Comfort Systems USA Inc (FIX) 2006 Q4 法說會逐字稿

Welcome, and thank you for standing by. At this time, all participants are in a listen-only mode. [OPERATOR INSTRUCTIONS] Today's conference is being recorded. If you have any objections, you may disconnect at this time

Now I will it turn the meeting over to your host, Mr. Bill George, Chief Financial Officer, Comfort Systems USA. Sir, you may begin

Thanks, Marcella. Good morning, everyone. Welcome to Comfort Systems USA 2007 year end earnings call.

As always, we want to remind everyone that our comments this morning, as well as our press releases, contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. What we say is based on the current plans and expectations of Comfort Systems USA. Those plans and expectations involve risks and uncertainties that could cause actual future activities and results of our operations to be materially different from those set forth in our comments.

You can read a more detailed listing and commentary concerning our specific risk factors in our Form 10-K that was just filed, as well as in our press release covering these earnings.

On our call with me this morning are Bill Murdy, Comfort Systems USA's CEO; and Tom Tanner, our Chief Operating Officer. Bill Murdy will open our remarks.

Thank you, Bill. Welcome, everyone, to Comfort Systems 38th quarterly earnings call, and thank you especially for being on the call this morning on this rather interesting morning on the market. We are very pleased to report solid results for both the Q4 '06, and full year 2006.

For the fourth quarter, revenues were up 15% over last year's fourth quarter, and net income was up 6%. For the year, revenues of just over a billion, at $1.056 billion, represented an increase of 18% over 2005, and net income was $0.70 a share versus $0.49 a share, excluding the non-cash goodwill impairment that we took in '05. That represents a 43% increase in net income.

While these are very handsome results, we nonetheless continue to feel the drag from the under performance of our multi-family, our high rise condo and apartment project business. Bill and Tom will have a little more to say on that later in the call here.

Our backlog was slightly down from historic high levels of last year and continues to be robust, and I might mention that over 100% of the decline from last year is due to our efforts to downsize our multi-family activities. All other sectors, schools, healthcare, office, et cetera, remain strong. In general, with certain geographic exceptions, we are seeing healthy commercial construction activity continuing and we believe that continues through '07, and into 2008.

Comfort Systems continues its three-part strategy of, one, productivity improvement, two, increasing our service component, and, three, overall growth. Our productivity improvement shows up in increased net operating margins, and while improved from prior periods to now, 4.2% for calendar 2006, we still believe further improvement is possible, especially as our multi-family construction and installation improves.

In the service area, which we are expanding, currently stands at 40% of our revenues, and we've stepped up our efforts even further to increase our service business, and early progress is encouraging. As to general growth, let me say this, over the last few years, our growth has come from internal expansion primarily, in both construction and service, and that will continue. But further, we have established new locations in Charlotte and Memphis and Las Vegas, but not by bringing on any new companies.

However, acquisitions do remain on Comfort's path forward, as we continue to look for operations in areas where we are now not presently located and that fit with Comfort Systems. In general, the efforts and expertise, experience, enthusiasm of our 6,500, plus or minus, employees in both field and office around the country are gratifying and indeed responsible for our continuing positive results. These efforts are something our people themselves and our stockholders should be quite proud of. I'll come back with some concluding remarks, but would like to turn the mic over to Bill George.

Thanks, Bill, I would like to discuss a few details of our strong results. As the numbers that Bill reviewed demonstrate, our earnings have increased strongly. Our fourth quarter of 2006 exceeded the same quarter in 2005 on both the net income and revenues lines, which is gratifying given that in 2005, we had a particularly strong fourth quarter. In 2006, our full year earnings exceeded 2005 results by more than 40% with earnings per share of $0.70 in 2006, compared to 2005 earnings of $0.49, not including the negative effects of our 2005 goodwill impairment.

Unfortunately, our strong and steady improvement in our combined book of commercial, institutional and industrial work was, again, offset by challenges in our large multi-family projects. These projects continue to experience margins that are substantially lower than our remaining book of business. The simple truth is we took on more of this work than we could efficiently perform. We are working hard to improve the results at our operations that specialize in large multi-family, and Tom will talk more about that in a few moments.

