Comfort Systems USA Inc (FIX) 2012 Q2 法說會逐字稿

Welcome to the Q2 2012 Comfort Systems USA earnings conference call. My name is Vanessa, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Please note that this conference is being recorded.

I will now turn the call over to Julie Shaeff. You may begin.

Thanks, Vanessa. Good morning, everyone. Welcome to Comfort Systems USA's second quarter earnings call. Our comments this morning, as well as our press releases, contain forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. What we will say today is based 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 release covering these earnings. A slide presentation will accompany the prepared remarks and has been posted on the investor relations section of the Company's web site, found at comfortsystemsusa.com.

Joining me on the call today is Brian Lane, our President and Chief Executive Officer; and Bill George, our Chief Financial Officer. Brian will open our remarks.

Thanks, Julie. Good morning, and welcome to our second quarter call. Before we start, I'd like to take a moment to thank the Comfort Systems employees who are listening for their continued hard work and dedication. On today's call, I will start with a quick overview of the quarter. Bill will then take a few minutes to walk through the financial results, and finally, I will discuss backlog and the outlook for the rest of the year.

We are happy to report a profitable second quarter and $0.12 per diluted share, as compared to the $0.80 per diluted share we reported in the second quarter of last year. We had good performance across the board, and most of our locations delivered solid results. Our construction operations continue to focus on execution, and our service operations achieved continued strong profitability and growth.

We had good top-line growth, both from acquisitions and on a same-store basis. As we mentioned during our first quarter call, we have a very large, fast-paced data center project that has contributed to our same-store revenue increase for the first half of the year. Backlog is down slightly on a sequential basis as we burn through revenue at a fast pace on that large data center job. The majority of our markets are stable, but pricing remains very competitive. We continue to see large projects being delayed and in some cases being awarded in smaller phases. Our focus, as always, is on project selection, estimating and execution. We are keeping our eye on costs and we are focused on generating cash. We still feel good about the rest of the year, but before I get into that let me turn this over to Bill for some financial comments.

Thank you, Brian. Despite weak overall demand, there are a number of indicators of incremental improvement and stability in our results this quarter. If you're online and you have access to our slides, you can refer to slides 1 through 5 as I review our financial results.

Total revenue this quarter was $355 million, an increase of $43 million or 13.6% compared to the second quarter of 2011. The EAS acquisition, which was completed during the fourth quarter of last year, contributed 7.6% of this increase. Revenue on a same-store basis increased 6% or $19 million to $331 million. As Brian mentioned, most of the increase in same-store revenue arose from the fast-moving data center project in the mid-Atlantic area. Data centers are classified as manufacturing in our pie chart. That project contributed significant revenue for the first half of the year, but that increase will disappear in the third and fourth quarters, as July was the last significant revenue month for that project. As a result, we expect same-store revenue for the rest of the year to be closer to the 2011 levels.

Gross profit was similar to last year at 15.4% for the second quarter of 2012 compared to 15.2% in the second quarter of 2011. As Brian mentioned, we had solid performance from most of our operating companies. Despite the small relative improvement, we continue to experience gross profit and operating income results at lower levels due to continued challenging market conditions. SG&A expense was $47.1 million for the second quarter of 2012, which compares to $41.9 million for the second quarter of 2011. The largest reason for the dollar increase in SG&A was the acquisition of EAS, and we also saw an increase in bad debt expense as we made a decision in the quarter to reserve specific receivables at a couple of locations. Overall, SG&A as a percentage of revenue decreased during the quarter compared to last year, dropping from 13.4% to 13.3%. EAS added revenue of $23.8 million, and its overall impact on the bottom line was approximately breakeven. As we have previously discussed, we have a 60% interest in EAS, and thus we consolidate their results. From the field level, EAS reported a small operating loss in the quarter due to job write-downs on two jobs that are substantially complete. Within our purchase agreement we have contractual mechanisms in formula that specifically adjust for changes in the gross margin on jobs ongoing as of closing. As a result of this purchase adjustment, much of the impact of the job write-downs has not been borne by covered systems. The former owners expect some recovery through negotiated change orders; and when and if the recovery occurs, they will receive the benefit of such recovery.

