Julie Shaeff - Senior Vice President and Chief Accounting Officer Brian Lane - President and Chief Executive Officer William George - Executive Vice President and Chief Financial Officer.

Sean Eastman - KeyBanc Capital Markets Joseph Mondillo - Sidoti & Company, LLC Fran Okoniewski - Friess Associates, LLC William Newby - D. A. Davidson & Co..

Good day, ladies and gentlemen, and welcome to the Q2 2016 Comfort Systems USA Earnings Call. My name is Joyce and I will be the operator for today. At this time, all participants are in listen-only mode. Later we will conduct 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 call over to your host for today, Julie Shaeff, Chief Accounting Officer. Please proceed..

Thanks, Joyce. Good morning. Welcome to Comfort Systems USA's second 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 and it has been 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. Before we start I would like to take a moment to thank the Comfort Systems’ employees for their continued hard work and dedication. Let me take you through the highlights and then Bill will discuss our financial results in detail. We are extremely pleased to report another solidly profitable quarter.

Our profitability has increased sharply and today we are reporting the highest quarterly earnings per share in our history. We earned $0.47 per share in the second quarter a 34% increase compared to the second quarter of 2015. Once again our operating teams at our field locations continue to deliver improving results.

Revenue for the quarter was $428 million a 3% increase compared to the second quarter of 2015. Backlog was $724 million, a 2% year-over-year increase however backlog decreased 7% sequentially.

As we have explained in our recent earnings calls this summer the comparisons with regards to our revenue and backlog appear less robust as a result of an extraordinary bulge of activity last summer, including large simultaneous mobilizations on two data center jobs in the mid-Atlantic region last year.

However, we believe that our backlog and prospects are consistent with continuing strong results in the coming quarters. I will describe industry conditions and our outlook in more detail in a few minutes, but before that let me turn this call over to Bill to review our financial performance..

Thanks, Brian. If you have access to our slides, you can refer to Slides 2 through 6 as I provide some additional information regarding our financial results. Second quarter revenue increased to $428 million as compared $417 million last year.

Shoffner Kalthoff are newest company contributed $22 million of revenue during the second quarter and they were neutral at the earnings per share line due to their acquisition related amortization expense.

On a same-store basis our revenues were down by $11 million and that’s as a result of the extraordinary activity levels last summer that Brian mentioned. Gross profit was 20.9% for the second quarter of 2016 with further improvement from the very strong 19.7% that we achieved in the second quarter of 2015.

The increase was broad-based reflecting solid project execution and improved service performance. SG&A expense was $61.0 million for the second quarter of 2016 compared to $57.4 million for the second quarter of 2015 and this increase was primarily due to the Shoffner Kalthoff acquisition.

Net income for the second quarter was $17.7 million or $0.47 per share compared to $13.4 million or $0.35 per share last year. As mentioned, we had strong performance across our operating indications. Our year-to-date tax rate was 35.6% which is consistent with last year at this time.

With the acquisition of the remaining interest in EAS, we had expected our rate to increase to more normalized levels. However, so far this year that's been offset by the tax benefit from the adoption of a new accounting standard relating to equity awards and other discrete items. We had another quarter of a very, very good free cash flow.

For the quarter, our free cash flow was $16 million which compares to $25 million for the same period in 2015. We already have $26 million of positive free cash flow this year. And we've also already retired a good portion of the modest debt that we incurred for the two large strategic transactions that we closed in the first quarter.

Although, the comparable to last year is down, this is the best performance we've had other than that in a very long time and last year really was an anomaly, so we’re very, very happy with our free cash flow.

During the second quarter of 2016, we purchased 68,000 of our shares at an average price of $30.52 since we began our stock repurchase program we bought back more than 7 million shares. Overall, we are pleased with our results for the first half of 2016.

We are optimistic about industry conditions and about our prospects for the remainder of 2016 and for 2017. We are continuing to look for ways to put our strong balance sheet and cash flow to work with acquisitions, while we plan to continue to reward our shareholders directly. That’s all I have Brian..

Okay. Thanks, Bill. Let me start with backlog and activity in various sectors and markets. Please refer to Slides 7 to 9. Backlog as of June 30, 2016 was $724 million can be at $712 million as of June 30, 2015. The February 2016 acquisition of Shoffner Kalthoff contributed to the year-over-year increase in backlog.

