Comfort Systems USA Q2 2024 Earnings Call Transcript

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July 26, 2024

There are 8 speakers on the call.

Operator

Good day and thank you for standing by. Welcome to the Q2 2024 Comfort Systems USA Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Julie Schaeff, Chief Accounting Officer.

Operator

Please go ahead.

Speaker 1

Thanks, Daniel. Good morning. Welcome to Comfort Systems USA's Q2 2024 Earnings Call. Our comments today as well as our press releases contain forward looking statements within the meaning of the applicable securities laws and regulations. What we will say today is based upon the current plans and expectations of Comfort Systems USA.

Speaker 1

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 can read a detailed listing and commentary concerning our specific risk factors in our most recent Form 10 ks and Form 10 Q as well as in our press release covering these earnings. A slide presentation is provided as a companion to our remarks and 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.

Speaker 1

Okay. Thanks Julie. Good morning everyone and thank you for joining us on

Speaker 2

the call today. We had a fantastic quarter as our teams achieved superb execution for our customers. We earned $3.74 per share this quarter which is an increase of over 90% compared to a year ago. Our mechanical business exceeded last year and our electrical segment achieved unprecedented margins. Both operating income and EBITDA dollars increased by 100% this quarter compared to 2023.

Speaker 2

Demand remains strong, especially in the industrial sector including technology and other manufacturing customers. Our backlog continues to track at high levels despite our strong revenue for the quarter. Backlog is $5,800,000,000 far higher on both an absolute and a same store basis than this time last year. And we continue to select work that has good margins and good working conditions for our valuable people. I will discuss our business and outlook in a few minutes, but first I will turn this call over to Bill to review our financial performance.

Speaker 2

Bill?

Speaker 3

Thanks, Brian. So, 2nd quarter results were really remarkable. We had 30% same store revenue growth, higher margins, good SG and A leverage and over $165,000,000 in free cash flow. We achieved more than $200,000,000 in quarterly EBITDA for the $1,800,000,000 and that is an increase of $514,000,000 or 40% compared to last year. Our Mechanical segment revenue increased by 49%, benefiting from organic construction and service growth, recent acquisitions and modular expansion.

Speaker 3

Electrical segment revenue increased by 12% and overall our same store revenue increased by 30% or $383,000,000 with the remaining $131,000,000 of increase resulting from acquisitions. We are facing tougher prior year comparable results for the remainder of the year. Through 6 months, our same store revenue growth has been 26%. And currently, our best estimate is that for full year 2024, our same store revenue growth will be in the low to mid-twenty percent range. Gross profit was $364,000,000 for the quarter of 2024, a noteworthy $136,000,000 improvement compared to a year ago.

Speaker 3

Our gross profit percentage grew to 20.1% this quarter compared to 17.6% for the Q2 of 2023. Quarterly gross profit percentage in our Electrical segment jumped to 23.6% this year as compared to 17% last year. Margins in our Mechanical segment also increased significantly to 19.2% as compared to 17.8% in the Q2 of 2023. EBITDA doubled to $223,000,000 this quarter from a strong $112,000,000 in the Q2 of 2023. Same store EBITDA increased by over 80% and even without recent acquisitions, our EBITDA exceeded $200,000,000 Considering the strong ongoing demand, we expect that for 2024 EBITDA margins will continue in the strong ranges that we have achieved over the last several quarters.

Speaker 3

SG and A expense for the quarter was $180,000,000 or 9.9 percent of revenue compared to $136,000,000 or 10.5 percent of revenue in the Q2 of 2023. Our operating income increased by just over 100% from last year from $92,000,000 in the Q2 of 2023 to $185,000,000 for the Q2 of 2024. With improved gross profit margins and favorable SG and A leverage, our operating income percentage surged to 10.2% this quarter from 7.1% in the prior year. This is the first time that we have achieved 10% OI margins in the quarter. Since I became CFO, Comfort Systems has not used adjusted numbers to make our results look better.

Speaker 3

However, today I do want to point out a notable factor in our results. Our recent acquisitions have exceeded our high expectations, resulting in larger than usual earn out expense. Without the changes in the fair value of our earn out obligations this quarter, certain earnings would have been notably stronger. We always have purchase related adjustments in the periods following an acquisition. However, they currently are and likely will continue to be much larger over the next several quarters because of the significant contingent consideration opportunity included in recent transactions.

