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Comfort Systems USA

Q4 2007 Earnings Call

February 28, 2008 11:00 am ET

Executives

Bill George - Chief Financial Officer

Bill Murdy - Chief Executive Officer

Tom Tanner - Chief Operating Officer

Analysts

Matt Duncan – Stephens, Inc

David Yuschak - SMH Capital

Terrence McMahon – BCS Partners

Tahira Afzal – Keybanc

Barry Haimes – Sage Asset Management

Rich Wesolowski – Sidoti & Company

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2007 Comfort Systems USA earnings call. My name is Tanya and I will be your coordinator for today. (Operator Instructions). I would now like to turn the presentation over to your host for today’s call, Mr. Bill George, Chief Financial Officer of Comfort Systems. Please proceed.

Bill George

Thanks Tanya. Good morning everyone. Welcome to Comfort Systems USA’s yearend 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 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 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 that was just filed, as well as in our press release covering these earnings. On our call with me this morning are Bill Murdy, Comfort Systems USA’s CEO and Tom Tanner our Chief Operating Officer; and Bill Murdy will open our remarks.

Bill Murdy

Thanks Bill and welcome everyone. We are pleased to announce our Q4 for results including an increase, in our earnings of about 16% compared to the fourth quarter of ‘06. For the full year, we’re reporting 32-1/2% of net income, $0.79 per share as compared to $0.70 per share in 2006, which is about a 13% increase and all of this in spite of taking a substantial accrual as against the number of jobs at Atlas, our multifamily high-rise focused operation. Tom and Bill will both have more to say on Atlas in their remarks.

Our revenues in Q4 were $293 million versus $268 million in Q4 ’06, and revenues for the full year were $1.11 billion versus $1.056 billion in 2006. That is up about 5%, and notably without the purposeful right sizing of out multi-family operations, revenue growth would have been more on the order of 10% growth of ‘07 versus ‘06.

Backlog at the end of 2007 stood at $787 million down slightly from September 30, 2007, but $130 million higher than at year-end 2006. Notably our positive free cash flow in Q4 and indeed for 2007 was remarkable at $72 million for the year. Bill will have more to say about that. In fact, I’m going to turn this over to Bill George. [Cut dictation] [0:03:36]

Bill George

Thanks Bill. Let me just take a minute or two and fill in a couple of additional details of our results. The main item that I want to discuss is the nature and purpose of the substantial accruals that we took for Atlas. As Bill mentioned, our overall revenues and earnings improved compared to the prior year, and this was in spite of the setback at Atlas which reported a loss of $7.5 million, in the fourth quarter. The largest component of the fourth quarter loss at Atlas was the $6.2 million accrual which is a provision for potential back charges and costs to resolve our remaining challenging jobs. Well, over half of the jobs that have caused the Atlas losses over the last few years are completely closed out without the outstanding receivables fully collected. However, there are a handful of jobs where we had filed claims and are in the process of pursuing the remaining amounts that we are owed. The $6.2 million accrual that constitutes the bulk of the Atlas fourth quarter loss will provide us with the ability to either settle or fight claims and contingencies on certain other jobs that struggled in the overheated, multifamily market of the last few years, especially in Florida. With respect to many Atlas jobs over the last few years, we invested significant sums to meet our obligations, and this is true even on jobs that experienced challenges caused by third parties or by facts and circumstances that were not caused by Atlas.

As a company, we take our contractual commitment seriously. We generally take the approach of accepting back charges and fairly compensating parties where we feel we may not have met all of our obligations. However, the deep pocket on job’s involving residential developers and contractors, who in many cases are currently experiencing disappointing results. We feel that we are sometimes unfairly targeted. The accruals we took will allow us to fairly resolve or to fight claims where we deem appropriate. It is our best judgment that these accruals are sufficient in light of the remaining risks, and we felt that it was prudent to take account these risks by recognizing losses that diminish our 2007 results, even though we expect to vigorously contest many of these matters.

Notably, it maybe useful to point out that if Atlas had simply broken even in the fourth quarter, our quarterly earnings would’ve been at least nine cents higher and we would’ve reported approximately 30 cents in 4QEPS. Outside of the challenges and these legacy jobs, Atlas had results that we feel were consistent with our plans and expectations, and clearly Tom will talk about Atlas and additional details in a few moments.

Having spent a few minutes on Atlas let me just briefly note one or two more items. Cash flow is an extraordinarily positive aspect of our fourth quarter. As Bill mentioned, free cash flows surged to $55 million in the quarter and ended the year at $72 million. Our cash balance was $140 million at year end, about $50 million higher than a year earlier, and this was despite our increasing dividends, our substantial stock purchases, and our two acquisitions. Since year end our stock re-purchase program has continued to return money to our stockholders in a disciplined way, and we have now retired more than 1.1 million of our outstanding shares. Our board of directors extended that program yesterday with its third stock purchase authorization in just 10 months. We feel that disciplined and opportunistic share repurchases will continue to be a good use of our cash, particularly while our enterprise value to EBITDA multiple remains at the very low levels, very low levels we have been experiencing.

