Comfort Systems USA Inc (FIX) 2014 Q2 法說會逐字稿

Good day to you, ladies and gentlemen and welcome to the Q2 2014 Comfort Systems USA earnings call. (Operator Instructions). As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Julie Shaeff, Chief Accounting Officer. Please proceed.

Thanks, Karen. 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 most recent Form 10-K and 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.

Okay, thanks, Julie. Good morning, everyone and thank you for joining us. I will start with an update on our results and comments about recent events and then Bill will take us through the financials in more detail and finally, I will discuss backlog and the outlook for the rest of the year. During the second quarter of 2014, we had revenue of $363 million and earnings of $0.12 per share. The results for the quarter are disappointing and reflect additional job write-downs at our Southern California operation.

In addition, our SG&A increased this quarter due to our planned incremental investment in service and information technology that we have been discussing since 2013. Apart from these factors, our field operating income was approximately the same as last year. Bill will provide more details about these factors in our operating results in a few minutes.

On a positive note, our cash flow was very strong and we have the largest backlog increase on a same-store and year-over-year basis since the beginning of the recession. Our backlog was $674 million as of June 30, 2014 and includes approximately $43 million from our recent acquisition of Dyna Ten, which expanded our footprint into the Dallas and Fort Worth markets. We have owned Dyna Ten since the beginning of May and I couldn't be more pleased with the resources, capabilities and teamwork that they bring to Comfort Systems.

As you may recall, last June, we increased our credit facility from $125 million to $175 million. Last week, we amended our credit facility to further increase the capacity from $175 million to $250 million and extended the maturity to 2019. This new arrangement will allow Comfort Systems to have the continued financial flexibility to prudently invest in our future. Although this quarter had its challenges, we have seen encouraging signs in our backlog and cash flow this quarter was terrific. We believe that over the next several quarters demand for nonresidential construction is likely to gradually increase in a majority of our markets and as a result, we are optimistic about 2015 and beyond.

I will describe our outlook in more detail in a few minutes, but before I get into that, let me turn this call over to Bill to review the details of our financial performance.

Thanks, Brian. If you are online and have access to our slides, you are welcome to refer to slides 2 through 6 as I provide some additional information regarding our second-quarter financial results. Total revenues increased by $12 million compared with the second quarter of 2013 with $10 million of that increase resulting directly from the two months that we owned Dyna Ten this quarter. Without that acquisition, quarterly same-store revenues increased by approximately $2 million.

Net income and EPS were below expectations. Net income for the second quarter was $4.4 million, or $0.12 per share, down significantly from the second quarter of last year when we earned $7.8 million, or $0.21 per share. The two biggest factors that negatively impacted our earnings per share this quarter as compared to last year were, first, additional disappointing results at our Southern California operation where job losses reduced our EPS by $0.03 per share and second, SG&A increases relating to our service growth initiative and the investments that we are making in information technology with those SG&A increases accounting for a reduction of $0.03 in EPS compared to our expense levels of last year.

We also experienced a reduction in our EPS of $0.01 from a small goodwill impairment as we determined that it was appropriate to write off approximately $700,000 of goodwill relating to our Southern California operations. That was the entire remaining goodwill balance on our books relating to that operation.

I think it is important to note that if you set aside the job losses and goodwill impairment in Southern California this quarter, our aggregate field operating income was virtually the same in the second quarter of 2014 as it was one year ago. In fact, our gross profit percentage this quarter, which is 17.1%, is identical to the 17.1% gross profit percentage that we reported one year ago. We had hoped that we could cover the increase in SG&A from improvements in operating results and we did not expect the losses that we experienced in California. On a broad basis, apart from California, our operating locations are earning profits at the same levels as 2013.

The final factor that accounts for the lower earnings per share this quarter compared to last year was a larger than usual subtraction of minority interest, which is a product of very strong results at our partially owned North Carolina subsidiary, Environmental Air Systems, or EAS. When EAS does well, 40% of the income goes to the minority owners.

Switching to SG&A details, our total SG&A expense was $50.6 million for the second quarter of 2014, which represented an increase of $4.9 million as compared to the second quarter of 2013. SG&A as a percentage of revenue increased from 13.0% during the second quarter of 2013 to 13.9% during the second quarter of 2014.

