Comfort Systems USA Inc (FIX) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2014 Comfort Systems USA earnings conference call. My name is Sara and I will be your operator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Ms. Julie Shaeff, Chief Accounting Officer. Please proceed.

Thanks, Sara. Good morning, everyone. Welcome to Comfort Systems USA's third-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 Reform 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.

Thanks, Julie. Good morning, everyone, and thank you for joining us. I will start with an update on our results and a few comments, and then Bill will take us through the financials in more detail. Then finally, I will discuss factors affecting our results this quarter, our backlog, and our outlook.

During the third quarter of 2014, we had revenue of $370 million and earnings of $0.20 per share. The results for the quarter reflects solid earnings in a majority of our locations, but unfortunately, they also reflect an additional job breakdown on a project at our southern California operation. Apart from this write-down and excluding an unusual gain in prior-year results, our field operating income showed some improvement as compared to the same time last year. Bill will provide more details about our operating results in a few minutes.

Our backlog was $657 million as of September 30 and includes approximately $38 million of backlog from our acquisition of Dyna Ten in May. On a same-store basis, our backlog is up significantly, increasing by $48 million as compared to a year ago. Our free cash flow on a year-to-date basis was $23 million, which is much higher than the same period last year.

Our Board recently approved an increase to our quarterly dividend of $0.06 per share for distribution in November and also increased the shares available under our share repurchase program to 1 million shares. We are continuing our eight-year track record of consistently paying dividend and buying back stock to provide a share of our profits directly to our shareholders.

Although this quarter had its challenges, we continue to see encouraging signs in our backlog and in the underlying business environment. We believe that over the next several quarters, demand for nonresidential construction is likely to gradually increase in a majority of our markets.

I will describe our results and 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. Bill?

Thanks, Brian. If you are online and have access to our slides, you're welcome to refer to slides two through six as I provide some additional information regarding our third-quarter financial results.

Our revenue increased by $20 million compared to the third quarter of 2013. Of that $20 million increase, $18 million resulted from our May 1 acquisition of Dyna Ten in Dallas, with the balance reflecting a small same-store revenue increase.

Net income for the third quarter was $7.6 million or $0.20 per share, down from the third quarter of last year when we earned $11.4 million or $0.30 per share. Our third quarter last year benefited from approximately $0.03 arising from income from prior reporting periods and a $0.02 gain associated with the change in the fair value of an earnout liability.

The two remaining factors that account for the difference are, first, additional disappointing results at our southern California operation where a job loss reduced our EPS by $0.03 per share and, second, SG&A increases for additional resources relating to our service growth initiative and the investments that we are making in IT. If you set aside the job losses in southern California this quarter, our aggregate field operating income was higher than in the same quarter of 2013.

Our gross profit percentage for the current quarter was 18%. Excluding the prior-period adjustment that was recorded in the third quarter of 2013, our gross profit percentage for the third quarter of 2013 would have been 18.6% and the remaining year-over-year decline in our gross profit percentage relates to our southern California results.

The final factor that accounts for the lower earnings per share this year compared to last year was a larger-than-usual subtraction of minority interest, which is a product of remarkably strong earnings 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.

Our total SG&A expense was $52.2 million for the third quarter of 2014, which represented an increase of $2.8 million as compared to the third quarter of 2013, some of which is attributable to our acquisition. SG&A as a percentage of revenue was 14.1% in the current quarter and was flat as compared to the third quarter of 2013.

On the same-store basis and excluding intangible amortization, SG&A expense increased $1 million for the comparable quarters. This increase related to higher IT expenditures and investments in service growth. The comparative impact of these additional SG&A expenses as compared to last year is less than earlier this year because our higher expenditures on service had already begun by the second half of 2013.

We had good free cash flow of $18 million during the current quarter, and with year-to-date free cash flow of $23 million, we are $11 million better than at the same time last year.

Our year-to-date tax rate for 2014 was 35.1%, which is lower than last quarter. The lower tax rate is primarily due to the continued strong performance at EAS, as the 40% minority interest is treated as a partnership for tax purposes.

Before I finish, I want to update you on our stock buyback program. We have been opportunistically repurchasing our shares since 2007 and our Board has increased our authorization many times since we began. During the third quarter of 2014, we purchased 396,000 shares. On a cumulative basis since 2007, we have repurchased 6.4 million shares at an average share price of $11.25.

As Brian mentioned earlier, our Board recently topped off our shares available for repurchase to 1 million shares and we expect to continually and gradually purchase shares, but in a price-sensitive manner.

Despite a few current-year setbacks, we are optimistic about the underlying trends for new construction in a majority of our markets, that they 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.

All right. Thanks, Bill.

First, I will comment on our results, and then I will review our backlog and activity in various sectors and markets.

