Comfort Systems USA Inc. Q1 2023 Earnings Call
Okay.
Good day, and thank you for standing by and welcome to the Q1 2023.
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Mounting officer. Please go ahead.
Thanks, Scott Good morning, welcome to comfort systems, Usa's first quarter 2023 earnings call our comments today as well as our press releases.
We're looking statements within the meaning of applicable security laws and regulation.
We will say today is based on our current plans and expectations of comfort systems USA.
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.
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 remark. The presentation is posted on the Investor Relations section of the company's website found at comfort systems USA Dot com.
Joining me on the call today are Brian Lane, President and Chief Executive Officer threat Mckenna, Chief Operating Officer, and Bill George Chief Financial Officer, Brian will open our remarks.
Thanks Julie.
Good morning, everyone and thank you for joining us on the call today.
We have had a great beginning to 2023.
With increased revenue and pre tax earnings.
Unusually strong cash flow.
Another increase in backlog.
Our teams delivered amazing execution, and we are very grateful for their hard work.
Excluding the prior year tax gain that bill will discuss in a few minutes.
We earned $1 51 per share and.
And that included 15 related to the favorable resolution of certain claims related disputes.
Current year revenue was $1 2 billion.
Unprecedented same store revenue growth of 30%.
Our backlog is now over $4 $4 billion.
Which is a same store increase of $1 6 billion or 58% from a year ago.
Our backlog growth is tangible evidence of the ongoing demand in traditional and modular construction.
Cash flow this quarter was exceptional.
This morning, we also increased our dividend by two and a half cents per share to <unk> 20 per share.
This increase reflects our continuing strong cash flow and our commitment to reward our shareholders.
I will discuss our business outlook, a few minutes, but first I will turn the call over to Bill to review our financial performance built.
Thanks, Brian .
So revenue for the first quarter of 2023 was $1 2 billion, an increase of $289 million or 33% compared to last year.
Our mechanical services segment revenue increased $236 million or 35%.
Our electrical services segment increased by 26% to 200.
To 200 or $256 million.
Same store revenue increased by 30% or 265 million with the remaining $24 million increase resulting from acquisitions. Our revenue growth resulted from increased activity combined with the pass through effects of inflation, including higher cost for equipment and materials.
The same store percentage increases.
Fluids by the fact that first quarter revenue last year was lower than the rest of the year and we will confront much higher prior year revenue comparables over the next few quarters. So our percentage growth is unlikely to remain at these levels.
Revenue trends have a lot of moving pieces, but overall, we now expect full year same store revenue growth percentage for 2023 to finish the year in the mid teens.
Gross profit was $205 million for the first quarter of $52 million improvement compared to a year ago.
Our gross profit percentage was 17, 5% this quarter compared to 17, 3% for the first quarter of 2022, including the benefit from strong winds on claims that Brian mentioned.
Quarterly gross profit percentage in our mechanical segment declined from 18, 6% in 2022 to 17, 9% in 2023.
That revenue decline is largely driven by the relative growth in modular construction as a portion of our revenue modular construction has lower gross profit margins than built construction and then our service businesses.
Margins in the electrical segment rose to 16, 1% this year from 13.0% in 2022.
It is currently challenging to predict how our margins will unfold for the remainder of 2023.
Important factors that will influence our margins include increases in materials intensive modular and new construction ongoing cost inflation.
Fact that with the surge in bookings we continue to be early as many projects modular.
Modular is also growing as a proportion of our revenue and we are managing ramp up considerations as we bring that new modular capacity online.
Despite these structural trends that might put some pressure on margins.
We expect good continued profitability and we are optimistic that overall, our margins in 2023 will be at or near the strong levels that we achieved in 2022 on higher revenue.
SG&A expense for the quarter was 135 million or 11, 5% of revenue compared to $118 million or 13, 3% of revenue for the first quarter in 2022.
On a same store basis, SG&A was up approximately one $4 million due to inflation and ongoing investments to support a much higher activity levels.
