Comfort Systems USA - Earnings Call - Q1 2020

Transcript

Speaker 2

Good day, and welcome everyone to the Quarter One 2020 Comfort Systems USA earnings conference hosted by Comfort Systems USA. My name's Sheila, and I'm the operator for today. During the presentation, your lines will remain on listen only. If you require assistance at any time, just please stay on zero on your telephone, and a coordinator will be happy to help you. I'd like to advise all parties this conference is being recorded for replay purposes, and now I'd like to hand over to Julie Jayce. Please go ahead.

Speaker 0

Thanks, Sheila. Good morning. Welcome to Comfort Systems USA's first quarter earnings call. Our comments this morning, as well as our press releases, contain forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. 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 more 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.

Speaker 6

Okay, thanks Julie. Good morning everyone, and thank you for joining us on the call today. Let me start by sincerely thanking all of our Comfort Systems USA employees for their work and commitment, and especially their incredible courage and resilience during this global pandemic. As you all know, these are challenging times, but Comfort Systems is rising to the occasion, and we have been very fortunate so far. COVID-19 began impacting our business at very significant levels in the second half of March. In spite of that, we had good earnings and terrific cash flow in the first quarter, and our backlog is holding up. We will get into those details in a few minutes, but I want to comment a bit more about the immediate challenges we are facing. Most important, we are working to keep our employees and our community safe.

Our locations have been working to implement CDC and OSHA guidelines to ensure our workforce and our community is kept safe and healthy during COVID-19. In addition to working to meet these guidelines, we are taking many other actions. In various markets, we have implemented segmenting and designated work zones, staggered start times, temporal scanning and screening, disinfecting equipment and work areas, distancing and wearing a protective face and nose personal protective equipment. As you know, we operate in scores of different markets in dozens of states, and our leadership in each location is conforming to the measures that are required locally and seeking the path that will work best to keep our people safe and well. That is a true strength of Comfort Systems. Our overall business was affected in the closing weeks of the first quarter, and of course, those effects are continuing.

Our service business experienced the most immediate and pronounced negative impacts, largely as a result of building closures or decisions made by customers to limit building access. Although our construction activities are considered essential services in most markets, we have also had certain jobs temporarily closed due to government pronouncements, due to decisions by owners, and when sites reported positive tests for COVID-19. While we have seen some construction jobs delayed, so far we have not experienced material cancellations. In addition to actual stoppages, our project and service work has experienced efficiency challenges as a result of the important precautions that we are taking. Our amazing teams across the U.S. are still managing to accomplish great work and are being productive in light of these circumstances.

Our local leadership, project management, and especially our field workers have been extraordinarily effective, exceeding my high expectations for how they would respond at a time like this. In the midst of these challenges, we have started 2020 on a very good note. Revenues were $700 million compared to $538 million in the prior year, and our growth included a 6% increase on a same-store basis. We earned $0.48 per share in the first quarter, and that result is despite a direct impact of $0.09 due to COVID-19. In addition to the directly quantifiable impacts, as I described above, we are also impacted by less quantifiable ways by COVID-19, including weakness in service and productivity challenges in project work. As of March 31, 2020, our backlog was strong and is more than $200 million higher than the prior year on a same-store basis.

We are reporting fantastic first quarter cash flow, which is a tribute to our team's focus on cash in a traditionally weak cash flow quarter. Before I turn some time over to Bill, I also want to mention our acquisitions. During February, we added a strong company in North Carolina, Star Electric, to our electrical segment. In addition to having a great contracting business and customer list, they will strengthen our modular construction business in North Carolina. Star and our local business already have a long history of successful collaboration. On April 1, we completed the acquisition of TAS, which we believe will make us the leading modular and offsite construction expert across the growing modular mechanical contracting industry.

With TAS now a part of Comfort Systems USA, and when considered in connection with our existing capabilities at EAS in North Carolina, we believe that we now have unmatched capability to complete complex modular and offsite construction in the growing modular construction industry. Our offsite construction business is particularly strong in the technology, medical, and pharmaceutical industries. This combination gives us a great opportunity to cross-sell our capabilities to our existing customer base at all of our locations and augments our already strong industrial segment, which increased to 39% of total revenue in the first quarter. In the midst of these challenges, we continue to invest, and we remain optimistic. I will discuss our business and outlook in more detail in a few minutes, but first, let me turn this call over to Bill to review the details of our financial performance. Bill?

Speaker 3

Thanks, Brian. Good morning, everyone. First quarter revenue increased by 30% to $700 million this quarter compared to the same quarter last year, which means, as Brian said, same-store revenue also increased by 6%. The rest was due to our acquisitions. Quarterly gross profit increased by $10 million to a total of $117 million in the first quarter of 2020 compared to the same quarter last year. The gross profit dollar increase was due to the Walker acquisition. Our first quarter gross margin was 16.7% in 2020 compared to 19.8% in 2019. The decline in gross profit percentage is the continuing result of the addition of our electrical segment, which is weighted to large and complex projects with significant amounts of material and equipment pass-through costs, and which has a lower percentage of service work, combined with the effect of inefficiencies from COVID-19.