We experienced strong results in many of our markets, including Wisconsin, Virginia, and North Carolina. Most of our remaining markets are continuing to achieve solid profits, although they are not yet benefiting from gradual economic improvements.

Unfortunately, we booked another loss this quarter in southern California. During the third quarter, we successfully finished and met all meaningful benchmarks on the first and larger phase of our financially troubled prison project. Following that completion, we carefully reassessed Phase 2, which will begin this month and is about one-third the size of Phase 1. And in light of our disappointing performance on Phase 1, we provided for additional expenses to cover Phase 2 costs, and these additional expense accruals resulted in a $0.03 per share reduction in our quarterly income.

Although the majority of Phase 2 will be performed during 2015, we believe that these are prudent steps to ensure that we have fully provided for the money we need to continue to deliver a high-quality product at this site.

Please turn to slide seven. Backlog at the end of the third quarter was $657 million and includes approximately $38 million of backlog from our acquisition of Dyna Ten earlier this year. On a same-store basis, backlog was $619 million this quarter, which is a seasonal decrease of $17 million since last quarter and a strong increase of $48 million from a year ago.

Pricing, while definitely stable, remains competitive overall. At this point, although underlying activity levels are solid, we do not see an increase in bookings that would support meaningful revenue increases in the first half of 2015.

Please turn to slide eight for a look at our end-user sectors. Our industrial and commercial sectors comprised 62% of our revenues for the first nine months of 2014 and are about one-half of our current backlog. Manufacturing represents just over one-quarter of our 2014 activity and includes projects at industrial plants, food production facilities, data centers, and pharmaceutical projects. We are pleased with the existing distribution in trends for our work in the various sectors.

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

Finally, I would like to discuss our outlook from both a near-term, as well as a longer-term, market perspective. Our backlog is showing signs of improvement and we have invested in our future through our service investment and our training programs. We expect to see the benefits from these efforts as market conditions improve.

The current environment suggests that underlying economic conditions will not provide significant revenue lift in the first half of 2015. We currently expect improved bottom-line results as service pays off, SG&A investments move to somewhat lower levels, and our operations achieve incremental improvement.

In the longer term, we believe that our service investments, acquisitions, the signs of improvement in our backlog, together with our belief that gradual strengthening is likely in our markets, will provide improved earnings and growth in 2015 and beyond.

Before I turn to questions, I want to thank all of our 7,100 team members for their efforts. I will now turn it back over to Sara for questions. Thank you.

(Operator Instructions). Tahira Afzal, KeyBanc Capital Markets.

That was very helpful, first of all, and congratulations. Outside of the California work, everything looks pretty good. I guess the first question is, when you do look at 2015 and if we are looking at sort of a 3% to 5% non-residential growth type of environment, could you give -- frame for us what you think the revenue growth could be in comparison if we do see a nonresidential growth cycle in the 3% to 5% range?

I think that we -- I would take the over on revenue in the first half of next year compared to this year, but I think -- I don't see any signs of the significant kind of revenue that we hope for and expect as markets improve.

So I think we will get the kind of a modest revenue you are talking about in the first half of the year. We are still hopeful that we start to get lift. We got a little bit of backlog building and signs of improvement -- real improvement in a couple of markets and good signs of gradual improvement in other markets. So we are hoping to get something incremental to that in the second half of next year. It is just -- unfortunately, there have been a number of times during this recession when we sensed that. The difference now is we are getting at least some help, so we feel pretty good about it.

All right, and second question is on free cash flow. Clearly, you had a very strong quarter again. Could you folks talk a bit about the opportunity set and cash allocation going forward? Clearly, you've issued another repurchase program, but would love to get a sense of opportunities outside of that as we continue to hear about opportunity for M&A in this space.

Yes. So we are actually going to consult very closely with our Board. We do that every November -- in the next few weeks. But the fact that they went ahead and increased -- when we reported our earnings to them, they went ahead and increased the share repurchase program at the same time as they increased the dividend -- I think indicates that I expect them to continue to be supportive of us being willing to go buy our shares when they are a good price.

If you look at what we think the reasonable range is of EBITDA should be for us in the next couple years, and you sort of combine that with our market cap, share repurchase is a good use of our funds, we think.

As far as acquisitions go, we continue to actively work with acquisitions. If you look at this quarter, we got an awful lot of our earnings from companies we bought in the last couple years and we want to continue to provide that incremental lift to developments over time. We think we have good availability. We are prudent. We think about opportunity cost, but we think we have good availability of funds, good capacity to make some more investments.

Adam Thalhimer, BB&T.

In terms of activity levels, bidding activity, can you talk a little bit about what you -- maybe what you saw or how that trended throughout Q3 and what you are seeing thus far in Q4?

Yes. Bidding activity has been pretty strong since probably the spring, very good throughout the summer, and has continued even deep into August. We are seeing good activity. If you look at our backlog, over one-half of it is in that manufacturing and government space, so we are still optimistic with these activity levels that we'll continue into 2015.

