Good day, ladies and gentlemen, and welcome to the Q4 2018 Comfort Systems USA Earnings Conference Call. My name is Emma, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Julie Shaeff, Chief Accounting Officer. Please go ahead ma'am.

Thanks Emma. Good morning. Welcome to Comfort Systems USA's fourth 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 might 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, as well as in our press release covering these earnings. A slide presentation will accompany our remarks. The slides are posted on the Investor Relations section of the Company's website found at comfortsystemsusa.com. Joining me on the call today are Brian Lane, President and Chief Executive Officer; and Bill George, Chief Financial Officer. Brian will open our remarks.

All right. Thanks, Julie. Good morning, everyone, and thank you for joining us on the call today. 2018 was a record year of Comfort Systems USA. Our fourth quarter results provided a strong finish to a great year. Fourth quarter revenue was $588 million and represented a 19% same-store increase from last year. We had strong earnings for both the quarter and the full-year. We reported $0.67 per share for the fourth quarter and $3 per share for all of 2018. Full-year free cash flow was fantastic at $122 million. Like our earnings and revenue that was our best ever cash performance. Our backlog continues to strengthen. Backlog at the end of 2018 was $1.17 billion. We are entering 2019 with $218 million more backlog than we had at the start of 2018, and most of that increase $199 million represents same-store backlog growth. Year-over-year our same-store backlog is up by just over 20%. 2018 was another year of strong execution by our operating teams and we are as ever deeply grateful to our dedicated employees. Before I turn over to Bill to talk about our results in more detail, I want to take a minute and say, how happy I'm to announce our agreement to acquire the Walker engineering companies. A family-owned business that for decades has provided commercial electrical, network, end-user, industrial, and related services at the highest levels to its clients at all four the major markets of Texas. As many of you know, we have spent the last few years learning more about the electrical business and getting to know many substantial and fantastic businesses and markets that we serve on the same jobs and for the same customers. Even prior to this transaction, we have had electrical contracting embedded in certain of our operations. There are many ways in which these businesses are complementary to our own. When completed our agreement to team up with Walker and its great team will provide us with our first fully independent electrical business. We were attracted to Walker because of its people, including a strong top level leadership and its bench strength at all levels. And because of its capability and reputation in the largest and most complex projects that exist in its markets. We can't wait to welcome Walker's employees to Comfort Systems. Bill will now review some of the specifics of our quarterly and full-year performance. And then, I will take a few minutes discussing our outlook. Bill?

Thanks, Brian. Please refer to Slides 2 through 6, as I provide some additional information regarding our financial results. Fourth quarter revenue increased to $588 million, an increase of $127 million or 28% compared to the fourth quarter of 2017. From the fourth quarter of 2017 to the fourth quarter of 2018, our same-store revenue grew by 19%. Revenue for all of 2018 was $2.18 billion which represents an increase of $395 million over last year. On a same-store basis, full-year 2018 revenue increased 17%, compared to 2017. 2018 marked the first time that our revenue has exceeded $2 billion. I'm going to review the details of our gross profit and SG&A next, but I want to first point out how they relate to each other into our revenue jumps. Our gross profit percentages for the quarter and for the year are down just slightly from the prior periods. That slight decline was driven by the sharp increases in revenue as larger projects picked up in 2018. That same growth permitted SG&A leverage that far exceeds the mile of profit percentage dilution and that SG&A leverage is an important reason why our fourth quarter and full-year 2018 pre-tax profits increased by 32% and 47% respectively. Quarterly gross profit increased by $24 million compared to the same quarter last year, as we earned $118 million in gross profit in the fourth quarter of 2018, compared to $94 million in the same quarter of 2017. Our gross profit percentages were very strong and are comparable to our unprecedented levels of 2017, even as we achieved strong revenue growth in 2018. Gross profit was 20.1% for the fourth quarter of 2018, compared to 20.3% in the fourth quarter in 2017. For the full year, gross profit was 20.4% in 2018, compared to 20.5%…