On a same-store basis and excluding intangible amortization, SG&A expense increased $3.9 million for the comparable quarters. This increase is primarily related to the incremental investments in service growth that we discussed throughout 2013 and higher IT expenditures as we implemented a couple of important initiatives to improve our basic IT infrastructure.

2014 is the year that our strategic investment in service is expected to peak and we continue to expect that our combined investment in service growth will be lower by approximately $2 million in 2015. Although that spending is subject to adjustment as we assess the traction we are getting in the overall initiative. We had very strong cash flow of $18 million during the second quarter, which was a big increase from $3 million in 2013.

Finally on financial details, I want to point out that our year-to-date tax rate for 2014 was 37.4%, which is down slightly. The improvement in our tax rate is primarily due to strong performance of EAS as the 40% minority interest is treated as a partnership for tax purposes.

Before I finish, I want to note a few details about our acquisition and the increase and extension of our credit agreement. As I previously mentioned, we closed the Dyna Ten acquisition in early May and two months of their results are included in the current quarter. Dyna Ten is off to a good start having added $10 million of revenue and good gross margin and field level profitability. As expected, amortization of intangible assets and other fair value adjustments related to the contractual terms of the transaction resulted in offsetting expenses that meant, as expected, the Dyna Ten effect on EPS was neutral.

Also, as Brian mentioned in his opening remarks, last week, we amended our senior credit facility to increase it substantially from $175 million to $250 million and to extend the maturity to more than five years from now with the facility now set to expire in the fourth quarter of 2019. The terms, covenants and conditions of this arrangement are substantially similar to or improved from the prior agreement with continuation of very good financial terms for borrowings and letters of credit, to very reasonable covenants, additional acquisition flexibility and improvements in our already very favorable terms regarding returning money to our shareholders with dividends and buybacks. We currently have $50 million of borrowings outstanding under this agreement and as of today, the interest rate we are paying on those borrowings is approximately 1.5%.

Despite a disappointing first half of 2014, we remain optimistic that the underlying trends for new construction in a majority of our markets are gradually improving and we believe that our investment in service growth will turn out to be money well spent. That is all I have on financials, Brian.

Thanks, Bill. Let me start with backlog and activity in various sectors and markets. Please turn to slide 7 and we will start with backlog. Backlog at the end of the first quarter was $674 million and it includes approximately $43 million of backlog from the recent acquisition of Dyna Ten. On a same-store basis, backlog was $630 million as of June 30, 2014, which is an increase of $18 million since last quarter and an increase of $40 million from a year ago.

One thing that I find encouraging is that we are seeing modest increases in backlog in various geographies throughout the US and this increase is not the result of a few large projects at a handful of locations. It truly is broad-based. Pricing, while relatively stable, is still competitive overall, even in markets where we are starting to see signs of increased demand. At this point, although underlying activity levels are solid, we do not see an increase in bookings that would support meaningful revenue increases in 2014.

Please turn to slide 8 for a look at our end-user sectors. Our industrial and commercial sectors comprise 61% of our revenues for the first half of 2014 and 45% of our current backlog. The largest sector continues to be manufacturing, representing just over a quarter of our 2014 revenue to date and includes projects such as industrial plants, food production facilities, data centers and pharmaceutical projects. We are seeing a slight increase this quarter related to the amount of institutional work in our backlog and this is primarily due to the fact that Dyna Ten does a significant amount of work in the healthcare area. Overall, we are pleased with the existing distribution and trends for our work in the various sectors.

If you will please turn to slide 9, you can see our current revenue mix. Pure service, which is maintenance and repair, was strong at 18% of revenue for the first six months of 2014 and service, repair and retrofit together again exceeded 50% of revenue. Our service businesses are producing good results and our maintenance space has increased by approximately 6% since year-end after a very strong 12% increase in 2013.

Finally, I'd like to discuss our outlook from both a near-term, as well as a longer-term market perspective. We are disappointed in our results for the first half of 2014 and although we expect to be solidly profitable for 2014, our full-year earnings per share will be lower than we reported for 2013. On a longer-term basis, our backlog is showing signs of improvement and we have invested in our future through our service investment and our training programs and we expect to see the benefits from these efforts as market conditions improve. We are optimistic that our investments and the signs of improvement in our backlog will provide life in 2015 and beyond.

Finally, I'd like to thank all of our 7300 team members for their efforts. I will now turn it back over to Karen. We would be happy to take questions. Thank you.

