Comfort Systems USA Inc (FIX) 2018 Q3 法說會逐字稿

Good day, and welcome, everyone, to the Quarter 3 2018 Comfort Systems USA Earnings Conference Call, hosted by Julie Shaeff, Chief Accounting Officer. My name is Sheila and I'm your operator for today. (Operator Instructions) I'd like to advise all parties, this conference is being recorded for replay purposes. I'd now like to hand over to Julie. Please go ahead.

Thanks, Sheila. Good morning. 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 Act of 1995.

What we will say today is based on the current plans and expectations of Comfort Systems USA.

Those plans and expectations include risks and uncertainties that might 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 most recent Form 10-K and Form 10-Q as well as in our press release covering these earnings.

A slide presentation will accompany our remarks. The slides are posted on the Investor Relations section of the company's website found at comfortsystemsusa.com.

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

Okay. Thanks Julie. Good morning, and welcome to our third quarter earnings call. I want to start by thanking all our Comfort Systems USA employees for their hard work and dedication.

I'll cover the detail -- I'll cover the highlights of the quarter, and Bill will discuss the financial results in more detail. Thanks to superb execution by our field teams, we are happy to report our best-ever quarterly results. We earned $1.02 per share this quarter, which is the first time in our history we have exceeded $1 per share in a quarter.

Revenue for the quarter was $595 million, another quarterly record and a 24% increase compared to the third quarter of 2017. Profits improved substantially and our operating income for the first 9 months of 2018 has already exceeded last year's record full year operating income.

Free cash flow for the quarter was also strong and our cash performance this quarter and year-to-date bodes well for the health of the underlying work. We are on track for very good cash flow performance in the fourth quarter and next year. We have had positive free cash flow for 20 years in a row.

In light of our strong results and cash flow, our Board of Directors raised our dividend again this quarter, increasing it to $0.09 per share. We remain committed to using our cash flow to invest in our existing business, add great companies and return capital to our shareholders.

Robust construction activity continues in the majority of our markets, and our backlog has increased by a remarkable $300 million since this time last year. Overall, I am very optimistic about our prospects going into next year.

I'll discuss our backlog and outlook in more detail in a few minutes. But first, let me turn this call over to Bill to review the details of our financial performance. Bill?

Thanks, Brian. Please refer to Slides 2 through 6 as I provide some explanations and details of our results.

Revenue growth accelerated this quarter as we reported $595 million in revenue for the third quarter of 2018, which is an increase of $114 million or 23.6% compared to the third quarter of 2017. Our same-store revenue increased by $87 million. So same-store revenue increased by approximately 18%, driven by strong increases in construction project activity.

Gross profit was $128 million for the third quarter of 2018, an increase of $27 million or 26.8% compared to the third quarter of 2017. Gross profit as a percentage of revenue increased by 50 basis points from 21% in the third quarter of 2017 to 21.5% for the third quarter of 2018. And that increase is a remarkable accomplishment in light of the revenue growth.

SG&A expense was $75 million for the third quarter of 2018 compared to $67 million for the third quarter of 2017. The modest dollar increase reflects our recent acquisitions and an increase in bonus accruals. SG&A leverage benefited this quarter's results as our SG&A, as a percentage of revenue, decreased from 13.9% in the third quarter of 2017 to 12.7% for the third quarter of 2018.

Pretax income was $52.1 million for the third quarter of 2018, an increase of $16.3 million or 45% compared to the third quarter of 2017. In light of the change in tax rate, I believe that the 45% increase in pretax income is a good indicator of the underlying performance improvement achieved by our operations.

Income tax expense was $13.6 million with an effective tax rate of 26.1% as compared to income tax expense of $13.6 million, exactly the same last year, with an effective tax rate of 37.9% for the same period in 2017.

Net income for the third quarter was $38.5 million or $1.02 per share compared to $22.3 million or $0.59 per share for the third quarter of 2017. So to illustrate the effect of the new tax rates, our profits increased by 45% before tax. But with the help of tax reform, they increased by 73% after tax.

Free cash flow was $23 million for the third quarter of 2018 and that compares to $39.5 million a year ago. Our 9-month free cash flow is $47 million, which compares to 46 -- $49.6 million for the first 9 months of 2017.

During the third quarter, we repurchased 85,000 shares. And so far in 2018, including purchases we have continued to make since the quarter ended, we have retired over 350,000 shares and we have returned more than $16 million to our shareholders via stock repurchases.