All right, Bill. Thank you. Let me start with backlog and activity in various sectors and markets. Please refer to Slide 7 to 9. 2018 was a year of outstanding an unprecedented results for Comfort Systems USA. I want to reinforce what Bill said about the effect of the tax law changes. Although the new lower tax rates did increase our after-tax earnings, the majority of our improvement was accomplished by the great results achieved by our field workforce and their local leaders. Business levels are good, and our backlog continues to strengthen. Backlog increased by $218 million from one year ago, from $948 million to $1.17 billion. The year-over-year increase includes $27 million from standalone acquisition. So we are reporting a same-store year-over-year increase of $191 million as I mentioned earlier. That is a little more than 20% same-store growth. Our backlog strength is broad-based, and we remain optimistic given the year-over-year increase in bookings. All of our end-use sectors have good activity. Institutional markets, which include government, healthcare and education, made up 39% of our revenue for 2018. The commercial sector was 34% of our revenue, and industrial achieved a new peak for us as that represented 27% of our 2018 activity. Please turn to slide 9 for our current revenue mix. For 2018, 38% of revenue was from construction projects of new buildings, and 37% of our revenue was construction projects in existing buildings. Our construction business is benefiting from good fundamentals and trends in the non-residential construction market. We continue to win projects in most of our locations are reporting strong ongoing prospects. We remain committed to deploy our discretionary cash flow in ways that add value to our shareholders. Our logic acquisition announced today is evidence of that commitment. Our latest dividend increase also demonstrates that commitments and opportunistic share repurchases remain important to our strategy. Our carefully paced acquisitions have been a major contributor to our performance in 2018. We have made and continue to make investments in our service business. Service revenue is up over 6% on a year-over-year basis. Our maintenance base continues to grow and our service business is more profitable than it has ever been. Finally, our outlook. Our backlog and pricing environment are strong, and our ongoing prospects remained strong. We currently expect mid single-digit full company revenue growth in 2019, excluding our recently announced acquisition. With continued strength in most of our markets and especially as we continue to benefit from our ongoing investments, we are optimistic that 2019 will be another great year. In closing, I want to again thank our 9,900 employees for their hard work and dedication. I'll now turn it back over to Emma for questions. Thank you.

[Operator Instructions] The first question comes from the line of Tahira Afzal of KeyBanc. Your line is open. Please proceed.

Hi, Brian and Bill.

Hello.

Good morning, Tahira.

Congrats on Walker by the way, it seems like a nice acquisition.

Thank you.

First just speaking to the organic part of the business. Obviously all the indicators that are coming out to support Brian what you've been saying of a very resilient cycle visibility, which is more far reaching than you've seen in the past. Is it conceivable at this point that as we exit this year and are sitting at this point next year, that you're still seeing a year of organic growth for your business?

Yes. Hi, Tahira, who knows what's going to happen next year, but as we sit right here, there is still a lot of activity. If you look at the ABI and you look at Dodge all very positive. So I think we're pretty optimistic that we're going to get mid single-digit growth, we think we're going to get this year, excluding the acquisition. So we feel good about this year Tahira. Bill do you want to?

And as far as beyond that goes, there's really nothing indicating weakness. There's really good underlying dynamics for capital investment in the United States, where we are right. There was a long, long period of underinvestment via projects just came back in that last year, that's after many, many, many years of people not building. So I think it's always hard to predict, but I think you'd have to be pretty brave to say the United States doesn't need at least to keep investing in its building stock.

Got it, okay, Bill. And then folks just on Walker, Brian, you've talked in the past about becoming bigger in electric. Is this your first step and if you look in the past, when you've got a big company, it served as fundamental source of market intelligence further. So could we see a state of electric add-ons for you? And is that going to present some counter cyclical momentum for you all?

