EMCOR Group Inc (EME) 2009 Q3 法說會逐字稿

Good morning. My name is Kiery, and I will be your conference operator today. At this time, I would like to welcome everyone to the EMCOR third-quarter 2009 earnings 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 session. (Operator instructions) Thank you. I would now like to turn the call over to Mr. Gordon McCoun. Mr. McCoun, you may begin your conference.

Thank you, and good morning, everyone. Once again, I'd like to welcome you to EMCOR Group conference call. We're here to discuss the Company's 2009 third-quarter results, which were reported earlier this morning. I'd now like to turn the call over to Kevin Matz, Executive Vice President, Shared Services, who will introduce management. Kevin, please go ahead.

Thank you, Gordon, and good morning, everyone. Welcome to EMCOR Group's earnings conference call for the third quarter of 2009. For those of you who are accessing the call via the Internet and our Web site, welcome. And we hope you have arrived at the beginning of a slide presentation that will accompany our remarks today. Currently, everyone accessing the call should be on Slide 1, which is the EMCOR title slide. Please now advance to Slide 2.

Slide 2 depicts the executives who are with me to discuss the quarter and nine-month results. They are Frank MacInnis, Chairman and Chief Executive Officer; Tony Guzzi, President and Chief Operating Officer; Mark Pompa, our Executive Vice President and Chief Financial Officer; Mava Heffler, Vice President, Marketing and Communications; and our Executive Vice President and General Counsel, Sheldon Cammaker.

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 sections of our Web site under "Presentations." You can find us at emcorgroup.com.

Before we begin, I want to remind you that this discussion may contain certain forward-looking statements. Any such statements are based upon information available to EMCOR's management's perception as of this date, and EMCOR assumes no obligation to update any such forward-looking statements. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. Accordingly, these statements are no guarantee of future performance. Such risks and uncertainties include, but are not limited to, adverse effects of general economic conditions, changes in the political environment, changes in the specific markets for EMCOR services, adverse business conditions, increased competition, mix of business, availability of adequate surety bonding, and risks associated with foreign operations. Certain of these risks and factors associated with EMCOR's business are also discussed in the Company's 2008 Form 10-K, its 10-Q for the third quarter ended September 30, 2009, and other reports filed from time to time with the Securities and Exchange Commission.

With that said, I'd like to turn the call over to Frank MacInnis. Thank you, Frank.

Thank you, Kevin. And good morning and welcome, everyone, to our 59th regular quarterly conference call for investors, analysts, and other friends of EMCOR Group. Today's call is being conducted, as usual, by telephone and by simultaneous Webcast. And I'll be referring from time to time to a slide number to identify the relevant slide for Webcast participants. Right now, we're still on Slide 2.

The focus of today's call will be on the 2009 third-quarter and year-to-date earnings press release and Form 10-Q that we issued and filed earlier this morning. We'll conduct this call in our customary manner. First, a brief discussion of those operating results, including highlights of segment performance, cash flow from operations, and overall quality of earnings. After commenting on our quarter-end balance sheet and liquidity, I'll discuss the recent evolution and current status of our contract backlog portfolio, with special emphasis on sectors that are being affected, positively or negatively, by current market conditions. Then, I'll turn the call over to Tony Guzzi, our President and COO, for his views on some notable recent contract awards from around our broad and diverse group of operating subsidiaries, followed by a Company profile on our New York City and Long Island-based subsidiary, Welsbach Electric, a company whose current success perfectly illustrates EMCOR Company's nimbleness in adapting to current market demand.

During our respective presentations, Tony and I will strive to evaluate EMCOR's excellent current performance and our future prospects in light of the challenging macro-economic circumstances in which most large companies are operating today. I'll talk about trends that I believe will influence our performance through the fourth quarter and into 2010 and I'll provide modified revenue and earnings guidance for the full-year 2009. At that point, there will be an opportunity for listeners to make comments or to ask us questions. And you can see from Slide 2 that a number of our senior officers are on hand to provide helpful answers.

So let's begin. Please move to Slide 3.

In mid-1995, EMCOR began a record of consistently profitable operations that continues today, 57 consecutive profitable quarters later. Recent events have shown how difficult it is, even for well-capitalized, well-managed companies, to achieve such a record of consistent performance. It's worth noting that EMCOR's more than 14-year profit record includes several major market cycles, an indication that our business model works in a variety of macroeconomic conditions.

In the third quarter of 2009, illustrated on Slide 3, EMCOR performed well despite a significant year-over-year reduction in revenues as a result of the recession and related factors. In 2008, in response to looming recessionary warnings, we began to cut costs, both in the field and in our administrative offices, and stress the importance of execution of construction and service contracts and maximization of project cash flow. As a result, we were able to mitigate, in part, the recessionary impact on market demand and we reported operating income of more than $67 million for the quarter just completed.

On Slide 4, we show our performance for the nine-month year-to-date period, once again in the midst of macroeconomic malaise. This slide illustrates even more vividly the impact of our cost control and project execution efforts. Notwithstanding an 18% year-over-year reduction in revenues, our diluted earnings per common share are nearly equal to last year's record performance, the result of operating margins nearly 100 basis points higher than last year.