In summary, the third quarter of 2018 was marked by revenue growth, margin expansion and SG&A cost discipline, leading to exceptional overall performance.

That's what I have on financials, Brian.

All right. Thanks, Bill. I am going to spend a few minutes discussing our backlog and activity in various sectors of the markets. These are covered on Slides 7 through 9. I will then comment on our prospects for the rest of this year.

Backlog is very strong. Backlog at the end of the third quarter of 2018 was $1.25 billion. On a same-store basis, our year-over-year backlog increased by $319 million or 35%, growing from $900 million to $1.2 billion. These increases are broad-based and are distributed over most of our companies.

Sequentially, same-store backlog is barely down, but that is a positive trend for a third quarter when we typically experience a heavy burn. Virtually all of our end-use segments remain solid. Institutional markets, which include government, health care and education, made up 40% of our revenue for 2018. The commercial sector was 35% of our revenue, and industrial continues to be strong and has now increased to 25% of our business.

Please turn to Slide 9 for our current revenue mix. For 2018, construction is 73% of our total revenue with 38% from construction projects for new buildings and 35% of construction projects in existing buildings. Our construction business is benefiting from good fundamentals and trends in nonresidential construction markets. We are booking good projects, including many for next year.

Geographically, we experienced strong results in most of our markets with particular strength in the Mid-Atlantic, the Upper Midwest and the Northeast. We continue to reap benefits from the investments we have made in our service business. Our service business exceeded the third quarter of 2017 in volume and profits. Service is 27% of our revenue with service projects providing 9% of total revenue and pure service, including hourly work, providing 18% of revenue.

Overall, our backlog and pricing environment remains supportive and we are optimistic about the fourth quarter and our 2019 prospects.

Thank you, once again, to our 900 -- [9,800] employees for their hard work and dedication.

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

(Operator Instructions) The first question comes from the line of Bill Newby of D.A. Davidson.

I guess, just to kick it off. I mean, Brian, with backlog up where it is, I mean, it doesn't -- you guys have grown that through the summer, which is pretty unusual for you guys. I mean, as you look into 2019, are you thinking, I don't know, mid- to high single-digit growth on the revenue line should be pretty achievable? I guess how are you thinking about it into '19?

Yes, Bill. That's what -- that's exactly what we're thinking. With the backlog we already have committed for next year, I think Bill and I both agree mid- to high single-digit growth going into 2019 is what we're expecting.

And for the last quarter or 2, we've gotten significantly better than that. But we did have -- we do have one factor affecting that, which is we have a subsidiary in North Carolina that had extraordinary growth. They have accounted for more than 1/3 of that growth by themselves because there was a slow year last year in the markets of North Carolina, and then they're hitting a record year this year. So they doubled up. That factor can't continue. So that's why we're saying mid- to high single digits is the most reasonable outlook.

Yes. We'd be pleased if we got mid- to high single-digit growth.

Yes.

Okay. And then, I guess, on the margin line, I mean, I'm a little surprised to see the strength this quarter, just given how much construction is coming into the mix versus service. Is -- I mean, any color on what's driving that? Obviously, execution and mix is helping you out. But how sustainable is this margin going forward?

Bill, I've looked at that gross profit number for every day for a month now and it's fantastic no matter how you look at it. And it's a real tribute to the folks out in the field that are doing the work. They're just performing exceptionally. They're well-trained, they do it safely and serving our customers, which helps drive the results. So we're just really pleased if we could hover around that number for a while, but it's just fantastic performance. And also we've had an absence of bad news that we've had to report. So a combination of good pricing, good execution and lack of bad news gets you good gross profit. Bill, do you have anything you want to add?

No.

And just a little bit more on that, guys. I guess -- I mean, part of that has to be this, I guess, tick-up in industrial and health care. I guess, 2 end markets that you guys have pointed out in the past as being kind of higher-margin work for you guys. Do you see the strength there continuing? Any thoughts there?

So I would say that you're absolutely right. That's a big part of it. Medical's come back some. It's still far off of what it really was for most of the time I've been at Comfort Systems as an opportunity and as a proportion of our revenue. But industrial, if you look at -- if you were to look -- if you look at over time at how much more industrial we've been doing, it's a combination of really -- it's the acquisitions that we've done over time have just had more industrial in them and especially the one that we just did in Indiana this year. They're just fantastic in that segment of the market. Virtually 100% industrial at the moment. And then one of the reasons it was such a big leap year-over-year is that company that I mentioned in North Carolina that had a lower revenue year last year and is setting a record this year, they have proportionately more industrial than our average mix across the company. So you'll see the numbers -- we have -- they've really popped up but I think the new levels that they're at are more what you're going to see in the future because its compositional and I think Comfort is changing, and we're becoming more industrial. We're having a bigger segment of our company that's industrial.

