EMCOR Group Inc (EME) 2003 Q2 法說會逐字稿

Good morning. My name is Judy and I will be your conference facilitater. At this time I would like to welcome everyone to the EMCOR Group second quarter 2003 conference call. All lines have been place owed mute to prevent any background noise. After the speaker's remarks there will be a question and answer period. If you would like to ask a question during this time, simply press star and then the number one on your telephone key pad. If you would like to withdraw your question, press star 2.

Thank you. I will now turn the call over to Mr. Eric Boyriven of Fd Morgan Walk. Sir, you may begin.

Thank you and good morning. This is Eric Boyriven of Fd Morgan Walk, and I would like to welcome you to the EMCOR Group conference call. We are here to discuss the 2003 second quarter results reported this morning.

Now I would like to turn it over to Kevin Matz who will introduce management. Kevin, please go ahead.

Thank you, Eric.

Good morning, everyone. Welcome to EMCOR Group's earnings conference call for the second quarter 2003. For those of you who are accessing the call via the internet on our website, welcome. And we hope you have arrived at the beginning of a slide presentation that will accompany Frank MacInnis's remarks. Those listening on the telephone, you too have the opportunity to view the slides by simply accessing the link on the home page of our website, a quick registration and you will be at the slide show. Currently everyone accessing the slides should be on slide one. This is the EMCOR title slide. Instructions will be given for to you advance to the next slide. This is one of those times. Please advance to slide two. Slide two depicts the executives who are with me to discuss the quarter and year to date results. Frank MacInnis, Chairman and Chief Executive Officer; Leicle Chesser, Chief Financial Officer and Executive VP; Mark Pompa, VP and Controller; and Mayva Heffler, our new Vice President in marketing and communications. Call participants not accessing the call via the internet, this presentation including the slides will be archived in the investor section of our website under presentations. Find us as EMCORGroup.com.

Before we begin, this call may include forward-looking statements. These statements are based on certain assumptions and perceptions of historical trends, current conditions, expected future developments and other factors it believes are appropriate. Actual results or developments may differ materially from those anticipated in these statements.

With that said, please let me turn the call over to Frank. Frank?

Thank you, Kevin. That was a truly stirring address.

Good morning, everyone and welcome to our 34th quarterly conference call for investors, analysts and other friends of EMCOR Group. Today's call, as usual, is being conducted with a simultaneous webcast, and I will be referring from time to time to a slide number to identify the relevant slide for web-based participants. Right now we are currently on slide two. We will conduct today's call our customary way. First a discussion of the second quarter and year to date financial results, which we released earlier this morning. Followed by a review of the evolution of our contract backlog with special mention of notable contract awards from the most recent quarter. Then I will comment on EMCOR management outlook for the remainder of the year in light of current and anticipated market conditions at our year to date performance. And finally, continuing a policy we started more than a year ago, we will present a short series of web cast slides and comments that illustrate a particularly promising sector of our markets and of our business. Thereafter, there will be a chance for you to make comments or to ask us questions, and you can see from slide two that a number of EMCOR senior managers are here to assist me with the answers. Incidentally, I would like to congratulate Mark Pompa and Kevin Matz on their recently announced and well deserved promotions and to welcome Mava heffler, our new vice president of marketing and communications to the call and to the company.

Let's begin. Please move to slide 3. The second quarter of 2003 was the 32nd consecutive profitable quarter reported by EMCOR Group. The remarkable record of consistency and growth. We are proud of our history and the unique business model that made it possible. But our second quarter results were more complicated and mixed than is usually the case in our company. As we discussed in this morning's press release our second quarter revenues and midyear backlog set new records for the company and reflected strong organic growth. Clearly our markets and our strong position within those markets remain in tact and even growing. Both our electrical construction and our important facility business grew in revenue and profitability over the year-ago period. On the other hand, our mechanical and construction service businesses experienced a slight reduction in revenue and significant reduction in operating profit compared to 2002 for a number of coincident reasons. First, the continued decline of a number of our midwestern industrial markets and the relatively small size of some of those markets. It lost some of our local subsidiarys for no where to go for revenues or profit when major customers see spending. Remember EMCOR is involved in the mechanical sector than electrical service in most of the midwest. Secondly, the extremely late onset of hot summer weather in many of EMCOR's markets led to the postpone meant of numerous work orders involving HVAC service. These are typically small task orders with very high gross margins. Meaning their postpone meant from may or June into July or later depressed mechanical revenues to a limited extent, but add disproportionately large impact on margins. Lastly, there was a noticeable impact on discretionary spending and on margins in the mechanical service and HVAC upgrades of the markets attributable to the more general business recession and conservative spending policies by some of our customers. As a consequence, our overall financial results reflect continued strong revenue performance and backlog growth largely attributable to the strength in the public and quasi public sectors. Our margins fell overall as a result of the absenses of implementary, high margin private sector demand.

Our UK company also reported its second consecutive quarterly operating loss. At the end of the first quarter of this year and on our conference call I expressed my disappointment and frustration with our British management and expressed the hope and belief that the problems that affected that company's profitability had been identified and addressed. That was not the case. We moved earlier this week to replace senior UK management with industry veterans from inside our company who I believe will act quickly to reduce risks and improve results in our UK markets. In general, I believe EMCOR operational managers have responded quickly and appropriately to challenging market conditions. Our UK managers were the rare exception. One of the important ways in which our managers have responded to market conditions is through reduction of our overhead costs. EMCOR's overhead costs are significantly more variable than at many companies. SG&A as a percentage of revenue during the second quarter was lower than the year ago, despite expenses reflecting aggressive cost reduction efforts at many subsidiarys. We expect the efforts to continue to bear more fruit during the remainder of this year. We also expect our managers to exert vigilant control at all times, good or bad, over their cash collections and accounts. And as a consequence, the balance sheet is one of the strongest and most liquid in the industry. This program continued its long record of success in the second quarter.

Total debt remained flat compared to the first quarter and balance sheet leverage is well within our comfort range. While cash, net over billings and accounts receivable and payable were at normal levels. Overall we believe, with the exception of our UK operations, EMCOR managers have generally responded accurately to the challenges experienced in a number of our important markets and our continued profitability and stability is the result.

