Earnings Call Transcript - FIX Q1 2021

Operator, Operator

Good day, and welcome, everyone, to the Q1 2021 Comfort Systems USA Earnings Conference Call. My name is Matt, and I will be your operator today. And with that, I'd like to hand over to Julie Shaeff, Chief Accounting Officer. Julie, please go ahead.

Julie Shaeff, Chief Accounting Officer

Thanks, Matt. Good morning. Welcome to Comfort Systems USA's first 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 these actual future activities and results of our operations to be materially different from those set forth in our comments. You can read a 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 has been provided as a companion to our remarks. The presentation is 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; Trent McKenna, Chief Operating Officer; and Bill George, Chief Financial Officer. Brian will open our remarks.

Brian Lane, President and CEO

Okay. Thanks, Julie. Good morning, everyone, and thank you for joining us on the call today. We are pleased to report a strong start to 2021. Earnings improved substantially with earnings per share of $0.73 compared to $0.48 in the pandemic-impacted first quarter of last year. This quarter, we achieved unprecedented first-quarter cash generation, thanks to strong execution as well as the receipt of large advanced payments, served orders, and projects. Our backlog has also strengthened sequentially, and we see good trends in underlying activity levels, especially in our industrial, technology, and modular markets. Overall, we are optimistic about our prospects for the next several quarters. I will discuss our business and outlook in more detail in a few minutes. But first, let me turn this call over to Bill to review our financial performance. Bill?

William George, Chief Financial Officer

Thanks, Brian. Good morning, everyone. As Brian mentioned, our results were once again very strong. First-quarter revenue was $670 million, down $30 million compared to the same quarter last year. Our same-store revenue decreased by $83 million. However, recent acquisitions contributed approximately $53 million to this quarter's revenue. Last year, we had significant data center work in Texas, which drove high revenue in the comparable period. We will continue to encounter challenging revenue comparisons in the second quarter of 2021, but to a lesser degree than this quarter. Gross profit for the first quarter of 2021 was $123 million, an increase of $6 million, and gross profit as a percentage of revenue rose to 18.4% compared to 16.7% in the first quarter of 2020. The improvement in gross margin results from stronger margins in electrical. SG&A expense was $88 million, or 13.2% of revenue for the first quarter of 2021, compared to $93 million, or 13.3% of revenue in the first quarter of 2020. On a same-store basis, SG&A declined by $6 million to $11 million. This reduction included a $6 million decrease in bad debt expense, as last year's concerns around collectibility for retail and other customers have trended better than we anticipated. The remainder of the SG&A decline was due to cost discipline. Our 2021 tax rate was 24.8% compared to 27.6% in 2020. The current year's tax rate benefited from permanent differences related to stock-based compensation, and we expect it to move back into our normal range for the full year. Overall net income for the first quarter of 2021 was $26 million or $0.73 per share, compared to $18 million or $0.48 per share in 2020. For the first quarter, EBITDA was $51 million, a 39% improvement over last year, and our trailing 12-month EBITDA is a record $264 million. Free cash flow in the first quarter was $80 million compared to $15 million in Q1 2020. This quarter's free cash flow was significantly higher than we've seen in the first quarter before, as we received advanced payments on large projects that are starting and our lower same-store revenue led to some temporary harvesting of working capital. As we carry out these projects over the next few quarters, and if organic revenue improves in the second half as expected, we will see some absorption of working capital. Our free cash flow over the trailing 12-month period is $330 million, and that strong performance has reduced our leverage to well under 1x EBITDA despite our ongoing and recent acquisitions. That's all I have, Brian, for financials.

