EMCOR Group Inc (EME) 2010 Q2 法說會逐字稿

Good morning. My name is Jane, and I will be your conference operator. At this time, I would like to welcome everyone to the EMCOR second quarter 2010 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session.

(Operator Instructions.)

Thank you. Mr. Eric Boyriven with FD, you may begin your conference.

Thank you. Good morning, everyone, and welcome to the EMCOR Group conference call. We're here to discuss the Company's 2010 second quarter results which were reported 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, Eric, and good morning, everyone. Welcome to EMCOR Group's earnings conference call for the second quarter of 2010.

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 our remarks today.

Currently, everyone accessing the slide should be on slide one. During the call, instructions will be given to you to advance to the next slide. Please -- this is one of those times, so please advance to slide two.

Slide two shows the executives who are with me to discuss the quarter and six-month results. They are Frank MacInnis, Chairman and Chief Executive Officer, Tony Guzzi, our President and Chief Operating Officer, Mark Pompa, Executive Vice President and Chief Financial Officer 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 section of our website 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 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 market for EMCOR services, adverse business conditions, increased competition, mix of business, and risks associated with foreign operations.

Certain other risks and factors associated with EMCOR business are also discussed in the Company's 2009 Form 10-K and its 10-Q for the second quarter ended June 30th, 2010 which was filed this morning.

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

Thank you, Kevin. That was dramatic, but not punchy. You're punchy, but the message has to be improved. We'll work on that.

I'll get that at the next conference.

Thank you. Good morning, everyone, and welcome to our 62nd 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 we'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 two.

The focus of today's call will be on the 2010 second quarter and year-to-date earnings press release and Form 10-Q that we issued and filed earlier this morning. However, the order of business this morning will reflect the forthcoming change in our senior management structure that we announced in our May 25th press release in which I indicated my intention to retire as CEO of EMCOR Group, effective January 3rd, 2011.

I think it's more than appropriate for this call, and future EMCOR earnings calls, to reflect not only Tony Guzzi's succession as CEO early next year, but also Mark Pompa's excellent performance as our Chief Financial Officer.

Accordingly, I'll begin with a summary of the [sailing] events and trends that have affected EMCOR and our markets since we last talked. And I'll add my comments about some general aspects of our new earnings report. Then I'll hand off to Mark for a more detailed review of our financial statements. And Mark, in turn, will hand the call over to Tony Guzzi for an operational overview, a discussion of trends and contract backlog in new orders, and his comments on our prospects for 2010 and beyond.

Finally, I'll wrap up the call with a few words on our modified earnings guidance, at which point there will be an opportunity for listeners to make comments or to ask us questions. And you can see from slide two that a number of our senior officers are here to help with the answers.

So, let's begin. Please go to slide three. During the second quarter of 2010, lingering macroeconomic pressures from the great recession continue to affect EMCOR and our markets, despite which we were able to report a good earnings quarter and continued signs of stabilization in important forward indicators for our business.

In particular, continued excellent project execution enabled us to avoid the stock losses that pose a major danger for service companies faced with reduced margin opportunities. Our discipline and experience in selecting projects and contracts with acceptable risk-reward ratios enabled us to report profitable operations in all of our reporting segments, including solid performance in our US construction segments and good results from the international group. This, combined with continued emphasis on cost control at all levels, resulted in encouraging improvement in our adjusted operating income percentage for the quarter, despite expected year-over-year declines in revenues and profits.

Our second quarter GAAP EPS of $0.40 a share included gains and charges of $0.12 and negative $0.18 respectively, excluding which our adjusted second quarter EPS was $0.46 and our similarly adjusted operating income percentage was 4.3% of revenues for the period, a very encouraging number.

Please go to slide four. We have speculated in the past that some of the early signs of stabilization and improvement in our diverse array of businesses would arise in our service companies, whose contracts do not generally involve major capital expenditures from our customers. Many of our HVAC service companies performed well in the second quarter and should continue to do well in the third as a result of persistent hot weather in some of our major markets that led to demand growth for HVAC service and repair.

In addition, overall service companies' backlog is up 10% year-over-year and 25% for the year-to-date, suggesting improved customer spending across a broad range of end markets. Our overall contract backlog of $3.15 billion, identical to our 2009 year end, reflects a general stabilization of demand despite continued weakness in certain markets. And our cash flow from operations improved sequentially, although they are still far short of last year's record performance.

Our disciplined and conservative financial management ensured that our balance sheet continues to be one of the strongest and most liquid in our sector, including $600 million in balance sheet cash.

Finally, I'm pleased and proud to announce that the quarter just past was our 60th consecutive profitable quarter, 15 years of continuous stable positive performance in a tough business. I'm honored to have been selected to preside over such a long period of continued excellence, which has always been the product of the collective skills and talents of our dedicated employees. I'm confident that ongoing EMCOR management will retain and enhance our reputation for consistency and shareholder value creation in years to come.

Now, here's Mark Pompa for a more detailed discussion of our financial report. Mark?

Thank you, Frank. For those participating via the webcast, we are now on slide five.

