EMCOR Group Inc (EME) 2003 Q3 法說會逐字稿

Good morning, ladies and gentlemen. My name is Paul, and I will be your conference facilitator. At this time, I would like to welcome everyone to the EMCOR Group Third Quarter 2003 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press star, then the number two on your telephone keypad. Thank you.

I would now like to turn the conference over to Mr. Eric Boyriven of Financial Dynamics. Please go ahead, sir.

Thank you, and good morning. This is Eric Boyriven of Financial Dynamics, and I'd like to welcome you to the EMCOR Group Conference Call. We're here to discuss the Company's 2003 third quarter results, which were reported this morning.

I'd now like to turn the call over to Kevin Matz, Senior Vice President of Administration and Strategic Services, who will introduce management. Kevin, please go ahead.

Thank you, Eric, and good morning, everyone. Welcome to EMCOR Group's earnings conference call for the third quarter of 2003.

For those of you who are accessing the call via the Internet and our website, welcome, and we hope you have arrived at the beginning of the slide presentation that will accompany Frank MacInnis's remarks. Those of you who are listening via 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'll be at the slide show.

Currently, everyone accessing the slides should be on slide one, which is the EMCOR title slide. During the call, instructions will be given for you to 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. They are Frank MacInnis, Chairman and Chief Executive Officer; Leicle Chesser, Executive Vice President and Chief Financial Officer; Mark Pompa, Senior Vice President, Chief Accounting Officer and Treasurer; Sheldon Cammaker, Executive Vice President and General Counsel; and Mava Heffler, Vice President, Marketing and Communications.

For call participants who are not accessing the conference call via the Internet, this presentation, including the slides, will be archived in the Investor Relations section of our website under Presentations. You can find this at 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 thrilling.

Good morning, everyone, and welcome to our 35th 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'll be referring from time to time to a slide number to identify the relevant slide for our webcast participants. Right now, we're still on slide two.

We'll conduct today's call in our customary way -- first of all, a discussion of the third 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 some notable contract awards which we think illustrate current market trends for the most recent quarter.

Then I'll comment on EMCOR management's outlook for the remainder of the year, which we specifically addressed on this morning's press release in light of current market conditions and our year-to-date performance.

And I'll reiterate some preliminary impressions of EMCOR's baseline operational performance opportunities for 2004, which we also discussed in our October 2 press release and again this morning.

Finally, we'll present a short series of webcast slides and accompanying discussion of our recently announced alliance agreement with Siemens Building Technologies, a transaction that is squarely within a particularly promising sector of our markets and of our business.

Thereafter, there will be an opportunity 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 plan for future EMCOR conference calls and webcasts to include more significant direct participation by our officers to better showcase the broad array of talent and experience that our senior management possesses.

So let's begin. Please move to slide three.

On October 2, I guided the market with respect to our earnings expectations for the second half of 2003. The results we announced this morning were directly in line with those expectations. They also reflect our 33rd consecutive profitable quarter at EMCOR and our expectation that those profitable results will continue next quarter and next year.

Quarter revenues of $1.16b were 10 percent higher than the third quarter of 2002, demonstrating our continued dominant revenue position in many of our markets.

Organic revenue was flat with year-ago levels, with revenue growth primarily attributable to the CES acquisition transaction in the fourth quarter of last year.

Contract backlog of $3.11b was 3.6 percent higher in organic terms than a year ago but was virtually equal to the value of work-in-hand at the end of the second quarter of 2003.

This flattening of the organic revenue and backlog growth curve reflects our active management of project intake to better match subsidiary management capacity with revenue and risk and to ensure that we have backlog capacity available when economic recovery provides us with opportunities for new higher-margin private sector work.

Third quarter net income was $6.5m, or 42 cents per diluted share, compared to $19.5m, or $1.26 per share, a year ago.

Operating results reflected all of the challenges and the limited opportunities that we discussed in detail on our last guidance call -- continued disproportionate reliance on public sector projects with longer durations; reduced private sector spending on discretionary small project work, which typically produces some of our highest margins; slower-than-anticipated return to profitability of our U.K. operations; and selected instances of substandard operational management of project risks.