Speaker 3

Our year to date tax rate was 21.3%. We currently estimate that the full year 2024 tax rate will likely be in the 21% to 22% range. And after considering all of these factors, net income for the Q2 of 2024 was 134,000,000 dollars or $3.74 per share. This is a 90% improvement from last year. Free cash flow for the 1st 6 months of 2024 was $290,000,000 We continue to benefit from advance payments for work that we will fund and complete in upcoming quarters and operating cash flow continues to exceed our earnings by about $300,000,000 on a trailing 12 month basis.

Speaker 3

So we are well ahead of earnings in collecting our cash. Even with 2 notable acquisitions earlier this year, we have succeeded in retiring all of our bank debt as of June 30, 2024 and other debt was $91,000,000 with cash balances exceeding our debt. We also spent around $11,000,000 on share repurchases this quarter. Go ahead, Brian.

Speaker 2

Okay. Thanks, Bill. I'm going to discuss our business and outlook. Our backlog at the end of the second quarter was $5,800,000,000 a large year over year increase and a modest sequential decline. Since last year, our backlog has increased by $1,600,000,000 or 38 percent.

Speaker 2

$1,000,000,000 of the increase was same store and $600,000,000 was new backlog from recent acquisitions. We are entering the second half of twenty twenty four with 25% more same store backlog than we had at this time last year despite a roughly 30% surge in organic revenue. Our revenue mix continues to trend towards data centers, chip fab, battery plants, life science and food. Industrial customers accounted for 60% of total revenue in the first half of twenty twenty four and they are major drivers of pipeline and backlog. Technology which is included in industrial was 31% of our revenue, a substantial increase from 20% the prior year.

Speaker 2

Institutional markets which include education, healthcare and government are also strong and represent 23% of our revenue. The commercial sector remains reasonably active in the regions that we serve, but it is now a smaller part of our business at about 17% of revenue. Most of our service revenue is for commercial customers. So the share of our construction revenue that is commercial is now relatively small. Construction activities continue to be extraordinarily strong and our project pipelines continue at unprecedented high level.

Speaker 2

Construction accounted for 84% of our revenue with projects for new buildings representing 59% and existing building construction 25%. We include modular in new building construction and year to date modular was 18% of our revenue. Service revenue was 16% of our total revenue. As our service revenue increased by 10% and service profit grew by 20% this quarter. Service is a reliable source of profit and cash flow and is on track to exceed $1,000,000,000 in revenue for 2024.

Speaker 2

As noted above, we are entering the second half of twenty twenty four with a backlog that is 25% higher on a same store basis that we had at this time last year. And we have a superb team working hard for our customers every single day. Thanks to the dedication and hard work of our employees across the country, we are optimistic about our future. As always, I want to close by thanking our over 17,000 employees for their hard work and dedication. I will now turn it back over to Daniel for questions.

Speaker 2

Thank you.

Operator

Thank you. Our first question comes from Alex Dwyer with KeyBanc Capital Markets. Your line is now open.

Speaker 4

Hey, good morning. Thanks for taking my questions.

Speaker 5

Good morning.

Speaker 4

Good morning. So it's nice to see the continued strength in margins and the guidance calls for this to continue this year. But how sustainable do you think these margins are as we think about the business on a longer term basis? Is there any reason to think these margins would ultimately revert back more towards the historical averages over time?

Speaker 2

I think Alex particularly the upcoming short term, I think we're in pretty good shape to maintain these margins. We're getting good pricing and we're getting excellent execution in the field. And also you can't forget, we are growing service 10% and you see profitability increase there. So I think we're pretty optimistic in the near future that we

Speaker 3

should maintain these margins. I would say every factor that is creating these margins is continuing at least as strong as it has been and in some cases continues to get stronger.

Speaker 4

Got it. And then the modular construction performance in the quarter, Was most of that project activity for data centers? And then more broadly, how do we think about the growth algorithm in modular going forward, capacity additions and the ability for the business to gain efficiencies over time?

Speaker 3

So modular like really every single part of our business did great, this quarter. And it's as you can see, it's growing. It's up to near 18% of our revenue. And so it's adding a percentage while the revenue is growing very quickly. So that's continued to grow.

Speaker 3

As far as the future, people have been asking a lot, are we going to make new large commitments to space? I don't think that that is something that we are taking incremental commitments. We have added incremental space within the last few months. We're more likely to do things incrementally. And I do want to say that one of the things that we emphasized when we took the additional 1,000,000 square foot of space that we took recently, we took space that was much had much higher roofs and was much more configured for automation.

Speaker 3

So I think a lot of our goal is going to be to improve the production and productivity of the newly deployed space. Ultimately, Comfort is going to take the amount of work we can execute. And when people there are businesses that you can scale easily. This is a business that you're doing things in the real world. You're delivering things that are 3 stories tall and 100 yards long and have incredible complexity inside them.

