Comfort Systems USA Management Discusses Q1 2013 Results - Earnings Call Transcript

May. 2.13 | About: Comfort Systems (FIX)

Comfort Systems USA (NYSE:FIX)

Q1 2013 Earnings Call

May 02, 2013 11:00 am ET

Executives

Julie S. Shaeff - Chief Accounting Officer and Senior Vice President

Brian E. Lane - Chief Executive Officer, President and Director

William George - Chief Financial Officer and Executive Vice President

Analysts

Richard Wesolowski - Sidoti & Company, LLC

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

Cory Mitchell - D.A. Davidson & Co., Research Division

Operator

Good morning, ladies and gentlemen, and welcome to your Q1 2013 Comfort Systems USA Earnings Conference Call hosted by Julie Shaeff. My name is Bupendra. I'll be your event manager today. [Operator Instructions] I would like to advise all parties that this conference is being recorded for replay purposes. And now I would like to hand the conference over to Julie. Please go ahead.

Julie S. Shaeff

Thanks, Bupendra. Good morning, everyone. Welcome to Comfort Systems USA's First Quarter Earnings Call. Our comments this morning, as well as our press release, contain forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. What we will say today is based on our 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 operation 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 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.comfortsystemusa.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.

Brian E. Lane

Thanks, Julie. Good morning, everyone, and welcome to our first quarter earnings call. Before we start, I would like to take a moment and thank all of our employees for their continued hard work and dedication.

I will be reviewing some highlights, and then Bill will cover the financial results in more detail.

We are pleased to report a strong start to 2013. Earnings for the quarter were $0.07 per share as compared to the $0.03 loss in the first quarter of 2012. Thanks to solid execution by our operations, we realized significant margin improvement as compared to the prior year. Our backlog as of the end of the quarter was $631 million, which marks an improvement, both sequentially and year-over-year. Although economic conditions remain challenging, we are seeing stability in most of our markets. We remain focused on project selection and execution, but we are also making prudent investments in our future growth. I will discuss that further after Bill reviews our financial results in a bit more detail.

Bill?

William George

Thanks, Brian. Good morning, everyone. So I'm going to take a few minutes and discuss our quarterly results. If you're online and you have access to our slides, you can refer to Slides 2 through 4 as I review our financial results.

Revenue this quarter was flat compared to a year ago as we reported $326 million of revenue compared to $327 million in the first quarter of 2012. You may remember that our revenues in the first quarter of 2012 included our fast and large data center project that recognized approximately $20 million of revenue in that quarter. And even without that project this year, we maintained essentially flat revenue levels.

As we disclosed at year-end, during the first quarter, we reached an agreement with a general contractor on that large data center job, and the agreement provided for an increase in the contract price. And as a result of that, we received the benefit of about $1.4 million in the first quarter from that settlement.

Gross profit was 15.8% for the first quarter of 2013, and that was a strong increase from 13.1% for the first quarter of 2012. As Brian mentioned, we had solid performance for most of our operating companies and improvement in the company in Maryland that has underperformed in the prior year. Despite the relative improvement, we continue, overall, to experience gross profit and operating income margins that reflect the continued challenging market conditions.

SG&A expense was $46.5 million for the first quarter of 2013 compared to $46.1 million for the first quarter of 2012. SG&A as a percentage of revenue increased from 14.1% during the first quarter of '12 to 14.3% during the first quarter of '13. This slight quarter-over-quarter dollar increase reflects higher compensation accruals due to improved profitability and slightly higher professional fees as compared to the prior year.

Our tax rate for the quarter was 42.6%. The increased tax rate reflects the distribution of operating results between high and low tax jurisdictions.

Our net income for the first quarter was $2.5 million or, as Brian said, $0.07 per diluted share, and that compares to a net loss of $1 million or $0.03 per diluted share in the first quarter of 2012.

As we always expect, first quarter cash flow was negative, following strong year-end cash collections. Free cash was negative $13 million in the quarter. However, that was an improvement over the negative $21 million we experienced in the first quarter of last year. Overall, we feel good about our cash prospects for the balance of 2013.