Our electrical segment was added at the start of the second quarter of 2019, so this is the last quarter where that segment will not have been included in the year earlier quarter. Our electrical segment, in addition to their large project mix and lower service component, experienced specific project challenges, including the impact of COVID-19 on productivity and certain adjustments that impact our gross margin. With larger projects and less service, our electrical segment also lowered our SG&A percentage. Net income for the first quarter of 2020 was $18 million, or $0.48 per share, as compared to $20 million, or $0.53 per share, in 2019. As Brian previously mentioned, we had approximately $0.09 of direct COVID-19 impact, and we were additionally impacted in less quantifiable ways by COVID-19, including weakness in service and productivity challenges in project work.

For the first quarter, EBITDA was $37 million compared to $38 million for the prior year. The small decline in EBITDA results from the negative effects of COVID-19, offset by EBITDA that was contributed by Walker. Now that I've run through our various profit measures, before I move on to other aspects of our financials, I want to take a few minutes to comment on potential ramifications for our company from COVID-19 and talk briefly about the mechanics of how and when that is affecting and will affect us. I'm going to talk about some of the risks we're facing, how they create more potential volatility in our results and judgments, and the timing for how they could unfold. The global pandemic brings with it many proximate risks, most of which are fairly obvious. Work sites are subject to closure and reopening.

Precautions and adjustment measures create inefficiency that's hard to measure, and as you saw this quarter, the challenges for our customers can affect the timing of, and in some cases, their ability to pay for services. Although we have not seen jobs canceled, that is a possibility, and even the likely deferral of some work can create air pockets and planning challenges. There are also second-order risks that are less proximate, the most obvious being the effect of these challenges on industry activity and business cycle conditions. The volatility of the results we are suddenly experiencing can also affect judgmental areas, and we will need to closely monitor the ramifications for accruals relating to risk, our medical costs, purchasing rebates, and our intangibles such as goodwill. As the next few quarters unfold, we will see these effects.

This quarter, we reconsidered certain receivable exposures in light of the effect of COVID-19 on certain of our customers, and as a result, we increased our receivables accrual. As a result of our bad debt, our bad debt expense for the first quarter was $4.6 million, which is a stark increase from last year when our bad debt was only $200,000. We also reassessed our jobs in light of productivity challenges. We currently believe that the second quarter will see the greatest direct impacts, especially on revenue, as we cope with additional service delays and job stoppages, and as we continue to adapt to changes that can affect efficiency. During the second half of the year, although we're optimistic conditions will improve, there will still be productivity impacts, and we may see some air pockets that arise from delays or the slow return of smaller work.

We feel that we're prepared to confront these challenges, and we believe that our investments in service and our growth in the industrial segments of technology, medical, and pharmaceutical give us a good opportunity to cope with these challenges successfully. We believe that we can face these challenges in 2020 and that we will emerge stronger. With that as background, let me now comment on a few more areas from the first quarter. SG&A expense was $93 million for the first quarter of 2020 compared to $79 million for the first quarter of 2019. SG&A increased primarily due to SG&A from new acquisitions, as well as an increase in bad debt expense of $4 million.

The increase in bad debt expense was primarily driven by concerns about collectibility of certain receivables due to the business interruption caused by the global pandemic, specifically with respect to receivables with retail, restaurant, and entertainment companies. SG&A's percentage of revenue was 13.3% in the current quarter compared to 14.7% in the first quarter of 2019, and we continue to benefit from SG&A leverage largely due to the electrical segment, which requires lower levels of SG&A. Our 2020 tax rate was 27.6% compared to 25.9% in 2019. Our prior year tax rate benefited from permanent differences related to stock-based compensation. Cash flow for the quarter was remarkably strong, as our free cash flow was a positive $15 million compared to negative $7 million in 2019. This is a traditionally weak cash flow quarter, so this positive cash flow is a notable achievement for our operators.

We feel good about our cash prospects despite the ongoing challenges. As of today, our debt balance is $348 million and includes borrowings under our credit facility of $291 million. We have two principal financial covenants under our facility. The first one is a total leverage ratio, which cannot exceed 3.0. The leverage ratio as of March 31, 2020, was 1.5, and today we have very substantial additional capacity of $244 million. The second financial covenant is the fixed charge coverage ratio, which is required to be at least 1.5, and which on March 31st was 10.7. We exceed that trailing 12-month requirement by more than 700%. Those of you who have been around our company for a long time are well aware that we run our balance sheet in order to be ready for a time like this.