Our operating income roughly doubled increasing by 99% in the first quarter of 2000 $23 million to $71 million compared to the quarter last year.
We still expect interest expense in 2023% increase from 2022. However, this quarter the higher interest expense was partially and temporarily offset by an increase in interest income related to a favorable legal outcome.
Our tax rate for the quarter was 13, 1% this.
This included an incremental benefit of $5 million or 12 sets from a conforming adjustment for the R&D tax credit of which eight related to 2022.
If congress were stores immediate deductibility of research expenditures.
Percent is conforming adjustment, we will have to reverse that 12 income statement gain in the period that this occurs.
Although many individual items have affected our tax rate lately, we continue to estimate that our normalized tax rate.
It's approximately 21% to 23%.
After considering all the factors above.
Net income for the first quarter of 2023 was $57 million or $1 59 per share.
When comparing EPS to last year.
It is important to recall that in the first quarter of last year, we booked a massive incremental $1 49 per share tax gain that was related to prior years.
With those gains are removed from both years, our first quarter 2023 earnings per share was $1.51 as compared to <unk> 91 in the prior year.
On that basis, our quarterly EPS increased 66%.
About a fourth of that increase coming from our positive claim outcomes.
Another way of looking at the year over year profitability comparison without tax complications just simply compare our EBITDA, which increased 49% from last year to $90 million.
Free cash flow for the first quarter of 2023 was $111 million.
The main driver of this outperformance was advanced billings and deferred revenue as we benefited from favorable.
Payment terms upon receipt of large orders.
The benefit from these advanced payments will reverse as project costs are incurred.
To the extent that additional advance payments are received.
So please note. The following we are facing a large cash flow headwind in the coming quarters. As a result of congress's ongoing failure to extend the current deductibility of research expenditures.
Less current expensing is restored we will make additional tax payments during the last nine months of 2023 of approximately $120 million to $140 million.
Because of the deductibility of a large portion of our business costs will be spread over the next five years.
Also capital expenditures will be higher than usual this year as we add over 1 million square feet to our modular capacity and as we purchase vehicles at a higher than usual rate, resulting from the deferrals in vehicle availability during COVID-19.
This quarter, we had $17 billion of capital expenditures, which is an 80% increase compared to the prior year overall, we estimate that our capex spend in 2023 will be roughly $60 million to $70 million.
Our debt was lower at quarter end as our substantial free cash flow allowed us to reduce debt by $47 million and even fund the purchase of <unk> from cash received during the quarter.
We also continued to purchase our shares acquired a 29000 shares at an average price of $121 36.
In the first quarter and adding to the over 10 million shares we have repurchased since 2007.
At an average price of $24 86.
As Brian noted we.
We implemented another meaningful dividend increase this quarter as well.
All I've got on financials, Brian Okay. Thank you Bill.
I am going to spend a few minutes discussing our backlog in markets.
And I will also comment on our outlook for the rest of 2023.
Our backlog at the end of the first quarter was a record $4 4 billion.
Since last year at this time same store backlog has increased by $1 6 billion or 58% with.
With increases in our traditional mechanical and electrical business.
Substantial new bookings and our off site construction operations.
Where we are continuing to invest in new capacity.
During the first three months of 2023.
Two our backlog increased $300 million, despite heavy backlog burn in the first quarter.
With a number of advanced bookings or backlog will burn over a longer period and include audits.
Will be produced in 2024.
Industrial customers were 51% of total revenue in the first quarter.
This is the first time that industrial customers.
Source of more than 50% of complex volume.
This sector, which includes technology life Sciences, and food processing remained strong for us.
Industrial is a major driver of new backlog.
Starting this year, we are breaking out technology in our industrial revenue and.
And technology was 19% of our revenue in the first quarter.
Potential increased from 11% in the prior year.
Institutional markets, which include education healthcare and government are also strong and represents 28% of our revenue.
The commercial sector is active.
But without changing mix there is now a small part of our business at about 21% of revenue.
Much of that concentrated in our service revenue.
Construction was 80% of our revenue in this quarter with construction projects for new buildings at 54%.