I will begin with certain highlights of our second quarter results before moving to key financial data derived from our consolidated financial statements included in both our press release and Form 10-Q filed with the Securities and Exchange Commission earlier this morning.

Quarterly revenues of $1.28 billion decreased 10.3% from quarter two 2009 due to weakness in US construction activities within the commercial, hospitality and industrial markets. Our US facility services segment revenues declined 1.7% within the quarter, while our international operations experienced revenue declines of 3.2% over quarter two 2009 activity, primarily related to our UK operations.

The Company reported a $19.9 million pretax non-cash impairment charge pertaining to the diminution in value of certain trade names based on changes in fair value. We also successfully divested our equity investment in the Middle East resulting in a $7.9 million gain during the quarter.

Our income tax provision for the quarter reflects a rate of 30.5% which is inclusive of certain discrete items. While this tax rate is substantially less than our quarter one 2010 rate, we are still anticipating our full-year rate to approximate 38%.

Operating cash flow for the first six months was a negative $80.3 million compared to a positive $138 million in 2009. This equates to effectively breakeven cash flow in the second quarter, despite a supplemental funding contribution to our UK defined benefit plan of $25.9 million.

Please turn to slide six. Quarter two gross profit of $176.4 million represents 13.8% of revenues, which is down from the comparable 2009 quarter, but up sequentially from our first quarter 2010 operating results. We continue to reduce our selling, general and administrative expenses with quarter two expenses of $120.7 million representing 9.5% of revenues and a $16.2 million decrease from 2009's comparable period.

Restructuring expenses of $797,000 were reported in the quarter as compared to $3.1 million in 2009's second quarter and were primarily isolated to our Canadian operations.

And as previously indicated, we recognized a $19.9 million impairment loss due to the change in fair value of trade names associated with certain prior year acquisitions within our United States facility services segment.

The resulting operating income for the quarter is $34.9 million or 2.74% of revenues as compared to $74.9 million or 5.26% of revenues in the year-ago period. And as Frank indicated, operating income adjusted for the add back of the impairment loss is $54.9 million or 4.3% of revenues which represents a 26.7% reduction from the aforementioned $74.9 million value reported in quarter two 2009.

Diluted earnings per common share for the quarter is $0.40 on a GAAP basis compared to $0.67 per diluted share a year ago. On an adjusted basis, reflecting the add back of the impairment loss and the elimination of the equity investment gain on sale, diluted earnings per share would be $0.46 per share.

Please turn to slide seven. With respect to our six-months results, we reported revenues of $2.5 billion which declined 11.7% from 2009's year-to-date period results of $2.8 billion. Gross profit of $341.5 million or 13.7% of revenues decreased 80 basis points as compared to the $408 million or 14.5% of revenues of gross profit in the corresponding year-to-date period.

Restructuring activity in the quarter is all that we've had on a year-to-date basis. However, when compared to 2009 levels, that amount was $4.1 million if you take that on the slide.

Our first six-months operating income is $77.3 million or 3.11% of revenues, down roughly 44% compared to last year. Operating income adjusted for the add back of the impairment loss is $97.2 million or 3.91% of revenues or approximately 100 basis points lower than the first six months of last year.

Diluted earnings per share for the 2010 year-to-date period is $0.72 compared to $1.22 in 2009. And as adjusted for both the impairment loss and elimination of the equity investment gain on sales, diluted earnings per share would be $0.78 as compared to the $1.22 for the six months of 2009.

We are now on slide eight. EMCOR continues to maintain a liquid balance with cash of approximately $600 million and total debt levels of $150 million. Working capital levels are slightly up from December 31st, and other than the identifiable intangible impairment previously disclosed, our goodwill and intangible levels remained relatively constant as transactional activity has been minimal.

Leverage as represented by our debt to capitalization ratio, as Frank previously indicated, is a modest 10.46% as of June 30th, which is down from year-end levels due to the associated debt repayment during quarter one's refinancing discussed at this call last quarter.

That completes our financial review, and I will be available for questions, as everybody else will be later, and I would like to turn the call over to Tony for his operational review.

Thanks, Mark.

We're on slide nine. We continue to execute well in a very tough environment across all business segments. Our construction business continues to exercise discipline with respect to bidding. Our mechanical services business in EFS is benefiting from more seasonal weather patterns. And just to be clear, this should have up to a 5% per share benefit for us as we move from first to second and third quarter, where you'll see the most of that. And our international business continues to perform well.

Our margins continue to remain strong, despite adverse markets, and we're doing this through cost reduction, productivity, protecting our contractual rights, and working with our customers to reduce their costs and enhance margins through our performance.

Our industrial businesses are a mixed picture. Refinery remains very challenging, with a dearth of both maintenance and project capital available. Our utility and process customer business is much more steady, especially as compared to our refinery customers. We see signs of stabilization and some improvement in the refinery business, and we believe we are at the bottom in the refinery business. And hopefully the spring 2011turnaround season is poised to be strong after two very lackluster spring seasons.

