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. After today's presentation, there'll be an opportunity to ask questions. To ask a question, you may press star on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I'd like to turn the call over to Julie Shaeff, Chief Accounting Officer. Please go ahead.
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.
All right, thanks, Julie. Good morning, everyone. We had another great quarter with continued increases in revenue, earnings, and backlog, and we are really grateful for this 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 $0.15 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?
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 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 passthrough of inflation 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 increase is 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. 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 - 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%-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 - 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 R&D tax credit in the 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. That's all I have on the financial front.
All right. Thanks, Bill. I am going to spend a few minutes discussing our backlog and 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. 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. 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, giving 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 capability. 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.
We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question will come from Julio Romero with Sidoti & Company. You may now go ahead.
Thanks. Hey, good morning, Brian, Bill, Julie.
Morning, Julio.
Hey, good morning. Starting on the revenue, the organic growth, it's the second straight quarter of 20%+ growth. You broke $1 billion in organic sales, in sales, I should say. Just talk about the trend line for organic growth, ex of cost pass-throughs. I know you mentioned same-store headcount up 8%. Is that kind of the baseline for organic growth?
Yeah. No, I would not say that's the baseline because, of course, we're charging more for those 8%, right? There is inflation in that number. Also, our temporary labor is up quite a lot, by more than 8%. I think 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. As far as the first part of your question about sort of the trend line, 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 up, you know, as our second quarter was up 25%. A year from now, you know, depending on what inflation is doing, it's much, much harder to prognosticate that you're gonna grow from there. Even if we don't by the way, if inflation abates, right, that'll, that could create at least some of a sort of a turnaround in that effect. 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. 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.
No, totally. I appreciate the comprehensive answer there. Just on the increase in bookings, it's up almost $500 million 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?
Yeah, Julio, it's Brian. You know, we got broad-based increase in backlog, to be honest. For sure, we are getting increased bookings, and you'll see that continue into the fourth quarter. You know, the backlog increase, quite frankly, is broad-based.
You know, coincidentally, service was up by exactly the same percentage year-over-year as construction. I think it's all across the board.
Yeah
Like that gain. For sure, you'll probably see in the coming quarters more of that coming from these industrial bookings because they're just so big. Also, this third quarters are always, you know, strong service quarters.
Understood. Maybe 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? You know, have you kind of reached some critical mass where you start to see some better operating leverage there?
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.
Okay, very good. Thanks very much for taking the questions.
Thanks.
Our next question will come from Sean Eastman with KeyBank. You may now go ahead.
Hi, team. Fantastic quarter.
Thank you.
Many compliments. This kind of early project commitments dynamic that is, you know, part of the momentum in the bookings we're seeing in the quarter, how would you characterize the duration of the backlog at this point? Does this early commitment on orders suggest there's some pull forward in the bookings we're seeing this quarter? You know, is the message that bookings momentum still continues post-quarter?
Definitely, there's pull forward, right? I mean, because if they book earlier, they book earlier than they would have been.
Yep.
Now, does that mean they won't continue to book heavily? 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? 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.
Yeah, it's very robust. You know, we're even seeing, you know, our backlog extend great. It's about the highest number we've had longer than a year, Sean. We've seen. You know, it's been the opposite. I think it's actually picked up, quite frankly.
You know, we have companies that aren't selling for 2023. They're full.
Yeah.
As you think about that's why people are committing earlier, 'cause they understand, oh, these guys are getting full. If we want a building, we better get.
You know, equipment's one thing. You also gotta, you know the labor, right? You gotta make sure you know, they wanna make sure you have the people to do it, so.
Yeah. Kind of fair to say that pretty abnormally high visibility for 2023 at this point.
Unprecedented.
At least since I, you know, in the 20 years I've been here, for sure.
Yeah. Okay. Okay, got it. Then just this notion of locking up your labor resources early. You know, you know, you guys are kind of the. I mean, there's a lot of scarcity in the system, I suppose. The labor resource is a really kind of core scarce resource in the project life cycle. I just wonder how you think about monetizing locking up those resources early, particularly in a kind of an uncertain cost environment as well.
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 gonna have to pay them well for it.
Yeah.
Our guys, you know, you can see it in our numbers, right?
Yeah. Yeah. You can see it in the results, Sean.
Yep. Yep. Okay.
