Comfort Systems USA, Inc. (FIX) Earnings Call Transcript & Summary

Okay. Good afternoon, everybody, and thank you for joining the Sidoti December 2024 Small Cap Conference. My name is Julio Romero, I'm the Industrials and Building Products analyst here at Sidoti & Company. We're really pleased to be able to host Comfort Systems USA, their ticker is FIX. With us today is Julie Shaeff, Chief Accounting Officer and Senior Vice President; and Trent McKenna, Chief Operating Officer. So we're going to do some prepared remarks by the company for about 10 minutes or so, followed by Q&A. [Operator Instructions] With that, Julie and Trent, thanks so much for being here, and the floor is yours.

Great. Well, thank you very much. So happy to be here, and good morning or good afternoon to everybody. I'll just give some brief opening remarks, just talking to you a little bit about the company. What Comfort Systems is, is really an assembled workforce. We have about 18,000 employees. I would say probably 80% of them have tools in their hands. They're plumbers, they're welders, they're pipefitters, they're electricians, plumbers, service techs. And they go out to customer job sites every day. We install and service mechanical, electrical and plumbing systems for our customers. We're nonunion. So a lot of our -- and a lot of our companies do work between like Virginia through Texas. So a lot of our revenues are kind of in that geography. But we're all -- we do all of our work in the U.S. About 80 -- we'll do about $6.5 billion of revenue in 2024. About 84% of that is construction work, where we'll do work, and we'll either install systems in new builds or we retrofit for our customers in existing buildings or add on to existing facilities. We also do about 16% of our revenues are service, where we'll go in largely to commercial facilities such as office buildings or retail centers, and we'll do preventive maintenance work on those facilities, and then we'll get some small projects and add-on projects associated with those customers. As far as who our customers are, that's really changed over the last 5 years. We are now about 60% industrial. And industrial for us is technology. We do work with data centers, chip manufacturing facilities; and then other manufacturing, which includes life sciences such as pharma. We do a lot of food services for both human and pets. We'll do some battery facilities. And those are all in that 60% of industrial work. Institutional-wise, we do a lot of health care, a lot of hospitals and surgical centers. We also do some higher education, where we will do work at private universities, places like Duke or James Madison University. We'll do a fair amount of work at those types of schools. And then we do -- like I said, commercial is about 16% of our revenues, but that's primarily service for us, where we'll go in there and do work on office buildings and that like. It's a very -- we focus a lot of our efforts on cash. And so we established a capital allocation strategy probably in 2007. We -- from a strategy standpoint, we spend about 75% of our free cash flow on acquisitions. And that's not on an annual basis. That's kind of over a business cycle, a 3- to 5-year term, we'll spend that much. And the other remaining quarter we'll spend kind of split between through dividends and share buybacks. So that's how we spend the free cash flow that we generate from all the project work and service work that we do for our customers. So Julio, that's probably a pretty good overview of the company. I think a lot of the folks on here probably know us a little bit. So I think it might make sense just to go into Q&A.

Absolutely. Great rundown as always, Julie, and you're right, a lot of folks aware of the story, and you guys are a little popular these days, for sure. So maybe I'll start with just demand, particularly around data center construction. Maybe talk about how that has evolved over the last 24 months.

Yes. So I think that demand is really -- we continue to see a pipeline that goes well into the future on that demand. And that's across the board. That's both in the modular business, which is, at this point, almost exclusively being built for data center customers. And then, in the traditional stick-built construction world, demand still remains really, really high going all the way through next year and into '26 even, which we see in our pipelines. So yes, it's still very, very strong, very robust. And we don't see any reason for it to slow down or we're not seeing any slowdown in it, let's say it that way.

Got it. And one of the key questions that we always get is just your take, I guess, on where we are in this AI super cycle, early stages, are we in a bubble? Just love your view on it.

Well, I ask ChatGPT for its opinion. I think we're pretty early stages. I think that most of these -- certainly, the hyperscalers see this is existential. And so they're in very much a land-grab modality. They're going to continue to do that. Really, as I look at it, the only thing strategically that worries me some is just the ability of the U.S. to continue to deliver electricity at the levels it needs to in order to continue to build out that these -- that the hyperscalers and others have planned. I think that the administration that's coming in is probably more favorable to those outcomes in some ways as far as electricity is involved. But that's a little above my pay grade, Julio. I don't -- it's tough for me to predict that. But that's -- I think they're going to build until one of them creates super AI and then it will build everything else for us.