And Bill, also service has actually grown in real dollars, both within volume and profits. So that's helped, too.

And the next question comes from the line of Adam Thalhimer of Thompson, Davis.

Can you -- along the same lines on the gross margin side, can you give us any sense for the composition of your portfolio of large projects? And when you look at it as a whole, do you feel like we're early in the large projects still? Or are they starting to mature and contributing on the gross margin line?

So if you were to look at the percent complete across our POCs, it's sort of below and neutral. But it's -- we're earlier in the projects than because a lot of them have started, right? We haven't been doing them for that long. So, we won't -- for example, we won't have as many closing out at the end of this year as you would expect next year, like in a robust market that's been around for longer. As far as the composition, I would say there is more -- that the industrial work that's there's more of, it turns a little quicker. It's a higher percentage of the total job is with the owner. That's one of the reasons it can be more profitable. So in some ways, it's easier to understand, manage and forecast. Although this business is almost impossible to forecast. So I don't know if that helps. But I would not say that we're any -- if you look back in times in our history when we had a lot of big work going on, we're nowhere near where it was at times in our past, as far as the percent of our work that's big project. By the way, I'm not predicting we're going to get back to those levels. But our business, we've more than doubled our service business. We've strengthened our small projects business. The industrial mix that we've brought in has a lot more of like small and in-plant [broad] work like $1 million or $2 million. We have more controls. Our controls business has grown. We have some electrical embedded in some of our companies. So we're just a more mixed company, which I think is very healthy.

So best guess, maybe middle of next year when you would start to say that you're -- in terms of the percent complete in your POCs, will you be above average?

I'd say, it'd be closer to the third quarter or fourth quarter, Adam.

Okay, and then your North Carolina subsidiary. How does their backlog look? And what will be the expectation for revenue from them next year? Kind of flattish year-over-year?

I think they'll have another year like this year. They're backlog's fantastic, by the way. So our backlog sequentially was down $7 million. They're more than all of that. By the way, a number of our companies can be more than all of that. But there -- if you were to just back them out across the rest of our company, we're up, and we're up noticeably, $20 million or $30 million. And they, their backlog's still the second highest it's ever been. They have $150 million backlog. That's double their average in the last 5 years. So it's not as if it's healthy for their backlog to moderate a little. That has to happen sometimes when you get this busy. So I would say, one of the reasons we're pretty positive about 2019 and we're willing to talk about 2019 a little earlier and just say, "Look, we think it will -- should be another really good year" is because our backlog's really, really good.

Okay. And then lastly, Brian, I was just going to try to push you on the regions. I mean, the only -- if you look at the September ABI report, the only region that shows any weakness is the Northeast. But you said your bookings were good there. I mean, ABI looks fantastic in the Midwest and the South. I mean, what are you seeing by region?

I think we've seen a broad-based -- pretty strong. It's been pretty interesting. For us, the Northeast has always been our strongest region historically. Just got great companies up there. They got a fair share of the work. So I know the ABI is down, but our workload there is still very strong. We've got really good companies up there, Adam, too. This is exceptionally-run companies.

And the next question comes from the line of Tahira Afzal of KeyBanc.

So folks, obviously, your free cash flow remains very strong. The overall macro environment for yourselves looks strong. Obviously, the stock market, in general, is saying something else. And you guys have bucked that trend now for 2 days. But is there a chance you could get more proactive in terms of buybacks given the disconnect between the 2?

We have gotten more proactive in buybacks over the last -- 350,000 shares at this point in the year is -- that's way more than -- that's just -- that's more than -- far more than covers our dilution. I think that we should see very good cash flow in the next 6 months. We'll be together with our board here in the next week or 2. But I think between acquisitions and buybacks, there's no point in us earning this cash and not finding ways to benefit our shareholders. So what we won't do is go borrow a bunch of money to do buybacks. But we don't need to.

Right. And Bill, just talking about that. I mean, obviously, the optics of operating performance for next year seem to be shaping up well. You have a tough tax comp into next year. Between buybacks and between really organic and acquisitive strategies, do you think you can offset that on the EPS side?