Cash flow was strong in the fourth quarter. Although we have been investing substantial additional money in working capital due to strong growth, free cash surged as we cleared over $22 million in the fourth quarter, and ended the year with free cash flow of $17 million. Our cash balance at year end was more than $90 million and we have no debt.

We have also closed a new credit facility that added capacity for strategic initiatives while simultaneously removing all but two of our covenants. This agreement gives us even greater stability and flexibility for the next five years. As Bill mentioned, total backlog was down, although it remains at very robust levels. The change in our backlog continues to reflect a shift away from multi-family bookings to all other categories of commercial work, and thus backlog in non-residential building work, which is the bulk of our business and is the most profitable, has increased again.

This is a very good trend and we believe the shift towards even more commercial, institutional and industrial work will help us improve our mix of business, and will help margins in 2007. As we have mentioned in the past, a small backlog does not necessarily indicate a decline in revenues.

Service and smaller project work does not appear in our backlog, and larger projects stay in our backlog for many quarters and sometimes for years. Since multi-family projects represent far larger average project size than our overall book of business, the transition away from multi-family work can reduce our backlog, even though revenues for the Company continue to rise.

Over the past for years, we've been able to demonstrate increasing success at seizing the opportunities that have been afforded to us by good markets. Discipline and work selection and execution, and then diligence in collecting payment are important in any kind of market. We feel that the mix of work and opportunities that we have and the underlying market conditions give us a good opportunities to continue to produce strong results. And speaking of results, that's it on financial. So now, I'll introduce Tom Tanner, our Chief Operating Officer. Tom?

Thanks, Bill. Good morning, everyone. I would like to start by acknowledging and thanking our 6,500 team members whose efforts resulted in the 47% increase in our net income year-over-year. We would also like to specifically recognize a majority of our companies for their contribution to our very strong financial performance in 2006.

I'm very pleased that it is a long list. From our larger revenue companies that achieved very strong results include Tri-City Mechanical, Comfort Systems USA (Syracuse), the S.M. Lawrence Company, Quality Air, California Comfort Systems USA, Comfort Systems USA (Southeast), North American Mechanical, Hess Mechanical, S.I. Goldman, Comfort Systems USA National Accounts Accutemp, and Climate Control.

Our smaller revenue companies that contributed very strong results include AirTemp Mechanical, Seasonair, Batchelors Mechanical, ACI Mechanical, Comfort Systems USA (Ohio), Capital Refrigeration, Temp-Right Services, James Air, Comfort Systems USA (Baltimore), Eastern Heating & Cooling, and [Amtech] Services.

Our continuing investment in training for both our construction and service team members has proven to be a key element in our current and future financial performance. We will continue to make that investment in 2007. Our focus for our construction group will continue to be on project selection, pricing and execution. We will use the resources of our regional staff and our construction mix groups to continue to implement best practices to achieve incremental improvements in all of our operations.

In our Service Group, we will continue to expand our training programs that relate to growing our preventive maintenance service agreement base. We have also added training programs for sales management, and for sales of retrofit quick turn projects, which typically carry higher margins than larger construction projects.

In the same manner as the Construction Group, we will use the resources of our regional staff and our newly created service mix groups to implement best practices as they relate to improving the delivery of our service offerings. For both Construction and Service, we will continue our efforts to maintain and improve our industry-envied safety record, which has one of Comfort's core values since our inception. As always, we will closely monitor and evaluate all of our SG&A expenses to ensure that we continue to maintain the appropriate level of our expenditures, even as our revenues increase.

As Bill previously mentioned, our margins on the great majority of our multi-family housing projects have been unacceptably low. In 2006, we simply had more work than we had adequate resources to profitably perform. The situation was made even worse when certain projects that should have been substantially performed in 2005 were delayed, pushing even more work into 2006. To significantly improve our financial performance in this market, we are continuing to downsize certain operations while also adding and/or changing our management resources.

We are making better project selections which allow us to improve our project pricing and our execution. The management teams in these certain companies are fully committed and capable of making the necessary improvements that are operations that will result in improved profitability. We believe we will see these changes will begin to have a positive impact in the later part of this year.