Our service contract business continues to remain steady with customer retention exceeding 90% plus in this downturn, which has served us well this summer with very good seasonal weather on the east coast as we've been able to take advantage of those service contract customers and serve them in their time of need.

Backlog continues to reflect the lack of confidence in the private sector commercial and hospitality markets, but is more steady in the public area.

Let's turn to slide 10 and review our backlog in more depth. Our second quarter contract backlog stands at $3.15 billion. It's level with year end 2009 and down marginally versus the end of the first quarter. It's pretty much as we expected.

Commercial and hospitality markets remain weak, as these two groups now comprise just 18% of our total backlog. However, we continue to see worthwhile projects in our other five market sectors. We continue to see activity in the public and public-related sectors as well as industrial, as this group now makes up 82% of our $3.15 billion of backlog.

In previous calls, we discussed the flattening or broadening of backlog, and we continue to see this trend. While commercial and hospitality have declined, we have seen year-over-year growth in healthcare, institutional, industrial and water and wastewater. Transportation is down slightly, and we believe this is more timing differences in project awards as we continue to see transportation infrastructure projects as a source of future work.

We continue to be disciplined and selective in our bidding opportunities, and the current backlog composite is the positive result of that effort. As has been the case in the last year, less commercial and hospitality, but some growth in public and public-related sectors, which is a testament to the strength of our position in our markets and the flexible nature of our skills.

It is -- it feels like we are bumping along the bottom. It's where we are, and backlog can move up or down a little from here as the economy hopefully starts to pick up steam. We do see some pick up in our small project and service work and have a good three-month booking average. But, it's still too early to call it sustained yet. We expect backlog continue to stabilize at this level. It may be up or down a little from this level for at least the next few quarters unless we book a significant project award.

Now, moving to slide 11. I want to talk about some recent project awards and give you a flavor for what's going on in our backlog. The first project is the Naval District of Washington, and it's a maintenance project. And it's in our government services business, and it's an operating services support contract for the Naval District of Washington, also known as the "Quarterdeck of the Navy". This multi-facility contract has an initial period of one year with options to extend for seven successive one-year periods, which is typical of these type of government outsourcing and maintenance agreements, and we've been very successful in our award years.

Our scope of work will include facilities management, fire protection system maintenance, ground maintenance, janitorial work and snow removal for numerous naval installations within a 100-mile radius of Washington, DC. Some of the facilities are marquee facilities. They include the Navy Yard, Marine Corps Barracks, National Maritime Intelligence, Bethesda Naval Hospital, Defense Intelligence Agency, and the Naval Research Laboratory.

We now have the facilities management for all the naval facilities within 100 miles. We had half of this contract previously. We've kept that, performed well, we just won the other half. So, we now maintain 18 million square feet of space in the DC area for the Navy, which has 14 major installations in our base contract with significant IDIQ opportunities on top of the base awards. This is a big award.

We won the other half of this contract three years ago, and so obviously we've performed well. And we continue to win our contract extensions. We won that award based on our previous performance, and we won this award based on our performance for the Navy and the DC area. We have nice synergies with the other half of the contract. This is a nice piece of anchor business for our government business and continues our excellent relationship with the Navy.

In Canada, our Comstock Group, who has a long history of working in automobile manufacturing plants, we'll be transitioning an assembly plant for a US manufacturer in Oshawa, Ontario. Manufacturing of the current auto model being produced there is being discontinued. So, Comstock is de-installing the associated assembly equipment and turning around and installing different assembly equipment for two new models that were produced for this Canadian plant.

And here in Connecticut, our Tucker Mechanical subsidiary will be installing a new chilled water system for the Trumbull, Connecticut mall, which by the way is about 12 miles from our office here. Associated with this project, Tucker will also replace 18 rooftop HVAC units with higher rated energy efficient models in an effort to significantly reduce the mall's energy consumption. This energy efficiency product will drive lower energy costs, thereby pay for the installation in a very short period of time.

We talk about energy retrofits all the time, and it's a good market. It had a little trouble there in the back half of '08 and the first part of '09, but it's a good long-term market because the projects just make sense in the big mechanical systems or even smaller mechanical systems.

We are the leader here. We are an originator. We are the implementer. We are the verifier. It has good long-term growth, and we are really good at this work, from audit to design to installation to commissioning to re-commissioning to long-term monitoring controls. And the best of all for our customers is we are brand agnostic when we do it. We offer the best solution for the customer regardless of the equipment make or model.

Going down to Houston, Texas now, our Gowan subsidiary is working on a fast-paced data center project for Enterprise Products. Our work here consists of installing the chilled water piping, the HVAC and plumbing controls, the digital controls and facility monitoring system. This is a fast-paced project, and this is what we hoped to see as the economy recovers. This should go live by the end of the year.

And on the west coast we have three projects we're going to talk about. The first one is the Palm Springs Airport where our University Mechanical subsidiary will be installing the new HVAC system, sheet metal piping control systems, for a new air traffic control tower. We're also putting in a new 2,000 gallon emergency generator fuel system.