Now for some details. Please click on slide 4. Quarterly revenues of $1.14 billion were 16% higher than a year ago. A result of the December 2002 purchase of CES together with year over year organic revenue growth of 4.4%, Gross profits increased in dollar terms to $123.3 million to $120.2 million in the second quarter of last year but declined as a percentage of revenues as a result of mechanical sector and UK results just discussed to 10.8% of revenues from 12.2% in the year-ago period. General administrative costs rose in dollar terms due to the inclusion and integration of ces, but fell as a percentage of revenue 9.3% compared to 10.3% in the first quarter of 2003 and 9 poining 5 -- and 9.5 a year ago. Declining margins, as discussed reduced EBIT to $16.6 for the quarter compared to 26.9 million a year ago. But EBIT doubled from the first quarter of 2003. Net income of 8.3 million dollars or 53 cents per diluted share was more than twice that of the first quarter, but was lower than last year's profit of 14.8 million dollars or 96 cents per share. Please move to slide 5. Revenues for the first half of 2003 were $2.2 billion. 22.7% higher than a year ago including 5.2% growth from organic sources. Operating income and net income affected by the cost of CES integration together with the operational factors already discussed were $22.2 and $11.5 million respectively compared to 39.4 million and 22 million a year ago. Year to date diluted earnings per share were 74 cents compared to $1.43 in 2002.

Please move to slide 6. Our quarter end balance sheet remains liquid and strong. Cash was was $57.7. Total debt of 168 million flat for the first quarter of this year and shareholder's equity rose to $509 million. Total debt as a percentage of total come pill sation was 28.4%, slightly lower than the preceding quarter and well within EMCOR's comfort range. EMCOR's total availability among the multi-bank revolving credit facility was $350 million. Net over billings were 121.4 million compared to 99.2 million at the end of the first quarter reflecting the continued efficiency of our contract management and the strength of our customer relationships. The scope of our evolving customer relationships is vividly illustrated on slide 7. A bar chart showing the growth of our backlog since 1997. Along with his overall growth from about a billion dollars at the end of 1997 to an all time record level of 3.2 billion today, our contract backlog has become much more diverse and restistant to volatility in recent periods. Despite continued weakness in demand for continued construction for example, EMCOR's overall backlog has grown steady due to our strength in growth markets like transportation, institutional work including educational facilities and health care.

The kind of projects that are contributing to our continued backlog growth are illustrated on slide 8. A schedule of about $200 million of contract awards from the last few months. Central Mechanical will provide the total mechanical for six new buildings including two new barrocks for the US Army at Fort Riley, Kansas. While Dynelectric L.A. will perform the second phase of a new pier construction at the port of Los Angeles. Hanson Mechanical reflects our strengths in the Las Vegas market with two recent awards of two new time share buildings and the entire hbac in plumming for a 1,000 room tower hotel for Ceasar's World while University Merylick will refresh and install the complete HVAC and plumbing systems for a state-of-the-art word class indian casino development in California. The Perdue University [nano] Technology Center contract award will incorporate and implement the latest technology in clean room design. While Dynelectric Miami will perform the entire electrical package on Miami airport concourse J, a 7-story 340,000 square foot development. In the energy sector, Wells Back Electric will construct the gas interconnect facility at the Freeport, New York, power plant.

EMCOR companies received three important health care awards. JC Higgins will provide HVAC and plumbing for the Rhode Island hospital bridge building in Providence. [INAUDIBLE] will provide multiple mechanical systems at the Exempla Good Samaritan Medical Center in Dever. And Forest Electric will provide the entire core shell electrical package for the new Memorial Sloan Cancer Research and Testing Facility in New York City. The geographic and market sector diversity of these awards and the high level of customer quality speak to EMCOR's continued strength in a multitude of markets and are an important aspect of the fact underlying our view of earnings expectations for the second half of 2003.

Please go to slide 9. This slide shows the intra-year and annual pattern of EMCOR's revenue and EBIT over the last 7.5 years. Every year exhibits the same characteristics: a slow start, especially in EBIT terms due to seasonal impact on productivity and to our conservative accounting policies with respect to revenue recognition on multi period projects. As productivity improves and our income recognition policies permit, profitability increases significantly while revenues typically grow more slowly. We expect the same intra-year pattern to occur in the second half of 2003, albeit from a lower base in the case of our EBIT performance. Our first quarter 2003 results were impacted by the usual seasonal factors including a very bad winter. Together with enhanced SG&A charges associated with the ces acquisition. The quarter just completed for reasons already discussed under-performed the year ago quarter but still more than doubled the first quarter's profitability. We make the following assumptions and provide the following guidance with respect to second half and full year performance: Our year to date revenues are in line with internal budget expectations, and our contract backlog is above budget, although it continues to be overweighted toward longer term, slower burning projects of a larger than normal average size. We expect second half revenue to be similarly strong at levels of 2.2 to 2.4 billion dollars, and we reiterate full year 2003 revenue guidance of 4.4 to 4.6 billion dollars. We also expect our contract backlog balance to remain strong. Our previous guidance with respect to profitability was explicitly based on the maintenance of the status quo which existed at the end of 2002 with respect to both our public and private sector market demand. That assumption did not materialize. We have, in fact, experienced a further deterioration in our private sector mechanical construction and service markets, notably in the midwestern and northeastern U.S.. For reasons and with results already presented and discussed. Although most economists expect a general economic recovery to take route in the second half of 2003 and to accelerate in 2004, we are unwilling to rely on any such general improvement in our overall markets. And we see no obvious signs of resurgence in final demand, although the final arrival of summer heat has been good for our HVAC service business. Our UK and international operations have made operating losses for the year to date of a total of $7.4 million dollars including the write down of all known and anticipated project losses. We expect those losses to be reversed in the second half of the year and for the UK operations inclusive of reorganization costs to reflect roughly break even results for the entire year. We expect to make continued progress in the rationalization of general and administrative costs, and we expect that growing cash flow from operations will permit us to reduce debt and interest expense for the second half. Finally, we are encouraged by the growth and by the sustained profitability of our facility service business, including our CES acquisition. Especially since it, too, was affected by the downward pressures on the demands and margins and we expect it to grow in both revenue and profit terms in the second half now that integration is essentially complete.