We continue to believe that this segment of our business can achieve margins comparable to the margins generated by other segment of our construction operations. We are pleased with the current level of our backlog. Our non-multi-family housing backlog has increased year-over-year. The overall small reduction in our backlog results from achieving our goal to reduce our backlog of multi-family housing to more manageable and profitable levels. Our pipeline for both Construction and Service opportunities continues to remain strong.

Our financial results for 2006 have created a strong momentum in our operating companies going into 2007. Our management teams are excited and passionate about what they do. They are committed to bringing incremental improvements and innovation to the operations each day. Thus, I believe we will have improved financial results in 2007 as compared to 2006. Thank you. I will turn it back to Bill for his wrap-up, and then question and answers.

Thanks, Tom. And my wrap-up really is a short summary of things that Bill and Tom have said. During 2006, we made very significant investments in dollars and effort, and, of course, in time in our core business activities. It included training our people, adding to, especially our service sales resources, and expanding into new locations.

Based on these investments and what we see already coming out of them, it's our sense that, and our sense that the commercial and institutional, industrial sector remains strong, but we are optimistic that our revenue and net income for 2007 will increase as compared to 2006. At this point, we would like to entertain questions from those of you on the phone. So Marcella, if you are there, you could conduct that session. Looking for our operator here. Hello?

I'm here, sir.

We're, we would like to start Q&A, Marcella. Thank you.

Thank you. [OPERATOR INSTRUCTIONS] One moment, please, for the first question. Our first question comes from David Yuschak, Sanders Morris Harris. Sir, you may ask your question.

Good morning, gentlemen. Question for you. Gross margin in the quarter was your best at 17% that we'd seen in like three years or so. And given the kind of level of drag that multi-family you indicated has been on the operations, does that suggest the drag is becoming less a drag because of the performance of gross margin in the quarter?

I'll address that briefly, David. I think it's more that the gross margin that we are experiencing in the other sectors is better and offsets the multi-family. Tom, I don't know if you want to add anything?

I totally agree, we had some very, very strong results from the great majority of our companies and that's what was able to offset the much lower than acceptable margins in the multi-family housing business.

How much was multi-family in the quarter as far as percentage of revenues?

About 20%, so for the year, we will average in the low 20s.

Okay. When do you think this, the drag here ultimately begins to have a fade? First half? This year?

It will continue to affect the first half is the way I would put it.

Second half, second half should be more unencumbered by it then?

We believe that.

Given the performance in your gross margin, then in the quarter, your operations as you addressed, Tom, is it pricing? Is it execution? What, because -- it's dragging on the multi-family like it is that the rest of the operations are really, are cooking well.

Well, you know, I think so it's a combination of both, obviously, the robust construction market has allowed us to get some pricing, but really, it's the culmination of several years of working on our execution, of sharing best practices among our companies, and the relationships developed over the years have really ended up in people really sharing best practices, and we've seen just a great deal of implementation of new ideas in our various companies, which has really improved our execution.

One last question, SG&A, you guys generally have been trending about $30 million for several quarters, picked up a little in the third quarter, $32 million, and then jumped another $2 million plus in this fourth quarter, and up $4 million from the end of last year on no more than, made a $29 million revenue increase. Is there things in there that you are spending on that represents future opportunities or could you give us a sense as to the recent ramp and what the nature of it is for?

We absolutely think some of it's investment, some of it is simply the fact that we have much higher number of employees, much higher levels of activity, but if you, when I look at the detail of what our dollar increase in SG&A is, and just for the everybody else on the call, I know you know this, Dave, our SG&A is not up nearly as much as our net income, for example, or our revenue, so we are still getting some leverage.

But when I look at the dollar amounts, attributable to specific items, the two items that jump out are, one, increases in incentive payments to the people that run these operations, and the other is a big increase in the number of sales people. We've hired from competitors in the industry and from a number of places, some pretty high-powered sales people across the Company, particularly on the service side, and we are definitely making a net investment in that effort, and we, it costs dollars out the door to get that going.

Would you say it could cost you upwards of $0.02 or so?

Those two things together would cost more than that.

Yes, I know.

I wouldn't want to quantify just the sales. I would say the sales would be above $0.01. I could put names to $0.01 of that.

I think -- and I've never, never mind you guys spending more resources to grow the top line just because without acquisitions, you need other resources to get you the business, so that certainly makes sense.