Although we expect operating margins to decline somewhat until market growth begins to spur margin opportunities, we are proud of our performance and, in particular, the significant variability of our costs that our financial results illustrate.

Slide 5 mentions some highlights and details from our third-quarter financial results. I've spoken in past quarters about the continuing weakness of two of our market sectors, commercial and office construction and gaming and hospitality, and their disproportionately negative impact on our revenues. That pattern continued in the third quarter, although it was offset, in part, by much smaller declines in our health care, transportation, and institutional sector revenues.

Our US facility service segment revenues for the quarter declined 3.5% year over year and UK and Canadian revenues also fell, due in part to foreign exchange impacts. As I mentioned earlier, our third-quarter and year-to-date results are really a story of execution, as shown in the operating margin table on Slide 5.

Quarterly operating profit, as a percentage of revenue, in our US operations rose 30 basis points year over year to 6.4%, including 100 and 160 basis point increases in our US electrical and US mechanical segments, respectively, partially offset by an operating margin reduction in our US facility service operations, due, in part, to one-time items. Operating margins in our UK and Canadian segments gained 140 basis points to 3.9%, and our operating income percentage for the Company as a whole was 4.9%, an EMCOR record for a third quarter.

We're encouraged by our operating margin performance in both the three month and nine month periods, especially since an increasing proportion of our revenues is being derived from contracts acquired during the recession. Please go to Slide 6.

In addition to excellent project execution, the quarter and year to date have reflected significant reductions in overhead costs, which fell $7.8 million compared to the year-ago quarter and more than $35 million for the year to date. Our resulting pretax income was $66.1 million and net income was $40 million, or $0.59 per diluted common share, compared to $48.6 million, or $0.72 per share, in the third quarter of 2008.

As I mentioned earlier, this is our 57th consecutive profitable quarter and our quality of earnings as measured by operating cash flow compared to net income was also extremely high. Year-to-date cash flow from operations was a remarkable $272 million, versus just under $200 million in the last year, strong evidence of the strength of our cash-centric culture and the efficiency of our contract administration. Please go to Slide 7.

All that operating cash led to a very strong and liquid balance sheet at quarter end. Cash on hand was nearly $650 million; balance sheet working capital was $625 million; and our total debt to total capitalization ratio was 14.2%, reflecting our conservative view of balance sheet leverage.

Contract backlog at quarter end was $3.39 billion, compared to $4.42 billion a year ago and $3.4 billion at the end of the 2009 second quarter. Please go to Slide 8.

The quarterly rate of decline of our contract backlog slowed dramatically during the third quarter compared to the first two quarters of this year. Continued weak demand in our commercial and gaming and hospitality sectors resulted in reduced backlog, but that reduction was substantially offset by growth in our health care and institutional sectors, resulting in essentially flat backlog value in the consecutive quarters.

While it's a little too early to identify a definitive bottom to the value of our contract portfolio, we're pleased with the relatively stable performance of our health care, institutional, industrial, transportation, and water and wastewater sectors and believe that they form a foundation for future good performance, supplemented by the eventual rebound of the commercial and finally the gaming sectors. It's worth noting that while our commercial and hospitality and gaming backlog is down 54% year over year, our remaining sectors have been very stable, declining only 5.1% during the same year-over-year period.

Now it's time to review some recent project awards from around our broad and diverse subsidiary group. And here to discuss them, together with our featured Welsbach Company, is our President and COO, Tony Guzzi. I must say before Tony starts, however, that in the shameless pandering to Tony, as a former Army ranger, I see two Army jobs at the top of the new project list. Tony?

Hey, Frank. Maybe we'll get lucky enough to beat Navy this year.

We always use the slide, this slide, to talk about the diversity of our customers, our geographies, and our services. And I think what you see in the slide typically is we can do a lot of things for a lot of different people. And what this slide shows today is the continued transition in our backlog mix really away from the commercial and hospitality sector, not by choice necessarily, but by necessity, into more stable markets fueled more by public sector money, such as health care, transportation, and institutional. And it's not only public sector money; it's where you're really putting in long-term infrastructure for projects that are made over a 20-year time horizon versus a more economically sensitive 5-to-7-year time horizon. And we continue to see very good end demand in some of these sectors, especially for the large projects, for both the construction work we offer and the service work that we offer.

With this in mind, let's take a look at a couple of the projects. I think through these slides over the last four years you've seen that EMCOR has been a fairly significant player in the Base Closure and Realignment Commission, the BRAC. It's been good work for us because it's usually sophisticated work that has to be done on a tight schedule.

First, in El Paso, Texas, with Fort Bliss, Texas, our Border subsidiary will be providing plumbing and HVAC systems for 12 tactical equipment maintenance shops, totaling 390,000 square feet in Fort Bliss. And it's pretty creative construction they're using there. And this is where a lot of the equipment coming back from the war will be reconditioned.

The project was designed by the Corps of Engineers, required BIM design, Building Intelligence Modeling, and drawings for trade coordination and clash detection, something we excel at. And, additionally, this project is targeting LEED. That's the energy-efficient design by the US Green Building Council Silver Accreditation.