In light of the fore going assumptions, we estimate second half fully diluted earnings per share to be in the range of $2.16 to $2.36. Weighted slightly toward the fourth quarter. Resulting in revised 2003 full year earnings per share guidance of $2.90 and $3.10. The corresponding net income, EBIT, EBITDA, and EPS are as follows, net income of 45 to $50 million. Ebit of 88 to 94 million. EBITDA of 111 to 117 million dollars and free cash flow of 50 to 55 million dollars.

The second half and full year operating results will be the product of a number of moving parts, as usual. In order to explain the kind of analysis that leads to us our $3 range for full year guidance we offer the following general expectations: $3 earnings per share requires that EMCOR produce about $67 million of EBIT from second half operations. If we assume the second half revenue was equal to the first half at 2.2 billion, an assumption by the way that I consider very conservative, then the following assumptions would produce the $3 result: second half gross margins at 12.3% compared to 12.6% for the last half of 2002. Second half, general administrative costs at 9.2% of revenues compared to the same percentage for 2002, and second half EBIT of 3.1% of revenue compared to 3.45% for 2002. In other words, we don't have to perform as well in the last half of this year as we did a year ago in similar market circumstances in order to achieve our $3 range for the year. Looked at another way, we can build up to the required 67.5 million EBIT number from the following divisional estimates: UK operations turning around in the second half to break even for the year and contributing $7 million of EBIT. Electrical operations to contribute 37 million of EBIT as compared to their 29 million in the first half. Mechanical operations improving to 20 million contribution from 11 million in the first half. Facilities operations contributing 18 million dollars as compared to 7 in the first half. And our Canadian operations improving to 3 million from 2 in the first half. All leading to cumulative EBIT of $85 million before corporate charges of 17 for a net of 68. There are innumerable variations that could give rise to the same result. We consider this illustration and this scenario to be realistic, conservative, and achievable.

As discussed earlier, we are generally satisfied with the reaction of our companies and their management through the market deterioration with the UK being a major exception. And the company is perfectly positioned to take prompt advantage of the inevitable economic up turn, although we make no such assumption in our revised guidance. One of the strongest performing and most promising sector of EMCOR's contracts is the subject of this quarter's sector focus, health care. Please turn to slide 10. For a simple, over arching demographic reason the aging of the population, demand for health care facilities is soring with annual health care expenditures rising by 5% or more for year, long-term elderly care requirements expected to double over the next 30 years, baby boomers becoming AARP eligible at the rate of 1 every 7.5 seconds, and 35% of the U.S. population expected to be over 50 by the year 2020. On slide 11 the graph shows that in 2020 50 million Americans will be 65 or older including 10 million age 85 or older. A major underling and unavoidable source of demand from our numerous and more efficient health care facilities. But there are other supplementary sources of health care facility construction and service demand as shown on slide 12. New treatment techniques, testing equipment and efficiency in cost control requirements are leading to enhanced emergency and outpatient capacity needs. Redesign of existing space including more private rooms and new construction and maintenance criteria reflecting changes in safety and environmental requirements. As health care institutions everywhere try to cope with annual increases in hospital days for unit of population. EMCOR benefited from these demographic, political and societal trends. I mentioned three new hospital projects awarded to EMCOR companies in the past 60-days. And slide 13 shows our overall health care contract backlog has surged more than 50% to a current total of more than $200 million in the last few years. On slide 14 we show a remarkable map. EMCOR has a total of more than 70 active health care projects with a with a value of $1 million or more going on at the present time in 15 different states. As is the case in many of the consistent growth sectors of the broad and diverse company, EMCOR's future growth expectations are supported by strong demographic trends.

That concludes my remark with respect to this quarter and year to date operations and 2003 expectations. Now we have time for a few questions or comments, and Judy is on hand to instruct you on how to queue. Thank you.

At this time I would like to remind everyone if you would like to ask a question, please press star and then a number one on your telephone key pad. We will pause for just a moment to compile the Q&A roster. Your first question comes from Michael Roesler of CJS Securities.

Good morning.

Good morning, Mike.

Frank, looking at what you talked about number wise for the second half of this year, and if you look at it versus last year, can you characterize the changes you think will happen if you get electrical? Last year you did 48 million in EBIT over the second half and 34 million in the second half for mechanical. So pertty significant declines is what your forecast is saying right now. What differences are you seeing or are you being overly conservative?

Mike, I am being very conservative. I think this is a tough market, and I am unwilling to rely on a consensus of economists that says things will improve in the second half. If they do improve, we are positioned to profit unusually promptly from such an up turn because of the amount of small task service and upgrade work that many of our companies do. But I'm not going to say that. You are right, and I think I illustrated on the call that our second half expectations are not only consistent with the past performance of our company over many years, but are conservative to our performance last year when we were in a recessionary economy. I am not prepared to go out on a limb at this point. Although I can easly visualize circumstances that we would out perform the estimates that I have given for the second half and for the year.

I mean, the numbers are significantly below what you do last year. If you look at electrical, that's down 23%. What would you suggest would be the case?

Once again, the absence of private sector high margin electrical work is one of the major categories of conservatism for us. We find that in general -- and we have spoken about this on a number of past conference calls, there has been an over all change in the make up of our contract backlog. Even though it is very large and growing, it is overweighted on the side of public sector projects. And you saw that in the slide that illustrated the recent awards. Of those 10 or 12 recent awards a majority were in the public or quasi public sector. And we have spoken on previous calls about the fact that the opportunities for excess profits, if you will, profits associated with efficiency, profits associated with value engineering do not occur with the same regularity on public sector projects as they do on private sectors. So when I reflect reduced expectations for a good performing sector of our company like our electrical business which showed growth in both revenue and profitability in the first half compared to the year ago, I am just being conservative with respect to my expectations on a macro view of what I know to be in backlog in the electrical segment. But you are quite right in characterizing -- characterizing it as an over all conservative assumption.

