Good day. And thank you for standing by and welcome to Q1 2022 Comfort Systems USA Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that this call is being recorded. [Operator Instructions]. I would now like to hand the conference over to your host today, Julie Shaeff, Chief Accounting Officer. Please go ahead.

Thanks, Justin. Good morning. Welcome to Comfort Systems USA's first 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 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 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.

Thanks, Julie. Good morning, everyone. And thank you for joining us on the call today. We are pleased to report a fantastic start to 2022. Our teams are busier than ever, and we are incredibly grateful for their hard work and we thank them. Excluding the tax gains that Bill will discuss in a few minutes, we earned $0.91 per share this quarter compared to $0.73 a year ago. New work is commencing across all markets and our same-store revenue increased by 16% compared to a year ago. Bookings climbed again, as demand is strong for our services. We had good cash flow, despite deploying working capital to support our growth. Yesterday, we also announced a $0.01 increase to our quarterly dividend. On April 1, we acquired Atlantic Electric headquartered in Charleston, South Carolina. Atlantic performs electrical contracting in various South Carolina markets, as well as specialized work on airfields in the southeast. This partnership brings new capabilities and new markets to Comfort Systems USA. I will discuss our business outlook shortly, but first I will turn this call over to Bill to review our financial performance. Bill?

Thanks, Brian. Good morning, everyone. I've been doing this call since 2005 and this is the first time I've ever started with tax. And I'm very happy it's for a good reason. The reason I'm going to start with taxes this morning is because our recent tax events affect so many of our numbers. So, as previously discussed, in January, the Joint Committee on Taxation approved our previously filed refund claims for the 2016, 2017 and 2018 tax years, primarily to claim the credit for increasing research activities or the R&D tax credit. Up to the end of last year, we had not recorded any benefit for those refund claims. So this approval in the current quarter triggered recognition of a $30 million benefit for the 2016 to 2018 tax year. Because these credits were approved for past years, we also reevaluated the realizability judgments that we have made with regards to the R&D tax credit for the intervening years of 2019, 2020 and 2021. And as a result, we recorded a $27 million non-cash for now, tax benefit for those years. After subtracting SG&A expenses related to those tax credits, the net result of those gains was an additional $1.49 in earnings per share this quarter. Consequently, our effective tax rate for the first quarter of 2022 is a negative 130%. Additionally, when we evaluated our taxes for the first quarter of this year, we also included consideration of the R&D tax credit, and that lowered our tax rate for the quarter. Excluding the prior year benefit, our tax rate for the first quarter was 22% and we expect our ongoing normalized rate will be similar in the future. So, with that background, I'll now discuss our remaining performance. Revenue for the first quarter of 2022 was $885 million,…

Okay. Thanks, Bill. I'm going to spend a few minutes discussing our backlog and markets. I will also comment on our outlook for the rest of 2022 and on inflation and supply chain considerations. Our backlog at the end of March was $2.73 billion. Sequentially, our same-store backlog increased $421 million or 18%, an increase that is broad based. Year-over-year, our same-store backlog is up by $844 million or just over 50%, with increases across most of our operations and with notable strength in Texas and North Carolina. Our industrial revenue was 46% of total revenue in the first quarter. This sector, which includes technology, life sciences, and food processing, will remain strong for us as industrial is heavily represented in new backlog, as well as in our recent larger acquisitions. Institutional markets, which include education, health care and government, are also strong and with 32% of our revenue, which is consistent with what we saw in full-year 2021. The commercial sector is also doing well, but without changing mix, it is now a smaller part of our business at about 22% of revenue. Year-to-date, construction was 78% of our revenue, with 49% from construction projects for new buildings and 29% from construction projects in existing buildings. For full-year 2021, new construction was 46% of our business. So, we are seeing an increase in that sector. Service increased this quarter by 30% compared to last year, including a same-store service revenue increase of 13%. Service is 22% of our year-to-date revenue, with service projects providing 8% of our revenue, and pure service, including hourly work, providing 14% of revenue. Our service maintenance base increased by 5% in the first quarter to an all-time high of $154 million. Overall, service continues to be a consistent and growing source of profit and…

[Operator Instructions]. And our first question comes from Sean Eastman from KeyBanc Capital Markets.