If you move a little north, or a lot north, up into Fort Riley, Kansas, our Central Mechanical subsidiary has had a long run there, really rebuilding the base, especially with the housing. And they are going to design, assist, and install a complete mechanical system -- HVAC, plumbing, piping -- for the barracks for the unaccompanied enlisted housing. It should be about 50,000 square feet, 72-man sections for the barracks. And they're also targeting LEED Silver Accreditation. It's a big trend we're seeing in government and municipalities across the country. They're searching for en- -- and a lot of that is based on energy efficiency.

If you go to the City of Los Angeles, you'll again see our span across these institutional sectors or these public sectors. A city-wide automated traffic surveillance and control project, and they'll phase in geographic areas of LA. And Dynalectric LA will be installing a system for the San Pedro area. This is Dyn's second project phase and it will include the upgrade or replacement of 64 traffic signal controllers, including various modifications to existing traffic signal poles, gear, and wiring at all locations.

Additionally, Dyn LA will replace over 18 miles of underground conduits and fiber-optic cables, 13 video surveillance cameras, loop detectors for vehicle traffic, video and data communications equipment, and the refurbishment of a communication hub facility. Pretty complicated project and the kind of stuff, again, that we do well.

In Phoenix, Arizona, our University Mechanical subsidiary is providing the entire mechanical package for the new Maricopa County court tower. This 680,000 square foot parking facility will house criminal courtrooms, jury assembly holding areas, underground parking, secured judicial chambers, waiting areas, and hospitality. Again, University is leading the effort with them and the projects will be LEED-qualified. Again, a trend we're seeing at all levels of government. And I know we're being a little repetitive here, but the reality is the strive for sustainability and energy efficiency is big with our customers and, quite frankly, it's big with EMCOR and we have the capability.

And as you move down to Texas again, and you see in a recent press release, our Houston-based Gowan Mechanical subsidiary is installing the HVAC system in the new maternity center at Texas Children's Hospital. And we have a big footprint there in the Texas Medical Center. The new 790,000 square foot, 15-story facility, and 1,000-car garage is based on the latest concepts of evidence-based design, which recognizes the environment and sustainability are a critical part of the patient experience and treatment. The hospital addition will be licensed for 90 beds, with the capacity for more than 5,000 births a year. And Kevin executed some pretty good math here, so that will be about 14 births a day.

Our Government Services Group secured the contract for the facilities operations and maintenance for NASA's Dryden Research Center at Edwards Air Force Base. Dryden is NASA's primary alternative space shuttle landing facility and provides orbital support for the International Space Station. Our scope includes the development of a quality, reliability-centered maintenance program, integration of the new program into a computerized maintenance management system, again, something we do well. It's really building on what we do at the Jet Propulsion Lab in Pasadena, and we have quite the credential now with NASA, another important customer of ours in our government space.

And sorry for this last one, it's a little bit of a vague descriptor, but, again, it shows the breadth of what we do and how people trust us and the kind of facilities we work in. Our Dyn Washington subsidiary is providing the electrical systems for a client we can't talk about. It will be one of the most advanced and secure datacenters in the eastern US. There will be two buildings, 62,000 square feet. And, look, we think the datacenter market is a good market. It's going to continue to be a good market. And then go back to the theme -- complicated structure, you need BIM, you need prefab, you need the best supervision, and schedule is important. All things we do well.

And finally, we'll talk a little bit about Welsbach. They'll be removing and installing new fire detection and alarm equipment at New York's Penn Station. And Welsbach has two locations in and around New York City. It's a very interesting company and we'll talk to a little bit more about it now on the preceding page. Please move to page 10.

First of all, Welsbach, like most of EMCOR's subsidiaries, is a long-term company. A hundred years in the greater New York metropolitan area. It's New York's largest electrical contractor specializing in outdoor electrical construction and maintenance. This is an infrastructure company. It's an infrastructure maintenance company and it's an infrastructure construction company. It's something we've built a lot over the last seven years, especially the construction side.

What do they do? Well, most of the things that keep things moving for us -- the roadway lighting, the traffic signaling, the intelligent transportation systems, runway lighting, SCADA systems, transmission and distribution circuits, mass transit and railway, high-voltage. These folks at Welsbach work and service on the things that keep things moving, lit, safe, running, and all the things that you only know there's a problem with when they don't work. Welsbach is one of the companies in EMCOR that actually has a stable growing backlog in this environment because it's a big player in infrastructure, infrastructure services, and it's a terrific team of professionals. And we look for continued great things from them in the future.

And with that, Frank, I'll turn it back over to you.

Thank you, Tony. We're proud of the performance of Welsbach, a 100-year-old company that has adjusted very well to current contracting conditions.

Now for a few final comments on our future expectations before we turn the call over to you, our listeners. Please go to Slide 11.

I won't surprise anyone on the call when I say that we continue to live and work in a time of considerable uncertainty. Although the end of the recession has now been declared as of this morning's GDP announcement, serious doubts remain about the scope and the pace of the recovery, the future of the stimulus program, and the availability of credit for new construction projects. While most of our blue chip customers don't have to worry about access to credit, I believe that there is still a serious lack of confidence about the future in the private sector as a whole, and this will inevitably inhibit capital spending, at least on greenfield projects, until the future becomes easier to estimate.

