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spk08: Thank you for holding. The conference will start shortly in just a moment. Thank you. Good morning and welcome to the Comfort Systems third quarter 2022 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. As of today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star on your telephone keypad. To withdraw a question, please press star then two. Please note this event is being recorded. I'm going to turn the call to Julie Shafe, Chief Accounting Officer. Please go ahead.
spk00: Thanks, Anthony. Good morning. Welcome to Comfort Systems USA's third quarter 2022 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 on the current plans and expectations of Comfort Systems USA. Those plans and expectations include risks and uncertainties that might cause actual future activities and results of our operations to be materially different from those set forth in our comments. You 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, and Bill George, Chief Financial Officer. Brian will open our remarks.
spk06: All right. Thanks, Julie. Good morning, everyone. We had another great quarter with continued increases in revenue, earnings, and backlogs. and we are really grateful for the success created by our employees amid unique challenges. We earned $1.71 per share this quarter compared to $1.27 a year ago. Our results this quarter include a net gain of $0.10 per share related to legal matters and $0.04 related to tax benefits from prior years. This quarter marks the first time that we have achieved $100 million in EBITDA in a single quarter. Strong activity levels and ongoing cost increases in equipment and other inputs have again produced same-store revenue growth of over 20%. Bookings increased this quarter, and we continue to experience solid bidding and planning activity. Our strong cash flow also continues and is especially satisfying since we are investing working capital to support our growth. We have also announced an increase in our dividend to 15 cents this quarter. I will discuss our business and outlook shortly, but first I'll turn this call over to Bill to review our financial performance. Bill?
spk04: Thanks, Brian, and good morning. Revenue for the third quarter of 2022 was $1.12 billion. an increase of $286 million, or 34% compared to last year. Our recent acquisitions contributed a total of $97 million of new quarterly revenue, and so we had the same store revenue growth of $198 million, or about 23%. That sharp increase in revenue was broad-based and was driven by strong market conditions. Inflation of equipment and materials also contributed to revenue growth. Our same-store revenue increased by 23% in the third quarter, and same-store employee headcount increased by 8% in the same timeframe. For the fourth quarter, we currently expect double-digit same-store revenue growth, although there are more variables than usual. Gross profit was $202 million for the third quarter of 2022, a $43 million increase compared to last year and the first time we have ever reported over $200 million of gross profit in a single quarter. Our gross profit percentage was 18.1% this quarter, compared to 19.1% for the third quarter of 2021. The decrease in gross profit percentage resulted from the change in project mix, including the pass-through of inflated materials and equipment costs. Gross profit percentage was impacted by a decline in gross profit margins in our mechanical segment compared to extraordinary performance last year, partially offset by a strong increase in the electrical segment, which was further enhanced by a job-related litigation gain. SG&A expense for the quarter was 121 million, or 10.8% of revenue, compared to 95 million, or 11.4% of revenue for the third quarter of 2021. Most of the dollar increases from new companies. Our operating income increased by 27% or 17 million as compared to the third quarter of 2021. Our tax rate for the quarter was 17.4%. During the current quarter, we filed our 2021 federal tax return and we included the R&D tax credit in this original return. And as a result, we increased our estimated tax benefit related to the R&D tax credit for the current year as well as for the years 2019 to 2021. That was a gain of $0.04 for the third quarter of 2022 that related to prior years. We continue to view our normalized tax rate to be approximately 22% to 23%. Net income for the third quarter of 2022 was $62 million or $1.71 per share. The $1.71 per share includes the 10% net gain related to legal matters and $0.04 related to the revised estimate for the R&D tax credit related to 2019 to 2021. Net income for the third quarter of 2021 was $46 million or $1.27 per share by comparison. EBITDA increased from 82 million in the third quarter last year to 101 million this quarter, a 23% year-over-year EBITDA increase. As Brian pointed out, this is the first time in our history that we've achieved over 100 million of EBITDA in a single quarter. Free cash flow for the first nine months of 2022 was 137 million, including the $33 million refund from the IRS tax credit. first quarter. This is strong cash flow considering the investments we're making in working capital as we fund our growth. Our debt at the end of September was $381 million and our debt to EBITDA ratio at quarter end stands at 1.2. We are actively repurchasing our shares and in the first nine months of 2022, we have repurchased 425,000 shares for approximately 36 million dollars. All right.
