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

Tahira Afzal - KeyBanc Capital Markets Adam Thalhimer - Thompson Davis & Co. Brent Thielman - D.A. Davidson Sophie Karp - Guggenheim Securities John D'Angelo - Macquarie Terry McMahon - BCS Partners.

Good day, ladies and gentlemen, and welcome to the First Quarter 2017 Comfort Systems USA Earnings Call. My name is Tony, and I will be your operator for today. [Operator Instructions] 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 conference over to your host for today, Ms. Julie Shaeff, Chief Accounting Officer. Please proceed..

Thanks, Tony. Good morning. Welcome to Comfort System 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 commentaries concerning our specific risk factors in our most recent Form 10-K and Form 10-Q as well as in our press release covering these earnings.

A slide presentation will accompany the prepared remarks and has been posted on the Investor Relations section of the Company's website found at 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..

All right. Thanks, Julie. Good morning, everyone, and thanks for joining our call this morning. Before we start, I would like to take a moment to thank the Comfort Systems employees who are listening for their continued hard work and dedication.

Let me take you through a few key highlights of the quarter and then Bill will discuss the financial results in more detail. We are pleased to report strong first quarter results given that the first quarter is traditionally our seasonally lowest and most variable quarter. We had revenue of $381 million and earnings of $0.20 per share.

The majority of our operating companies delivered solid results and for the third-year in a row, we achieved positive cash flow in the first quarter. We experienced a significant increase in backlog in the first quarter. As of March 31, our backlog was $863 million, an increase of $100 million since year-end, and the increase is broad-based.

I will talk more about that in a few minutes. During our last call, we mentioned that we had a definitive agreement to acquire BCH Mechanical and its affiliates. BCH is a well-established regional mechanical contractor based in the Tampa, Florida area. I'm pleased to announce that we closed this transaction on April 1.

BCH is a first-class addition to our organization and we are excited to have them on board. This quarter included a few challenges, but we continue to believe that we are well positioned for another year of strong earnings and cash flow. The underlying non-residential construction markets are strong, and I am optimistic about our prospects this year.

I'll discuss our backlog and outlook in more detail in a few minutes. But before I get into that, let me turn this call over to Bill to review the details of our financial performance.

Bill?.

Thanks, Brian. Please refer to Slides 2 through 4 as I provide some additional information regarding our financial results. Revenue this quarter was $381 million compared to $386 million for the first quarter of 2016, representing a 1.4% decrease. We experienced a few project delays, but overall activity levels remain good.

Gross profit was 20.0% for the first quarter of 2017, a continued improvement from the strong 19.0% in the first quarter of 2016. The increase was generally broad-based, reflecting solid project execution at most of our operating companies.

SG&A expense was $63 million for the first quarter of 2017 compared to $58 million for the first quarter of 2016 and was flat compared to the fourth quarter of 2016. SG&A as a percentage of revenue was 16.6% in the current quarter, which compares to 15.1% in the first quarter of 2016.

The increase included acquisition costs and compensation costs associated with leadership changes, along with continued service and technology investments at multiple locations. Net income for the first quarter was $7.5 million or $0.20 per share compared to the first quarter of last year when we earned $9.8 million or $0.26 per share.

The factors that impacted our earnings per share this quarter as compared to last year were disappointing results at our Southern California operation, reducing our EPS by $0.02 per share and the acquisition costs and compensation costs reducing EPS by another $0.02 per share.

And last year, we collected some very old receivables that added to our results. We also had a reduction in our EPS of $0.02 per share from a small goodwill impairment as we determined it was appropriate to write-off approximately $1 million of goodwill relating to our Southern California operations.

Our tax rate for the first quarter was 34.2% as we continue to benefit from the change in treatment for equity grants. During the first quarter of 2017, we purchased 61,000 of our shares at an average price of $35.78. And since we began our stock repurchase program in 2007, we have bought back 7.4 million shares.