So as I said last quarter, the net effect on Comfort Systems is not large but I wanted to describe the mechanics to help you understand numbers that you may have noticed on our income statements and also so if these numbers turn around later in the year it will be clear why the benefit is muted in our numbers.

Our tax rate for the quarter was 43.9%. We currently expect the full-year tax rate to be in the 38% to 40% range. We are happy to report that free cash flow was positive $2.6 million for the second quarter of 2012. This compares to negative free cash flow of $5.8 million for the second quarter of 2011. Although we expect overall headwinds in 2012, we have generated positive free cash flow for the past 13 calendar years and we feel good about our cash flow prospects in 2012.

We repurchased 96,000 shares under our share repurchase program during the quarter. We continue to be price-sensitive and opportunistic in share repurchases.

Overall, this was a strong quarter in a tough environment. The recession continues but we're still investing and we feel good about our prospects when markets improve. That's all I have on financials. Brian?

Thanks, Bill. I will now comment on backlog, performance and revenue mix as well as our prospects for the rest of the year. Please turn to slide 6 and start with backlog.

Q2 backlog was $618 million, down $4 million or 0.7% sequentially. The decrease is due to the burn-off of a large, fast-paced data center project mentioned earlier. That project is slightly unusual for us, as the majority of our very large projects typically take more than a year to work their way through our backlog. Absent the effect of the burn on that large project, our backlog would have been up slightly this quarter. But viewed either way, backlog is still flat in a tough market.

As noted in slide 7, the institutional markets, which are government, healthcare and education, still represent a significant portion of our revenue. These markets are active and make up 55% of our backlog. The private commercial sectors remain challenging, but the proportion of work in our backlog that is private is increasing and we feel an industry shift towards private work plays to our strengths. We have continued to win our fair share of smaller and mid-sized projects. Overall, although margins remain tight, we remain cautiously optimistic that activity levels in most market sectors are stable.

Geographically, the Northeast region, which for us also includes the companies in the upper Midwest, remains stable and is the most profitable region. The operations in Maine, Michigan, New York, Northern Maryland and Wisconsin continue to report good results. Building on their strong performance for the first half of the year, the majority of operating countries in this region have strong backlog and are operating near capacity.

As we told you during our first quarter call, the mid-Atlantic region experienced the downturn later in the cycle, and we expect this to continue in the near future. The Southeast region, including the mid-Atlantic continues to experience a week pricing environment. Elsewhere in the Southeast, our central Florida operations had very strong results despite tough conditions. Most of the markets in the West have stabilized, but conditions in many of the Western markets are still among the slowest in the nation.

Please turn to slide 8 for a comparison of the revenue mix. Pure service, which is maintenance and repair, was 15% of revenue for the first half of 2012 compared to 17% in 2011. The large data center job led to a temporary increase in the relative proportion of revenue that came from construction. Revenue percentages will likely shift back towards service and retrofit, although that project continues to impact year-to-date numbers. Our service maintenance base is steady.

Finally, let me discuss the outlook for the rest of the year. The ongoing weakness in the non-residential markets continues to impact our business. Pricing is still competitive and the customers are often hesitant to commit and pursue construction and improvements, and some are taking a wait-and-see approach. That being said, the majority of our markets are stable and we have a good baseline of work. We are focusing on ways to be successful in this environment. Execution, cost controls and efficiency continue to be our main focus. Our strong financial position and the bonding capacity remain a competitive advantage. We are confident we are more efficient than ever, and we are ready to take advantage when markets improve. Again, I would like to thank all of our 7000-plus team members for their efforts.

I will now turn it back over to Vanessa for questions. Thank you.

(Operator instructions) Rich Wesolowski, Sidoti & Company.

These are the highest bookings you have reported in a long, long time, but your commentary is a little bit darker. Are you feeling any better about your bidding prospects than three months ago?

Rich, this is Brian. The bidding is pretty much the same as it was. We are in a very large industry; there's always going to be stuff to bid. But I think it's pretty stable. We are seeing at opportunities, and I think we'll get our fair share.

Would you maybe elaborate a little bit on the data center project, specifically with regard to the influence it will have on the comparisons in the second half versus the first half and messing with the seasonality a bit? Are we going to see less revenue but higher gross margin as result of that?