If we look at the two areas we are growing backlog in health care and transportation, could you characterize the EBIT margins in those sectors versus the more private commercial type construction in those projects?

Both have been positive contributors for EBIT purposes. In sterms of health care, these are the facilities we love to work on because they are extraordinarily system rich. If you think about a typical hospital or clinic and the fusion of systems such as sophisticated air conditioning and clean room systems, the medical gases, the delivery of ultra pure water specialized lighting and ventilation in operating rooms, the nurse's call communications and emergency treatment and security systems, these are all the kinds of systems that make our work in a hospital an important part of a critical path. There by increasing our influence of scheduling decisions and reducing our risks. We like health care and its EBIT characteristics. We have been careful in the transportation sector. The t-Rex project in Denver, where we are part of the team, the same team that rebuilt the arted rethrough Salt Lake City several years ago in time for the Olympic games is now rebuilding a major traffic cloging artery through downtown Denver along with associated light rail transit systems. Being part of a proven team which established its profitability history on a previous project has been very positive for us. We're also a major participant in transportation system reconstruction in the UK where a large but relatively slow moving project so far will result in the establishment of a high speed rail link between London and the coast. So the transportation sector is a very positive one for us, but I would characterize the nature of those projects as being on the large side and on the slower moving side. Meaning that we take a conservative stance with respect to both revenue and income recognition on these projects until their direction is very clear. In the UK, for example, we booked quite a lot of revenue from our transportation projects in the first quarter, but with very limited income contribution because of the fact that the projects are still at an early stage and their cost chart ris sticks and ultimate profitability are not clear. I do not mean toim ply they are troubled projects, but they start slowly.

In order to help us understand the profitability profile, a company gooding -- going forward, could you quantify the difference in ebit margins on a public-type project versus a private project?

I think that I would be resorting -- I prefer to resort to generalities. I think it is fair to say that gross margins -- ultimate gross margins on public sector projects are probably a half to a full percentage point lower than corresponding private sector projects over time.

Okay. And one final question, one of the things that we always liked about the business model was that you had the systems and controls to keep from being surprised by things. It seems like the UK seems to be a surprise. Can you comment on what's gone on there, and how we got to this point?

Yeah. As you know, you were on the last call and I spraesed at that time my surprise and frustration with UK management with respect to the first quarter results which you may recall were associated with four or five individual problem projects. Our UK operation is made up of a proportionately larger number of large projects both on the construction and on the facility management side. And the first quarter reflected write downs of the results in a number of those contracts. And both applicable accounting principals and policies require that all foreseeable risks and losses be taken into account and booked when it is clear that they are going to occur, even if they haven't occurred yet. And we thought and we were informed that those policies principals had been applied in the first quarter. As it turned out, they were not. Bad projects continue to go bad. We have now completed our own view and the audit of the second quarter and year to date results and we are satisfied at this point that the -- that the losses attributable to those bad first quarter projects, together with a couple additional ones have been fully provided for. However, we do not believe the UK management that was in charge of those operations did an appropriate job of dealing with the deteriorating state of the projects and have au koringly replaced them.

Okay. Thanks.

You're welcome, Mike.

Your next question is from Jamie Cook of CSFB.

Good morning, Jaime.

Hi, guys. My first question is in the first quarter, how much did the UK and the midwest hurt on you a per share basis if we look at that?

Who has the UK quarter for the first quarter? It was negative 3.--

Excuse me. 4.5 negative debit in the first quarter.

And how about the weakness in the midwest? Is there any way to estimate that?

The weakness in the midwest, Jaime, was probably not a real significant factor in the first quarter. It really accelerated in the second. We always start slowly. I think that graph is still up on the internet screen. And as you can see we always start slowly across our entire company for reasons that I discussed. And accordingly, individual segment weaknesss like the midwest maybe didn't stand out very much against the entire backdrop of a slow start for our company. But they certainly impacted the second quarter. I can give you one number that will perhaps help to explain the delta between the -- between the earnings we just announced and the analyst consensus estimates for the second quarter. That is that the difference between the UK companies operational results for the second quarter and our internal budget Terry affected earnings by 22 cents.

what was that? Do you have the number for the first quarter?

What? I am sorry.

But if you take the loss of 4.5 million for the UK and you assume a normalized tax rate which is probably different buts that the best I have. Let's say that cost you 15 or 16 cents or so, I guess what I'm trying to figure out is, if you assumed it -- I'll give you 20 cents because you had the midwest. You know, if you take that and you take the second quarter, you know, you have, you have -- it is unexpected issues cost you probably about a loss of 55 cents or so. But if you look at your guidance, you know, your loan, your earnings by 135 to 150, you know, sos that about, you know, a buck to 85 cents or so. I'm just trying to get a handle on what's going on or if there is anything else internally that, you know, you guys are being cautious about.

No, in fact, Jaime, I took the time to look at and to derive the 67 or 68 million of ebit that we need in the second half of the year to make $3 from a couple different ways. I first of all broke it down and then I built it up. Both processes arriving at the $68 million dollar number. In order to make $3 we don't have to do nearly as well as we have done in the past and we only have to follow the patterns that this company has followed every year for the last seven years. -- years, in order to significantly improve our results of the second half. It does not surprise me to hear you conclude, as I think you are concluding, that we are being very conservative in the -- in the number that we are puting on the table. But I assure you that we are not hiding anything. We are merely unwij -- unwilling to rely on any kind of private or public sector, for that matter, improvement in the second half. And I honestly don't want to come off as a Pollyanna by suggesting that I think everything is going to be terrific and that we're going to significantly out perform estimates in the second half. I want to -- to the assistant I can, to maintain EMCOR management's strong and long-term reputation for credibility and conservatism and this is the way I am doing it.

And my next question, sort of adding to the first question, this is the second quarter where we had -- where we have had a surprise and I guess my concern is, you know, the controls in place that we knew there was a problem in the UK in the first quarter and it seems like there is another negative surprise. So I'm trying to get a better understand of how often the smaller subsidiarys report to you, and, you know, whether you have made any changes internally to get a better feel for, you know, what's gone on at the operating level?

