Comfort Systems USA Inc (FIX) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first-quarter 2010 Comfort Systems USA earnings conference call. My name is Derek and I will be your operator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to Mr. Bill George, Chief Financial Officer. Please proceed, sir.

Good morning. Thanks, Derek. Good morning to everyone. Welcome to Comfort Systems USA's first-quarter 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 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 listing and commentary concerning our specific risk factors in our Form 10-Q, as well as in our press releases covering these earnings.

On our call with me this morning are Bill Murdy, Comfort Systems USA CEO, and Brian Lane, our President and Chief Operating Officer. Bill Murdy will open our remarks.

Thank you, Bill. Happy Cinco de Mayo, everyone.

The first quarter is always a low quarter for us. And Q1 of this year was also seeing the effect of very, very much reduced overall nonresidential activity in the construction sector. And some impact of the severe weather that we had in the mid-Atlantic area, as you recall, this past winter. We don't really have any out of the ordinary execution busts, maybe quick to note here.

Revenues were down from $280 million in Q1 2009 to $236 million, and that $236 million includes $9 million or $10 million revenue from our new acquisitions. So, on a same-store basis, revenue was actually down 19%.

From what we are able to discern from published statistics and conversations, that is not as great as the overall downturn in nonresidential construction activity.

Gross margin at 16.7% for Q1 here was very substantially less than the gross margin in the quarter of last year by about 300 basis points. And even with SG&A cuts of almost $6 million in the quarter, which is about 12.5% of SG&A, the net income from our continuing operations was only $1.6 million, or about $0.03 a share, versus $6.9 million, or $0.19 a share, in the quarter of last year.

Our backlog was down to $525 million from about $550 million at year-end, but over $700 million at year-end 2008. We are seeing a fairly good quote and potential job pipeline and we think backlog will not deteriorate further here. But triggers continue to be very slow to pull, and in many instances, candidly, we are losing work to low bidding, mostly private contractors. We believe that will end with more available work and as small private contractors prove unable to handle jobs of any size or sophistication.

Our -- we believe our inherently -- our inherent strength and our strong balance sheet and our focus on service, which now, by the way, is greater than half of our revenue, and energy efficiency will bring us through this very tough time. In fact, we are already seeing an increase in some of our business as user funding for maintenance, repair, and retrofit seems to be loosening up. I'm sure Brian will have a few more things to say on that.

But before going to Brian, I'd like to turn the mic back over to Bill George for some financial comments.

Thanks, Bill. As Bill said, the first quarter is traditionally our seasonally-weakest quarter. And during the quarter, we were broadly impacted by the ongoing weakness in nonresidential building markets.

Gross profit and operating income margins declined to 16.7% on the gross margin line for the first quarter of 2010, and that compares to 19.7% in the same quarter last year. The decrease in gross margins was generally broad-based, reflecting weaker pricing overall.

Our operating income margin for the quarter dropped as well, and was 0.9% compared to 4.3% for the first quarter of 2009.

Backlog suffered a modest decline of 4.6%, a decrease of about $26 million. Backlog is currently $525 million, and although down, we continue to feel that when viewed in light of historical trends, our backlog level is good and supports our expectation that we will maintain profitability and preserve the core of our business in 2010.

Our SG&A was lower by a very substantial $5.8 million for the first quarter of 2010, as compared to the first quarter of 2009. However, because revenues dropped faster than SG&A expense, SG&A as a percentage of our revenues increased slightly during the quarter.

We have continued to make investments in our business and we continue to benefit from the aggressive cost-control attitude that we adopted in late 2008 and throughout last year. We continue to focus on cost control and we believe our cost structure is fundamentally well positioned for 2010.

As has been typical for us in the past, during the first quarter cash flow was in negative territory at minus $12.6 million. Despite overall headwinds in 2010, we expect to continue to earn money and we expect to translate those earnings into positive cash flow in 2010.

