Comfort Systems USA Inc (FIX) 2012 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Comfort Systems Third Quarter Earnings Call. My name is Matthew, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference.

(Operator Instructions)

As a reminder, this call is being recorded for replay purposes. I would like to turn the call over to Julie Shaeff, Chief Accounting Officer. Please proceed, ma'am.

Thanks, Matthew. Good morning, everyone. Welcome to Comfort Systems USA's Third Quarter Earnings Call. Our comments this morning, as well as our press release, 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 could 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 website, found at www.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 third-quarter call. Before we start, I would like to take a moment to thank the Comfort Systems employees who are listening for their continued hard work and dedication. Let me take you through a few key highlights of the quarter, and then Bill will discuss the financial results in more detail.

We are happy to report another solidly profitable quarter. Earnings for the quarter was $0.15 per share, compared to third-quarter earnings last year of $0.14, not including the goodwill and non-cash charges that affected that quarter on a GAAP basis. Revenue for the third quarter was also up due to acquisitions, although it was down slightly on a same-store basis. Backlog is steady at $623 million, up slightly on a sequential basis.

We had solid operational execution across the board, including significant improvement in margins. Thanks to the solid execution by the majority of our operations, we achieved significant year-over-year improvement. It has also been a good quarter from a cash standpoint, and our free cash flow was strong in the quarter, and is well ahead of last year. I'm going to ask Bill George to discuss some financial details, and then I will comment a bit further on our future prospects. Bill?

Thanks, Brian. If you're online and have access to our slides, you can refer to slides one through five as I walk through our financial results. I will discuss both our quarterly results and our performance for the first nine months of the year. Revenue this quarter was $335.5 million, an increase of $7.4 million, or 2.3%, compared to the third quarter of 2011. The revenue increase is a result of our EAS acquisition, which was completed during the fourth quarter of last year. Revenue on a same-store basis actually declined by $12.5 million, or 3.8%, to $316 million. This small decline in revenue appears to be normal quarterly variation in an essentially flat market.

Total revenue for the first nine months of 2012 was almost exactly $1 billion, which represents an increase of $97 million, or 10.6%, compared to the first nine months of 2011. We experienced both same-store and total increases for the nine-month period, and the EAS acquisition contributed 7.2% of this increase. Revenue for the nine months on a same-store basis increased by $31.6 million, or 3.4%, to $954 million.

As we've discussed during our calls earlier this year, much of the increase in same-store revenue during the first six months arose from the fast-moving data center project in the mid-Atlantic area. As a reminder, data centers are classified as manufacturing in our business segment pie chart. That project, which was completed this past July, contributed significant revenue for the first half of the year. We expect same-store revenue for the rest of the year to be similar to 2011 levels.

Another important effect of that big data center job was on backlog. This quarter we reported a significant drop in backlog year-over-year, as compared to a sequential same-store increase in backlog even in a seasonally busy quarter. A major driver of the year-over-year decline was the fact that last year at this time was the first time we reported backlog that included that data center job. If you eliminate that effect, even year-over-year backlog trends appear steady, especially when considered in light of our current job sizes when you eliminate the data center.

Gross profit was 16.6% for the third quarter of 2012, a strong increase from 15.0% for the third quarter of 2011. Gross profit was 15.0% for the first nine months of 2012, an improvement over the 14.2% gross profit we reported for the first nine months of 2011. As Brian mentioned, we had solid performance for most of our operating companies. A good portion of the increase resulted from the absence of job under-performance at our southern Alabama operations that we experienced last year. That company appears to be on track. We also had improved results at our Maryland and Virginia operations.

Despite the relative improvement, we continue to experience gross profit and operating income margins that reflect the continued challenging market conditions. We did experience a small pickup on the large data center during the quarter as we received confirmation of payment for some changes. We continue to pursue additional compensation on that job.