Backlog decreased by $53 million compared to the end of the first quarter. The fluctuation in our backlog levels was primarily at our larger project companies which tend to have lumpy of backlog. However, we are encouraged by backlog growth in the Northeast and Upper Midwest, which is our most profitable region.

The majority of the operating companies in these areas have active pipelines, many are operating near capacity. The mid-Atlantic and Southeast markets continue to strengthen and improve. Our operations in Dallas had another very strong quarter. The Western markets are mixed.

Pricing is stable in the majority of our markets with some incremental improvement in select markets including the Northeast. Our pipelines are still very active and we continue to book good projects. Please turn to Slide 8, for a look at our end-user sectors.

Institutional markets, which include government, health care, and education, made up 40% of our revenue for 2016. The commercial sector made 37% of our revenues, and industrial and distribution represented 23% of our 2016 activity.

Industrial and distribution for us includes projects at industrial plants, smooth production facilities, data centers, and pharmaceutical projects. We are pleased with trends for our work in the various sectors. Please turn to Slide 9 for our current revenue mix.

Work in existing buildings continues to provide the majority of our revenues, with new construction at 40% of revenue and service, repair and retrofit at 60% of revenue. Our construction business is benefiting from strong underlying fundamentals in non-residential construction markets. Our service business is strongly profitable.

We continue to benefit from the investments that we've made and that we continue to make in our service business. Our maintenance space is growing and we are seeing improvements in profitability has the business continues to build scale.

As a result of our service strategy, we believe we are one of the largest commercial HVAC service organizations in the U.S. and we see continued growth in this highly profitable business as we move forward.

Over the course of the long recession in non-residential construction, we actually increased our investments and training, construction technology and our services business. At the time, those investments were painful and reduced our results in years where we were already struggling.

However, those investments have paid off for us and improved profitability as markets have trended upwards and we believe they will continue to benefit us in the coming quarters. We remain optimistic about our prospects for the rest of 2016 and for next year. In closing, I want to thank nearly 8,000 employees for their hard work and dedication.

I will now turn it back over to Joyce for questions. Thank you..

[Operator Instructions] The first question comes from the line of Tahira Afzal with KeyBanc Capital Markets. Please proceed..

Good morning, this is Sean on for Tahira here today. The first question from us is just really if you could give us a bit more color on some of the positives hints you gave around 2017. Just kind of in light of organic growth being on the softer side and bookings being on the softer side.

It would be helpful to know what really gives you confidence around your longer-term outlook..

I’ll hit that first, I’m sure Brian has thoughts too. Sean, the reality is our guys are pretty busy and so they're working on 2017 work earlier than in the year. In past years, we were trying to get the work we needed for the fourth quarter at this point. We have really good prospects work availability in 2017 and that leads us to be optimistic.

We're not as worried about the softness in the revenue because we think a lot of that is a product of the mix. We sell labor hours, right. What we try to maximize is gross profit for man hour.

The work we're doing is work in existing buildings that comes with less material, less subcontracting, less insulation, less equipment and so less revenue comes through, but our gross profit for man hours is fantastic and that's why we have a record EPS quarter..

And Sean, if I could just add on to what Bill said it’s – we are seeing broad-based pretty much across the country, good activity in bidding. I think that's the basis of our optimism. We're looking at a lot of stuff with 2017 already..

That's great.

And so just as we have this air pocket here on those two big data center jobs, I just wondered what are the prospects does look like for kind of replacing those, it seems like there should be a lot of opportunities both in the data center side and some large hospital seem to be coming out, so any kind of comments on some larger projects that could come through would be helpful?.

So just to talk about last year for a second. Those two big data center jobs got stacked on top of each other unexpectedly, right. So we wouldn’t want to replace that. If you look at the amount by which that subsidiary is environmental air systems is down.

It's more than the amount – year-over-year it's more than the amount that Comfort Systems is down, that one subsidiary. So at the end of the day, we think there is good prospects for work. They look like they'll have a good year next year across the country. Overall, the people are up.

If you back those guys out I don't know that we want to replace and get two jobs stacked on top of each other of that magnitude at one subsidiary, but we like the trends, we like - I don't think it's so much an air pocket this year as a tough comparable..