I don't know about the word space. We don't think of our acquisitions as space, but we would – we think Walker's fantastic. We've been getting to know electricals for a few years now. There are a lot of really great companies out there that we, if the time is right for them, we would continue to invest in electrical. I will say we just did a big deal and we're spending a significant amount of money on it. So we are never, we're not going to go race off and try to consolidate something at a high speed. We're just going to get to know people, get conviction, they would be great members of the team. By now we can get to a fair price with them and if they have a logical reason for sale to sell and we're going to make those investments when all of those conditions are met. And the other thing I really want to say is, this doesn't mean that we're not still buying mechanical contractors. We still love that business. So...

Tahira, you and I have talked a lot about this, but we like good companies with good people, good customers and we'll keep looking for those companies. But we'll continue to pursue electricals as we go forward.

Okay. And I have got a host of other questions, but I'll hop back in the queue. Thank you, guys.

Okay. Thanks.

Your next question comes from the line of Adam Thalhimer of Thompson Davis. Please go ahead.

Hey, good morning, guys. Congrats on a great year.

Thanks, Adam.

First, I wanted to dig in on margins. And just get your sense for the trends that we saw in 2018 with gross margins flat to down, operating margins up, good SG&A leverage. Do you think that's roughly how 2019 plays out?

So I would say, maybe even more so on some of those. The acquisition of Walker, once that will not – they will not start to give revenues to Comfort until the second quarter, but they do have lower average margins than Comfort as a whole. So that's going to pull the gross margin down. They do big projects and they have very disciplined SG&A. So I think that gives us an opportunity for our numbers to show SG&A leverage. I took a minute during my script to point out there is a lot of focus sometimes on gross margin and it is very important, but it's really the other side of the coin of SG&A leverage and it's also highly related to what's trending in our revenues. So we had unbelievable gross margins in the 2020s and really got well into the 2020s for a year to a year or two ago. But keep in mind, we have no organic growth at that time, right. And so our service was bigger as a percentage. At the end of the day, we just want to make as much money as we can for the amount of risk we take. If we can install a chiller and it's 90% of the cost of a project, but it's the small markup we put on that chiller is risk-free cash for our shareholders, we just want to make as much money as we can. So I think you'll see those trends continue, but it's kind of a high-class problem. It's very easy to pick one metric and concentrate on that and it's very dangerous to do that either getting too negative or too positive because of it. I think the metrics that include all of that – the metrics that for me that I look at that include all of the relevant considerations, the number one metric by far is cash. The number two really is earnings per share. Although with that you do have to pay attention to intangibles, amortization, because frankly they can hide a little bit of what they can hide a lot of what's going on, frankly.

And Adam, I just want to jump on one thing, you see, you look at gross margin, it's really how we execute it on the field and I got to tell you we are executing right now at an extremely high level in the field. So we do not have problem work. It's all good work and they're doing a great job executing it.

Okay, understood. And then I wanted to get your sense of the Q4 revenue. Kind of how that trended versus your expectations. And then as we look out to Q1, over the last five years revenue is kind of been flat between Q4 and Q1, but my sense is this would probably, would expect a decline between Q4 and Q1?

So I'll comment on the first part of that. We never expect a 19% same-store revenue increase. And that's what we got in the fourth quarter. And for the full-year, 17%. You guys know that last year at this time, we were talking about mid-to-high single-digits. We did have a company in North Carolina that had a – there was a slowdown in North Carolina, the year before. So they had a really, really favorable comparable. So I don't think you'll – they were very significant part of that outsize revenue performance. I don't think you'll see that again this year at the levels we saw last year. But our backlog is up 20% year-over-year. Some of that is longer term backlog, so it won't translate in the 20% growth. But we – we got a lot of work to do.

And we're very busy right now, even in January and February.

Yes. As far as quarter-over-quarter I don't know. I think that with the backlog it would be logical to expect at least, that it wouldn't be flat, but I wouldn't fall off my chair if it was. All we really care about is cash flow and net earnings.

So most of us we'll fully utilize that.

Okay, I get it. Thanks for the time.

Your next question comes from the line of Joe Mondillo of Sidoti & Co. Please proceed.

Hi, good morning guys.

Good morning, Joe.