Yes, so I think that we will definitely see less revenue, and there is a possibility of higher gross margins. The data center -- the vast majority of those revenues have now come through. A little bit came through at the end of last year, but then something in the $15 million to $20 million range came through each of the first and second quarter, so there would just be a couple million in July and August of this year.

But, because of the -- because we were asked to accelerate that project, as we indicated on the first quarter call, and the acceleration demands forced us to commit to and incur costs before we had negotiated the appropriate change to the contract price relating to those changes, we did not meet -- we have not met our strict criteria for booking a claim or a change order. And so we've added the cost to that project, but we have not put any -- we have not increased the contract price for any compensation we would get for those incremental costs. What that means is that project for the first six months of the year revenued, coincidentally, on a breakeven basis. And there is a prospect that as we get compensated for those additional costs, that would essentially improve our results later in the year.

The timing of that is difficult, because if it's negotiated change it could happen in the third or fourth quarter, but if it turns into a more protected situation, of course, it could push it into next year. As far as we can tell at this point, there's only upside left on that project.

Great. Lastly, EAS seems to be contributing more revenue than I would have expected, or I think maybe it is being recognized in 2011. How is that subsidiary doing, and have you had any early success in expanding their prefab capability to any of your other operating companies?

We've had a little bit of -- we certainly had them -- they have worked very well with some of the operations that surround them, in particular ColonialWebb. They have shared labor; they have sold work for each other. They are off to a good start. It has not been -- there certainly hasn't yet been -- it hasn't yet been the case that they have expanded their capability to add that capability to another subsidiary. And I think if that were to happen, that would take a long time.

As far as how they are doing, their net contribution to Comfort Systems has been approximately breakeven, a slight negative if you take into account all of the amortization that we've had to put into, but a nice EBITDA contribution, but not as much as we would have liked. As we said, the recession has hit the mid-Atlantic and it has hit them as well, so they have not done quite as well as we would have hoped, but we still feel very good about that acquisition.

Appreciate your time, thank you.

Tahira Afzal, KeyBanc Capital.

It's (inaudible) on for Tahira. First off, congrats on a great quarter, great execution in a tough environment.

Thank you very much.

Looking at your gross margin profile, and thanks for the additional commentary, Bill, on the data center project's impact. But if I'm to take your commentary, which is pricing is not getting better on the non-res side and I'm just looking at gross margins for the rest of next year and into next year, and taking the data center project out, maybe I can see it trending up to the high 15 range. But going into next year, can you really get to the top of your 14% to 16% range without pricing coming back?

In 2013, it's a little early for us to really have clear expectations for 2013 because we haven't really seen bookings and pricing and backlog that we will have seen in three or four months. It's getting kind of late in the game for 2013 to be strongly helped by a recovery. Remember, we're a late cycle player, so when things get noticeably better in our industry, that tends to hit us in a rolling manner, 6 to 18 months later.

But having said that, I think we feel pretty good that 2013, at least, we continue to benefit from this stabilization. Until last year or the year before this year, although markets are at very low levels, they have been at low levels for a while. And so capacity has had more time to adjust to the lower levels. People who were coming in and maybe making a mistake on a bid or taking work at a loss or breakeven -- they are not doing that anymore. They generally -- it still happens, but it's not ramped at the way it was a year ago. So I think we have prospects even if we stay stable at the bottom for modest continued gross margin improvement in 2013 over 2012.

It's Brian. The other spot in the curve is our workforce has done a terrific job over the last few years, through this recession -- efficiencies, just getting better at what we're doing -- and that continues, and I think a lot of the progress we've made is here to stay.

That's perfect. And then one --

Let me add one other thing. If we were to see some demand come into the market, then I really like our prospects for improvement. I just want to add that. We talk as if it won't be there, but having said that --

Someday it will --

It's going to come. It's just a matter of when. I'm sorry; go ahead.

And so if it does come earlier than expected, you could see initial benefit six months from when the demand comes up. Right? So you could still see the benefit, potentially, in 2013 or something?

Yes, you would see benefit late in the year on the margin line. You start to see revenue sooner.

Your assessment is correct.

And then one follow-up on the institutional end market, different leading indicators, and how everyone looks at different things, but a few of the major metrics I have been looking at have been showing that institutional could be taking a little bit of a hit in the 2012 time frame, early 2013. Are you guys seen anything from your customers to suggest that that trend is happening, or would you say institutional is going to just stay at this current level?