In LA, our Mesa Energy subsidiary, which is part of EMCOR Services, our mechanical services business, installed a new automated HVAC and lighting controls, again building on that theme of energy efficiency upgrades, for the US Federal Courthouse, as well as replacing the existing chilled and hot water coils in the main air-handling units.

Just as an aside, EMCOR is the largest independent building controls company, and that serves us well as we do this energy efficiency work.

And staying in LA, Dyna-LA will do electrical systems for the Los Angeles Department of Transportation's Automatic Surveillance and Control project. 36 separate contracts have been divided here for a citywide effort, 56 traffic signal controllers, and it requires surveillance and cameras throughout 10 miles of underground fiber-optic cable.

And here in -- right down the street in Long Island, New York, our Welsbach subsidiary is performing another traffic infrastructure project that will continue to upgrade the motorist information system, projects that we do all the time and is part of the bread and butter of our transportation work.

In summary, as has been the case in the last year or so, our projects reflect bid discipline and patience during this down cycle, and the backlog mix has changed accordingly. We'll continue to remain selective in our approach to the market, and we look to respond affirmatively as market actions dictate.

Now, turn to slide 12. We continue to execute in this market in a disciplined manner. The commercial and hospitality markets remain pressured. Private sector confidence looks like it's returning, especially in the industrial space and especially for our small maintenance projects and for energy retrofits, and that's where it needs to return first.

For the larger projects to come back, we need more normal lending conditions to return for these markets, from both a demand for funds and the supply of those funds when the demand returns.

So, what do you do? We control -- we work to control what we can control and maximize our opportunities. We continue to have focused execution. We talk a lot about rigid cost and risk controls, and they're more important than ever. We look to leverage our existing opportunities and resources, but we have had the opportunity to add talent in this downturn. And we continue to push productivity, and we have the ability to do that because now we are left with our best people, especially in the field working on our projects. People that have been with us for a long period of time.

And we always are looking for the right investment and acquisition opportunities. We are always meeting people. We have long-term relationships with acquisition opportunities, and we're looking both at large and small opportunities, but we will continue to exercise the discipline we have in the past.

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

Thanks, Tony. For those listeners who may not have heard clearly the figure related to our estimate of the impact of unseasonably hot weather on our HVAC service earnings, we estimate that impact to be somewhere around $0.05 per diluted share of EPS. It could be more, might be less, but that's our best guess right now.

Please go to slide 13. As we discussed this morning, EMCOR's future prospects will be a function of various factors, only some of which are under our control.

Firstly, we are working toward a continued "absence of badness" through disciplined bidding and project selection, excellent execution and continued rigid cost control. Our success in significantly reducing variable costs should contribute to a very strong earnings growth rate when demand strengthens.

Secondly, our end market diversity is enhancing our growth prospects due to our major presence in growth sectors, such as healthcare, government services, power generation and water and wastewater, even as office, commercial and hospitality and gaming remain depressed.

Thirdly, the pace of the overall recovery, and particularly the stabilization of domestic and international credit markets and sovereign risks, will directly affect the customer confidence that is necessary to stimulate new private sector capital projects.

Taking into account all these factors, together with anecdotal information from across our far-flung and diverse company, we find ourselves very, very cautiously optimistic about the second half of 2010 and into 2011. I hasten to add that most customer spending is still in our public end markets, that we do not yet see a basis for any significant broad-based revenue growth assumptions and that our earnings performance for the year 2010 will be driven primarily by excellent project administration, productivity gains and cost controls.

Having said all that, we now reiterate our previous 2010 revenue guidance of about $5 billion and we narrow and refine our full-year diluted earnings per share range, excluding the two items discussed earlier, from the previous range of $1.45 to $1.85 to a current estimate of $1.60 to $1.85 per diluted share. Inclusive of the two items mentioned earlier, the corresponding new EPS range would be $1.54 to $1.79. Please note that the latter are derived numbers and should not be taken to imply a level of forecasting precision that we do not currently possess.

Well, I think that's it for now. Thank you all for your interest and support, and a special thank you to our wonderful EMCOR employees whose efforts and skills created 60 consecutive quarterly profits.

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

(Operator Instructions)

And your first question comes from the line of Tahira Afzal with KeyBanc.

Hi, T.

Thank you, and congratulations on a great quarter.

Thank you.

A couple of questions. Number one is, generally, I would love to get an idea that as we go into 2011and hopefully start seeing some of your private sector business come back, do see some kind of transitional choppiness as you move from public sector to private sector work again as you see it right now it'll be more complimentary than being substitutive in general?

No, T, I don't. I think I see a reverse of the same process that we have accomplished over the last three years or at least the two years that we've now been directly affected by the recession. That is, that at the beginning of that period, and in fact well in advance of the recession, we had taken steps to significantly diversify our end markets so as to ensure that we took advantage of whatever growth and profit opportunities were to be had in a very broad range of customers.

So, when the recession hit and private spending went away, we were still present in the growth areas, like healthcare and government services, that have helped us a lot in the -- in terms of the excellent execution that we've shown throughout this recession.