The latter factor has resulted in decisive and aggressive action on our part to replace under-performing management and to right-size ongoing operations to match management's strength and capacity. We discussed these actions in detail on the last call. There were no fresh or previously undiscovered management problems in the interim.

General and administrative costs in the third quarter also illustrated our management focus on cost control during these challenging times.

Although SG&A costs increased to $104.7m, or 9 percent of revenues, compared to $93.4m, or 8.9 percent of revenues, in the year-ago quarter, more than 100 percent of the increase was related to the CES acquisition. Excluding CES, SG&A costs in the current quarter were $87.4m, a $6m reduction from a year ago and 8.3 percent of revenues. We expect our SG&A reduction program to continue to bear fruit in the fourth quarter and in 2004.

All of our North American sectors were profitable during the third quarter, although our U.S. sectors reflected lower percentage margins throughout. Recessionary market impacts were most concentrated in our U.S. mechanical and facilities service businesses as expected, while U.S. electrical and services and U.S. facilities services performed better, although not up to year-ago levels on a percentage basis.

Showing the solid performance of the former CES facilities management companies, U.S. facilities services' operating income doubled in dollar terms compared to third quarter of 2002, and our Canadian company also exceeded its 2002 profit performance. Our U.K. subsidiary reported continued operating losses during the third quarter as new management continued its housecleaning and reorganization activities.

Please go to slide four.

Our year-to-date results show the same trends for the same reasons as the third quarter -- continued strong revenue performance, demonstrating our continued market strength, and lower gross to net margins due to the same factors that affected our quarterly results.

Revenues for the year-to-date were $3.36b, 18 percent higher than year-ago levels but 3.2 percent higher from organic sources.

Net income was $18m, or $1.16 per diluted share, compared to $41.6m, or $2.69 per share, a year ago.

Please go to slide five.

Balance sheet strength has always been a focal point of EMCOR management, and the current balance sheet is both strong and liquid, rewarding management's efforts. Our companies are typically net investors of working capital in our many projects at this time of year, and balance sheet comparisons to year-end 2002 illustrate this normal trend. Although total debt rose about $60m from year-end levels, balance sheet cash and working capital remained strong, and the debt-to-capitalization ratio was 27.5 percent, well within the comfort range of EMCOR management.

We expect both total debt and the leverage ratio to decline between now and year-end, in concert with normal cash flow trends.

Net overbilling of accounts receivable, an important indicator of efficient contract administration, was just under $100m at quarter-end, confirming the continued strength of our customer relationships.

The scope of those customer relationships is vividly illustrated on slide six, a bar chart showing six years of consistent growth and diversification of our contract backlog. This quarter's bar shows our continued success in deriving revenues and profits from growth sectors, like public transportation, healthcare, education, and water and wastewater in the face of continued weakness in our traditional private sector commercial markets.

Although our public sector projects produced lower net margins than corresponding private sector jobs, make no mistake, we're glad to have them and the stability they have contributed to our revenue performance and cost coverage.

We often present this slide and comment on the trends that it illustrates without stopping to point out the remarkable strength of some of our individual market positions derived from our diversity strategy that the chart depicts.

The third quarter 2003 backlog bar includes the following contract backlog balances, calculated both consistently and conservatively. In private sector commercial, we had $733m of backlog at quarter-end; in healthcare, $260m; in institutional, particularly education, $666m; in hospitality and gaming, which, of course, is another private sector, $205m; in manufacturing, including power generation, $315m; and in water and wastewater, a very promising long-term sector, $185m.

These are strong market positions that provide us with important visibility concerning our revenue base in future periods.

On slide seven, we list a few of the contract awards to our companies during the third quarter, illustrating some of the stronger trends that we see developing in our markets.

For many years, our Welsbach Electric Company has provided maintenance services for all of the traffic signal systems and significant portions of New York City. They have recently received a new two-year award for the Bronx and the borough of Queens.

Hansen Mechanical will provide total mechanical services for 1,000 new high-end suites, a new central plant, and the renovation or addition of more than 250,000 square feet of public space at the [Belagio][ph] complex in our healthy Las Vegas market.