All right. That's really helpful guy. And then just lastly for me is you guys keep throwing off a considerable amount of cash so just and update on what you are seeing out there in terms of how you are going to put that to work would be helpful..

I mean Sean, Bill can talk a little bit about acquisitions, but we are going to continue to pay a dividend and it’s right now those $0.07 per share quarter. We also continue to buyback stock on a program and then of course acquisitions which Bill can comment on it..

Yes. So when it comes to acquisitions for years we've said that we do most of our acquisitions during recessions. And then we're likely to be quiet during expansions.

Two things give me optimism that we'll get some acquisitions done despite the good markets, one is that we really have free cash flow, we have cash flowed heavily much earlier in the cycle than we usually do which is a good sign by the way for the underlying business in every way.

But also one of the things that was not true at past recessions, most of these in particular mechanical companies you know mechanical contracting HVAC became widespread in the U.S. in the 70's.

Most of these companies are owned by baby boomers and we only need a few of them to say hey I'm not going to wait for another whole cycle for us to be able to do some you know do some good transaction. So as always we'll be picky, we won't do a deal unless we have conviction.

That means we don't do a deal that will mean we don't do a deal but actually I feel surprisingly optimistic right now compared to what I would have expected at this point in a cycle..

That sounds promising guys. Thanks so much for taking my questions and you know congrats on that commendable margin from this quarter..

Thanks Sean..

The next question comes from the line of Joe Mondillo with Sidoti & Company. Please proceed..

Hi, guys, good morning..

Good morning, Joe..

So my first question related to gross margin or growth. How you're able to expand which is another great quarter? Just wondering if you could provide some color on what are the biggest drivers to that.

Is it the size of jobs? Is it higher mix of complex type jobs where you're capturing higher profits? Is it productivity? Is there one or two that definitely driving it or just a combination of everything?.

Yes, Joe, it’s Brian. I'll go first and I think you hit them both one is the mix. Right, we are doing a lot of small work right 90% of our work is under $1 million in size. So a lot of repair retrofit work and then we're executing it very well.

I think we've seen the payoff Joe we've talked about this a long time, a combination you know prefabrication we are building more in this shop.

First, I think the training is really taken hold of the field [indiscernible] in construction and service, and I say we’re more efficient getting work done quicker I think a combination of all those things is and the folks are just executing a heck out of work, it couldn’t be proud of the work that’s been done in the field.

So Joe, I think it’s a combination of those two heavily.

Bill, do you have anything to add?.

Yes, that will be more..

Yes.

So what are your thoughts on going forward? Do you think you can continue to see the kind of year-over-year expansion that you seen? Is the pipeline of similar type projects the same is what you've seen in the last few quarters or how are you thinking about the ability to expand gross margins going forward compared to what you've been doing?.

Joe, if you look inside the numbers and you talk to our guys, at least right now the trend is upward. Our two risks to that, one is a risk which is execution, mistakes if we make mistake we pay for it. The second not really risk to that, but factor is the business mix of big projects come back to a greater extent. Our gross margin would come down.

Our dollars of operating income should go up greater scarcity. But it certainly the case like I was saying earlier that is more newbuilds started to come through, the gross margins would come down but our gross profit per man hour and our net income should still trend upwards. So right now I think we've said it two or three times.

We're seeing what visibility we have for 2017 looks pretty good..

Joe, if I could just add-on I mean I think I’ve said this probably last three quarters, yes gross margins have improved, but really it’s attributed to the folks outlook field and you are cranking up 21% the industry we are in, that is really a world-class gross margin in my opinion..

Okay. Good to hear. Well, keep it going. So another question then I had was in terms of the backlog. It wasn't unexpected, I don't think maybe a little bit weaker than expected, but, but we knew it’s a tough comp.

But one thing I noticed in your Q was that you cited EAS, but you also cited a Cali operation and Arizona operations of similar magnitude in terms of downside in addition to that EAS comp. So I was just wondering – I was surprised to see that there was other operations that I guess had tough comps and if you can comment on that.

And then also in terms of all your other operations, it sounds like you're positive, but what kind of organic growth rates are you seeing out of all these other operations that you own and how is that trending? Is that accelerating? Is that slowing? That’s it..