SG&A expense was $46 million for the third quarter of 2012, which includes SG&A from the acquisition of EAS, and compares to $41.5 million for the third quarter of 2011. SG&A as a percentage of revenue increased from 12.6% during the third quarter of 2011 to 13.7% during the third quarter of 2012. This increase is mainly due to events in the quarter, including higher medical claims costs, settlement of a legacy lease, and additional amortization from the EAS acquisition, as well as higher compensation accruals based on the somewhat improved results. For the first nine months of 2012, SG&A as a percentage of revenue is flat, at 13.7%, compared to the same time as last year. EAS added revenue of $20 million for the third quarter and $66 million for the first nine months of 2012. Its overall impact on the bottom line was approximately break-even this quarter.

Our tax rate for the quarter was 42.9%, and 47.5% for the first nine months of 2012. The increased tax rate reflects accruals that we discussed earlier this year, and a distribution of income with some of our better earnings coincidently coming from high tax jurisdictions. We currently expect the full-year tax rate to be in the 43% to 48% range.

Our net income for the third quarter was $5.7 million, compared to a $36.6 million loss on a GAAP basis for the third quarter of 2011. You will recall that the third quarter of 2011 included a goodwill impairment and some other non-cash items. Excluding those items, non-GAAP net income as adjusted was $5.3 million for the third quarter of 2011, similar to the $5.7 million this year. Net income for the first nine months of this year was $9.1 million, compared to an adjusted non-GAAP net income of $3 million for the same period last year.

EPS for the third quarter of 2012 was $0.15 per diluted share, which compares to the GAAP loss last year of $0.98 per diluted share, but excluding goodwill impairment and the other non-cash items, adjusted non-GAAP earnings per diluted share reflected our strongest quarter last year, at 14%, so we improved year over year by $0.01.

We had very strong cash flow during the quarter. Free cash flow was positive $13.8 million for the third quarter of 2012. This compares to negative free cash flow of $0.8 million for the third quarter of 2011. For the first nine months of 2012 we had negative free cash flow of $5 million, as compared to negative free cash flow of $27.8 million at the same time last year. As you know, we've generated positive free cash flow for the past 13 calendar years, and with a strong improvement over last year we continue to feel good about our cash flow prospects in 2012.

We re-purchased 49,000 shares under our share re-purchase program during the quarter, for a total of 145,000 year to date. We continue to be price-sensitive and opportunistic in share re-purchase. Overall, the recession continues but we are still investing in the business. That's all I have on financials. Brian?

Thanks, Bill. Let me walk you through backlog, what was seen in the various sectors and markets, and our prospects for the rest of this year. Please turn to Slide 6 and start with backlog. Backlog at the end of the third quarter was $623 million, up $5 million, or 1% sequentially. Backlog on a same-store basis was $570 million, compared to $636 million as of the third quarter of 2011. The year-over-year decrease is due to the burn off of the large fast-paced data center project that Bill mentioned earlier.

Please turn to Slide 7 for a look at our sectors. The institutional markets, which are government, health care, and education, still represent a significant portion of our revenue. These markets are active, and make up 56% of our backlog. The private sector remains weak, but we continue to win our fair share of smaller and mid-sized projects. Larger projects are still few and far between. Overall, while the margins remain tight, we remain cautiously optimistic that activity levels in most markets are stable.

Let me discuss what we're seeing across the country, starting with the west. The operations in the west were the first to be impacted by the recession. The markets for operations in Southern California, Colorado, and Arizona have stabilized. While we are encouraged by this, the conditions in many of the western markets are still among the slowest in the nation. I was in Colorado, Arizona, Montana, and California over the past two weeks. Our folks there have done a terrific job working in these tough market conditions.

The northeast region, which includes our companies in the upper midwest, remains stable and is the most profitable region. We had strong execution and solid results from the operations in Maine, Massachusetts, Michigan, New York, Ohio, and northern Maryland. The vast majority of the operating companies in this region have strong backlog going into next year. Our operations in the mid-Atlantic experienced the downturn later in the cycle, and continue to face a weak pricing environment. Despite the tough climate, we had strong results from our Alabama, Arkansas, central Florida, Florida panhandle, and central Virginia operations.

