Comfort Systems USA Inc (FIX) 2006 Q1 法說會逐字稿

Good morning, or good afternoon. Thank you for standing by for today’s conference call. I would like to inform all participants that your lines have been placed on the listen-only until we open for questions and answers. I would also like to inform all participants that today’s call is being recorded. If anyone does have any objections, they may disconnect at this time. I would now like to turn the call over to Mr. Bill George, CFO. Thank you, sir. You may begin.

Thanks, Dalynn. Good morning, everyone. Welcome to Comfort Systems USA’s first quarter 2006 earnings call. To begin, we want to remind everyone that our comments this morning, as well as our press releases, contain certain 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 operation 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 Form 10-Q that was filed, as well as our 10-K from year end.

On our call this morning with me are Bill Murdy, Comfort Systems USA’s CEO and Tom Tanner, our COO. Bill Murdy is going to open our remarks.

Thank you, Bill. Welcome, everyone. A strong residential construction economy and really excellent continuing execution by our operations enable us to report an outstanding quarter. Actually, the best first quarter we’ve reported in many years. Revenues increased almost 22% to $237 million from the $195 million of the corresponding quarter of last year, and net income was $0.11 a share versus any share in Q1 of ’05.

Our backlog continues to grow and reached a new high at the end of the quarter of $727 million, up from $682 million at the end of 2005. Activity was particularly strong in our Central and Northeastern area and in Phoenix, but across the board. And functionally, we saw a lot of growth and activity in the multi-family sector, multi-family high-rise, especially condominiums and for rent multi-family building, and some continuing strength in the school sector. But again, across-the-board kind of growth.

This build up of activity used some cash, and I’ll ask Bill George to comment on that and some other items. Bill?

Thanks, Bill. I would like to briefly highlight a few items with respect to the strong results that we released. First, I’ll comment on our cash flow, as Bill mentioned. Free cash flow was a -$15.4 million for the quarter. Although we generally experience negative cash flow in the first quarter, this year it was larger than usual. For example, our negative free cash flow was about $7.4 million last year, which is about half of this year’s number. We attribute the difference to a much larger than usual investment in working capital based on our extraordinary same-store revenue increase of over 20%.

Our cash flow and our collection metrics are all tracking normally, and we still feel good about our ability to generate cash. Despite the negative flows, our cash balances were up $3 million from year end to $58 million thanks to the proceeds from the sale of the two control subsidiaries that we discussed at year end.

Like our revenues, our earnings were up considerably, and our EPS was helped somewhat by our lower effective tax rate, which came in at 40.2% for the quarter. The tax rate improvement stems from our increased earnings, which dilute the effect of our permanent differences and from the fact that proportionately more of our earnings were in favorably state tax jurisdictions. We have not changed our full year effective tax rate guidance of 41 to 45%.

Finally, in the quarter we began expensing options, as required by FAS 123R. Our total equity compensation expense was just over $300,000 for the quarter, and of that, just over $200,000 was attributable to options expense, or the new requirements.

That’s in on financial, so I’ll introduce Tom Tanner, our COO. Tom?

Thanks, Bill. Good morning, everyone. Let me start by thanking and recognizing all of our team members for their efforts and commitment over the last several quarters. Those efforts resulted in our achieving the best first quarter we have had in several years. As a whole, we were certainly very pleased with our financial performance. These results were even more impressive when compared to our performance for the first quarter of 2005.

These financial achievements continue to illustrate the positive effects we are recognizing from our continuing focus on project selection and execution, improvement in our service division, and increasing our team member education. During the first quarter, our team members participated in educational programs that were respectively focused on leadership, project management, superintendent development, and preventive maintenance sales. We will continue to offer these educational programs for the balance of the year. In addition, we will continue our initiative of providing productivity improvement training at select operations.

Looking forward, the sequential increase in our record backlog was spread over a broad base of our operations. In addition, our pipeline opportunities remain strong. One of the reasons for our record backlog and our strong pipeline is that our individual operations and Comfort Systems as a whole are recognized as industry leaders in our respective markets.

This recognition stems from the quality of our team members, which has resulted in our proven record of performance, our enviable safety results, our available binding capacity, and our very solid financial foundation. Thus, we are often the mechanical contractor of choice for many new project opportunities.

In our service divisions, we have intensified our efforts to achieve both revenue and operating income growth by changing our operational structure to have a vice president of service operations for each of our regions. These individuals will work directly with their respective senior regional vice president, where they will primarily focus on growing our preventative maintenance service base and implementing processes and procedures that will improve our operational efficiencies.