During April, we were able to take advantage of our strong balance sheet to enter into a swap agreement to fix the variable portion of our interest calculation for a substantial portion of our debt. As a result of the swaps we executed, we expected about 75% of our bank debt, which up to now had variable interest rates, will bear interest at a roughly 2% fixed rate for the next 30 months and an immediate decrease of about a half a percent, even from the low rates we were getting. During the first quarter, we purchased 237,000 of our shares at an average price of $3,785. Late in the first quarter, and specifically as the scale of COVID-19 challenges became apparent, we withdrew our automated share repurchase plan, and thus we've stopped purchases for now. We will reevaluate that action as conditions develop.

That's all I have on financials, Brian.

Speaker 6

Okay, thanks, Bill. I am going to spend a few minutes discussing our backlog in various sectors and markets. I will also comment on our outlook for the second quarter and beyond. Backlog at the end of the first quarter of 2020 was $1.6 billion, the same store increase of $252 million, or 22%, compared to March 31, 2019, primarily due to the strong reputations and performance of our many locations. Sequentially, our backlog was roughly flat, with a small sequential increase in our mechanical segment and a sequential decline in our electrical segment, and overall, we remain at the high levels that we reported at year-end. Most sectors have remained strong, with particular strength in industrial. Our industrial revenue increased to 39% of total revenue in the first quarter.

Institutional markets, which include government, healthcare, and education, were 36% of our first quarter revenue, which is consistent with what we saw in 2019. The commercial sector was 25% of our revenue. With the acquisition of TAS and Star Electric, we expect to continue to grow our offsite construction business, particularly in the technology, medical, and pharmaceutical industries. For the first quarter of 2020, construction is 79% of our total revenue, with 49% from construction projects for new buildings and 30% from construction projects in existing buildings. For the first quarter of 2020, service is 21% of our revenue, with service projects providing 8% of revenue, and pure service, including hourly work, providing 13% of revenue. Beginning in late March, our service business experienced the first and most pronounced negative impacts associated with COVID-19, largely as a result of building closures or decisions by customers to limit building access.

Although our construction activities have been classified as essential services in most markets, we have had certain jobs temporarily closed due to government action, decisions by owners, or upon positive tests for COVID-19 of workers at various sites. We have also had some delays in the award of new work, and we have been informed of instances of delayed stops. Up until now, we have not experienced material cancellations in our backlog. In addition, we have implemented safety precautions and other COVID-19-related guidelines that have added cost or inefficiency as we work to create a safer environment for our team members and our communities. Geographically, COVID-19 has impacted us more in the Northeast and Upper Midwest, especially in states where construction has not always been classified as essential, particularly in New York, Michigan, and Washington State. Finally, our outlook.

We expect to experience the most significant impacts from COVID-19 during the months of April, May, and possibly June. However, that will depend on how national events unfold. We also expect that COVID-19 will affect us for the remainder of 2020. Assuming that some relief is evident by June, we currently believe that earnings per share in the second quarter will be considerably positive, perhaps achieving levels that are about one-half of the same quarter in 2019. We also anticipate improvement from those levels in the second half of 2020. However, we are preparing for a wide range of economic circumstances in 2020 and beyond. We have a great workforce, and we feel confident that we can continue to be profitable, cash flow positive, and that our ongoing investments will continue to pay off and will accelerate our growth when strength returns to our industry.

Thank you once again to all our employees for your hard work and dedication. I'll now turn it back over to Sheila for questions. Thank you.

Speaker 2

Thank you so much. To ask a question, just keep Star then 1 on your telephone. If you then decide to withdraw your question, simply keep Star 2 to remove it. Okay, the first question comes from the line of Sean Eastman of KeyBanc Capital Markets. Please proceed.

Hi, thanks, gentlemen. Thanks for taking my questions.

Speaker 6

Thank you for calling, Sean.

I'd just like to start on the service business. Clearly, it seems like the most material near-term disruption. Just curious to get your sense on how you'd frame demand recovery once the environment normalizes. I'm just curious on how you'd frame what demand looks like on the buildings that have been empty or near empty and how the business comes back once people get back to work.

Sean, that's a really good question. I'm always optimistic about service. I think this is just a blip personally. I think as you're seeing some of the warmer weather increase, people still need to take care of their buildings. They just can't let them sit dormant. I mean, we're seeing good activity and service in the Southeast still today. Also, I think there's going to be opportunity as we go forward, looking at the way air flows through a building, looking at filters. I think there's going to be opportunities, and I think service can come back very, very quickly. We're pretty optimistic going into the summer that that will happen. Bill, do you have anything? You're good there? All right.

Okay, great. Really helpful. Makes sense. Maybe just broadly, if you can comment on what the bidding environment is like currently. Has bidding paused or stopped for new construction in the interim, or are you guys still bidding and booking work at this point?