When private spending comes back, and we know it will, in fact, we suspect that it's already coming back in terms of those service company backlogs and revenues that we reported on in the body of the call this morning, we will be able to respond, I'm sure, with the same kind of nimbleness that enabled us to move from private sector to public when prospects in the private sector first began to wane in 2008.

So, I'm quite optimistic about our ability to move quickly back to where the profits are.

Great. Okay, thank you.

And the second question I had was, you're seeing a $0.05 potential increase or benefit coming, which is sort of unexpected from services work related to hot weather. Any reason why you have chosen not to take the upper end of your guidance up by $0.05?

It's just -- there are so many moving parts still at this time of year, T. And you know us, there's very little to be gained from making a big jump in mid year until we get finished our mid-year re-budgeting and re-forecasting review. But, you also know us, that the first time we see a very positive impact from the next couple of months of summer weather, if it looks like it's outsize and of the type that should be -- that should result in an increase on the top end of the range, that is certainly what we will do.

Right now, the lower end of the range represents the highly confident number that represents an extension of our current OI percentage of about 3.9% or 4% for the year-to-date to anticipated revenues for the remainder of the year. But, we're going to stay cautious concerning other aspects of earnings growth until closer to the end.

Fair enough, Frank.

And last question is for Tony. Tony, as you look to transition, I would love to get an idea of what you plan on doing differently? And also, in regards to strategically where you'd like to see EMCOR headed? And also, what you plan on doing with the cash?

Give it to Frank on his way out.

Yes. (Inaudible - multiple speakers)

I've already got it.

He's already taken it off.

No, look, T, I've obviously -- we worked as a team for almost six years now, and I don't think there's been a major decision that Frank and I have disagreed on in those six years.

I think markets change and opportunities change, right? And so, the hallmark of this Company's been the ability to be flexible. And I sort of put things into buckets, right? One of the reasons I think I was brought here in October of 2004 was, one, I think my reputation was I was a little bit of a disciplinarian, and I think that's proven to be true. But, I also like growth, and I knew a little bit about the service business. And I think that's why they hired me. And so, that's what we've done as a team.

And if you look at growth, we've always taken a three to five year rolling average -- three to five year view of the world as best we can. That's a process that we've had in place, and we continue to do it. And we do it collectively as a team, about 14 of us.

You play that out a little more and you say, "What will change?" We'll react and take the best advantage of the markets. You go to the cash -- and it'll probably disappoint some people that would like us to pay big numbers, but I have the same bent on you have to pay for value and that you can't delude yourself with crazy assumptions.

And so, that's been one of the hallmarks of our Company, and that'll continue to be. And I think the things that have made EMCOR great, we've all been a part of. And I told Frank this, I said, I think a couple of things you got to give him a lot of credit for. One, he's kept the entrepreneurial spirit of this Company alive. He focused on pay-for-performance, never overreacted to too much bad news, and he helped really lead collective decision making.

Those things are going to stay the same. What changes? I think the markets dictate, and I think the availability of opportunities dictate. And think that's the best answer. I think we've done well. This should be fairly seamless, and I think that's what it's going to be.

Thanks a lot, Tony. And Frank, just to clarify, I look forward to working with you for at least another six months and lots more.

Likewise, T, thank you.

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

Good morning, gentlemen.

Hi, Alex.

So, Tony, does this mean that you're going to be taking Frank's responsibilities for making a crack on Kevin every quarter?

No, I don't find Kevin nearly as amusing as Frank does.

Maybe it's time for it to go the other way. I'll start to make fun of them.

I might mail it in, Alex.

I guess, the reality -- I noticed that started happening at about quarter 52. And so, when we get to quarter 52, Kevin will be so damn old that he won't even know we're cracking on him.

Too funny.

As it relates to your backlog, can you comment on backlog and the margin that you think is embedded into backlog and how that compares to the margin reported in the current quarter?

Look, Alex, if you think about when we got most of this backlog, we got it in the current environment. That's when we brought it in. Yes, there's project close-outs, but there's always project close-outs and they can go both ways.

So, when you think about what we have in backlog today, I think it's reflected in the degradation in our operating margins from their peak and the guidance that we gave this year.

What we have done a very good job of, and I think why you see the conversion like it is, is we really have retained our best field supervision and our best labor in the field. And I think that's a testament to the folks that we have out there on the frontlines and their relationships with the local labor markets, both union and non-union.

I think as you play this out, we don't see the markets getting much worse right now, and that's a good sign. That had to happen first. And we've had about two and a half quarters of that now.

And one thing I would caution you on, right now the international margins are a little high in the current quarter because we did a great job settling out with one of our customers that we performed extremely well for on the facilities side. But, if you look at those international margins, if we can keep those where they've been, or maybe just a tad higher in the UK, over the next couple quarters, we'll have done very well.

Very helpful.

And could you also comment on the stimulus from February of last year and how you've seen that play out through both your income statement and potentially what's in your backlog today over the last year and how it's going to play out over the next year? And what kind of work are doing related to that and what projects?

