Julie Shaeff - SVP & Chief Accounting Officer Brian Lane - President & CEO Bill George - EVP & CFO.

Tahira Afzal - KeyBanc Capital Markets Adam Thalhimer - BB&T Capital Markets John Rogers - D.A. Davidson & Co. Fran Okoniewski - Friess Associates, LLC.

Good day, ladies and gentlemen, and welcome to the First Quarter 2016 Comfort Systems USA Earnings Conference Call. My name is Katina and I will be your coordinator for today. At this time, all participants are in listen-only mode. Later we will facilitate a question-and-answer session.

[Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. Julie Shaeff, Chief Accounting Officer. Please proceed..

Thanks, Katina. Good morning. Welcome to Comfort Systems USA's First Quarter Earnings Call. Our comments this morning as well as our press releases contain forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. What we will say today is based on the current plans and expectations of Comfort Systems USA.

Those plans and expectations 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 most recent Form 10-K and Form 10-Q as well as in our press releases covering these earnings.

A slide presentation will accompany the prepared remarks as is posted on the Investor Relations section of the company's website found at www.comfortsystemsusa.com. Joining me on the call today is Brian Lane, our President and Chief Executive Officer; and Bill George, our Chief Financial Officer. Brian will open our remarks..

Okay. Thanks, Julie. Good morning, everyone, and welcome to our first quarter earnings call. Let me start off by thanking our great Comfort Systems USA employees for their hard work and dedication. I'm going to briefly cover the highlights, and Bill will discuss our financial results in detail.

For the first quarter of 2016, we are very pleased to report improved year-over-year results. Revenue for the quarter was $386 million, a 4% increase compared to the first quarter of 2015. Backlog was $777 million as of March 31, 2016. It includes approximately $56 million from our recent acquisition of Shoffner Kalthoff based in Knoxville, Tennessee.

We had solid first quarter bookings at many of our operating companies and, as a result, backlog is up sequentially and year-over-year. Earnings for the first quarter of 2016 was $0.26 per share. That's compared to $0.13 per share a year ago.

This significant earnings improvement reflects great execution by our workforce during our traditionally weakest quarter of the year. We are also off to a good start in 2016 with positive free cash flow during the quarter. Once again, I'm very pleased with the terrific execution as the majority of our operating companies.

Both the construction and service sides of the business continue to deliver results. Our service investments and our strong emphasis on project selection and execution have positioned us to take advantage of a robust nonresidential construction market. We continue to grow both organically and through acquisitions.

The Shoffner acquisition in February expanded our footprint and customer offerings in the Southeast and mid-Atlantic markets. The deepening of our connection with Environmental Air Systems in Greensboro, North Carolina also provided a lift in the first quarter. Overall, I'm very optimistic about our prospects for 2016.

Before I discuss our outlook, though, let me turn this call over to Bill for a review of our financial performance..

Thanks, Brian, and good morning. If you have access to our slides, you can refer to Slides 2 through 4 as I provide some additional information regarding our financial results. First quarter revenue increased by $16 million or 4% compared to the first quarter of 2015.

The majority of this increase related to our recent acquisition of Shoffner Kalthoff while our same-store revenue was up by 1% or $2 million compared to last year. We owned Shoffner for two months, and they contributed approximately $14 million of revenue and were slightly accretive to earnings per share even after amortization.

As a reminder, Environmental Air Systems, or EAS, was already consolidated in our financial results last year. So the acquisition of the remaining 40% minority interest of EAS did not impact our revenues. As expected, EAS had lower revenues this quarter compared to a year ago, down $19 million.

However, because we now own all of EAS, their contribution to earnings per share was similar to the first quarter of 2015 and still in the $0.04 to $0.05 range. Gross profit was 19.0% for the first quarter of 2016, and this was an improvement from the 17.5% we achieved in the first quarter of 2015.

The increase was driven by broad-based improvement at a majority of our locations. Net income for the first quarter was $9.8 million or $0.26 per share compared to $5.1 million or $0.13 per share last year. SG&A expense was $58.2 million for the first quarter of 2016 compared to $53.7 million for the first quarter of 2015.

Approximately 1/3 of this increase is related to the acquisition of Shoffner Kalthoff and the remaining increase is due to the increased compensation expense related to expanded service activities at multiple locations.

SG&A as a percentage of revenue was 15.1% in the first quarter of 2016, which compares to 14.5% a year ago and the increase is due to the expanded service activities. Our tax rate for the quarter was 36%, which is higher than last year at this time.

We expect our full year tax rate will be higher this year due to the acquisition of the remaining 40% interest in EAS, which had the impact of lowering our rate in previous years. So we'll now get and pay taxes on all of EAS' earnings. We create very good free cash flow for our first quarter.