Finally let me comment on financial aspects relating to the acquisition of a wonderful company that became a partner of ours yesterday, Riddle Berger Brothers. As we mentioned in our press release, annual revenues for that company should exceed $65 million, and they have a consistent record of strong earnings with over $7 million in EBITDA last year. We will own them effective March 1, and they will be a part of our results for 10 months this year. Under new accounting standards, we will need to amortize the portion of the purchase price against our earnings for the next year or more, particularly as it relates to their existing backlog in customers. They will be accretive this year and we expect them to directly add at least 10 months of EBITDA to our bottom line at rates similar to or better than their last year results. Unfortunately, gap rules, requiring amortization of intangibles, will reduce to some extent that transactions’ accretiveness to earnings per share. Until we have completed our evaluation analysis, it’s impossible to say for certain what the effect of that acquisition will be on 2008 ABPS. However, even in the current year we expect that this acquisition will be noticeably EPS Lucrative.

We feel optimistic about 2008 and beyond. Over the past few years we’ve been able to demonstrate increasing success at seizing the opportunities that have been afforded to us by good markets. Discipline and work selection, tight execution, solid cash practices, and above all, the best technical and project management workforce in the industry, mean that we could be successful in any market condition. We believe we will continue to produce strong results. That’s it on financials. And now I introduce Tom Tanner our Chief Operating Officer. Tom.

Tom Turner

Thanks Bill. Good morning everyone. I would like to start by thanking all of our team members for their efforts at this quarter and for the entire year that resulted in achieving of our strongest annual performance since 1999. We truly have a remarkable group of very talented individuals, which were the foundation for a very large percentage for our companies to have outstanding results, for both this quarter and the full year. The highlights for our fullyear results were the achievement of an operating income of 41/2% of revenue, which would’ve been 6.2% of revenue without the Atlas losses and the generation of free cash flow of almost 73 million. These results are directly related to our continuing focus on the key drivers of our business in both our construction and service divisions.

Obviously, our results were seriously diminished by the operating loss from Atlas, our large multifamily housing company. Atlas’s continuing business basically broke even for the quarter. However, as several of their large legacy projects, projects booked in late 2004 and in 2005, entered the close out phase, we ended the year with approximately 6.2 million of accruals to offset potential and asserted back charges for certain projects. The 6.2 million accrued at the end of the year was in addition to certain back charges that were booked in the quarter to allow us to finally close out several projects in our mid-Atlantic market.

Over the last two years we have replaced the entire Atlas senior management team including the CEO, the President, and the CFO. We have totally exited the fire protection business. We have exited the Florida market with the exception of two ongoing projects in the Tampa area, and we have sold our operations in Las Vegas and Los Angeles. The company’s backlog at the end of the year was 50% less than its peak backlog, which was at the end of 2005. Project selection and pricing have improved. New processes and procedures have been implemented to better manage the labor productivity on all their projects. Today we have the appropriate manpower resources to profitably execute our backlog. Plus, assuming no further deterioration on any of the remaining Legacy projects, we believe that Atlas will operate at break even or with a small profit for 2008.

In the current year, our operations will continue to focus on the following areas: improve margins for our construction projects, primarily from focusing on labor productivity and expanding our prefab capabilities; growth in our service operations in terms of revenue, operating income, and our preventative maintenance agreement phase; increased participation in projects that are related to improved energy and efficiency including many projects that will qualify for LEED certification. We will focus on team member education in the areas of leadership, estimating, and project management. We will provide craft and technical training for our field superintendents and foremen, our skilled craft workers, and our service technicians. We will continue to focus on safety to maintain and improve our leading position in the industry.

With the economic uncertainty we are currently facing, we will diligently maintain very tight cost control to minimize the impact of any economic downturn. Last, we’ll continue to be optimistic about our future, we are very pleased with the ac–, acquisition of an outstanding company. Riddle Berger Brothers that was announced earlier this morning. Our current backlog, which is at a record level for the fourth quarter of any year, is up 20% from a year ago. Our pipeline continues to be active. Our operating companies are much better managed today, and as they operate much more efficiently than they did in the last economic downturn, we have very strong momentum coming up of our record 2007 performance.

Thus, we believe that we will have improved financial performance in 2008 as compared to 2007. With that, I will turn you back to Bill for his wrap up, and then questions.

Bill Murdy

Thanks Tom. I would like to make a few remarks both in summary and in looking forward. As Tom mentioned, our, our backlog is at its historic high and beyond that, our indicative pipeline business is very good. In fact we’ve booked some very good businesses already in Q1. As Tom described we believe the Atlas situation is well in hand and we are encouraged by what is going on in our atlas operations. As said in our release, we are not certain what the economy holds, for late 2008 or 2009 but what we do know here’s that Comfort Systems is much better positioned for a nonresidential construction downturn, should there be one. If we compare today and say five years ago, early 2003, which, a year which proved to be a recessionary year especially in nonresidential construction, today we have twice the backlog, and it, it’s essentially the same-sized company. Actually, we’ve added just a couple of companies not including, this conversation doesn’t include Riddle Berger yet, but we have twice the backlog, our recurring service business, is 45% to 50% higher than it was. Our initiatives in energy efficiency projects are gaining traction.