Sean, bidding activity, probably surprisingly, is still quite good. Maybe a little bit more active in different parts of the country, but in general, we are seeing a lot of opportunities to look at still. Some opportunities, like in New York State, for example, with Abbott, both in Maine and facilities outside of Syracuse that need some quick build. I looked at a couple of bonds, one this morning, one last night. The activity is, as far as I'm concerned, still pretty good. Bill, do you have anything to add to that?

Speaker 3

Yeah, I think I actually made a couple of even phone calls this morning just to double-check. There's activity. There were in the last month, there were going to be job interviews that were canceled or delayed, well, not canceled, delayed. There's going to be some delay. Obviously, you shut things down, they're shut down. I also think that there may be, over the next quarter or two, a little bit slow return of the quick-turn work. Our book of business for projects is made up of projects that are developed for a really long time. But as you know, our average project size is like, I don't know, in the hundreds of thousands. And a lot of that's quick-turn work. We'll have to wait and see how fast that gets going again. That's one of the reasons we mentioned the possibility of air pockets.

I have not yet talked to anybody who said they see things that were going to happen that are not going to happen now. That could come, but that has not come so far.

Speaker 6

Sean, you take, like I mentioned in my script about New York, Michigan, New York's been coming back a little bit. Washington State, recently, I think the other day, has started turning it around to add construction. I think we'll be all right. It's just how this is going to play out long-term.

Okay, helpful. Last one for me, you guys mentioned the pharma, medical, technology opportunity set holding out well a few times in the script. Just wondering if there's already signs of strength there or just how you expect these opportunities to play out.

Speaker 3

On technology, we've had big technology customers contacting us to ask us for reassurance that this won't slow us down. That's encouraging. On pharma, that stuff takes a little while to get going, but I do think that maybe America will see some charm in the possibility of having more important pharmacological ingredients prepared in the U.S. rather than far away. I think it's pretty—I feel pretty optimistic. I don't think it magically transforms things within a quarter or two, but I think these have some good fundamental characteristics.

Speaker 6

Sean, we are really, really well positioned in pharmaceutical. The sectors, I know we mentioned it numerous times for a reason. I'm pretty optimistic that that's going to come back, and there'll be a lot of opportunities for us going forward. I think it's pretty exciting, actually.

Excellent. I really appreciate the time. Thanks, guys.

All right. Have a good day.

Best of luck out there.

Thank you.

Speaker 2

Thank you. The next question comes from the line of Joe Mondillo of Fidoti & Co. Please go ahead.

Hi, guys. Good morning.

Morning, Joe.

Speaker 3

How are you?

Good. Doing well. Hope you're doing well as well.

We're doing terrific. Thanks.

Good to hear. Very good to hear. In terms of your sort of 2Q outlook, could you help us understand how you're thinking about that? You sort of talked about how potentially down 50%, but I think there's probably a range. Any other information that you can give us, whether it's how April's trending or how you're thinking about that 2Q guidance that you sort of provided?

Yep. We gave that guidance because it's the best thing that we have. There are going to be facts that develop on the ground. As far as April goes, we have jobs closed down as we speak because of COVID tests. We have jobs that closed for two days. We have jobs that closed for a week. Walker's had probably more job closures than anybody else on some of their bigger jobs. We don't know how that's going to develop. That is still—we're talking about out of thousands of jobs. We still have work to do. We think service will pick back up. Really, it's what we said in our press release. This is assuming we start to get noticeable relief in June, that we're very vulnerable to changes in government pronouncements.

We have certain states where we're shut down because the way that the governor worded the order shut us down. We are subject to facts and circumstances as they develop. Right now, assuming things trend at these levels for, let's say, another month and start to get a little better in June, that guidance we gave is what we're thinking.

Speaker 6

It's interesting, Joe. We have an opportunity outside of Syracuse. We got a call last Wednesday, and we're already on the site today. There are some opportunities, and they're quick. They need someone with a workforce that can get there quick. We're well positioned with some of these opportunities, particularly if it relates to some COVID-19 remedies.

Okay. In terms of your comments that you made about sort of COVID impacting even the second half of the year, but most likely improvement from the 2Q levels, what are the biggest sort of impacts that you're anticipating to the business once we even start to reopen by June or July?

Speaker 3

I'll go first.

Speaker 6

Yeah, okay.

Speaker 3

Yeah, I'm going to go first on that. There's a couple of things. One, immediately, we had to look at our receivables and say, "Okay, we got this customer. They're not paying their rent right now. Should we impair their receivables to some extent?" Yes. You have those kind of immediate impacts. They hit us even by the end of March. This quarter, you have the actual stoppages, the closed building. Once you get past this quarter, I think your biggest risks are there's productivity, and there's air pockets. Productivity, at the end of the first quarter, and we'll do this again as we close March, we have to estimate how much it will cost us to complete a job. We have to take into account, when we make that estimate, all of the facts and circumstances that we know about.