Yes. And then we could just let go of the wheel, I guess. So to your point, it's like, right, that's a key point is McKinsey has said that current power consumption today is like 25 gigawatts, and we're going to go to 80 gigawatts or so by 2030 or so, so a huge need for power consumption. I know it's above your paygrade, as you said, but I just still want to just touch on it a little bit, like how are we thinking about what can help alleviate that lack of supply for power consumption? Like obviously, your take on whether clean energy will play a role just because we need more energy sources? Is it going to be more deregulation and easier permitting? Just any color there.

Yes, I think it's going to end up being concession on some of the goals that we had around carbon emission. And so I think it's just going to be plants that were scheduled to be taken offline aren't going to be taken offline now. And so we'll probably -- I think if you read some of the environmental kind of stuff that even the hyperscalers have put out, they're starting to back off of some -- maybe not as publicly, but you can kind of read between the lines that they're backing off some of their climate goals because they just kind of see the writing on the wall as to renewables can do a lot of this, but it's -- this is happening so fast and at such a volume that it's hard to imagine that we -- something doesn't give and the give is probably going to be the carbon goals that we have.

But this is one of the advantages, too, that we have of modular is that modular, we can deliver it into remote locations like Idaho or Wyoming, where maybe there aren't as many power issues as you do in Virginia and other parts of the country.

That's a great point, Julie. Like how we see right now, like there's data centers being built in Mississippi, where we have -- previously, we hadn't had data centers being built in that state, right? But because of power considerations, they are being built there now. So that modular delivery really does help with those remote locations. Not that Mississippi is remote, but you get what I'm [ saying ].

You guys are making my job really easy because that segue is perfectly -- let's stick on modular. Like what else is driving kind of increased adoption of modular in your view? Because as -- historically, construction is very, very behind other folks in terms of adopting new technologies, right? So maybe if we can go into that a little bit.

Well, I mean, I think the first thing to start with is the leading hyperscaler with regard to our business has been doing this for a very long time, right, so had seen the kind of vision of a modular delivery. So I think that's part of why that adoption is happening. And then when you look at the other hyperscalers, we have one that's come in and sort of dipped their toe in and now it's getting deeper into the water, right? And then, there's 4 really. And so there's 2 others that we're having conversations with, one getting very close to dipping its toe. So the whole point of that kind of me saying it that way, is that in construction, the status quo is preferred for a reason. It's because it's very risky to build buildings and the tail risk is very long if you get it wrong. And so they -- I don't -- I understand why there's reluctance to say, okay, we're going to fully commit to this modular delivery. So it's going to take a little while for the other data center builders to start to see the benefit of the modular delivery, right, and to be willing to commit to it. But I don't see any reason why modular can't be a part of the solution to get these data centers online for other customers as well. Does that answer your question?

Yes. No, it does, for sure. And then one thing I think you guys have talked about is, you mentioned the Mississippi, Idaho, Wyoming as areas where traditionally, there wasn't construction but because of power considerations, it's being built out there. You've also talked about modular being able to help the fact that maybe craftspeople aren't out there to build some of these facilities or maybe they don't want to travel out there, right? If you could touch on that a little bit.

Yes. So you kind of said it exactly the way I would say it, which is if you're in an area where there's more cows than there are people, it's going to be hard to find the skilled labor to do the project, right? So if you can -- if we can build it in our facility in Houston or Greensboro and ship it to you and then you just have to have on-site people to connect it up, that's a much less -- there's much less labor involved. So it's much more doable where labor is even more scarce, right? So yes, you kind of set it out.

It also allows us to use automation some, too. We can use robots to do some of the basic welding. We can use a little bit less-skilled workers because they are in a more supervised doing repetitive tasks in a facility that there's people that can help them. So it does help on a couple of fronts with the issues we have with the scarcity of labor.

Yes. Key theme for you guys for sure. And then how far can you ship, right? I think you guys have talked about even shipping some modular items overseas in some instances.