One of the reasons for our much-improved results this quarter versus a year ago is that there was a marked improvement in certain previously under-performing companies. We have begun to see improved results from the collective actions, begun in 2005, of changing certain management, improving the quality of manpower resources, and right-sizing certain operations to better align their expertise and manpower resources with their marketplace. Although there is still work to do, we believe we will continue to see improvement in this area in subsequent quarters.

As Bill George mentioned, we did experience seasonally expected negative cash flow for the quarter as we invested in working capital to finance our revenue growth. If you look back at the cash flow our operations have generated in the last two years, it is evident that we have developed a very strong culture that truly understands the importance of cash flow. We believe this culture is the foundation that will cause our operations to generate positive cash flow for the remaining quarters of 2006.

At our recently completed national meeting, the mood of our company presidents and their team management was upbeat and optimistic concerning 2006. We continue to see examples of sharing best practices, manpower resources and project opportunities among our operating locations. Our presidents are clearly focused on achieving the necessary objectives that will contribute to improved operating results in 2006 as compared to 2005.

I will now turn it back to Bill for his wrap-up and then questions. Thank you.

Thank you, Tom. At this point, I’d like to turn to questions. Dalynn, you are on that.

Thank you. [Operator instructions] Our first question comes from [Rich Lazowski]. Your line is open.

Thanks. Good morning.

Morning.

Hi, Rich.

Bill Murdy, you stressed, both, I think, in the commentary and definitely in the Q, that you guys are focused on margin expansion rather than revenue growth, and yet when you look at the contribution for the recent quarter’s earnings growth, I think it’s been roughly equal, and the market seems to be taking you in the direction of sales growth with greater contract sizes and a lot more work from new construction projects. Should we expect this to continue in the future? I mean, are you going to be able to really boost margins that quickly in that environment?

Well, there was certainly a growth expansion in Q1 versus the prior Q, versus Q4 of ’05, as a matter of fact, as there was, at least at the net line, an increase in operating income versus Q1 of ’05. We continue to work on productivity in all kinds of ways. Tom alluded to a lot of that. Our big emphasis on education is, in fact, a way to get at productivity. We are training continuously at all levels that focus on the maintenance, sales. Training is an effort not only to increase productivity there, but also to emphasize the service side of our business, which, as we’ve indicated many times before, is a higher margin opportunity. So I think we continue to make progress in that area, Rich.

You are right in that there is a robust – maybe I shouldn’t use that word. There is an increase in the number of large projects out there that almost naturally have lower growth and net margins than smaller projects in the service business. We are judiciously choosing them. We don’t want to strain our capacity or just take projects for revenue purposes, so there’s a dynamic that works there, that you pointed out. I think we’re making good progress on the structure we’ve got.

Okay. Would you expect the margin progression in the sequential quarters that we saw in 2005 for that direction to play out in 2006 as well?

I think so, and we’re on record as having said that we think our operating margins can and should be higher with this mix of business that we have. And I think we’re moving well in that direction. The first quarter is an example of it, and the last three quarters of last year were all directionally in the right direction.

Okay. Finally, the numbers that I look at from the industry commentators and the census all suggest the market environment is improving. Judging from what you see from your customers, are you comfortable saying that ’07 is going to be a good year?

Yes, that’s what we see. I mean, our backlog build, what’s in the pipeline, indications – Tom and I visit lots of places in the country all the time, and it’s almost palpable in some areas of the country there’s future growth. So I think ’07 looks like a continuation of what we’re seeing in ’06.

Okay. Thanks a lot.

Okay. Thanks, Rich.

Our next question comes from David Yuschak. Your line is open.

Congratulations, gentlemen, on a great quarter. Without you guys giving kind of guidance here, I just wanted to kind of go back to this gross margin in the first quarter. When you take a look at gross margin, the revenue you produced in the quarter [inaudible] to the fourth quarter. Help me reconcile a 15.49% gross margin that you did then with, I think it was, almost 17% in the fourth quarter on the same revenue. Are there some extra expenses in there for ramping up for resources, or can you give me a sense how much maybe the divestiture that you did may have lowered the gross margin? I’d like to get some sense as to what may have impacted that number relative to what you did in the way of revenue in the fourth quarter.