Brian Lane, President and CEO

Okay. Thanks, Bill. I'm going to spend a few minutes discussing our backlog and markets. I will also comment on our outlook for the remainder of 2021. Backlog at the end of the first quarter of 2021 was $1.66 billion. We believe that the effects of the pandemic are beginning to subside as same-store backlog increased sequentially by nearly $150 million or 10%. Although we expect some delays in bookings will continue through the second quarter, we remain optimistic about trends for the second half of the year. Overall, we are very comfortable with the backlog we have across our operating locations. We are seeing good trends in the underlying activity levels, especially in our industrial, technology, and modular markets. Our industrial revenue was 40% of total revenue in the first quarter. We expect this sector to continue to grow as the majority of the revenues at our newer companies of TAS and TEC are industrial. And industrial is heavily represented in new backlog. Institutional markets, which include education, health care, and government were 35% of our revenue, and that is roughly consistent with what we saw in 2020. The commercial sector is now about 25% of our revenue. For the first quarter of 2021, construction was 77% of our revenue, with 45% from construction projects for new buildings and 32% from construction projects in existing buildings. Service was 23% of our first quarter 2021 revenue, with service projects providing 9% of revenue and pure service, including hourly work, providing 14% of revenue. Year-over-year service revenue is up approximately 4% with improved profitability. We are seeing good opportunities in indoor air quality, which has helped many of our service departments return to pre-pandemic volumes. The high new interest in IAQ plays to our strength of solving problems for our customers, and air quality considerations help us differentiate ourselves in both service and construction. Our mechanical segment continues to perform extremely well. Our electrical gross margins improved from 5.5% in the first quarter of 2020 to 14.7% this year. Finally, our outlook. Our backlog strengthened this quarter and the effects of the pandemic are fading. We expect some continued organic revenue declines in the second quarter of 2021, but less than we experienced in the current quarter. We continue to see strong project development and planning activities among our customers, especially in technology and other industrial verticals. Our large operations are in places where companies continue to invest, such as Texas, North Carolina, Florida, and Virginia. It was one year ago that we reported our first quarter at a time when everyone was adjusting to the risk and uncertainty of the pandemic. Looking back at our success over the last year, I am more grateful than ever for how our people overcame unprecedented challenges and for their undaunted courage and perseverance on customer sites across our nation. I really thank them. We will continue to work hard to keep our workforce and our community healthy and safe. We look forward to continued strong profitability and good cash flow in 2021, and our strong pipeline makes us optimistic about activity levels in the second half of this year and into 2022. We will continue to invest in our workforce and to improve our formidable mechanical and electrical businesses in existing and new geographies. Thank you once again to all our employees for their hard work and dedication. I will now turn it back over to Matt for questions. Thank you.

Operator, Operator

And the first question is coming from Adam Thalhimer.

Adam Thalhimer, Analyst

Great quarter.

Brian Lane, President and CEO

Adam, thanks a lot.

Adam Thalhimer, Analyst

Bill, how do you see SG&A trending this year?

William George, Chief Financial Officer

I believe that if there's any slight upward pressure, it will come from the resumption of travel and an increase in our activities. We have continued our training online, but we will return to more in-person sessions. Overall, I am very pleased with our SG&A. If someone had told me we would experience this level of same-store revenue decline yet still achieve SG&A leverage, I would have been very happy. I truly believe we have good control over our SG&A. We will likely remain above the 13% level until revenue begins to increase later this year. Overall, we feel very positive about this.

Brian Lane, President and CEO

And just to add on to that, Adam, it just goes to show the great job that the operating companies do in monitoring the overhead and not bringing it back until we really need it. So they've done a terrific job.

Adam Thalhimer, Analyst

Okay. And then I kind of hate when people ask companies this question because what are you going to say? But on acquisitions, you guys have done such a great job. And you usually don't do big acquisitions during the construction season. So is the best chance for something kind of next winter? What are you seeing out there, I guess, is the question?

William George, Chief Financial Officer

We are observing strong interest from individuals who recognize the benefits of joining Comfort Systems. They appreciate that their company won't be immediately put up for sale after a transaction and that we will integrate their balance sheet into ours, committing to a long-term partnership. This aspect is appealing to many. Conversely, there are areas of the market where companies are willing to take on significant leverage, which can result in attractive pricing, although the structure might have certain disadvantages. In essence, I feel positive about our opportunity to acquire companies that align with our values. Typically, we prefer to make acquisitions during the winter, although some may occur in the summer if circumstances allow. Our approach is to engage with companies we have established relationships with over time, ensuring the timing works for both parties since our strategy emphasizes long-term success. The current discussion around tax rates may influence the timing of potential deals, depending on how those rates are perceived.