Brian, just high level one for you. The backlog trend relative to the organic growth numbers you've been putting up is remarkable. How would you explain that to investors just in broad strokes and how sustainable you think this strength is?

I think, Sean, you've known us a long time. We are really proud of the labor force and the project planning that we do. We're able to have really good customers. We have terrific vendors that are working through with us to all the challenges that are out there. So, when you combine all that and work with everyone and communicate with them, I think that we'll be able to get to our backlog in reasonable shape. There are challenges. We all know them. Everybody's talking about them. Well, we're just doing the best thing we can to serve our customers, and we'll take care of our people and our vendors to execute efficiently and productively.

As far as the underlying trend, we don't know what will happen. But at this moment, there is no sign of any curtailing demand. There's a lot of demand on the work we do.

The opportunities we're seeing is still very good, Sean.

Just in light of the margin pressure from a year-over-year perspective, and part of that bridge being this earlier stage, new construction work ramping up and also this kind of caution and contingency around estimating cost to complete. How does that dynamic evolve? When do we sort of get on the back end of projects and maybe you can start to release some of that contingency. I'm just kind of curious the timing element there.

I'll start and Brian can add anything he wants. So, guys are leaving resources and jobs because of concerns about all of the challenges that they're facing. Right? So, that makes the fact that we have very good pricing today and the fact that we are positioning ourselves to be able to deal with challenges on a cost basis gives us more opportunity maybe than we've ever had for improvement late in jobs. At the same time, the cost challenges are real. The supply chain problems are real. There's a reason why they're doing that. And so, there's a lot of execution to do this summer. As far as when we start to see that – get the question answered, it will be after the summer. So, fourth quarter, our guys will take a very hard scrub of jobs. Most of this work, by the way, we won't be done with this year, the stuff that's starting right now. In fact, very little of it. But they'll take a hard scrub and that's when you might – you'll really get to – I think start to get a good flavor for that. If I had to guess, I think it'll be a mixed bag. I think we'll have some home runs and we'll have some jobs where people really are scrambling and they're spending some money to make sure the customer gets what they need. But I think we'll be in a good place overall.

Lastly, just as I think about backlog as a predictor of revenue – and I appreciate the walk up on the organic growth outlook for this year. Just in light of the big shift in mix in the business, should the burn on that backlog kind of come down versus what we've seen over the past, say, five years on average. Does that make sense?

Yeah. Yeah, there's two factors. So the mix has been moving really more than ever, which is astounding, towards industrial. And industrial does have a quicker burn, generally speaking, than the rest of – for example, healthcare, which probably has the longest burn. But some of the new industrial projects are very big, and people are committing earlier, right? They're trying to lock up – just like we're ordering stuff earlier, they're committing to us earlier, right, which pushes backlog up. So, if I were to bake those two together, I think the backlog has a longer burn than usual. Thank goodness. Right?

I was going to say that, thank goodness. Yeah. But it's within the range, though, Sean, your model.

And our next question comes from Julio Romero from Sidoti.

Can you talk about the mix of new bookings that are coming in in terms of the mix of maybe new construction versus existing building construction? And maybe as well talk about the mix of electrical versus mechanical?

I'll go first, then Bill. So, in terms of the backlog, we're seeing a pretty consistent trend. 45%, 50% is in the construction range, heavily new construction today. There's a lot of new projects going on. We are seeing a lot of electrical work, particularly in Texas. So, I think you'll see electrical pick up, although mechanical is staying strong, but electricals will be increasing as a percentage of our business going forward.

Yeah, I would agree with that.

I guess what's the biggest change to the operating environment you've seen over the past two months since the February call?