In our efforts to improve productivity via training and improving processes in our various operations are having great impact. Our cash balances are more than $120 million greater than they were five years ago. And in addition we have added four very strong companies to our mix, most recently as announced this morning Riddle Berger Brothers in the Shenandoah Valley of Virginia. Tom mentioned Riddle Berger did Tom and Bill mentioned Riddle Berger earned $65 million last year, a very profitable and has a backlog at this point of $56 million or so, a number by the way which is not included in the backlog numbers that I mentioned before.

We are looking for very substantial operating income contribution from Riddle Berger in 2008. In 2008 and beyond, we will be looking to continue to prudently add high quality operations to Comfort, especially in geographic areas where we are not now represented. And in summary, I guess I’ll say in going forward, we intend to capitalize on our strengths and positioning, and thus believe our results in 2008 will be even further improved versus 2007. I think that concludes our more or less formal remarks and Tanya, if you want to open up the questions I think we’re ready.

Question-and –Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Matt Duncan with Stephens. Please proceed.

Matt Duncan – Stephens Inc

Good morning, gentlemen.

Bill George

Good morning, Matt.

Matt Duncan – Stephens Inc

A couple of things. Let, let’s start with a little bit more difficult topic and then we’ll move on to happier stuffs. Let’s start with Atlas here real quick. You talked a little bit about the, this charge you’ve taken. You know kind of what the basis for the accruals are, and you know sort of what the philosophy behind taking all the charge now was? And, and do you feel like you’ve captured you know, all of the, the potential back charges in these accruals so that you won’t you know, you won’t have to do this again in 2008?

Bill George

Well you know, we’ve signed our name that we ha–, that we feel like these are the right numbers. Obviously you haven’t seen accruals like these in prior quarters. We’re, we are far closer to the end of these jobs. People live in virtually all of these buildings today. We do feel like we’re much, much closer to knowing what it is we need to do. You know the, the nature of these accruals, some of are back charges that have been asserted, some of are the back charges that we think potentially may be asserted. The standard is pretty high to, to go ahead and take losses for, for that kind of a consideration and so obviously we’ve had to do a lot of work to prepare for this, but we do, we feel like it is the right number, and as Tom said, we feel like Atlas, we’re right you know. What we’re saying is we believe Atlas will, will certainly, at least break even next year.

Matt Duncan – Stephens Inc

Okay. Fair enough. Do you have in front of you what Atlas revenues were in the fourth quarter of ‘07 versus the fourth quarter of ‘06?

Bill George

They were 19.9 million in the fourth quarter of ’07. I don’t remember what they were in ‘06, but they were 163 million for all of ‘06.

Bill Murdy

They were probably 40 million.

Bill George

And yeah, they were quite close to 40 million at the end of last year. They were 95.9 million for this year, so you have about a $70 million reduction in annual revenues. And then for, you know the coming year, we, we expect that the continuing operations of Atlas will be about 70 million. We will have a little bit more revenue from the, from the geographies that we’re closing down, so that will add to that a little bit.

Matt Duncan – Stephens Inc

Okay. So I guess, kind of what I’m driving at there is that I want to focus on your business excluding Atlas, because you know if you back out Atlas, it looks like you guys had a great quarter here. I’m curious if you know what your sales and profit growth were, excluding Atlas in this quarter.

Bill Murdy

Well, I, I can give you one benchmark Matt. I, if you eliminate Atlas from both sides of the equation, take out the revenues, take out the losses our operating income would’ve been 6.2% versus 4.5%.

Matt Duncan – Stephens Inc

And that’s for the full year or for the quarter?

Bill Murdy

That’s full year.

Matt Duncan – Stephens Inc

Okay.

Bill George

For the full year, if you add back the Atlas number, EPS would’ve been up 66%

Matt Duncan – Stephens Inc

Okay.

Bill Murdy

It, it, it, it’s a, it’s a major, major difference.

Matt Duncan – Stephens Inc

Sure. Fair enough. Let’s move on to a couple of other things here and then I’ll get back in queue. You know, tell us just a little bit of what big activity looks like right now. I mean I know there’re some concerns about where non-residence is headed; and no, and no one really knows for sure. But just any feedback you can give us on kind of what you’re hearing from your customers and what you’re seeing in the market place would be helpful.

Bill George

Now we actually talked to our companies over the last week or so to, to, in anticipation of this call and, and we’re seeing you know, active pipelines, and we’re s–, we’re seeing consistent bidding opportunities in the market place. So today, we haven’t seen any, any significant change from, from a year ago. So we’re you know, we’re constantly monitoring it. We’re, we’re concern–, we’ve asked questions about project delays, or cancellations, and, and fortunately we just haven’t seen any of that to date.

