Comfort Systems USA Inc (FIX) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2011 Comfort Systems USA Inc. earnings conference call. My name is Steve, and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of today's call. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Bill George, Chief Financial Officer.

Thanks, Steve. Good morning, everyone. Welcome to Comfort Systems USA's first-quarter earnings call.

Our comments this morning as well as our press releases contain forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. What we will say today is based on the current plans and expectations of Comfort Systems USA. Those plans and expectations involve risks and uncertainties that could cause actual future activities and results of our operations to be materially different from those set forth in our comments.

You can read a more detailed listing and commentary concerning our specific risk factors in our Form 10-Q and our most recent Form 10-K, as well as in our press release 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. I've got some opening remarks, and I will turn this over to Bill and Brian and then wrap up at the end and we will go to a question-and-answer session.

Needless to say, this has been a difficult quarter. Q1 is always our weakest quarter. Construction activity is truncated in many geographies. The winter maintenance and repair on heating equipment has already taken place in previous quarters and work on cooling equipment awaits the spring.

Q1 of 2011 has been especially challenging with the general and continued weakness in the construction sector. Market recovery seems still delayed.

Exacerbating these seasonal considerations, we've managed to misperform on a handful of jobs, especially in Alabama and Virginia. Brian will have considerable more to say on that in a minute.

Of course, in an environment like this, we don't have high-margin projects to offset these miscues. In fact, we've completed most of the projects booked in the robust days of 2006, 2007, 2008, and are now processing projects booked in the reduced-activity and margin-compressed periods of the last two years.

Are we at the bottom? We believe so, and there are indeed some signs of recovery. But they are not, as you can imagine, entirely positive.

Our backlog, though, is actually up very slightly. And most of our operations have adjusted well to reduced activity. Overall, our recent aggressive action to deal with problem jobs exhibits our management's strength and resolve.

We have a strong balance sheet. We have a positive attitude. We are increasing the service component of our business daily. And we are oriented on productivity here, and thus, are well-positioned for the recovery when and if it arrives.

At this point, let me turn this back over to Bill George, our CFO, for some financial comments. Bill.

Thanks, Bill. As Bill noted, the first quarter is traditionally our seasonally weakest quarter. We were broadly impacted by the ongoing weakness in nonresidential building markets, and as expected, gross profit and operating income margins were lower due to challenging market conditions.

However, the weakness and challenges were greater than we anticipated, particularly in our new construction book of business.

As compared to the first quarter of 2010, total revenue increased by $46 million this quarter, primarily due to our acquisition of ColonialWebb. Even without acquisitions, quarterly same-store revenues increased for the first time in a few years, although the increase was a modest 2% compared with the first quarter of 2010.

Gross profit declined significantly this quarter, dropping from 16.7% in the first quarter of 2010 to 12.1% this quarter. The decrease in gross margins was generally broad-based, reflecting weaker pricing overall. As we covered in our press releases, we had particular challenges in our southern Alabama operation, as Brian will discuss further.

Our backlog this quarter increased just slightly from December 31, rising by $1.6 million or 0.3%. The year-over-year increase in backlog was $95 million, primarily due to the acquisition of ColonialWebb in July 2010. And on a same-store basis, the change in backlog was somewhat larger, reflecting a $10 million same-store increase, about 2%. Overall, backlog continues to track sideways, but remains a strong by historical standards, especially in light of many years of rough industry conditions.

Our SG&A expense increased $5.2 million for the first quarter compared to the same period in 2010. However, same-store SG&A decreased by $1.7 million, or nearly 5%. SG&A also decreased as a percentage of revenues, dropping from 15.8% in 2010 to 15.1% in 2011.

The ColonialWebb acquisition added revenue of $41 million and incurred a $1.3 million operating loss for the quarter, after the amortization of intangible assets and other fair value adjustments.

Our tax rate for the quarter was 41.7%. We continue to expect our full-year tax rate in 2011 will be in the usual 37% to 40% range overall. We did not repurchase any shares under our stock repurchase program during the quarter. We will continue to look for opportunities, but we plan to continue to be price-sensitive and opportunistic in our share purchase program.

As we expect in the first quarter, cash flow was negative, following very strong year-end cash collections. Although we expect overall headwinds in 2011, we have generated positive free cash flow for the last 12 calendar years and we expect to earn money for 2011, and we believe we can achieve positive cash flow for the full year.