So it's early -- it's very early for us to get to a point where we're talking about getting very specific about next year. I think our sense is, next year ought to be another great year. There's a range of what that could mean. But I will say, we do have some things going for us. We -- even -- we have acquisitions if we do them right. They're not that accretive, but we have the acquisitions we've done in the past. The amortization on those acquisitions continues to come down a little bit. The shares we've bought back already have not fully baked into our fully diluted, although those are all small things, but they all help. So there are things that will help us and with another good year. That should be helpful as we go into next year. It's really too early for us to give directional guidance. It's actually -- for us to be this positive this early is out of the ordinary for us.

Yes, and what we're really basing it on, we have a good backlog going into next year, Tahira. So I feel good.

Got it, okay. And Bill -- Brian, if you look at -- what should we be watching through that -- we should view as red flags? It's always tough to call these turns, both for the positive and negative, but are there things that would get you a little more defensive in your strategy going forward?

So I would -- as far as what to look for, the gyrations in the residential market, I don't think are very good indicators for us. They haven't been in the time I've been CFO since 2005. The broader market, like businesses' willingness to make capital investment, is really what's going to drive us at the margin. And as far as what to look for going forward, we -- and becoming defensive, we're kind of always defensive. And I will say acquisitions, it's a moment in time where you've had a few good years where you have to be very careful to maintain your discipline with acquisitions. So we like our chances. But I will say we're only going to do a deal if we have conviction about it. That's the area where we'd be defensive. In all other areas, we just go take what the market gives us, and right now, it looks like it's going to give us a chance to make some money for little while.

Our structures, Tahira, we are in many parts of this country. So that gives us some protection, in that not the whole country would have trouble at the same time.

That's a good point.

And we have industrial. We doubled our service business. So...

So we've got some protections going forward if things hit the skids.

And the next question comes from the line of Joe Mondillo of Sidoti Company.

Most of my questions were answered. But I just wanted to ask you on pricing. As we progress throughout this year, it seems like labor shortages and wages, inflationary environment, the environment overall in terms of construction demand, all of it seems like it has escalated. So has -- and over the last 2, 3 years, you guys have consistently sort of said, "yes, we're starting to get a little pricing, starting to get..." Have we gotten to a point where things are started to go exponentially at all or starting to really start to escalate on pricing? And are you seeing the net benefit of that? Or how is that pricing environment been progressing?

Yes. I mean, the pricing environment has been good. It's been good across the country. You're right. There is -- there's going to be wage increases this year. No question about it. We're able to pass them along. But a lot of what's going on, as well as pricing, is the improvement in productivity and the application of technology that we use, and whatever it's been, Trimble, et cetera, et cetera, and all the training we do. So it will offset some of these costs in the future, for sure, as one way to help with that. But Bill, you want to add onto that?

Yes. The one thing I'd say about pricing is it's a busy market and our guys are pretty full. So for them to take new work, they have to be happy with the pricing when they get in it. They're working their people pretty hard. They care about their people. So I'd say our opportunity's very good on pricing.

And one thing you get, Joe, is when there's a lot of work out there, you can be a little bit more selective and do the work you're good at. And guys are good at a lot of the work. So they're able to pick a little bit what their strength is.

Is this the ideal sort of environment right now, where you can get a widening spread between the price that you bid a job on versus the cost that requires you to complete that job? Or not so much?

No. That has been -- that is describing what's happened over the last 18 months, right? We're at gross margins, frankly, we didn't necessarily ever think we'd see. That is exactly why. As far as how far that can run, that I don't know. I mean, we -- like I said, there are a lot of things -- there are a lot of secular things, like energy in the U.S. and offshore having run its course and lower, a more competitive tax rate, a more competitive sort of receptivity for capital and sort of worldwide capital allocation decisions that make me feel -- make me wonder if it -- if anybody ought to be getting too negative right about now, at least about the verticals, the Main Street, the nonfinancial center verticals we're in. But man, that's just -- that's predicting the future.

Yes. Right now, there's a lot of work out there to do, Joe.

Okay. And sort of, I guess, to touch on maybe the negative component to everything. Tahira might have asked this question, but I think I might have missed it and maybe it didn't go into much detail. But just in terms of the environment right now, I mean, I went back historically, I don't know if I could find a period of time where you're seeing backlog up 35% year-over-year. We're starting to see higher interest rates. The cost to build in terms of labor, materials -- obviously, the cost to build a building is escalating. I'm just wondering, you guys have gone through these cycles many a time. Does this give you any sort of pause or caution at all seeing such an escalation, sort of going -- 35% is pretty big and considering interest rates and cost to build. Just wondering what your overall thoughts are on sort of a cycle and where we're at right now.