Yes, we can ship as far as it is justified in cost, right? So the transportation cost goes into it. And that's the one thing that I think people forget when they talk about the volumetric modular business is it's not that -- it's not whether we're going to build it volumetrically modular or not at all, it's are we going to build it that way? Or are we going to build the traditional stick-built construction, right? So once the transportation costs start to get too high, the stick-built construction becomes more preferred even if you have labor shortages and things like that, you'll pay more to bring the labor in because that will be cheaper than the transportation costs. So the only thing that really in the modular group constricts that ability to deliver is the transportation cost.

Got you. Got you. Can you maybe talk about lead times today in modular and your best sense of where you guys stand versus others?

Okay. So let me do the lead time, and then I might have to get a clarifying question what you meant in the second half. So right now, we are -- our capacity is -- we're -- as people on this call who spent time with us in the past, we doubled our capacity from -- over the last, basically, 18 months as far as manufacturing space. So we're now done with that build-out. However, as you can imagine, day 1, it's not as optimized as you want it to be. So we're continuing to optimize that and get -- and pull even more production out of the square footage that we have online. And we -- as we look into the future, we're -- that business is very -- has a very full belly well into '26 and has commitments even beyond. And by commitments, I don't mean backlog commitments, I mean I mean, commitments from customers to say, "Hey, we want capacity into the future. And we want to make sure that we have that spot in line and here's a financial commitment to make sure that, that is the case."

Yes. No, that's great. And you definitely talk about capacity reservations, people booking further and further out. I guess to clarify what I meant, I meant like lead times in terms of how quickly you can go from design to skid construction and then how that compares to maybe some of the other folks that are trying to do what you do?

Well, if it's a new program, it's a long lead time, right? So dealing with like a new customer, so the third hyperscaler coming in, that's going to be a much longer lead time. We can do very short lead times on a program that we've already developed, designed and is in place, and it's just a repetitive deployment. So that might -- hopefully, that answers it, but yes, because it's variable, right? It depends on the end product, exactly what their use case is. But for a brand new use case with a new customer, it's going to be a much longer lead time than it's just taking a current program, making a variation of it and then having that go out to the customer.

Okay. Got you. But you guys are also able to do this kind of modular work at scale, right? And scale is a key differentiator, I believe, for you guys. Just speak to your scale and how that stands.

I think of it this way, Julio, I think of our scale is a differentiator in our ability to -- because when we think about what we are, and Julie mentioned it right out of the gate, we're 18,000 people, right? We're a bunch of craft professionals that know how to do really hard work. And that scale to me is where we get our -- we can talk about the modular scale, but I think the scale of the 18,000 is where we really start to get scale because we can do training, we can do apprenticeship programs, we can do all sorts of programs that are designed to make Comfort Systems a better place for a plumber, for a pipefitter, for a welder, for an electrician to work. And so that creates a competitive advantage against who we go to market against because they don't have the scale to provide that to their craft professionals at the level that we can. So that's where I really start to see our scale differentiate us competitively. And then obviously, modularly, that scale, yes, there's no one at our square footage of manufacturing space that can deliver those modules the way that we can.

Yes. No, absolutely. You spoke earlier about folks reserving capacity further and further out. Can you maybe clarify how far out you're booked right now? And then secondly, maybe touch on those capacity reservations. Like as you go further out, I'd imagine the further out that somebody wants to book you, the higher the lock-in price that goes that you'll quote somebody for. Is that fair?

Yes. You're right on both counts. And then like I said, I think the easiest way to answer the kind of out into the future is that we can see pretty clearly through '25 and into '26 in that business right now. So that I think is a sense of where we're at as far as our capacity and our pipeline on the modular side of the business. But you got to remember, that's still just 17% of the overall business, right? So...

Right. How do you -- I assume that grows over time.

I think that we look at that every -- and we've had some incremental additions to the build-out that we've done, right? But that -- we're very careful with that because when we say that business grows, that business grows in a different way than the construction business grows because then we have overhead, and we have facility space and things. So we're very, very conservative in how we think about the growth of that. So yes, I think it's -- there's always -- there's a potential that as we get more and more buy-in from hyperscalers that we look to grow that piece. But that would be as we get commitments from them going forward, right? And we won't build it on the come to put it in a simple term.