On the other hand, a few things have become clearer at EMCOR since we last talked. We've had an excellent nine months with diluted EPS only a $0.01 below last year and strong operating margins producing great cash flow. We've demonstrated yet again our ability to adjust costs and headcount quickly and efficiently with minimal restructuring charges. And we've rebalanced our backlog with promising projects in growing sectors like health care, government services, and transportation.

As we predicted, stimulus program benefits were slow to arrive in our sector, due largely to the sophisticated and highly engineered nature of many of our projects. However, we're now seeing at least anecdotal evidence of stimulus-related project opportunities, with more to come we believe.

Finally, we're very well positioned to take advantage of investment opportunities whenever they arise. We have a history of successful acquisitions and we'd like to continue to enhance the scope of our customer services and the foundations of our margin performance. Please go to Slide 12.

For full-year 2009, we now expect to earn revenues of $5.5 billion to $5.6 billion, an approximate 18% reduction from a year ago. We expect operating margins to decline in the fourth quarter as a result of changing revenue mix, but not to the levels previously foreseen. Assuming no sudden and material degradation in business conditions, we now expect 2009 diluted earnings per common share to be in a range of $2.20 to $2.35. I believe that it would require surprising and currently unforeseen circumstances to produce full-year results outside of this range.

We'll be back to talk about our 2010 prospects when more clarity is possible with respect to the macro risks and uncertainties discussed earlier and, in any event, no later than our February 2010 earnings conference call. Until then, EMCOR will continue to play to our strengths -- conservative disciplined management, cost control, and liquidity for opportunistic investments.

Thanks to our employees who make this all possible, and thanks to you, our listeners, for your interest and support.

Now it's time for your questions or comments and Kiery is here to tell you how to queue.

(Operator instructions) Your first question comes the line of John Rogers of D.A. Davidson.

Morning, John.

Frank, I know you don't want to get into 2010 numbers yet, but in terms of the margin improvement that you've seen this year, and it's impressive, and I guess I'm trying to understand, are those margins sustainable when and if we ultimately see a recovery in revenues?

There are many moving parts, John. EMCOR is a big and intentionally broad company, to enable us to take advantage of margins that are available in some markets, perhaps, and not in others. Let me see if I can recite some of the variables that we have to take into consideration in thinking about 2010.

I've already mentioned that I think that a broad resurgence of private sector confidence will be required in order to begin to stimulate demand in private sectors like commercial and, ultimately, gaming. I don't think, by the way, that the gaming and hospitality sector and market comes back for at least another couple of years, which is exactly what I said in the last couple of quarters as well.

Commercial I have more confidence in, sometime perhaps late next year. And it's worth noting, as I have done in past calls, that EMCOR doesn't go to zero in the commercial and office space because of the significant amount of energy-efficient retrofit and restacking that we do that is unrelated to new construction, especially greenfield construction. So I see a moderation and a bottoming of our commercial and office market and backlog sometime soon, with perhaps some modest growth opportunities sometime next year.

The stimulus program that we've talked about that has not, as we predicted, had a big effect on our backlog or revenues this year, may do so next year. We're beginning to see some of the highly engineered projects that we thrive upon coming through the stimulus or stimulus-enabled pipeline. And we think that we'll see more of that in 2010. Added to that, we have recently acquired, as most of the people on the call will know, a refinery services group headed by our Ohmstede subsidiary that has performed very well for us. But that is in a highly seasonal business where most refinery turnarounds and maintenance activities are performed in the early months of the calendar year. So we're watching carefully for performance there, performance, which in the past has been significantly stimulative for our operating margins in the Company as a whole.

I think that in a nutshell, John, that we expect operating margins to decline somewhat as a result of project and revenue mix changes that began about a year or a year and a half ago with the commencement of the recession and have proceeded through the recession. We're very happy, of course, with the very strong margins that we've reported in the year to date and especially for the third quarter, but we think that those margins will decline somewhat and indeed our guidance reflects that for the remainder of 2009.

2010, in my view, will be a matter of timing. We have a chance at some transactional changes to our revenue and profit base. We have significant opportunity for participation in the stimulus program. And I believe that our efficient performance of promising new projects in health care and transportation and government services, and even water and wastewater, will help us to make 2010 a good year as well. But, as I mentioned at the outset, we have a lot of balls in the air, a lot of moving parts, and 2010 is not yet clear enough for us to be clearer than that about it.

Okay. I appreciate the help. Thanks.

You bet.

Your next question comes from the line of Alex Rygiel of FBR Capital Markets.

Morning, Alex.

Alex, your line is open.

Frank, although you didn't comment on Kevin's performance, I thought he did an outstanding job this morning.

I agree with you. I wish there was a prize category for it.

Two questions. First, can you talk a little bit about how your institutional business today is similar or different than your institutional business in 2001 and 2002? Because if I remember correctly, last recession you did move into the institutional market a little bit more aggressively and didn't necessarily seem to make the profits that you expected in that business. So what's different today?

Good question that Tony is going to take on in detail.

Alex, if you look back, 2001, maybe '02 to '03 is really when that work came into fruition. One, we were very heavily based in commercial. Let me really give you three things that are different and a couple that are the same.