We remain financially and operationally sound. Our balance sheet is rock-solid. And despite tough market conditions, we plan to keep searching for opportunities to prudently use our strength to compete, improve and grow.

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

Thanks, Bill. Good morning, everyone, and welcome to our first-quarter call. Before I start, I want to thank each of our dedicated team members for their efforts in this tough market.

We are off to a slow start to 2011. We were broadly impacted by pricing weakness, coupled with seasonally low activity levels. Although we expected gross profit margins would be lower across the majority of our companies, after three years of recessionary conditions, the pricing in our construction work combined with some individual challenges to produce weak overall results. Despite the tough economic climate, however, substantially all of our operations continued to execute the work extremely well.

Overall weakness was the key factor in our results this quarter. However, we were also hurt by job underperformance at our operation in Mobile, Alabama, which turned in an operating loss of $4 million.

During the quarter, we were forced to make changes that involved combining that operation with a very successful sister company in the Florida Panhandle, and we have replaced the majority of the personnel at this location. The remaining backlog of approximately $13 million has been taken over by a seasoned management team, and we have recast the ongoing and new work consistent with that operation. We remain committed to that market and believe that our product offering will be strengthened by these changes.

On a smaller scale, three of our mid-Atlantic operations experienced negative impacts from weak pricing and/or execution issues. First, one of our Maryland locations had lower relative profitability and was negatively hurt by one job write-down.

Second, ColonialWebb had a tough first quarter and reported an overall operating loss of $1.3 million for the quarter. The loss at ColonialWebb arose from seasonal weakness, combined with additional costs incurred on two large, complex projects. The loss also includes approximately $0.7 million of amortization expense associated with acquired intangible assets. While we will seek to recover a portion of these costs, we have not included any anticipated recoveries in our results.

The final event factor coming out of the mid-Atlantic was the effect of the construction division of our other large operation in Virginia working through some low-margin work in a seasonally slow first quarter, which also resulted in some uncovered SG&A.

We are actively working with operations to address challenges, while preserving the core strengths of our business. Our regional vice presidents are deeply engaged, and our operating company presidents all pull together to help underperforming locations. While I'm never happy with loss-making operations, I am pleased with the level of attention and focus that we are bringing to bear on this. We are working to make sure that we get everyone moving in the right direction and back in the black. In tough times like these, even strong operations struggle to make money and maintain their core strengths.

We had good results from Service during the quarter. Pure Service, which is maintenance and repair, held steady at 17% of revenues for the first quarter of 2011. We continue to invest in Services sales efforts, and this has translated into a steady maintenance base.

We remain committed to our safety culture. Our OSHA recordable rate is 43% below the industry average. This outstanding result is thanks to a continuing focus by our operations.

Backlog at the end of Q1 was $619 million, up $2 million from quarter 4. On a same-store basis, backlog was up $10 million or 2% as compared to Q1 2010. The institutional markets, government, healthcare, education, are active and comprise 68% of our backlog. The private commercial sectors remain weak.

Geographically, the Northeast remains stable. The Southeast is becoming softer, and softness also continues in the West, although most Western markets have stabilized and a few are beginning to show some strength.

We continued to see a lack of large project awards, but we have won our fair share and have recently booked some sizable projects in New York and the Washington, D.C. area. Overall, we remain cautiously optimistic that activity levels in most of our markets are stabilizing.

Industry forecasts are signaling gradual improvement in nonresidential construction. We continued to experience pricing pressure as the anticipated recovery has taken longer to develop. When markets improve, the effect on us will be somewhat delayed.

Our strong financial position and [bargaining] capacity remain a competitive advantage. The key for us in 2011 is maintaining a tight focus on project selection, estimating, pricing and execution, while preserving the core of our business, our top-notch workforce. We have a disciplined cost structure, project execution remains a top priority and I am confident in our ability to execute and deliver solid operating results. Most importantly, we are ready for strong performance when the markets improve.

Again, I would like to thank all of our 6400 team members for their efforts. I will now turn it back over to Bill for his wrap-up and then questions. Thank you.

Thanks, Brian. All of us continue to feel we have a bright future, and we are going to maintain our focus on the HVAC mechanical sector. We are in the process of increasing the percentage of service work in our mix. And we are going to take -- and are taking -- good advantage of the substantial opportunity we've got in the energy efficiency area.

We've said it -- all three of us have said this. We are well-positioned in a good -- what is generally a good business. All we need really is a little vitality in the construction economy.

At this point, I want to throw it open to questions.