I think the biggest change in the last two months is the lack of change. Like, the most surprising thing in the last two months is that there seems to be no letup in people sort of still wanting to onshore. Pharma, still very high levels of interest. So we know everybody across the economy is taking a hard look. So far, there's no sign of that with our customers. So, I'd say the thing I'm most surprised about, but the thing that's most notable is there may be changes coming, but they're not apparent right now.

I think, Julio, I agree. The broad base strength of it, too, is still hanging in there. So, not much change.

You may recall that when we were coming out of a couple of recessions in the past, we were kind of famous for – everybody would say things are getting better and we'd say, well, we're really hoping they do, but we don't see any sign of it. And we're usually right. In this case, maybe the world's about to end, but we're not seeing any sign of it.

Interesting dynamic there. And maybe last one for me. It's just if you could talk about maybe the M&A pipeline. And given the rising interest rates and maybe more challenges for some of the other industry players, are you starting to see any change in valuations for some potential acquisition candidates that you may have had your eye on?

The answer is, for ones we've had our eye on, no, the relationship deals are the same. For stuff that people are hiring a broker, there's a lot of stuff that we wouldn't be interested in that we see. It seems like they certainly are expecting to get higher pricing. I've seen instances where that's confirmable. But there seems to be higher pricing expectations. So, we're really happy we had these deals we just did that were based on long-term relationships. I think it was good timing for us to get a lot of good deals done last year. This year, we're probably going to take a breath. We'll probably continue to do some tuck-ins. But there's a lot of reasons why we've got work to do to integrate and make sure we do that right. Pricing is high. Two of the deals we did late last year, two of the bigger deals would have happened this year. They just happened sooner because there was this conviction that people had for a period of time the capital gains rates were going up. That turned out pretty good for us. I think, this year, there's also – in the midst of uncertainty isn't necessarily the time to pile into acquisition. So, I think we'll be pretty calm this year. I think we'll keep really developing the pipeline, and it's still good.

And our next question comes from Brent Thielman from D.A. Davidson.

Brian, when you look at a $2.7 billion backlog that you're going to try and execute on, how do we sort of think about the incremental capacity you have to address kind of that smaller book and burn work. And then, I guess, second part of that is, did you have a workforce capable of supporting an even larger book of business?

So, really good questions, Brent. And luckily, as Bill mentioned, it is broad based. So, larger companies have the largest share to work. So, from a capacity and labor standpoint, we're in good shape. We spend a lot of time, as you know, you've known us a long time, timing out this work, labor planning, make sure we have the right resources. We're also very fortunate with an acquisition that Bill did at the end of last year, a company called Kodiak which supplies us with labor throughout the country. So, we do have multiple sources to increase our capacity. So, I think, right now, as I sit here with you, we're in good shape with the backlog we have and we'll continue to win work and do it. But our guys are really good at looking at their workforces, how much they can take, and when it's going to take it. So, we're very fortunate with the folks that we have running our organizations and making sure they can take work that we can do.

If you don't mind, I'll add one more specific consideration, which is that, in the same way that our cost of goods sold going from 34% to 40%, materials and equipment, the same way that made our revenues bigger, it makes the amount of labor in our backlog proportionately smaller. So, we've got jobs that are on the very big end. We have jobs that a couple of years ago, we're at a certain size, that where you might top out with 300 people, we have jobs of the same size where the highest number of workers you're going to have on the job site are 200 people. So, what happens is, if materials start to come back down, then it'll make the backlog a little sluggish and suddenly we'll look smart on the margin line. Right? But for now, the trend is definitely towards more materials, paying more for them and that makes the backlog bigger as well.

But we're in reasonable shape right now, Brent.

Yeah.

Not a lot of spare capacity. I'm sure the guys out there are saying, you come and do it, Brian. But right now, we're okay.

The second one was just – the two segments between mechanical and electrical, which would you expect to see more of a kind of a positive inflection in margins once you get towards the more mature stages of these larger projects?

