Q2 2024 Comfort Systems USA Inc Earnings Call

Participants

Julie Shaeff; Senior Vice President, Chief Accounting Officer; Comfort Systems USA Inc

Brian Lane; President, Chief Executive Officer, Director; Comfort Systems USA Inc

William George; Chief Financial Officer, Executive Vice President; Comfort Systems USA Inc

Alex Dwyer; Analyst; KeyBanc Capital Markets

Adam Thalhimer; Analyst; Thompson Davis

Josh Chan; Analyst; UBS

Julio Romero; Analyst; Sidoti & Company

Presentation

Operator

Good day, and thank you for standing by, and welcome to the Q2 2024 Comfort Systems USA earnings conference call. (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, Daniel. Good morning. Welcome to Comfort Systems USA's Second Quarter 2024 earnings calls. 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. 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 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 William George, Chief Financial Officer.
Brian will open our remarks.

Brian Lane

Okay. Thanks, Julie. Good morning, everyone, and thank you for joining us for 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 a net, which is an increase of over 9% 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. Demand remains strong, especially in the industrial sector, including technology and other manufacturing customers.
Our backlog continues to track at a high level despite our strong revenue for the quarter. Backlog is $5.8 billion, far high up 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 Will to review our financial performance. Will?

William George

Thanks, Brian. So, second quarter results were really remarkable. We had 30% same-store revenue growth, higher margins, good SG&A leverage and over $165 million in free cash flow. We achieved more than $200 million in quarterly EBITDA for the first time, and our EBITDA doubled compared to the same quarter last year.
Revenue for the second quarter of 2024 was $1.8 billion, and that is an increase of $514 million 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. Electrical segment revenue increased by 12%. And overall, our same-store revenue increased by 30% or $383 million with the remaining $131 million of increase resulting from acquisitions.
We are facing tougher prior year comparable results for the remainder of the year. Through six 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-20% range.
Gross profit was $364 million for the second quarter of 2024, a noteworthy $136 million improvement compared to a year ago. Our gross profit percentage grew to 20.1% this quarter compared to 17.6% for the second quarter 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 second quarter of 2023. EBITDA doubled to $223 million this quarter from a strong $112 million in the second quarter of 2023. Same-store EBITDA increased by over 80%. And even without recent acquisitions, our EBITDA exceeded $200 million. 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.
SG&A expense for the quarter was $180 million, or 9.9% of revenue, compared to $136 million or 10.5% of revenue in the second quarter of 2023. Our operating income increased by just over 100% from last year from $92 million in the second quarter of 2023 to $185 million for the second quarter of 2024. With improved gross profit margins and favorable SG&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. 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 earnout expense. Without the changes in the fair value of our earnout 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.
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. After considering all of these factors, net income for the second quarter of 2024 was $134 million or $3.74 per share. This is a 90% improvement from last year.
Free cash flow for the first six months of 2024 was $290 million. We continue to benefit from advanced payments for work that we will fund and complete in upcoming quarters and operating cash flow continues to exceed our earnings by about $300 million on a trailing 12-month basis. So we are well ahead of earnings and 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 million with cash balances exceeding our debt. We also spent around $11 million on share repurchases this quarter.
That's all I got it, Brian

Brian Lane

Hey, thanks, Will. I'm going to discuss our business and outlook.Our backlog at the end of the second quarter was $5.8 billion, a large year-over-year increase in a modest sequential decline. Since last year, our backlog has increased by $1.6 billion or 38%. [$1 billion] of the increase was same-store and $0.6 billion was new backlog from recent acquisitions. We are entering the second half of 2024 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 2024, 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% in the prior year.
Institutional markets, which include education, health care 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 though the share of our construction revenue that is commercial is not relatively small.
Construction activities continue to be extraordinarily strong, and our project pipelines continue at unprecedented high levels. Construction accounted for 84% of our revenue with projects for new buildings representing 59% and existing building construction 25%. We include modular and 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 billion in revenue for 2024. As noted above, we are entering the second half of 2024 with a backlog that is 25% higher on a same-store basis than 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'll now turn it back over to Daniel for questions. Thank you.

Question and Answer Session

Operator

(Operator Instructions).
Alex Dwyer with KeyBanc Capital Markets.