While construction projects in existing buildings with 26%.
Service grew rapidly in this quarter as revenue increased by 21% compared to last year.
Virtually all of this increase was same store.
Service was 20% of our total revenues with service projects, providing 9% of revenue and pure service, including hourly work, providing a 11% of revenue.
We just published our annual sustainability report and in addition to the actions that we're taking in our business, we continue to encourage and support cut.
Customers as they focus on the efficiency and sustainability of their buildings and operations.
Before I close I want to briefly point out a few things about certain trends in our business.
As noted earlier construction this quarter is now 80% of our revenue.
Which means that over the last several years services declined on a percentage basis.
A proportion of our overall business.
This is not because services underperforming.
The absolute contrary.
Service was up over 20% just this quarter.
In fact, our overall service business today is twice as large as it was in 2016.
Construction has just increased even more.
Also when looking at the increasing share of our business that industrial and technology represent.
Might ask yourself, if other sectors are declining.
In fact, when you look at absolute volumes as opposed to percentages. This quarter every one of our sectors actually increased.
Comfort systems is thriving in nearly every possible way and that is because of our teams across the country continue their superb execution.
Thanks to that excellence and in light of the strong ongoing demand that we are experiencing we remain optimistic about our prospects for continued growth.
And strong profitability in 2023.
Our number one priority remains to preserve and grow the best workforce in our industry.
So we can continue our legacy of investing to meet the needs of our customers and our communities.
We are grateful for their and your trust.
I want to end by thanking our over 14000 employees for their hard work and dedication.
I'll now turn it back over to Rick couple of questions. Thank you.
Thank you at this time, we will conduct a question and answer session. As a reminder to ask a question you will need to press star one on your telephone and wait for your name to be announced.
Draw your question Press Star one again, please standby, while we compile the Q&A roster.
Our first question comes from the line of Julio Romero Sidoti <unk> Company. Your line is now open.
Thanks, Hey, good morning.
Maybe starting on the backlog if you could speak to the organic sales growth you saw in the backlog quarter over quarter, and then what type of customers are activity type for the drivers.
It all just modular or were there other.
Drivers there.
Yes.
First and then bill can follow up but so anyway good morning Julio.
Based increase in backlog quite frankly.
Most of the cost.
We had strong performance out of the technology.
But we're getting it in multi sector is just not one on one part of the country. So it some.
It's still very active out there and we don't see it stopping in the short term for sure yes, Julio we got a nice order from a new customer and modular this quarter, but the majority of our backlog increase within the sequential backlog increase was broad based and.
It really just where you'd want it to be in a lot of our most successful companies.
Got it that's helpful. And then maybe turning to cash flow second straight quarter of very strong cash flow, but you talked about the uncertainty you have there for the for the next nine months or so.
How are you managing through that uncertainty.
And does that affect anything regarding to capex to your M&A pipeline, our cash usage.
So that's one of the great things about having.
A fantastically strong balance sheet.
We.
We flowed $111 million of cash this quarter.
So it's very unfortunate.
Federal government needs to borrow some money from us over the course of the rest of the year, but.
It's not a problem.
<unk> really impact anything else that we need to do.
Got it that makes sense and then Conversely, I guess could that change in deductibility to the R&D expenditures, maybe create some M&A opportunities from smaller companies who.
May not be as.
Able to handle that change to their balance sheets.
So maybe when some of them realize it.
I think it's going to be I think it is going to be devastating for companies.
Certain companies on the West Coast, certain places, where where research is really what they do as a company I don't I don't know how that will be able to cope with this.
But in our industry.
I think it will have that big of an effect on the smaller companies most of them are unaware of it.
It might clear up by the time they figure it out but it's black letter law, if you're a big company like ours, you have to just follow the law.
Got it I'll pass it on thanks, so much.
Thanks Neil.
Thank you very much please standby for our next caller.
Hello risks.
Next call our next.
Question comes from the line of Sean Zhang.
Bank capital markets. Your line is now open.
Okay, great great start to the year, thanks for taking my questions.