Matt Duncan – Stephens Inc

Okay. And then last thing here and I’ll get back on queue. Bill you talked about the acquisition pipeline a little bit and, and you know, mentioned that you guys will con–, continue to look at deals. Can you give us a little color on kind of what that pipeline looks like right now when you guys have still have plenty of cash even after Riddle Berger, very little debt you know, if you count the, the note it’s got there. But just talk about kind of what you’re seeing on the acquisition front right now; what we can expect from you guys, you’re going forward.

Bill Murdy

Well, without front running anything, you’re, you, you could see something fairly soon. The acquisition of the pipeline, we’re really looking at. We’re really looking for very high quality companies in jurisdictions where we are not currently represented or, or don’t have a complete coverage.

We’ve identified a lot of targets. We’ve had discussions with many, I, I think when, when one is looking for just high quality operations you know, it’s hard to talk about the robustness of the pipeline, and we haven’t done it in that way. We’ve targeted some companies that we want to talk to. They want to talk to us and I think that’s, that’s more characterized properly. I, we have some goals in mind. I think we will achieve those but we’re not going to sacrifice quality for volume of revenue.

Matt Duncan – Stephens Inc

Okay. That’s helpful. Thanks guys.

Operator

Our next question comes from the line of Rich Wesolowski with Sidoti & Company. Please proceed.

Rich Wesolowski – Sidoti & Company

Thanks a lot. Good morning.

Tom Tanner

Good morning. Good morning.

Rich Wesolowski – Sidoti & Company

First is a point of clarification. You guys had previously reported 37 million in Atlas revenues for December ‘06 quarter and a $3 million operating hit. Tom Tanner, I was surprised to hear you say that increasing the margins further in the construction work remained a goal even from the implied margin posted in 2007 ex-Atlas. Are the contracts being added to the backlog expected to be as profitable as those that were in 2007?

Tom Tanner

The, the contracts in backlog today have similar margins to the contracts that we did in 2007 and you know, the business is very, very susceptible to improvement in labor productivity. So you know, we well, and, and so we coupled labor productivity which is high lighted by increasing our prefab capabilities and, and we still believe that, our goals to increase our margins in 2008.

Rich Wesolowski – Sidoti & Company

Did you mention the back log that Riddle Berger brought?

Bill Murdy

I did Rich. It, they currently have 56 million, more or less not more or less. 56 million is what they have.

Rich Wesolowski – Sidoti & Company

So is 70 million a good estimate for the acquired revenue, added in a way with 10 months of Riddle Berger, and then the rest of Madera, and Air System add in for your annual contributions?

Bill Murdy

No.

Bill George

It’s more than that.

Bill Murdy

It’s more than that.

Bill George

It will be more than that. I mean it, that’s probably a good estimate if you were to take the three months that we didn’t have last year of Madera and the nine months that we didn’t have last year of ASDI. So if you were to, and to assume we did no more acquisitions, that’s, that’s a pretty, that’s a, that’s a pretty good number. I think the reason you got an immediate no, is because the, the people in this room don’t think we’re necessarily done doing acquisitions for the year. But I think just based on what you’ve seen, that’s probably a good number.

Rich Wesolowski – Sidoti & Company

Okay, in the volume of new work, are we entering a situation where absent any acquired backlog, it would hover at that say $825 million level, or do you expect a big change organically as you move through ‘08 in either direction?

Bill George

You know backlog I think, is not, I wouldn’t expect a big upward change. Mostly it, talking about same store backlog because most of our companies were very, very fully booked over the last couple of quarters. And so, I would expect it to, to, to trend at high levels assuming that what we’re experiencing now continues, but you know it could –

Rich Wesolowski – Sidoti & Company

But now I am curious.

Bill George

Moves around quarter to quarter. Sorry.

Bill Murdy

I had some discussions in the last couple of days, and that [inaudible] [0:24:57] allow me to mention that we have s–, have booked some significant business in, in this quarter. Yeah, we’re, we’re seeing especially in the education area, health care area and even the hospitality area some good potential work and, and we’re getting we don’t have, you know we no longer especially at Atlas don’t have a 100% hit rate mentality. We, we are being very selective in what we take, both because what Bill said, we have to pass the strength. But also if we just, were aimed at bottom line here as much as for revenues. We also have a significant amount of business in for work on military bases which continues to be a strong opportunity going forward.

Rich Wesolowski – Sidoti & Company

Okay, thank you. And finally, can you just expand on a little bit of the further than immediate future of Atlas? I mean the contract that you’re booking now from, that representative that say 60 or $70 million of, recurring type business. Are those doing well? Are you getting more than break even from that work?

Bill Murdy

Yes. You know we, we have substantially been able to raise our prices in the market place and we’ve improved the quality and the performance of our work, so we have some long standing customers that like doing business you know, with, with, with the Atlas group. And they like to, you know we still have bonding, you know binding which is important in market places, especially on larger projects which show you know, which we are now taking advantage of the pricing and the ability for us to, to provide bonds on these large projects. So you know, we’re, we’re confident you know, moving forward because there’re a couple of jobs that we started in the middle of early ‘07 when we were still you know, upside down with work. We have some concerns above, but the work we’re booking and starting today we feel very confident in, in our ability to spruce very profitable margins on that work.