I'll go first on that, and then Brian can give his high-level thoughts. As far as Comfort goes, we've never seen period-over-period increases like this in backlog. Some of that, because I get to see the individual numbers, like for example, that Mid-Atlantic situation where there was that slowdown in North Carolina and then it's come back. Some of that, it's a little bit of bunching. But in general, it's very strong. If you go pull out sort of McGraw-Hill numbers or the census numbers that are derived from them, these levels are not crazy. The year-over-year percentage increases, we've seen bigger ones in the United States many times than this. So I think there's -- it's -- some of it just we're lucking out, and we made some good investments, and we bought some good companies, and we're in some good markets.

You're saying the macro? The macro of your peers?

I don't think the macro's like off the charts at all. I don't think it's -- I think it's really good, but it was off -- it's been off the charts like in -- a couple of times since I've been CFO of this company. It's not off the charts right now. Whether -- I'm not saying it will be, by the way. I'm not sure it could be given the capacity that's out there. Brian, what do you think?

Well, I mean -- I think you can't help but agree -- Well, everything you said, Joe, is correct. I mean, if it's going to affect business, it will happen, and we'll respond like we always do.

Okay. Yes. No, everything's going well. So congratulations. Just always looking out for the unpredictable or cyclical business. So just wondering.

(Operator Instructions) And the next question comes from the line of Sophie Karp of Guggenheim Securities.

I wanted to push you a little bit on the M&A angle. I guess historically, you've done deals in the -- at the end of the year, in the winter time frame maybe. What -- given how great the business is going right now and what you're seeing in the macro, is this environment conducive for M&A? Or is it just getting to a point where it's too pricey and people are not willing to sell?

So I'll be honest. For us, M&A is not really an environment issue. We're not sort of feeding a process. We're looking for individual companies that we really, really like. I think that the availability of good targets to talk to is as good as I've ever seen it. Sort of, their interest in being a part of us is very good. The reason that I think it could go either way as far as whether we close a big deal in the next 6 months is, whether we can get to pricing, right? You're -- a person selling their company is staring at very, very good recent results. They're typically staring at very good forward results. They're being told by bankers still that -- because if they -- especially if they have a more than a certain amount of EBITDA, they can go sell to private equity. And we tell them, "yes, they'll be bankrupt within 5 years to 7 years or you'll be the first." Then it wasn't. So we have a -- there's a lot of things going on there, and I think at the end of the day, we have some good opportunities. Whether we get somebody who's willing to sell at a price that we can get a rate of return on and be confident we can take care of their people on that basis, I don't know. I think we -- most years, we get a deal. But we'll only do it if we have conviction. And if -- also how does this -- how do equities trade, right? I mean, what -- our stock could also be at an attractive place to deploy extra capital. I do think when you -- if you look back in 5 or 10 years, you'll see that we -- in the next 5 or 10 years we did exactly what we did in the last 10 years, which is spent about 2/3 or 70% of our cash on acquisitions and split the rest between dividends and buybacks. But if you look forward or backward, any given year, that can be way off of those, way off of those percentages.

Right. And so on that, right, on the topic. So you obviously, have a lot of free cash flow that's going to be coming your way, just looking at the backlog and the organic growth opportunities. You have some balance sheet capacity, which you have discussed in the past. So it's quite a bit of a war chest. If the acquisition opportunities become more scarce, is there an option to increase the dividend yield a little bit in your mind?

Well, we have methodically increased the dividend, increased it again this quarter, and the board looks at it at every board meeting. We both look at that, and we both look at our buyback strategy, so as we go forward and we'll continue to do that.

I think we've increased the dividend 3 quarters in a row. So I think the board -- what happened was for years, we were increasing our dividend to $0.005 a quarter. But really, that wasn't enough to -- $0.005 each year, $0.005 per quarter. That wasn't enough to keep up with the growth the company was having. So I think the board, in recognition of that, has increased the dividend a little more frequently lately. I think they'll continue to consider that and then when they get to a point where they feel they want to pause, they'll pause. But 3 times in a row, that's never happened for us. So clearly, there's a little bit of recognition of what you're saying.

We have no more questions. I'd like to hand back to Brian Lane for closing remarks.

Okay. Thanks, Sheila, and thank you, everyone, for joining the call today. We had an outstanding quarter, and I am confident of a strong finish to 2018. I hope you all have a great weekend, and let's go, Red Sox. So, thank you.

Thank you. That now concludes your conference call for today, and you may now disconnect. Thank you for joining, and have a great weekend.