Sean.
So I mean, clearly clearly a message.
The demand environment remains.
Strong in and the strength is broad based and we're still seeing it in the bookings.
But we also have this kind of unique dynamic where customers have changed their behavior their kind of booking new guys up early.
There is more duration in the backlog so.
How would you kind of set.
Expectations around the trajectory of the backlog around those kind of two dynamics.
So if I, if I'm being honest I was surprised our backlog went up further this quarter I think some of it we're not booked into 2025 and a lot of places. It is really it is possible that this is a new trend in our industry just based on that.
Extraordinary.
Really scarcity of productive capacity, but I suspect.
For healthy reasons, our backlog at some point will come down.
Later, probably late this year.
Two things that will trigger that one is less advanced commitment and certainly the advanced commitments that were made to induce us to enter into some leases.
We'll rollout of our backlog and the commitments that are being made by that customer will go back to a normal basis, but also I think.
I think most likely you will see backlog decline.
Both when inflation moderates and.
Lead times get shorter having said that.
The demand is really the underlying demand is really really strong. It's just the backlog is lumpy and this is probably a very lumpy moment.
Sean if you look at the bigger picture as well therefore strained demand strong and we're just seeing the beginning.
Of all the money the government passed in terms of these various act sort of coming out of engineering and start going.
So early days of that as well so I think the demand environment is.
That will be strong for a while.
As I've said that if you are if you are following our stock it's very important to listen to what we say about backlog right. Because we're very transparent about sort of the factors that are outside of demand that are affecting our backlog and we will do that for the rest of this year, great. We'll we'll be very clear about if we see backlog start to come down I think will be.
Very clear about whether that demand based or whether thats just a normalization.
But as of right now there is no there is no sign of demand weakness.
Yes, Okay very helpful.
And then just for clarity.
Bill you highlighted the modular margins are dilutive at the gross margin level, but.
I would imagine when you look when you dropped that down to operating margin, they're accretive is that right.
Well, so they are absolutely accretive to cash flow and earnings or we wouldn't be doing it right. We don't take risk if we can repay ample debt.
And we'd rather be smaller than take work for which were not paid for the risk because there's a lot of a lot of risk in what we do there is probably lower overhead and.
In that business.
But yes no.
Keep in mind that that business can be done with less skilled labor. So one of the reasons that.
If you need a lot of licensed electricians on something youre going to pay a higher margin for that and then if you need skilled plant workers, even though they are really really at a premium there not nearly at the same premium.
As a pipe fitter thats licensed in the state. It is the only person who can touch certified.
So are you trying to say, it's lower perhaps lower operating margin, but higher return or.
How does it really not.
Not at all I would say higher scalability.
And higher related to expand because you can you can you can hire somebody to work in our plants and they can be making it they can be making your money within a week right. There's a couple of days of safety training and other staff then they will start doing one task. They will then training on the tasks that are left in there right when you hire them.
Construction worker.
You might lose money on that worker for years as you train them and bring them up to speed and then they are incredibly valuable forever. So it's just a different it's a different.
We're willing to take with you want to demand our most scarce resources, we charge more for it than if you want to if your demand is for less scarce resources.
Yes.
That's helpful.
And how is the service business continuing to grow so fast we kind of get into the drivers and a lot of detail on that new construction side, but maybe a refresh on the.
The revenue build there would be interesting.
Yes, Thanks, Shaun pointed it out as we've been talking about 10 years ago, we made a.
Organizational wide commitment.
To grow our service business.
All aspects of it.
Our significant commitment to training.
Hi leadership side and the tech side.
<unk> been able to use a number of innovative tools that.
Mckenna.
Adds up for us that we're bringing that we're bringing to the service techs. So we are still very active in hiring salespeople hiring technicians.
Expanding our base both from some of the companies we bought but most of it most of it seems to us so that commitment is still 100%.
We'll still fully embraced growth because the profitability has been terrific for us to service business.
I expect that to continue for many many more years Sean.
And so is that a market share story just to be clear is that a market share story, there or is it.