Our free cash flow was $9.5 million, which compares to $17.0 million for the same period in 2015. However, this is only the second time in 12 years, last year being the first, that we've had positive free cash flow in the first quarter. During the first quarter of 2016, we purchased 102,000 of our shares at an average price of $27.84.

And since we began our stock repurchase program in 2007, we've bought back 7 million shares. Overall, we're off to a great start for 2016. We're optimistic about industry conditions and we continue to expect that revenue and profitability in 2016 will be similar to or above the levels that we experienced in 2015.

That's all I've got on the financials, Brian..

Okay. Thanks, Bill. Let me start with the backlog and activity in various sectors and markets. Please go to Slide 5. Backlog at the end of the first quarter was $777 million and includes approximately $56 million of backlog on the February 2016 Shoffner Kalthoff acquisition.

On a same-store basis, backlog was $720 million as of March 31 of this year, which is an increase of $9 million since last quarter and an increase of $3 million from a year ago. We are seeing modest increases in backlog in various geographies throughout U.S., and we're starting to see a handful of larger projects in the pipeline.

Pricing is stable in the majority of our markets with some incremental improvement in select markets. Let's turn to Slide 6 for a look at our end-user sectors. We have a well-balanced portfolio. Institutional markets, which include government, health care, and education, made up 37% of our revenue for 2016.

The commercial sector made up 36% of our revenues, and manufacturing represented 27% of our 2016 activity. Manufacturing for us includes projects at industrial plants, food production facility, data centers and pharmaceutical projects. We continue to win our fair share of projects.

And overall, we are happy with trends for our work in the various sectors. Let's discuss what we're seeing across the country. Our companies in the Northeast and Upper Midwest continue to execute and produce strong results, especially our operation in Michigan this quarter.

We also have got strong continuing contributions from our 2 large operations in the mid-Atlantic. The majority of the operating companies in these areas have active pipelines. Many are operating near capacity. Our operations in the Southeast region continued to strengthen and improve.

Our operations in Dallas had a strong quarter, but overall, Western markets are mixed. Please turn to Slide 7 for our current revenue mix. Work in existing buildings continues to provide the majority of our revenues, with new construction at 41% of revenue and service, repair and retrofit at 59% of revenue.

Our service business continues to grow and is strongly profitable. The investments we've made in building service capabilities provide us with a competitive advantage in this highly fragmented market. We believe that our expanded service offerings will contribute to positive results for 2016 and beyond.

We remain 100% committed to continuously improving our culture of safety. While our OSHA recordable rate is 25% below the industry average, we believe there's room for improvement. We have redoubled our commitment and increased our investments in safety.

The nonresidential construction markets have improved over the past few years, and we expect these positive trends to continue. However, as our markets get busier, the challenge shifts towards execution and staffing. There is an industry-wide shortage of skilled labor.

We have a history of developing our labor force through our investments in our national training programs. We believe these investments will continue to help attract and develop the best workforce in this industry.

We continue to emphasize execution in cost discipline, but we believe now is a good time to pursue growth initiatives based on our view that industry conditions are supportive. We are experienced overall good bidding activity and remain optimistic about our prospects for 2016 and beyond.

Before I turn to questions, I want to thank all of our 7,800 team members for their efforts. I'll now turn it back over to Katina for questions. Thank you..

Thank you. [Operator Instructions] Your first question comes from Tahira Afzal representing KeyBanc..

Hey, folks, congrats on a very strong quarter. So I guess first question is, I know yourself and Bill George do a pretty tough job on the macro side. It seems like the commentary indicating, in terms of trends, really suggest what you've said earlier. You don't really see the non-res market peaking, let's say, perhaps late 2017 and into 2018.

Would that still be the case?.

Yes. Tahira, it's Brian. We believe we're in a good run-up here this year, next year. The opportunities look good. We're optimistic about what we're seeing, both in construction and service. So I think your statement, we believe, is true..

Yes..

Got it, okay. And Brian, a couple of years back, you did the very sensible thing of , investing in some people, some systems.

Anyway, it had a bit of a drag on the G&A side, if you recall, but when you talked earlier on about having to support the growth going forward, could you kind of elaborate and provide color in terms of any investments you might have to make?.

Yes, it's actually....

We'll both do it. I'll let Bill go first..

Essentially, we made meaningful incremental investments. It was $1.5 billion in the first year and an incremental $4 million in the second year, you'll recollect. And in fact, it even went up in the third year. We were prepared to scale back those investments, but I would say that it's fair to say we've redeployed those monies.

We think we're getting a good return on it. So what -- some of it was going into training early on. More of it's going into technology now, sales-related and performance-related technologies like mobile, trying to tighten up processes in our business..

