Comfort Systems USA, Inc. (NYSE:FIX) Q4 2023 Earnings Call Transcript

Comfort Systems USA, Inc. (NYSE:FIX) Q4 2023 Earnings Call Transcript February 23, 2024

Comfort Systems USA, Inc.  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and thank you for standing by, and welcome to the Q4 2023 Comfort Systems USA Earnings Conference Call. At this time, our participants are on a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Julie Shaeff, Chief Accounting Officer. Please go ahead.

Julie Shaeff: Thanks, Justin. Good morning. Welcome to Comfort Systems USA’s fourth quarter and full-year 2023 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 as well as in our press release covering these earnings.

A slide presentation has been provided as a companion to our remarks. The presentation is posted on the Investor Relations section of the company’s website found at comfortsystemsusa.com. Joining me on the call today are Brian Lane, President and Chief Executive Officer; Trent McKenna, Chief Operating Officer; and Bill George, Chief Financial Officer. Brian will open our remarks.

Brian Lane: All right. Thank you, Julie. Good morning, everyone, and thank you for joining us on the call today. Our teams achieved an amazing finish to 2023 with exceptional results, including unprecedented growth, earnings and cash flow as well as a surge in new bookings. We earned $2.55 per share this quarter compared to $1.54 a year ago. Current quarter revenue was $1.4 billion, with same-store growth of 18%. During the fourth quarter, both our mechanical and electrical businesses grew and increased margins to drive our annual results to new heights. Construction finished an already strong year on an up note, including notable profit and activity increases in our modular business. Service also continued to grow as we continue to benefit on ongoing service investments.

Backlog is $5.2 billion, up by more than $1 billion from last year, and we had a remarkable sequential increase of $870 million even with strong revenue. Demand remains supportive and is especially robust in our industrial sector. We are carefully selecting work that has good margins and good working conditions for our valuable workforce. Cash flow for the quarter was superb at $149 million and we finished 2023 with an extraordinary $550 million in free cash flow. Earlier this month, we closed two acquisitions, Summit Industrial and J&S Mechanical. Summit is a specialty industrial mechanical contractor serving the advanced technology, power and industrial sectors. Summit performed off-site and site-based construction, including process piping, equipment setting and large pipe rack trusses.

Summit is a trusted supplier to some of the world’s largest advanced technology, power and industrial companies and is currently deployed on several major chip fabrication projects. J&S provides mechanical construction services to commercial and industrial sectors across the Mountain West region of the United States and works on many of the largest and most technical construction projects in that area. We are thrilled to have both of these companies as part of the Comfort Systems USA family, welcome. 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. Bill?

Bill George: Thanks, Brian. Good morning, everyone. Revenue for the fourth quarter of 2023 was $1.4 billion, a 22% increase, while same-store revenue increased by 18% or $195 million. Full-year revenue for 2023 increased by 26% compared to 2022 to $5.2 billion. For the full-year, our Mechanical segment revenue increased by 24% including a big contribution from our module business. Our Electrical segment increased by an even larger 31% and we now have a $1.3 billion electrical business. Overall, our same-store revenue increased by 23% or $931 million. We are facing tough comparables. However, our best estimate is that we will achieve same-store revenue growth in 2024 in the mid-teens with growth weighted a bit more heavily to the first half of the year.

Gross profit was $280 million for the fourth quarter of 2023, a $68 million improvement compared to a year ago. Our gross profit percentage improved to 20.6% this quarter, compared to 18.9% for the fourth quarter of 2022, driven by improved electrical margins. The quarterly gross profit percentage in our Electrical segment improved to 22.9% this year as compared to 18.2% last year. Margins in our Mechanical segment also increased in the quarter to 19.8% as compared to 19.1% in the fourth quarter of 2022. Our mechanical segment includes our modular business, which operates at notably lower margins than our remaining businesses. For the full-year 2023, gross profit increased $249 million our annual gross profit margin was 19.0% in 2023 as compared to 17.9% in 2022.

For the full-year, segment margins were similar with mechanical gross margins of 19.0% for the full-year, while electrical was 19.1%. Fourth quarter EBITDA increased 42% to $141 million. Our full-year 2023 EBITDA increased by an even greater 48% as our full-year EBITDA was $499 million. As we look to 2024, we are optimistic that overall EBITDA margins will continue to trend in the strong ranges that we achieved in 2023. Gross margins will also continue to be strong, but gross margin percentage may be more variable in 2024 in light of the effect of amortization and certain purchase adjustments arising from our two large acquisitions. SG&A expense for the quarter was $160 million compared to $132 million in the prior year. And as a percentage of revenue, SG&A expenses — expense was consistent again at 11.8%.