Speaker 3

And you have to respect the difficulty of what you're doing and make sure we will always put our ability to keep our promises to our customers above sort of pushing for growth on the top line.

Speaker 4

Thank you. I'll turn it over. Thanks.

Operator

Thank you. Our next question comes from Adam Thalhimer with Thompson Davis. Your line is now open.

Speaker 6

Hey, good morning guys. Great quarter.

Speaker 2

Hey, Adam. Hey, Adam. How

Speaker 6

are you doing? Good. All right. So also on Modular, I think it was late, was it December of 2022 you had like a program award for modular? I'm curious if you see the potential for more of those going forward or if future modular awards are more one off?

Speaker 3

So I don't know about one off. They're just constant. So in 2021 December, there was a big commitment that was part of a really more than a year's negotiation with a large customer that induced us to make a really big investment in a 1,000,000 square feet of additional space. Since then, we have been able to keep the backlog at least the levels that we achieved sort of in that timeframe. But it's the awards sort of come in as programs are completed, right?

Speaker 3

There's short there are redesigns that happen in the products that we sell. And I don't know if it will continue, but I will say in the last 3 years, we've tended to get more of the modular bookings in the winter months, sort of December, January, February, and we've had sort of a net burn in the middle of the year. We certainly had a net burn in modular this quarter, but we it's because we had really big bookings over the winter. And I think our prospects are good for that, but obviously, it depends if people are still planning on having data and computing power, right, which we think they are.

Speaker 6

All right. That was my next question, backlog seasonality, because for a couple of years now, it's been burn over the summer and build over the winter, can that happen again?

Speaker 2

Yes. So if you look at last year, we sort of went through the same cycle. I mean, the thing you look at, we look at, Adam, is what's the demand, what's our pipelines look like. They're robust. It's in all the markets we served.

Speaker 2

It's probably a strong I've been doing this for 40 some years. It's probably the best market I've ever been in. So we're pretty optimistic to see plenty of work for a while.

Speaker 6

And then lastly, can you just comment on Texas Electrical, The margins over 22% again for the 3rd straight quarter, kind of what's the outlook for that business?

Speaker 2

Yes. Well, first of all, the electrical company we have here is really is a superb company that Bill found for sure. They're in the 4 big markets that we like in Texas. We have more electricians than anyone else and Texas is booming. We got a lot of mission critical work, which is really in the sweet spot.

Speaker 2

So we're really humming along in that business right now, and I think it

Speaker 3

will go on for a while. It's also important to know it's the Electrical segment is not just Texas. We have unbelievable results right now in Kentucky and North Carolina. We have just fantastic Electrical businesses. People need what they do.

Speaker 3

They do a great job for their customers, and they make sure that they get paid for the capacity that they can bring to bear and for the risks that they take. So it's really to hit those kind of numbers, pretty much everybody had to be just having an amazing outcome.

Speaker 2

It's good to have electricians right now, Adam.

Speaker 6

Good to hear. All right. Thank you, guys.

Speaker 2

All right. Take care. Thanks.

Operator

Thank you. Our next question comes from Josh Chan with UBS. Your line is now open.

Speaker 5

Hi, good morning guys. Congrats on a really good quarter.

Speaker 2

Thanks, Josh.

Speaker 5

I guess, Brian, if you really look at the bidding pipeline, do you see kind of new projects popping up for bid at similar or stronger rates? And where are those verticals, any difference versus sort of the recent past?

Speaker 2

I think if you look at the pipelines in the backlog, it's been pretty consistent for the last 18 months to 2 years. We're still seeing, as we mentioned in the script, similar opportunities, data centers, pharma, life sciences, food, etcetera. So we're seeing the mix pretty consistent in the markets that we serve and there's been no let up, Josh.

Speaker 3

If you don't mind, I'll just comment on data centers. There are people right now who seem to be concerned that something is happening with the data center build. What we are hearing from our customers and experiencing in the market is that they are continuing to believe in deploying data centers. They've bought a lot of very, very expensive computer chips. They're taking delivery of those on a regular basis.

Speaker 3

Our understanding is they're going to be deployed into servers and put in buildings that are going to need to be cooled. They're going to need to be heated. I mean, sorry, they're going to need electricity, they'll be heated by the data by the servers. But and also we're seeing data center work pop up in places that hasn't started yet in states where we hadn't seen data centers before. So it's possible, I guess, that that's slowing down.