This is Brian. If you look at it from a year ago, 70% of our backlog was institutional. It's 55% today. Manufacturing, office buildings and multi-family have increased. The one good thing about our structure is our operating companies are close to our customers, and we are able to adapt pretty quickly. So the adjustment we are seeing is pretty smooth, but the institution has slowed down a little bit. Private work has picked up and we are right there for it.

All right, perfect, thank you guys.

Adam Thalhimer, BB&T Capital Markets.

Good morning, guys, nice quarter. I know you don't like to give outright EPS guidance, but can you just give us a flavor for how the second half might shape up on a year-over-year basis?

I think what we have said last couple of quarters continues. Absent any effect of that data center, I would expect the third and fourth quarter of 2012 to be very similar to the third and fourth quarter of 2011, with the exception of you will get incremental revenue from EAS. But having said that, as we announced at the time of acquisition, I don't think they will -- given their amortization early on, I don't think that they will add much to EPS. I think they may make a small contribution to EPS in the second half of the year, but early on they've got a lot of amortization to overcome. So I'd say more of the same.

Okay, and as it relates to the economic softness we've seen since, I guess you would say over the past three months or so, it looks to me like maybe that has pushed -- maybe that has caused the hope for a new construction recovery -- maybe that has pushed that out a little bit. But it doesn't seem like that has really impacted your service and repair and remodel work. Is that right way to think about where we are today?

You are right on. And we've seen a lot -- as I said in my script, a lot of small/midsize work that never even makes it into backlog because we've burned it in the quarter. But we've seen a lot of activity. Luckily, we are able to do that work and do the large construction work as well. So, Adam, you are right on the money on that -- we are seeing a lot of that small to midsized stuff around.

One interesting factor is, there's a lot of delay. Things that will get really -- they will have a date they're supposed to start in February, and then they're supposed to start in May and they just keep not starting. And yet, compared to a year or two ago the differences, in these cases the owner owns the land. The owner has permits, but it just seems like people are not pulling the trigger.

Were they are letting it out in small bits and pieces as opposed to letting it go on the whole thing at one time. That's happening recently as well.

And is that somewhat typical in prior recoveries, or are we in uncharted territory?

There's nothing typical about this recession.

Okay, thanks, guys.

John Rogers, D.A. Davidson.

A couple of things -- first, Bill, the receivables charge that you had in the quarter, how much was that?

It was a little over $1 million and it was a diverse group of specific things that we just -- we reached a point where we said we're going to go ahead and reserve them. They are all things that we continue to pursue, but it's just some distinct things. In any quarter, there's a certain amount of that, right, and this time, there just happened to be a little more that we put up than usual. We run our bad debt expense through the SG&A line. So the reason I bring it up is, if you were solving for the dollar increase in SG&A, there wasn't much of one once you take out EAS in that, and so I just wanted to point that out.

Just one more thing, John. We have a lot of stuff focused on collecting that money.

God, good. Secondly, the tax rate, 38% to 48% -- that's a big range.

It is, isn't it? It is. So I'll give you some detail on our tax rate. I believe our tax rate by year end will be a very, very low number with a 4 in front of it. But the problem we have is, we have such a small numerator of earnings right now in the second quarter that, even if you had a little -- if you have a little $300,000 charge from a state matter, which is a very small number on the scale of Comfort Systems, but it's a big number on the scale of year-to-date, we only have $3 million or $4 million of earnings, so the problem is it's a small numerator.

Having said that -- and we did have -- we had about $400,000 or $500,000 earlier this year of negative incremental development on some tax situations on some audits and stuff. That created a big loss of benefit in the first quarter. Remember, we were at a loss. It got us that at a weird tax rate of like 43% now. But, assuming nothing else unexpected happens with that, we will slowly moderate towards a typical tax rate for us. A typical tax rate for us is going to be the federal rate of 35% plus the blended average state rate of 6% or 7%, minus the benefit -- right? You get to deduct your state taxes -- so minus the benefit, I believe we said about a 39% normalized rate. This year we are going to be a percent or two above that just because of discrete items.

Okay, thank you. And in terms of the market, on a short-term basis are you seeing any impact from the weather, especially the heat?