EMCOR Energy and Technologies will provide construction services for a central plant at Casino [Melango][ph] in California, while our Dynalectric companies in D.C. and Michigan will perform the electrical contracts for new commercial developments at Tysons Corner in Virginia and at Visteon Village in Detroit. And EMCOR Facility Services, in partnership with [C.B. Richard Ellis][ph], will provide ongoing services to the McGraw-Hill companies at various locations.

These projects, and many others like them, form the foundation for our confidence about the future evolution of our Company's operations and our financial results.

On our earnings guidance call, we estimated that EMCOR's profitability would be higher in the second half of 2003 than in the first half, and we reiterate that guidance today. Specifically, we anticipate fourth quarter earnings for diluted share to be in the range of 51 cents to 56 cents, leading to full-year 2003 earnings of $1.67 to $1.72 per share on record revenues of $4.5-4.6b.

As discussed in detail on our previous call, we expect all of our operating sectors -- U.S. electrical and services, U.S. mechanical and services, U.S. facilities services, Comstock Canada, and EMCOR Drake & Scull, before reorganization charges, to be profitable in the fourth quarter.

Finally, we reiterate our previously stated impressions of our Company's operating profit opportunities in 2004.

We are still in the early stages of our 2004 budget process, which is a bottom-up process involving collection and interpretation of forecasts from each of our subsidiaries, and we will not have completed this process until early December. Accordingly, I stress that the following is not guidance.

However, taking into account the numerous factors that have defined our operating and financial results during 2003, including continued recessionary impacts on private sector spending, modest improvements in small-test discretionary work, gradual improvement in our U.K. operating results, consistent performance of our facilities service businesses, constant attention to the control of interest expense and administrative costs, and a resulting reversion to a kind of baseline financial performance, for want of a better word, we look for 2004 operating profits to be in the range of 2 percent of revenues, with a significant possibility of enhanced performance if private sector capital spending strengthens, as predicted by many economists. The anticipated baseline level of performance would produce 2004 EPS growth at least 40 percent higher than estimated 2003 levels.

Please move to slide eight.

In early October, we announced an agreement with Siemens Building Technologies, or SBT, for the establishment of a broad operating alliance and for the acquisition by EMCOR of Siemens' U.S. facilities management services business. We expect the acquisition transaction to close very shortly.

Today, I'd like to put a little meat on the bones of the alliance between the two firms by discussing the combined capabilities of EMCOR and SBT and the strategies which will drive our alliance.

The concept is very straightforward. EMCOR, the premier facilities service provider in the country, allies with Siemens Building Technologies, a world-class provider of building infrastructure solutions for comfort, life safety, security systems, and energy efficiency. Both firms are expert at optimizing both building performance and operating cost. The alliance creates a broadly skilled nationwide capability to bundle the best and most comprehensive solutions for building management and control.

On slide nine, we illustrate the complementary nature of the alliance partners' skills and services. EMCOR's strength in facility management services, operations maintenance, and electrical and mechanical construction, teamed with Siemens building management products and solutions in the fields of building automation, fire safety, security systems, and HVAC products will offer customers a broader suite of products and services from a single-source supplier, bringing efficiency to building management budgets and an unmatched facility management knowledge base.

On slide 10, we illustrate the product, solution, and service delivery capability of the EMCOR/Siemens alliance. Both companies operate nationwide networks with a total of more than 200 locations. Alliance products and services reflect the talents and efforts of more than 30,000 trained personnel, and the combined estimated U.S. revenues of the alliance partners this year will be more than $5b. The EMCOR/Siemens alliance has the potential to be a formidable force in the growing building performance technologies' solutions and services sector.

On slide 11, we recite the competitive advantage and the strategic power and focus of the new alliance, a unique combination of world-class products and solutions with local and national service delivery capabilities, offering our customers the broadest available suite of offerings over the entire lifecycle of a facility, putting into practice our combined market expertise in a team that's devoted to the utmost in customer satisfaction.