Our stock repurchase program continued in the first quarter, and we purchased an additional 188,000 shares. Since we began buying shares a few years ago, we've now purchased 4.6 million shares, returned over $50 million to our stockholders, and reclaimed more than 11% of our outstanding share base.

Our balance sheet remains rock-solid, with cash balances of approximately $110 million. Collection statistics remain solid as well, and over 90s decreased in the quarter. We have strong cash balances and nominal debt, and very favorable credit and financial covenant terms. We plan to continue to prudently deploy our balance sheet into our operations and we will continue to make good acquisitions as opportunities arise.

In 2010, we expect great opportunities to invest in existing operations and to add new operations, and we truly believe that these investments will benefit us in years to come.

That's what I have on financial, so I'll now introduce Brian Lane, our President and Chief Operating Officer.

Thanks, Bill. Good morning, everyone. First of all, we would like to recognize and thank each of our talented and dedicated team members for their efforts in this challenging market.

We are reporting net income from continuing operations of $1.2 million, or $0.03 per diluted share, compared to $7.1 million, or $0.18 per diluted share, for the first quarter of 2009.

As expected, we earned less this quarter as nonresidential market conditions remain challenging. We are also returning to a more seasonal construction cycle with lower activity during the first and fourth quarters.

The Company's service operations remain steady and have helped maintain our profitability. During this quarter, planned maintenance and repair service made up 17% of our revenues, compared to 13% for the first quarter of 2009. We continue to invest in service sales efforts, upgrade the quality of the sales force, and improve our operational processes.

We are seeing good results from our investment in energy services. Activity and bookings increased in the industrial sector, with a significant number of opportunities generated from our existing customer base.

The focus on safety continues to be a key Comfort strength, and our OSHA recordable rate remains 44% below the industry average. This outstanding result is thanks to a continuing focus by our operations.

The Company's backlog, while still at solid levels by historical standards, has been declining. Backlog at the end of Q1 was down 5% sequentially, mainly from the New Hampshire and northern Virginia operations. On an encouraging note, we are starting to see some improvements in backlog at our central Florida, Alabama, Michigan, and Phoenix operations.

We continue to focus on the more active sectors in the market -- government, healthcare, and education. During this quarter, we have stepped up efforts in the federal markets. The Baltimore operation has historically performed well with work for the federal government. We have now established this location as the Company's federal services division in a more centralized effort to target this market. We believe we can leverage existing relationships to pull through additional work.

Continuing the trend from 2009, over the last three quarters more than half of our revenues were from the institutional sectors and currently about 68% of our backlog. The pipeline remains very active. We have had a number of bookings aggregating to approximately $52 million of small- to mid-sized projects in April, especially in the Northeast and Southeast.

Overall, we continue to see pricing pressure as local and regional competitors respond to challenging conditions. But we remain committed to maintaining good margins.

We expect that weakness in the nonresidential market will affect activity levels for the remainder of the year. We have been actively addressing these challenges to minimize the negative effects of a continued downturn.

We continue our focus on project selection, estimating, project pricing, project execution, and maintaining a disciplined cost structure.

Currently, SG&A costs are down $5.8 million, or 13%, on a year-on-year basis. The headcount is down 3% sequentially and 12% year on year. We continue to monitor costs to ensure that we have the appropriate level of SG&A costs in light of our revenue projections.

We are positioning ourselves to improve our competitiveness in our various markets. Despite challenges, we are making additional strategic investments in service and training, and we are actively pursuing high-quality operations in geographies we are not currently represented. The Company's strong financial position and bonding capacity remain a competitive advantage, and we are prepared for strong performance when the markets improve.

At our recently completed national meeting, the mood of the Company's operators was cautiously optimistic going into 2011. We continue to see positive results of sharing best practices, manpower resources, and project opportunities. I am confident that we will continue to acquire more than our fair share of upcoming work.

Again, I'd like to thank all of our 5,400 team members for their efforts. I will now turn it back over to Bill. Thank you.

Thanks, Brian. Just in summary, and I think all I can do is summarizing what Bill and Brian said and what I said initially, that we have a decline in our backlog, and most of it -- in fact, all of it on the commercial/industrial side. We believe, though, we'll continue to earn more than our share of available business out there -- more than our fair share.