So first on the Walker deal, congrats on landing that deal. But just in terms of the general guidance that you gave in terms of neutral to slightly accretive. I was wondering are you baking in any sort of debt paydown regarding that guidance?

So that does include consideration. First of all, that's a very general guidance, right. It's not very specific. But it does include a consideration of the interest we will pay on debt for a little while. We just think – so the deals we've done in the past, some quarters they've given us – in the first few quarters after we get that, we have massive amortization of backlog. Essentially the accounting rules kind of make you high earnings – the money you're making on the backlog that was existing the day you bought them, even though it still happens in the real world that we still own them while it's happening. But at the end – and by the way that amortization runs through the cost of goods sold line. So just FYI, the rest of the amortization by the way it runs through SG&A. The longer-lived amortization. So those are very important. And there is a table once your in the 10-K that you can look at that gives that the forward amortization. Obviously, it doesn't include Walker. So I don't know, those are just important things I'd point out.

Right. But just to clarify in terms of that sort of general accretion guidance, you're not baking in any sort of debt – paying back the debt that you're going to use to make this deal. Because you're going to have a good amount of cash flow. And I imagine you're going to be quite aggressive…

You mean reductions in interest because of paydown of debt?

Right.

We think the paydown maybe faster. Now, I mean it's 4%. We are paying 3% or 4% interest on our revolver. So those numbers don't become very important compared to what they are. And how it compares to what we had to amortize, but no.

Okay. And generally, how long does the backlog amortization – just the amortization related to the backlog last? Is it like 18 months or so?

So for most of our deals, it's 12 to 18 months. And it's a sinking pool. So it's a bigger – actually for some odd reason, it get a little bigger like about – for about the first quarter or two and then it goes down. So it's not a straight line. But it's usually about 18 months. For Walker, we haven't – obviously we're not even closing that deal till April 1. So we haven't even begun to get our valuation firm involved the way we are required to. But I would predict, it's more like a 24-month run out, their projects are bigger and longer. They do a lot of mission critical, a lot of heavier stuff. So I suspect it will stretch out a little longer in this case. That's why we said 18 months to 24 months, we usually say 12 months to 18 months.

Okay. And just lastly on the Walker deal, regarding sort of the first quarter or two, given your comments that you just made on the amortization, is there any risk that the deal is dilutive to EPS, maybe given some -- the large backlog amortization in the first quarter or two? Just wondering if there's any risk there…?

I think that's highly unlikely, but also even with the deals we've done in the last few years, there might have been a quarter where one of them was a $0.01 dilutive based on the matching and timing and, because they are just like us. Their earnings are a little lumpy. We're talking about one subsidiary. But I don't think it will be meaningful. I think that ultimately they will be neutral to slightly accretive. You made me guess there'll be one quarter of the first four where they cost us $0.01 and in some quarters where they give us $0.02 or $0.03. But it's just not, especially the size we're at now. It's pretty much neutral to slightly accretive. It is really neutral is the way to think about it.

Okay. On the organic business, your backlog obviously strong on a year-over-year perspective, but it declined from the third quarter in the last few years that actually increased from the third quarter to the fourth quarter. It looks like your orders were sort of flat year-over-year. Just wondering if you could comment on that?

Yes, Joe, I think, it's pure seasonality, maybe some awards got pushed out to January, but not a concern of ours, still plenty of opportunities and backlog will be good this year. I think it's more of a timing issue than it was anything else.

Okay.

A lot of our guys are pretty full.

Yes. And we're pretty full too. So we'll take and work that if we like and that's it in a wheelhouse, so.

All right. And then in terms of that, it seems like utilization rates are really high. You've talked about how pricing on a net-net basis, obviously you're having to pay wages a little more. But on a net-net basis, it seems like pricing has been positive over the last year or two. Does that given sort of the capacity issues and utilization rates, does that become more of a positive in 2019 in terms of pricing?

It's really hard to say. We've been getting raises since 2015 in different parts of the country sort of at different times that would spike up. It started for us in the Mid-Atlantic in 2015. We're still happily giving raises to guide our strong workers. And we are raising our prices to cover them. And so far, it's worked out well for us. It seems like the trends are the same, but...