I hope you can tell that we're pleased and proud of our agreements with Siemens and dedicated to our mutual success.

That concludes my comments on this morning's press release. I'm sure there will be some comments or questions even though our announced earnings and our expectations are directly in line with previously issued guidance. I'll conclude by stating that EMCOR at the end of 2003 will be larger, stronger, more diverse, and uniquely positioned to profit, short- and long-term, from the inevitable macroeconomic recovery.

I thank you for your interest and your support, and now we have time for some questions or comments. Paul?

[Caller instructions.]

Your first question is from [Jeff Beech][ph] with Stifel Nicolaus.

Yes, good morning, Frank.

Good morning, Jeff.

The Midwest -- would you discuss the current market conditions there going into the fourth quarter? And on the prior conference call, you had talked about downsizing some operations because they had maybe exceeded capabilities to handle projects. Is that primarily oriented in the Midwest? And if it's broader than that, could you talk about how many locations that that might impact?

Thank you, Jeff. I think that on the last call we spent some time talking about this concept of right-sizing operations to more accurately and directly match management's capacity with both work quantity and risk, and that process is [inaudible] underway at all of our locations. We're always watching to see that companies have not taken on too much work or too much of a particular kind of work, or too much risk in relation to the available reward.

In the case of the Midwestern companies, you are quite right in that those companies had recession-related impacts on their markets that were significantly out of proportion to some of the larger urban markets that we work in on the East and West Coasts, and some of those Midwestern companies essentially had no place to go if a major customer decided to suspend capital spending for the year.

The process at that point is not to flee the market because markets always get better after they get worse, but one has to reduce the risk profile of the operation, and that will almost always involve reducing the general and administrative costs, reducing estimating expense, collecting the money from the market, and waiting while the market improves. And that's what we have done in a number of operations in the Midwest.

There were also a couple of companies that we think had exceeded their capacity to manage volumes of work, and those companies will be smaller companies next year, reflecting our assessment of their ability to handle certain quantities of work.

I've also spoken on previous calls about the U.K. company and about the fact that our ongoing reorganization of that company will involve, among other things, substantial reductions in the amount of construction revenue derived from the U.K. market so that in the future, I believe, that construction will account for probably no more than a third of the U.K.'s overall revenues, with the balance derived from our consistently profitable facilities service business.

I think that the focus of our right-sizing activities, Jeff, will be in those two areas, that is to say the Midwest and the U.K., but we will always be looking at the right-sizing of operations, both for the purpose of matching risk with management capacity, but also in current circumstances, in making sure that there is management capacity and performance capacity immediately available when market recovery begins to provide us with new and higher-margin opportunities from the private sector.

Again, just in North America alone, can you give us an idea of about how many total operations you have and how many might be right-sized enough to see a difference? Can you give us a ballpark if it's 10 percent of the locations or --?

Well, I think it's probably between 10 and 20 percent of the locations, Jeff, that we're looking at right-sizing for, but in revenue terms, it would be probably 10 percent of our revenues --

Okay.

-- because the locations are disproportionately small ones in small markets.

All right. Thank you.

Okay.

Your next question is from Jamie Cook with Credit Suisse First Boston.

Hi, Jamie.

Hi, guys. My first question is, when you guys talked about last quarter issues on the public side where customers did not want to pay for change orders. My question is, was that just a couple of contracts, or was that an ongoing trend?

And then after that, my question is, are you still fighting to get that money? Is that sitting out there in a receivable, or have you already taken a hit for that?

Okay. Good question, Jamie, and if you don't mind, I'm going to use your question to make a slightly broader comment about the characteristics of our business, and I know that you understand it well.

But for people listening on the call who tend to look at gross margin in backlog as some kind of an indicator of trends, I want to spend just a moment to explain how backlog becomes revenue and profit.

There is a tendency, I believe, on the part of some observers of our company to think that a project going into backlog at, let us say, an 11.5-percent gross margin necessarily comes out the other side as revenue with 11.5-percent gross margin. That, in fact, is rarely the case. The resulting margin from a job in backlog is frequently more than 11.5 percent, in this particular case, or it might be less. The process of converting backlog to revenue and profit is a function of management and of management's control of all the risks associated with the project.

