Comfort Systems, Inc. Q4 2008 Earnings Call Transcript

Mar. 2.09 | About: Comfort Systems (FIX)

Comfort Systems, Inc. (NYSE:FIX)

Q4 2008 Earnings Call

February 27, 2009 11:00 am ET

Executives

William George, III – Chief Financial Officer & Executive Vice President

William F. Murdy – Chairman of the Board & Chief Executive Officer

Brian E. Lane – Chief Operating Officer & Executive Vice President

Analysts

Matt Duncan – Stephens, Inc.

Richard Wesolowski – Sidoti & Company, LLC

John Rogers – D. A. Davidson & Co.

Clint Fendley – Davenport & Company, LLC

Tahira Afzal – Keybanc Capital Markets

[Barry Hayes – Sage Asset Management]

David Yuschak – Sanders, Morris Harris

Terry McMahon – McMahon Technology Associates

Operator

Welcome to the Comfort Systems fourth quarter earnings conference call. My name is Inka and I will be the operator for today. At this time all participants are in listen only mode. We will have a question and answer session towards the end of the conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. At this time I would now like to turn the call over to Bill George, Chief Financial Officer.

William George, III

Welcome to Comfort Systems USA fourth quarter and yearend earnings call. Our comments this morning as well as our press release contains forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. What we say is based on the current plans and expectations of Comfort Systems USA. Those plans and expectations involve risks and uncertainties that could cause actual or 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 Form 10K which we published last night as well as in our press release that covers these earnings. On our call with me this morning are Bill Murdy, Comfort System USA’s CEO and Brian Lane, our new Chief Operating Officer. Bill Murdy will open our remarks.

William F. Murdy

We’re very pleased to announce record fourth quarter and full year results for Q4. Our earnings increased by 44% over Q4 of ’07 and for the full year we’re reporting almost $50 million of net income, $49.7 million or 3.7% of revenues compared to 2.9% in 2007. Measured on a per share basis we earned $1.24 in ’08 versus $0.79 in ’07, a 57% increase in EPS. Our revenues in Q4 were $329 million versus $293 in Q4 of ’07 and revenues for the full year were $1.33 billion versus $1.1 billion in ’07. That’s an increase of about 20%.

Our project backlog at the close of 2008 stood at $752 million and that is down from the $105 million at the end of Q3 and down from the $787 million at the end of ’07. Although our backlog is down as the market weakens in the non-residential construction sector, it remains at high levels compared to our history on any basis.

Cash remains a very, very positive story for us. We had $32 million in free cash flow for Q4 and free cash flow for the year was over $69 million. That cash will provide us with additional cushion and flexibility as we move in 2009. Our yearend cash, by the way, was $117 million and notable in the sense that we used in excess of $50 million of cash for dividend, stock buybacks and the cash portion of acquisitions that we made in 2008.

I’ll have some remarks to close out but we’ll turn this back to Bill. But, before even doing that I’d like to introduce and welcome Brian Lane our new COO to the call. Brian has led our large and very successful Region One for the last five years and prior to that he has had a long career in the construction sector including about 15 years with Halliburton and Kellogg Brown & Root. After Bill George addresses financial matters further, Brian will have some remarks on operations. But first, Bill George.

William George, III

As Bill just noted, we posted very strong fourth quarter and full year results in view of challenging economic and industry conditions. Gross profit was very strong in the quarter and for the year. Overall our gross profit improved from 17.8% in 2007 to 19.7% in 2008. Full year operating income margins increased from 4.5% to 6% for the full year in 2008.

For the quarter, gross profit percentage was a very strong 22.1% eclipsing the 18.6% gross margin in the fourth quarter of 2007. These increases result from broad based improvement in execution and results particularly in our large project companies as they closed out a multitude of very successful projects.

Revenue increased by $36 million in the fourth quarter as compared to the same quarter in 2007. Coincidentally, acquisitions during 2008 contributed $36 million to the fourth quarter so same store revenues were approximately equal to the strong fourth quarter we reported in 2007. Acquisitions also affected our backlog comparison.

As Bill mentioned, year-over-year backlog decreased by $34 million however, because we acquired operations that had backlog, the same store backlog comparison reflected a $126 million increase with about a fourth of that decrease arising from our planned downsizing at our Atlas subsidiary. Although our backlog has come down as non-residential construction market fundamentals have weakened, backlog remains at very high levels compared to historical trends and totals.

SG&A expense as a percentage of revenues increased both in the quarter and for the full year. These increases however resulted in large part from incremental incentives that were incurred due to our extraordinary results, additional receivables allowances which we judged to be prudent in light of changes in overall market conditions and also the requirement that we value and amortize intangibles arising from our acquisitions.

Let me also briefly update our progress and accruals at Atlas. Atlas is on track. For the quarter continuing operations at Atlas were profitable. As previously discussed at the end of 2007, Atlas had a total of $6.2 million in accruals relating to claims and contingencies on certain of its legacy jobs. As of the most recent yearend, this overall accrual stood at $5.8 million. Currently, this accrual substantially relates to jobs that are complete but for which we are negotiating disputed amounts and close out terms.