Adam Thalhimer, Analyst

Okay. And then just a quick one on kind of how you guys see EPS shaken out this year. Because there was some language last quarter about not matching a very strong 2020, and that was removed.

William George, Chief Financial Officer

This year is challenging to comment on due to the many variables involved. In the first quarter last year, we were quite cautious when finalizing our accounts because we anticipated significant productivity declines due to COVID. Consequently, we had a favorable comparison in the first quarter. By the end of the second quarter, it became evident that the productivity drop was less severe than we had expected, and we had ample capacity in several of our guaranteed maximum jobs. We recorded earnings of $1.08 in the second quarter last year, which is a difficult benchmark to compare against. In the second half of the year, perspective would hinge on two distinct items, one from each of the last two quarters, which are readily available in last year’s press releases. In the third quarter last year, we earned $0.17 from settling an R&D tax audit related to the 2014 and 2015 periods, which is quite a specific item. In the fourth quarter, partly due to COVID impacting the outcomes of some of our larger recent acquisitions, we received $0.18 from earn-outs because it became apparent that our payouts would be less than initially anticipated. While analysts have adjusted for these items, we believe we have a solid opportunity to achieve earnings in line with last year’s numbers, excluding those exceptional items, understanding that this year presents very tough comparisons when factoring in the extraordinary gains. Is that clear? I realize that was a lot of information.

Adam Thalhimer, Analyst

Well, it sounds like a tweak better than before. You're not telling us to go nuts, but it's not firmly down the way we might have thought a couple of months ago.

William George, Chief Financial Officer

So it turns out we'd have to go put in some pipes, yes.

Brian Lane, President and CEO

No, but in general, we are optimistic about the year, Adam.

Operator, Operator

The next question is coming from Brent Thielman.

Brent Thielman, Analyst

Brian, the industrial bucket as a percentage of the revenue pie is as large as I can remember. Love to just get some flavor of what the bigger drivers of that are in terms of the market that sort of make up that bucket?

Brian Lane, President and CEO

Yes. I'll go first, and I'll see if Bill wants to follow on. But yes, it's the biggest we've ever had it. We've talked a lot about the recent acquisitions, heavy industrial focus. Obviously, data centers right now in technology is a big component of that today. But also including that, we're seeing a lot of good pharma and food processing opportunities as well, Brent. So I think those would be the three largest areas that we're looking at the moment. Bill, anything else that you want to add?

William George, Chief Financial Officer

Our strength in the Mid-Atlantic and Southeast regions is closely linked to where companies are choosing to invest. Additionally, we acquired a strong company, TEC, in Tennessee at the end of last year, which is entirely focused on industrial markets and generates around $100 million in revenue. The full-year contribution from this company will enhance our industrial growth as they integrate into our operations.

Brian Lane, President and CEO

And Brent, in terms of that sector going forward, we're still seeing plenty of opportunities. And as I mentioned in the script, it's got a lot of legs in the industrial sector going forward.

William George, Chief Financial Officer

Commercial has been a shrinking segment for us. However, in absolute terms, it has remained relatively stable. The growth in other sectors has outpaced it. It's important to note that much of the commercial space, particularly office buildings, is constructed by developers who are very focused on initial costs. For instance, when we construct office space for pharmaceutical companies, it is typically part of a mixed-use development. True office buildings are often the responsibility of developers who may not intend to retain ownership of the asset post-construction. They tend to be heavily influenced by competitive bidding and our contractors generally prefer to negotiate work at this time. These structural dynamics may make commercial projects a better fit for our competitors than for us.

Brian Lane, President and CEO

But on that front, we're still seeing a lot of good service opportunities, and we'll have some IAQ opportunities on the commercial office building.