And whereas it's useful, I suppose, in a marginal kind of way to look at margins in backlog as an indicator of macro trends in the markets, it's not that useful because there is a very significant management function associated with converting backlog margin into operating margin.

One of the risks that management has to deal with and one of the impacts on margins as they proceed from backlog into revenue is the attitude of the customer. And on the last call, I talked about an evolution that had taken place in the administrative attitudes of some customers, particularly in the public sector and particularly with respect to public sector customers, which had come under financial stress, typically as a result of the diminution of tax revenues associated with recessionary impacts.

And my point at that time, and what Jamie is referring to, is the fact that we noted a change in attitude on the part of some of those customers, the effect of which was to make it more difficult and time-consuming to negotiate and obtain approval for and payment of extras, of changes in scope or changes in design, or other charges that affect a great many construction projects.

Facility service contracts, by the way, show very little variation between backlog and revenue and profit, whereas construction projects tend to show significantly more.

We did note that change, Jamie, in the last quarter and on the guidance call, and fortunately, this is the kind of relationship that our construction managers are accustomed to managing and to dealing with. We are experts at proposing and obtaining approval for change orders before they are performed. I think that one of the healthy indicators of the fact that our contract administration remains in healthy condition was that $100m overbilled number that I mentioned to you with respect to the end of the third quarter. That's a good number. That's a high number, particularly in current circumstances, with a fairly high proportion of public sector customers.

So, all in all, I think that our receivables' accounts, particularly, for this time of year are in normal condition. Our cash account is strong. It's in normal condition for this time of year. And although there will always be individual situations among our thousands of projects in which we have a battle going on with a project manager of some kind or another, in general, I think our business is evolving normally.

And I'm sorry for that lengthy response, and I, frankly, used your question to talk about something else that I think is important to an understanding of EMCOR.

Okay. And then my next question, can you quantify what would be the reorganization charges in the U.K. in the fourth quarter?

I can't break it down between quarters, but I can tell you -- I can reiterate that our costs overall in the second half of the year will be between $3-5m.

In the U.K.?

Correct.

And what about -- how much did the integration of CES cost you this year? Just because I'm trying to get a feel for, you know, what we had in '03 that was sort of a one-time issue versus '04, where I'm assuming, you know, the U.K. should be behind us, and we shouldn't have the one-time charges.

Yeah, I think I said at the end of the second quarter that I thought it had cost us 1 percent of revenue on the SG&A line for the first two quarters of the year.

Okay, thank you.

You're welcome, Jamie.

Your next question is from Alex Rygiel with Friedman, Billings, Ramsey.

Hi, Alex.

Hi, Frank. A couple quick questions.

Okay.

Follow-up on that last question, 1 percent of your U.S. CES revenues, so that would be, call it, $2m, integration expense--?

No, no, no, higher than that. Kevin, go ahead.

No, I believe it's 1 percent of total revenues, Alex.

Correct.

Total revenues, total company revenues.

Yeah, as I say, I think I'm pretty confident that on the second quarter earnings call I said that I thought that -- and don't hold me to this, but I think that our SG&A as a percentage of revenues for the first half was 10.3 percent and that I thought that normalized for the CES integration, that it would probably be a percent -- would have been a percentage point lower.

Fair enough. The U.K. operating loss in this quarter was a negative $3.2m. Since you just stated that the second half of the year restructuring's going to cost you $3-5m, is it fair to say restructuring in the fourth quarter will be $0-2m?

No, I think it will be more than that, Alex, but I do reiterate that the British company will be profitable in the fourth quarter before those reorganization costs and --

Okay.

Okay?

So you did lose a little bit of money from operations?

Yes, yes, sir. There is continuing -- as I mentioned in the body of my call, there is continuing housecleaning going on by the new management, who are acting very decisively, and headcount has been significantly reduced.

Okay. Within the U.S. facilities services operating income line, which was $5.6m, if we back out to $4.7m from CES, we get to an adjusted U.S. facilities services of about $1m.