We experienced a good free cash flow for the quarter. Our free cash flow was $5.3 million, which compares to $9.6 million for the same period in 2016. This is only the third time in 13 years we have had positive free cash flow in the first quarter. Before I finish, I would like to note a few details about the BCH acquisition.

As we previously mentioned, the BCH acquisition closed on April 1. BCH is expected to contribute annualized revenues of approximately $100 million to $110 million at profitability levels that are generally equal to or above those currently experienced by our overall Comfort Systems USA operations. We will own BCH for nine months this year.

In line with the required amortization expense related to intangibles as well as other costs associated with the transaction, the acquisition is expected to make a roughly neutral contribution to earnings per share during 2017. BCH should be modestly accretive in 2018.

Overall, we are very pleased with our results for the quarter and we're optimistic that improved activity levels will continue in 2017. That's all I've got on financials, Brian..

Thanks, Bill. I will add a few more comments on our results and then I will review our backlog and activity in various sectors and markets. We had very strong results in many of our markets with standout performances in the Northeast and Upper Midwest.

Although we were affected by some expenses and investments this quarter and did not match our results from a year ago, we are happy with our performance and we remain on a positive track. In general, our operations are achieving great results and we see signs of improving demand. Our Southern California operation is currently being restructured.

We believe that we have made the necessary management changes to continue stabilizing this operation. Let me now discuss our backlog. Please look at Slide 5. Backlog at the end of the first quarter was $863 million, an increase of $100 million or 13% compared to the fourth quarter of 2016.

Compared to a year ago, our backlog increased $86 million, an 11% increase distributed over several companies. These increases give us confidence that our backlog and prospects are consistent with continuing strong results. Pricing is stable and we continue to book good projects. We see signs that large projects may be returning.

Let's turn to Slide 6 to look at our end-user sectors. We have a well-balanced portfolio. Institutional markets, which include government, healthcare and education, made up 40% of our revenue for the first quarter. The commercial sector was 37% of our revenues. And industrial and distribution represented 23% of our 2017 activity.

We continue to win our fair share of projects. And overall, we are happy with sector trends. Please turn to Slide 7 for our current revenue mix. For the first three months, 39% of revenue was construction projects for newbuildings and 31% of our revenue was construction projects in existing buildings.

The combined 70% of our revenues that arise from the activities we jointly refer to as construction are the revenues that are primarily supported by our backlog.

Projects performed in connection with our service activities provided 11% of revenue and pure service, which is composed of repair, maintenance agreements and other hourly work, was 19% of revenue. Our service business is solidly profitable. And as we mentioned earlier, we continue to make investments to grow this business.

The non-residential construction markets have slowly improved over the last few years. We believe that the majority of our markets are likely to remain active and supportive for the next several quarters. Our balance sheet is strong and our long history of cash flow gives us confidence to continue to invest and return capital to our shareholders.

We are positive in our outlook, especially in light of our backlog increases and the BCH acquisition. We are optimistic about 2017 and beyond. Thank you once again to our 8,500 employees for your hard work and dedication. I'll now turn it back over to Tony for questions. Thank you..

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

Hi, folks..

Hello, Tahira..

Good morning..

So if I look out and really pay attention to your commentary, it seems like you're seeing a bit of resurgence on the construction side.

Are you kind of seeing this concentrated in some regions, some areas? Or it seems like it's a little more broad-based?.

Tahira, it's Brian. Well, I guess, really a positive for us as we see it's broad-based. And we're looking at it this morning, Northeast, Southeast and the West, everyone has picked up, which is a really good sign, it's not one company or concentrated in one area..

All right. Okay. And then, Brian, you were right a year, a year and a half ago when I think everyone was obsessed with data centers falling off and whether your broad-based improvement would be able to cover that. It has.

As you look at that broad-based improvement you're seeing right now, does it include any data centers? Or to the extent they come back, they could be upsides to your outlook?.