Well, that is a very good question. Nobody, including you, is more concerned about surprises as I am. And the action that we took in the UK, I hope, illustrates the fact that there are always consequences at EMCOR when management fails to adequately deal with or inform us about risks or problems that are being experienced. And there are several smaller companies in our mid western operations, predominantly companies associated with the comfort systems acquisitions last year that have also performed poorly in response to deteriorating market positions. But I tend to cut them a little slack in some cases because of the relative inflexibility of their markets. They are not in great big markets where as in the case of New York for example, our New York electrical company turned from building core and shell electrical systems for new commercial buildings to building power plants. A few years ago they wouldn't be interested in power plant construction, but it is available and they are doing it, albeit at reduced electrical margins becauses that where the work is currently. s that part of the overall portfolio shift -- that's part of the overall portfolio shift I eluded to earlier. With respect to our systems, I believe and fervently that our systems are among the best, if not the best in the industry. It is not a matter of our subsidiarys reporting to us on a periodic basis. Our subsidiarys report to us all the time, literally every day they report to us on our their cash flow characteristics. And you knows that one of the major ways in which we control results. And we saw -- our system showed us that there was a deterioration in some cases in the -- in the cash flow performance and in the pnl performance of some of the subsidiarys. But we had a mixed result for the quarter. Revenues stayed strong. The electrical performance was good. Facilitys was good and growing. So we had a really odd mix of positive and negative impacts for the quarter that left us with the ability to come to a conclusion about the mix only very late in the second quarter. If we had known earlier we would probably have preannounced or given the market an indication of revised expectations. We did not.

And one last question, I think you said in the second half you expect the UK to have about 7 million in ebit, and I guesss that -- I understand you made changes over there. If I look historically at the UK facility over the past couple years, I don't think you guys have ever done that. So I'm just trying to get a feel how -- I guess that just seems aggressive for me while I think your overall guidance is very conservative, the second half guidance for the UK to me seems aggressive.

I don't really think so, Jaime. Firstful all, I want to reassure you -- first of all, I want to reassure you, and I think I mentioned this on another call, we have taken a very searching loor at the UK situation in the second quarter. And this is not one of those cases where this time we really mean it. we thought we had done so at the first quart but we were extraordinarily careful in the second quarter and we think that operating risks for the balance of the year have been significantly reduced in the UK. Secondly I am not going to differ with you strongly because I don't have the number directly at happened, but I believe the UK operation has in fact performed at that level in the past. I will say our facility service business in the UK which comprises more than half our business was profitable in the second quarter and it is expected to be increasingly profitable for the remainder of the year. And the mandate that is being given to incoming UK management is that during the second half and the foreseeable future, the general pattern of UK operations will be to deemphasize construction operations except for our rail and transportation business. And to reduce the proportion that construction revenues bear to overall UK operational revenues.

So you are not expecting an improvement in the UK in terms of market improvement?

We are not.

Okay. That's it. Thanks, guys.

You bet.

Your next question is from Andrew Wollack of Cumberland.

Good morning, Andrew.

Good morning, Frank. Number one, I can't remember, did you specify exactly how much downside there was from the lack of air conditioning servicing in the first part of the year?

I did not. I think that in general it was note -- it was not a large revenue number. I would guess it was probably not more than 25 or 30 million dollars. And you can see that if you look at the mechanical segment revenues for the second quarter were down only slightly compared to the year ago quarter. I think 13 or 14 million dollars or there abouts. So it wasn't on the revenue side that the pressure came. What was missing from the mix was typically very high margin, high teams or even low -- high teens or low 20s gross margin work of a type that is associated with the spring turning on and servicing and upgrading of hbac units. And it was purely and simply a weather-related problem in the northeast and in the midwest exsas bateded -- exacerbateed by the small market problems in the midwest I au luted -- I alluded to earlier. And general margin pressure with the -- not the characterization but the change in backlog mix from predominantly commercial, as much as 50% private sector commercial over to a mix that is less than 20% commercial today.

And then a couple other things, could you just update us on the steps you have taken so far far to integrate the big acquisition whose name I just forgot.

CES. Yeah. And where you are in standardizing them to your normal template. And then just a little more long-term oriented, what do you think the chances or what's the time frame for you to get back to the kind of margins that we got used to over the last year or so.

Okay.

The whole company. All right. Firstful all with respect to ces for financial discussion turns, the integration of CES is complete. There will be on going structural issues associated with physical integration, management, reordering and the like. But these are internal and normal and typical management issues. And I don't mean to imply they are negative in any way. From the financial stand point I am finished talking about ces integration costs. It is done. With respect to margins, I did think a little about this margin performance issue in connection with the build up of anticipated or a scenario for 2003 second half performance I discussed. And you will recall that I suggest eld that -- suggested ta second half gross margins at 12.3% which is.3% lower than we performed in 2002 would be sufficient even on the basis of conservative revenue numbers information get -- to get to us the $3 range for the year. I regard both of those as conservative. I think that a great deal for the future hinges on two things. Firstly, the continued growth of our facility service business which is extremely encouraging and in which I believe will be a significant contributor to the second half improvement in our operational results. And secondly, and this is trite, but nonetheless true, the inevitable economic recovery. We are in great shape to participate in that economic recovery. Our competition hasn't gotten any larger or more -- or stronger or more profitable and we are in position where we will benefit short and long-term from the inevitable resur jention of private sector demand. But I am unwilling to guess publicly as to when that resurgence will be and I make no such assumption concerning that resurgenc for the purpose of estimating 2003 or 2004 margins.

Yeah, but Frank, thank you. But if at this point if you look out, if you have a significant mix change toward private sector and you fix the UK, you should see pretty good margin improvement, very good into 04.

That's correct.

Right. And just to put this to bed, I mean, you don't think there has been any kind of permanent mix change downwards for this company as a result of what's happened in the economy in your -- and your move toward more public sector?