We repurchased 12,000 shares in the first quarter, a nominal amount. We continue, though, to be open to price-sensitive and opportunistic share repurchases as we move forward.

Overall, we remain financially sound and solidly profitable, although our profit levels, overall, continue to reflect weak industry conditions. We are continuing to implement strategies to use our resources to compete, improve and, especially, to grow.

That's all I have on financials. Brian?

Brian E. Lane

Okay, Bill. Thank you. Let me walk you through backlog, activity in various sectors and markets and, also, our outlook for the rest of 2013.

Please turn to Slide 5 and start with backlog. We are pleased with our increased backlog, both sequentially and year-over-year. Backlog at the end of the first quarter was $631 million compared to $618 million at the end of last year. Year-over-year backlog increased $11 million. Our most significant backlog increase was EAS, our 60%-owned subsidiary located in North Carolina.

Please turn to Slide 6 for a look at our end-user sectors. The institutional markets, which are government, health care and education, make up 45% of our revenue for the current quarter and 56% of our backlog. The private commercial sectors remain weak, but we continue to win our fair share of smaller and midsized projects. Larger projects are still few and far between. Although margins remain tight, we remain cautiously optimistic that activity levels in most market sectors are stable.

Let me discuss what we're seeing across the country, starting with the West. The operations in the West were the first to be impacted by the recession. The markets for operations in Southern California, Colorado and Arizona have stabilized. While we are encouraged by this, the conditions in many of the Western markets are still among the slowest in the nation. The Northeast region, which includes our companies in the Upper Midwest, remains stable and continues to be our most profitable region. We had strong execution and solid results from the operations in Maine, Michigan, New York and Northern Maryland. The vast majority of the operating companies in this region have a stable backlog and are doing a superb job of making the most of a tough environment. The Southeast is experiencing improved demand in some markets but still has pockets of weakness, such as Florida and Atlanta. Our operations in the mid-Atlantic experienced a downturn later in the cycle and continue to face a weak pricing environment.

Let's now review our revenue mix as you turn to Slide 7. Pure service, which is maintenance and repair, was 16% of revenue for the first 3 months of 2013, which is consistent with full year 2012. Service, repair and retrofit again exceeded 50% of our 2013 revenue to date. These activities continue to provide us with the majority of our earnings and cash flow as we prepare for a recovery in construction. Our Service & Maintenance base is steady. We have consistently invested in our Service business for the past several years, and we plan to increase these investments in 2013.

Finally, let me describe our outlook for this year and our general approach to the overall market. We are pleased with our improved margins for the first quarter, as well as our backlog level at the end of March. We believe that we are achieving stability in most of our markets, but we don't believe we are in the midst of a recovery at this point. The nonresidential construction markets remain tough. We are continuing to face mixed demand and competitive pricing conditions similar to recent years. Therefore, we expect the weakness in the underlying environment for nonresidential activity will continue to affect our results and our industry for the remainder of 2013, with overall activity remaining at subdued levels.

Our primary emphasis for 2013 remains on execution, including a focus on cost discipline and efficient project and service performance.

Those of you who follow us closely know that we have continued to invest in our business during this recession. We increased these investments in the first quarter, especially in the areas of service growth and talent development. And we will continue these incremental investments in 2013 because we believe it's time for a renewed emphasis on growth. We are hopeful that incremental demand will appear for 2014. But whether or not that is the case, we believe that, after more than 3 years of unprecedented weakness, most of our markets have adjusted to ambient levels of demand, and we plan to leverage our excellent workforce to achieve growth in the coming years. The benefit of our approach is not likely to appear in 2013. However, our focus is profitable growth, and we are optimistic about the future.

Finally and again, I would like to thank all of our 6,700-plus team members for their efforts. I'll now turn it back over to Bupendra for questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] First question is from the line of Rich Wesolowski from Sidoti & Company.