The first thing that's different is back in the 2002/2003 time frame, we probably made too big of a bet, we did make too big of a bet in the K-12 school construction. It's not that they're not complex projects. It's not that they're not sophisticated projects in most cases. The problem is it's a relatively unsophisticated customer base. The bidding list is way too extensive and a lot of the things we do well aren't valued. And so our institutional mix in that 2003 time period was heavily weighted towards K-12 schools.

As you fast forward into the future now, what is the institutional mix today versus then? The institutional mix for us today is very different. We still do some K-12 schoolwork, but it's mainly fire protection work or in local markets where they value what we do. It's a very small part, though, of our institutional mix.

We tend to focus on post-secondary education. Some of the projects we just discussed now were in institutional work. The BRAC realignment work and work like that. It's work where it's a little more complex. Schedule matters, the working relationship with the general contractor is a little more sophisticated and, quite frankly, EMCOR's value during a bundled package on the mechanical or electrical side has value. So mix back then, K-12 schools done with municipalities that really didn't value what we did; mix today with much more sophisticated customers.

If you look at the mix in the backlog overall, because I think what you're trying to do is draw a parallel between last recession and this recession, what's happening with the mix, there's some differences and there's some similarities. Some of the parts of backlog performed very well in the last recession. Our transportation backlog performed exceptionally in the last recession. Our industrial backlog, although small, performed very well and will continue to perform well. Our institutional backlog performed poorly in the last recession. We think in this recession it has performed well. We've taken work since the recession began and it's continued to do well. Our health care performed average and now it's performing above average.

And a lot of that's due in just fundamental changes in operations too. A lot's happened with labor productivity. A lot's happened with building intelligence modeling; a lot's happened with prefabrication; and a lot's happened with the maturity of our company. Remember, as we were going into the last recession, we had just purchased the Comfort Systems companies. They are now a full part of EMCOR and now have the same bidding discipline instituted there as we have had across EMCOR. So there's some similarities, there's some differences, but overall we feel a lot better about the mix of that kind of work.

And Frank or Tony, I understand the importance of backlog stabilizing. But, with the understanding that backlog isn't quite as meaningful as profitability is, could you comment on where we stand from a pricing dynamic? Do you feel as if the level of competition has also stabilized, that prices are firming up?

Well, I think that I should, first of all -- I'm going to hand this to Tony in just a moment, Alex, but I think I should, first of all, comment on what have been numerous newspapers reports, at least in the trade magazines, about the multiplicity of alleged bidders for stimulus-related projects and the like. And there are stories of 25 or 30 bidders showing up for a road construction contract that used to attract 5. And there are stories about home builders trying to get into or nibble away at the edges of commercial or office construction or the like. I think that we can say with finality that we are not seeing that in the kind of projects that we are best at. Substantial, sophisticated, complicated, time-sensitive, quality-sensitive projects requiring both a strong financial statement and surety bonding are what we do and the competition has not increased for that kind of work. So, to the extent that the ongoing macroeconomic circumstances support the availability for estimating and bidding of projects like that, we will do fine.

Tony?

Alex, clearly, we've made the decision to not cash flow the business by taking projects just to cash flow the business. We've made the decision to apply our resources where they can best be used to generate the appropriate profit margins for the Company and keep the base strong for when we come out of the recession and we're not dealing with nagging problems. So I would segment it in a couple different ways.

First of all, as you go to the projects Frank was talking about, the sort of above $15 million, $20 million project, it requires really good things -- really good execution. Schedule is important, bonding is important, and you go down that list. There's competition there, but the competition there, you're always competing against the budget, how much value engineering ideas you can bring. Are we going through a little more -- a few more iterations on really getting the scope and all those things right? Yes. But ultimately the contractors that we compete against in that segment are sophisticated enough to know you have to have the number right and have the contingences right to have a successful project. And the customers know that also.

As you go to the sort of smaller project work that's with our owner customers, the demand there I think goes to what Frank spoke about lack of confidence. As that confidence rebuilds, our competition there is more, again, against competing for their capital dollars with good return projects or projects that need to be done. We're seeing some inklings that that may come back. When that comes back, that means I think confidence is coming back broadly with our customer base.

The competition again there has been a little more rigorous. But, again, our margins have held in there in that segment of the business because we're continuing to bring -- that's a sold service, those small projects, and our folks are doing a good job of talking about the value. And, quite frankly, a lot of that has been deferred.

It's the middle ground that's been bloody, sort of the $1 million to $5 million, the $2 million to $7 million, pick a number, project, sort of the under-$8 million project. It was probably more intense in the first, second, and first half of third. And you're seeing some signs of that subsiding because some of the people have taken that work are about getting their belly full in some of the local markets of bad work and they're now realizing it. So it's a complicated answer, but I think we're more focused on margin and execution than we are on the ultimate size of the backlog. And you've heard Frank say it a thousand times -- revenue sometimes is not a meaningful number for us because of the kind of business we're in, especially on the construction side.

Alex, Frank again. I feel quite confident in saying that in this post-recessionary period, like others that we have experienced and successfully navigated, EMCOR will be stronger and our competition will be weaker than was the case pre-recession.

Nice quarter. Thank you.

Thanks, Alex.

Your next question comes from the line of Avi Fisher of BMO Capital Markets.