Absolutely not. We have reacted to what the markets are giving us. You can see from the backlog chart that the proportion of our backlog represented by private sector commercial construction is probably at 15 or maybe 16% right now. s that not by choice. If there were more and better -- that's not by choice. If there were more or better construction projects available we would be taking them. But the market is giving us an attractive but none the lels -- but nonetheless, larger than normal group of public and quasi public projects that we identified on the slide and we are taking those for the time being. I guess I should stress that we are not by any means taped out in terms of capacity to take on private sector work as and when it materializes. We will kmenls the reweighting and rebalancing of our portfolio at once when the private sector emerges and will profit short-term from customer decisions with respect to upgrading and deferred servicesing -- previously deferred servicing of their fau sitss. We will profit immediately from the restacking of facilitys associated with rental of currently vacant space to new tenants associated with an economic recovery and the absorbtion of real estate that takes place in conjunction with that. And we will benefit long-term from long deferred capital spending decisions that customers make with respect to new facilitys.

Thank you.

Our next question comes from Jeff Beach.

Good morning.

Hi, Jeff.

Two questions. One, you reported in your press release at ces -- that ces made an operating profit of 4 1/2 million and off the 10 q I see that operating profit for all facility services is 4.56. Does this mean that you Seng shallly -- that you essentially broke even at all EMCOR services this quarter?

It means the sec was the source of the vast majority of our operating profit for the quarter. That is correct. Remember that ces is significantly larger facility service business. That is a segregated facility service business than what preexisted in EMCOR in terms of separate facility service companies. We also perform blended facility services in conjunction with both our electrical and our mechanical billss. -- businesses. So don't forget that when you think about the overall facility service revenues. We have segments composed of electrical construction and facility services in which those facility services are part of the customer's electrical construction programs. We have mechanical construction services and we have separate facility services in which the services are provided to the customer per say and not as an aspect of or in conjunction with construction services. So the numbers that you are looking at of 4.5 million contribution to ces is for a sector that is composed of ces together with a number of -- a small number of other company lz whose -- companies whose existence in EMCOR preexisted the acquisition of ces.

All right. But just to expand on this, if we went back to third quarter last year before ces was in here, 2 1/2 million operating profit from your EMCOR facilitys and in the fourth quarter with a slight contribution from ces, you made $1.7 million and again it looks like you are near break even off that. Operation this quarter, can you shed some light on what's happened there?

Absolutely I can. And I mention it in the body of the call earlier. And that is that facility service revenues and profits were affected by some of the same mechanical service decisions on the part of customers that impacted our mechanical construction and facility service lz sector. You could -- I'm particularly happy with the ces performance in light of the fact that its operations were subject to some of the same downward pressure on both revenues and margins that affected the mechanical sector and they were nicely profitable and growing. By way of explain nation, I think it is probably fair to say that customer relationships that are reflected by long-term contract actual obligations are less subject to variation and variability of the type that affected our mechanical service operations.

Okay. And could we expect with this rebound --.

Jeff, sorry to interrupt and there was one last thing. There were interest gration costs in the first and second quarter as well.

All right.

But you knew that.

All right. Can we expect a rebound in the profit? It sounds like a lot of the things, you are expecting a rebound in profitability and mechanical in the second half. I guess we can say the -- I know there is no separate entity, but we should see a rebound in the profitability as the maintenance work picks up?

Yeah, I think the maintenance work is picking up. I Americaned in the body of the call again that the hot weather did finally come and we did get it back. Whether or not we got it all back in terms of the springtime service revenue and profit, I don't know. I doubt it. I think that some customers have deferred that work now until the fall or into next year. But I do think there will be continued growth and improvement in both revenue and profitability in the business for the remainder of the year. And that has been our pattern. All I am talking about when I possible few late improvement in these segments is what we have always done going back to 1990 knife -- 1995.

And then just a follow-up on facility management. Kind of two things, can you help us at all in any way, shape or form quantify the integration charges that you put -- that you expensed or at the expense of earnings in the first half to integrate these two companies and then second can you see now that there is going to be Cingergys in this operation that will produce a operating profit margin that you have described before as being higher than your construction oriented margins?

I'll deal with the second one first. The integration has gone very well. We acquired seasoned accomplished management at ces and the integration process and the customer relationships that came with it have shown us fertil ground for business development and service expansion over the last half of the year and in periods to come. So I'm very positive about the synergistic opportunities not only within the facility services per say, but also with our construction clients which as you saw from the award slide is another area of very high quality of customers for the purr of cross selling services into. And the first question I forgot.

First question is quantifying integration.

Right. On the first quarter call I said I thought that sgna as a percentage of revenue that was 10.3% or that quarter was probably between half and 3 quarters of a percentage point higher than it otherwise would have been by virtue of integration expenses both in the facility service operations and also at EMCOR Group. Because you will recall my explanation of the integration process of being a two way street. That we were not only integrating ces into EMCOR Group, but also integrating the previously owned EMCOR facility company ces. So the costs were in both places. In the second quarter I think the financial impact was significantly reduced. You saw the way we reduced sgna all the way down to 9.3%. -- in the second quarter and we'll continue to do better in that regard. I think that in dollar terms, I don't have the specific number, but I would guess that dollar expenditures for integration in the second quarter were probably between 2 and 4 million dollars. Something like that range.

Okay. That's very helpful. Thanks.

And you're welcome.

Your next question comes from Mark Foster of Kermabeck and Company.

Good morning, Frank.

Good morning, Mark.

A couple quick questions. In the past you have been hesitant to buy back stocks -- buy back the common stock because of slow issues given the reaction of the stock this morning is that something you would consider? And secondly can you give us a little more color on how the third quarter is shaping snup you eluded how the hot weather helped on the hvsc side, have you seen a pick up in other areas?

First of all, I think the stock is a buy. But then I thought it was a buy at 48 and also 52 dlas and -- dollars and I am not just joking. I think what we are doing in the facility service business is the development of a new business that hasn't existed before that has characteristics that it existed in a troubled quarter in the mechanical service business. It nonetheless exhibited strong and growing profit bimt -- profitability. I think that if I do my job by the end of this year I will have convinced the market that a company with more than a billion dollars of recur rent business consisting of long-term contracts from multiple small tasks and substantial margins with blue chip customers is worth more than the multiple that we have currently -- or historically been trading at in the market. So I think EMCOR stock was a buy before today. And I will certainly think it is a buy after today. I will apply my usual principals to the decision regarding stock buy backs. And that is I am not a shrinker of balance sheets. I like to use my cash for investment and the profitable investment purposes. But I never say never to those prospects. And you know that we have in fact repurchased stock primt in the past although not recently.