In light of deteriorating industry conditions that could affect these negotiations, we increased the accrual by about $3 million during the fourth quarter and that $3 million is included in the $5.8 million number that I previously mentioned. We are committed to vigorously pursuing the remaining amounts we are owed and we believe these accruals are sufficient to finally and fully put these matters behind us.

Our stock repurchase program was extremely active in the fourth quarter as stock market conditions provided us with an opportunity to buy shares at reduced levels. We purchased 1.2 million shares in the fourth quarter and 2.3 million shares for all of 2008. During 2008 we returned $26 million in cash to our shareholders through this program and since we began buying shares a year and a half ago we have purchased 3.2 million shares and returned a total of $37 million to our shareholders and we’ve reclaimed more than 7% of our outstanding share base.

Our balance sheet remains rock solid. We have strong cash balances and nominal debt and our unused credit lines to don’t expire until 2012. In light of the recessionary outlook we have intensified our efforts to maintain disciplined cost structures and to adjust rapidly the changes in our individual markets. We plan to continue to prudently deploy our balance sheet strength in to our operations and we’ll continue to consider acquisitions as good opportunities arise.

Our reputation and balance sheet are remarkable assets as we confront economic challenges and we look forward to opportunities to invest in existing operations, to add new operations and to retire shares of our stock. As great as it is for the CFO to be at a company that has substantial cash and no meaningful debt, it is the quality and commitment of our workforce that is the real key to the confidence and sense of opportunity that I and all of us feel and we look forward to 2009.

That’s all I have on financials so now I’ll introduce Brian Lane, Chief Operating Officer.

Brian E. Lane

I am grateful for the opportunity to serve this company in my new role and I look forward to getting to know many of you. I would like to take a moment to introduce myself. As Bill said, I have spent the past 24 years in the engineering and construction industry and have had the pleasure over the last five years of being with Comfort. Comfort is its people and I am very proud and the highly talented and skilled members of our team.

Though my focus has been on the 17 companies in the Northeast and Midwest, my recent experiences with our other companies has reinforced my belief that Comfort has the best people in the business. Their hard work, dedication and commitment will always be the foundation of our ongoing success. I thank all of them for their efforts this quarter and for the entire year that resulted in achieving our strongest annual performance ever.

Even as we move potentially in to challenging economic conditions, we are confident of our future long term success because of the quality of our team members. The highlights of our full year results with the achievement of an operating income of 6.1% of revenue and the generation of free cash flow of over $69 million. Thank you very much to all.

As we go forward, we will continue our focus on safety, productivity and quality. The depth and experience of Comfort Systems operations provides a real differentiator from our competitors and we will continue to improve our delivery systems and provide solutions to our customers. We are very fortunate to have a large and varied customer base.

As we move in to uncertain times, our operations will focus on the basic foundations of our business including projection selections, estimating, project pricing and project execution. We will also focus on the service segment of our business. That will certainly help us to maintain our profitability in a downturn.

We continue to see that energy prices and green awareness are driving opportunities for larger retrofit projects and for multiyear maintenance agreements to reduce energy costs. We will increase our participation in projects that are related to energy efficiency including many projects that will quality for LEED certification. The majority of our companies have LEED accredited professionals who are fully qualified to advise our customers on the long term benefits of having a LEED certified building.

We are also focused on reducing our costs wherever possible and our companies have contingency plans to minimize the potential negative effects of a future downturn. Our experienced management teams have made the necessary cost reductions in past downturns and we’ll continue to use that experience to effectively manage our operations in the current market.

Our backlog continues to be at solid levels. In spite of the recent declines, our pipeline remains very active and we have had substantial bookings in 2009. In closing, we will focus more than ever on execution, costs, quality and innovation. Our prime goal is to deliver value to our many important stakeholders including, of course, the people who own our company. I will now turn it back over to Bill for his wrap up and then questions.

William F. Murdy

Let’s go back to backlog, our current backlog is reasonably high. Most of our locations are seeing a substantial number of opportunities in their pipeline. Competition is certainly increased but we have a belief that our size, our productivity, our operational flexibility, our financial stability that Bill talked about and our ability to provide surety based on that financial statement stability along with our reputation puts us in a very good position here certainly a much better position than we were in, in the last down cycle, the 2001 to 2003 cycle where we did reasonably well anyway.

Today, as opposed to then we have a much, much stronger balance sheet, actually we have a balance sheet today we didn’t have one then. Even taking out our recent acquisitions, we have 175% of the backlog we had at the end of 2002. Further, we’ve got a very diversified base of business as Brian mentioned and there’s substantial revenues now and to come in the healthcare, education and government sectors both state and federal and the military.