There were some juicy.
Market growth story happening under the Hood there.
I think service market share I, just think there's a lot more opportunity right. We have a lot of very skilled technicians.
You might look at energy efficiency and are building just.
Upgrading the system. So I think it's a combination of both I think we were able to expand that services higher capability of check now we have within the organization all of our companies are doing service. So it's not one thing, it's probably 10 things.
Great I'll turn it over there thanks for the answers guys.
Yes, Thanks, Sean.
Thank you please standby for our next question.
Our next question comes from the line of Adam Thalheimer with Thompson Davis. Your line is now open.
Hey, good morning, guys great quarter.
Thanks, Kevin.
On the tax.
So if congress doesn't fix that Bill one question I've had is if the if there is a free cash flow impact next year.
So interestingly enough.
Theyre doing is theyre, saying this expense of your business.
Has to be.
You have to take the deduction for the expense over five years.
So.
Next year, there would be a smaller headwind because we would be in the year in year two.
60% of it would be deferred rather than 80%. This year. The following year, there would be a smaller headwind than you would normalize in the fifth year. So this would be.
This is a headwind for five years, if they don't for everybody.
That takes the credit or actually done frankly, taking the credits is irrelevant to whether you have this money but.
And it's a much broader definition of expenses.
Finding the R&D tax credits, but yes, no it does.
Thinking thing over five years, but.
I mean, Adam I think it will put people many people, especially.
Yes.
Research based businesses out of business, if they don't fix it at some point.
I think they have to at least moderate it but we'll see.
Okay helpful and then.
Sure.
On modular how are the capacity additions coming are you still thinking that comes online this summer.
And then what would you do if you had another order.
Similar to the one that you had in December .
Well, so we get to decide whether we can take orders right.
But keep in mind that the one in December was for a couple of years and it was also they also made some other commitments over a longer period.
Permit us to make those.
Really to permit it really it was to permit us to make those investments without raising our prices.
And so.
We have with <unk>.
These additions we have capacity to take some more work some of the space. We're adding is also tolar, which gives you an opportunity to work at two levels, but if we at some point, if we get an opportunity to expand further will.
We'll take a look at the risk and reward of that opportunity and how our this expansion will make a decision at that point right now we're working on what's right in front of us.
Yes.
We're on schedule in terms of getting them up and running.
Okay.
And then just lastly, maybe you can.
Opine on the M&A outlook.
So.
We advanced a certain amount of M&A into 'twenty, one with the concern people had about an increase in the capital gains rate. So we are in a very patient mindset and we're only buying companies, where we have very high conviction or have had a very long gestation I think that would certainly continue this year.
I was surprised.
We did all the code this year.
But this is a company we've talked to since 2016, we had a great deal of admiration for that company. When they were ready to sell we were ready to buy.
I'd say.
The middle of the it's we're coming up on the middle of the year I don't know.
Most if there could be zero or one more deal this year, but we're not right now we're in a.
We're also watching the market changed drive the cost of capital is changing the people who compete with us for those companies are facing very very different circumstances than they have in the past we've always been patient about these things and I would say, we definitely have a patient high conviction mindset, but we're doing development all the time in fact I.
We will do more development business this year than I have done on the on track to do far more than I have done in the last three years keeping in mind Covid. So we're really we're really trying to make sure we're working hard on development for the future.
Got it thanks guys.
Yes.
Sure.
Thank you please standby for our next question.
Our next question comes from the line of Brent Wadman of D. A Davidson your line is now open.
Hey, Thanks, good morning.
Hey, good morning, Brian .
Hey, Brian Hey, Bill on just on the R&D tax.
You made a comment.
People out of business.
Referring to folks within your own industry.
No I'm really referring to technological companies pharmaceutical company like startup pharmaceuticals, or they'll have to go sell very quickly to somebody I mean.
If you if once you do as a primary part of your business is research and you are only allowed to treat 20% of every dollar you spend on research.
A.