Rich Wesolowski – Sidoti & Company

Thanks a lot.

Operator

Our next question comes from the line of David Yuschak with SMH Capital. Please proceed.

David Yuschak – SMH Capital

Good morning gentlemen. A quick question on the, on Atlas, because I think you know, when you take a look at what this, that you guys earlier said on the evaluation of the shares, Atlas has certainly been a big factor in what evaluation is there, which kind of base the question you’ve been very patient with Atlas, to try to get this ship right sized to the point where maybe some of the investors got totally frustrated and said you can’t right size this thing. Why should they should be jealous in all this? And so I think the question that I really have to say is, ask is you do have other multifamily operations. Could we get a sense from you as to how profitable those are internally versus what Atlas is doing? And is it possible at all because of the frustration you guys have had, this frustration the investors have had, that some how that Atlas culture can get transitioned to the kind of profitability that the rest of businesses and multi-family is doing for you?

Bill George

We have several operations that successfully perform multifamily work year-in and year-out Dave. And we believe that we’ve made a significant change in the culture at Atlas, by free, with all the changes we’ve made and, and by the new management they’re recognizing that this could be a profitable business. You know, we’re holding employees accountable. I mean we will move forward and, and, and this will be a profitable piece of business. We’ve maintained that all along that we can we believe in this segment of the business. But not when you have poor pricing, poor execution, and overwhelming resources.

David Yuschak – SMH Capital

Is that, is that, is that, well the problem there is that it’s just strictly multifamily where your other operations have other thing to compliment it, that make it make that a little more little more manageable for the other operations to cover the blend of products first to these guys. Strictly being multifamily?

Bill Murdy

I, I wouldn’t characterize it quite that way Dave.

Bill George

You, you got to look at Atlas and it just, it wasn’t necessarily the fact that it was in a multi-family business. The biggest problem was that the company just was a bridge too far. It grew; you know it’s more than doubled its, its size in 13-14 to 61. Just ran out of all kinds of, of capability and then compounded that with problems, and then has hurricanes in North Florida. But the in our other companies, they approach the business much the same way. I think they are more prudent in their, have been more prudent in their, estimating and, and more because of they haven’t overwhelmed themselves they have been able to execute.

David Yuschak – SMH Capital

Let’s go to another topic then. The you know your cash flows that you produced in the quarter it looks like even the cash coming into the company for, for new projects remains pretty strong suggesting that in your customer base anywhere, there isn’t any surfacing other than as you mentioned what multifamily that you with these accruals were taken that there is any problems with any of your customer bases as far as beginning to see some pro–, are you beginning to see anywhere in the customer base away from Atlas that suggest that there are some financial issues beginning to surface within the potential project developers that could lead to that slowdown that everybody is so fearful at this point in time?

Bill George

You know so far there’s no sign at all of that. No. You know we are, we are what some people refer to as the late psycho player. The buildings we work on have been in the pipeline for a while, but, but there’s, there really is no sign of that. We’re very mindful on what people are worried about, financing and other items, so we feel pretty good at the moment.

David Yuschak – SMH Capital

Well that’s what kind of just the cash flow you have produced in the quarter kind of suggests that there’s a you know, cycling money in and out of this, out of your operations that got ongoing project opportunities.

Bill George

The ability, you know the ability to flow that cash suggests that you’re performing well on those jobs. We’re, we’re $83 million over-billed. If you take a look at our income statement and you know we are collecting that money and I think that there is very, very good performance on, on these nonresidential building jobs.

David Yuschak – SMH Capital

Well that’s why they kind of suggest to me that at this point in time, there’s nothing financially from anybody that’s bringing in, that, that, that, as you collect that cash. There’s, nothing out there financially. It suggests there’s a problem.

Bill George

Hard to fake cash.

David Yuschak – SMH Capital

Well that’s exactly the kind of way I look at it too.

Bill Murdy

Now, well you, you know going forward Dave, we’re not sure that all the projects that we have in back log, are fully financed. I mean some of those projects have not started. You know very good about most of them. .I will start, if that, if that is the fact that with delays in the start of projects we, and we have no better gauge on the state of the financial market than, than anyone else. We keep up with it. We’re interested. We haven’t seen any broad impact.

David Yuschak – SMH Capital

Are you seeing any of these projects being delayed materially at all?

Bill Murdy

I, I think we have one in San Diego that may get delayed for financing but we, that’s the only one that I can think of Tom, I…

Tom Tanner

Now we, we have not, we you know, we, we’ve closely monitored that, and asked people to report, you know any instances of, of that. Whatever, you know we’ve seen a couple of delays for typical reasons. A project starts and they find that there’s rock on the site that nobody anticipated. But as far as you know the way is through the financing and, and we’ve tried to maintain a very stringent discipline about putting work in backlog, so that if there’s any concerns about whether the financing is fully in place, you know we, we try to develop the discipline that we don’t put it in backlog, so we don’t have to take it out of backlog.