Additionally, we’ve improved our recurring service business and we are gaining momentum in our energy efficiency project and service work. Lastly, we expect to be a beneficiary of the developing federal and state stimulus program. We are not sure of when, where and how precisely at this point but we believe we stand in the way of a lot of that especially on the energy efficiency side.

So, in summary, I think we’re as well prepared and positioned today to deal with the current recession and economic downturn as anyone in the non-residential construction sector. With that statement we ought to open this back up to questions at this point.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matt Duncan – Stephens, Inc.

Matt Duncan – Stephens, Inc.

The first question I’ve got and Bill you talked about this a little bit on the gross margins being driven by some very good projection execution on some projects that were closed in the quarter. Kind of looking forward what would be your expectation for gross margin? Is this sort of an unusually high number and we shouldn’t be thinking about using this in our models going forward? Any help you can provide us there would be great.

William George, III

I would absolutely say that this I a very high number. The number that we experienced in the fourth quarter of 2008 is a number that I’ve never seen before. I would like to think we’ve established a new base line but I don’t know that I’d be comfortable making that conclusion. Seriously thought, we mean what we say in the K and elsewhere, we do expect to have a profitable year coming up, it’s just that 2008 was a very special year.

Matt Duncan – Stephens, Inc.

Then looking at the G&A line, can you quantify for us was there anything sort of unusually high in that line? As a percent of sales that was quite a bit higher than normal. Talk a little bit about what drove that.

William George, III

SG&A, the percentages are up but the controllable SG&A expenses that most people think about when they’re scratching their heads about SG&A actually were down as a percentage of revenues. The things that lead our SG&A percentages to be much higher in the quarter and to be noticeably higher for the year included the normal things that you see in a good year like strong incentive payments at all levels of the organization.

We have bonus programs where people get a share of the profit once they break through a threshold and we had a lot of profits. We also had things like bad debt expense that was much higher than usual and I will take a minute just to comment on that. We made substantial bad debt accruals, our bad debt expense for the year was $3.6 million, it was $1.6 million for the quarter and that’s much, much higher than the prior year and quite honestly a lot of that came from the fact that we made a judgment late in the year that it was not prudent for us to use historical assumptions when we were looking forward in assessing our debt.

So, we sharpened our pencil and scratched our heads really hard about all the different ways that we need to collect money from people and we ended up putting up a lot more money. I’ll be candid with you, we have not yet seen different behavior within these classes of assets but we really felt and frankly our external auditors agreed with us that it was legitimate to really take in to count the underlying conditions. Other things affected SG&A expense but those were the two big ones. If you were to take those two things out though we would have been down so that just gives you an idea.

Matt Duncan – Stephens, Inc.

Then kind of looking forward a little bit just to help us understand what you guys are seeing out there in the market right now in terms of bid activity and the margins on the projects that you’re bidding on today, are you seeing any meaningful changes from what you might have been seeing six to 12 months ago.

William F. Murdy

Well, I think my comment about the fact that we’re seeing more competition would sort of naturally result in some compression on the margins, there’s no doubt about that. Some of that is offset by the fact that we’ve got lower commodity materials costs, lower gasoline costs but we’ll see some compression in margins here based on what’s going on in the economy generally.

Matt Duncan – Stephens, Inc.

Bill, will that compression pick up as the year goes on as you sort of start working off some backlog that was bid in better times?

William F. Murdy

I think that’s logically, absolutely. I think our own strength and capabilities may allow us to get some good jobs at decent margins that other people can’t get because they can’t product the surety or there are other concerns about their capabilities but yes, you’re right that’s an inevitable consequence.

Matt Duncan – Stephens, Inc.

A couple of more things and then I’ll get back in queue. First, on acquisitions are you guys still active there and are you seeing multiples contract any? Are sellers willing to sell at lower multiples given the more precarious state of the end market right now?

William George, III

I would say we are certainly seeing getting greater traction talking to the kinds of companies we really want to own. There’s a little bit of wait and see out there but when you say multiples, that’s an interesting question because usually you apply a multiple to a historical earnings numbers. We’re coming off of peak earnings so I would say what we would really hope to see is reasonable multiples of reasonable earnings expectations for the future. There are certainly signs of that and I think other people in this industry have noted that and that should continue to develop.

Matt Duncan – Stephens, Inc.

So the thought is you’ll still use balance sheet to make acquisitions going forward but you’ll probably be a little patient in the near term until people’s expectations get more reasonable for their businesses going forward?

William F. Murdy

Well said.

Matt Duncan – Stephens, Inc.

Then the last thing and Bill you guys talked about this a little bit but if you could maybe expand upon how the push to make government buildings more energy efficient could impact you guys going forward? What sort of impact can that have on Comfort Systems?

William F. Murdy

Well, first of all we’re geared up for that. We some years ago recognized the potential and the necessity for this. To the extent that states and federal agencies are serious, we are ready to do the work and we’ve got the capability to analysis buildings and facilities and show how to make them more efficient. Whether or not we get them all the way to LEED qualification is another question really. We’re getting traction, a lot of interest but it remains to be seen how much of the stimulus money really goes for that. I know it’s in all the comments about the package and everything else. But, we want to see it. I think it’s there but we’re not doing any of it yet.