<unk> expense for that year, you can take a company that's losing money in the real world and tax. It is if it's got 70% margins. Many of those companies do not have the balance sheets to stand up to that so I.
I think that's the kind of thing I'm talking about.
Okay.
In the context of your own sort of capital deployment.
I guess strategy over the next coming quarters is that top of mind for you before you decide to buy.
Buybacks and deals and things like that.
If we're being honest.
Our cash flow.
Has trended.
Better than we would've expected a year ago or two years ago by more than this headwind. So it doesn't feel like a terrible constrained it feels like.
I think we have cash.
Our guys are really executing people value plumbers and pipe fitters.
So I don't see.
I don't see how this is a big issue other than.
We will pay interest if we have less cash flow.
Either earn less interest or pay less interest depending on whether we are cash positive.
A little bit.
Great.
Okay. Okay.
And then.
Eight per scale data center activity has been a huge driver.
Modular business I guess for the company overall.
It's still kind of some varying views out there about future prospects could you talk about the level of the <unk>.
Gary maybe reviews.
You guys, you see and how does that market compare to the last couple of years.
What's been pretty robust activity.
Already.
I'll go for Us yes.
The activity is very still very strong.
<unk> modulates traditional construction.
Sure.
Quite frankly.
We're not concerned about the data center market, we have plenty of work.
Yes.
I would say some of the Hyperscale guys, they're all.
The level of inquiry is as high or higher than it's ever been.
More they're putting cost into the conversation earlier and more prominently than.
And then they have in the past the thing about US is that we really when we do this kind of work for people we partner with people, we work hard with them to get them, a really really good value and they typically understand that we take we take a ton of risk.
And have to make investments to really give them the quality they expect.
Im optimistic that.
The demand is high and I'm optimistic that actually were the best way to meet that demand right now for them.
Sure.
And then on the modular side at least I think it's been mostly focused in that specific market with one.
A single large customer correct me if I'm wrong is that is that expanding to new potential customers now in that market.
So it would be premature to say, it's expanding well so first of all that one big order was from one customer right. They were.
We're keen to make sure they got some things they needed frankly for their business as far as we can tell.
We did get.
Trial order from somebody else like them.
And we'll see how that goes but there is definitely interest really the reality is these guys who need to build hyperscale data centers, they're like us we need to hire people when people say well what are you doing to hire people, we say everything that can be done as what we're doing to hire people I think these hyperscale data center guys. When you ask them what do you.
They do it to build Hyperscale data centers I think every path.
Towards getting these things.
High quality production is what they're taking.
So the overwhelming majority of the data centers are not built modular right.
The math couldnt, possibly support that but we think there's a nice opportunity here for us to grow and provide for our customers.
Really good more scalable than most.
Path to getting what they need.
Got it.
And I guess, just lastly, I think you said.
Past few quarters sort of ambition that yet.
Electrical margins to match the mechanical margins over time.
Presumably with the work Youre seeing inbound.
I guess any views on that turns into bid margin things attached to that new projects. It gives us some more confidence around that.
Yes, Brett.
Sure we've had a really is.
Steady state increase in the margins in the electrical business over the last few years.
I think.
That's going to continue.
Plenty of electrical.
We're good at.
Yes.
We like to do and the work and the work coming forward.
Sufficiently challenging for us.
Raising our prices a little bit so I'm really optimistic that we will see continued margin strength in the electrical business.
Okay, Alright, thanks, Scott Congrats on a great quarter alright. Thanks.
Great. Thank you I would now like to turn the call back to Brian Lane for closing remarks.
Okay. Thank you everyone for your continued interest in comfort systems.
And once again, thank you to all.
Diligent employees for just doing a really an outstanding job.
<unk> results.
This show.
<unk> commitment is being made.
We are looking forward to the summer and we are very optimistic for the remainder of 2023 hope everyone has a great day and we hope to see on the road soon thank you.
<unk>.
Thank you for your participation in today's conference. This does conclude the program you may now disconnect.
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Okay.
Yes.
Yes.
Okay.
Okay.
Yes.
Thank you.
[music].