Right.

With respect to the third quarter what I can tell you is we are seeing and hearing lots of an neck dough tall kmening Terry -- commentary about enhanced bidding activity. We are getting budget Terry inquirys from markets like the New York commercial market. I don't rely on this an neck dough tall information to boost profit estimates. On the other hand, we have received a kind of bump from the hot weather finally arriving that has helped our mechanical service operations to recoup some of the revenue and profits loss -- lost in the second quarter. But visibility this early in the third quarter is not very good as yet.

I understand. One last one, at what point will you give us a first look at 04?

I'll probably give you a first look at 04 in conjunction with the third quarter earnings call. Not later than that. We don't like to get out too far ahead of the pack. And in particular, if in the absence of a post war bump that nobody is saying, and in the absence of any indication that business is coming to the party that the economists have announced, I don't know that we're the right people to be getting out in front of 2004 expectations. But I'll try to be helpful with the market and with you guys as soon as I can. And if I think I can say something intelligent in conjunction with third quarter earnings I will certainly do it.

Great. Thank you.

All right.

Your next question comes from Raymond Cheung of Lehman Brothers.

Hello, Ray.

Good morning, guys. My first question is that I understand you don't have to do a swear in into the gross margin for the second half this year compared to last year, but, yet, you did incorporate some sort of up take in terms of the gross margin quarter over quarter. Was that primarily to do with the accounting pressure or did you pick up in terms of the settling margins particularly the mechanical side.

What I took into account, Ray, is what we always do. We always perform a better -- perform better as the year goes along. Risks are identified and qaunt fight and dealt with in the early stages of construction and service contracts. Efficiency improves, productivity improves, conservatism with respect to recognition of both income and revenue is relaxed as information gets better, as assumptions before more valid and it is just a fact that over the last -- almost the entire history of our company, at least under this administration, we have performed better in the second half of the year than in the first half for all those reasons. And our assumptions are merely the same ones that have -- that have taken place in the company every year since have I been here. That is that we do better in the second half for although foregoing reasons. So when I say that I think that things will improve in the second half, I am not saying the markets will give us anything better than what they have been giving us so far. I am saying that we will do better with what we have got because we always do.

In terms of the backlog, can you comment on the margin associated with overall backlog dollars and also can you give us a rough sense how much of the backlog numbers we lated to facility services?

With respect to margins in backlog, I'll make a general comment that you might take in conjunction with one that I made in answer to an earlier question. Our backlog on the construction side consists of a larger than usual proportion of public and quasi public sector companies.

Right.

Just looking at thesegments in the bar graph for example. Those plants are owned by states or municipalities.

Right.

The hospitality segment is emphaticly private. They don't want any public involve men chblt the institutional is at least predominantly public with this predominantly public with this particular emphasis on educational buildings and the like. Health care runs the gamut. You have private for profit, health care operations and you have got the municipal, state and federal institutions. Transportation once again is a combination of public and private with airport work being on the public side and with private sector transportation, for example, for transportation providers, airline and the like being part of the mix as well. Exercise shall is private as is manufacture except we booked power plant work in the manufacturing sector so that there is some public work associated with manufacturing. Overall we have got and we'll go back to what I mentioned to Andrew a couple minutes ago, we have more public sector work frankly than we would want under ordinary circumstances. And the first chance we get to rebalance our portfolio of projects in favor of private sector, commercial projects with faster moving characteristics and lower investment requirements for working capital purposes, we will do it. But the market is not giving us that so far. In terms of overall profitability and backlog, I mentioned earlier that I think that the gross margin characteristics of public sector projects in general are probably half of a fers tej point to a percentage point lower kau mens rat sized projects in the sector. I thinks that a fair comment overall on our backlog.

Okay. Fair enough. And would you maybe be automobile to give as you sense how much of the backlog is related to facility services?.

Well, I can tell you that the backlog that we acquired in conjunction with the ces acquisition was about $200 million. The overall -- and by the way we calculate facility service backlog, extremely conservatively. These contracts are typically multi year contracts. Usually three years, occasionally five, sometimes 10. You know we have been at heathrow airport for British airways for about 12 years. Nonetheless, we account for the backlog value of these of these contracts only on the basis of one year of the revenue from the relationships. The number is very small relative of the overall revenue potential for these contracts. I think that our domestic facility service proportion of overall backlog is probably in the 10% range. Or for a number of reasons, notably the conservatism of the method by which we account for the value.

Okay. Great. Speaking of these multi year UK contracts, particularly in facility services, would you be able to comment -- was there any problem contracts related to that area? And can you speak to some status of any of these major projects?.

Yes. I'm glad you mentioned that. In the first quarter we alluded to a couple of problem projects in what we call our defense services sector of the uk facility service business. And there were three projects if memory serves. One of which has been terminated. The second of which has been renegotiated for on gooding darb dash on going profitable operations and for which a loss has been recognized and the third in which negotiations are expected to commence shortly for renegotiation or termination of the same -- with the same pattern that I have just described for the others with an end date at the end of the year.

Those three are construction work?

No your question was with facility services.

Okay. They are all relate to facility services?

Yes, right. If you remember my first quarter comments, our first quarter British results were functioned both of problem projects in construction and in facility services. The second -- in the second quarter uk facility services were profitable, albeit at a reduced level due to another couple of problem projects, but they were nonetheless profitable whereas construction continued to lose operating.

Great. My last question is with the midwest region. Have you undertaken any action or plan to take any action to affect the excess capacity you are dealing with right now?