If you don't mind, Tahira, I'll answer that. Once in the history of Comfort Systems, data centers were super important for a year. And fortunately, that was the - and that was the last time we had a $100 million jump in backlog, the last quarter of 2014. So you're right. Those were jobs reported to us that year.

But there's always a sector in any given year that's going to have a couple - possibly have a couple big jobs and be important. What we really like this time is this is broad-based. So we won't have those comparable issues where you have a concentration and it drives so many of the metrics over the next little while. It's a mix of - in size of jobs.

It's a mix in geography of jobs. And it is some new work. Not just work in existing buildings, just a little more work in new construction, which is something we've been looking for years..

And if I could add on to that, Tahira. Even as we sit today, the project opportunities and bidding activity is still quite good..

Got it. Okay. And then last question, Bill and Brian. As we look out and we start to see this construction revenue flow, could you talk a bit about how it nuances your margins? You've seen margins that are more maintenance-driven, higher margin-driven. I would love to get a sense of that. Thank you..

Right. So the first thing I would say is, the changes I'm about to describe will come gradually. New construction doesn't start as quickly. You go and you do underground work, which is not high-revenue work. As you know, we're also early in projects. We carry reasonable margins. We carry conservative margins.

We're not a company that sort of predicts that a job is going to go well before we know how much it's going to rain and how other contractors are going to perform. So when this work first starts up, it doesn't create a big immediate leap in anything. But what you'll see is, as quarters pass, we should start to have better organic growth.

This will trend if the mix changes. And we think, by the way, we think service will remain strong. We see every sign that work in existing buildings will remain strong. But as we do more new construction, it could average our gross margins down a little bit. New construction, there's a lot more pass-through.

There's a lot more material that you buy that passes through the job. So you might see a little bit of degradation in gross margins, but the net should increase, right.

More demand means better pricing and it means a better opportunity for us to go out and really chase what we consider the mark of success, which is higher gross margins per labor hour..

Got it. That's pretty helpful. Thank you..

Let me add one more thing. Actually, we will also possibly, if this were to pick up any faster, we'll see a little more net investment in working capital. So you'll see, we'll still continue to have positive cash flow, but you'll see a little more deviation temporarily between sort of what we earn and how much we cash flow just as we make a small net.

You've seen it before, Tahira, right. So that's another thing I'll mention for new people on the call..

Got it. Okay. Thank you, folks..

Thanks Tahira..

Thank you for your question. Your next question comes from the line of Mr. Adam Thalhimer of Thompson, Davis. Please proceed..

Hey. Good morning, guys. Nice quarter..

Hey. Good morning..

The organic revenue decline in Q1, do you think weather had any impact on that?.

Adam, as you know, we don't like talking about weather too much. But I think in the aggregate, we had a relatively mild winter. Particularly in the service side and the replacement side, you need extremes, multiple days of either cold, hopefully multiple days of flood coming out. So probably impacted us a little bit, didn't help us..

There were fewer service projects, fewer, what I would call, occasional service projects. And yet, our service revenue still held up, which meant the demand side was doing - was still trending the way it has been.

But if you don't have multiple very cold days in the Mid-Atlantic and Southeast, you just don't get as much failure and opportunity for those little projects. But having said that, this is a small - a part of our business on a big number. It's not really driving the ship.

But yes, there's absolutely no doubt that a tougher winter would have probably helped us pick up a few more perhaps small projects..

Okay. And I don't know how specific you want to get here.

But with the backlog growth, when do you think organic revenue growth returns?.

I'd say, I would say by the fourth. The problem is, it's too - it's hard to see a lot of that revenue hitting the second and third quarters, right. Booking is in January and February.

A lot of what will happen this summer will be the work that's needed to be done in order to get the underground done while the weather is good to sort of get the building in a position where it can be worked on when the winter comes.

So I'd say it'd be later in the year you'll start to just - you'll see signs of it and then depends on how backlog trends as well..

Yes, but I'll also add that we're full bore right now. And by the next couple of weeks, we'll be really busy this summer. So whenever it falls out numerically, maybe close to the end of the year, but we are going to be full tilted if we're not already..