One last question, on the size of the credit facility, knowing you guys got $90 million, is that, does that suggest that, is there the potential for an authorization for a share buy-back with $90 million? Or is your focus going to be on trying to find additional resources because, certainly, we are very optimistic about the next couple of years in non-residential construction, and some of your investments are showing up in the income statement, any maybe instead of new business opportunities and way of acquisitions, just give us a sense as to how that might divide up? Between those two.

The primary effort will go toward growing the business, and that could be, as I said, certainly probably will be in part through acquisitions. We are not represented in a lot of geography in the country, a lot of attractive places. We continue to look, we want to buy, bring companies in reasonably priced, and want to make sure they fit from their perspective and ours. We've got certain things we want to continue to do within the current structure, and we've spent some money here, of course, quote/quote investment, not [capitalizable], but investment in new sales, especially service sales persons and service operations persons.

That's the primary use, we continue to look at, discuss, share buy-backs. But there's such, we think there are real opportunities for growth of the business, and that takes some capital.

Thank you, guys.

Thanks, Dave.

Your next question comes from [Kevin Wank], [Poly News Capital Management]. You line is open.

Good morning. I have a couple of questions. The first is concerning potential acquisitions. Maybe you could give us a summary of, given that not much happened in the past year, what your business development/acquisition activities consisted of a year ago in terms of trying to identify potential candidates, and what it consists of right now?

Well, yes, it's stepped up, both in terms of time and focus, no doubt about that. That's not the -- not having acquired something is not hindered by our efforts . We haven't found the right things at the right costs to us at this point. We are, we are actively in discussions in various jurisdictions in the country over things. We don't think, Kevin, that we are going to be -- I take that back, we are not going to be a serial acquirer, we're not going to be a re-consolidator here, we will judiciously add operations that fit and that want to be part of Comfort Systems going forward. And we are looking for activities of size and weight and quality to, that we can bring in.

It sounds from those comments that we're more likely to see something that might cost, let's say, $25 million to $100 million. That's more of a strategic acquisition than five to 10 things that might be, oh, I don't know, $5 million to $15 million. Is that a fair assessment?

I hate to be predictive like that, one of the things in our business is a lot of the very good service oriented HVAC mechanicals tend to be smaller, and we are certainly not going to pass up opportunities there just because we are, we designed something that we need sized from, but on the other hand, we are looking at, we would be very favorable toward looking at larger entities, as well.

Speaking on the service side, you mentioned that there have been a number of hires on the sales side of people that are possibly more oriented towards selling maintenance and services versus new projects. How long do you think on average does it take someone joining various Comfort Systems operations to get ramped up and where you start seeing the sales come in from a new hire like that?

In many of the cases we're talking about, we have hired experienced sales people that have a reputation in their existing marketplace, so certainly, within three to six months, we would expect these people to be up to speed, and generating a new revenues in a relatively quick manner. We are planning to work on people that are experienced, where Comfort's reputation in the marketplace has made, brought us some opportunities we might not have had a couple years ago, so we can get these people on board and get them ramped up, and bringing new contracts through the door relatively quickly.

Okay. And then in terms of the multi-family, given the experiences with lower profitability and some of the ups and downs of some of these projects, do you have an objective for the future of how much you would like multi-family to be of your mix, to lessen some of the risks of that, I mean is it 10% to 12%, 15%? What are your thoughts on that?

We've publicly said before that we are looking to get that, to have that business in the mid teens as a percent of our total. It's a good sector, and as Tom indicated earlier, we believe, and we know and we have in the past at the right size of business, achieved profitability comparable to the profitability of the sectors. We know that's possible. We got out in front of ourselves, Kevin, on that, too much business too fast, just out distanced our ability to properly execute.

Okay. And one last question. Depending on how quickly multi-family goes down to those levels, in view of overall construction activity in the U.S., and your comments earlier that, I hope I'm not mischaracterizing this, but it says you hope that '07 is above '06. But what's the possibility with multi-family contracting and, let's say, 6% to 8% growth in other construction, that it is a stretch to get revenues in '07 above '06?

I don't think I used the word "hope," I said we were optimistic they will be, and we see growth in the other sectors, and you know, we are not radically, in terms of the actual numbers, we are not radically downsizing multi-family. We are downsizing for sure. I think on balance, the net will be that we will produce more revenues in '07.