Yes. We are in the process of reviewing in particular some of the smaller and less flexible mar of market companys with a few toward determining whether they should be merged or otherwise modified in terms of -- in terms of their capacity and in terms of their target markets. I mentioned earlier that we made some management changes in the uk. I didn't au luted to -- allude to other changes in the midwest, but we have in fact made a couple in order to ensure that on going management correctly grasps and deals with the risks associated with these relatively inflexible small markets.

But for some of the suspended work in the region, do you see any of those activities being released in this quarter or in the fourth quart sner.

I make no such assumption. I think that at least to the assistant that the -- to the scent -- to the extent it would imply some resurgeons of private sector demand in the midwest, do I not see that, at least for the purposes of the earnings estimates I have given for the second half and for the year.

Okay. Great. Thank you very much, Frank.

You are welcome, Ray.

Your next question comes from David Herman of Shumway Capital.

Good morning.

Hi, David.

Thanks for taking my call. A couple quick questions. I guess the first thing is the backlog. Can you help me understand what it would look like about a year ago in terms of private versus public sector?

A year ago . I don't think they would be enough to worry about. What you're missing perhaps is not in backlog at all. The revenue and more to the point the profit impact associated with this quarter's results was from projects that typically don't get into the backlog schedule because they are a small, fast moving project, under $250,000 that we typically don't report as part of backlog, but that contribute disproportionately to the profitability of the company in ordinary times and didn't contribute to the profitability of the company in the second quarter. s that really the crucks of the message I am trying to get across. Our backlogs performed routinely. The quarter I thought it was appropriate in all the circumstances. Leaving aside the uk. What I -- what affected us disproportionately was the absence of those contracts outside the backlog report. That typically SUPPLEMENTS our earnings from backlog projects.

Were those less than 250 k projects that don't go in the backlog -- I want a sense of second half last year versus your projections for this year. Was there a decline in the sort of walk in less than 250,000 projects from the second half of last year to now?

Yes.

Okay.

Yes. And I think that implicit -- and I'll make it explicit it in -- in my au summings -- assumptions is there won't be an improvement for the remainder of the year and we nonetheless state our earnings.

So I don't need to get a pick up to hit the 68 million dollars of ebit?

You do not.

The only other question I have is could you give us an update on what's going on with Abbie wood? Did you guys file a counterclaim there? What's the timing on the arbitration?

I'm sorry. But you have drawn a blarning around the table here. Abbie wood is not --.

It is the 70 million, $60 million claim.

That is a term that we do not use in connection with any of our litigation files. Let me --

I'm sorry.

I'm sorry. I'm not familiar with it. Yeah, right. We refer to that as the mod contract.

Mod. Okay.

Do you want to comment?

We will let Mark Pompa comment on the dispute.

We are continuing our discussions with molluns and their attorneys with regard to settlement.

Mava will come on board and show us how to do this. We are going want to spend money in the sgna sector as it pertains to facility services in order to drive the EMCOR brand and maximize this in order for us to be the leader worldwide in facility worldwide in facility services. And so if the sgna does not go to 9%, it will be for a very good reason associated with business development and not because we can't get it down.

And this is my last -- it is a last comment. I know I mentioned this to you in the past. Obviously any small change in your dollars impacts the eps given the small share count. Obviously if you could do -- if you can -- obviously not at today's stock price, considering a split may help take out the volatility.

We have considered a split a number of times. I think I have board support for a split. We are sympathetic with the float issues and the volatility issues and the interests of investors in minimizing those and we will without question make the appropriate move at the appropriate time.

Thank you.

You're welcome.

Your next question comes from Alexander Rygiel.

How are you Alex.

Good. A couple quick questions with regards to your U.S. electrical business, in the first half it would appear that ebit was down about 5% but yet your guidance for the second half is suggesting that ebit will be down 23% from I think about 48 million to about 37 million. What I'm talking about is year over year second half 03 versus second half 02.

Yes.

Can you talk about that decline? I know we talked about the mechanical business and margins are down. Can you focus on the electrical business on a year over year basis?

Yeah. Excuse me. First of all the build up that I gave of the -- of a plausible scenario that could build up to the required 68 million dollars -- dollar level of ebit for second half performance purposes was of course based upon actual knowledge on my part of what we have in hand and what we can do. But was not meant to be specific guidance as to the performance of an individual segment of our business. Nonetheless, I do think that electrical can and will perform at or in excess of the levels that I mentioned for electrical for the second half. Now, the first half results from electrical were affected by the closeouts, some advantageous close outs of private sector projects that are long running and that were closed out in the first half. And that was one of the contributors to the improved profitability of the segment during that first half. Because I want to be conservative and because our sector is overweighted with public sector, longer term projects. You have yektly pointed out the assumed election in profitability is very conservative in all the circumstances but that is intentional.

And follow-up on that. The changes you made to management in your midwest markets were those acquired from comfort systems.

Yes.

Ladies and gentlemen it is just a few minutes before 12. I very rarely do this, but I am beginning to lose my voice. And I think that we'll take another couple calls. I understand that is the number of calls that are still in the queue in any case. So we'll call it a day perhaps right around the noon hour. Thank you. Your next question comes from Mike Clorfeld from High Grove.

I was wondering. Is there any chance you would disclose the magnitude of the integration charges since they have seem to affected the performance of the company in the first half?

Actually Mike I did that on a previous call. I will just reiterate briefly that three months ago I suggested that sgna costs as a percentage of revenue for the first quarter had been impacted to the tune of perhaps 1 half% of revenue or higher by virtue of the ces integration costs that occurred both in the costs of the facility services segment and also at EMCOR corporate. Because the integration process was a two way process. In the second quarter I think it is costs that are now complete were in the range of 2 to 4 million dollars.

Okay. Thank you.

You're welcome.

At this time there are no further questions. I will now turn the call back over to management for a closing remark.

Ladies and gentlemen, thank you for your interest in EMCOR Group. We are pleased with the overall reaction of our management to difficult and challenging circumstances. We expect to report our 33rd and 34th consecutive profitable quarters between now and the end of the year and reiterate our confidence faith in the ability of EMCOR not only to produce consistent results for you but take advantage of the positive prendz of the market as they occur.

Thank you for your participation today. Reporter: This concludes today's teleconference. You may disconnect at this time.