Okay. And then I guess the corollary to that is the gross margins. If the revenue line is still being driven by service work and small projects, I guess the gross margins will continue to - I don't know if you want to say expand, but at least continue to be solid..

I think we'll continue to have historically exceptionally high gross margins. But I think it will be hard to - like some of the peaks we hit in the middle of the last - middle and late in the last couple of years where we had work in existing buildings well over 60%. If it goes below 60%, those peaks will be hard to hit.

But I think what we work for is, I mentioned earlier, gross profit per labor hour and just to make more money. So it's good news. The mix will affect the gross margins..

Well, Adam, but we still need to execute the work that we get on our books here and we've been executing construction really well last year. Looking forward to that continuing..

Okay. Thanks guys..

Thanks, Adam..

Thank you for your question. Your next question comes from the line of Mr. Brent Thielman of D.A. Davidson. Please proceed..

Hey, good morning guys..

Good morning, Brent..

Brian, are you of the view that unless something really appealing comes along, you're going to take your time and absorb BCH before looking at other deals or are you going actively out there and talking to folks?.

I think you hit it right the first time. I mean we got BCH in the clubhouse now and bringing them on board. We're still out there looking at opportunities, but our history has been, bring someone in and make sure that's solid base moving forward and then we'll continue to look at them, but it's not urgent..

Brent, if you look over the last many years, we don't usually do bigger deals during busy season. There's a lot of risk to distracting an organization during busy season. So we tend to do our deals in the winter..

Okay, makes sense.

And then just it stuck out to me, I know it's just one market, but look like Michigan kind of pulled back a bit there from a revenue and I guess a backlog standpoint, anything to read into that?.

No, no..

No, not at all..

The backlog, the MD&A rules require you to name the biggest delta. So if somebody had a great - super great whatever little period last year, you have to list these guys, but that company is doing fantastic..

Yes, if we had everybody doing what Michigan was doing, I'll tell you, we'd be in Costa Rica on the beach..

Fair enough. I figure it and I'd ask. Well, and then the other one. Okay and then maybe one more of that sort of a technical question.

Bill, depreciation, amortization with the new deal, thoughts on the run rate there and then also CapEx?.

So I think their CapEx will be proportional to our CapEx. The depreciation, the amortization is a hard question to answer. Nowadays, it's unbelievable they have contortions, you have to go through with the valuation firms and the accounting firms to sort that out.

Having said that, I think that it will be proportional to the deals to Dyna Ten, if you went back and you looked at Dyna Ten, I don't have a reason today to think it would not be proportional to that. So I will say you'll see our amortization trended down during the year.

It will be up in the second quarter just because of - but it will be - they should cover that. They will cover if we get lucky, more than cover that..

Okay, great. Thanks guys..

All right, thank you..

Thank you for your question. Your next question comes from the line of Ms. Sophie Karp of Guggenheim Securities. Please proceed..

Hi, guys. Thanks for taking my question. I wanted to ask you one more on the gross margin. So obviously, despite slightly lower revenue, the gross margins have expanded quite nicely in the quarter.

And is that mostly mix driven or is that efficiencies that you find in your business and how should - help us think about that?.

So Sophie, this is Brian. Thanks for joining us. I think it's a combination of both. The mix that we've had has been largest service component of our business over time, which is a higher margin business.

But also on the construction front, we're just more efficient and productive using a number of things such as prefabrication that we build more things in the shop. So it's a combination of both things, efficiencies and the mix.

Bill, you want to add on to that?.

No. It's really - it shows that the underlying business is very healthy and performing. Yes, there's just superb people out there who work for Comfort Systems, who are doing a great job..

Okay. This is helpful.

And then so if you begin to see a bigger mix of new construction later maybe this year, would you expect to see gross margins actually kind of stagnate maybe at the levels that you've seen before or decrease or how should I think about the trajectory here?.