We, as Bill said, expect to remain solidly profitable, expect to be cash flow positive. But industry conditions are something we can't escape from. And over the next few quarters, our profitability will not be what it was last year.

In the meanwhile, we are optimistic about being able to negotiate a challenging market. We have a very strong capital position, as you know. And we can support our current operations well and indeed, also, can take advantage of potential expansion through acquisition, which we -- and we're continuing to work on a number of situations here.

Overall, we're in a good business generally. For the longer term, we're optimistic. And we believe that the underlying strength that we have and have demonstrated in the past will lead to renewed momentum later this year and, of course, into 2011.

Derek, I think at this point we ought to open the mic to questions and answers here. Certainly questions. I think we have some answers.

(Operator Instructions). Matt Duncan, Stephens Inc..

The first question I've got is with regard to backlog. Bill, if I heard you correctly, I think you said you thought your backlog has probably bottomed at this point. What gives you the confidence that that would be the case, given that the market conditions are still fairly tough for you guys?

Well, we've been at the current level for a while. That's one reason.

And we have -- we have more than a backlog to fence things out there. We are in touch very closely with our individual operations, and they do have pipelines. They have prospects. I think Brian could probably expand on this.

We will admit that those prospects are not as large on average size as they have been in the past. In fact, our average project size for Q1, I think, is down almost $100,000 on average. So it's going into the $300,000 -- I think it's $340,000, $350,000 for the first quarter.

But there's a lot of smaller work out there being talked about, and I think we are seeing some loosening of the reins on spending by corporations and other commercial entities toward substantial retrofits and even some new building. So, Brian, do you want to add to that?

Matt, the only thing I'd add is on the federal government side. We've been at it for a number of years here, and I think we're seeing a lot more opportunities come our way recently and get let as well.

Okay, that's helpful. I'd like to move on to the gross margin for a minute. Obviously, I am sure it was disappointing to you guys this quarter. Is this gross margin level indicative of the applied gross margin in your backlog? And then, maybe, if you could quantify for us the impact that weather may have had on your gross margin this quarter?

Matt, the gross margin in our backlog is -- this is indicative, I think, of what you would see in the next quarter or two. We will get a natural improvement based on seasonality. I think where you'll see the tough comparisons will be the year-over-year comparisons, and as far as -- I don't have much more than that.

I think that we expect to see work start to loosen up, and obviously that will improve pricing. The reason you won't see big jumps off of this for a while is because, obviously, it takes a while for things to start and for revenues to actually begin to get into what we are reporting.

And then, from an operating margin perspective, in the past I think you guys have said you thought the trough operating margin on an annual basis for your business would be sort of 3% to 4%. Obviously, the first quarter is seasonally weak, so the 0.9% that you had there is hard to draw too much from that. But do you think that given the level of activity you see out there, a 3% to 4% operating margin in 2010 is something you can achieve, or is that going to be difficult given where gross margins are?

We still think we can achieve it. That obviously means some very, very good performance in the subsequent quarters here. But we haven't lost sight of the fact that that's possible.

It will be a challenge. And -- but we are very well positioned, and a few of the right jobs in a couple places can really make a difference here. We're sort of on a -- we've got a lot of operating leverage, if you will.

Absolutely. And then the last thing I've got, and I'll jump back in queue, is just the acquisition landscape. That's obviously a key part of the Comfort Systems story. You guys have a very nice, clean balance sheet. I know you would like to continue to make accretive acquisitions. Can you give us an update on what you're seeing out there right now, Bill?

There are two Bills here and both of us will comment, I think. But the -- we're seeing a lot things. There are a lot of opportunities, some things that we didn't think we would see are potential opportunities. Nothing -- we're very prudent about things. We haven't tracked it precisely, but we seem to work on things from nine months to a year. We really get to know these operations. We want them to fit with us, so we don't pop out and do things that quickly.