We've got one of the largest stimulus-related projects we announced, I think, almost a year ago with the new Coast Guard campus which is on the site of the old St. Elizabeth's Hospital in DC. That could have a long term three or four year impact for us as they build out that site with other Department of Homeland Security facilities.

What we're seeing for the most part with stimulus is we are starting to see the energy retrofit work roll out, and that's in our backlog. In a $3.15 billion backlog, Alex, it's probably less than 2.5% to 3% of it would be directly stimulus projects.

I've seen some statistics, when you look at our industry in general, the stimulus at its peak, which I think will be fourth quarter this year through second quarter next year, will have about a 7% impact on our industry. I think that'll be the part that we look at outside of road construction.

So, I don't think it's -- it certainly hasn't hurt, but it's not been a huge driver of our performance, and I'm not so sure that the Department of Homeland Security campus wouldn't have been built anyway with or without stimulus because it's -- there's a whole new thing that has to happen there with the Coast Guard, and we're all over DC right now.

That's great, and nice quarter.

I had one last comment. Since change is relatively slow at EMCOR over time, I do appreciate your white slides this quarter versus the colored slides.

You've made Kevin a happy man, Alex.

You can thank Sheila for that.

Alex, times are tough, and we got tired of printing colored slides.

Thanks again.

Thank you, Alex.

Your next question comes from the line of Richard Wesolowski with Sidoti.

Good morning.

Good morning, Richard.

The sectors that are dragging your backlog lower, the retail, the office, the hospitality, they're down by some 70% from the peak, and now they're about 20% of the pie. Would you expect that they can still hurt backlog? I mean, are you booking any work in those sectors?

I don't think they could hurt backlog any more. You could over the next year see that purple slice, which is hospitality, get cut in half, but it's a pretty small number now. So, it'll have not much of an impact.

I actually think commercial's got to move the other way here soon because the level we're at in our backlog now is pretty much our service agreement base and not much more on top of that.

Okay.

Tony, you sounded hopeful for the spring 2011 turnaround season, but skipped over the fall 2010. Is there any reason to expect to pick up later this year for Ohmstede?

Not that we can tell right now, Richard. We just went through that. We have another detailed outlook review meeting with the folks there in August.

There could be things happen. I mean, the best part -- one of the best parts about Ohmstede business is when customers need quick response or -- like, we just had a refinery up in the Pacific Northwest that had a fire. We're benefiting from that now. So, unplanned things could happen, but as far as planned events for the turnaround season, I think we already have that reflected in our forecast.

Richard, it's Frank. I would supplement that by saying, however, that a year ago, we were talking, around about this time of year, with the -- with our refining customer group, about the possibility of labor shortages and the possible acceleration of a turnaround program by six months from the spring into the preceding fall, if you will, in anticipation of otherwise capacity shortages emerging among contractors.

So, if the refineries who are doing well financially and whose utilization percentages finally edged up to 90 -- or maybe a little over Tony?

Yes, it's a little over.

If they get into a position where they can see themselves able to finance a full and complete and extensive spring '11 turnaround season and they -- and those same concerns emerge about contractor capacity, we could see some spillover back into this fall.

Okay.

Can you discuss what prompted you to make the supplemental UK pension plan contribution?

Richard, a number of factors. Obviously, as you've been looking at our annual financials statements, you've seen that. The asset -- the underlying asset performance in that plant hasn't really been that great, which is no surprise.

Obviously, we've been trying, as most companies in the UK are trying, to move away from defined benefits to defined contributions. And one of the things that we needed to do to provide the opportunity to move those employees that were currently active in the defined benefit plan into a DC plan was to make some funding contribution to have the trustees work with us and get paid to get us that answer. So, that was the main reason.

The other thing too, as a result of the regulation in the UK, as you may or may not know, all companies that have an underfunded plan in the UK are required to make additional supplemental annual contributions. And in order to -- and with the need for 10-year pay down of the underfunded status -- once again, it's because as the performance has been so horrible over the last three years, that a 10-year window would result in a very large increase in the annual supplemental, and we were trying to mitigate that as well.

Appreciate it.

You're welcome.

Your next question comes from the line of Adam Thalhimer with BB&T Capital Markets.

Good morning, Adam.

Thanks. Good morning, Frank. Good quarter.

Thank you very much.

Few questions that are left here. The weather benefits of $0.05 a share that you and Tony talked about, how much of that did you recognize in Q2?

Not a whole bunch. The first really hot month was June, so that's one month of our three months second quarter and one month of our six month year-to-date.

The -- we think the bulk of the benefit will come in July and August and perhaps into September, depending upon weather conditions.

Okay, great.

And then, US electrical saw a nice improvement in operating margin sequentially in Q2, which I think you told us to expect. What was the biggest driver there and talk about sustainability if you could?

Look, our electrical business has consistently been a very higher performer at EMCOR, and we don't get wound up quarter-to-quarter views there because it depends on project start-up, project close-outs, the mix of business.

And then, just remind everybody on the call, when we start a project, we don't take any profit for the first 20% of a project, on a project that's over $250,000. So, it's -- some of that can be as simple as that. It could be timing differences. And so, we tend to look at our margins over six to 12 month periods before we try to draw any meaningful conclusions out of them.