At the end of March, we now knew that we could only put four people in an elevator on a vertical job where before we put 10. We now knew that at a scissor lift, you'd only have one guy standing on the platform rather than two. We knew our guys would be backed up getting their temperature taken. Because of that, we wrote down some of our jobs. That new margin that they're at is what they'll play out for the rest of the year. We have jobs. We lowered their margin one time. Obviously, the jobs that are newer are the ones that that's going to have the bigger impact on. The other concern I have, and these are incremental concerns, but they matter, is air pockets. I really believe that some of this quick-turn work will be slow to come back.

We actually think we may have some competitors who are getting these loans and have to have a certain number of people working to be forgiven. Their loans may take work cheap here and there, especially that last-minute quick-turn work. We've seen a little bit of evidence that that might happen. We have concerns that we may be slow getting some of our labor back because of concerns employees have about coming back, but also because in some cases, they're being paid pretty well not to work. All of those are what we're baking into those considerations. Overall, we feel like we've got a good business. Our guys are fantastic. They want to work hard, and they know how to make money. This is the real world, and those are real things, and they're going to matter a little bit somewhat.

Speaker 6

Joe, while we're talking about this topic, and we've talked a lot about the field, but we are really fortunate here. We've had to work remotely, and I'm talking about the finance administration accounting folks, both at corporate and the operating that Julie leads the charge, and she opens up these comments. I can't thank them enough that they were able to meet all the deadlines and get us ready for this call today. It was a lot of hard work. I think Julie spent a few nights here making sure that we were tied up. I really want to thank them for all their hard work and how professional and disciplined they were.

Just to follow up on that question, do you—sorry, lost my train of thought. My last question, and I'll hop back in queue. Just to follow up on the prior question regarding new project work, looking back to past sort of occurrences in the economy, obviously, we've never seen something like this with a pandemic, but we have seen some shocks in the system: 2008, 2001, 2000. When you look back at those time occurrences, would you anticipate in this time around to feel an impact to new project work six weeks into sort of the shock, if you will? Or would bidding and new project work, would it take a little bit more time?

Just wondering, should we expect to feel the effect of new project work being affected by this at this point in time, or if it's going to take a little longer, if it will happen at all?

Speaker 3

I'll take that question, Joe. This is, give or take, my 60th quarterly call. I will agree with you that we've never seen anything like this. There are some big differences from those prior events you're talking about. The biggest difference to me is Comfort Systems USA is a very different company today. Our biggest segment going into the most recent, the financial crisis, was multifamily. Today, it's 3% of our revenue. We have tech and pharma that we didn't have then. We've made a big investment in service. Those are big differences that make me feel like this will unroll in a better way. As far as when these events hit, I think there's two things going on. There's the effects of the emergency that's just happening right now. That will be more in the—that will be this year.

That will be in the nature of some air pockets because of deferrals, that lowered productivity. There is the question of what the impact will be on the business cycle next year. I would say the biggest difference between the thing that makes it the hardest to calculate for me, one really big difference between this and the other two big recessions that I have been at Comfort Systems for, was when the 9/11 recession hit and the financial crisis recession hit, we were already in an unbalanced situation. We were already seeing big increases in unemployment in the U.S. We had high levels of vacancy that had already happened. We were at the start of a recession, and then we had a shock.

What's different this time is this shock came when the fundamentals were as good as they've ever been, when people were reassuring, when the tax regime was more welcoming, let's say, when we had cheap and abundant energy, when good things were going on. I think that could make a big difference. I'm going to be honest with you, it's a really hard call about what kind of recession this triggers. We're trying to prepare for all eventualities.

Okay. Thanks. I'll hop back in queue. Thanks for your help.

Speaker 6

All right. Thanks, Joe.

Speaker 2

Thank you. The next question comes from the line of Brent Fieldman of BA Davidson. Please proceed.

Hey, thanks. Good morning.

Speaker 6

Morning, Brent. How you doing?

I'm doing well. Thank you.

Good. Good, Brian. I know you had some work at Walker coming into the quarter that had some lower margins, I think, attached to it. It sounds like that might have been amplified by some of the COVID impacts. Are you through that now? I guess any estimate kind of how diluted that was on the electrical margin this quarter? I guess to take that a step further, how do we think about—and I know there's a lot of variables here in the next couple of quarters—how do we think about that target gross profit margin in the business as we move through 2020?

Speaker 3

Even if you set aside the uncertainty that's appeared for all of us, that's not a super easy question to answer. Let me tell you first about Walker. Walker, historically, before we bought them, they really have never made money in the first quarter. That was not culturally something that they had an expectation of. This quarter, they really were punched in the mouth in a lot of ways. They had—I don't know. Some of it might have been in April, but they've had multiple COVID-19 shutdowns. They had bad weather on an important project that had challenges. This was a quarter that I believe will not even be remotely indicative for them. They also still have a little bit of those purchase adjustments coming through.