Thanks for your help. And your cash flows look great, I'm sure you can boost the growth with those.

Thank you very much, Kevin.

Your next question comes from Rich Wesolowski, Sidoti Company.

Thank you.

Good morning, Rich.

Can you give us a sense of timing as to when we should expect to see backlog begin to rebound?

You mean aggregate backlog?

Total backlog.

We are not particularly good at crystal balling this. We are purposefully downsizing the multi-family as we've continued to say here. It's stabilized -- what's happened here, it's stabilized at a high level, and we are running off work here. And adding at the same time. We have a healthy pipeline, which is beyond backlog.

It's a complicated question, because it's impacted very strongly by business mix in addition, and not just by activity levels, I think everybody in this room feels good about activity levels and about our ability to grow like we've always done, we've always been able to grow faster than our industry, even in our worst times.

But business mix issue, we are spending so many money and time trying to increase our service, and of course, if we are successful in that, that does, that does emphasize stuff that doesn't go into back backlog. But all of that said, I don't think there's any reason to fear backlog going down much more. I don't know.

It also can be deceiving in that we could book two or three large projects in the $20 million to $25 million range, and it would drive up our backlog and people would have, would look at it and say, well, the backlog level has gone back up, but that work may take two to three years to perform, so it's misleading as to the impact of that increase in backlog would have on revenue.

I think you have to go back to Bill George's earlier comments about the size of it, how long it stays in the backlog, and as we focus on this quick turn work, we can see revenue increases that are never going to reflect in our backlog. So we are pleased with the level of our backlog as reported, we focused on our companies making proper project selections and not out selling their resources, and we, so we can incrementally grow that business, grow the service side and have a revenue increase without a big increase in our reported backlog.

Okay. On a related issue with the timing, you've been reducing the revenue contribution from the multi-family sector since the March '06 quarter, when should we begin to see year-over-year increases in the gross margin which, I can assume, is what Bill Murdy was referring to in the profitability mix comment in the press release?

We are optimistic that by Q3, we will have worked through this low margin backlog and that the newer backlog that has come on in our books over the last two quarters will be working through our operations and then we will see very, a nice improvement in those gross margins.

We still see the multi-family housing business as being robust in certain markets, so we are just being more selective about what we are taking and how we are pricing it, moving forward, but it isn't like it's going to disappear from our backlog.

Two months into the first quarter, can you give us just a general idea of how operations are going so far, whether there's been any atypical issues in weather patterns, anything like that?

Nothing atypical. They are having a winter in certain parts of the country this year.

By the way, only one month has been reported, March 1, we don't really know what February is.

Okay.

Nothing --

Activity levels seem --

You know, this does give us a chance to mention for new listeners that the first quarter of the year is the seasonally low quarter for us, and we absolutely demand and expect profitability in the first quarter, but it is seasonally low compared to the other quarters of the year, and that's true for every company in our industry.

Okay. Thank you.

Thank you, Rich.

John Rogers, of D.A. Davidson. You may ask your question.

Hi, good morning.

Good morning.

Your comment on the low margin portion of your backlog that you will be working off, I guess, primarily in the first half of this year, how much backlog is that ?

John, I think the comment you are referring to is Tom talking about the multi-family backlog?

Right, and I understand that some of your multi-family you hope will be higher margin, but -- you referred to a low margin bit of work now, and I'm trying to get a sense now of how much that is?

I think we have a good number for you right here. $50 million, including work in progress. Yes, I would say $50 million is a low probability, low margin.

Below your sort of target?

Yes. Absolutely.

And how much of that work did you have last year, for the whole year? Was it 100 million?

More than $50 million.

Yes, yes.

I would say more than even $100 million.

Okay. I'm just trying to get a sense of how that is going to transition this year?

You have to, one thing that's complicated when you think about that, this kind of stuff over represents in backlog as compared to how it represents in revenues, so keep that in mind, but we had a lot of people working really hard this year for not a lot of money, and it was very disappointing for us in that segment.

But I guess the point is, that proportion is going to drop significantly.