Speaker 3

But I will say, if that's happening, it's certainly not in anything that we can see or experience in our vision or our markets or in our conversations with our customers.

Speaker 5

That's encouraging. And thanks for the color there. I guess in this current environment, how do you keep your employees kind of happy? And I know no one is like relaxed working this hard, but any concerns about the sustainability of everybody working this hard for a long time?

Speaker 2

Yes. Josh, that is a great question and thanks for asking it. We really take great pride in protecting our folks from a health and safety perspective, treat them fair, we treat them with respect. We have a lot of work for them to do, which is great for themselves and their families. But at the end of the day, we are extremely grateful for the hard work and commitment they're all making, but we really go out of our way.

Speaker 2

We're very field focused in this company, which I'm really proud of, And we really do try to take care of them as best we can. So they like a lot of work. They like to work. So we're in a good time for them as well. So thanks, but thanks for

Speaker 5

asking. That's good. And then maybe I can sneak one more in. If people were to ask you what percentage of your business do you think is exposed to AI, how would you address that? Is that the data center portion or how would you kind of think about that?

Speaker 3

I don't I think AI let's say the demand for data, right, because even the AI build really only started at last year, 15 months, right? There's been heavy data center construction because people were getting ready for streaming. Everybody's forgotten about that. Compute Power, the AI thing is an incremental add to what was already a very, very solid pipeline. I would say that it's both AI and chips that are affected by, driven by decisions by hyperscalers to protect their core businesses by making sure they're not left behind and to prepare for opportunities of the future by building out this capacity.

Speaker 3

I don't know if that helps, but

Speaker 5

Yes. Thanks, Bill. And thank you both for the response and the time.

Speaker 6

Thank you.

Operator

Thank you. Our next question comes from Julio Romero with Sidoti and Company. Your line is now open.

Speaker 2

Thanks.

Speaker 7

Hey, good morning guys.

Speaker 2

Good morning.

Speaker 7

You guys talked about good morning. You guys talked about same store sales growth in the low to mid-twenty percent range for the full year. I guess that implies at least 15% -ish growth in the back half. Just any thoughts about how we should think about same store sales growth percentages in 3Q and then in 4Q?

Speaker 3

So through 11 months, it was 26%. So to sort of be the low mid teens, it would have to it would come down some, but maybe not down to 15%, right? If the second half was 15%, that's going to average below 20%. So we're it's a little stronger than that. We don't really know what's going to happen.

Speaker 3

There's a lot of we are on July 1 this year, we had 25% more booked work on a same store basis than we had last year. So we believe we're going to have very strong growth for the full year. Our best estimate is that low mid-twenty percent range. But I will say there's a range around that of what could happen and we do we have seemed to be surprised to the upside lately.

Speaker 7

Got it. That's helpful. And then, you guys talked about factors that are creating these margins. One of them, I would think would be project selection. Can you maybe just talk about that and how crucial of a factor that is in creating these margins?

Speaker 7

And is that kind of like a rising tide of sorts where you can just continue to see greater quantity of opportunities than you're able to do and therefore you're able to become more and more selective on these projects?

Speaker 2

Yes, I think we have a process like most people do go, no go, but we're very careful to select. We will put in our valuable resources with good customers in doing good work. So it's really important that you go through the factors in selecting what work you're going to take in a market like this when there's a lot of work out there, Julio.

Speaker 7

Okay. Okay. And then last one for me would just be on that 10% operating margin milestone that you hit in this quarter. I think it may also be the first time, at least in quite a while that your SG and A margin has a 9 handle on it. So maybe if you could just touch on SG and A leverage and how we should be thinking about that going forward?

Speaker 3

It's a great question. It's going to be hard to get much more SG and A leverage just mathematically, right? But I do think this range is we should continue in because we're continuing to get the revenue growth. We did have notable dollar increases in SG and A this quarter. It does take money to do this work.

Speaker 3

So I guess I would say I guess if that were a modeling question, I wouldn't count on a whole lot more leverage. But I don't think I think the leverage we've gotten so far is pretty solid until revenue trends were to change here.

Operator

Thank you. I'm showing no further questions at this time. I would now like to turn it back to Brian Lane for closing remarks.

Speaker 2

All right. Thanks everyone for listening in today. I really want to thank our amazing employees again. We're really grateful for the work that they do. I hope everyone enjoys this summer and the weekend and we look forward to seeing everybody in the road soon.

Speaker 2

Thank you.

Speaker 3

Thanks,

Operator

everyone. This concludes today's conference call. Thank you for participating. You may now disconnect.

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Comfort Systems USA Q2 2024
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