John, it's Brian. Yes, the weather has helped our results in the quarter. But basically, we had a warm summer last year, so the marginal improvement isn't there.

But in the third quarter, it seems like it's appreciably hotter. We're only a month into it, but --

Right, as we move through this quarter, we will see how that pans out. But, obviously, the month of July was warm as well. Last year we also, in the third quarter, had a lot of flood/tornado damage in the middle of the country that picked up a lot of work for us as well. So we will see how the quarter plays itself out, but it is still warm, and it does help our service numbers, no question about it.

Lastly, I appreciate you guys' conservatism. But on the other hand -- and I know it's a tough recovery and it's low and there's no snap back. But if you look at overall nonresidential construction spending, it's better than we were a year ago, specifically in a lot of the building markets that I think you address. And are you -- and I know you are a later cycle business, but is there any hope that, even though it's coming off a small base, that we should see some acceleration in growth at some point? I don't know whether it's a couple of quarters from now, just based on what we've already seen?

I presume by conservatism you're not referring to our politics? (laughter)

Either way you want to answer it, Bill, is fine.

Maybe I'll answer on that basis. No; we have a lot of help. We feel pretty good. But having said that, if this recession has taught us anything, it's that you can't count on the fact that something is about to take off just around the corner. Our focus -- Brian Lane, I've heard him say it 100 times -- has been we need to make money now and we need to run our business for now. We need to be ready for improvement. We are ready for improvement. We are late cycle player. I'm just not sure where the guys who ought to be out there calling the -- sort of calling the upturn -- but we feel good. Brian?

Well I tell you, John, it is a little bit better than it was than a year ago. We are just hesitant to call it because it has been up and down before. We like to see some length to wait. And, yes, we are conservative, but we are cautiously optimistic that this thing is going to turn at some point.

It's got to turn.

And lastly, if I could, acquisition pipeline -- what does it look like now?

I think, for the foreseeable future, you'll see us concentrate on tuck-ins. We did a tuck-in, actually, during the quarter. It was small enough that we really haven't brought it up, but it's one we like a lot, it's a controlled tuck-in, in the southeast. We continue to very actively look for tuck-ins, but probably you will not see us do freestanding businesses this year. And if you saw it next year, it would be because we were actually convinced that there was some strength coming into the market. We are very, very happy with acquisitions we've been able to do during this downturn. We've deployed the vast majority of our available capital. We bought the largest private company in our business. We bought at least 60% of a super-innovative company in the mid-Atlantic. We got into markets like Nashville and Raleigh that we've wanted to be in for a long time. But at this point, you are not going to see anything but tuck-ins probably for at least two or three quarters.

Okay, great, thank you.

Rich Wesolowski, Sidoti & Company.

I was hoping to just expand on that last discussion. Even at reduced earnings, by my model at least your cash is going to start building back up. Would you mind discussing your priorities for that, historically? Of course, you paid a dividend. Is there a potential for that to go up, for the share repurchases, M&A, etc.?

I would say nothing has changed on our priorities for cash. Our Board has given us very, very clear, strategic guidance for many years. Our number one priority with our cash is good acquisitions that we feel good about. After that, it's -- obviously we pay our dividend and we would like to begin to increase that. If cash were to get better, we'd like to get back to at least incremental improvement there. At the end of the day, though, when the stock price is low, we think our stock is a very, very good use of our cash. But the number one use is acquisitions, and we continue to believe that at the multiples that companies trade for in our industry, we ought to be buying an incremental $100 million or so of revenue, we ought to be averaging buying that every year. And we think we can absorb that, we can effectively grow comfort and make it a better place and take advantage of synergies by doing that. And that's the plan for the foreseeable future. So hopefully, cash starts to build. In good times, we get a chance to buy some more great companies at points in the future and we become a much bigger, stronger and more effective force in our industry.

Here's to that, thank you.

And that was our final question. I will now turn the call back to Brian Lane for final remarks.

Thanks, Vanessa. Everyone, we really appreciate your joining us on this call today. Thank you for your interest in the Company. We really would like to thank once again employees of Comfort Systems for doing a terrific job, and we are very happy with the second quarter. Hope you all enjoy rest of your summer and we look forward to seeing you down on the road here in the near future. Thank you and have a great day.

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.