David Yuschak – SMH Capital

The, the one last question because you know, what the revenue production in this fourth quarter versus the third still, thus suggests that this remain strong and, as I’m just kind of curious. As you look on you know, in, Bill George, you made, made some adjustments mid-year on the markets you served, that you had to break to out other, into other into other categories in which you know, in your, in your 10K, you break out nicely an 80 and your 2007 results. Is in there anything there compared to a year ago, that really is, kind of stands out this opportunities? Or is it the continued breath of results across all non-residential construction markets that’s helping this? Your results, that is, that’s kind of what’s been impressive about the nonresidential construction market. To date, the, the breath of market categories has been, with very few exceptions, pretty strong

Bill Murdy

Now one, one fortunate thing for us is, we’re not proportionately as exposed to some of the most vulnerable categories as, our industry in general is, in, in par because the nature of our work force was sort of the, the high value at the end of our end of the spectrum. And therefore, we’re more likely to be working in hospitals and you know, schools are strong, that’s for sure. All the institutional work is strong, but the most exposed at the moment is retail, which isn’t that important for us, and the retail that we tends not to be big bucks, retiled out on the periphery of the city. It, it tends to be pretty sophisticated stuff in a downtown area or something where you’re going to have central chiller plans, or things that we work on. Now we think, you know we think we, I don’t know. There’re a lot of strong areas. Schools a lot of reasons to think some of those areas will stay strong, but it’s so obvious we’re keeping our eye on it.

David Yuschak – SMH Capital

Well I think you know, that’s what kind of, when, when you look at to what you put in the 10K. That suggests that, some markets should’ve been strong. You get, you get pretty good representation. At this point would you say that that has a really helped? That those areas that are ready for you in the last few years blossomed then? Because you’re just getting more penetration and visibility in those market places where there isn’t much stability?

Tom Tanner

I think in part, one of the things that happened is that comfort companies have helped each other to move up the food chain. If you, you know 10 years ago when we started buying these companies, there were just a few companies that were real expert hospital constructors, real expert, sophisticated systems constructors. Now you know, you can’t count ten, fifteen, twenty of our companies do hospitals regularly and a lot of that, I think they’ve helped each other to, to achieve that expertise. And I think that’s another big difference between what we’re looking at if we do happen to be going into a downturn compared to several years ago. I think we, I thing our companies generally have, have really, fundamentally, and in, in a meaning full way’s improved their, their capabilities.

David Yuschak – SMH Capital

We’re just judging from your gross margins you’re producing and, and I remember even, Bill you said if you can get the five to six sustained, and you’re over six in the quarter to make the adjustments, so you guys are, are doing a good job on your existing businesses. I think the investors just like to get some comfort that that Atlas is no longer going to be the drag. So I appreciate your comments and, and answers.

Tom Tanner

Thank you. Thanks.

Operator

Our next question comes from the line of Terry McMahon with BCS Partners. Please proceed.

Terry McMahon – BCS Partners

Yeah gentlemen just a quick question, Riddle Berger Brothers, the acquisition. Is their business primarily nonresidential? Or residential? Or what? What is the mix?

Bill Murdy

Well it, it is all nonresidential as, as is Comfort Systems. We have a little bit of very high-end residential, but we are essentially 98, 98-1/2% non residential construction and service.

Tom Tanner

By res–, by residential we mean, that means single-family residential?

Bill Murdy

Yes, single family. We consider this large multifamily projects a, a commercial project.

Terry McMahon – BCS Partners

Okay so, so the Riddle Berger Brother does do multifamily residential projects?

Tom Tanner

I don’t, not typically. Not typically.

Terry McMahon – BCS Partners

Okay. Okay.

Tom Tanner

By the way, interestingly enough just to comment on Riddle Berger, that company taken as a whole, is very similar to Comfort Systems takes as a whole. If you got out our pie charts in our investor presentation, those pie charts would look very much like if you get the same pie chart in Riddle Berger. It’s you know obviously without the, the multi family, but I am talking about, you know the purest man in the pure service, and very interesting to sort of just an interesting thing to note.

Terry McMahon – BCS Partners

Thank you very much.

Tom Tanner

Thank you.

Operator

Our next question comes from the line of the Tahira Afzal with Keybanc. Please proceed.

Tahira Afzal - Keybanc

Good morning gentlemen and congratulations on an underlying strong quarter.

Tom Tanner

Thanks.

Tahira Afzal - Keybanc

Hello.

Tom Tanner

Thanks absolutely.

Tahira Afzal - Keybanc

I just have a couple of questions just to go over. Number one, I remember, Bill George, you mentioned a while back that you know, if you look at your business, it typically lags the Dodge Construction Forecast, and you know I would love to get a little more color on what you’re seeing schools on, in regards to those forecast numbers, because unfortunately my budget doesn’t allow me to get them. And number two, how you think, you know if they are showing a trend, let’s say NOH which is declining which would translate into a lag trend for you? How you think your company defers.