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 terms of all facets of the business. You know, we're very fortunate with the companies we have today.
Yep. We can see that. Maybe one last quick one for Bill on M&A. Obviously, 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, you know, could expect to see?
You know, it's certainly. 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 of companies for sale right now. I don't mean the companies we usually buy. I mean, companies owned by private investors. I'd say there's three times as many books, you know, pitch books on the street than I've ever seen.
I think it's a moment of inflection, and I think we're gonna be very, very careful. We've said forever we don't have to do a deal in any given year, right? We just wanna create value. We play a very, very long game for this. I know it's a bit of a mixed answer, but there's really two parts. I would say we're gonna be very, very, very, very watchful right now.
You know, Sean, if Bill keeps his track record he's had for the last 10 years, we'll be in good shape.
Yeah. No, no doubt about that. Thanks a lot, guys. I'll turn it over.
All right, Sean. Thank you.
Our next question will come from Adam Thalhimer with Thompson Davis. You may now go ahead.
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?
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 wanna hold that inventory over the next year or two. You might wanna at least test the market. I think that it's really astounding, quite honestly. Maybe I should. I'm speaking out of school. In general, everything's for sale. It's you know, everything that is owned by people who trade businesses seems to be for sale. 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, not, you know, but in general, we don't participate in any of that. We like to get to know people over years, right? 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 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.
I mean, you added electrical and you're doing well there. What would be the appetite to add something else to the portfolio?
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? By the way, we did. We added a labor company. 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.
Yeah. I think we see a lot of opportunity, Adam, in just continuing to improve the mechanical and electrical businesses that we're in. I think there's, you know, constant improvement and, it's pretty exciting. We'll keep at that, I think.
Okay. I guess, gotta ask one nitpicky one. Just on the margin outlook, what are your thoughts on margins Q4 and next year?
Yep.
Some of that relates to, like, the, you know, where we were in these jobs when you start to finish up some large jobs that got started over the last, you know, year and a half.
Well, I'm really happy with the margins that we're cranking out right now. We are, you know, 18.1%, as I said, probably a trillion times. You're 17.5%, 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. 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.
It might dip down in Q4, right?
Adam
Yeah.
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. Materials and equipment passes through at a lower margin. 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 mix issues where if you made me pick, I'd expect our margins to be higher next year. That's the assumption in that.
The unknowable assumption is that I'm assuming inflation gets under control.
Okay. Got it. Thanks, guys.
All right. Take care.
Our next question will come from Brent Thielman with D.A. Davidson. You may now go ahead.
Hey, great. Thanks, guys. You had a great quarter. This sort of ties with Adam Thalhimer's question, I think Julio Romero'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 late? And of course, what would those be if they have?
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. 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 gotta do it, right? It's easy to talk about it.
Yeah.
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.
I wanna 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. One of the interesting things you saw this quarter was we had a gain on a big job-related litigation in electrical. Well, essentially what that was was an arbitrator saying, "Oh, yeah, they didn't fairly compensate you for work you did in the past, you know, two years starting last year, really starting the year before. We actually did better in electrical. That money should be pushed back to them." I think they're new. 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-
I think they can get there.
Yeah.
to be the same.
Yeah. I think they're on the construction side, I think electrical's every bit as
Yeah.
If not, it's every bit as profitable.
I'm very optimistic about our electrical companies, Brent.
Yeah. Really helpful. Yeah, just to follow up, 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?
Yeah. We get. If you look back at our last several years, we don't call it out separately, although you could find it at some places if you look carefully. We've gotten a few pennies from that, right? Here's what happens. With the 179D, the customer gets that unless it's like a public company. When it's a public entity, I mean, sorry. When it's a public entity, we can take that deduction and give them some benefit for it. We've had a 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. 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 kind of, you know, it's not big enough now for them to pay much attention to. In general, it can only be a positive. Let me tell you something. That's just one of many positives, and the bigger positive is like reshoring. You know what I mean? It's, you know, a lot of things are pointing in the same direction, that's for sure.
Okay. Hey, great. Thank you. Appreciate it, guys.
All right, Brent. Take care, bud.
This concludes our question and answer session. I'd like to turn the conference back over to Brian Lane for any closing remarks.
All right, thank you. You know, in closing, I really wanna 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. Everybody be safe out there and hope you enjoy the upcoming holiday season. Thanks and have a great day. Thanks.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.