Hey, guys. Thanks for taking my questions. Regarding facility services, what are you seeing in terms of pricing outside of the Ohmstede acquisition in sort of the core facility services business?

Yes, I mean you break our business up and we show it in our presentations typically, it's five major components to that business. Ohmstede is one of them and we won't talk about that. We do industrial service, we do government service, we do site-based services on the commercial side, and we do mechanical and fire protection services. We'll talk about a couple of them and turn to the major drivers.

In the mechanical service market, we're actually growing our service contract base. What happens in a recession is people that -- and we've had about a 95%-plus retention on that contract base in mechanical services, which is good news. So we see people come out and revalue their scope of services and we would rather people reduce scope than price. So we work creatively with them to think about how to do that so we can hold our margins. We also see more projects -- more service agreements come out to bid, especially those from the OEMs where they may have had a long-term relationship. And that opens up an opportunity for companies like EMCOR, with our ability to be brand agnostic, and then, quite frankly, be more self performing than an OEM would do.

As you move into government services, again the barriers of entry there are relatively high. And you have to be -- you not only compete on price, but you compete on best technical value. And we haven't seen a big shift in how that works. There is always an oddball bid that will go in and someone doesn't understand the scope. The government is usually pretty good at ferreting that out. And we continue to have net gain. What we have seen there is a slowdown in decision making in the government business, but we think that's a temporary situation as people try to sort out stimulus funding and other things.

As you go to commercial site base, that has gotten more competitive, especially for the large contracts. And what's happening there is the real estate companies are getting very, very aggressive. It's not a segment we compete against extensively. We do expect to see more outsourcing opportunities for just pure O&M services, Operations and Maintenance, that's the area we play in. And the pricing will hold there because we tend to have some productivity tools that even if the pricing is tough, we can [kind] of mix [of] services between what we do with outside vendors, our productivity enhancements and others.

And on the pure industrial service, pricing is holding there also, because, again, it's about schedule, productivity, and being able to take people off the job quicker is worth a whole lot more than your per-hour rate.

And that's a great detail. I really appreciate it. Can you just provide some general sense of mix of the business in terms of how big generally is mechanical, fire, site-base, etc.?

The majority of the business is outside of commercial site-based.

Okay.

The smallest segment is commercial site.

Smallest segment?

Yes.

Okay, I appreciate it. And then specifically to Ohmstede, the PPI shows, and again there are a lot of inputs into this, but declining pricing for heat exchanger pricing. I reckon some of that is the lower steel pricing, some of that is lower demand because of fewer incremental refineries coming online. But are seeing now, specific to Ohmstede, any pricing issues there?

Ohmstede's mix is 80% aftermarket or turnaround services. That PPI exchange would be for about 20% of Ohmstede's business. And for the capital projects business, for the standard heat exchanger, that would be true. For the higher alloy heat exchanger that's a little more technically advanced, that pricing reduction is a lot less.

And are margins on the turnaround different from the margins on the new construction?

They're -- yes, it's better. Right, because it's response time and schedule again.

It's better? Aftermarket turnaround services, the 80% is a higher margin than the 20%?

Oh, absolutely.

Yes.

Okay.

They are on-demand services that are typically performed in urgent circumstances with time at a premium. And what EMCOR does best is the large-scale deployment of trained, technical labor in an efficient way, and that is the epitome of a turnaround for a refinery.

Yes. That's good to hear. In terms of Canada, what are you seeing -- first of all, can you just remind me what your role is in the Canadian energy market and then what the environment you're seeing there?

Well, that's a great question that I love to talk about. We are earning some major nuclear generating credentials in Canada at the present time. We are a major service provider to the Bruce Power facility, the nuclear facility, in Ontario, Canada, performing outside of the reactor core, heavy mechanical and related services for Bruce and the building credentials that I believe will be important in the US nuclear renaissance in years to come. I don't think that borders will matter at that point in terms of the availability of seasoned project management and project performance personnel. And Comstock Canada, our cross-Canada subsidiary and the largest company in that sector in Canada, is doing a great job, both in nuclear and in conventional power, including projects from time to time in the Alberta oil sands and other types of energy transmission, such as compression and pumping stations for pipelines and the like.

They're more diverse than that, however. They're involved in the -- in a resource program for Potash Corporation in New Brunswick. And we're involved in several significant municipal hospital projects across the country. So they're a diverse company that has done a great job of repositioning themselves in response to changing market conditions in Canada, notably in the extractive and power industries, and we're very proud of their progress and their success.

And hw -- it sounds like -- obviously, nuclear should be fairly noncyclical. What do you seeing up in the oil sands area? Are there mining, mining and minerals, or is it too small to be really material?

Pretty small. We think that the future lies with power generation, both conventional and cogeneration and also the continuation of the Canadian nuclear program, which is very well advanced and very well managed. We have significant presence in the automotive market and we think that that will grow in time to come. And, as in the United States, we prosper when we're asked to perform large, complex projects like municipal hospitals and the like. And Comstock has done a good job in those sectors as well.

And, finally, one last question, and I appreciate the detail there. Can you -- when I look back historically at sort of free cash flow generation relative to net income, we saw similar levels, if you look at both on a trailing 12-month basis, back in 2004, kind of lagging the last recession and then as sort of falloff as the kind of backlog declines caught up in the business. What's different this time that might help you sustain strong free cash flow generation?