On a same-store basis, SG&A was up approximately $22 million due to inflation and ongoing investments to support much higher activity levels. For the full-year, SG&A expense as a percentage of revenue was 11.0% in 2023, that’s down from 11.8% for 2022. Fourth quarter operating income increased by 50% from last year from $80 million in 4Q 2022 to $120 million for the fourth quarter of 2023. With improved gross profit margins, our operating income percentage increased to 8.9% this quarter from 7.2% for the prior year. Our full-year operating income was $418 million, a remarkable increase of $165 million. OI margin increased from 6.1% in 2022 to 8.0% in 2023. Our year-to-date tax rate of 16.7% included an incremental benefit of $10 million or $0.27 of tax gains that related to prior years.

Although individual items have affected our tax rate lately, we estimate that a normalized tax rate for us is approximately 20% to 22%. After considering all these factors, net income for the fourth quarter of 2023 was $92 million or $2.55 per share. This compares to net income for the fourth quarter of 2022 of $55 million or $1.54 per share. Our full-year earnings per share for 2023 was $9 and 1% Excluding prior year tax gains in both periods, earnings per share increased to $8.74 per share from $5.29 per share in the prior year, and that’s an increase of 65%. Full-year 2023 free cash flow was a remarkable $551 million. We continue to benefit from advanced payments for work that we will fund and complete in the upcoming quarters. 2023 operating cash flow exceeded our earnings by an astounding $300 million.

Over the coming quarters, we expect pre-bookings and equipment advances were normalized, creating some cash flow headwind. In the meantime, these early collections have allowed us to invest heavily and fund acquisitions from current cash flows, while at the same time significantly lowering our debt and interest costs. During 2023, we spent $95 million on capital expenditures, almost double the amount we had spent the prior year. The increase includes the build-out of three vast new modular production facilities and the purchase of mini vehicles to catch up from COVID. In 2024, we estimate that our CapEx spend may be roughly $65 million to $75 million, around the midpoint of the spending levels over the past 2 years. Our substantial cash flow allowed us to pay down our revolving credit facility to 0 and to reduce our overall debt by $212 million over the course of 2023.

Again, while investing in unprecedented levels of CapEx buying back shares, increasing our dividend and fully funding both of our acquisitions, the purchases of Eldeco and PECO from cash flow. In 2023, we purchased 139 shares of our common stock at an average price of $153. Finally, as Brian mentioned, we acquired Summit Industrial and J&S Mechanical at the beginning of February. Our best estimate is that Summit will contribute annualized revenues of approximately $375 million to $400 million and EBITDA of $35 million to $40 million. We also estimate J&S will have annualized revenues in the range of $145 million to $160 million and EBITDA of $12 million to $15 million. In light of amortization expense, these acquisitions are expected to make a neutral to slightly accretive contribution to earnings per share in 2024 and 2025.

Both of these companies will be included in our mechanical segment. That’s all I got, Brian.

Brian Lane: All right. Thanks, Bill. I’m going to discuss our business and outlook. Our backlog surged at the end of 2023 to a record $5.2 billion. Since last year at this time, our same-store backlog has increased by $913 million, around 23% and the increases were broad-based. During the recently completed fourth quarter, our sequential backlog increased by $870 million and virtually all of the increase was same-store. Our pipelines remain strong. Our revenue mix continues to trend towards data centers, life science, food, chip fabs and battery plants. Those industrial customers accounted for 55% of total revenue in 2023, and they are made to drivers of pipeline and backlog. Technology, which is included in industrial was 21% of our revenue, a substantial increase from 13% in the prior year.

The technology sector will continue to grow with the recent acquisition of Summit Industrial as they have several ongoing and large semiconductor projects. Institutional markets, which include education, health care and government are also strong and represent 26% of our revenue. The commercial sector remains active, but it is now a smaller part of our business at about 19% of revenue. Majority of our service revenue is for commercial customers. So the proportion of our overall construction revenue from commercial has become relatively small. Construction was 80% of our full-year 2023 revenue with projects for new buildings at 55%, while existing building construction was 25%. For the first time in 2023, Compass Systems USA achieved $1 billion of annual service revenue.

Service was 20% of our total revenue, with service projects providing 9% of total revenue and pure service, including hourly work, providing 11% of revenue. 2023 service revenue was up by 11%. And with our continuing strong margins, service is a great source of profit and cash flow for us. At Comfort Systems USA, our core purpose is to build legacies with our people, customers and the companies who join us. To accomplish this, we strive every day to be the best organization in the world. For a craft worker to build a successful career for construction, service and administrative professionals to grow and thrive, for customers to meet their crucial building and service needs, and for any company in our industry to join with the assurance that their people will be respected and nurtured and that their legacy will be perpetuated and built upon.

We believe that our commitment to those principles to our people and their legacies has been and continues to be the lynchpin of our success. Safety, quality and innovation remain at the forefront of our operations. We constantly strive to improve and grow our operations to enable sustainable and efficient building environments to improve the productivity of our diverse workforce and to acquire great complementary businesses. Thanks to our careful and relentless investments in existing and newly acquired businesses, we have the crucial skills and capability to help meet our country’s surging needs for mechanical and electrical experts and to build and service buildings, including to grow data capacity for artificial intelligence, to increase our nation’s capacity to build its own chips, manufacture its own medicines, supply batteries and provide health care resources for our aging population.