Well, I think it’s more – the main story is what, if you’re looking at a comparison, it’s what happened in the first quarter, and what happened in the first quarter was really a very good level of activity, which – and frankly, the pricing progression. Over time, our margins – they come from productivity, but they also come from the prices that we’re able to charge. Pricing – it won’t surprise anybody to know that as work has become more available, the ability to charge better pricing has helped. I guess those are the things I’d look at as opposed to – yes, you may [inaudible] dollar amount is down as a percentage of revenues, but –

But I’m just kind of – the 15.5% gross margin has been relatively low compared to what you’ve done. I mean, last year’s first quarter was extraordinarily low because of issues with weather and project delays, so I don’t know if this 14.3% is a fair – but I’m just wondering if there were some issues with gross margin in the quarter from some other project-related costs.

It still is the first quarter, Dave.

Well, one of the things I could add, Bill, is that in the fourth quarter and later on in each year, we have more project close-outs, where oftentimes we improve our margins at the end of the job, so you don’t have that in the first quarter of the year. Also, our service operations suffered somewhat from a very mild winter across the country. We all know that that is more profitable business, so as that business increases as we move into the warmer months of the year, that will also contribute to margin improvement as we move forward.

Okay. So some of that may be just a mix as well as where you are in the project life.

Correct.

Because the comment you made earlier is a lot of the issues – because you had commented in the past that some of the areas were under-performing as you cleaned those out and made them better. In this quarter, it sounds like, for the most part, there wasn’t any issues with any of your operations where there was an exception that needed to be noted and needed to be corrected, so to speak. That doesn’t sound like that happened in the quarter.

That’s correct.

Okay. So operationally, you had to – so at this point in time, you’re at the best you’ve ever been in some time as far as under-performers versus overachievers.

Yes. That is not to say, Dave, that we don’t have things that we’re working on improving. There are a few operations that continue to disappoint in terms of performance that we’re working on, and there is room for improvement there.

Yes, but I think it’s a situation where a good thing is getting better instead of being a drag, so to speak.

There are fewer companies that have done poorly, and the ones that have are – the numbers are much, much smaller. That’s certainly true.

Okay. Now, just give us a sense on the backlog to where are you getting your best results as far as additions, what kind of projects, where this project’s been versus where maybe you’ve not done as well as maybe expected, because the environment itself is healthy and strong. I’m just wondering if there are some areas that have done less than expected, possibly, as well. I always like to hear the good and the bad.

Tom, you want to address that first?

Yes. In all honesty, when we look across all of our operating locations, we see very good backlogs. In 2005, we always commented that there were weaker opportunities in the upper Midwest than there were in other parts of the country, and that really has not been the case. We have three very, very good companies in the upper Midwest who all have very strong backlogs and are doing very well. San Diego is doing very well backlog-wise, Phoenix, our Houston-based companies, Orlando, Atlanta, Birmingham, Washington D.C. market is very strong, and our companies in the Northeast all have very, very good backlog, so this backlog concentration is really probably spread out more so than it’s been in a very long time for us, so we’re optimistic from that standpoint.

I’d add this, Dave, as you may be alluding to our multi-family sector, and that is a good portion of our backlog, a good portion of our current revenue, and we’ve made very substantial improvements in the execution side of that over the last year and months, and I think that offers a very substantial positive upside.

Okay. As far as you’ve had good backlog here for several quarters now, is it possible that resources are going to become strained enough that that backlog could potentially slow in a positive environment because of the resources issues despite all the work that’s out there?

I think that’s possible. We, today, I think, certainly on a comp basis, a number of company locations have more employees today than we’ve ever had. We have 6,200 people at work today. So we can add a certain amount, but you do run into supervisory and technical person shortages that you want to be careful about, but it is possible. But we haven’t seen it yet. We don’t usually face that as an either/or. We try to make it an and. But we are sensitive to that, and that’s why we’re being selective on projects.

Are you getting any sense, too, that projects want to get done sooner because of the potential concerns for resources?

I don’t sense that. I think in the multi-family high-rise condominium business, there’s always pressure to move those projects forward because it’s a time-to-market situation, but I don’t sense that there is a push to do that because they think we’re going to run out of resources through the project. Tom, I don’t know if you can comment on that.

No, we don’t see that. If anything, we’ve seen some projects slow because of governmental restrictions, permitting problems, et cetera, so in certain instances we would like to see completion dates compacted, but we really have not seen that across the country at all.