Yes. I would agree with that. I would say if you look inside backlog trends and areas that we consider pre-backlog sort of stuff that we don't have the paperwork for, it is as good as I have seen it really in years. So nothing popping off the page, but definite work that is supportive of backlog continuing to at least trend upward.

Gradual and slow improvement continues.

And then, what -- Bill, in the past, you talked about you are bidding a lot of work, but it just feels like clients won't really pull the trigger, the general lack of confidence. And the hope is that confidence improves and maybe the floodgates open and a lot of stuff that you already bid, people say, okay, let's go on this now. Where are we -- obviously, you are still waiting for the floodgates to open, but are you seeing any pockets that clients who are waiting to move forward on projects are moving forward now?

I would say we definitely are seeing some bigger projects in a few markets and we have seen bigger projects in some of the mid-Atlantic, and obviously Brian mentioned that Wisconsin has good stuff going on.

So I would say it is better. It is more than it was, but the reality is most of our companies are not living off big projects right now. They are living off the work that they have been living off throughout the recession.

So we're -- I am hopeful that -- the area -- industrial is good, and the parts of our geographies that have industrial, more and more of our companies are getting involved in it and I love that trend.

The one thing that I think could make a big difference is if medical -- if you look at sort of the healthcare industry, those guys have year-over-year revenue increases that are really virtually unprecedented. They are not building a lot of healthcare facilities.

I think that is a temporary pause. I don't know when it picks up again. But I think if that were to pick up, it would drive everything because until -- over the last couple years, it is industrial -- as industrial became better, healthcare has kind of stopped a little bit, on a relative basis. And I think -- I don't know that that -- I am optimistic that that will pick up at some point, just as the baby boomers continue to age, and at least right now the trends are that a lot more money is going into -- a lot bigger percentage of our economy is going into healthcare. So I think that would be the driver when it comes.

Okay, and just a couple model questions. What tax rate would you use going forward? And then, how should we think about SG&A as a percentage of revenue? What is the right number there once the service initiatives start to wane?

As far as tax rate goes, I don't think we will stay as low as 35% because that is driven down -- what happens is when EAS makes money, their entire revenues are in the denominator of our tax rate, but only the amount of tax we are going to pay, which is on 60% of what they make, is in the numerator that creates that percentage.

And I think they will continue to do well into next year, but I think some other companies -- the proportionality of how well they are doing, they will start to be a more standard part of the mix. So I think we will have a similar tax rate to what you are seeing in the fourth quarter, probably a little higher just because other companies, I think -- I think the mix will change a little bit, will standardize a little bit.

I think next year we will head back toward the more normal tax rate of 38% or 39% because I think EAS will continue to do well. I just think that that will become -- there will be other companies doing well, as well.

But all that's a guess. We pay 38%, 39% on domestic wholly-owned income and we pay 60% of that on EAS. And really, the changes you see in our tax rate drive out of those two factors, except for discrete items in any given quarter. Maybe more information than you wanted.

No. That's really helpful. And then, what about SG&A percent?

SG&A, I think -- if our revenues go up, I think our SG&A as a percent will come down some. I think if you could see greater -- the biggest single variable for next year, we will spend less money in service. There will be less training. There will be hundreds less plane tickets bought as people -- there will just be less of that training. So that will help SG&A by $1 million or $2 million.

But something that moves the percentage for the entire company is going to be -- really, it's going to come from revenues coming up and getting a little bit of leverage. We will pay some more bonuses, hopefully, because we will make more money. But usually that is when our SG&A percentage goes down is when we start to get increases later, hopefully in the next second half of next year.

I think the range you're seeing is the range we will probably be in next year.

Yes. Revenue's the variable on that.

John Rogers, D.A. Davidson.

Couple of things. First of all, I guess, Bill, what are fuel costs right now as a portion of your business?

They're not -- they're actually moving up slightly because as service gets bigger, we have bought more vehicles. You will see a little bit of that in our SG&A.

But it is just not -- it's not an important variable. The monthly bill can be $600,000 or it can be $1 million, but it is not -- we have a single fuel card nationwide. When it is $1 million, it is because it is the middle of the summer and gas prices are high over the last couple years. It'll be lower in the depths of winter and gas prices are a little lower. But it is not an overall important driver.

The other thing is when gas prices are above a certain amount, we charge a fuel surcharge on better than 80% of our trips. And so, that kind of takes away the variability. Most customers let you charge a fuel surcharge if they see prices higher at the pump.

Okay. And the service investment that you have talked about, the $1 million a quarter, hopefully -- I mean, the costs will come down, but you will get a return presumably on that investment, too, in 2015. Is that a $1 million incremental swing in costs or how should we think about that? Is it -- I mean, it should be even more than that if you are getting a profit on the service business, is that right?

