Thanks.

Our next question is from David Yuschak.

Your line is open.

Follow-up on that, Bill, the -- there's always been a discussion out there about the potential for a replacement market because so much of the HVAC equipment that's out there is getting to the end of their useful lives. It's been 15, almost 20 years, some of this has been done. Does these energy prices potentially help move up the potential for a replacement cycle?

Yes. I think the logic is yes, but just as I said, the decision chain on that is not perfect and clear. It's going to happen. It's going to happen just because of the life of that equipment. The OEM's certainly are interested in that. They see that. We look at what, Train and York and Carrier and Lennox, Quay, Aon, and other people are looking. They certainly see that out there, energy efficiency, obsolescere of equipment, et cetera, as a driver for them, and somebody's going to construct it, install it, service and maintain and retrofit it, and that's us.

Okay.

Following up on your comment about York, York being acquired by Johnson Controls, and in trailing 12-month EBITDA that was pretty impressive as far as the kind of value being placed on that business by Johnson Controls.

One, how do you -- it's my understanding Johnson Controls was primarily interested in York because of its service component, and because of the price being paid on there, how does that reflect on any kind of acquisition strategy you have as far as the kind of values being placed on the business knowing some of these dynamics may be more favorable than we've seen in some time?

We've certainly have taken cognizance chance of that and understand that. We certainly don't think it necessarily changes much for us, certainly not in the short-run. I'm can say here, we're not going to acquire a major OEM, if that's your question.

No, that's for sure. The balance is too nice for that.

Yes, right.

It's an interesting -- all the major OEMs now have substantial controls offering or will here, and there's a lot of bundling of controls equipment and HVAC equipment here that's -- we take -- we're watching and very cognizant of as we go forward.

Okay.

Then one last question on California -- I think you -- Tom had indicated earlier, San Diego was tracking very nicely. You had mixed results in California and other places. Is there a reason to be more optimistic about California longer term just because of the size of the opportunity out there, as well as the marketplace that, as you -- as you formulate your plans for California, can that become a significant factor, or is the competition going to make it more of a fragment of opportunity?

There are a couple of issues. Our operation in San Diego suffered from some very severe rain conditions and weather conditions in the first quarter, and, frankly, a backlog that didn't move because of that. Their backlog has since increased, and they are moving forward nicely. They have always been one of our stronger operations, and we believe they'll return there.

Our other California operations, we've changed the management there, and we've down-sized the operation, one, to minimize our risk. We are very pleased to-date with the new management team there, and we think that that organization will continue to grow.

In L.A., we see opportunities in the multi-family area, where we have some special expertise, and we have some customers that have access to go into that market. So we're optimistic there that if we select properly, we can avoid any of the competitive pressure. Right now, like in San Diego, there's, frankly, so much work going on that the biggest problem is getting resources, it's not getting work.

Somewhere between 12 and 14% is our backlog is in California, and California's in 12 to 14% of the GMP, or population or anything else. It's an important area for us.

That's all for now.

Thanks.

[OPERATOR INSTRUCTIONS]

There are no further questions at this time.

[Meralee], thank you very much, and thank all of you for participating in the call. We'll see you here in three months.

Thank you.