But there's some things that are coming to conclusion here, and we're seeing good opportunities in geographies where we aren't currently represented.

Rich Wesolowski, Sidoti & Company.

Can you discuss the execution of your contracts, whether it has maintained your standard as it has in recent quarters or whether there are any subsidiaries that you're discovering problems with their ongoing backlog?

Rich, it's Brian. The margins you're seeing are not execution related, market related, related to the recession we're in, but we have no outstanding execution issues that are concerning us right now.

So the margin in Q1 didn't get much help from closeouts, nor did it get any real charges from write-offs?

Correct. Yes, that's correct.

Okay. And then historically, you mentioned the seasonality. I think it was Bill George. Comfort's March quarter gross margin has been the lowest of the year. I know you don't expect a big ramp, but would you expect 2010 to be typical in that regard?

As far as the shape of the year, I think it will be typical. We will see, obviously, higher activity levels as we get into the warmer months. Weather will have some impact on that. We could benefit a lot if there were hot weather, especially in the Northeast where there wasn't much hot weather last year.

There's been a lot of deferred maintenance. So there are reasons to be optimistic for this middle quarters of the year, optimistic that they will be, especially on a comparative basis, good quarters.

Okay. How much did the acquisitions add to the revenue in the March quarter?

Just under $10 million revenue.

$10 million in revenue. And are the margins much different from what you had reported for the Company?

No, they were pretty representative.

The other important thing to know is because two of the -- the two largest of the three acquisitions that we did at year end last year closed on December 31, their backlog was already in backlog numbers. There was a de minimus, I think less than $1 million, that came in from this small deal that closed in January, so there's a revenue effect on the quarter but not a backlog affect on the quarter from acquisitions.

Because that already happened in December.

Exactly. It got reported when we -- because they had already been closed -- their balance sheet.

John Rogers, D.A. Davidson & Co., Inc..

Bill Murdy, you and Brian talked about the turn in the market here that hopefully we are starting to see. And maybe you could just talk a little bit further about -- if this is a recovery that we're starting into, do we see it first in a lot of small and upgrade projects, and then later in the large projects, because -- you said that it'd be the large projects that could really give you the margin lift, or maybe I misunderstood that. Are we still a way aways from that?

Well, you understood the margin lift incorrectly. I do think, and we are seeing it, it starts with small projects.

John, I don't need to tell you this, in an economy like this, it takes some courage to step out and build something new or tear something down and rebuild it, and everybody sees new vitality and things moving, but it's not at a great pace and it's not broadly based yet.

I think we're seeing the retail come back some, etc., but you add the uncertainty of committing to a big operation, the financing, the permitting, and the fact that in many parts of the country, we have been overbuilt in certain product -- building arenas -- lodging, malls, retail. Big box. You add all that together, and that says to us it's going -- it's there, but it's slow coming back.

The financing thing seems to have broken open here in the last weeks. It's quite something, but that doesn't mean that people are committed. It just means it's available, it looks like. Brian, do you have anything to say to that?

This is Brian. We are seeing right now an uptick on the small project work. It's a combination of people freeing up funds, plus a lot of work wasn't done last year, and we've had a little bit of hot weather in certain parts of the country that has helped trigger some of this.

Additionally, we've made a significant investment on the seal side of our business for a number of years, and I think that's starting to pay off, as those projects are sold and the efforts and work that the people are doing are starting to pay off right now.

And Brian, those are retrofit-type projects?

Retrofit replacements, yes, John.

And you mentioned that some of the more active sectors were government, healthcare, education, public dollars at work, I guess. But, one, I guess, how long does that last and, two, are we still waiting for the private sector or are those just the strongest markets? And how big a portion of your business is that publicly-financed portion?

It's more than 50% of our work today. If you talk about health care, schools, hospital -- hospitals, healthcare, schools, and government of all kinds. It's more than 50%, which is a real change for us over the last couple of years. It used to be a quarter of our business.