Operator

Your next question comes from Richard Wesolowski – Sidoti & Company, LLC.

Richard Wesolowski – Sidoti & Company, LLC

We talked previously about contractors formerly busy in other markets such as residential now competing for like commercial work, though we listened to EMCOR yesterday and they said that was not the case for them. Any of the factors that differentiate your two companies, would any of them translate to meaningful difference to the barriers of new competitors?

William F. Murdy

We certainly operate at a lower register in terms of size of project and thus might be considered more vulnerable to people coming up from the bottom if you will. What happens though is though people who maybe have been a residential mechanical contractor really at the end of the day don’t have the capability [inaudible] screw things up but we’ll see that. I don’t know if we’ll see it to any greater extent than EMCOR and I don’t know their complete book of business.

Getting in to comparing us with EMCOR is always a little dangerous. We really don’t see them that much because they’re doing other kinds of work and they’re big and we’re a merit shop and they’re union, etc. We think we’ve got some flexibility and nimbleness that maybe a big contractor like EMCOR doesn’t have but, we really don’t compete head on head with them so we don’t know everything about them.

Richard Wesolowski – Sidoti & Company, LLC

Separately, is there some kind of broad way to characterize how you’re tailoring your bidding strategy to the market be it size of the projects, types of projects, holding the line on pricing versus volume, that sort of stuff?

William F. Murdy

We’re clearly more focused on the bottom line than the top line. I don’t think we’ll experience the growth in 2009 that we did in 2008 because we’re pretty disciplined about what we want to do and we will not be the low bidder to get a project. We come out okay where there are a lot of bidders but we’re not usually the low price brand if you will. We’re exercising those disciplines and I think they’re sticking. We’re on solid runs all the way back to our incentive remuneration programs, people are not remunerated on things that don’t ultimately result in net operating income and cash flow.

Richard Wesolowski – Sidoti & Company, LLC

Lastly, on the Atlas charges can you give a bit of detail on the legacy backlog that remains to be negotiated with owners? Do you still have contingency on some of the outstanding jobs?

William George, III

The kind of jobs that we’re talking about are the kind of jobs where people live in them today or they could live in them today if they could sell the unit. Really, that’s part of the reason why we thought it would be good to be more prudent. The accruals we just made frankly were the entire amount is accounted for by two big jobs that seem to be headed towards the litigation posture where the owner is in a lot of pain and we don’t want to have problems in future years from them so even though we felt reasonably good about the accruals we’ve made we’ve had a very, very good track record so far on matching up with the accruals we’ve made in the past. We decided that it was prudent to accrue more money and put ourselves in a position to just really fight for what we think is fair.

Richard Wesolowski – Sidoti & Company, LLC

Kind of a follow on to that, can you detail or summarize what Atlas looks like now versus what it looked like a year ago? I know it’s kind of melded in to other companies.

William George, III

Well I’ll tell you financially and then Brian can comment sort of – financially, Atlas had three big parts one was in the Southeastern United States, one was in the Mid Atlantic and one was in Texas. What’s left inside comfort and is called Atlas is the part that was in Texas. It is the historical Atlas that has been Atlas for a long, long time and frankly has generally made money consistently even over the last few years and before.

The Southeastern part mainly in Florida doesn’t exist today. We’re closing out some projects but there’s really nothing meaningful left of that and some very good crews, some good attributes and a small number of good jobs are melding in to one of our most successful operations that’s been in enforce in the Mid Atlantic for decades. What’s left I would say probably $20 to $30 million under the name Atlas and then a few jobs in other organizations that maybe flow some revenue as well.

Brian E. Lane

And, our operation here in Texas is strictly focused in Texas and the merger in the Mid Atlantic area and Washington is going very well and just about concluded.

Operator

Your next question comes from John Rogers – D. A. Davidson & Co.

John Rogers – D. A. Davidson & Co.

I guess first Bill George, I missed what did you say organic revenue growth was in the quarter and organic backlog growth?

William George, III

In the quarter it was within $500,000. 4Q 2007 was within $500,000 of 4Q 2008. I think it was higher than 2008 but I’m not even sure of that because it rounded to the same number. But, remember 2007 was a remarkable fourth quarter so we feel pretty good about that. So, the entire $36 million increase in the quarter happened to add up to the revenues from the companies we bought.

On backlog, same store backlog from a year ago is $690 million, it was $126 million difference same store. But, a big chunk of that difference, about a quarter of it is the planned reduction at Atlas. So, if you were to look at true same store backlog decline it’s under $100 million but it’s pretty much $100 million.

John Rogers – D. A. Davidson & Co.

Then did you say that you took a goodwill provision in the quarter?