(Operator Instructions). Tahira Afzal, KeyBanc.

Good morning, gentlemen. This is Sean Eastman here on behalf of Tahira.

Okay, good morning.

How are you?

I'm doing great, thank you. So my first question is just with regards to the strong free cash flow in the quarter. I mean obviously this is good to see, but we are just wondering how you are thinking about a sustainable run rate and free cash flow versus net income going forward?

So I will take that question. So this was a great second quarter. Honestly, I don't know that -- it is probably our best second quarter ever and really gratifying. The cash flow, where it came from, the biggest factors in the increase in cash flow in the second quarter were good collections at EAS, which is always lumpy because they do a lot of offsite construction where you get paid at one time when you deliver big items and Colonial Web.

The other factor that is apparent in our cash flow right now is, historically, we would get more than half and sometimes a lot more than half of our cash flow for the year in the fourth quarter. The last couple of years, we have trended away from that because we have been doing less large construction projects that tend to close out and get paid in the fourth quarter. A much higher proportion of our work now that the US isn't building as many buildings is service work, which sort of pays ratably over the year.

So we feel great about cash flow for the full year certainly well exceeding last year. I don't think you will see the same pattern where you have -- 18 probably is a special quarter this year. We will still have a good fourth quarter, but it won't be proportionately as good as other years, but I think we feel great about our cash flow trends for this year.

And as far as your other question about how it will relate to income, we should cash flow actually a little better than our after-tax income over time just because our cash tax rate is a little lower than our reported tax rate. So if the backlog continues to go up, you might see next year that our cash flow is less than our income just because we would have a net investment in working capital as our revenues started to go up. That has historically been what has happened. But other than that, within a few months, plus or minus, we should be cash flowing our net income.

All right. That's very helpful. Thanks very much. And just as a follow-up to that, based on the strong outlook for free cash flow going forward, what can we expect with regards to capital allocation between dividends and acquisitions? And do you expect the profile of your acquisitions to remain a smaller niche like we've seen in the past or could we see a more transformative move in the future?

Smaller niche is in the eye of the beholder. In our industry, the deal we did this quarter is a pretty big deal for us. But having said that, I think our goal would be to continue to buy the best companies in the attractive geographies that we are not in. One of the reasons we went and significantly increased our borrowing capacity is to make sure that we can continue to do that, but we will be opportunistic. I think our Board is currently still very interested in getting -- continuing to get cash to our shareholders. Our buyback in the first quarter -- we didn't do any buyback. I think we bought 6,000 shares. That doesn't mean we won't do buyback opportunistically throughout this year.

One of the things we did was we just -- this credit agreement has additional flexibility for buybacks where the first -- if you looked at it -- it is available online because it is on the SEC website -- the first $25 million we spend on buybacks doesn't count against our covenants. We have a basket to do that and then also our new credit agreement gives us greater flexibility to increase our dividend. And then obviously we've got additional acquisition flexibility. You heard -- so I think we want to -- our goal is to grow, but to be very prudent about it and I think we will do whatever the market gives us and whatever we think will benefit our shareholders the most.

Okay, that's helpful. Thanks very much, gentlemen. Have a nice day.

Thank you.

Adam Thalhimer, BB&T Capital Markets.

Hey, good morning, guys. Can you talk about margins in the back half of 2014 a little bit? I mean you are up against a tougher comp. You had some pretty good margins in the back half of last year, 18.6% gross margins. Can you be flat there?

I don't -- we are up against a good comp. Our tough comps were the second and third quarter of last year where we beat earnings by as much as we missed them this quarter unfortunately. Having said that, I think normally the last three quarters of the year we have higher gross margin. I think that is true this year. Last year in the third quarter, we had some special events that happened where we had $0.03 of out-of-period income that ran through that line. So I think that would be a tough thing for us to do this year. I don't think we feel like the first half of the year is a reason to be pessimistic about the second half of the year.

Adam, this is Brian. If we look at what the market is out there, they are about stable, they are up a little bit. Bill alluded to a couple of one-off events, but our margins should be good for the rest of the year.

Okay. And then, Brian, in your prepared remarks, you mentioned that, even in markets where demand is improving, you're not seeing much pricing momentum. And I just wanted to ask about that because part of the story was that, with so much capacity taken out as bad as this nonres downturn was, that when demand comes back, maybe even a little bit, you would start to get some pricing. So I am just curious why you are not seeing that.