It is endemically a little bit lower margin, too, by the way. Certainly now. We don't -- John, the candid answer to your question, we don't know. It's subject to school bond issues in Madison, Wisconsin, to whether the federal government continues the military programs related to quality of life for soldiers, sailors, and airmen, and transformation of the Army. I think they do. Their budgets and appropriations are all there.

Do schools -- like I said, it's a bond thing. Healthcare, we've got a lot of new people that are going to be getting healthcare here. Maybe the facilities side of that is going to increase. It's just very, very hard to track. The outside economists and prognosticators think that it does continue. We have no evidence to show that it doesn't.

Just last thing, if I could. Is there much of an opportunity in the coming months from just normal weather because it seems like it's been a little cooler over the last couple of years in the peak summer months? But I don't know so much about your specific regions.

I think the Northeast would have a lot of promise for us for this summer if we were to get normal weather. They have not had normal weather in a couple of years, and if you combine that with deferred maintenance, that projects -- and some loosening of willingness to spend, that projects well.

Weather is always a factor on the service side, and service is a bigger part of our business as a percentage. Interestingly enough, this is a factor all the time. It just becomes a bigger factor as a proportion of the whole pie at a time like this because the other side is down.

Okay, thanks, Bill, and thank you all.

Clint Fendley, Davenport & Company.

Good morning, gentlemen. Probably a question for Brian here. I wondered if you could help us understand the impact from the mid-Atlantic. I believe it's a Delaware project, based on your filing. Was this all weather related or were there any pricing or execution issues with that work?

Yes, Clint, a combination of a couple of things. One of them was pricing.

But to say that, we won that bid in a very, very tight margin. We didn't leave a lot of money on the table. We did have some execution [issues] on the site management side that we repaired, and compounded that with some very heavy weather that they went through that neck of the woods in February, so a combination of all three things impacted it. But the changes have been made and the projects are running okay now.

Snow has melted.

Snow has melted.

And Clint, mathematically, just so you know, mathematically although there was a lost there, it was a normal loss. It was a loss in most quarters would have never been mentioned. It's just that when you do an MD&A, the rules require you to say, okay, name the biggest couple of factors. This is an ordinary situation. It's not an extraordinary situation.

That's very helpful, and last question. I wondered on the $52 million in the backlog. You mentioned some of the smaller projects in the Northeast. I wondered if you could help us just to understand what gives you the confidence that you won't have any undue pricing pressure on this work from some of the smaller contractors that have kind of given you some challenges here in this quarter, in particular.

Are you talking about existing backlog?

The pipeline, more.

I think that that continues. It's a competitive world out there, and the private contractors have flexibility on the downside that we may not want to have.

We are pretty disciplined in trying not to take projects where we know we're going to lose. So, yes, that continues, and the only cure for it is more work and the fact that some of these smaller private folks have taken on things that they don't have the capability to really execute at all and certainly not -- it's a question whether they can do it well, so we may find ourselves doing some of that in the end.

Clint, one more thing. Our local operating companies are extremely good at executing this work. We've become a lot more efficient over the last few years, and all that's really come into play now, but the folks we have doing the work are very good.

[Mark Aiden], KeyBanc Capital Markets.

I just had one quick question. I noticed in your filings as well that the education sector had saw some reduced activity during the quarter, which, compared to some of your peers which have commented that education has been maybe a more stable sector, I was just wondering is the difference being the areas of education in which you serve as compared to your peers?

I think that was just a quarterly blip. I think you have different work starting and finishing at times. I don't think there's any sense in our Company that education won't continue to be a good and strong part of the business for us.

One of the problems when you -- in a first quarter is we only give you year-to-date numbers, and so, by the nature of it being a low-revenue quarter and it being just covering three months, you get some aberrations from time to time, just based on sample size.

And also, a lot of the education work we do, we tend to do it over the summer time when school is out.

Just another quick question, along the same lines as the question about Delaware, was the issues with central Florida where there was reduced profitability. Are those for the same reasons as what happened in Delaware?