William George, III

No. The only two types of provisions that I talked about where stuff related to accounts receivable and other types of assets that we just decided to scrub very, very hard really based on the facts that were developing in the broader economy not based on facts that are specific to us or to those assets. Then also, we put up the money on Atlas that I mentioned.

John Rogers – D. A. Davidson & Co.

Then sort of a bigger picture question, you’re looking as is everybody, lower results in 2009 with the contraction. The last time we went through a downturn like this your business suffered for a couple of years. Now, part of that I assume was the restructuring that was going on there and I guess I’m just trying to think about how far behind the economy you are both in terms of the downturn and then the upturn as it’s currently structured? Can you help me with that?

William George, III

A couple of things one, back in those days an enormous part of the pain we felt was going from about 120 P&Ls down to about 35 or 40. We had companies that were losing a lot of money and so frankly I don’t know how you can even – given what I know and I know a lot and I’ve been here since the beginning, I can’t really make good comparisons that I feel comfortable those days with sort of what we’re facing except that I know we don’t have the disadvantages we had then and I feel better, I feel a lot better. So, as far as those comparisons go, they’re only positive but they’re very, very hard to quantify. What was your other question?

John Rogers – D. A. Davidson & Co.

I guess that’s it, if we start to see a recovery, and hopefully we do later in ’09, the way your business is structured now, do you see the benefits from that in 2010 or does it take longer? Obviously, it depends on the type of recovery and all that but I’m just trying to get a sense of how much of your business is just new project driven versus sort of services versus small projects and just how sensitive it is to the terms.

William F. Murdy

The service repair retro fit business which is 45% of our revenues sustains us even in a radical downturn we believe. You add to that the energy efficiency push or the green awareness push because not always do projects we do have the kind of economical pay out that is compelling but there’s so much awareness, people want to do them so that helps. The other part of this that helps is remember more than 40% of our project work is in the schools, hospitals and government/military sector. So, those things continue apace here. That money was appropriated a long time ago, there are needs, the projects are on the books, we’re booking more of them.

The part that’s really exposed to what you’re talking about is the commercial industrial piece which is some part of our revenue for sure. We’re late cycling that, we’ll cycle off of that and it will take a long time to come back. I think that’s the part and I assume the same thing that you do that there will be a recovery here and that’s the part that recovers later than sooner and that’s probably 2010.

John Rogers – D. A. Davidson & Co.

Bill, is that the business that is giving you the most pause relative to ’09 right now?

William F. Murdy

I think so, absolutely. Now, the condo and high rise apartment businesses is a strange animal. Clearly, it’s mitigated today based on the available financing but, there are going to be people who are building and renting apartments going forward. So, that’s some concern but I think that recovers earlier than the commercial office or the industrial plant or the warehouse business for instance which we don’t do a lot of but we have to be cognoscente of.

John Rogers – D. A. Davidson & Co.

Last question, in terms of the energy efficiency portions of it, the maintenance type work, have you seen that business change at all with the decline in energy prices? Has that had an impact?

William F. Murdy

Well, some yes. But, I think what people get confused about is that yes crude oil has fallen precipitously to $40 a barrel but if you opened your electric bill lately I don’t think you’ve seen a lot of savings. Electricity drives these HVAC mechanical systems. So, there’s that and there is some pause, I think it’s more based on economic conditions than anything else. People just don’t want to spend any capital regardless of the payout. But, we’re getting very substantial traction on a lot of traction on this and the government stimulus money clearly is going to be spent there.

Operator

Your next question comes from Clint Fendley – Davenport & Company, LLC.

Clint Fendley – Davenport & Company, LLC

I apologize if I missed this I logged on a bit late but, I wondered Bill George if you could just comment on the gross margin here. The 22% seems to be maybe the highest it’s been in about a three year time period. Just some of the drivers here and how sustainable you believe that may be in the next few quarters.

William George, III

The gross margin is very high. Our comments about declining profitability obviously they come in to gross profit line and that won’t be repeatable in the near future. In the near future we’ll have developing weakness over the year and that will be reflected in the gross profit line.

Clint Fendley – Davenport & Company, LLC

Then any thoughts on how your working capital needs might affect your free cash flow in 2009?

William George, III

We expect to have good free cash flow, we’ve had good free cash flow for 10 years so that goes right through some recessions that were pretty hard and we were making big interest payments and had a bunch of other disadvantages for paying off the hundreds of millions of dollars of debt we paid off etc. There are factors in a downturn that help your free cash flow, there’s a disinvestment in working capital but of course then it’s harder to bill and collect so your cycle slows down a little bit at some point along the way. We think we can cash flow our earnings, probably our earnings plus a little just because our cash tax rate is lower than our GAAP tax rate.

But, I think we feel pretty solid about our ability to continue to flow cash and frankly strengthen our balance sheet or make investments.

Operator

Your next question comes from Tahira Afzal – Keybanc Capital Markets.