spk06: Thanks, Bill. I am going to spend a few minutes discussing our backlog in markets, and I will comment on our outlook for the rest of 2022 and 2023, and on inflation and supply chain considerations. Our backlog at the end of September was $3.25 billion. A year over year, our same-store backlog is up $1.1 billion, or 57%, with increases across most of our operations. Sequentially, our same-store backlog increased $443 million, which is remarkable for a third quarter as we are also burning backlog at record levels. In addition to strong demand in technology and other industrial sectors, An important factor driving our backlog higher is that our customers are committing orders to lock in our labor so that we can place equipment orders earlier in order to allow for exceptionally long lead times from manufacturers. Industrial revenue was 47% of our revenue in the first nine months of 2022. This sector, which includes technology, life sciences, and food processing, remains strong. and is very, very heavily represented in New Backlog and in our pipeline. Institutional markets, including education, healthcare, and government are solid and represent 32% of our revenue, consistent with last year. Finally, the commercial sector remains active, but with our changing mix, it is now a smaller part of our business at about 21% of revenue. Year to date, construction was 78% of our revenue, with 48% from construction projects for new buildings and 30% from construction projects in existing buildings. Service was particularly strong during the third quarter. Overall, service is 22% of our year to date revenue, with service projects providing 9% of our revenue and pure service, including hourly work, providing 13% of revenue. Year-to-date service revenue is $674 million, a 33% increase, with same-store service revenue up by 16%. Service continues to be a consistent and growing source of profit and cash flow at Comfort Systems. In all our activities, including both service and construction, We are encouraging and supporting our customers as they seek to improve the efficiency and sustainability of their buildings and operations. And we are raising our own standards in the areas of sustainability, diversity, and governance. Inflation is widespread, and we expect continued challenges in the cost and availability of the inputs that we use to serve our customers. Although conditions are hard to predict in the near term, we are recognizing these challenges in our job planning and pricing, and we are working to order materials earlier than usual while seeking to collaborate with customers to share supply risks and to mitigate these challenges. We have a very good pipeline of opportunities, and so far, we have been able to maintain activity levels and productivity despite supply chain challenges. We are watchful of world events and Fed tightening. However, given ongoing demand, our record backlog, and strength in the industrial and institutional sectors, we anticipate continued strong earnings and cash flow in the coming quarters. As we look ahead, our priority is to preserve and grow the best workforce in our industry. so we can continue our legacy of safely constructing, installing, maintaining, repairing, and replacing our nation's buildings, while helping our communities achieve sustainable growth. With the highest backlog in the history of Comfort Systems USA, we will continue to invest in our workforce, technology, and execution capabilities. Thanks to our amazing workforce, We are optimistic about the remainder of 2022 and 2023. I want to end by thanking our 14,000 employees for their hard work and dedication. I'll now turn it back over to Anthony for questions. Thank you.
spk08: We will now begin the question and answer session. To ask a question, you may press start the one on your telephone keypad. If using the speakerphone, please pick up your hands before pressing the key. To withdraw your question, please press the R2. At this time, we will pause momentarily to assemble our roster. Our first question will come from Julio Romero with Sedoti & Co. You may now go ahead.
spk01: Thanks. Hey, good morning, Brian, Bill, Julie. Good morning, Julio. Starting on the... Hey, good morning. Starting on the revenue, the organic growth, it's the second straight quarter of 20% plus growth, broke a billion in organic sales, in sales, I should say. Just talk about the trend line for organic growth, X of cost pass-throughs. I know you mentioned same store headcount of up 8%. Is that kind of the baseline for organic growth?
spk07: Yeah.