Actually, that's a completely different situation. Our central Florida operation is well above average this quarter. It's just that they had such an extraordinary first quarter last year that when you do a rate/volume analysis there, you're really compelled under the MD&A rules to point out that's where the comparable difference is.

You may recall, one of the things that we've been saying is that the results you're seeing are generally the -- they are broad-based and they are the result of sort of a gradual decline over the last several quarters, but there have been quarters where big pick-ups in various organizations have been instrumental in helping us report, nevertheless, really remarkably good numbers in certain quarters over the last few quarters, and so sometimes that's also going to create comparable issues.

Adam Thalhimer, BB&T Capital Markets.

Thanks. Good morning, guys. How does the -- Brian, did I hear you correctly, there were $52 million worth of awards in April?

Yes.

How does that compare to recent months and maybe year ago?

It's about the same we've had in recent months and it would be a little down from probably a year ago, but has stabilized, which was the good news for us.

You guys didn't say much about 2011. I mean, if it's possible to even look out that far yet, do you think -- would your best guess be that 2011 kind of looks like 2010 or do you think that could be more of a recovery year for you?

Our best guess is that it's a recovery year, definitely a recovery year.

Remember, standing at the end of 2008, where it was clear things were going to go down, everybody was talking about 2010 being the recovery year. That may add credibility to the fact that 2011 may really be the year when the nonresidential economy recovers.

Then I just -- Bill, you made a comment about the public-sector work. You said margins aren't quite as good as it is for private, and I think you made the quip that particularly that's true in this environment. What is -- can you quantify that at all? What kind of margin degradation have you seen in public work just because that's where everybody's going?

I don't have the precise numbers on margin degradation, but because of competition, to include bid competition where all of those jobs generally go out to bid and are subjected to things, and -- people are looking for work. So they're ready to be competitive, and in the federal government work, relationships just go so far. So, I think just generally, it's slightly lower, and not much lower, work -- margin, on average.

Rich Wesolowski.

Thank you. If you look at the composition of your income statement coming out of the last recession, your gross margin stayed at the trough for three years after revenue had begun to rebound from the bottom. Is it reasonable to expect a pattern of revenue growth first, then only later margin expansion whenever the recovery ultimately arrives?

I think there were a lot of interesting things going on. I think what you'll see is you'll see a much quicker -- including some trouble we were having with multifamily operations and some other issues, I think what you'll see is a much quicker rebound in revenues and a gradual increase in gross margin.

And I want to emphasize something I sort of brought in a few minutes ago. The decrease in gross margin has been gradual as well. It's just been masked by pick-ups from time to time. Well, an increase is less likely to be masked by pick-ups. It's more likely to show up as a gradual increase because you don't take pick-ups on a job. You load it at what you consider to be the right margin and you don't even consider whether it's doing better until you get very far along in the job, such is the nature of how a well-run business works in our industry.

So, I think -- I don't believe -- I believe once we begin to recover, you will see steady -- although affected by seasonality, but you will see steady improvement in gross margins.

Bill, why would you suspect the revenue growth would be a lot greater this time around? Is it just because the recession is deeper?

I don't mean greater. I mean -- I just mean it will come more quickly than the margin improvement.

It may come --

I don't know (multiple speakers)

I was just thinking about this whole business that's affected by the Atlas work. We had very substantial problems, as you recall, Rich, with that, and we purposefully truncated the work that they did and the multifamily work that we went after. So, we were putting on the brakes a little bit in that sector as things were returning. So, without that problem, maybe -- not maybe, but what Bill talks about is logical.

At this time, I am showing no further comments -- no further questions in queue. I would like to turn the call back over to Mr. Bill Murdy for any closing remarks.

I think I summed up before. We are fairly optimistic going forward here, prudently optimistic, especially based on our balance sheet strength and our ability to prudently bring in some new operations and the sense we have that things are returning, albeit not quickly returning. Right now.

But, we thank all of you for being on the call. We'll have more pleasant things to report next quarter. And Happy Cinco de Mayo. We're all going to go get a margarita. Thank you very much.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a good day.