As we look ahead, we remain optimistic about the prospects of service and construction across our vast markets. With our backlog over 20% higher than even the robust levels of the prior year, and with persistent strength across our markets, we believe that we can continue to grow and invest in 2024. Our number one priority is to preserve and grow the best workforce in our industry. And so as always, I want to close by thanking our over 15,000 employees for their hard work and dedication. I’ll now turn the call back over to Justin for questions. Thank you.

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Q&A Session

Operator: And thank you. [Operator Instructions] And our first question comes from Alex Dwyer from KeyBanc Capital Markets. Your line is now open.

Alex Dwyer: Hi, guys. Thanks for taking my question.

Bill George: Good morning, Alex.

Alex Dwyer: Hi, so I wanted to ask about the backlog increase in the quarter and specifically the modular orders. And was that one order or multiple orders? Was it one customer or multiple customers? And do you think there’s the opportunity to see more of these larger modular orders as we go into 2024.

Bill George: Alex, the way that — so if you look at the sequential backlog increase, about 6 — a little over 60% of that was an increase in modular. So that was $800-something million. If you look at the year-over-year increase in backlog, about 20% of it was modular. So we have a situation where we had some big bookings in the fourth quarter of last year, which was actually last year was more than all of our sequential increase. And then big bookings in the fourth quarter of this year. And of course, over the course of the year, we burned down, we performed a lot of that modular. We’re back to higher-than-ever levels of modular backlog with these new bookings. But 80% of our year-over-year backlog increase is broad-based.

So honestly, we just couldn’t be happier with the breadth, the composition, et cetera. And as far as additional bookings absolutely. Right now, we’re taking as much as we can, but the people who are buying these services from us tell us they would like to give us more.

Alex Dwyer: Got it. And then the press release mentioned an increase in modular profitability. I don’t think we get the disclosures for this. But how was the margin performance this year in modular. And should we expect continued margin expansion in that business this year?

Bill George: So modular margins for the full-year were just a little higher than the prior year, but they’re at very, very good levels. You may have heard in my script that I mentioned. The gross profit per modular is lower than it is for any of our other businesses. And that’s a combination of it. It does have a high component of materials and pass — the passthrough. It’s also performed — the work we do in the field is performed with licensed electricians and certified medical gas technicians. The work that we perform in our plants is highly skilled, but it isn’t as it isn’t as difficult to find that labor. So we’re very happy with those margins. As far as margin expansion in modular, we’ll be thrilled if it stays the same. Of course, we’re always working for margin expansion, but man, when you — after a quarter like this, it’s pretty hard to talk about doing better.

Brian Lane: We’re really happy with the modular business.

Alex Dwyer: Got it. And then just last one on the margin outlook for 2024. I think we’re talking EBITDA margins more so this year than gross margin. There’s the deal amortization. I think inflation could be a tailwind to margins this year. And then maybe like a mix versus the early stage versus the later stage jobs could be like a swing factor. Can we just talk about like the puts and takes in margins this year?

Brian Lane: Yes. So if you look at this overall, I just want to comment on the margin performance we’ve been getting over really since 2016. We’ve been pretty consistently having 18% to 20%, leave the amortization aside for a minute. So I am personally thrilled with the level of performance we’re getting and executing our work. I mean if I was running this work, I’d be really happy myself. So I consider that we’ll keep going. If you want to add on…

Bill George: I think you made all the right points. The one thing I’ll just refine a little bit for everyone. So if you think about it, the amortization is always big at comfort because we buy companies on a fairly regular basis. And the companies we buy come with a lot of backlog. So for example, Summit will roll into comfort with something like $400 million of backlog. And the accounting rules require us to put a value on that backlog and amortize it as an expense. In addition to things like customer list and trade name that all businesses have, our amortization is higher than most. Obviously, it’s non-cash, the money is gone. It’s never coming back. So in a way, it’s not sensible to worry about it because you own what you own today and it’s going to earn what it earns.

But we’re required to reduce the sort of the earnings that we present — the margins we present to you guys for that. And the reason we wanted to call it out is, last year, we had less acquisitions than we have had over the last three or four years proportionate to the size of Comfort Systems. So amortization was probably the lowest and definitely the lowest proportionate to the size of the company that has been in a long time. Well, on February 1, we did our biggest deal ever. We did another top five or six deal ever. And so amortization is going to come back very — in a very notable way over the next 18 months. And so obviously, that pushes down gross margins because it’s an expense. You put tens of millions of dollars, million tens of millions of dollars of expense through your cost of goods sold, and it’s all noncash.

So the cash flow still does great. EBITDA still — EBITDA really is what I look at, still looks good. So we’re comfortable with the cadence of our EBITDA margins, we are going to have choppiness in the gross profit margins. So sorry, that’s a little bit longer, but it’s just — I think it bears — given the size of the deals we just did and the fact that we were at a low ebb last year, I just wanted to mention all of that.