And, Tahira, also, we are upgrading on talent. I mean, if I look at the last three years, the quality of the people that have come to this organization is really improved. So we're going to keep doing that. We're going to keep training, investing in technology and systems, particularly heavily on the service side.

We're getting a great return on it and couldn't be happier in what they're doing..

Got it, okay. And Brian, last question and I'll hop back in the queue. As you had indicated, this is the year you're seeing a bit of a drag from EAS because you had some large projects complete. So if I get on the calls of some of those type of clients who deal with that, those data centers, the outlook is very strong.

So as we go into next year, could you potentially see a recovery over there?.

So let me answer that just because I spend a lot of time at EAS. So I would say, they're only -- it's only a drag because the last year was amazing..

Right..

They're still having the second best year ever, far above anything that we projected or thought of when we originally bought the first 60% of that company. And as -- and I just have to repeat, we will get the same bottom line contribution because now, we own all of them.

Having said that, $19 million less of revenue in the first quarter, still very high revenue. Everybody else had to step up and cover that. As far as data centers go, I think data center is still a ride barrier for them. They happen not to have a lot of big activity going on right now or for the next little while.

But I will say, there's other areas like pharmaceutical and tire plants that they like just as well that are active. It's not -- they're not just a data center company. It just so happened that they had 2 data centers stacked on top of each other last summer, and so that was a big story for us..

But I'll tell you, Tahira. Their backlog is terrific. These folks are doing a great job. Whether it's data centers in the market, as Bill mentioned, they just have outstanding relationships in the markets they serve, outstanding..

Got it. That's very helpful. Thank you, guys. And I'll jump back in the queue..

The next question comes from the line of Adam Thalhimer representing BB&T Capital Markets. Please proceed..

Good morning, guys. Great quarter. I wanted to ask first on organic growth.

Do you think -- and I know you have that EAS comparison, but do you think organic growth can accelerate from the plus 1% as the year progresses?.

Yes. I think that -- what we said a few weeks ago when we reported the year, where we said, for the year, we expect to see mid to low single-digit organic growth, I think 3% to 5% for the year is the most likely outcome. I'd stand by that. In the first quarter, it was a particularly steep revenue comparable for EAS.

Their revenue was over $50 million in the first quarter of '15. The fact that we covered that and still were flat-to-up is probably actually a pretty good sign for the year..

And you know, Adam -- are you done, sorry. Adam, we have good backlog pretty much across the country. Most people are up so I'm pretty optimistic, going forward, what this year looks like..

Okay. And then on the margins, I don't expect you to give guidance, but can you just talk a little bit around -- if I look at the operating margins, it was up 100 basis points in Q1.

As you guys tried to think about the full year, what are the puts and takes? What could push you to flat or up a little bit or down a little bit on the operating margin line this year?.

So at this point, when we talked a few weeks ago, we were -- there's a lot of questions. Can you guys do 20 of gross margin this year? Obviously, this comparable makes that much more likely. I think we feel like that's very achievable for the year.

I think what drove those margins higher in the comparable for the year-over-year was 40 -- we were 59% work in existing building. And with that mix, our margin, that's a mix that definitely favors our margins. Just add a little bit of good weather.

Brian, anything else jump out at you?.

Well, Adam, as I mentioned in my notes, we're just getting terrific execution out in the field. Running projects, you always have a few go south on you, but right now, we have nothing major, and that is really helping our margins. We're not having to fix something.

That, combined with services doing, being 59% of the business, barring something unforeseen, it should be okay this year..

Okay.

And then Brian, can you give a little bit more color on the real-time bidding conditions, just in the last couple of months? You said you had started to see a few large bids?.

Yes, yes..

That period, just a little color on that will be helpful..

Yes, I think -- if you look at what's going on here, first of all, bidding activity is pretty good across the country just in terms of volume. I think over the last few months, I've seen larger projects come through the funnel than I've seen, probably, since 2008, 2009 in the aggregate pretty much across the country.

Whether we get them or not, it's up in the air. But we are looking at more jobs here. We're looking at bigger jobs that come through here. We're just seeing a lot more of them. We'll see what happens as we go forward.

But seeing a little bit of healthcare come through here, and to some larger projects in general, Adam, that I probably I've talked to you about in a while..

Okay. Thanks for the color..

[Operator Instructions] Your next question comes from the line of John Rogers representing D.A. Davidson. Please proceed..

Hi, good morning.

Can we go back, just Bill, I guess your comments relative to cash flow? And, Brian, given your comments relative to larger construction project, at least potentially out there, how does that affect how you think about your investment in working capital this year? And is there a big difference in the service business, your collections there versus the construction business?.

No. So there's an enormous difference in the collection cycle for service versus construction. If big projects were to be awarded and were to start, which would, really, it's not -- that's very -- not much of that could happen this year.