(Operator Instructions) Matt Duncan, Stephens, Inc.

Good morning, guys. This is Jack Atkins on the call for Matt. Thanks for taking my questions.

My first question here is on your gross margin. Could you maybe talk for a minute about what the underlying gross margin was in the quarter, if you back out the write-downs for your businesses in both Alabama and the mid-Atlantic?

You know, I would be quicker to back out the Alabama loss. I think that although we mentioned the things that happened in the mid-Atlantic, to me, they are more symptomatic of broad-based weakness. These were things -- in a tight quarter, you discuss in your MD&A enough factors to cover your variance. But I would be more likely to simply add back the $4 million in Alabama as being something that -- that is truly something that is not going to repeat. In other first quarters, we are going to have jobs that fade by about a few hundred thousand bucks here and there, and people who don't quite have enough activity to cover their activity level.

So I would just -- I think, Jack, you could just add back $4 million, and I don't at my fingertips have the percentage that would get you to, but (multiple speakers).

But it looks like adding that back will get you somewhere around 13.5% gross margin in the quarter. I guess my second question is -- I know you guys have talked about the pricing pressure that is ongoing here. And I'm just wondering about the implied gross margins in your backlog. And maybe if you could talk a minute about sort of how we should think about gross margin going forward for the rest of this year, understanding that the first quarter is your seasonally weakest quarter for gross margin.

I would say that the implied gross margins are lower. And one of the things that you are seeing is, in a first quarter, you are seeing a different mix than you will see for most of the year. And that is going to be true -- any first quarter, we are going to have lower gross margin percentages because we are going to -- a higher proportion of our work is going to be from the construction book, because service is very slow.

So I think that you will see -- you should see -- even setting aside the one-time events, you should see higher gross margins for Comfort Systems USA than anybody in our industry in the second, third and fourth quarters. What you're really seeing in the first quarter is a more bare representation of what is in the construction book. And it's tough gross margins. Big projects are going out, they are being bid at barely double-digit margins. A really quick-turn job might dip below that in the bid. And that is enough money to cover a construction business's overhead. Unfortunately, we have a construction business and a service business.

So in the first quarter, when service isn't very busy, you get to very, very small margins. I think a year ago -- I can't remember -- I think we earned $0.03; year before that, $0.05. We are always on the edge of reporting a loss in the first quarter. So it doesn't take much difference to push you into a loss position.

Okay. Thank you for that color, Bill. That was very helpful. And then turning to ColonialWebb, it sounds like that was slightly dilutive in the quarter, and maybe it sounded like that was a little bit unexpected. Could you maybe talk a bit about your expectations for the accretion or dilution from ColonialWebb for the full year 2011?

Yes, absolutely. ColonialWebb cost us $0.02 in the quarter; now, just over half of their net negative came from amortization. Of course, it was because of amortization that we said we would not likely get net accretion from ColonialWebb for the first 18 to 24 months. I would say that -- and if you look back, we picked up $0.01 from ColonialWebb in the last five months of last year. So net-net, they are within $0.01 of breakeven, which to me is about what we said would happen.

Having said that, I think many of you have heard us say many times we didn't buy ColonialWebb for the first year or two. It is going to be -- we bought ColonialWebb at a very low multiple of their trailing earnings, like 3. We probably bought them at a high 7 or 8 multiple of their forward earnings, because, like us -- they are a company very much like Comfort Systems. They were heading into challenges.

We think over a long period of time, we bought them at 5 times and they are going to be extraordinarily accretive. They are going to make a big difference in our Company when times get better. But the reality is, for now, it is a dogfight.

Okay, thanks. And then my last question here is with regard to your appetite for additional acquisitions. Could you maybe comment on the acquisition landscape and are you guys still actively pursuing deals at the moment?

Yes, we are -- principally smaller acquisitions. Although we are looking at a couple that would move the meter, as they say. It takes a while. It is a process. We are not an acquisition machine. We are simply prudently growing the Company by bringing in new companies in good jurisdictions.

Okay, great. Thank you for the color, guys. I appreciate it.

Saagar Parikh, KeyBanc Capital.

A quick question. On the last call, you said that you were optimistic about the summer booking season in 2011, which would be good for 2012. I just wanted to get your thoughts on with the new weakness being seen in the Southeast, the West stable but still soft, if you guys are still optimistic about the summer booking season. And then where do you see margins on that booked work or potential booked work?