Richard Wesolowski - Sidoti & Company, LLC

Would you discuss the performance that resulted in a very good margin for the first quarter, specifically, which entities, perhaps, underperformed a year ago that -- where the execution has been righted?

William George

So the underperformers, to address that first, we had a company in Maryland who -- that actually had a loss a year ago. Then we had 2 of our new large acquisitions. They're in -- both of them are in the mid-Atlantic area, EAS and ColonialWebb, that failed to cover their amortization. When we buy these companies, we have to amortize against our earnings a portion of the purchase price, which means that even if they have positive gross profit, even if they have positive net profits, sometimes they have a negative effect on the overall. So we got a little more of a contribution from those 2 companies. The bigger part of the difference, if you saw for the difference between last year and this year, came from improved performance, although the improvements of the negatives were also -- were a big factor. And as a first quarter, we typically have low volume, low overall earnings. And so it's a little more -- it's a little harder to predict. There's a wider range of what can happen in a first quarter as far as predictability goes.

Brian E. Lane

And Rich, I'd like to add, I'd like to tip my hat to those 3 companies. They've done a lot of work in their organizations to improve their performance in the first quarter.

Richard Wesolowski - Sidoti & Company, LLC

Secondly, the -- Brian, you mentioned that we are not in the beginnings of a private nonresidential recovery. Your backlog has been range bound for the better part of 2 years. And I'm wondering, if we are to see volume, first; price, second, when the recovery eventually arrives, when is the earliest you can envision your backlog breaking out of this $600 million to $650 million range?

Brian E. Lane

Rich, I wish I can answer that for you. Our feeling is back into this year and to next year, we're cautiously optimistic we'll see some improvement, but time will tell. We've hit the main blockage in the last few years, so we'll see what happens.

Richard Wesolowski - Sidoti & Company, LLC

Okay. Then -- sorry, last one is, with regard to the maintenance and retrofit business, which sounds like you're aiming to bolster however long the private nonresidential slump lasts, what is the likelihood that, that effort will be stifled by lack of demand and that, when the recovery eventually does come, it's only then that you will see the improvement in the Maintenance business?

William George

Rich, I think the nature of that business, it is certainly subject to the business cycle, especially -- it's especially subject to the business cycle early in downturns because you have the ability to defer when that uncertainty first starts. You can only defer for a certain period of time. The mechanical system, it will catch up with you. But I think that we really ought to be able to improve service even if we continue to go sideways for a while with the right investment. Obviously, a little tailwind would help. But I don't think it's an excuse for us, as much of an excuse for us when the economy is weak on the Service side. We need to get out there and do it.

Brian E. Lane

Rich, I really believe that there is some demand out there that needs to be addressed. I think a lot of people have repaired stuff that needs to be replaced. So I totally echo what Bill said. I'm extremely confident that, that business can be grown.

Operator

Next question is from the line of Saagar Parikh from KeyBanc Capital Markets.

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

First off, Brian and Bill, you guys mentioned that your first quarter year-over-year, you had improvements in your Maryland operations, improvements at EAS. When we look at the second quarter that we're in currently, and then we look at the second quarter of '12, is there anything similar we should keep in mind, where last year, there were some issues in some of your operating units that could end up helping you guys outperform the second quarter this year?

William George

That's really an insightful question. And the truth is, if we were to get incremental improvement in the last 9 months of '13 compared to the last 9 months of '09, the most potent source for that would be improvement at our 2 biggest entities, ColonialWebb and EAS. The plan -- they still -- we mentioned -- Brian mentioned in his comments, they are both located in the mid-Atlantic, which continues to have -- it started the recession late, and it's still in the recession. But having said that, we certainly are looking for some improvement from those guys, and that will help us out. And then having said that, none of that -- the ranges of this improvement really don't get us to the kind of earnings that we feel like this company ought to average over 10 years. We'll need a little demand for that to happen. Brian, do you have different thoughts about that or...?

Brian E. Lane

I think you're right. But I'd also say, we've talked a lot about ColonialWebb and EAS. You just got to remember, these are premier mechanical contractors in this country, and they are improving every day. So I'm really confident going through in the performance of both of those.