Alex Dwyer

Hey, good morning. Thanks for taking my question, bonding for it. So, it's nice to see the continued strength in margins and the guidance called 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?

Julie Shaeff

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

William George

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.

Alex Dwyer

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?

William George

So modular like really every single part of our business did great this quarter. And it's -- as you could 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. 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 million 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. And 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. 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 topline.

Alex Dwyer

Thank you. I'll turn it over.

Operator

Adam Thalhimer with Thompson, Davis

Adam Thalhimer

Hey, good morning, guys. Great quarter. 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 the future modular awards are more one-off?

William George

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 negotiation with a large customer that induced us to make a really big investment in 1 million 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 time frame. But it's -- the awards sort of come in as programs are completed, right-- 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 three 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.

Adam Thalhimer

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?

Brian Lane

Yeah, 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. 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.

Adam Thalhimer

And then lastly, can you just comment on Texas electrical, the margins are over 22%, again for the third straight quarter. Kind of what's the outlook for that business?

Brian Lane

Yeah. Well, first of all, the electrical company we have here is really a superb company that Will, 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. So we're really humming along in that business right now. And I think it will go on for a while.

William George

It's also important to note, 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. 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 kinds of numbers, pretty much everybody had to be just having an amazing outcome.

Brian Lane

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

Adam Thalhimer

Good to hear. Thank you.

Brian Lane

Thank you.

Operator

Josh Chan with UBS.

Josh Chan

Morning, guys. Congrats on a really good quarter.

William George

Thank you so much.

Josh Chan

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?

Brian Lane

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

William George

If you don't mind. I'll just comment on other data centers. We're going to have people there are people right now who seem to be concerned that something's 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. 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 servers. The but -- and also, we're seeing data center work pop up in places that hasn't started yet in states where we haven't seen data centers before.

Josh Chan

So it's possible, I guess?

William George

That's slowing down. 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.

Josh Chan

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

Brian Lane

Yeah, Josh, that is a great question. 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'll really go out of that way.
We're very field focused in this company, which I'm really proud of, and we really do try to take aim 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 -- but thanks for asking.

Josh Chan

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?

William George

You know, I don't 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. I don't know if that helps, but--

Julie Shaeff

Yeah, thanks, Will, and thanks and thank you both for the response and the time.

William George

Thank you.

Operator

Julio Romero with Sidoti & Company.

Julio Romero

Thanks. Good morning, guys.

William George

Good morning.

Julio Romero

You guys talked about good morning. You're talking same-store sales growth in the low to mid 20% range for the full year from 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.

William George

So through 11 months, it was 26%. So to sort of be that low mid 10s, that would have to it would come down some, but maybe not down to 15, right? If you if the second half was 15% and that's going to average below 20%. So we're a little stronger than that. I don't really know what's going to happen. There's a lot we are on July 1 of this year, we had 25% more folks were on a same store basis than we had last year.
So, you know, we believe we're going to have very strong growth for the full year. Our best estimate is that low mid 20% 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.

Julio Romero

Got it. That's helpful. And then and you guys talked about factors that are creating these margins on one of them, I would think would be project selection. Can you maybe just talk about that and how crucial the factor that is in creating these margins? And is that kind of like a rising tide of sorts where you can just continue to see a greater quantity of opportunities and you're able to do and therefore you are able to become more and more selective on these projects?

Brian Lane

Yeah, I think you know, we have a crisis. We like most people do go no go, but we're very careful to select will put another valuable resource with good customers in doing the work. So, it's really important that you go to the factories and selecting what work you're going to take in a market like this. One is when there's a lot of work out there, Julio.

Julio Romero

Okay. Okay. And then and 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&A margin has a 9% handle on it. So maybe if you could just touch on SG&A leverage and how we should be thinking about that going forward?

William George

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

Julio Romero

Got it. I'll pass it along. Thanks very much, guys.

William George

Thanks.

Brian Lane

Thanks.

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.

Brian Lane

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 their summer and the weekend, and we look forward to seeing everybody on the road soon. Thank you.

William George

Thanks, everybody and this concludes today's conference call. Thank you for participating, and you may now disconnect.