It's been pretty – I think last year would be similar to this year in terms of that Joe.

Okay, last question for me. The projects that you have in backlog, could you talk about the mix there, because I know some projects are more profitable than others. Just wondering how that backlog mix looks like compared to maybe the work that you already did in 2018?

Yes. That's a really good question. In fact, the backlog mix and our revenue mix going into 2019 are almost identical. So we are seeing good strength in education, and healthcare is around 20% of our backlog, which has been very good for us. And it's the strength we have industrial today is a lot stronger than we've ever had over 20% of the backlog there. So the mix is very similar to the revenue we saw last year and I think it will hold that way to the rest of this year.

Great.

It's really balanced.

It's really balanced, and it's broad-based. So it's good geographically.

Okay, great. I have a couple more questions, but I'll hop back in queue. Thanks.

All right.

All right. Thanks.

[Operator Instructions] The next question we have is from the line of Bill Newby of D.A. Davidson. Please proceed.

Good morning, guys. And thanks for taking my questions. Congrats on the deal on a great 2018.

Thanks Bill.

Thanks, Bill.

So I guess just a couple more on Walker. Bill, you mentioned the lower margin and the larger project mix. Is that really the only driver for that that difference is there anything else going on there? And I guess the follow-up would be is there an opportunity for you guys to bring them closer to what you guys are currently doing as for business?

This is a very innovative company. They have just extraordinarily good workforce. They've begun to invest in things like prefab. We certainly hope and plan to support that in every way we can. But I will say those kinds of changes at Comfort, they have – they unfold over a long period of time. So we don't put synergies and deals. So I would say, yes – no, we think they got a lot of potential to continue to get better and better.

I mean, we are really optimistic, Bill that we're going to learn from them. And hopefully, they can learn from us, and we'll move forward. They're very good people. And I'm very confident. And their work in the field is exceptional.

Okay. Is there any service aspect of their business at all?

So proportionately much smaller than Comfort as a whole, we think that is an opportunity. It's a place where they've invested. They had a service business in Dallas for a while. They very recently pushed into service in their other three markets. So that's – they had a lot of vision on. Service is different for electrical. Service is more reacting getting the power back on disaster recovery. It's a little less break fix and a much less preventive maintenance. But it's a really good business, really good skilled labor force that has a nice mode around it. Customer relationships are valuable. So I would say the answer is proportionately less, like if we started to do more electrical, you might see the percentage of our revenue that service average down a little bit, but it's still, it's much a lot of people don't think there is service in electrical and we disagree with that. We think it's a good opportunity.

Particularly, Bill in the stuff, you see that goes 24/7 mission critical data centers, hospitals stuff like that. So I think there's an opportunity there for them to grow it.

Okay. That's good to hear. And then I guess this will be my last one. Any revenue synergies with this business? I mean, are there opportunities that open up for you now that you have both mechanical and electrical contracting services, where you can like I guess do a one project with both of those capabilities, bid one project with both of those capabilities?

I wouldn't emphasize that. We take work based on it. We don't really – we would just want good work. We take what the market gives us. It's going to be very different superintendents. I would say that's not something. Certainly there may be times when we help each other. Our businesses help each other, but in general, these business standalone in most markets.

Yes. I agree.

Okay cool. Appreciate it, guys and congrats again.

All right. Thank you. Thanks.

Next question comes from the line of Joe Mondillo of Sidoti & Co. Please proceed.

Hi guys. Just a couple of follow-up questions, looks like you're your service revenue was up for the year, but it looks like it might have been down in the fourth quarter. Am I reading that correctly and if so, any insight on what was going on there?

So I don't believe it was down, but let me just look here for a second. All right so services of course, service revenue increased by $9 million in the fourth – barely up, not that much. It increased by $9 million in the fourth quarter of 2018, it was $140 million versus $131 million, but our percentage was notably between the fourth quarter of 2017 and the fourth quarter of 2018, In fact that strength in the fourth quarter really made the year-over-year comparison for service, look much better to our guys who run service let's say, so...