Let's now review our revenue mix. Please turn to Slide 8. Pure service, which is maintenance and repair, was 16% of revenue for the first nine months of 2012, up from 15% for the first half of 2012. This compares to 18% in 2011. The large data center job led to a temporary increase in the relative proportion of revenue that came from new construction. Revenue percentages have started to shift back towards service and retrofit, although that project continues to impact the year-to-date numbers. Our service maintenance base is steady.

Finally, let me discuss the outlook for the rest of the year. The non-residential construction markets remain tough. Demand remains mixed, and pricing is still very competitive. We continue to see large projects being delayed, and in some cases, being awarded in smaller phases. Execution, cost controls and efficiency continue to be our main focus. Our strong financial position and bonding capacity remain a competitive advantage.

Despite overall industry challenges, we expect continued profitability and positive free cash flow for 2012. Although we continue to hope for improvement in 2013, as yet we are not experiencing any change in demand. It appears that at least the first half of next year will be a continuation of the stable but tough times we have experienced for several quarters. Again, I would like to thank all of our 7,000-plus team members for their efforts. I will now turn it back over to Matthew for questions. Thank you.

(Operator Instructions)

Rich Wesolowski, Sidoti & Company.

Brian, you had mentioned the data center job affecting the mix between construction and service, but it does look like the service revenue dollars were flat, maybe down a little bit, versus the first nine months of 2011. I was wondering if you discussed the progress and the hurdles in front of you in building the service business while construction is still flat-lining?

Rich, on the numbers, I will say flat is a good description of them. Service is affected by the ambient conditions out there. We continue to make a big investment in service. We believe we're taking share, and we're focusing on specific markets. Is there anything you'd add to that, Brian?

Rich, I'd like to say as Bill said, we are continuing to invest in training and hiring folks. It's a long, slow climb in service, but we will continue that effort.

The other thing is we've had, for many quarters now, continued improvement and strong results in the margins in our service business. I think some of the flatness in revenue also reflects a little bit of a concentration on margin in certain of these markets. The money we're making on service is really very important to the overall results right now, given the market for construction. I will say we have seen margin increase that we're pretty happy with, but we're disappointed in growth and we want more of it.

Are there many non-union, service-heavy, or even service-only companies out there to buy?

The answer to that is not in a way that's meaningful to our numbers. Many of our -- certain of our companies will occasionally buy very small operations. Sometimes it's as small as they buy the assets of a company and hire somebody. Pure service operations tend to be very small. We're going to have to continue to grow this internally to really position ourselves for when demand comes back some.

We've done a pretty good job of maintaining a maintenance base in the face of people really driving, first of all, much higher cancellations than we've historically seen over the last couple of years, as people forgo or get very price-sensitive on those; or, they change from a full-service contract to some -- we have several levels of coverage to some lesser level of coverage, which immediately hits the revenues, although it should come back as we make more money when we repair things. It's an example of another tough market. The nice thing is it's a place where you can continue to make money and we are making really good money in service.

Lastly, should we expect FIX to continue buying companies during the down-turn, perhaps sizable companies, which makes a lot of sense, even if it takes the Company to a net debt position of -- I don't know, pick a number, $50 million -- or do you view yourselves as approaching a self-imposed limit on how much you'll spend?

I think the way I would answer that -- and Brian can correct me if I'm wrong, and obviously the Board, it's not just the people on the phone, our Board is very active in this strategy -- is that we would not rule out additional large acquisitions, but I think you will see us being very slow to buy additional construction revenue until we become -- really, we obtain a conviction that strength is coming back into the market. We bought, as you know, the largest private non-union -- we bought another large company in North Carolina. We've gotten into some markets where we really are glad to be in, like Raleigh and Nashville during this recession. I think that we're open to acquisitions. I think we will become especially open if we reach a point where it's clear that construction markets are coming back somewhat.

I believe -- this is something -- I believe actually we may have opportunity at that point, because a lot of these companies' balance sheets have gotten pretty stretched during the course of this recession. If you talk to bonding companies, they'll tell you that most business failures in our business are right after the end of a recession when people are trying to fund growth. I think there may be some opportunities for us when things look better, but I think we're going to be very slow to make incremental investments until we see signs we believe in that the construction markets are coming back. That was a really long answer, Brian.