Bill George

I’m, I’m happy to comment on that Dodge has, has done some things for its market recently, that made them an even better resource. They have started putting out a monthly release. They’ve started a pre- releasing their daily table, and they’ve, they’ve started, giving commentary on a monthly basis.

As of right now, the way when I read all and I synthesize it, what I think Dodge is saying that there will a discount, that nonresidential building will remain at high levels, high absolute levels compared to say the five year average, but that there will be some downturn, particularly in the ’08-’09 which would lag for us.

They do have more multi family interestingly enough coming back in ’09 but the downturn is not, is nothing like the upturn of the last two years. .’06 was up 16% on a nominal basis, ’07 was up five or six percent. Because the downs that they’re projecting are in mid and low single digits, really in the low single digits you still, you still stay at pretty high absolute levels. So I’m happy to go over that with you in more details to hear it one-on-one but you know, I would say that, and if we do have some commentary by the, by the way on that in the 10K where we sort of say we’re expecting to continue at fairly high levels on, as far as activity levels for the industry goes. But they do show some trimming done. Well another comment I’ll make is, a lot of people in our industry have a pretty big backlog like we do which I think means that some of that downtrend was almost inevitable, people need, in, in some ways, people need to catch up a little bit.

Tahira Afzal - Keybanc

Right, okay. And I mean if you look at your acquisition pipeline and even the one you have right now, it seems that you know you have enough cash. You know just doing some quick math’s to, you know at least come out flat if not grow top line, then if that made, single digit, you know decline translates for the lag decline for you guys for the next not in ’08 but going out further.

Bill Murdy

Well I, actually we have a lot more acquisition capability than our cash would indicate because we’re not paying all cash where the owners of these corporations are, are, are taking back some paper and there are contingent payments out there as that contingents earn out payments out. So, and when, and then we have the ability to lever if we want. We don’t have that currently in mind. Now there’s, there’s a lot more acquisition capability, I think what you saying is if, if things slowed down and we, didn’t see any organic growth, we could make it up with acquisition. We could more than make it with acquisition, but we, we think there’s also organic growth, that growth on this current platform.

Bill George

No. Historically, historically Tahira, our same store companies have done better than Dodge. Every year that I’ve, I’ve been here since the beginning and every that I have been here, you know when, when the industry is up it helps us more and more, when the industry is down, we still up or we’re down last. But we have consistently done better than what Dodge would report, and we certainly feel accountable to continue to do that.

Tahira Afzal - Keybanc

Yes. I mean I, it seems like you know you have enough levers to pull, you know assuming a top position even.

Bill George

Well, we sure hope so.

Tahira Afzal - Keybanc

Okay. And you know just another question. In terms of the, you know when you go back inn your experience and look at several past cycles, are there any specific areas in your end markets that are more susceptible, and the ones that you typically watch for as turning fast if there is a down turn?

Tom Tanner

When it’s retail, which Bill mentioned is not that big of a piece for us, that’s certainly, more volatile to, to, ups and downs. The schools, steady hospitals increasing, schools that stay and hospitals increasing. Manufacturing. We’re, we’re doing slightly more work in manufacturing, and with, with good results. So, you know the, the overall Dodge non-residence building indexes, etcetera, have a higher percentage of retail in, than in our mix. I think we probably have a s–, they have a slightly higher percentage of multifamily residential currently in, in our mix than the Dodge does. I, I have monetized that, you know. Really.

Bill George

But you know, at Centers, yeah we, we do actually but what’s interesting is, for years, I talked to a lot of people who are on this call, and talked about the fact that you know, office where buildings haven’t come back as quickly as a lot of the other sectors we have. Our retail hasn’t come back. I think one of the things I was missing was, and this has been proven in the recent upturn, is our company was changing. As a company, the, the company is to make up Comfort Systems now, do a higher proportions of medical, of education, and I think you know in part, that was, there were, there were st–, there were things going on with activity levels in those areas but I really think that our companies, many, many of our companies were changing and migrating to that frankly better work and more companies were improving.

Tahira Afzal - Keybanc

Okay.

Bill George

Well that will be great for us in the downturn I believe.

Tahira Afzal - Keybanc

It should be, and I guess one last question and that’s, you know you had that, energy act that got passed in the last month of 2007. I assume it’s really still early, for any real material positive to pull, pull through but there seemed a lot of energy efficiency mandates and I was wondering if any of your customers whether they’re, you’ve had any buzz so far on that?

Bill George

Yes. We have, we’re working, and analyzing, and exploiting that the, the big driver here you know, is not absolutely that energy legislation. It legislation, it’s more than the people have recognized. Energy costs are high, and we need to do something about it, and one way to do something is to make the HPAC mechanic plan a lot more efficient to use less electricity and save costs. It’s not, most people still replace their systems based on the fact they don’t work as well but we’re out educating and working with and the users on the basis that you can get a lot out of efficiency if you retrofit now and, and get savings on electrical costs and, and that has a big payoff. So yes, we’re seeing a lot of, we are greening ourselves if, if you will…

Tahira Afzal - Keybanc

Yeah, and I, if I recall correctly, your retrofit business is one of the most profitable segments?