I would say less optimistic, just because I think if you were to ask anybody in our industry, prognosticators, anybody, the changes people were expecting have been slow to appear. But that doesn't mean we are not optimistic. Brian?

We had a strong booking month of April, pretty much in line with what we've been doing. So it is more stable, and I think Bill is right. I don't think we are as optimistic that the summer will be a material bump.

Okay. And then looking at your Services business, you said it is 17% and it continues to grow. Typically, that carries higher margins. Is that still the case and should we expect that to offset a little bit of the weakness in the construction backlog?

On the service side, we are growing, and our profit margins -- gross margins have remained stable over time. So we have not seen deterioration on the Service business.

I might add, there is a little bit of investment there. Not investment in the sense of accounting, but investment in people and rolling stock and training, et cetera, as we build that pure Service side.

Where can you really see that business -- if I'm looking at 2012 -- as a percent of the revenue? Right now, it is 17%. Where do you really see it going? Because I know you guys are putting a lot of resources into it and hiring.

One important thing to understand, we expect to continue to have increases in the absolute number of dollars that we bring in through that line. The most important thing that drives the percentage is what is happening in the construction market. Because once construction starts to pick up, that percentage -- things can be going great there and that percentage will be diluted.

So assuming, Heaven forbid, that construction hasn't picked up by 2012, I think we would probably want to see 50 to 150 basis points every year. But I will say that is not what I hope we are reporting a year from now. I hope we are reporting that construction revenues are much more robust and that percentage may be shrinking. But I am confident -- I feel pretty confident, particularly if the markets improve, that the absolute dollars coming through that line will get better and better.

Sounds great. That's all I have. Thanks, guys.

John Rogers, D.A. Davidson.

I'm not sure who was -- Bill or Brian's comments -- where you talked a little bit about the regional differences in your market. Could you dig into that a little bit further and just maybe talk about what types -- I mean, are any of your customers, by category, showing any growth, or is it all just pretty flattish?

Yes, I think most of it is pretty flat. Healthcare is still pretty strong, to be honest. And we are seeing some growth in manufacturing. But John, I don't want to paint a picture here that it is a big blip. It is growing modestly. Healthcare is still hanging in there.

Okay.

John, did you pick up my -- I quoted you in my comments, without attribution. Market recovery is still delayed. That is right off of your --.

I thought your quote was about the coming earnings bonanza that John is predicting.

I'm hoping.

We appreciate it.

I guess what I am trying to understand a little bit, too, is in terms -- and every recovery is different, like all recessions. But where -- how -- what gives you confidence that we are at least seeing it turn? I mean, could we be sitting here a year from now and still be looking at a no-growth market?

John, I will take a first shot at that. I don't know if we are seeing it turn; I think we are seeing it stabilize.

Okay.

And what I'm seeing that is based on the activity we have in our pipeline, which has not slowed, pretty much across the country. And awards are still low, pricing pressure, which we've talked about. But our award bookings are relatively stable month by month -- within a range.

I think there is also -- when you talk to people, there is definitely more pricing discipline. The kind of crazy stuff that people were doing a year or two ago to put work on the books, you are not seeing as much of that. Which I think bodes well even if we stay at low levels for a little while.

Having said that, the one thing that gives me the most hope is private -- particularly like the manufacturing types and the food types and certain of the technology types, the private guys are making plans to build. They are keeping our planning departments very busy. They are getting budgets, and in some cases they are getting bids. They seem not to be pulling the trigger. But it does give me hope that -- I think -- I believe many of them do not want to miss this opportunity to build. I think a lot of them believe that we are going to go back to experiencing a lot of pricing pressures when things get better, based on the changing global economy. I think many of them don't want to miss this opportunity, and I think some of them are poised to go ahead and make commitments if they become convicted that things are getting better.

I think we were really, really -- it was really unfortunate going into the spring to have all the uncertainties surrounding the earthquake in Japan and the problems in the Middle East. I think when you think about it, building a building is the most -- it is the most long-term planning decision that most businesses make, and uncertainty is an enemy to that. And I think we were just starting to -- people were just starting to feel good and then they were given an excuse to scratch their heads for a little while. So it is going to happen; it's just a matter of when.

Okay. And just lastly, in terms of the manufacturers providing service, has that dynamic changed at all? I know they kind of come in back and forth and depending on --

I don't think -- perceptively, I don't think it has. You see Johnson Controls and Siemens out there doing things. Siemens just signed a big deal with the GSA.

But they turn to people like us to actually implement some of the solutions that they devise. So we get our piece of that.