I will start by saying we are anxious for pricing to improve and we are ready for it, no question. We had some capacity go out, but until people have confidence that they can keep their workforces busy, as far as they can see out, margins are going to stay pretty competitive. But they will improve over time. I just think that this is a very slow recovery and margins are going to be the last to react to improvement. Bill, do you want to add anything to that?

No, no, I think we see signs of improvement in selected markets, but it's gradual. Keep in mind, we are a late cycle player, right? So there has been -- the first half, there was a delay for everybody else and we are a late cycle player, so naturally there is going to be a delay for us.

Okay, thanks, guys.

John Rogers, D.A. Davidson.

Hi, good morning. (technical difficulty) the name of the company that you acquired in Fort Worth, was that dilutive or accretive in the quarter?

It was neutral.

It was neutral. And Bill, are you expecting it still to be neutral this year for the remainder of the year?

I think the weighted likelihood is that it will be neutral for the year. I don't think it will hurt us at all. I think if we got some help from it, it would be almost -- it would be difficult to measure. I will give you a little more on that. Their gross profit margins, their gross margins are similar to Comfort as a whole, which actually means they are doing very well because they have less proportionate service. But they actually -- the gross margins that they are contributing in this quarter and for the next few quarters will appear lower because the amortization of intangibles related to backlog runs through cost of goods sold. It runs through a line that reduces the gross margin.

So the two effects you are going to see in the numbers just at the margin is that they do depress the way that gross margin gets reported because you have an intangible running through that line and the biggest intangible at first always is your backlog amortization and then most likely based on two things, one, amortization of intangibles and very strong contracts that we enter into at the time we close deals where they guarantee how the jobs that are ongoing will do, but we let them have the upside. It is just sort of a practice we have that we think is prudent, sort of keeps them from having upside surprises for the first couple of quarters -- or downside. By the way, it also insures us against downside surprises.

Yes, okay. I appreciate, Brian, your earlier comments just on allocating for acquisitions, but what does the pipeline look like? Are there deals out there to be done? I know you are always generally out talking, but do you expect the activity to pick up?

This is Bill. So I run the acquisitions. I would say that we probably don't have another Dyna Ten in this calendar year in us. We would be open to that, but we have long lead socialization and due diligence times when we do deals like this. And I would say I think we will have a couple of small -- we have reasonable prospects of a couple of small acquisitions. We have a couple of good prospects we are working hard with, but as far as something that would close and certainly something that would close in time to affect numbers you are putting in your model for this year, that is probably not something -- Dyna Ten is just a month or two old; it is our third biggest deal in the last 10 years. It is probably the biggest deal we will do this year.

And Bill, if I look back over time, I think acquisitions have been 3% to 5% of your growth annually and obviously less in recent years. But is that a good sort of long-term expectation?

Our long-term plan, the plan that we have agreed with our Board and that management gets measured on, is that we need to accrete $100 million of good acquisitions per year. And we have averaged that since 2010, but some years we have had zero and some years we have had double that. So I think that that is the best guideline I have for you. I think that is what we think we can do, that is what we think we can effectively bring in, but it is going to be very lumpy in our industry. For example, if markets pick up the way we think they might in 2015 or 2016, our 15-year history is that it is hardest to do acquisitions at the top of the market because when you pay 5, 5.5 times EBITDA and a guy's EBITDA is twice what it averages, he is going to keep it, you know what I mean? He is going to keep it for that good year. So it depends. If markets stay weak, we will get some deals done. If markets take off, it might be harder.

Okay. But that would still imply acquisitive additions of 6%, 7% to revenue.

That's the plan.

Yes, yes.

That's the plan.

But prudent, John, we are just not --.

No, no, I am trying to look out more than just the next year or two. All right, thank you. I appreciate it.

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

Okay, Karen, thank you. Everybody, thanks for listening to our call. We appreciate the interest in the Company. We really do feel good about the balance of the year, working hard to recover as much of our position as we possibly can. Excited about the service investment and what we are seeing there in terms of results we are getting so far and optimistic about the backlog will continue to grow. Hope you all have a good day and we will see you on the road soon. Thank you.

Thanks.

Thank you, ladies and gentlemen. That concludes your conference call for today. You may now disconnect. Have a good day.