Just on -- we should have a cost benefit of about $2 million in 2015. So we had --

For the year or for the quarter?

We were up by -- for the year --

For the year.

For the full year. So what we have said for the last couple years, and it has tracked about what we expected it to, although sometimes it is at different quarters than we expected, we began to -- just on the service part, we had a little over $1 million back in 2012, and back in 2013 and 2014, we had an incremental $4 million in service investment to the year before.

And then, that will come down by about $2 million this year, a big part of that. And that is driven mainly by training. Almost everything we were doing, we're doing for service, we are going to keep doing it, except obviously when you go train 300 people over a brief period of time, we will still have some training, but it will be nothing like that scale. So that gives you about a $2 million improvement for next year.

Having said that, then we absolutely expect, although we (technical difficulty)

We are going to wait a minute or so. If we don't get back online, we will call back into this number.

Sorry. There was technical difficulty there. All right. John Rogers.

(multiple speakers)

John, I don't know how much of that you heard, but it was going to change everything you think about Comfort Systems.

I assumed I was right and I figured I asked the wrong question.

You did.

I lost you, Bill, right when you said -- when you were talking about the service business and the $2 million cost savings, and then you said we absolutely think we will -- and I think you were going to say some earnings benefit, but that is where it cut off.

Yes. I would like to tell you that what I was about to say was that we are going to have an earnings bonanza, but -- actually, I think we said we just hope it will be a source of good news next year, and obviously deeper in the year is when you are most likely to see it. It is a building thing.

Okay. And then, just to the share buyback, at the rate you are generating cash, and, I mean, unless there is another acquisition out there, you should be able to fund the incremental 1 million shares fairly quickly, it looks like. So I guess my question is -- how does your pipeline for acquisitions look like? And I know you assume you will get some over time, but is that reasonable to think we will see more in 2015 or increased share repurchases?

I would say that our pipeline is actually really pretty good. We have some good opportunities. Whether we will get to a deal in six months or a year and a half with these companies -- we have some companies we are talking to that we think are destined to be a part of Comfort Systems. So I think there is good opportunities for acquisitions, and I think at current pricing levels, given our future expectations, we also think repurchasing shares is a really, really good use of funds.

So I think it is sort of subject to what Comfort Systems' stock price does, what feedback I get from my Board of Directors in about three weeks, because we have got some really, really sharp people who advise us on that on our Board who have a lot of experience. And whether some of these acquisitions ripen quickly or ripen over the longer period of time, I do agree we will flow cash and we will have some money to invest. And it is one of the reasons why we raised our dividend a little bit, just to -- that doesn't have a big cash cost, but we feel like we owe our shareholders a return.

Okay. But there is no change in the cash flow dynamics. In other words, as the construction business hopefully picks up, maybe by the second half of 2015, it won't consume an undue amount of working capital?

It would have to surge the way it surged in 2007. If it did, we would have a big investment in working capital. But we have a good credit line and, I don't know, we (multiple speakers)

We don't see that surge, John.

Yes. With gradual increase, I think we --

To be honest.

We have a little CapEx going on because we have got service starting to grow and we have an old fleet, but that doesn't really move the meter. Neither does -- I mean, as far as being able to invest. It doesn't make the difference. And same thing, unless we really start to see an increase on the construction side, it is just not an important variable as far as cash planning.

All right, great. There are no further questions in queue, so I will turn it back over to Brian for closing remarks.

Do we give John a minute? He said he was getting back into queue.

We'll wait for John if he wants to ask another question. Go ahead, John.

The other thing that -- I get your message, Brian, on not a strong rebound in terms of construction activity. But if you look out over the next couple of years, and with the service business in presumably -- I don't know what normal is, but a better construction market, remind me again where you see the balance of the business now. Service, maintenance, and (multiple speakers)

Our goal, drive revenue to $2 billion, have a nice balance 50/50. That has been our goal over the last few years and that is what we are driving to. We get a mix of construction and service that both have grown, if the percentages don't change because construction went down and service did this, but they both have been increased to contribute equally.

And that is still a high teens gross margin, mid single-digit operating margin?

Yes. We have not changed that, what we have talked about for the last few years. That is our goal. We think that is achievable.

All right, great. There are no further questions, so I will turn it back to you, Brian, for closing remarks.

All right, Sara. Thank you. Thanks for listening to our call, everybody. We really appreciate it.

We are poised for growth by investing in service and we are ready for construction markets -- for growth in it as those markets improve. We are very optimistic about the future of Comfort and I think we are doing all the right things for this to be a long and prosperous company. Hope everyone has a safe and happy Halloween and we will see you on the road soon. Thank you.

Thanks, everybody.

Ladies and gentlemen, that concludes today's presentation. You can disconnect and have a great day.