But, I do agree with you. I think we all agree with you, Adam, that we've shown nice stability in terms of the operating income percentage spread across all of our segments and end markets. We're really pleased with that.

But, looking forward, do you think -- you like the 6% -- I mean, obviously, you like it better, but you're more comfortable with sustaining at 6% rather than going back to something below that?

Well, we don't see first quarter performance being indicative of the future.

Yes, too many moving parts in the first quarter, Adam, and not, in my view, not very reliable as a comparator with subsequent quarters.

Okay, great.

Then, I guess, I wanted to ask about the free cash flow outlook in the back half of the year?

Adam, this is Mark. Obviously, I'll speak for myself, I'm disappointed with our cash flow performance in the first six months.

Obviously, on a comparative basis, the last year we were de-capitalizing the business and liquidating the balance sheet as the revenue run rate was coming down dramatically as we moved through 2009.

We're anticipating to be positive free cash flow for 2010 in its entirety, which obviously implies that we will be substantially favorable in the last six months of this year through our performance to date. And we're touching base with all of our operating companies on a monthly basis, and to this point there's been no indications that people are not going to adhere to our internal forecasts.

I think it's worth mentioning, in line with Mark's comment, that at least one of the analysts who cover EMCOR has opined in connection with another company's operations that the decline in cash flow from operations represented just that, an end to the de-capitalization associated with the recession-related downturn in revenues. And we kind of think that way as well.

Well, you did maintain your cash statement roughly the same quarter-over-quarter, so.

Yes, we generated positive cash in the second quarter absent the UK pension contribution.

Right, okay. Thanks a lot, guys.

You're welcome.

Thank you, Adam.

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

Hey, Avi.

Hey, guys. Good morning, and thanks for taking my questions.

Sure.

I guess the first question may be for Mark or -- but it seems like your working capital's increasing. Is there any concern with that? Why is it increasing so much?

Yes, I'll handle it. Well, first and foremost, obviously, cash is the big component of it. I think when you look at our AR turns, we've actually have driven almost a full day out since the first three months of this year. So, when I look at the AR turns and I look at the aging statistics, there's nothing there that causes concern.

One of the things that you did see change from the end of the first quarter to this quarter is there has been an increase in unbilled construction costs or costs in excess of billings at the financial statement caption. And that is, for the most part, just due to normal contract activity and not having milestones to be able to bill.

So, from that aspect, I'm not concerned. I will tell you on the liability side, because of the nature of the environment ourselves and all of our vendors and subcontractors are working in, I think our guys are probably being a little too generous with payments, first and foremost to take advantage of early payment discounts, which we traditionally -- it's not something we've spent a lot of time on, and it's certainly in the margin environment where we're trying to drive every last penny of margin that we can. But, I also think they're trying to make sure that they're not being disrespectful to some of those long-standing business relationships that we value in our local markets that might be feeling some stress.

Got you. Okay. So, that's -- thank you. I appreciate the color there.

When I look at the slope of decline in organic revenues, and it's getting less worse, and I wondered if you think that's sustainable, slow and steady, does it increase -- does the rate increase?

Well, I think the rate of decline's getting worse, and I think the big marker was the rate of decline in our facilities business. It has basically gone to almost flat, and that's where we would see it first.

So, yes -- look, I think we're pretty stable where we are right now. And we don't expect, obviously with our guidance out where it is, that the rate of decline is going to slow.

Okay.

So, facilities flat, easy comps, so organic revenues should continue to get -- or decline at a lower rate or get less worse?

Yes.

And then, the quarter -- the 10-Q mentions positive resolutions of -- benefits from positive resolutions on contracts in your construction segment. Normally, we see strong construction margins at the end of the year when you kind of true-up some of your contracts. Was there any pull forward or early completions?

No. This is just normal business timing. There's nothing abnormal here.

And just as normally year end we see true-ups on construction projects, should we see that this year? It might be too early to say, but--?

-- It's probably too early to talk about. I think one of the things you should take heart in is that our seasonal pattern of margins has changed, along with the mix of business, but also with some of these contract changes and close-outs here. We're taking them when we have them. That's always been the case, but it just seems more frontloaded this year, maybe.

Okay. I appreciate the color there.

And finally, are service call margins -- how do they compare to the maintenance margins?

Better.

They're better?

And emergency desperate ones are even better than that.

Yeah, go figure.

So, they're materially better than the maintenance margins?

Yes, you've just got to remember how much of a portion of our business that is and how much it's really going to move the margins.

Okay.

And just two other quick questions. Wondering about if you can comment on the pricing environment, and also the outlook for mega projects? Thanks.

There's some mega projects out there. We usually don't call them that individually by name. We're participating in a few of them. Typically they get down selected at three to five teams, and there's a couple that we're on the three to five team list.

The outlook is about -- is a little bit better than it was a year ago, but about the same. The margin profile's about the same. Those things never got terrible because usually the people that compete on mega projects, if they're going to make a mistake, it's on scope. They usually don't try to price it dirt cheap to just take work.