I think that this quarter is not at all indicative of what our electrical segment's going to look like. We just added to our electrical segment as well a nice company in North Carolina. That also adds a variable there. As far as what our gross margins are going to look like, electrical has less service. Electrical has less overhead and more project work. It has more direct and indirect costs in its cost of its overall cost of sales. They will average down our gross margins. If we were going to be 20 or 21, I would expect we might be 100 to 300 basis points lower, depending on the volumes in that sector. They also have another factor, which is they do a higher proportion of cost plus fee work.

Cost plus fee work is very attractive in some ways because of the certainty of it, but it doesn't give you the opportunities for high gross margins that you could get with fixed price work. They'll average us down. Where that shakes out, I think that Comfort's long-term gross margins were trending up. I think they will average us down some, but I think the underlying long-term trend is still good.

Speaker 6

Yeah. Brent, this is Brian. This is a fundamentally sound company. They do very good work. We've recently started working with them, as we usually do, on training, etc., etc. Been derailed a little bit by current circumstances. On a long-term basis, this is going to be a very good company for us.

Speaker 3

Yeah. This quarter, their biggest job shut down twice. That did not help for multi-day.

Speaker 6

Yeah. It's not that they're good with their work. It's just the events, so.

Yep. Yep. Got it. I mean, should we take from that that you should see sequential improvement in terms of the actual?

Speaker 3

Yeah. Absolutely. Yeah, yeah. Throw out the second quarter. Electrical, I would expect them to have better margins in the second quarter and us to have better margins in electrical in the second quarter. Comfort as a whole, the second quarter is when we're really going to—we only had two weeks of COVID impact in the first quarter, right?

Yeah. We got the full load now.

If we tell you we're going to earn half as much as last year, that obviously includes a lower gross margin. If you set aside the second quarter, I think we start to trend upwards. I think without COVID, this would have been a fantastic year.

Yeah. Yep. Okay. And then on TAS, when you guys came out originally, I think you'd said $170 million-$190 million in its first year. Is that still the right ballpark to think about here?

I think TAS is on track for this year. When we buy a company, we develop a conviction about what it will contribute to Comfort Systems USA for years to come. We bake into that that there will be recessions and strong markets over that period of time. I am completely comfortable that TAS is still going to provide for us in the years to come the levels of revenue and earnings that we talked about in our press release. I also think they're going to have—they're working hard and very good work for the next couple of quarters. If there's a big—if there's a recession of any kind in 2021, there's going to be a recession in 2021. I think they'd still be profitable. I think we'll still be profitable. Which year we get that return in, I don't know, but.

Speaker 6

Yeah. Brent, we visited them a little bit ago here. They're still very busy, and their prospects are very good if things progress on a normal time.

Speaker 3

We feel great about that.

Speaker 6

We feel really—yeah. We really feel good about that company.

Speaker 3

Look, they're going to add to the strength of Comfort Systems because they're going to add EBITDA, right? If you listen to what I said about our capital structure, the key to all of those—so our only two covenants is EBITDA.

Okay. Last one for me, you guys, as you said, Bill, you stepped up the accrual on the balance sheet, I guess, attached to maybe some of the receivables. Is that related to concerns in any particular sector or market or maybe even geography?

That is primarily—we took accruals against many of our receivables for retail businesses. We have a national accounts business. It's based in Indianapolis but goes nationwide, uses our companies and other companies to do work. A fair chunk of that work is for retail organizations. We also have a strong, similar site-based business that's operated out of Tampa, Florida, that came with BCH when we bought them. We felt like it was prudent, in light of circumstances, in light of, honestly, Wall Street Journal articles, to take their entire list of receivables and scrub it top to bottom, get as much intelligence as we could about the various retail companies, and try to do everything we could to make sure that whatever concerns we had, we addressed them day one of this situation. That accrual reflects us doing that.

The vast majority of it is retail.

Okay. Thank you, guys. Appreciate the call.

Speaker 6

Thank you.

Speaker 2

Thank you. The next question comes from the line of Adam Feldheimer of Thomson Davis. Please go ahead.

Speaker 6

Hey, good morning, guys. I also wanted to ask about the bidding. Is that more varied by geography, or is it more varied by in-market?

Speaker 3

I would say geography, both. It's too soon to tell in a way because there just hasn't been that much change in bidding. If you talk about sort of delayed interviews for a job, that's really going to be the industrial jobs because they're the big jobs. You don't interview people for an $800,000 job. You interview people for a $10 million, $20 million, $40 million job. So that particular comment relates to the big industrial work and maybe big hospitals.

Speaker 6

Adam, just in terms of geography, it's pretty broad. Even in Michigan, though that thing has shut down, like there's no tomorrow, there's still opportunities we're looking at, right? Though we're not doing a lot of work there because the state's closed, we're still bidding.