Brent Thielman, Analyst

Okay, that's helpful. From your comments, it seems that the hesitation in the market among your customers is easing. Could you discuss where you are still seeing delays and what the reasons for those delays might be? Is it related to contractor access, the economy, or what are you hearing from your customers?

William George, Chief Financial Officer

I wouldn't describe it as hesitation. When I spoke with our team, it seemed more like it wasn't an ideal time to begin new projects. During the COVID period, acquiring soil, planning, and obtaining county approvals became challenging because many offices were closed. I wouldn't categorize it as hesitation in the sense that our customers, the ones we are discussing, still wanted to pursue their projects. It was more about functional delays that occurred. I believe it's simply a matter of starting this work in an orderly way.

Brian Lane, President and CEO

Yes, Brent, the pace has increased regarding our review process, and decisions are being made more quickly. I can sense a significant change in the speed of progress.

Brent Thielman, Analyst

Okay. I have a question about the electrical segment. Margins have recovered to the levels you previously mentioned much more quickly than I anticipated. I'm interested in understanding what percentage of that improvement is due to your internal refocus initiatives compared to the acquisitions you've made. Additionally, how should we view the margins for this segment moving forward, given the significant shift from last year?

Brian Lane, President and CEO

Yes, I'll start and then Bill can add his thoughts. Thank you for the question. Regarding Walker, we've been discussing them for over a year. They have consistently been an outstanding electrical contractor in Texas, and that remains unchanged. Their quality of work is exceptional. I believe they have likely shifted their focus to a different customer base and moved away from certain sectors. We have hopefully provided some assistance through training and technology. Ultimately, it relies on the team in the field executing the work, which they have always done effectively. It seems they are just refining their focus. They have been a strong company historically, and I'm pleased to see that their hard work over the past year has started to pay off in the first quarter. Bill, would you like to share your thoughts on this?

William George, Chief Financial Officer

Regarding the specific question about the improvement, TEC is entirely part of our electrical segment. TEC stands for Tennessee Electrical Contractors, which holds the oldest license for electrical work in Tennessee. They currently engage in a variety of highly complex industrial services and projects. Their margins have been very close to Walker's margins, differing by only 100 basis points. These two are the primary components of our electrical segment. Walker's margins have completely returned to the same range as TEC's reported this quarter, indicating that it wasn't a mix issue this year.

Brian Lane, President and CEO

But we are glad to see it.

Brent Thielman, Analyst

Sure. Well, congrats on a great quarter and best of luck here going forward.

Brian Lane, President and CEO

All right. Thank you.

Operator, Operator

And the next one is coming from Julio Romero.

Julio Romero, Analyst

How do you think your service business progresses throughout the year? Should the growth rate outpace new construction? Or maybe how much of the overall revenue mix does service make up in '21?

Brian Lane, President and CEO

Service has been hovering around 20% to 25%. I think you'll see it outpace construction. We continue to grow it. It's very methodical. We will continue to invest in it, both in hiring people and training. We're seeing some good opportunities come out of indoor air quality front in terms of volume. And I think that will continue to be a great, steady growth and cash flow opportunity for us over a long period of time.

William George, Chief Financial Officer

Yes, what's interesting about service is that although it has been decreasing as a percentage of revenue, it has never declined in actual numbers. It has experienced consistent growth for us and is now twice as large as it was just a few years ago, with profitability that is three to four times greater, which is our primary concern. Ultimately, it has excellent prospects. It has seen more organic growth than construction, which has largely benefited from acquisitions. While we have also expanded in construction, particularly in industrial sectors where we have significantly enhanced our capabilities, service has overall performed exceptionally well. Our acquisitions have mostly focused on industrial project companies and similar entities.

Brian Lane, President and CEO

But we have a big focus on it, continue to grow it, and we will keep the pedal to the metal on service.

Julio Romero, Analyst

Got it. Regarding the IAQ opportunity, I'm not sure if education was mentioned earlier. However, I understand that IAQ is driving more activity in schools, yet I noticed a decline in education revenue this quarter. Can you help clarify this discrepancy?