There's nothing different. I think that, in part, what you're looking at is decapitalization and then recapitalization of the construction market. It is axiomatic that in times of reducing revenue in construction that working capital flows out of the business. When the construction cycle turns and new investment is required, working capital flows back in. I am not suggesting by any means that our successful, really truly remarkable cash flow from operations is the -- is solely the result of the decapitalization of the construction business, because that is not at all the case. You have only to look at our bad debt allowances and claims [and] disputes to see that we've managed our receivables extremely well and that there is no problem there at all. But it is certainly true in this recession, as in others, that working capital flows out of the business during the bottom of the cycle and then flows back in when growth resumes.

The difference, of course, is that this time you have a little less reliance on the construction and more exposure to facilities, I guess?

Quite true.

Okay. Thanks for the color.

A pleasure.

(Operator instructions) Your next question comes from the line of Matt Tucker of KeyBanc Capital Markets.

Good morning, Matt.

Good morning. I just have a few questions here on behalf of Tahira Afzal. I just wanted to touch on the stimulus again. I know you indicated again that you expect more of the impact to be on 2010. But I do recall last quarter's call you had mentioned some large opportunities where you were working with some general contractors and some were currently being bid or you thought would be bid by the middle of the fourth quarter. I was just wondering if you could give any update on those opportunities?

This is Tony. We are seeing parts of the stimulus. And for us, you break it down in two parts. There's the ongoing maintenance part of the stimulus, or the smaller task work that's happening through the GSA Schedule and then there's the larger project. We -- on the smaller task part, we are seeing where our GSA contracts are and we are seeing it in our mechanical service companies, stimulus-related projects coming out. The less advanced ones are getting done; the ones that require energy retrofit or other work are still in the queue. So it's helping. And for us a lot of times it's not clear, when we're asked to do something for a customer in those circumstance. We just know that they have more money to spend, we know that they're upgrading their facility, and we're participating in it.

For the larger capital projects, we won a pretty significant award, or in the pro- -- with the new Homeland Security campus at the old St. Elizabeth's campus in DC, a hospital campus. We'll do the electrical work there. And we're very well positioned; it looks like we're going to get the ongoing facility work after it's built.

The Coast Guard is becoming a more important customer of ours. We have a good past track record of performance. And across the company you're seeing different things in different bidding stages, or design/assist stages as we are. So results to date, not much; results for 2010, some. The real impact for us profitability-wise will be in '11; backlog-wise should come first half of '10 to third quarter '10.

Great, thanks. Then just wanted to just get a little more detail or clarification on the Ohmstede margins. I understand how the turnarounds lead to higher margins versus the new construction. It's my understanding, though, that with refineries currently running maybe reduced capacity and certainly seeing lower levels of profitability, that maybe the urgency, other turnarounds, is reduced somewhat. So are you seeing, I guess, lower margins, then, on that turnaround type work? And then if you could just comment, is that kind of what's contributing to the lower margins in the industrial services portion of your facilities? Maintenance --

We're seeing, just from capacity utilization of our facilities, we're seeing a little bit lower margins because the capital work is down, it's 20% of the volume. There is a little bit of fixed cost structure, not much at Ohmstede. And so we don't get the absorption that you would when times are a bit better and the utilization is better. Ohmstede's margins are still very good. They're better than anybody in the space that would be publicly released or anybody who would remotely be a competitor. We're taking the same bidding discipline at Ohmstede as we do everywhere else. We're looking for new markets and new customers to serve on the heat exchanger side.

On the turnaround services side and the embedded contract side, we continue to add a lot of value to our customers and they appreciate that and they reward us accordingly. So it's a mixed story. Service side, margins are hanging in there, as you would expect them to; new equipment side, they're down; and the turnaround services for the heat exchanger, because the urgency is not as great.

And some of it has a little less to do with urgency than the kind of fuel mix that's going through the refineries right now. We really would like them to use as much Canadian crude as they could and as much Venezuelan crude and as much Mexican crude as they can because that's heavy and sour. And because of the price of oil and what's happened with the mix and the reduction and demand for oil around the world, they've been able to use more light sweet. And when they use more light sweet, they don't rip their refineries up as much. When these small refineries go out of service, that's not necessarily bad for Ohmstede, because our customers tend to be the top ten refiners. And so, therefore, their capacity utilization eventually should go up and Ohmstede will benefit from that.

Yes, Matt, I think -- it's Frank, you should keep in mind that refining or refiners' behavior differs fairly substantially between the integrated oil companies for whom the refining process is just one part of a chain starting with exploration, production, and ending with distribution, and the independents who are looking to refining as a discrete activity and who have been whipsawed recently by lower demand for refined products and higher oil prices. I think that in the latter case, their fundamentals have to be around, once again, the pace of the recovery and the growth in the demand for refined products.

The integrated oil company's performance and behavior is more complex because they have production that needs to be refined. They have more -- long -- more well-established and longer-lived distribution channels and therefore they behave in a different way. And they tend to spend more money more regularly and consistently on both turnaround and maintenance. So I don't think one can generalize between -- among refinery owners. I will say, as Tony just mentioned, that our customers in the refining sector are the largest integrated and the larger independents.