Yes. So the way that works – so our companies that do some of the larger projects not large like we saw in 2008, but large today. They don't book a big job every quarter. They book a big job, things are good, and they book in every couple three quarters. What that means is there's always going to be somebody to burn some and didn’t book that quarter.

So I don't really have – I don't know neither of those locations that you mentioned, we like their backlog level. There's always going to be somebody mathematically going up and somebody going down. I hear what you say about that, but I think that sort of normal..

Yes, Joe. I just want to talk about those two places in particular. Arizona, we've had a company there a long of time, just a terrific company. So we are not at least bit worried, they’ll get their fair share work.

Southern California if I remember we had couple of bad projects a few years ago, really that management team, the Regional Vice President [indiscernible] is on the call and have done a heck of a job really rebuilding that operation. I look at the opportunities now and the causes there few weeks ago and the quality of people we have there.

I am really optimistic that Southern California has a lot of opportunities and we got a really good team put together out. Yes, so I'm pretty optimistic about our San Diego operation right now..

Okay. And then the second part just when you look at your other sort of 88 or whatever other locations that you have, when you look at all those other locations and looking at sort of the growth rates.

Is it mid single-digits and is it slowing or is it accelerating, what sort of when you look at across the board at all your operations, what do the growth rate sort of look like?.

If the business mix stays the same, we will deliver modest organic growth from existing operations, increasing earnings, but modest organic growth. There will be some growth. One thing though is if you look back over the last three or four years, if you look at a trend analysis.

I think we've only once had backlog go up from a second to third quarter or from a third to fourth quarter. So I think I'm pretty sure it's happened once and I know it's only happened once in three years, I think it's only happened once in four years.

So there's another thing going on here which is this is just not our booking season, our booking season is really the fourth quarter historically. So I just had to say that's why we're just not that worried, if you look at the comparison which we've been talking about since last summer.

If you look at the earnings, the cash flow, you know, cash flow is a sign of strong schedule. And if you look at, you know, you look at what our guys are telling us and you look at the back that they're looking for work now farther out than they had in the past, we just – we like our prospects..

And Joe, you know us pretty well, when times were top leading things. And I think right now we're pretty optimistic going forward as far as we can see..

I mean we have record quarterly EPS since the beginning of Comfort Systems and it's only a – it’s a second quarter, pretty hard for us to – I don’t know it's pretty hard for us, we like to cry..

We like to cry..

I hear you. I understood. Just lastly and I’ll hop back in queue. The SG&A, I think it was – I just want to say it was up like….

3.7 or something..

It’s up like 6.5% I guess year-over-year. What does that look like? Do you have the number what that growth would or what it would look like ex-Shoffner..

So if you look sequentially Shoffner was all, but about 400,000 of the increase. I think that – quarter-to-date, I think it’s mainly higher pay, higher bonus accruals is more than the rest of it, because we pay all these guys who run these business as a share of profits above a minimum threshold and these guys are – they're just a lot of profits..

The great news about that SG&A is that we are paying higher bonus, I means we are making more money, so we're happy to pay..

Okay.

So the softener is about 400,000 of SG&A?.

Just for the quarter they were three something and I don't have it in my finger tips..

Okay. All right, thanks. That's good for me..

All right. Joe, thank you..

[Operator Instructions] The next question comes from the line of Fran Okoniewski with Friess Associates. Please proceed..

Yes. Hey, good morning. I just wanted to circle back to the revenues in the quarter.

It seems as though some folks were expecting a little bit more there, can weather sort of have play a factor into Q2 and listening to some of the other HVAC related more on the equipment side companies earlier in the quarter, weather was a little bit unfavorable in April and May or June and now we're having this heat wave.

Can that have an impact at all on your service work at all?.

Yes. Fran, its Brian. Yes, but we usually don’t sight weather here because I think it bounces out over time.

Yes, right now it’s extremely hot, our service folks are extremely busy, but I don't think that accounts for much of the delta in revenue in my opinion, but obviously it helps us, its 100 degrees all over the place, we are going to be busy, but I don’t think it squeeze everything that much for us over time..

Okay. All right. Great, thanks..

All right. Thank you..

The next question comes from the line of Bill Newby of D. A. Davidson. Please proceed..