Yes, and I think, Rich, you won't see anything in the near-term, Rich.

Great. I appreciate it.

Adam Thalhimer, BB&T Capital.

I wanted to ask about seasonality of margins. Typically, you guys do see a sequential increase in margins in Q4. Is that the right way to look at your results historically?

Well, historically, if you're just saying the last couple of years, we have experienced that in the last couple of years. As far as whether you would see that this year, I actually would not personally view that as typical for us. If you look over a longer period of time, when you're not really busy, when the colder weather starts, sometimes you have some drop-off. I guess it's hard to predict, but I wouldn't count on an increase in margins in the fourth quarter. I'm certainly not counting on it. Having said that, fourth quarter is typically one of our two best margin quarters over the year. I don't know, that's crystal-ball stuff, but that's my thinking on it.

Okay. Bill, what was the tax rate guidance you gave again for Q4?

For the full year, 43% to 48%, which means if we're far off of the nine-month number, you have to solve for the difference for the effect on the actual quarter. I would say -- if I had to guess a rate for the fourth quarter, I would say something between like -- for the actual quarter itself I would say something like 42% to 43%, because my best indication is what I did in the third quarter. I'd love to see it a little lower, and there are -- if we got the right mix of earnings, we would -- it would come down a little. You'll also have a natural but very small tendency towards a slightly lower rate, because you'll be amortizing the negatives from earlier in the year over 12 months rather than nine.

Got it, okay. Lastly, I wanted to ask as it relates to the tone and the outlook, trying to think back, was there a time earlier this year where you were more hopeful that we were on the verge of recovery and that just didn't happen? Or would you say that your outlook or optimism for the business has been more or less stable throughout 2012?

I think -- Adam, this is Brian. I think for the most part we've been pretty stable. I think in the spring, though, I think we were probably a little bit more optimistic that maybe the curve was turning positively, but over the summertime, I think we've slowed down a little bit, and our outlook is probably going to be steady and stable going into next year.

Bill, you would echo those comments?

Absolutely. I would absolutely connect with those comments. It's been really a few years, right, that you'll see signs of life, and then they don't materialize. They will one of these times, but right now it certainly looks like there's a few more quarters of making some money and flowing some cash and preparing and investing for -- to really hit it when demand is ready to help.

Sounds good. Thanks, guys.

John Rogers, D.A. Davidson.

A couple of things, more as it relates to the market and looking out into 2013. As you talk to your guys in the field and some of the planning for projects, we've seen an up-tick in the ABI index and some other very forward indicators. I know you're a late cycle portion of the construction business, but -- I'm sorry for the long preamble -- but in terms of opportunities as we think about maybe second half 2013, 2014, is it going to be on the industrial, commercial, or non-residential markets? Any thoughts? Is it more data centers? Where are you guys saying there is planning activity or where there's nothing?

Yes. Okay John, this is Brian. I've been out running around here for the last little bit. What we're seeing is still good opportunities in education. Medical slowed down a little bit, but I think on a long-term basis, John, medical health care's going to be there, just based on the age of the population and the demands that's going to present itself. We're seeing a clear up-tick in multi-family -- not so much in the condo side, but on the rental aspects of multi-family, a significant amount of opportunities there.

The other one I think you've hit on is manufacturing/industrial data centers, I think would be a good opportunity for a while. We're also seeing industrial opportunities on the food side that we do, particularly at ColonialWebb and across the country. Those would be the sectors I see as most active. I think office buildings will be flat for a little while. The bids and the stuff we're looking at here that we approve, those would be the sectors that we see some strength in.

Okay. In terms of the margin opportunities over the next couple of years, in the past, you've talked about some shop work and pre-fabricating equipment, or doing things a little bit differently. I don't know whether it's service or more plumbing versus air condition. Is there anything else that we should be thinking about, as hopefully we do eventually see some sort of an up-turn? Is there a way to leverage the business, I guess, more?