There is a mix, there are two issues. As multi-family goes down, even if it didn't become more profitable, our overall mix is going to get better and that's why, that's probably why you hear us saying some things that are not entirely characteristic of us, which is being pretty positive about profitability, because even, we certainly hope we become more profitable in that area, but we, the backlog tells us we will be doing less of it.

One of the other encouraging things, we believe that a lot of this work that resulted in low margins in '06 and in the first half of '07 was really good work, we just didn't have enough people to execute it properly so, we had acceleration on jobs, we had a lot of rework, and things like that that affected the margins. If we'd had less work, we would have been much more profitable in that segment, and that's why we believe that this is a good segment of business for Comfort Systems to be in. And we had some companies that had -- did some large multi-family projects that had very substantial results in 2006.

I guess I was curious about the magnitude as opposed to the market segment.

You got it pretty much right, John. We're going to do a lot less low margin or lower margin work in the multi-family sector in '07 than we did in '06.

And then, the second thing is, can you talk a little bit more about your services business, providing ongoing service? How big a portion of that, of your business is now, and is it possible to break it out, because I know it's wrapped up within -- as opposed to new construction?

We don't break it out perfectly, but 40% of our business is service as defined, i.e., not new construction. A good portion of that is maintenance, a good portion of that is contracted maintenance. And then we've got repair and retrofit work, and by and large, that, not by and large, that business is almost endemically higher margin than the construction business for a lot of good reasons.

And that is the piece of the business we are working to grow, and that's the reason we've made the investment in time and dollars and effort and focus to grow that side of the business, and we've got to start with the sales side of it, of course, you have to perform it ,so we are recruiting and training techs and expanding our relationships, our national accounts business, it's getting new accounts.

So it, we are on a program to increase that as a percentage ever total revenue, and given the fact there is so much installed base, much of which is aging, much of which is installed based where energy efficiency is an operating concern, we feel very good about service going forward.

Do you try to sell that on a per facility basis or is it on a, I don't know, a national or regional account?

We really sell it on a per facility basis, where we go in and estimate the cost of maintaining the existing equipment in the facility, it is not something that you can look at across the board, it has to be specifically to the facility, and the great majority of our work is done for individual corporations, not on our national accounts book of business.

Okay. And lastly, is that included in your backlog?

No, there's no service included in our backlog.

Okay. Great. Thank you.

Thank you, John.

Greg Macosko, Lord Abbett, you may ask your question.

Yes, thank you. Just with regard to the lower margin residential business, are you turning away business on that score? Are there people coming to you and you are saying no?

Yes.

Okay, and you have sort of a standard or, when you bid on business, or accept business, you've set a margin level, sort of as the, above this level we'll take it and below we won't?

Absolutely. The things that we look at are where the project is geographically, who the owner, developer, general contractor is and what kind contract he will want us to sign, the pricing of the work, and the available resources to do the work within the schedule that we see when we look at the project. Those are the things we have all focused on in terms of making better project selection as we move forward here.

Resources are both supervisory and field physical resources.

And you don't feel that you have to, there are certain operations where you say, gee, I'm a little bit light here, so let's take some residential to fill up the hole that I might have on a short-term basis?

No.

Just the opposite.

You don't feel there's any operations of that in that nature?

Not today.

Okay. All right. Just looking forward, I sense that do you have a buy back in place, an authorization?

No, we don't, and we talked about that a few minutes ago. That's not to say that may not be in the future, but the priority of use for our available funds, fresh cash flow is to grow the business.

Okay, and finally, with regard to the SG&A, what I heard there was that the, perhaps, higher SG&A than some were expecting, is not structural within the Company. It's basically you are hiring for sales people that are ramping up, and the incentives, I guess, are driven by profitability in the previous quarters. Is that correct?

That's absolutely right.

Okay. Thank you very much.

Thank you.

Your next question comes from Susan McGarry, Granahan Investment Management. Ma'am, your line is open.

Hi, I have a few questions. The first is about labor rates, and if you could give us a sense of where those are trending?

Are you referring to cost of employees?

Yes.

In certain markets, there is pressure on labor rates to a certain extent, but right now with our backlog and our current work force, we are comfortable with our resources, so we do not anticipate having to go into the market in any substantial way to increase our work force. So we focus on how we treat our employees, Comfort Systems is a great place to work and there's more to it than just what goes into people's paycheck every week. So we feel we've made some great strides there which have kept our labor costs in line.