Even the stuff we're looking at would have be very, much more, have much more effect on next year, we would see a net investment in working capital. In the past, over a two-quarter ramp-up, it may be depresses our free cash flow $10 million or $15 million off of some pretty stealth numbers, so.

But at this moment, for this year, I don't see any of these big projects getting started soon enough for the net investment in working capital to materially push our earnings away from just cash flow and our cash flow away from what we're earn. I think the cash flow, what we are earn, there can always be a little lumpiness.

We saw that at the end of '14 where a few million, several million, fall into different period. But, yes, so working capital, let's hope we're making working capital investments very late this year and next year. That'd be the next leg up..

And, John, let's face it, right, we're getting these positive quick cash flow in the first quarter the last few years. We've got more of our businesses in service..

Last year was the -- before last year, for 10 consecutive years before last year, we had had negative free cash flow in the first quarter. At least half the time, we didn't even get positive for the year until the third quarter. So we're thrilled..

Okay, okay.

And then, maybe, Brian, in terms of your work right now, how much -- and I guess this is more the construction side, but what portion of it is flowing through shops or prefab?.

Oh, yes. I'm going to say most -- just about all of it, John, at this point has some prefab element to it. Whether or not it's construction at EAS, typical prefab we're doing all over the country, all of our companies do prefabrication today, which is usually different from, say, 2008 and before. And so...

In fact, John, I'd go so far as to say this past year and in the coming year, we're actually spending a little bit of CapEx because prefab is actually expanding. We're finding that we have to fit out more space because prefab is becoming really important in every market..

And, John, as you know, we -- everybody is -- you're prefabbing more and more, whether it's sheet metal, piping, or whatever, it's just people are figuring out more things to prefab, every day..

And I would assume that puts more pressure on some of the smaller local competitors?.

Absolutely. We're seeing -- there'll be information modeling. It's not as strong, but mid-2000 slowed down through the recession, coming back big time, and we really got our leg up on that. We have been in capability that people are going to access throughout the country, and that's a real advantage..

And it really helps that you prefab as you know..

Yes. Okay, thank you and congratulations on the start of the year..

The next question comes from the line of Fran Okoniewski representing Friess Associates..

Good morning. Thanks for taking my question. How do we think about 2016 versus 2015 in terms of the amount of new project startup? It seems that you guys completed a lot of projects last year.

Would that sort of puts any undue pressure on the operating line in terms of the labor component, other ramp-up expense headwinds? How are you guys thinking about that on the operating line in 2016?.

This is Bill George. I was more concerned about that late last year. We had a lot of closeouts last year that benefited us. And some of our most successful operations last year, we're going to have lift schedules that were kind of, on average, a little younger.

I think across the country, though, the fact that more and more of our locations are picking up, I think that's not too much of a factor. I think if anything -- yes, I would say it's a neutral factor. I -- you think you've got some of that from me, and I was scratching my head about that because I had seen what was driving our numbers last year.

I don't think that's a concern anymore..

Okay.

And in terms of just the first quarter, from a weather standpoint, I guess, did that help more productivity? Or how do you guys sort of feel about the weather in the first quarter and maybe how that sort of translates into activity into the second quarter?.

Yes. Fran, this is Brian. The weather is the weather. I really don't worry about it too much. It's going to help some parts of the business. It will hurt other parts of the business, but it washes out at the end. I thought this was a pretty reasonable winter. We were able to do construction pretty much straight through.

And if you get extremes, it helps the service business. Still on the aggravates, pretty much a wash. Last year was usually different because the weather in the Northeast, really, you just couldn't work. And a lot of that work got pushed out to April and May, but I don't see that being a big issue this year..

Okay. Great. Thank you. Congrats..

The next question comes as a follow-up from the line of Tahira Afzal representing KeyBanc..

Brian and Bill, Fran brought up a good point. Our homebuilding analysts that I talk to regularly said homebuilders are indicating some pull-forward of construction because it's been a mild winter.

And to your point, it's not fundamental, but could we see some lumpiness as we head into the second quarter because of that?.

Maybe a little bit, Tahira, but it could -- but I think it's all going to even out. Yes, we're able to do some work.

But the weather is the weather, right?.

I hear you. And I hope all your employees are safe in Houston..

Yes, we are. Thank you very much. It was -- last week was a wild week, I'll tell you that..

I hear you. Thank you ever so much, folks..

With no further questions at this time, I would now like to turn the call back over to Brian Lane for any closing remarks..

Okay. Thank you, everyone, for joining the call. We really appreciate your interest in Comfort Systems. We are off to a good start in 2016, and I'm very optimistic that this is going to be a good year for us. Thanks, again, and have a great day. Thank you..

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day..