Yup.

You stated that that was -- I think you stated in your text that that was twice as much as last year, but when I go back to your third quarter Q of last year, it looks like you made about $2.5m.

No, what I was comparing was operating income in U.S. facility services of about $5.6 million for this quarter, as compared to $2.8 million in the same period last year.

Fair enough. Can you comment then on your core U.S. facilities services business as to why operating margins there have eroded a little bit?

Yes, those operations were disproportionately affected by the reduction in discretionary service and small-task spending, whereas the acquired businesses had a significant amount of site-based service work that is a function of long-term contracts that were not significantly affected by the recession.

Okay, and one last question. Backlog -- you gave us a few numbers there, and I appreciate that. I think you gave us six of the eight components. Can you give us the other two components? I believe it's transportation and another to tie out to the $3.1b?

I'm sorry, Alex, I missed your question.

I captured -- in backlog you quantified private commercial backlog, healthcare, institutional, hospitality --

Yeah.

-- manufacturing, water. Can you also provide us with transportation and another so that we can tie out to the full $3.1b?

Did I not give a transportation number? I'm sure [inaudible].

[Inaudible] missed it, I apologize.

Yeah, 700 and -- I know I've got it, Alex.

We can get it.

Okay. Yeah, Alex, I'll come back to that as soon as I find it. It's in a -- hang on, got it. Transportation, $744m.

Great. Thank you very much.

You bet, Alex. Bye bye.

Your next question is from [Andrew Walach][ph] with Cumberland Associates.

Good morning, Andrew.

Good morning, Frank. My question is, if tomorrow morning we started to see a pick-up in spending for private sector projects, how long would it actually take before we really saw it in your bottom line?

Not long at all. It would be a mixture of impacts. Some major green field projects, if a decision was made by an owner to authorize a capital expenditure in a big, new development somewhere, that would immediately benefit the architects and the designers and the engineers, and the first contractors to benefit would, of course, be the excavators and the steel erectors and the concrete guys and the like, and we would participate, as usual, in the systems installation, which would be later in the process.

However, there would be a great many projects authorized in your capital spending scenario, which I very much like, by the way, which would be a long-delayed renovation or upgrading or restacking or even just deferred maintenance of facilities that have been allowed to underperform and to be unmaintained or unimproved for a lengthy period of time associated with this recession.

And we've got a broad suite of services that are geared to providing those kinds of short-term services involving, very frequently, just an upgrading of the systems that create those facility environments.

As tenants, for example, begin to move into space, we're already seeing statistics that suggest that positive absorption of vacant real estate is taking place for the first time in probably 18 to 24 months. As those tenants begin to agree to take on a new space, they're demanding new layouts, better systems and services, and that would be the short-term benefit that we would get. That would also reflect our facilities service capability and decisions being made by many owners and end-users of facilities, perhaps due, in large part, to the disciplines learned from three years of recession, to outsource those responsibilities instead of taking on new personnel to try to provide those services in-house. The specialization of the supply chain is a feature of the macroeconomic recovery, which I believe is starting to take place, and we are beneficiaries of those kinds of trends.

Okay.

Thanks, Andrew.

Thank you.

Your next question is from Michael Roesler with CJS Securities.

Good morning, Mike.

Good morning. Frank, just to follow up on that management control issue as to how important it is to your gross profits, anything going on at the executive management level, particularly as it relates to U.S. operations, to change your controls of the process at the subsidiary level?

Well, we have always thought that we have good control of our operations. You know that we are very diversified and that we rely upon the expertise of local personnel to manage and control risks. We did not anticipate the duration and severity of the recession. That is for sure. And in hindsight, we certainly could have reduced SG&A more aggressively than we did, particularly in the estimating and business development areas. But that's hindsight.

In terms of the efficiency of our controls and our communication systems between corporate and our various subsidiaries, we have made certain structural changes in our organization in order to reflect a better information flow, and at the same time, we've been looking at our financial and treasury functions because our cash flow monitoring, which is a daily report that I receive every afternoon, is an important way of triangulating the results that our subsidiaries are reporting to us.