Good morning, guys. Bill on here for John..

Hey, Bill.

How are you doing?.

Good. How are you? Congrats on the quarter..

Thanks..

Just sort of quick follow-up on kind of acquisitions that you guys are looking at, are there any like specific geographic regions that you're looking to expand into or is it mostly just around what the footprint that you guys already have in building that?.

So for us the future – an awful lot of our future growth will come in the mid-Atlantic in the southeast, because if you pull out a map and you look at where we are and where the kind of companies that are like ours are.

That’s where the most cities where we don't own the best the company, we don't own that company and we want to go by the best company and we try to get to know those people over years.

We try to make this – our company be the company they want to be a part of, they want their people to really have the opportunities that we can give them and then we try to convince them that they could have a better life with us, so I'd say yes, the Southeast and the Mid-Atlantic are typically going to be our most fertile areas over time.

Having said that, if we only do one or two deals it could be just about anywhere right, because we are talking to people not from other states..

Okay. Thanks for the color. That’s all I got..

All right. Thanks, Bill..

Thanks..

We have a follow-up question from Joe Mondillo with Sidoti & Company. Please proceed..

Hey, guys. Just one or two follow-up question. Just wondering I know over the last few quarter we’ve been talking about and I just want an update on what you're kind of seeing with wage pressure and how that's being offset if it is by pricing.

Are you seeing any strength in pricing?.

Pricing, Joe, is gone up incrementally. Everybody wanted to go up more obviously we are probably seeing the same as pretty much every other contract or as they gone up a little bit in terms of wage pressure.

Yes, for good people there are wage pressure and we got to do the best job we can to put it into projects and recoveries, but with the labor situation where it is you're going to see some increase wage pressures we go forward..

One interesting thing about the way pricing has separated a little bit. On the small and mid-size projects there are really all contractors know how tough it is to get labor and they want to be paid well to do those jobs. It still the case when a big job hits the street because there are that many of them.

There's a risk in most markets that one of those contractors will give recessionary pricing. And we're not going to be that contractors part of the reason why we're making a lot of money in that throwing off a lot of revenue.

And having said that that patience in the history of contracting and in the history of Comfort Systems our subsidiaries that have exercised that have patience it’s always paid off..

Okay. And then in terms just going back to show your 2017 work that you were talking about. I recall last summer. I think I was talking to you Brian I remember at least and just you know everything - things were extremely strong you were booking into the first or second quarter of 2016? Just wondering how that compares today from last year.

Is it similar in terms of volume orders or is it even in terms of volume of orders even that much better than a year ago..

Joe it’s pretty interesting. If you look at your good general contracts, they realize what the labor situation is - really try to tie you up. Right now to make sure they can get their work done. I think it's pretty consistent to what we saw next year. I mean we all looking at work and get commitments for 2017 already.

We have a significant one that we'll have coming up, but yes, I think it's very similar..

Okay. Okay that's it. Good for me. Thanks a lot..

Take care..

We have a follow-up question from Fran Okoniewski. Please proceed..

Yes, thanks.

Just in terms for modeling purposes sequentially here and given the mix of small-to-medium size project activity that you guys have been seeing and talking about, how should we think about the third quarter in terms of just revenues similarly to Q2 in terms of revenue run rate or should we be thinking about a little bit differently?.

I think it's going to – so normally I don’t answer these kind of questions, but since the overall gets – I think it’s going to shade towards Q2 on the revenue side, because we still, actually we had more activity in that bulge that we had in the mid-Atlantic last summer in the third quarter.

We climbed that mountain, but it's very hard for me to tell you to look for organic growth in the third quarter right now, because we still have a year ago and we had a subsidiary that increase its revenues in a single year by more than $50 million and that was in – loaded into two quarters. There's one more of those quarters to go.

And what we're saying is don't let it [indiscernible], we're not saying it’s not happening..

Okay. Thanks..

Okay. End of Q&A.

At this time, there are no further questions in queue. I will now turn the call back over to Brian Lane..

Okay. Thanks, Joyce and thank you all for joining us on the call today. We are very pleased with the results of quarter one and quarter two and we are optimistic for the remainder of the year. We hope you have a safe rest of your summer and look forward to seeing you all on the road. Have a great weekend. Thank you..

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day..