Tahira Afzal – Keybanc Capital Markets

To start with I just wanted to ask you a couple of questions about your margins. If your company has been through so many good changes structural over several years, if you try to decipher and build around that profitability comes down, should we be looking at it going down from 6% plus on the operating level to levels similar to those in 2007 where you had some losses from Atlas and hence the margins didn’t look that good? Are you viewing the worst case scenario of sort of 1% to 2% would be overdone based on what you’re seeing right now?

William F. Murdy

I think all of what you bring up Tahira is logical, it starts at the gross logic line and pushes down. We have done substantial cost cutting and as Brian mentioned we have contingency plans to do that further. We are in a variable cost business. But, there’s going to be an effect on the net operating income no doubt here. I mentioned the competition, compression.

I think what we’re saying is I think we’re positioned well and we’ve got productivity that we didn’t have last downturn and we have a lot of flexibility and nimbleness and some disciplines that will mitigate the decline for us and I don’t know what that is. We don’t give guidance but I think it’s logical to assume that we might not end 2009 with a 6.1% operating income margin.

Tahira Afzal – Keybanc Capital Markets

But I mean 4% to 4.5% and again, you don’t give guidance but I assume you’re not going to see a material extreme fall from where you stand right now given you’re a much more integrated company in a sense and given that you are a different company in a sense, I assume and as you said you’re more nimble and assuming the worst case scenario it doesn’t make sense as you see it today?

William George, III

Tahira I think what you’re saying is perfectly logical. The reason a company has a hard time answering that is because there’s one variable we don’t know yet and that is right now the world is still turning, right. We’re still seeing opportunities, we still have good back log. In a sense your real question I think, is almost about 2010 and there’s just things that are going to happen over the next year that are completely independent of us that affect how long this recession lasts and how deep it turns.

I’m feeling reasonably optimistic not necessarily about the economy but we have one good thing going for us – a couple good things going for us, one that we haven’t had in any past down turn is at least going in to the downturn we weren’t particularly overbuilt. So, because we missed a lot of the upturn in the ’04/’05 range we don’t have that big overhang that sometimes we have in these recessions.

The counterpoint to that is that it’s a financing led recession and obviously that affects development. But, also an interesting and important factor about our company is of our 40 or so P&Ls about five of them are in big cities and about 35 of them are in local communities, the Little Rocks, the Manchester’s of the world and those guys didn’t get the highs and we’re hopefully they won’t get the lows. I could answer your question better with assumptions about what’s going to happen the rest of this year to the non-consumer economy which is where we live.

Tahira Afzal – Keybanc Capital Markets

The other thing I guess I wanted to ask you was timing of your COO, why you’ve added a COO at this point? Are you worried about as we go in to a down cycle, is there something associated with you announcing a COO at the moment?

William F. Murdy

We probably didn’t do a really good job explaining this in the prior news releases, we’ve always had a COO and our former COO Tom Tanner happens to be sitting here in the room, he’s working very hard. He’s now focused on our business development activities, acquisitions, you can read there and focused on a whole lot of internal continuous improvement activities to include business information, management systems and that sort of things. He’s got a big book of responsibilities.

We’ve always had a COO and the COO changing positioning had very little, had nothing to do with the current state of the economy. It was planned before we knew anything about the current economy. It has more to do with the fact that there’s a potential succession plan, etc. that we’re working on here.

Tahira Afzal – Keybanc Capital Markets

I guess the last question I had was well, actually two questions, number one, if you look at your mix on the non-unionized side, does that make you more nimble in terms of cost as the market goes in to a down cycle versus a unionized shop? Or, is there very little difference?

William George, III

I would say that one important thing to think about, we have some union employees, very few. We’ve had union employees in the past and we had wonderful relationships with them. The big part of the reason that we are non-union today is because years ago when we needed to strengthen our balance sheet there was a buyer that was only willing to buy union shops. At the moment we’re non-union because of geography.

We’re in non-union markets and as far as what that means about us I guess you could attribute who we are and what we are to that but I think you could just as readily contribute our nimbleness, our smaller project size, our focus on the mid market to the fact that we are geographically in the mid market. We’re geographically in the Sun Belt, we’re geographically – just who the company is. I hate to sort of focus on that because really that’s just one factor and the factor almost as a result of where we are as opposed to who we are.

Tahira Afzal – Keybanc Capital Markets

So it doesn’t make a difference as you look throughout your unionized portions of your business and the non-unionized portion you would [inaudible] in a down cycle there’s limited difference?

William George, III

I would say there are advantages and disadvantages to each structure. I think our big advantage is the same in either type of business, this is as Bill mentioned earlier a variable cost business. Every morning our employees show up at some site we don’t know, the vast majority of our employees show up at some job site, the vast majority of our cost of sales is human beings who when there is work for them they show up and when we don’t have work for them we just simply don’t have work for them. So, I guess I would attribute it more simply to the 100 year history of the construction business and to the fact that’s just what we do.

Tahira Afzal – Keybanc Capital Markets

I guess last question has to do with the early cycle indication that I thought were interesting that you mentioned on the sort of condo apartment side of the story. Do you feel that – are there some early signs you’re seeing or is this just based on sort of the macro environment that you’re anticipating.