And then one last question. As far as construction activity, it was pretty strong in the first quarter, pretty much across the country because of better weather conditions, too, as you mentioned earlier. Just the amount of weather on the service side could hurt you a little bit in a quarter. Are you seeing that kind of construction activity being maintained here, as we’re getting through the early parts of this second quarter, to suggest that backlog could continue to grow for the rest of the year at pretty robust levels? Is there enough interest, pipeline and all that and coming from areas that have maybe been under-spending in construction or beginning to ramp up spending and so forth? Because when you take a look at even the Gulf Coast right now, all the construction and resources needed there, construction spending could be very robust for quite some time.

I think so. Industrial capacity utilization is moving up, and whenever that happens, people expand facilities, build new facilities, obviously. I would say that that is true. All the prognosticators who get paid to do this [inaudible], so we don’t argue with that, and we see the evidence of it in our backlog and our pipeline.

Okay. Thanks a lot. Thanks.

Thanks, Dave.

Our next question comes from [John Orelsani]. Your line is open.

Hi, thanks. Just a quick question. Looking at sort of the correlation between the build- and backlog over the last two and a half years and revenue, if I’ve got my numbers right, your backlog has been growing at almost a 15% compound rate, and yet your revenue’s closer to 5.5%. Is there any reason why those are getting kind of out of sync here, or are you going to expect to see revenues start to grow at a little faster rate?

No. Actually, it’s very predictable that that happened through this type of cycle for us. Backlog will generally build faster because average project size goes up as new construction increases in proportion to the overall construction market. And obviously, average project size means that the same revenues stay in backlog for longer. People do start to commit earlier, so that you might be – we don’t put anything into our backlog until we have something firm, something signed, or some sort of at least letter or intent or some sort of commitment from a customer, and people will commit sooner, so backlog is a very good directional indicator. It’s very dangerous to start trying to correlate backlog growth and expect revenue growth.

In addition, only about half of – historically, only about half of our revenues come through backlog. We have lots of quick turn work, we have a sizable book of service, and obviously the amount of – the proportion of our revenues that turns through backlog will go up during an increase in the construction market. So for all of those reasons, I think you should view backlog as a directional indicator, but it’s very hard to mathematically correlate indicator of actual revenue for us.

But as a directional indicator, I mean, you would still think if your backlog is up in aggregate 47% over the last two or three years and your revenues are – I won’t say they haven’t budged, but I think they’re up 15% during that time period – shouldn’t that start to tug up on your revenue rates?

Well, that’s a matter of judgment. If our average project size doubled, we could have twice as much backlog and have revenues flat, so it really depends. There are mixed issues that matter there. That being said, we had our largest revenue growth in forever in the first quarter, so I think, obviously, as you see backlogs become really robust, it’s a directional indicator. I’m just warning away from trying to correlate. We have a history of people trying to do that, and it’s not like a manufacturing backlog or something like that.

In fact, interestingly, sometimes your backlog will grow in a downturn because project starts will delay. So I just say all of that to emphasize the vagaries of backlog. It’s a good indicator, it’s something that needs to be looked at, but it should be looked at as a helpful directional measure.

Well, the other issue is we have booked larger projects. They typically have longer construction schedules, so when we’re in a period where jobs were basically completed in a 12-month period, and several jobs that we currently have now are going to be completed over an 18-mont period, again, the backlog is not necessarily an indicator of what our revenue is going to look like going forward.

But it should be an indicator of, say, quality of future – if it’s 12 to 18 months, it should give one a little bit more comfort going forward, I would think.

Absolutely.

It’s a good directional indicator. It’s a good indicator that there might be decent pricing opportunities. Obviously, a company with backlog has the freedom to scrutinize new work that it gets more. It’s not that anything you’re saying is invalid. It’s just that we have enough history here that we are always leery of people trying to correlate.

But you’re right. Directionally, this works. I mean, last year we grew from $800 to $900 million revenues and backlog grew at twice that rate, yes, but in the first quarter, we grew 22% in revenue, so the backlog was – that increase in the backlog is hitting. But it is very, very difficult to get a mathematical model that works here because you have different lengths of projects and different times of committing and delays. And then a very important fact that Bill mentioned is that just an awful lot of our work doesn’t even go through that announced backlog because it opens and closes in a quarter or it is service, and service is not part of our backlog.

Okay. Well, thank you.

Sure.

[Operator instructions] I don’t show any questions at this time.

Okay. Dalynn, thank you very much, and thank all of you for joining us on the call this morning. We are happy with the first quarter results, as we’ve tried to indicate here. We’ve noted over the quarters that the better the results, the fewer the questions, and that I hope we can continue. So thank you very much for joining us, and we’ll see you in another quarter.

This concludes today’s conference call. The participants online may disconnect at this time.