So I think that previously you all had been kind of surprised that labor rates hadn't gone up more this cycle, so do you feel like they are now catching up a bit in general?

No. If there's any wage pressure at all, it's in the project management field supervision area where those people are just terribly important to successfully completing projects. So if there's any wage escalation, it's more in that area than it is in the rank and file field force.

Okay. Bill, I think you mentioned when you were talking about the commercial construction market in general that there were certain geographic exceptions to overall strength, and could you go into a little detail about that, which markets you might be seeing a little bit of weakness in?

The primary weakness, this is not going to be surprise anybody, it would be the Upper Midwest, but we have always done very well, and of course, that's by virtue of the fact we have very good operations there that take market share, and we don't have that many operations there, but I don't mean to over dramatize this, we are seeing strength across the sun belt, southeast and southwest, but the Upper Midwest with the automobile and related to manufacturing downturn, et cetera.

It certainly has an effect on that part of the country. But our northeast activities and our mid-Atlantic activities continue a pace, some of that is based on the fact that there obviously is a, the heating load that helps us in the winter months and there is substantial activity and future opportunity in refurbishing and retrofitting existing plants. In the northeast.

Okay. I was wondering if you could actually tell us what the growth in backlog was ex multi-family?

It was, it would have been very small actually. Very small. Just from the third to the fourth quarter, growth in all categories not counting multi-family was very small.

I'm sorry, did somebody say 6%?

No, he said single digit.

Oh, single digits.

I don't have that exact number.

Okay.

Still at very robust levels, and earlier in the year it grew more, it's the time of the year, frankly, we are going into the first quarter where backlog can sometimes build a little quicker, although sometimes some of that is -- we don't put anything into our backlog unless we have a signed, at least a signed letter of intent on which we can mobilize and spend money.

Sometimes some of that growth slips into April, so if we go back to historical patterns, you'll tend see backlog building at some point in the first four or five months of the year. As we get into very, very heavy revenue months in the summer, you'll tend to see backlog, there's some chance backlog will go sideways or down even in good times because you are burning through so much of it, and you'll tend to see sideways all the way into the last of the quarter of the year when you are collecting money and nobody is signing contracts yet for the next summer.

So you start to see it build again as you get past the year end.

We had a number of years where it was just going up all the time when we were coming out of the giant 9/11 recession, so people don't have a lot of memory for those patterns, so I would say in the first quarter, you might see some seasonal backlog growth, although some of that may slip into April, depending on how much stuff gets signed, because like Tom said, if you got just a few, you've got a, we have 10 or 15 projects at any given time that are in the 10 to $7 million to $20 million range, and if two or three of those sign or two or three of those don't sign a week before the end of the quarter or week after, you can see pretty big swings, it's pretty lumpy.

How much of a drag on gross margin was the multi-family? What would the gross margin have been without it?

I don't think that's a number we are prepared to release. What we have said in the past was that gross margin for multi-family was less than half of the gross margin for our companies taken as a whole, and that trend continued. It was less than half.

Okay. And just checking in on acquisition pricing. I think that in recent discussions you have said that there's been a lot of upward pressure on acquisition pricing because of private equity and what not. Are you seeing any easing in valuations?

No. I think it's just about the same, seeing some, some people are moving toward us in terms of the way they look at things, i.e., looking at it over a longer period of time, going back, and getting more into the forward-looking view, as well, and trying to combine the two and come up with a multiple of EBITDA that is a little more sensible, in other words, not just paying on one year for good results. We haven't seen much easing of pricing per se. Although, we are trying to fly under the radar of the big private equity folks.

Okay. Thank you.

Thanks, Susan.

David Yuschak, Sanders Morris Harris. You may ask your question.

Okay, guys, you are going to hear from me one more time.

Always a pleasure, Dave, always a pleasure.

On the, just help us out on this backlog, because you know there was that period of time when, what was it, the last few years, when backlog was ramping up, and correct me if I'm wrong, but it would appear in retrospect that a lot of that ramp up was the multi-family?