William F. Murdy

I think it’s just a macro comment. We are building some high rise apartments or working on projects that are high rise apartments and condos as we speak. Certainly, we’ve cut back that area on purpose. But, I think there’s a business there going forward and projects will be taken on. There is a financing problem in that sector today.

Operator

Your next question comes from [Barry Hayes – Sage Asset Management].

[Barry Hayes – Sage Asset Management]

I had a question in terms of characterizing the backlog a little bit for us. One is, is the backlog spread across the quarters of the year or is it concentrated in one half or the other half? And, how much of it, if any, extends in to next year? Then secondly, are you seeing any either cancellations that are backlogged or deferrals where things get pushed to the right?

William F. Murdy

Let me take a shot at this and then Bill will follow up. The vast majority of what we count as backlog is work in progress, things that have commenced. Then there is backlog which is jobs that are not on the POC that will commence. We have not seen many, if any, cancelled deferrals as understandable most are based on financing. Our backlog, there are projects that are n there that will continue for another 18 months or two years. These are big prisons. I was on our company’s largest project last week that is a spectacular project and very large project for any of our companies and for us and it’s being well run and well done and it won’t complete until the end of 2010 in my view. Now, they have a little faster idea in mine but I think it will run through the good part of 2010.

William George, III

Statistically on average there’s always something like half of our measured backlog at any given moment performs in the next six months and then the rest of it trails out over a long period of time. Very, very tricky thought to try and model with any of that because there is a very substantial proportion of our revenues that never run through backlog or are deeply underrepresented in backlog because of project size and duration. Obviously, the 15% or so of our work that is call out service, dispatch service has nothing to do with that so I give you that caveat as well.

Operator

Your next question comes from David Yuschak – Sanders, Morris Harris.

David Yuschak – Sanders, Morris Harris

The question I have to ask you is as you look at your 2009 book of business today it would appear to me that you’ve got a good deal of visibility on what you can produce in way of an income statement the first half of the year, it’s really the second half that’s your problem?

William George, III

Yes, although that would probably be true every year and call we’ve had. I’m thinking about it more this time.

David Yuschak – Sanders, Morris Harris

So I guess we go back to the confidence level then is what is lacking because like you said it’s always pretty good visibility but right now that visibility given what you’ve seen happening in the marketplace today has to be pretty good relative to what’s happened in the marketplace I guess is the way to phrase it?

William George, III

What you’re saying is relative to the atmosphere?

David Yuschak – Sanders, Morris Harris

All the events we’ve had around us, yes.

William George, III

What we’re seeing certainly isn’t as bad as the atmosphere that you get if you watch TV all day but, nevertheless we’re certainly seeing measurable weakness.

David Yuschak – Sanders, Morris Harris

Then second then everybody knows where we’ve regionally had a lot of weakness and you guys had expressed earlier being in the smaller markets that has helped insulate you somewhat from that versus the big markets. What I’m kind of interested in is as you look, and everybody knows where all the problems have been and it certainly shows up in the non-residential construction data that constantly get’s published every day, commercial is very weak, retail is very weak in the non-residential area.

As you look at your various market verticals, where have you seen in 2008 that you already had a pretty good hit in those areas and how much more of a hit can that potentially be in the way of new business opportunities in 2009 versus where you’ve been very strong because I think where you’ve been particularly strong would probably worry me more than where you’ve been particularly weak because then that creates the second half problem more than where we already know the weakness is. I just kind of wanted to get some sense because you said in your earlier comments, first quarter bookings have been pretty darn impressive given what’s happening so something is working right, right here. Can you give us a little more transparency on that?

William George, III

I would say that what you said is generally right. Brian, what are some positive hits we’ve had so far this year?

Brian E. Lane

We’ve had if you’re talking regionally some recent success in the Southeast part of the country, healthcare and as Bill talked about before Military. We’re still see some strength and a lot of opportunity in that part of the country.

David Yuschak – Sanders, Morris Harris

Military you really haven’t had that much presence in the past have you?

William F. Murdy

Some, it’s growing mostly due to the hard work of a lot of people in the field. But, we have some substantial projects on military posts and we’re looking at more.

William George, III

When we do our pie chart that we’ve published now for many, many years, we put military under government.

David Yuschak – Sanders, Morris Harris

Do you feel like the strength you’ve had in those other markets away from where the problems have been have been relatively solid markets but nothing excessive at all to speak of that would suggest, “I’ve got a bubble in healthcare,” or, “I’ve got a bubble in education.” Just give me a sense as to those numbers haven’t been that extreme to the upside have they that could create a kind of problem in the second half.

William George, III

I would say healthcare and education are simply the continuation of a very, very long term secular trend relating to the demographics of students and in healthcare the demographics of an aging population where whatever happens the next year and the next year between now and 10 and 15 years from now if you’re a major hospital healthcare system you want to have the product positioned to deal with the aging baby boomers. If you don’t somebody else will.