Yes. I tell you, Joe. Just one sector that we can be really proud of is what's happened in the service business here. The size of it and the execution improvement that we get in the margin improvement that we are getting is really helping us. So we're going to continue to grow that business, continuing to invest in it, and I'm very optimistic going forward, what we're going to do there.

And with all this new construction that you've been working on, that you've been realizing in your revenue and still in the backlog, do you anticipate servicing as a percentage of the business to take another leg up in 2019 or 2020 as a result of maybe building relationships with all these buildings that you've been working on in terms of the new construction?

As a percentage of the business, the next time service is likely to go up is the next time construction goes down. The reality is the construction wave is just bigger than the service wave. So you have service – it's been constantly growing for us, really the whole time I've been here, right, which is the whole time, we've been here. It's just constantly grows on an absolute level, but during a time the constructions on the upswing as a percentage of revenue, it will go down even as the absolute levels have always continued to grow for us. And then suddenly, it will be super important in the next recession and it will make all the difference. Our goal years ago is – did we our service 2x17, we called it was to build a $500 million service business. We're happy to say we're way past that now. It's going to be great – that's going to be very helpful in the next recession.

Great. In terms of the new construction projects, you try to contract relationships after sort of working on the new construction. Do you try to contract relationship for the servicing going forward? Correct?

Absolutely. We developed relationship with the owner due to the construction phase and obviously give them a proposal and build a relationship with them to get that service work. Absolutely, Joe.

Okay. And then in the fourth quarter, your non-organic growth, the growth contributed from acquisitions seemed it was higher than I was anticipating, did that Indiana acquisition or any other…?

That's a good pick up. They had $8 million or $9 million more than we said they were going to annualize. They had a nice revenue quarter. So you're right.

Yes. That company is performing at a very high level for us.

By the way, they are like virtually a 100% industrial.

Yes.

And is that sort of a one-quarter off type of thing, or is there backlog still very strong and that's sort of being sustainable?

I tell you that backlog is very strong and their opportunities are a very strong, up and down the East Coast.

Yes, I think so the last quarter where they will be revenueing for the first time right there that we've owned them for nine months as of year-end is the first quarter. Certainly, I think they'll give us a little more revenue in the first quarter than if you wouldn't annualize what was in our press release last year. Now we're talking single-digit millions right, it's not – it matters I know in your model, but it had not changing the trajectory of Comfort Systems, but it's great. It’s awesome.

Great. Okay. And then last question from me. It seems like the mix of larger projects versus smaller is increasing. Could you just talk about what you're seeing that's – if you're meaning to do that or is that just what's taking place in the market? Or just talk about that and sort of the profitability aspect of that?

Yes. So you're absolutely right, Joe. There is been an uptick and let's call it work over $10 million in value to us. If you look at that data centers and work like that, it is larger work. We see many new opportunities, particularly in the Southeast here in Texas. I think that trend will continue to this year. We like bigger work at certain of our subsidiaries and we're going to continue to pursue them and we're executing very well on it at the moment.

It wasn't in the market, now it is. By the way, we're still only 1% different. Work in existing building is fantastic, like virtually that's kept pace with our new construction work. Some of that's because we're getting to be more industrial an awful lot of industrial is addition retrofit. In the United States, an awful lot of industrial investments is addition to existing capacity, great builds rarely happen and when they happen, it's to go get some state to give them a lot of money, usually, right. They almost always buy thousands of acres next to whatever they build and then they just add to it when they need it.

Right. Okay. Thanks for taking my questions.

Yes.

All right, Joe.

Take care.

I would now like to turn the call over to Brian Lane, Chief Executive Officer for closing remarks.

Okay. Thanks, Emma, and thanks everyone for calling in and participating in the call. We had a great year in 2018 and we look forward to 2019 and doing the same thing all over again. So once again thank you and we hope to see you on the road soon. Have a great weekend. Thank you.

Thanks everybody.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.