Thanks. No, I think that's a good distinction to make. Thanks for that color. I just had one more question. With that strong free cash flow you've seen this year and growing cash balance, obviously that creates some opportunities for you. You mentioned some possible acquisitions. Just hoping you could give a little color there and maybe indicate what end markets you'd be looking to increase your exposure to.

Yes. We have a lot of money. We understand that our shareholders want us to deploy it effectively and maximize our return on capital. We have a record of successful acquisitions going back to the Comfort Systems and CES acquisitions from 2002, and more recently the Ohmstede and related acquisitions and our power plant maintenance acquisitions in the last couple of years. So we think we know how to do this.

We are targeted, in general, on margins. You can always get revenue in our business, but margins are difficult. And we are determined to continue the transformation that began several years ago with the acquisition of companies that enabled us to significantly change our margin characteristics and to provide a much broader margin of safety against recessionary impacts. Now that the 2008 recession is officially over, I can now begin saying again that we are one day closer to the next recession, since I was saying that for the last six years. And I'm serious about that. We really need to continue to build margins at EMCOR, not revenues.

So we will be determined to expand the scope of our services, especially in some areas that we think are currently strategically interesting, like government services, like fire protection, like parts of the oil and gas sector. We're also very interested in expanding the scope of our mobile services business, the deployment of trained technicians to service and to improve the efficiency of installed systems. And we think that we'd like to move up market in some -- to some degree with respect to our project management and program management capabilities. So we're thinking about all of those. Of course, you don't very often create deals; you typically have to wait for opportunities to come. But we're watching and waiting patiently and carefully and we're determined to continue to improve our margin characteristics so that we'll be just as reliable a company and an investment in the next 57 quarters as we have been in the last 57.

Thanks very much.

You bet.

Your next question comes from the line of Richard Paget of Morgan Joseph.

Hey, Richard.

Hi, guys. This is Jim Warren for Richard Paget.

Oh, hi, Jim.

Just a question on the health-care-related backlog. What's driving that? Is it market share gains or more sector growth?

I'll take it. And Tony may have a comment. These are relatively large, sophisticated, difficult, complex, system-rich buildings in which the role of the systems contractor, that is EMCOR, is very important to the cost and to the performance of the modern building. The example that I typically cite is to ask you to think about a hospital bed and the wall behind the bed and the multiplicity of different systems whose outlets are behind a hospital bed. You've got medical gas, nurse's call, specialized kinds of plugs for blood pressure maintenance, all of the things that a hospital patient experiences. And all of those outlets are just the external manifestation of systems that fill the interstitial spaces in the hospitals. And that is what we're good at. We're good at the highly technological estimating and design characteristics of system-rich facilities where interferences have to be identified at an early stage so that complications are avoided.

We're good at the deployment of trained personnel in large quantities in order to get these time-sensitive buildings done properly. We're also the beneficiaries of an essentially unlimited surety bonding capacity. Most of these projects require surety bonds and that is a barrier to entry for a lot of smaller or less qualified contractors. So we tend to be the service provider of choice for these complex and difficult and time-sensitive projects and I think that's one of the major reasons why we've been gaining share.

I was just going to simplify it -- we're good at it.

Yes.

And just about any major hospital that's been built in the markets that we're in, we've been part of. We maybe took our lumps five, six years ago, as BIM was just coming in and prefab. We got really good at it. We share knowledge across the entity. We bring real value into the design/assist stage to our customers. We bring great value-engineering ideas and we're really good at schedule.

Okay. So you guys feel like you're gaining share there? That's --

Share is a tough thing in our business because it's big. It's -- what would you put in with -- do I think that in any market we're in where we have the capability, do we have the opportunity to compete and win for a hospital if the pricing is right? The answer to that is yes.

Yes, I agree with Tony. I don't think that share is -- it is certainly not a constraint. We are the largest company of our kind in the world by a substantial margin and yet I believe that our market share overall is less than 1%. So there is no -- there are no constraints on our growth opportunities.

Okay, understood. And then my last question is, how are owner expectations on the cost of projects? Are they realistic or still trying to squeeze margins and have they tried to shift more contract risks back to the contractor?

The owners always try to do that, good times and bad. I think that owners are reading the papers. They understand that some commodity prices are going down. Steel is substantially down, copper is moderating, PVC is down as a result of oil prices. So they expect, especially on the materials side, that there will be building cost reductions. And, generally speaking, we're able to pass those through. That's not an issue.

Tony mentioned earlier that we are -- we have gotten much more efficient in our labor productivity because of the adoption of various technological advances in the last ten years or so, and I can vouch for that. I think that customers get the benefits of that labor productivity and our technological skills when they contract with us. And they know that that costs in the short term but pays in the long term. So that's how we hold onto pricing on the labor side of our business.

Okay, great. Thanks very much and good luck.

It's a pleasure. Thank you.

There are no further questions at this time. Management, do you have any closing remarks?

As always, I'd like to thank our listeners for their interest in and support for EMCOR Group and our employees for making all of this possible. See you in a couple of months.

This concludes today's conference. Thank you for your participation. You may now disconnect.