Brian Lane, President and CEO

Yes. I think we're in the early days of reallocating the funds to school. We've done a lot of work, researching very specifically where the money is going. We have a lot of very good relationships with school systems. So I think you'll see that continue to grow here as people get a better understanding and schools have a better understanding of what they actually want to do. But we can do anything they need us to do. And I anticipate that will be picking up, I think, pretty soon now that they've allocated the money to it.

William George, Chief Financial Officer

By the way, a little structural factor. If you're comparing the first quarter to the full year, a ton of school work happens in the summer.

Brian Lane, President and CEO

Yes.

Julio Romero, Analyst

Yes. That makes a lot of sense. So I mean, I guess, quotation is going off in education and kind of overall activity levels, as you see it. And it's just a matter of those funds being allocated and just kind of translating to revenue over time.

Brian Lane, President and CEO

Yes. They're sharing what they want to do.

Julio Romero, Analyst

Right. Okay. And I guess just the last question for me is it's a minor one, but there was a mention of a Utah acquisition within the quarter in the Q. So I don't know if you could talk about that acquisition and how it fits within the broader mechanical segment.

William George, Chief Financial Officer

Yes. So that was a plumbing company. Fantastic little company with unbelievable relationships. And it was just an addition to our already very attractive business in Utah. We wanted to get stronger in Utah, and we have never regretted buying a truly good plumbing company.

Brian Lane, President and CEO

That's for sure.

Operator, Operator

And the next one is coming from Sean Eastman.

Sean Eastman, Analyst

I guess just continuing on the discussion around the funky comparables on earnings. Maybe we can have the same discussion just on same-store growth. Anything you can point out on the cadence of same-store growth trends as we move through the balance of the year?

William George, Chief Financial Officer

Yes, I'm glad you asked. In the first quarter of 2021, same-store sales were down 11.8% compared to the first quarter of 2020. A significant factor in that was the large number of data center jobs we had, with hundreds of people involved in those projects in the fourth quarter and the first quarter of last year. While we anticipate some revenue challenges in same-store sales for the second quarter, we expect the decline to be much lower, likely in the low to mid-single digits, which is a better estimate than the 12% drop in the first quarter. For the remainder of the year, we believe the revenue comparisons will be more manageable. That said, work is beginning, and there may be some delays that could affect timing. We're cautiously optimistic about 2022, a sentiment not typical for us this early in the year, due to the considerable amount of work slated to start in the latter half of this year that will carry into 2022. While I find it difficult to predict significant increases, I don't expect us to be down much in the second half of the year.

Brian Lane, President and CEO

Yes. I agree.

Sean Eastman, Analyst

Okay. That's helpful. And there's just a lot of discussion across the kind of industrial world these days about supply chain disruption, cost inflation. I mean, are those elements you guys are monitoring? Anything to point out in terms of what we should kind of track as it relates to flow through to fixed?

Brian Lane, President and CEO

Yes. It's a good question. Obviously, we monitor it. We have long-term great relationships with all our vendors. We work closely with them. We'll continue to do so. It's really up and down depending on where it is. So far, equipment has all been good, no problems. Steel and copper, you've probably heard it, I'm sure, 20 times now, pricing up but there is availability. But nothing that's really impacting us at the moment. We're functioning, our job sites are going and nothing has been delayed so far. So we'll continue to monitor it, but it's healthier. But thank God, we have the relationships that we do have.

Operator, Operator

Thank you, everyone. There are no further questions. So I'd like to turn it back to Brian for closing remarks.

Brian Lane, President and CEO

Okay, Matt. In closing, I want to once again thank all our wonderful employees and everyone for joining us on the call this morning. We're looking forward to seeing you again, of course, and soon, hopefully. But in the meanwhile, please stay safe and healthy. Thank you very much. Have a good rest of your day.

Operator, Operator

Thank you very much, Brian. Thank you, everyone. Ladies and gentlemen, that concludes the call for today. You may now disconnect. Thank you for joining, and enjoy the rest of your day.