No doubt about that, Dave. You'll recall at the time, we are at pains to say, our backlog doubled over the last probably approximately three years from about $350 million and at one point, it peaked its head up above $700 million, and we were at pains to say, guys, you won't see one-for-one increases in our revenues, or anything even like that, because that compositional issue makes backlogs so deceptive.

When the 9/11recession happened, the worst recession in 30 years in our industry, at first, backlog went up, because of project delays, and I think that's a good example of just how perilous it is to start taking a lot of straight line correlations out of backlog.

And, the other thing, just to help investors with is, a lot of your business gets burned off in a year or less, so lot of your projects are quick turn projects. What constitutes, is there a duration that you put it in backlog that qualifies for a backlog or if a project is only four months long, you may not put it in backlog because you know it will burn off quickly? Give us a sense of how you do that?

Actually, what really happens is the majority of our backlog number is our actual work in progress, which means there is a POC out there and we are some percentage done with a job, and we have a percentage left, and the majority of the number in that backlog is the work we have remaining on project that have started.

At the end of a quarter, there will be a certain number of projects that are, projects that only take six weeks that are only three weeks into them, and if that project had occurred the first week of a quarter, it would have never appeared in backlog, but the fact that it began a week before the end of a quarter, it appears in backlog.

So in reality, all the way down to some very, very small projects are included in backlog, but numerically they are very unimportant, and I would guess there also is the case that there are times whether people sign a little order, somebody signs an order for a $50,000 change-out, and nobody puts that into backlog, so there may be some outstanding orders for small stuff that simply as an administrative matter don't go into backlogs.

I give you a complicated answer because backlog certainly has in it some very, very, very small stuff, but it's simply because it on our POC, and the most rigorous way for us to measure that is to take our POC, use that as our base number, and then add in projects booked, but not yet started.

The other thing, the component in your business then is just the service revenue, and that wouldn't show up in --

That's right.

[INAUDIBLE] in the service shows up.

Just projects if it's two weeks of duration, it could be in there?

If they have to do something to get the numbers done at the end of the quarter, if they had to figure out that project, it's going to end up in the POC in some form.

All right, thanks a lot.

Thanks, Dave.

Kevin Wank, Poly News Capital Management. You may ask your question.

As we are looking forward to air conditioning season, if you could give us some indication of what the pipeline looks like for retrofit and upgrade projects relative to what it looked like at this point last year?

There's nothing that's changed in the marketplace to make it any different this year than last year. What we are encouraged by is that as we sat on this call, we've increased our sales force, a great deal of their effort will be in selling this retrofit, change-out type projects that are quick hit and that go through the, our business very quickly.

So we are encouraged we will see an increase in that business moving forward. As Bill also mentioned, we are actually seeing some traction in energy-related business, where the costs of energy are now high enough they are driving some investment decisions by building owners to change out equipment, that wasn't necessarily the case last year or the year before, so we are encouraged by some opportunities we see in that area.

Okay. And then in terms of potential margin improvement, if you could share for us what some of the operational initiatives might be, maybe two or three of them, or sharing of best practices that you are trying to implement across your various subsidiaries, and so forth, and what the potential for margin improvement might be from two or three of those?

One of our biggest focuses is on prefabrication of duct work, piping, and plumbing systems. Two weeks ago, we had a prefabrication conference that we ran for two days, sharing those best practices with over half of our companies.

We are really focused on the process in procedures of turning over work, getting it started, getting it bought, and then tracking the labor as we go through the job, setting daily goals through things like daily huddles, where we set labor productivity goals for the day, and those are the things that our best companies are continually using, and as we interact with our other companies, those become best practices that are adopted across the board.

Okay. And one last question, the multi-family business, are the poor margin projects, are they pretty much distributed across a lot of your companies that are doing multi-family work or are they somewhat concentrated in just a few of the companies in a are doing multi-family work?

They are concentrated primarily in two companies.

Okay. Thanks for your help.

Thanks.

At this time, there are no further questions. I'll turn the call back over to you, Mr. Murdy.

Thank you, Marcella, and thank all of you for being on Comfort Systems' 38th quarterly earnings call, and we look forward to the 39th. Thank you very much.

Thank you.

Thanks.

This does conclude today's conference call. Thank you for participating. You may disconnect your lines at this time.