So I would say that the reality is, if we have meaningful increases in new construction that will average down our gross margins. Now they could stay the same instead of going up. They could come down slightly, but it should ultimate - it will ultimately be good news. Comfort will earn more money.

And let me just - the reason that happens is when you build a building, you buy a bunch of materials. You can mark your labor up 15%. If you start trying to markup commodities 15%, that's just not - I mean that's just not possible. So at the end of the day, it's just that there's a mixture of things passing through us. So we'll finally get relief.

The revenue has gone sideways for us for a long time. We'll finally get relief from that. But on the other hand, we've been enjoying these fantastic margins because our highest margin work is such a high proportion of our work. But I do want to make sure people understand.

It's only good news, right?.

Yes, that's good. We'll take it..

Thank you. This is helpful. Thanks a lot. I'll jump back into the queue..

Thank you..

Thanks..

Thank you for your question. Your next question comes from the line of Mr. John D'Angelo of Macquarie. Please proceed..

Hey, guys. Good quarter and thanks for taking my questions..

Thanks John..

So looking at the value of projects in progress that you guys report in the Q, it appears that you guys had the strongest Q1 ever for projects in progress, which hints that Q2 and Q3 could be quite strong from a revenue perspective.

How do you guys view the outlook for the summer versus last summer? And then can you talk about what cause projects in progress to be so strong in Q1? Was it projects getting pushed to the right during the first quarter or what do you guys think caused that? Thanks again..

I think Brian said, we expect to have a very busy summer. But the new work won't have kicked in yet.

I will say probably project execution was helped a little by mild weather, but I don't think it's terribly important, so I don't - Brian?.

I mean, here's the interesting thing, John. Up in the Northeast and up in Midwest that I referenced, they just had - unbelievable first quarter, particularly that part of the world.

And I think the weather did help us there on construction, maybe hurt us a little bit in service, but that will be the only reason why I think we saw more work in progress. We were at work faster this year than we were in the last two years..

Okay, thanks for the color guys..

Thank you for your question. Your next question comes from the line of Terry McMahon of BCS Partners. Please proceed..

Mr. Lane, when you were citing the project breakdown, it seems the construction was 70% of your revenues and of that 70%, 55% was new construction.

Is that that's a very high figure?.

No, actually there's a chart if you look in our....

It's on Slide 7..

If you look on Slide 7 that's available online, the exact numbers were....

It's 39% of the revenue was construction projects for newbuildings and then 31% is revenue in existing....

Right that's what you say, but of that 70%, 55% is newbuilds..

Okay, I got you. All right, I got you..

And is that a high figure based on your history?.

No, that's probably historically near the lowest in our history..

Yes..

Frequently, on average before to the last two or three years when the U.S. wasn't building very much in the way of buildings, especially the sort of Main Street, second airplane markets we are in. The percentage of our construction work that was existing buildings has gone up.

In fact, we had a year four or five years ago, where 61% of our total revenues and over 80% of our construction was new construction. So this is actually very low for us..

Yes..

Okay.

And do you expect that to continue?.

We think it's trending..

In other words, do more existing building remodeling?.

I think the existing building work we'll maintain, but I think we'll get a little bit more new construction. I think the markets have picked up a little bit. But particularly with our backlog being what it is, I think we're taking on more new construction today, Terry..

Okay..

Trending that way..

Thank you..

Thank you..

Thank you..

Ladies and gentlemen, thank you for your participation in today's question-and-answer session. We will now turn the call over to Mr. Brian Lane for any additional and/or closing remarks..

Okay, Tony thanks a lot.

I just want to give a shout out to our project management academy that's going on and wish them good luck implementing what they are learning as well, I think you get from Bill and myself, we are optimistic about 2017 and beyond, looking forward to a good strong summer, and we look forward to seeing everybody out in the road in the short-term.

Thanks, folks and have a great day..

Yes, thanks..

Ladies and gentlemen, that concludes today's presentation. You may now disconnect and everyone have a great day..