You look at the gross margin in electricals at 13% for the quarter, we were up closer to 15% last year. So, I I'm optimistic as the year goes by. We're really early, Brent, in a lot of this electrical work. So we're really watching that closely. But if I had to guess, I am expecting that electrical will see a bigger bump in margins as we go throughout the year, early next year.

Amen, brother.

Just one more. Industrial continued to be a huge driver for you guys. But I've also noticed, just in the Q, it looks like some of the – maybe what we might associate as kind of light commercial work, the retail, restaurant stuff seems to be coming around for you, at least from a revenue perspective in the first quarter. And I realize you're not necessarily emphasizing that work. But I imagine it's getting better for others in the industry, too. Is that leading to a tighter kind of capacity environment in general and kind of favoring pricing on these bids as you're going out and looking at new work?

Demand is good for pricing, right, unless you're doing things wrong. I would say also, you've probably detected a little bit those deals we did in December. We've done a lot of acquisitions that were heavily industrial. Couple of the deals we did in December were more of our traditional stuff that we've done in the past, although they have very complex capabilities. They do a broader mix of work. And by the way, they brought in more service for us. Some of those deals had very, very nice service businesses, especially from the point of view of revenue and customer penetration. They didn't have quite the margins in service that we have. But to be honest, the companies we own today that have those margins in service didn't have them when we bought them. So, hopefully, there's an opportunity there.

And our next question comes from Adam Thalhimer from Thompson Davis.

Brian, you mentioned Texas and North Carolina strong. Is there anything else to call out at some of the other geographies?

Florida, I would say, is very strong. It's strong across everywhere around, to be honest with you. [indiscernible] Texas is obviously – it's well documented in everything you read, but I think the southeast in particular. Florida is very strong, too.

You can't get numbers like this, though, with everywhere being…

Everywhere being strong. But, no, with pickups, Texas, North Carolina, Florida, very good.

What are you seeing in data centers?

Steady.

Yeah.

Steady at high levels.

Steady and consistent and good volumes of work. Very good.

And then modular, high level?

Modular, very, very good demand in modular. We're actively adding more square footage. Today, we have about a million square feet of production space in modular. And that's going to be up significantly six months or a year from now because the demand is very good.

I'm not sure how to ask this question. But it's really a question on supply chain. And I guess I'm trying to think through, like, how much variability are you seeing just in your subsidiaries in terms of your larger subsidiaries? Like, are there some companies that are really sailing through supply chain issues and others are really struggling with it? How much variability do you see out there on that front?

There's a ton of variability about how this is going. But not necessarily just like this company versus this company. It's more like the variability is thematic. One month is nobody can get PVC. And the next month, nobody can get switch gear and then, suddenly, they seem to get some and it's very – it's clear that our suppliers who are very good themselves are struggling to make predictions to us. And unfortunately, more often than not, their prediction ends up being longer. But, occasionally, we get stuff we weren't expecting. And I don't know, it's very variable, but I don't think it's geographically variable or company type variable. It's just a lot of people try to figure out something that's hard with a lot of variables that – when is the ship setting off the coast is going to get called in. It's pretty hard to figure.

Yeah, I just want to add on a little bit to that. If you look at the whole chain from your vendors and how they're getting stuff and our customers, people are very rational about the situation we're in. Everybody knows it. We communicate with them being transparent. So, it's really important time to really be good at project management. And we're lucky that we are and we're working with these folks, and we have really good vendors. We really do appreciate them trying to help us get through this.

And I am showing no further questions. I would now like to turn the call back over to Brian Lane for closing remarks.

All right. Thanks, everybody. I really want to once again thank our diligent employees. They're doing a terrific job working safely, efficiently and productively and taking care of our customers. Also, thank all of you for your interest in Comfort Systems USA. We really do appreciate it. And we hope everyone has a wonderful spring and we'll be talking to you soon. Have a great day. Thank you.

Thanks, everybody.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.