Speaker 3

The Northeast is definitely more traumatized.

Speaker 6

Yeah. No question about it. Night and day from the Southeast, for example.

Okay. How material could the COVID remedies be?

Speaker 3

What does that mean?

Speaker 6

You mean in terms of opportunities to build production facilities for pharma?

Yes.

Speaker 3

Yeah. That could help certain of our companies. For Comfort as a whole, it's not going to turn into the basis of our business, right? I think more importantly, there may be additional impetus from this experience for people to consider that having more of their supply chain closer than China or something would be good, right? I think that I mentioned earlier, there are senators saying, "Gee, shouldn't we have at least one manufacturer of all of the most important pharmacological substances? And shouldn't we?" Hopefully, people sort of—the underlying trend of reshoring is reinforced by this. If it is, the good news for us, it would be most likely right in the sectors we're the best at. It would be in the geographies.

An awful lot of that, I think, is coming towards places like the Research Triangle and the Southeast and the Mid-Atlantic and Texas, maybe. I like our geography for that. The last thing is we do a lot of tech. I think it'd be a stretch to say that this experience would make people want less data centers or less streaming, so.

Speaker 6

Back to the pharma thing, Adam, we've got a terrific track record in pharma, and that goes a long way in that industry for them to give you more work.

Speaker 3

They like to hire people who have done it.

Speaker 6

Who have done the work, yeah.

Speaker 3

Especially stuff they want to do fast.

Speaker 6

Yep. We got some opportunities right now we're working on because they know we can do it, and we can do it fast.

Okay. What is the nature of TAS's backlog and their in-market mix?

Speaker 3

Did you say TAS?

Speaker 6

TAS.

Speaker 3

TAS.

Speaker 6

TAS. No, TAS. The one you just bought.

Speaker 3

Yeah, yeah. TAS is very, very technology-focused, maybe 90% technology-focused over the last cycle. They have some big customers, top 10 tech names, top 5 tech names that they do work repeatedly for. One of the things we hope we can do and are really confident we can do with enough time with TAS is diversify into some of the other industries that we do modular construction in. For right now, we feel pretty confident.

Speaker 6

Sounds like their in-market mix is perfect for right now.

Speaker 3

Yeah.

Speaker 6

Yeah. I mean, they don't have energy exposure, Adam, if that was your question.

No. I mean, there is no oil price exposure, right?

Speaker 3

Yeah. Yeah. Knock on wood.

Speaker 6

They're just based in Houston, but they ship all over the place.

Okay. Bill, what's the—you gave us the debt balance today. What's the cash balance today?

Speaker 3

The cash balance today is like $30 million, probably. Actual cash in the bank. If you did a book cash, right, that would include cash in transit, you might add $20-$30 million. If I close my books, you'd see $50 million. If you just looked into my bank accounts, you'd see a little over $30 million. We just try to—we're keeping about $10 million more liquid than usual, maybe a little more than that, even just because.

Speaker 6

The total debt of—because you closed TAS April 1.

Speaker 3

Yep.

Speaker 6

Yes.

You're at $348 million of debt. That's not even up much from Q1.

Speaker 3

Yeah. We had already borrowed the money for TAS. If you look on our balance sheet on March 31, we had over $100 million. Because we closed on April 1, we had already borrowed the money March 31. Actually, we're down. Our net debt is down since then slightly.

Speaker 6

Okay. Wow. Okay. And then I guess last one for me, as we think through the Q2, it sounds like the impact's really margins. Can your organic sales still be up in Q2?

Speaker 3

Oh, boy. We were so bad at that question. I would be surprised. I would be surprised if sequential, same store was up. I was just surprised in the first quarter when sequential, same store was up. The over/under number, I think, would be minus a few % over last year on the same store.

Speaker 6

Because to be honest, we're still busy right now, Adam.

Speaker 3

There are places where we're stuck. I mean, I got a job shut down for.

Speaker 6

We're not stuck everywhere.

Speaker 3

I got a job shut down for a week in the Mid-Atlantic. It's not revenuing, right? For one week, it's not revenuing. We'll see how we do when they count the chicken dough.

Speaker 6

This is a good call. Thank you very much, both.

All right. You have a good day, buddy.

Speaker 3

Thanks.

Speaker 2

Thank you. The next question comes from the line of Joe Mondillo of Fidoti & Co. Please go ahead.

Hi, guys. Just a few follow-up questions, if you will.

Speaker 6

Okay. Sure.

Speaker 2

Do you have any indirect—because I know you really don't have any direct exposure, but any indirect exposure to oil and gas? I know your 2016, you did see a downturn in the business, but I don't know if that was really related to oil and gas or something else.

Speaker 3

I don't think anybody has less exposure to oil and gas in the E&C industry than we do. If some building we're doing service on got some guy in there trading oil, probably.