Bill George

Yes, it is. It’s because we control a lot more of the project. You know we do construction project. There’re lot of unknowns, and we’re, some, someone on the work with, at retrofit project, we are usually in charge and we can best control a lot of things. And that turns to be a better force.

Tahira Afzal - Keybanc

Thank you very much gentlemen and thanks for being very straightforward.

Bill George

Thank you.

Operator:

Our next question comes from the line of Barry Haimes with Sage Asset Management. Please proceed.

Barry Haimes - Sage Asset Management

Hi. Good morning. One very quick question. You know you talked about your longer lead time, and I wonder if you can just kind of refresh our memories and, and you know understanding that this project is somewhat different, but kind of what if the, on average time line might be between, you know one of the project that’s kind of finance approved when they break ground and then when you would get the order for your type of equipment and service? Thanks.

Bill Murdy

But it’s a big question with a, with a long answer. Unfortunately, we’re doing projects of, from $50,000 values of 20 million, and each of them would have a different profile. And then you break it up into the type of kind of things, whether it’s a large project with a heavy permit front end, with lots of financing, you know that’s, that’s along thing, and then the project at large. And what, what’s important to understand is that, once we s–, we, we go on a project, you’re going to start to work, and we’re not there continuously. They do the underground piping. When we come off a little bit, then we’re going to the parking structure. We’ll come off of that, and then go into the, if it’s an office building, up the floors excreta and then all the place. So we’re on and off.

Barry Haimes - Sage Asset Management

Right. Then so and where, when you will we get the order? When you would see the order? So, where in the continuum?

Bill Murdy

Well, we would no matter how big such big project we’re sub to general contractor. Usually he will give that project fairly early, will be selected fairly early. We’re, we could be earlier you know since we’re doing it underground, and I think we’re there first thing. And, and the equipment order would come a little later in terms of the order. We have it all set up. We have the price, excreta but delivery would be later in that project. It, it just got to go through each individual project here and, and, and your average dollar in those times, it really didn’t mean anything because we have such a diversity of size and type of project.

Tom Tanner

You know another way to look at it from an analytical point of view is, you know when did they come into our backlog? We, there, it’s not uncommon on the project where we design building the project for us to have been budgeting it when it was a gleam in somebody’s eye. But we may not sign the contractor that we’ve already started working. We may have gotten a notice to proceed. We may have been an integrated part of the team. It may not show up in our backlog until we’ve already begun to run substantial revenues through. Whereas meanwhile, on bid work you know, we’ve, there may be a bid opening where we, it comes into our backlog. You know, certainly has to be financed because nobody is going to find a binding contractual commitment to pay somebody tens of millions of dollars without financing, but that, that might be earlier. Let me just boil all that down. Because it’s so complicated, just I’m going to tell you what I do. For, for internal purposes, for budgeting, for modeling, we lag Dodge a year but I have to be honest with you, that is a, that is a start of a shake-and-bake of a lot of different things that are going on and it’s really a continuum of phasing in of changes in the market so start a, that is the, the question you asked is an extra ordinary complicated questions so.

Barry Haimes - Sage Asset Management

Thanks that actually helps. I appreciate your answer. Thanks.

Operator

(Operator Instructions). Our next question comes over follow up from the line Rich Wesolowski with Sidoti & Company. Please proceed.

Rich Wesolowski – Sidoti & Company

Thanks just follow up on your capital allocation. If you look at 2007, and assume a break even, you’re right about $75 million run way in your stock less than five times, can you go back determining the size of your acquisition budget versus how much you are now spending in buying that stock.

Tom Tanner

I don’t think we do it that way. What we, we look further than just the acquisition, the mistake that a lot of consolidators made earlier on, we need to bring in companies on a schedule that we can assimilate and they have to fit so we don’t really do that kind of very sophisticated capital resource allocation, there are some of that and certainly we going to stay within various lines, and they might be the occasional thing that comes that we got to look at, re look at whether you know the purchases continue that we are not near that, strange on this one. So, it is more, it’s not quite as sophisticated in terms of capital resource allocation at an absolute.

Rich Wesolowski – Sidoti & Company

If you see good company will buy it, at a good multiple incomes, buy back a little bit of stock when it’s below twelve.

Tom Tanner

We are not buying too many of them, so that we don’t problems, integrating and simulating.

Rich Wesolowski – Sidoti & Company

Great, thanks again.

Operator

There are no further questions at this time and I would now like to turn the call over to Billy Martin for closing remarks.

Bill Murdy

My only closing remark is to thank everyone for being on the call and we will see you in 90 days or so. Thank you.

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Source: Comfort Systems USA, Q4 2007 Earnings Call Transcript
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