I'll answer it and then I'll let Bill have a go at it. I think all the things you talk about, we're doing. Leverage reflected in, I think, the gross profit you've seen. The more I'm out there, and I walked a couple of jobs this week -- one in San Diego at an airport job. You see guys doing fantastic work with less than the had before, John, heavily driven by pre-fabrication. I think that's been the biggest driver of efficiency we've seen probably in a large number of years.

I think on a go-forward basis you're going to see some technologies that get applied, either mobile technology, et cetera, that's going make us more efficient; but the overwhelming theme I hear is that we're functioning at these levels and these efficiencies that we're not going to go back to what we were four years ago. That the changes we've made, this recession's gone on so long, now are embedded in our culture. No one's even thinking about the way it was. In fact, were moving forward and pre-fabbing more than we ever did before, and I think that's going to continue, John.

Okay.

I would say I couldn't possibly agree with Brian more. In all seriousness, when I go and visit companies right now, it's really amazing to me at what they're accomplishing with the resources that they have. I've said before it's been a while, if you had taken me back three or four years and told me what was going to happen, I wouldn't have believed that the organizations that are a part of Comfort Systems would accomplish the things they've accomplished in the markets they're in.

We have been over the last few years in some pretty, I believe, significantly disfavored markets, even within the non-residential construction industry. The places where we have our strengths were some of the places that were the most hard-hit, and I just think we are very well-positioned for when things get better. From a point of view of everything from SG&A leverage to productivity to new processes. I think the only challenge for us is going to be to make sure we ration the capacity we have on price.

Okay. Is there -- I guess as a follow-on to that, are there -- is there any aspect to your business where you need to make investments to position yourself to either take advantage of a sector, or as a way to grow your existing operations within essentially a flat market environment?

I'd say the number one thing -- and this is not a short-term view, but the number one thing we have to be ahead of the market on -- as we view what will happen to the construction market over the next five and 25 years, is modularization and pre-fabrication. That's why we made the investment that we made and were willing to consider a structure we've never considered before in North Carolina to just buy a premier modularization company that will help, we hope over time, our businesses to really be ahead of that curve.

Okay. John, one of the things that exceeded my expectations is EAS, the Company that does the modular work, how quickly they've adopted into our culture and have helped other companies around, I think that's going to really grow. This -- it's been much quicker than I ever imagined.

Okay. Sorry, one other. A couple of some of the larger EMC companies have reported so far -- have mentioned that there's some concern about labor shortages developing, especially in the South, as possibly more out into 2014 with some of the big projects that are planned out there. Is that something that you're concerned about? Is that a factor to think about with Comfort Systems or--?

Well John, I think the labor issues, one for the industry, for the trades in general, for the construction all around the world, actually, it's been coming a long time. The number of youth that are coming into the industry is probably not the number one choice, but having said that, we're doing a lot here to train people, bring them in. I was really optimistic at this San Diego job. The age of the people on that job, and even in management, very young, doing a great job. We are aggressively bringing folks in, training them up, both to work in the field and to manage the field. I think it's a looming issue for the industry, but luckily Comfort's size, we're able to bring some people in and get us ready for that. There is no question as an industry it's a looming issue.

Okay. Great, thank you very much. Appreciate it.

Saagar Parikh, KeyBanc.

First, congrats on a good quarter. Quick question, and I apologize I dropped off the call by accident so I missed the beginning of the Q&A portion, so if any of these questions have already been asked I apologize, but can you talk about the sequential increase in gross margin you had from 2Q to 3Q? I know you mentioned in the beginning portion of your comments that there was a slight positive impact from the large data center project in terms of a change order. Could you talk about that, how much of an impact there potentially was, and what's remaining for the next few quarters?

Sure. The impact was about $0.01. It was -- obviously, that was some of the money we hoped to get. We're still going to pursue more, but obviously there's less of an impact, less debt to get. A lot of factors contributed to the gross margin difference. Obviously, the number one is always going to be companies making money, but as far as on a comparative basis, you quit having the Bank of America data center revenues run through at a zero margin, which changes how things average out. We had -- on a year-over-year basis, we had some negatives last year that weren't apparent in this quarter.