Speaker 6

For the most part, Adam, it's not—sorry, Joe, it's not going to affect your model.

Speaker 3

Yeah. We got very—

Speaker 6

I mean, we buy gasoline and stuff at the gas stations.

Speaker 3

Yeah, we just.

Speaker 2

Gotcha. How about competition? Could you talk about what you're thinking about maybe your smaller competitors? Is there any risk of them going under and that being a positive to your business at all?

Speaker 3

are two possibilities. One, they just got loaned a lot of money. They do not have to pay back if they can keep their people working for four months, which means I am very worried and think maybe we have seen them take some cheap work, cheap quick-turn work. That does not help for the next few months. I do think there are a lot of businesses—remember, I do acquisitions and talk to a lot of people—who I think that a lot of these owners are not going to be real happy to dump a lot of capital back into their businesses right now. A lot of them are in their mid-60s and 70s. I think you will see some people actually not desperately blowing up. I think you will just see some people choosing to downsize or.

Speaker 6

We've already seen a few Joes, some guys just calling it a day.

Speaker 3

Just call it a day. There's some of that. We saw some of that. There's a company in Virginia where a guy had a nice business, just called it, said, "This would be a good time to finish." Especially the guys who have small project work. They can do that very quickly. Sometimes they will just sell us; they'll just have us hire their guys, right? They'll just come over and say, "Hey, buy my equipment for $100,000 and hire my guys." We see some of that.

Speaker 2

Right. Got it. You mentioned in your prepared remarks that you're preparing for a wide range of economic scenarios, especially as we head to get to the end of the year in 2021. Who knows where we're going to be? What kind of contingencies do you have, and what kind of cost reduction actions can you really make? I know your business is largely people, so what can you do to offset the downside?

Speaker 3

There are two parts to answering that question. One is the actual business. Our business is a variable cost business. People show up at somebody else's premises. And our business also, in the construction industry, really, construction workers make a pretty good wage, but they realize that there are times when there's less work. In general, we can scale our costs really very effectively to the amount of work we can get. That changes at the bottom of a bad recession because you reach a point where you have this core of your business, people who've worked for you forever, that you just want to find a way to keep them busy.

When you see us in our worst year, like 2011, and we do not make a lot of money, a lot of that is we are deciding, rather than make a little more money this year and destroy the core of our business, we are going to keep our guys. In general, in the ranges we are in today, our costs scale to our revenues pretty quickly. The question is overhead, uncovered SG&A, and the reality is you have to do what you have to do. This is a thin-margin business. Anybody who does not control their overhead does not hang around for very long.

Speaker 6

We have done a variety of cost-cutting things even here at corporate. Many of us have taken pay cuts, Joe. We are doing everything that we think is prudent for the long-term viability of the company.

Speaker 3

We do what we have to do in bad times, and people know we treat them well in good times, so we can usually do that.

Speaker 2

Yeah. Okay. Just last question, following up on sort of the big near-term risk in terms of productivity on these jobs that you're already on and the margins being hit at these current jobs. What percentage of your jobs would you say are affected by this? I assume some of your jobs, productivity, you'll be able to maybe meet some of the margins that were in your original bids.

Speaker 3

Yeah. Here is my answer to that. My answer to that is more than half of our jobs, the vast majority of our jobs, can absorb this out of contingency. You will not see their margins go down from. What will not happen is we were going to make that contingency later as the job moved on. We will have some jobs that actually have to write down their margins as well. The reality is if you have to spend money on something and you have a fixed price, you might get a little bit of money for DMOB and REMOB in some cases, but you make less money.

Speaker 6

Having said all that, Joe, that's important. Number one is the safety and health and the well-being. We'll do whatever it takes to make sure we protect our people and where they're working.

Speaker 3

Covered, in bad times, we never try to get the last penny, right? We try to build for the future. We want to come out of a tough time as an even more important force, having a bigger share of our industry and being the people that customers can count on.

Speaker 2

Okay. I appreciate it, and good luck through the rest of the year. Thanks a lot.

Speaker 6

All right, Joe. Thanks. Take care.

Speaker 2

Thank you so much. I would now like to turn the call back to Brian Lane for closing remarks.

Speaker 6

Okay. Thank you. I want to once again sincerely thank our amazing, resilient, and committed employees. Without COVID-19, we believe 2020 would have been a record year for Comfort Systems USA. However, with the headwinds we are all facing, we still believe we will have a very good year. Last year, in the second quarter of 2019, we earned $0.65 per share. Unfortunately, at this point, we do not feel that is attainable in the second quarter. However, we believe that we will be solidly profitable. We are optimistic that as the year progresses, we can continue to improve. We are looking forward to seeing many of you again in person, hopefully in the near term. In the meanwhile, please be safe and healthy. Thank you very much.

Speaker 2

Thank you. Everyone, that now concludes the call for today. You may now disconnect. Thank you for joining.