We don't have a large capital asset depreciation budget, and accordingly, cash flow with adjustments for seasonal and other factors, is an important measure of how we're doing overall in P&L terms. It at least gives you the basis for asking a question, and that's why on these calls I allude to trends in such indicators as net overbillings and balance sheet cash and working capital as an indicator of how we are doing.

The incursion of significant debt in an operation like this is very dangerous, and that's why we have a very conservative comfort level as far as leverage is concerned.

Overall, I think that our reporting systems continue to be in good shape although, as I say, we have made certain changes in its structure on the operating side at group in order to make it more efficient.

And to follow-up on the net overbill position, obviously it remains strong at around $100m, but it was down about $28m versus last year. Can you talk about the trends going on there, what we should sort of start to build into our thinking on cash flow forecasts for '04?

Well, first of all, being net overbilled is a good thing. It reflects the fact that one has sufficient negotiating strength and administrative sophistication to build into our portfolio of contracts an ability to be paid in advance before costs are sustained, and this is an important aspect of our financing of our projects and of the mitigation and management of our risk exposure. It is axiomatic that you are less vulnerable to the predations of customers if you've got their money already.

On the other side of the coin, I have said for a long time that the evolution and growth of our facilities service business will be negative for our net overbilling account because a great deal of our facility service work requires that we sustain the cost before we can bill for it because it is a cost-plus kind of relationship. It's a good relationship from the standpoint of risk production and predictability, but it does mean that the cash flow characteristics and our opportunities to overbill or advance-bill the customer, rather, are not nearly as good as they are in hard-dollar construction.

So I think that -- I'm sorry, one more factor. Public sector projects are typically harder to advance-bill on than private sector, so we've seen a little bit of reduction from that area, although we've still managed to maintain our account at a good healthy level.

I think in the future the trade-off for the -- what we believe to be the inevitable growth of our facilities service business as a percentage of EMCOR in total will be that our net overbill position will decline marginally as that goes along. But we think it's worth the trade-off.

Okay. And onto the services side, when can we start to think about what the financial contribution can be from this combination with SBT?

Oh, I think that both companies will be working hard on framing the parameters for this business in the next quarter or so, and I would hope to begin to see significant fruit from this business by the second quarter of next year.

Good. Thanks.

You're welcome, Mike.

[Caller instructions.]

Your next response is from [Scott Shern][ph] with [Clovis Capital][ph].

A quick question. Frank, at the beginning of the year, right after you made the CES acquisition, at that time, it was pretty obvious that the acquisition would be accretive, and yet you refrain from increasing guidance, if I remember back earlier in '03, which essentially was lowering guidance. And the justification you gave was that you thought that you weren't that comfortable with you were seeing in the private business. You turned out to be right. Can you just talk about -- you know, you seem to have identified it earlier, but then you didn't take the cost actions. Can you just -- was there something going on that accelerated, or was there something that prevented you from wanting to cut the cost at that point in time? But I seem to remember at the time of the CES acquisition, you specifically did not raise guidance when it was pretty obvious that it was accretive just on the back of an envelope.

Yeah, that's right. At that particular time, Scott, that was prior to our completion of our 2003 budget. That was, in fact, in early December of '02, and I didn't have our budget in hand for '03 at that point. But I already had a feeling of discomfort with some of the market expectations for our overall operations during '03, and I didn't want to provoke a knee-jerk reaction out of the market until I was ready to talk about the details of our 2003 expectations based upon our budget, and those were numbers that I didn't have at that point. So, you're right. I reacted cautiously, and I turned out to be right. I'm kind of sorry that I was right, but there you are.

With respect, however, to acting early to take costs out, remember that ours is a growing company, and even in organic terms, we've grown between that time and today, so pulling costs out of a growing company is a little more of a challenge than pulling [indiscernible] out of a company whose overall operations are in a downturn, including the revenue base.

We've been very aggressive about pulling SG&A out of our businesses despite the fact that we're growing, as you can see by the fact that, apples to apples, we're down $6m year over year. But that's been done through increased efficiencies, distribution of shared services, and elimination of redundancies at various levels of the operation and other tasks that have, in total, had a fairly significant effect but consist of a lot of little activities.