spk04: So, no, I would not say that's the baseline because, of course, We're charging more for those 8%, right? So there is inflation in that number. And also, our temporary labor is up quite a lot by more than 8%. So I think the best, our best, you know, you can't know what would have happened without inflation. But our best estimate continues to be that about half of our same-store growth is caused by inflation and market conditions, and about half of our same-store growth is just us doing more work, you know, true underlying growth. And as far as the first part of your question about sort of the trend line, so, you know, we are still – we had a reasonably soft comparable compared to a year ago. We were still coming out of COVID. The comparables get a little tougher in the fourth and first quarter, but they're still really favorable comparables if all you were looking for is same-store revenue growth. By the second quarter of next year, we'll be comping, and for the rest of next year, we'll be comping to these big numbers we're posting right now that are, you know, our second quarter was up 25%. So a year from now, you know, depending on what inflation is doing, it's much, much harder to prognosticate that you're going to grow from there. Even if we don't, and by the way, if inflation abates, right, that could create at least some of a sort of a turnaround in that effect. But I would say we don't think that would mean we would earn less money. In fact, if anything, it could be slightly favorable if prices were to get better. So what you would see is you'd see lower revenue growth, but of course the margins would get better because we'd have less of that material pass-through. It's a long question, but it's a complicated situation as well. Long answer, I'm sorry.
spk01: No, totally, and I appreciate the comprehensive answer there. just on the increase in bookings, it's up almost 500 million, uh, sequentially, just how much of that, you know, are you able to parse out how much of that is driven by the larger industrial projects that are kind of committing earlier?
spk06: Yeah. Um, Oh yeah. Who are you? It's Brian. So it's, um, we, you know, we got broad based increase in backlog, uh, to be honest, but for sure we are, um, we are getting increased bookings and you'll see that continue into the fourth quarter. But, um, The backlog increase, quite frankly, is broad-based.
spk04: Coincidentally, service was up by exactly the same percentage year over year as construction. So I think it's all across the board, that gain. But for sure, you'll probably see in the coming quarters more of that coming from these industrial bookings because they're just so big. And also, third quarters are always strong service quarters.
spk01: Understood. And then maybe the last one for me is on the segments. This is the first time that electrical gross margins outpaced mechanical. Is that kind of an inflection point for the electrical segment? Have you kind of reached some critical mass where you start to see some better operating leverage there?
spk06: Yeah. Well, I mean, we've had pretty consistent steady state growth in gross margins. I mean, I think we have really terrific electrical companies. We had a challenging job. a few years ago that got helped by litigation pick up for sure, but we have improved significantly better across the board in electrical. I'm pretty optimistic we'll continue to see improvement in the gross margins as we go forward.
spk07: Okay, very good. Thanks very much for taking the questions. Thanks.
spk08: Our next question will come from Sean Eastman with KeyBank. You may now go ahead.
spk02: Hi, team. Fantastic quarter. Many compliments. So this kind of early project commitments dynamic that is part of the momentum and the bookings we're seeing in the quarter, how would you characterize the duration of the backlog at this point and how Does this early commitment on orders suggest there's some pull forward in the bookings we're seeing this quarter, or is the message that that bookings momentum still continues post-quarter?
spk04: So definitely there's pull forward, right? I mean, because if they book earlier, then they would have been. Now, does that mean they won't continue to book heavily? No. You know, the question is, at some point, do they stop booking earlier because the lead times for equipment become less or because the market softens? And I think there's certainly no sign of that in what's actually happening in our business. Of course, you know, we don't know. That could change in a month or a year or, you know, but right now, I don't know, Brian, it's very robust.
spk06: Yeah, it's very robust. And, you know, we're even seeing, you know, a backlog extend recently. Great. It's probably the highest number we've had longer than a year, Sean. So we've seen, you know, it's been the opposite.
spk04: I think it's actually picked up, quite frankly. You know, we have companies that aren't selling for 2023. They're full.
spk09: Yeah.
spk04: And if you think about that, that's why people are committing earlier, because they understand, oh, these guys are getting full. If we want a building, we better get, we better get.
spk06: And, you know, and equipment's one thing. You also got to, you know, the labor, right? You got to make sure, you know, they want to make sure the people that do it. So.
spk02: Yeah, so kind of fair to say that pretty abnormally high visibility for 2023 at this point. Unprecedented.
spk06: At least in the 20 years I've been here, for sure.
spk02: Yeah. Okay, got it. And then just this notion of locking up your labor resources early, you know, you guys are kind of the – I mean, there's a lot of scarcity in the system, I suppose, but the labor resources is a really kind of core scarce resource in the project lifecycle. And I just wonder how you think about monetizing, locking up those resources early, particularly in kind of an uncertain cost environment as well.
spk04: Well, as you might imagine, If someone in one of the many, many cities we're working at is very busy, if you want them to do work, you're going to have to pay them well for it. So, you know, you can see it in our numbers, right?