And in 2025, I think there's a lot of focus, too, on just improving the productivity that we have in our existing facilities. I mean we just doubled them, and I think there's still opportunity to potentially use more robotics to improve some productivity and efficiency within the existing facilities.

Yes, absolutely. You talked about it earlier about one of your advantages being really the 18,000 folks that work with you, right? And maybe just talk about how that plays into how you select projects, right, better labor satisfaction, keeping your folks kind of happy, like a little bit more color on how you prioritize that and maybe some examples.

Yes, I think...

I'll start. If Julie wants to add in, just jump in, Julie. But like -- I think a good way to understand this is to think about like this morning, probably nearly 1,000 of our skilled trades professionals woke up, got into their truck, drove to a job site where they're going to spend their day working. And in the process of driving to that job site, passed 1, 2, 3 other job sites that if they had pulled into, they would have been hired on the spot. And so when we focus on that -- so I tell that story because when we focus on that group, we keep that in mind that we have to stay the best place for that craft professional to come to work because they have a lot of other options. And that's just becoming -- every day, that's just becoming more and more true because the demographics in our industry aren't good from the standpoint of there's going to be a lot of these people. There is not. There's a scarcity of them. So we have to really be careful in making sure that we run the business and select projects better in what they're interested in. And so there's a lot of focus on making sure that when we select the project, one, it's profitable, obviously. Two, though, it's the people we like to work with, and it's the stuff that our people like to work on, right? So there's a lot of stuff that goes into it. And it's not -- it's more of an art to some extent than it is a science. But in this current environment, it's great because we have a lot of options. We're turning down more work than we're taking in our construction business. And so we're able to focus in on those projects that our people like to work on and with subcontractors and general contractors that they like to work with. And that makes a big difference in our ability to maintain that core expertise that we have.

Yes, for sure. And then that kind of plays into, right, you guys are a good place for someone to work, take care of their family and kind of build the legacy, right? And that's something you guys have talked about more and more. It's building legacies, not just for your employees, but for customers and owners. If you could dive into that a little bit.

Yes. And it's exactly that. So we call it -- what we want to make sure is people understand that we're more than -- in our minds, we're more than just a contractor, right? We're more than just a specialty subcontractor. Obviously, that's what we want to be great at. That's what our customers pay us for. But we also want to be clear that we're helping we're helping employees build a legacy for themselves. We're helping our people that -- our acquisition partners, companies that are -- a lot of times, those are their life's work, their life's investment. They want to make sure that they're -- that they get the proper compensation for what they've built, but they also want to make sure that they take care of the people to help them get there. And so that's very important for us when we're talking to people that we're looking to bring them into Comfort Systems, that they understand that we're going to preserve that legacy, and we're going to make that legacy even better with them, right? And so what they love is once they get into the environment, there's all these other companies that are great. They can look around and they've spent their whole life and their career kind of out on an island. And now all of a sudden, they're part of many islands, and they're able to figure out sort of, hey, this is what these other guys are doing. It's really a -- it's a self -- what's the right word for it? It's very self-propagating to excellence, right? Because they look around and they see the other excellent companies around them and then they start to move directions that make them even better than they were before we brought them into the company. So all of that is about making sure that those legacies are preserved and that we build them with. And then obviously, the people who pay us, our customers, we want to make sure that their legacies are built to the highest standards with the best safety and best efficiency.

Yes, absolutely. We don't talk about your service business a lot, but it's something I think that's important, right, if you could touch on that business a little bit, and how that's a backstop in areas where the economy is not as strong.

Yes. So it's been going down as a percentage of revenue because revenue has been going up faster than it has, but it's still increasing. So it will be $1.1-plus billion business. And it continues to be a focus. We're investing heavily in it. This year, we started a program that we've had 3 classes with now where we're taking people who have no previous skills in the industry and putting them through a several-week course in Indianapolis, where they then come out and they're an entry-level service technician. And when we hire for that -- for those classes, we are only interested in the candidate's propensity for work. That's it. And so we're looking at -- largely, we get people who come out of like low-paying fields that have very good work history, and they're looking for a way to better their families, right? And so they would bring them in, give them the courses, they come into the operating companies as a brand new entry-level technician. And that's the kind of thing we're focused on in growing that service business because what we recognize is there aren't enough service technicians in a lot of markets that we're in to continue to grow the business unless we grow them ourselves, these service technicians. And so that's what we've started to do. And like I said, after 3 courses, we have more than 100, now, entry-level service technicians that are doing great across our operating companies, and we're continuing to invest in that type of training. And then obviously, on the sales side of the service business, we continue to invest as well to grow that part of the business because it's heavy lifting. Because in construction, you can book multimillion-dollar project, but in service, you're going to book a $10,000 service maintenance agreement. So it's much more bunt singles and doubles than it is home run. So it's a constant focus of ours.