And I think given this, what end market are they in? Are they--?

They're all over the place. You're seeing some data center work, you're seeing some transportation work, healthcare, water and wastewater -- suffice it to say, you're not seeing a lot of entertainment, hospitality or commercial right now.

Right.

And the other one was about the pricing environment?

Pricing environment, I would say for the owner-directed projects, has gotten a little bit better.

I'd say realistic.

Yes. People know that people -- good contractors have come to the realization they shouldn't be working for nothing. On the smaller projects, people want -- and they prefer a provider to do it, and we are that person in a lot of cases. Whereas, maybe 18 months ago they were saying, "We can't do that with you." They're back to, "Maybe we've tried some of this other stuff, and it didn't work out so well."

The larger projects, I think, you're dealing with smart competitors there for the most part.

And smart owners. I think for a period of time in every recession, there's a period where predatory owners take advantage of contractors who are not capitalized or sized like we are and who are very vulnerable to being forced into working for a cash flow just to keep the doors open. We've never been vulnerable to that.

And sooner or later, those customers go away and what we get, especially in the mega project area, are sophisticated customers who understand the value of what we do and who don't create the kind of huge long bid lists that are typical of the very nasty stage of a recession.

Got you. Thanks.

And just one last question. The 38% tax rate guidance, does that include the unrecognized tax benefits that may be recognized this year?

It does not.

Okay. Super. Thanks very much, guys.

Thanks, Avi.

You have a follow-up question from the line of Tahira Afzal with KeyBanc.

Hi, T.

Hi. Just one more question, and that's in regards to something that you've talked about on and off on this call. It seems like visibility is now improving in a sense in your more challenged markets or perhaps troughing out at this point. What's your intention with cash? Is it going to be still be more allocated towards accruals or do you perhaps now with better visibility feel you can also perhaps look at the dividend policy?

Well, I'll reiterate what I said, I think, two quarters ago, back when our balance sheet was still in the same strong a liquid position it is now. There is an amount of liquidity, including both balance sheet cash and credit, that we have to mentally reserve for the purpose of funding working capital requirements as growth ensues.

If we're not there yet, we're going to be there pretty soon. And so, we cannot -- we're very proud of the fact that we have $600 million on the balance sheet, that's very good. And we certainly intend to spend some of it on acquisitions.

We have good ideas in that regard. One thing I've said systematically for about 60 quarters now is that we will recommend a dividend to the Board if and when we run out of ideas for shareholder value creation, and we haven't run out of ideas yet.

Right now we're thinking about that $600 million in terms of A, the amount of that money that we have to hold on to in order to ensure that we can fund the working capital requirements that are associated with growth. And secondly, we are avidly and actively looking at acquisitions, large and small. We're disappointed in the pricing that we're seeing on the large end in particular. Private equity is much more active than we anticipated would be the case. But, we're out every day talking to people and looking at possible opportunities.

And between those two areas, I think that there is not sufficient money left over from that to establish what I would call an adequate or robust dividend policy at this point.

Got it. Okay, Frank.

And in regards to private equity becoming a little more active again, are there more active and specific end markets or are you're seeing them really become active on a more broad-based level?

I see it across the board, T. I'm told by friends in that market that if you want to sell something by year end and you don't have your pitch book out, you're too late because both private equity firms themselves and their professional advisors are flat out at this point.

So, I think that given the tax changes on both -- on the part of both buyers and sellers that are going to take effect at year end, I think that there's a great deal of urgency about getting these deals done before then. And that, I think, is contributing to pricing as well as to terms.

Yes, and then back in the mode of what can we finance versus what's the company worth?

Got it. Okay.

And do you think -- does this change your -- the timing of this strategy? Obviously it seems like it's gotten a little pushed out as a consequence right now.

You know what, T? We've all done this for awhile, and deals happen when they happen. And the worse thing you can do is try to force one.

Got it. Okay.

So, you're just going to remain on the sidelines until--?

No, we're actively looking.

No, no, no. Absolutely not. We are not on the sidelines, but we're not going to force things to the point where we pay too much for something that's going to destroy shareholder value short and long term.

Got it. Okay.

And as you said, would this imply that you'll have to see more opportunities on the small to mid-sized transactions?

Well, that is always the case. But, one of the benefits that EMCOR represents for people who want to sell assets in operations that are in our sector is that EMCOR is a desired employer, we believe, for owners who care about what happens to their companies and to their employees. We have -- we can cite numerous examples of transactions in which we have paid a lower price because the owner was anxious to ensure that his employees and his beloved company landed with a company that treated them right.

And I think that reputation continues and is a differentiator for EMCOR in this market.

Absolutely.

Okay, got it. Thank you very much, gentlemen.

Thank you, T.

And at this time, there are no further questions.

I will now turn the call back over to management for closing remarks.

Thank you very much for your interest in EMCOR, and thank you, Tony, for your kind words about the Navy. And we will be back to talk to you soon. Thank you.

And this concludes today's conference call. You may now disconnect.