David Yuschak – Sanders, Morris Harris

If we don’t have as much visibility in the second half because of all the concerns out there, you guys have already said that you’ve cut some costs and a lot of discretionary spending for 2009 and I think this is probably one of the problems a lot of the construction companies have, “How long do I hold on to my resources right now knowing I’m maybe taking a short term margin squeeze but I’ve got to be positioned for the recovery?” The question is we don’t know when that’s going to come.

Is there any internal look at what you need to do to say adopt for better or worse the term plan B where you really would have to start looking at resources that if you have to start reining in those costs because things aren’t developing?

William F. Murdy

We’re looking at plans A, B and C looking out through the rest of the year and aligning our resources with our revenue projections and acting accordingly. But, we’re doing this on a pretty frequent basis right now. And, I might add it’s on an operation by operation basis. We are simply not going to say everybody cut 10%. It’s an operation by operation basis.

It’s not all letting people go, we’ve got companies that have already because of local conditions i.e. talking about Michigan have gone to seven hour work days and not letting people go, trying to retain people because as things come back we’ll need those people. There are things that we can do short of just disbanding our workforce.

David Yuschak – Sanders, Morris Harris

At least that’s encouraging that you’re saying if operations are doing well we’re going to leave them alone so to speak I guess on any kind of plan you have out there. One kind of last view and maybe you can share with me what you think of it but it would seem that because of the problems in the residential marketplace residential isn’t going to come back anywhere near what anybody hoped for in the way of this recovery as its shapes out when it does start to happen. With the government stimulus plan non-residential has traditionally been a late cycle, with the problems in residential and the stimulus plan isn’t it not possible that non-residential could be in fact an early cycle recovery business this time around? If that would be the case where do you think that would happen?

William George, III

You heard it here first, right. I hope you’re right. I can certainly make an argument really based on not being over built that when the recovery finally comes we’ll recover more quickly than we historically have. And, when I say we I’m talking about the industry not Comfort Systems, we’re part of the industry. But, it’s an interesting thesis. I think a lot of construction is going to return to more like historical trend lines but that could be a good thing on the non-residential side. We didn’t get to experience the bubble in the same way as almost any other part of the economy.

Operator

Your next question comes from Terry McMahon – McMahon Technology Associates.

Terry McMahon – McMahon Technology Associates

I just wanted to validate some numbers that I’ve been hearing here. The way I understand it 55% of your business is in the construction new projects area of which 60% of that could be classified of commercial industrial. Now, if I do the math that yields about a third of your total business is new projects commercial industrial. Now, this is the area that’s obviously soft now and you’re not looking for any recovery in this until maybe 2010, is that correct?

William George, III

Well, there’s one big disconnect there which is there’s plenty of commercial industrial in the other 45% of our revenues. Retro fit also happens in commercial buildings. But, at the end of the day, yes I think the best thing to do is take our pie chart which we publish and it sounds like you’ve been looking at and apply that to all our revenues because that’s actually derived from all of our revenues. I think the best way to look at it is to look at all the different subsets, some like retail although small is very affected, lodging can be very affected, office buildings are very affected and then there’s a continuum up to government and education that people will tell you isn’t as heavily affected although there are nuances even within that.

William F. Murdy

Some of this is definitional I think. In excess of 40% of our project revenue comes from schools, hospitals and government. That doesn’t mean the rest is all commercial industrial, there’s lodging, we have a big business in building prisons and churches which I guess you’re classifying as commercial industrial here. Commercial industrial I was talking about was plant facilities and office basically where they’re just isn’t much going on.

Terry McMahon – McMahon Technology Associates

You’re saying that’s less than 60% of your new project construction business?

William F. Murdy

Right.

Terry McMahon – McMahon Technology Associates

How much is it roughly? Is it half?

William F. Murdy

I think it’s 25%, commercial and industrial that we talk about –

William George, III

If you look at the Form 10K we published you can see percentage by percentage everything and really that number is really going to depend how you define commercial industrial. If you define it to be everything except for institutional then it is up near 60% if that’s the definition you choose.

Terry McMahon – McMahon Technology Associates

The main point here being though that it is a significant chunk of the total business and this is going to be a drag on the total company because of this one soft sector?

William F. Murdy

That is right but we have the ability in our operations to transform ourselves and just because someone has been dependent for revenues upon commercial office projects in the past doesn’t mean you will in the future. He can move his business towards the hospital, healthcare sector. That describes some of our flexibility actually. But, we are concerned about commercial office.

William George, III

That’s why we’re projecting less profitability next year for sure.

Operator

At this time there are no additional questions. I would now like to turn the call back over to Bill Murdy for closing remarks.

William F. Murdy

Thank all of you for being on the call. We can just stress our positioning at this point and we’ll see you as the year unfolds here.

Operator

Ladies and gentlemen this concludes the presentation. You may now disconnect. Thank you and have a good day.

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