Absolutely. Maybe we could talk about cash flow a little bit, if you could go into the cash flow dynamics of your business. Obviously, that's been a little bit different lately because of the advanced reservations that you've been getting from folks and some tax stuff that's a little bit more complicated than I like to admit. But if you guys could speak to that a little bit.

Yes, it's a unique time. I've been with Comfort for 25 years. It's the first time I've ever seen where you have significant organic revenue growth and you have a disinvestment in working capital. Usually, in this circumstance, you'd be investing in working capital because you'd be paying your people every week, you'd be paying your vendors every 15 to 20 days, and you collect your cash over a longer period. But in this unique environment, again, because we have these skilled craft workers, professionals, we're able to -- on the modular side, we're able to get some advanced billings. So when we sign the contract -- when our customers sign the contract, we'll get some percentage of it upfront to reserve that capacity and to buy the equipment. And even on the traditional construction as part of the negotiations for the contracts, we're able to get a good schedule of values, which is how we do our billings and good collection terms. And as a result, right now, we're just over -- on a trailing 12-month basis, we have a little over $300 million of cash flow in excess of our net income. So eventually, we're going to have to do that work and pay those bills. But for now, we -- that situation has been occurring consistently over the last year because we're continuing to book work on similar terms, and so it just perpetuates the situation. And what we do with that cash flow, we bought some -- we bought companies this year. We don't have any debt right now, and we're able to have very little interest expense. And I think it also means the strong cash flow that we're receiving is -- I think it also means that our jobs are performing well. And even if you have these good terms, I don't think your customers would be paying you if the projects weren't going well, and they want to keep us happy because they want us to continue to work for them. So I think it's just a great environment for us on a cash -- from a cash standpoint.

Absolutely. And with that strong cash flow lately, how does that kind of tie into how you think about working -- sorry, not working, capital allocation, I should say.

Yes. I mean in the back of our minds, we know that we're going to eventually have some small -- lower cash flow periods in the future. So -- but we have a very strong balance sheet. We still have -- like I said, we have nothing outstanding on our revolver. We have an $850 million facility. So we have a very strong balance sheet. So we're not worried. When it does turn around, I think it will turn around over a period of time. And yes, we'll have -- we'll just continue to buy companies as it makes sense and deploy our capital through sharing it with the shareholders.

Absolutely. And then just maybe to kind of cap it off, what do you feel like doesn't get asked about enough about your business? Or doesn't get maybe as much attention as it should?

What do you think -- you talk to more investors than I do, Julie. What do you think?

Yes. I think there's a lot of discussion about doing more work. What happens if there's a slowdown in data centers? What if there's a slowdown in semiconductors? And the answer is, our folks can do that work, can build, install -- air conditioning and cooling and install piping and do welding at any of these facilities. So we don't decide what buildings get built. But when a building is going to be built, our people can go do that work no matter where it is in the -- if it's a hospital or if it's a manufacturing facility, a pharma facility, that doesn't make as much difference. So -- and things will move around within industrial. For example, one of our companies, a very large company has done almost exclusively semiconductor facilities this year. They're going to be doing a large pharma project next year. It's not that semiconductors aren't still great, and we will still have tons of work in that area, but things will shift just because we make decisions to do certain projects based upon our customers' needs. So I think that's probably something that we're -- these things can be -- we can do these things anywhere.

Yes. And just to add on to what Julie said, I think that sometimes people think the product that we're -- that we have is the end result, the building, it's not. The product we have is the 18,000 men and women of Comfort Systems that have the skilled trade and technical expertise that can deliver for the customer. That's the product that we have.

Excellent. Well, Julie and Trent, thank you guys so much for taking the time. We really appreciate it.

Very good. Thank you.

Thank you.

Thanks very much.