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

Okay. And then when I look at year-over-year, you increased your EPS $0.10 in the first quarter of '13 versus the first quarter of '12, yet in your press release, you reiterated that 2013 results should seem more -- be similar to 2012 results. Could you just elaborate on that, what you're talking about when you're saying results will be similar? Are you talking about earnings? Are you talking about end market activity? Any additional color would be great.

Brian E. Lane

Yes. Since I made the quote, Saagar, I'll answer it. What I mean there is on earnings. And I'm talking about, if you're in the $0.35, $0.45, $0.50 range, I view that as being on the putting green. I'm comparing to what we did in 2008. We got to $1.24 a share. Then we see us trending up towards that. That has got to be materially different. So do I think -- you're quite right, we're 10% improved over last year. We should be improved last year -- this year over last year. But I don't see it materially better is sort of what I meant by that statement.

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

Okay, that's great. And then the last question, how much visibility do you have in terms of your different markets and institutional, for example? Is it 3 months, 6 months, 9 months? And how is the visibility now versus what it was, as you mentioned, the '07, '08 timeframe?

Brian E. Lane

I mean, I'll go first, and then Bill can give you his thoughts. Historically, in this business, you got about a 6- to 9-month pretty good look-see about what's being bid. I think it has lengthened a little bit from the last 2 years, where we're looking at it really quarter-to-quarter in terms of what opportunities are out there. So it's gotten a little longer. In the next 6 months, we'll probably get a pretty clear picture of what we have out there. Bill?

William George

Something's changed. Saagar, I would say, a year or 2 ago, even though we were at similar activity levels, you didn't know where they were going. You thought there was a chance there was another leg down. I think there's a lot more confidence in stability at a minimum, one of the reasons we're starting to invest again in growth. And frankly, our markets have adjusted somewhat. Some capacity has been destroyed, our markets have adjusted to the levels we've been at for a while. So I think that is -- it's a difference, it's not an exciting difference, but it's an important difference.

Operator

We have no further questions in the queue. [Operator Instructions] Next question is from the line of Cory Mitchell from D.A. Davidson.

Cory Mitchell - D.A. Davidson & Co., Research Division

You said earlier that you saw that there were some repairs that should have been new construction and installation. How does that compare to Q2 '12? And what's your outlook for the pent-up demand?

Brian E. Lane

Yes, this is Brian. I think it's been around for a while. I think people have put off making some capital expenditures and just repairing equipment that probably needs to be changed out. And eventually, as Bill talked about earlier, it is mechanical equipment. And it does need to be repaired, changed out at a certain point in time. So I'm probably a little bit -- I'm more optimistic right now than I was last year at this time, Cory.

Operator

Next question is from the line of Saagar Parikh from KeyBanc Capital.

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

Last question for me is related to the institutional market. You said that's 56% of your backlog right now. I think it was 43% or so of your revenue in the first quarter. I think it was 70% or so probably a year or 2 years ago. At this point, how do you see that trending? And what's really impacting that dollar trend that we've seen?

William George

I think the logical conclusion would be that it would continue to decrease as a proportion of what we're doing. Hopefully, we can get our activity levels up, and so the absolute can stay flat or maybe even go up. But I think that it is the part of the market that probably is least likely to provide lift over the next year or 2.

Brian E. Lane

But we have seen improvement on the manufacturing side. We see a lot of data center work, industrial work, food processing that we've seen increase, and I think we'll continue to increase there.

Operator

We have no further questions in the queue.

Operator

Okay. Thank you very much all. Thank you for listening to the call and the interest in the company. We had a nice solid quarter. I'm very excited about the future. We're poised for growth by investing in our Service business, and we're ready for Construction growth when the markets improve. Bill and I both look forward to seeing everybody out the road here shortly. Thank you, and have a great day.

William George

Thanks, everybody.

Operator

Ladies and gentlemen, that concludes your call for today. Thank you for joining. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!