The other thing is we had this same-store revenue decline. By the way, revenue in just a single quarter basis has a pretty high degree of variability for us. If there are no big equipment deliveries in the quarter, there are things that can happen that are pretty benign that can cause revenue swings, but when you have lower revenue, and you still have the profit, obviously, that affects the percentage as well. I think it was just a confluence of those factors, some of which will continue, so they should help, certainly should help margins in the fourth quarter; but apart from that, it's really broad-based. It's not one job or one individual item.

Okay.

Saagar, I just want to jump in because I know some people listening on this call -- we had a lot of folks out there just doing a great job running our mechanical contracting company, in all aspects like cost control, selling the work, and executing it. It's becoming more efficient and productive, so we really want to make sure that they know that we thank them for that.

That's great. You guys have done a great job with that in a down-turn. Looking at the top line, and again I apologize if this question's already been asked in a certain way, but top-line missed consensus, and I know us here at Key and others on the Street, we're baking in that the large data center project would be rolling off, but I think the drop or the miss versus consensus was much more than anyone would have even thought about. I know in the queue you guys mentioned the health care project. Could you just give us more color on that? Was the health care project, or the health care -- you mentioned that health care declined. Was there a push, as Bill just mentioned, was there a push-out there, or was the top line really what you guys expected internally?

Not sure I understood your question. I will say health care was -- if you just looking at the math a bit -- some of our health care jobs had fully closed out or had slowed down over the summer. We also had in a few important companies what we call air pockets. You have a work force that's committed to one job, and then it has to be mobilized to another job, and sometimes there are layoffs and delays in between those. We had a few of those hit in some specific places, where the business did a good job of writing their costs and not turning in bad results as a result of that, but they still, if the revenue's not there, there's nothing you can do with it. I don't know, it's really broad-based, Brian.

I think I have the just -- where we're all trying to go with that question is, was your top line what you guys expected, or was there anything that surprised you? That's pretty much what the question was.

I think from my perspective, we probably thought it was going to be a bit more robust, but we did have some project delays on some pretty large work that when you factor it in, the math isn't going to work for you.

Okay, perfect. Last question on hiring trends. It seems like you guys have -- your outlook's been -- become a little bit more measured versus what it was three months ago or six months ago on when the up-tick was going to happen. Has that followed through on the hiring trends also? Are you guys still hiring or are you looking at direct or permanent hires, temporary hires? What's the trend with that right now?

In general, we're not hiring. We're down probably a couple hundred people in the quarter. We used a lot of temporary work for us over the summer months, which does help your cost, particularly when that project is concluded and you have to send the folks back home. But in general, SG&A, we're not hiring.

All right. Thank you.

Rich Wesolowski, Sidoti & Company.

Thanks, just a quick follow-up. I was wondering if you would comment on the progress of settling the matter with Ferguson. It's been outlined in your last couple of filings.

I would say there were no major developments in the quarter, other than I would say that we're becoming more and more comfortable with the constructive approach that Ferguson is taking, but there aren't any actual factual developments in the quarter.

Is there any way you'd qualitatively bracket the potential liability of the Company, if any?

I don't think so, but I think it's getting better, I guess, would be our sense of what the risks that are there are. It's getting better. Obviously, we've had a quarter or two to see how customers react. We've had really no examples of customers over-reacting to this. We've had a couple quarters of seeing how Ferguson acts when we needed to at least take steps to reassure customers in some cases to take small actions to satisfy them. Ferguson has so far been the kind of partner we hoped they would be. I guess that's about all I have on that.

Great. I appreciate it, and best of luck closing out the year.

Thanks Rich.

Thank you. I would now like to turn the call over to Brian Lane for closing remarks.

Okay, thanks, Matthew, and everyone on our call, thank you very much. We appreciate your interest in Comfort. Like I say, we're in general very pleased with the quarter, and appreciative of the efforts of all the folks out there working for Comfort Systems. We look forward to seeing you all out there on the road here in the near future. Have a great day and a good weekend. Thank you.

Thanks, everybody.

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