spk06: Yeah, you can see it in the results, Sean. Yep. You know, we're very fortunate here. You know, at the operating company level, these folks have a really good handle on the markets they're playing in. in terms of all facets of the business. And we're very fortunate with the companies we have today.
spk02: Yep, we can see that. And maybe one last quick one for Bill on M&A. Obviously, the last couple of years has been quite active. It's been quite a good story for you guys. Any message on, say, the next one to two years in terms of what's in the pipeline and what we could expect to see?
spk04: You know, it's certainly – so we have two things going on in M&A. One is there are people we've just talked to for years. We're friends. And when they're ready to sell, we are there. You know, we've worked on it for years, and you may see some M&A for sure. But in general, we do think that the market is changing, that the cost of capital has an effect on what people, you know, are willing to – how people are willing to invest capital, and that there are a lot companies for sale right now and i don't mean the companies we usually buy i mean companies owned by private investors there are i'd say there's three times as many books you know pitch books on the street that i've ever seen so i think it's a moment of inflection and i think we're going to be very very careful we've said forever we we don't have to do a deal in any given year right we just want to create value over uh we play a very very long game for this so um I know it's a bit of a mixed answer, but there's really two parts. And I would say we're going to be very, very, very, very watchful right now.
spk06: You know, Sean, if Bill keeps his track record he's had for the last 10 years, we'll be in good shape.
spk02: Yeah, yeah, no doubt about that. Thanks a lot, guys. I'll turn it over.
spk07: All right, Sean, take care.
spk08: Our next question will come from Adam Thalimer with Thompson Davis.
spk03: You may now go ahead. Thank you. Hey, good morning, guys. Great quarter. Hey, thanks, Adam. Just out of curiosity, can you just follow up on that, Bill, on the three times the amount of books floating around? Why do you think that is?
spk04: I think it's because if you were somebody, you were an investment firm for whom a business really is inventory, right? If you have a lot of inventory, you might not want to hold that inventory over the next year, so you might want to at least test the market. So I think that It's really astounding, quite honestly. Maybe I should – I'm speaking out of school. But in general, everything's for sale. It's, you know, everything that is owned by people who trade businesses seems to be – everything I know of is they're at least testing the market. Now, do I think they're succeeding in selling these businesses? I wouldn't rule it out, but I don't know because we're not super active – We take a hard look at some of the really best stuff, but in general, we don't participate in any of that. We like to get to know people over years, right? And that's not really how that works. We're often not huge fans of things that other people have been assembling, right? We're very, very careful. We really understand how hard that is and how hard it is to put stuff together in ways that will last for decades, right? So far, we've never bought a company. We've never bought a contractor from anybody but a human being who owned it and lives in it and loves it. Never done it.
spk03: What would be the appetite to, I mean, you added electrical and you're doing well there. What would be the appetite to add something else to the portfolio?
spk04: Well, there's not much need to for the foreseeable future. So it would have to be something we really felt like we had a reason to expect synergy from, right? And by the way, we did. We added a labor company, but, you know, in a way that matters to you that creates a new segment, I think we're just barely getting started with the labor.
spk06: I think we see a lot of opportunity, Adam, in just continuing to improve the mechanical, electrical businesses that we're in. I think there's, you know, constant improvement, and it's pretty exciting. So we'll keep at that, I think.
spk03: Okay, and then I guess I've got to ask one nitpicky one. Just on the margin outlook, what are your thoughts on margins Q4 and next year? And some of that relates to where we were in these jobs when you start to finish up some large jobs that got started over the last year, year and a half.
spk06: Well, I'm really happy with the margins that we're cranking out right now. We're 18.1%, as I said, probably a trillion times You're 17 and a half, 18 above that. I think you're really performing well in the field. I think we're getting terrific productivity. I think we can maintain that level. You might get a little improvement as, you know, as service continues to grow, right? We're getting some good margin help from there. But if we continue to perform in the field, that 18% range is definitely doable, and I think that's a really good number for us to be around.
spk03: Q4 and next year? It might dip down in Q4, right?