Going back to what you said before about the sectors, there is some comfort in the notion that, as Bill [stuck with it], the in-being space, especially multifamily, hotel, suburban office, is getting old. And a lot of that stuff will be razed and/or seriously modified over the next couple years. And that, we may see some growth in.

I talk to a lot of people in the hotel sector, and there are a lot of plans to bring down and/or modify existing properties, once people get confident that there is enough vitality in the economy to support it.

Bill makes a good point. You, of all people, are aware that nonresidential missed most of the last expansion. We didn't get involved in the strong construction markets until very, very late in the game. And so then it ended quickly because of a financing-led recession. 10 or 12 years of people not doing very much in a lot of these markets, sooner or later, that is going to be our friend.

Okay. Fair enough. Thank you.

Clint Fendley, Davenport.

Good morning, guys. This is actually Drew Gaputis in for Clint. Just first on the question on Alabama, could you give us a little bit more color on what happened there? It sounded like it was -- is it fair to say that that was a management-specific issue and not something necessarily that had to do with the economy or economic conditions?

That problem in South Alabama was clearly execution-related, work project management and field labor specific. It was nothing to do with the economy. It was a -- poorly run projects.

All right, great. Bill, with regards to project size or contract size, we've seen that trending up I guess over the last couple quarters. Is there anything to read into that, or is that just mostly noise with kind of month-to-month variation?

I scratch my head about that. I think it is just noise. The number of contracts have come down some. Certain contracts stay on the books for a good while, but I think it is just noise. I would've expected it to trend the other way slightly, but it is all within a standard deviation of the mean.

All right. And then I've got a question with regards to backlog timing. And just could you remind us kind of the average length of delay between when business is placed in the backlog and when the revenue is recognized? I know you guys said maybe you are beginning to recognize things that were booked in -- over the last two years. But can you give us kind of an average number there on the timing delay?

Sure. About 60% of our backlog will be burnt in the next six months, on average.

All right, great. And finally --

That's construction work. That doesn't include anything we have in service. So it is just work we have in our backlog, which we just put construction in.

Got you. All right. And then with regards to acquisitions, I guess this has kind of been a downside surprise in the last quarter, and this kind of recovery has dragged out a bit. Has there been any fundamental change with regards to acquisitions or your appetite for them? Is there anything that has structurally changed with your ability or price you will be willing to pay for those acquisitions? Thank you.

I'll answer that. Having -- the main thing that has changed is we accomplished our primary acquisition objective, which was to put -- we had built up a very, very large cash balance through the last expansionary period. Our primary objective in the downturn was to put most of that or all of it to work.

We still have room to do some acquisitions. Having done a lot, we are going to be even more careful and more discriminating. But having said that, we are very interested in adding the best companies to Comfort Systems USA. And we have enough confidence in the future to believe that it is worth employing more of our balance sheet to do some of that in the next year.

It would be even easier if you became more convicted of the timing for the expansion. But we are working hard and trying to get some -- what I consider to be some really, really interesting and good opportunities sort of to the 50-yard line and then to inside the red zone. And in an ideal world, we might get some really good acquisitions inside the red zone right at a time where we're starting to feel pretty good about the market, and that could be the best of all possible worlds.

Adam Thalhimer, BB&T.

Unfortunately, I missed some of your prepared commentary. And the big question I have is basically modeling -- what to do with the model. And I wondered, did you make any comments about -- will you be profitable in Q2? I know you said you will be profitable for the full year. But I mean, for somebody trying to model quarterly earnings, did you give any guidance along those lines?

No guidance incremental to what we had in the press release. I will say, in our 10-Q, if you read that, it says that we expect to be profitable in 2011, but less profitable than in 2010. I think it is fair to say we expect to be profitable every remaining quarter of 2011.

And there is a range of what that could be, but I think the range only includes substantial -- I don't think it is barely profitable. I think we think we will be solidly profitable. We will overcome the $0.14 that we lost and will earn some money. But there is a pretty good range of what that could be, sitting here in April. And probably the single biggest variable in figuring out where in that range it falls is whether we start to get any help at all later in the year from underlying conditions.

Okay. Actually, that's very helpful. Thank you very much.

That concludes the Q&A portion of today's call. I would like to turn the conference over to Mr. Bill Murdy for closing remarks.

The only closing remarks is thanking everyone for being on the call. We remain optimistic about our own abilities and capabilities. We just are looking for a little help from the economy. Thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.