I was stuck at year-end last year with the need to determine where our revenues were going to come from and if, in fact, we were going to grow overall as I anticipated. That made aggressive cost-cutting decisions very difficult at that time.

Okay, just one follow-up if I can. What I’m a little confused about is that for years you've grown the business without a blip, and you have so many different contracts. One would think off a larger base that you would have diversified the business more and more, which sort of decreases the probability of any one contract causing a miss. Moreover, you bought this services business, the CES, which was -- you know, sounds like a great business and has a repeat customer, such that it should decrease the probability of a miss.

So, you know, from a macro standpoint, looking at your company after so many years on the largest base you've ever had and having bought a services business, which, in theory, has a repeatable business to itself, why is that in the miss? Because you would think it would happen off of a smaller base where any one contract makes a difference. Do you understand the question?

Sure, I do very well. First of all, the services business has performed well. We're delighted with the CES acquisition, and as you can see from the breakdown in the Q, it has contributed essentially to a doubling of our operating profit from the facilities service sector year over year.

The reduction in our margins is due not to any single contract or even any single group of contracts, but to an overall reduction in available margins associated with a very significant macro change in our overall backlog. Our base is much larger than it was before, but it is also currently skewed towards the public sector, a comment and a trend that I've made in, I believe, three consecutive calls now. We believe that the public sector work is an important part of our business. As I mentioned on the body of my call today, we're glad to have it even though it doesn't produce the kind of reward opportunities that private sector work does, and that's primarily because there are no particular rewards for efficiency in the public sector. You tend to get paid what you're entitled to be paid, but there is no motive on the part of the customer to pay you more in return for value engineering or increased efficiency or early delivery or anything of that type, characteristics that EMCOR always devotes itself to trying to accomplish for its customers.

So the risk/reward characteristics of our overall backlog, without reference to any particular jobs or sectors, has been lower as a result of macroeconomic trends. The fact that we have trended down and not collapsed as a more focused or smaller company would have in the circumstances is an indication of the benefits of the large size and the diversity of our portfolio. But we were not immune to the recession. We never said we were. We think our model works pretty well, but we have never said it's perfect.

Thank you.

Okay, you're welcome, Scott.

Your next question is from [Jeff Beech][ph] with Stifel Nicolaus.

Yeah, a follow-up. In this third quarter, your operating profit margin in mechanical in North America was under 1 percent, and it seems like it's a combination of shrinking revenues and probably more competitive market conditions, but corrective actions you're taking right now without a recovery in the market seem like it ought to be able to move up those profit margins from something under 1 percent. What corrective actions are you taking in mechanical besides the downsizing here, or maybe including downsizing? And what might be a reasonable margin to expect without a favorable mix change looking out into next year?

Jeff, I think that you'll see mechanical moving back towards the mean. In fact, I think they'll have a better fourth quarter than third. The disproportionate impact of all of the factors that I discussed this morning and also three weeks ago on mechanical is a function of the fact that (a) that mechanical companies are in more small and fragile markets than our electrical companies are, notably, the Midwest, and, secondly, that mechanical companies are much more vulnerable to the customer decisions to defer or eliminate small task maintenance work. That's where -- those are the HVAC companies. Those are the ones who didn't get the calls during the summer because of the historically cool and wet summer. Those are the ones whose trucks sit still if nobody makes a telephone call, whereas our electrical companies tend not to be as vulnerable to downturns in that kind of a business. So I think we've seen the worst of it in our mechanical companies. I do think they'll have a better fourth quarter and a better 2004.

Thanks.

You're welcome.

There are no further questions at this time. I'd now like to turn the call back over to management for any further comments or closing remarks.

I thank you all for your questions, for your comments, and your continued interest in and support of EMCOR Group. We look forward to talking to you further, particularly when we close the Siemens acquisition transaction, and we'll see you in the fourth quarter. Thanks very much.

Thank you, ladies and gentlemen, for your participation. This does conclude today's call. You may now disconnect.