spk04: So, Adam, there's a variable here that we don't know, which is right now our volumes are lower because of the pass-through. In our cost of goods sold, materials and equipment are three points higher of that proportion, not 3% higher in total, but three points of the 100% higher of our cost. And that materials and equipment passes through at a lower margin. So I think one way to look at it is we think the margins we're getting on our labor right now are stupendous, and we would be very happy for them to stay the same forever. Behind that, there's some mixed issues where if you made me pick, I'd expect our margins to be higher next year. But that's the assumption in that. The unknowable assumption is that I'm assuming inflation gets under control.
spk09: Okay.
spk08: Got it. Thanks, guys.
spk07: All right, take care.
spk08: Our next question will come from Brent Thielman with DA Davidson. You may now go ahead.
spk05: Hey, great. Thanks, guys. You're a great quarter. This sort of tails with Adam's question. I think Julio's as well in that I guess more around the electrical business, if you just take away you know, the inflationary element. Have your longer-term expectations for margins in that business changed just given the performance years of weight? And, of course, what would those be if they have?
spk06: Well, you know, absolutely, right? The goal of everything we do operationally is to improve, right, to improve our margins, to improve our productivity, to improve our efficiency, quality, safety, right? So we're continuing to work on the electrical business. The companies are. We've had nice steady-state improvement. You know, we'll see. You've got to do it, right? It's easy to talk about it. But I think you'll see continued improvement where we get to. I really don't know, but I'm pretty optimistic about the electrical business margin improvement.
spk04: And I want to say, you know, it's not that we're now expecting higher margins. We expected higher margins. last year and the year before, we had a little bit of softness. But one of the interesting things you saw this quarter was we had a gain on a job-related, a big job-related litigation in electrical. Well, essentially what that was was that was an arbitrator saying, oh, yeah, they didn't fairly compensate you for work you did in two years starting last year, really starting the year before. We actually did better in electrical. That money should be pushed back to them. And I think they're new. So I think the margins they're at now are their normal margins. And I think there is some upside in electrical margins. Now, having said that, keep in mind, the margin you're seeing, that 19%, has that gain from that, you know, so the margins, if you back out the gain from that litigation win – They're still a little below mechanical, but they're really right. They're all kind of bunched together, and I think... But I think they can get there to be the same. Yeah, I think they're... On the construction side, I think electrical is every bit as... Yeah. If not, it's every bit as profitable.
spk06: I'm very optimistic about our electrical companies, Brett.
spk05: Yeah. Really helpful. Yeah, just to follow up, I wanted to get your thoughts. The 179D... energy efficiency deduction, I think got revised with the IRA, Inflation Reduction Act. Any thoughts on the potential implications here for the industry?
spk04: Yeah. So we get, if you look back at our last several years, we don't call it out separately, although you could find it in some places if you look carefully. We've gotten a few pennies from that, right? Here's what happens.
spk07: With the 179D, The customer gets that unless it's like a public company.
spk04: When it's a public, I mean, sorry, a public entity, when it's a public entity, we can take that deduction and give them some benefit for it. So we've had direct few cents of EPS from 179D for a while. In addition, it... encourages people to do more work, especially more renovation work. And now they've, I think, more than doubled it. So one of the things we think might happen is at the margin, that will create more renovation work, which will be helpful to us. It may or may not increase. The direct benefit we get may or may not go up just because it was small to start with. And also, you know, it's easier for somebody to pass a benefit along when it's smaller. It's possible they'll demand more for it if it gets bigger because they're They're kind of, you know, it's not big enough now for them to pay much attention to. But in general, it can only be a positive. But let me tell you something. That's just one of many positives. And the bigger positive is like reshoring. You know what I mean? So, but it's every, you know, a lot of things are pointing in the same direction. That's for sure. Okay. Okay.
spk07: Hey, great. Thank you. Appreciate it, guys. All right, Brent. Take care, bud.
spk08: This concludes our question and answer session. I'd like to turn the conference back over to Brian Lane for any closing remarks.
spk06: All right. Thank you. You know, in closing, I really want to thank, again, you know, our tremendous workforce, and it's throughout the organization. We're getting tremendous performance from everybody, and I really appreciate it. We also really thank everybody for your interest in comfort systems and your time today. You know, we are grateful for the questions and the interest, for sure. So, Everybody be safe out there and hope you enjoy the upcoming holiday season. Thanks and have a great day. Thanks.
spk09: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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