EMCOR Group Inc (EME) 2011 Q2 法說會逐字稿

Good morning. My name is Keisha, and I will be your conference operator today. At this time, I would like to welcome everyone to the EMCOR second quarter 2011 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. Ms. Tramont, 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 2011 second quarter results, which were reported this morning. I would like now to turn the call over to Kevin Matz, Executive Vice President Shared Services, who will introduce management. Kevin, please go ahead.

Thank you, Alex, and good morning, everyone. Welcome to EMCOR Group's earnings conference call for the second quarter of 2011. 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.

Please move to slide 2. Slide two depicts the executives who are with me to discuss the quarter and six-month results. They are Tony Guzzi, our President and Chief Executive 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 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 include certain forward-looking statements. Any such statements are based upon information available to EMCOR's management 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 effect 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, and risks associated with foreign operations. Certain other risks and factors associated with EMCOR's business are also discussed in the Company's 2010 Form 10-K, its 10-Q for the first quarter ended March 31, 2011, and other reports filed from time to time with the Securities & Exchange Commission.

As I'm sure many of you have noticed, we have not issued our 10-K simultaneously with our earnings release this morning as has been our past practice. 10-Q, if I said K. As you know, XPRL filing simply takes longer, especially with all that detail tagging. Knowing this, we expanded the morning's earnings release document to include cash flow statement and segment reporting. We hope to issue the Q in the next day or so. And by the way, this might be the new norm for timing as we go forward with the XPRL.

And with that, please let me turn the call over to Tony. Tony?

Thanks, Kevin. Good morning, and thanks for joining us. Suffice it to say we have had a very busy few months here at EMCOR. So for today's call, here's what we're going to do. First thing I'm going to do out of the gates here is cover the sale of Comstock, which we signed late yesterday and announced earlier today and hope to close here in the third quarter. I will then cover the highlights of the quarter. I will then give our first impressions on our June 30 acquisition of USM. I'll then turn the call over to Mark, and he will cover our financials in detail. I'll come back on the call, talk backlog and our revised guidance for 2011.

With that, I'd like you to turn to page 3. Let's talk about Comstock. Comstock is one of the initial companies that comprise the original EMCOR. It has a longstanding reputation in Canada with well-established customers and a quality workforce, and up until five years ago or so, Comstock produced little to no value for EMCOR. Over the past five years, we restructured operations, narrowed the market and geographic focus of the Company, and, in fact, generated profits, however, not at the operating income margin level of the US construction operations.

About six months ago, management approached us to lead a management-led buyout of Comstock. And as you know, Comstock has been a volatile and lower margin performer over its history with EMCOR. The work we had done over the past five years had put us in a position that we could consider all the strategic options for Comstock. The Board and EMCOR senior management does not consider Comstock core to EMCOR strategy, and we have no reason to believe that we can further restructure Comstock to be margin accretive to EMCOR. Further, in a practical sense, a management buyout was one of the few exit strategies that could be executed at low risk and with no significant long-term liabilities for EMCOR from past Comstock performance.

Further, we saw no ability to use the Comstock platform to build any services portfolio to balance its construction operations to reduce the volatility of its return. While we believe that Comstock is positioned well for what it is, an Ontario-based, large project construction company, it does not fill a core position in the future of EMCOR. This divestiture allows us to extract the value created at Comstock, and the deal will result in net proceeds of CAD42.4 million, which is at book value deal, basically. We'll have no ongoing obligations, and we can turn the page. You know, we like the team up there. They're good folks. We wish them the best. I'm sure our paths will cross, and I'm sure we may do business together in the future. And we really look at this deal as a win for EMCOR and a win for the management team that bought Comstock.

Now I'd like to turn to page 4 and talk about EMCOR's quarter. During the quarter, we had a pretty good quarter here at EMCOR, and we continued to perform in a choppy market. Excluding Comstock, our organic revenues grew 5.5%. We had operating margins of 3.5% with USM deal costs of about $4.5 million suppressing margins, but our large project performance as we near the end of several large projects, although we have many more to do, helped margins.

Our backlog grew to $3.8 billion, up 21% aided by acquisitions. However, we had 4.1% organic growth versus last year and about flat from the March quarter. Our book to bill exceeds 1, which makes five of the last six quarters with an organic book to bill of 1 or over. And despite our recent acquisition spending of almost $300 million, our backlog remains -- our balance sheet remains liquid and strong and our cash generation is much improved on a year-to-date basis versus last year.

Now I'll talk segment. Our EFS segment had mid teens organic growth led by growth in our industrial business. We had growth in each of our EFS divisions, industrial, government, and commercial site-based. Our EFS growth did not have the [follow] through we expect as we continued to work off some lower margin, small project work and work through a large contract startup in our government business.

On a year-to-date basis, we have a tough compare. As you will remember, we sold the [district] chilled water venture last year, and we also earned some nice incentives in the second quarter of last year in our government business. Further, there was no real impact from heat in Q2 versus last year as cooling days in the critical Northeast, Mid-Atlantic, and Midwest regions are actually down year-over-year. In my view, our EFS segment is performing at least 100 basis points below our operating margin expectations on a year-to-date basis despite a very strong performance from our industrial business to include the refining business, our HVAC repair business, and our commercial site-based offerings.

Our issues are most notably in our small project work where we had to work through a less than optimal project backlog, and quite frankly, we are working with our owner customers and we've had less opportunity to up sell them. It's something we do well, it's something we see gradually returning to the market, but we intend to remain front and center with our customers and not lose them to other service providers. However, it is good to see overall growth in our services business, and it should be a precursor to better owner maintenance capital spending, which should lead to better opportunities to help them reduce cost while improving our margins in our services business.

In our mechanical and electrical segments, they turned in another solid quarter with both good performance in the electrical and mechanical segments. We had organic growth in our electrical segments, but did not grow organically in our mechanical segments, but they were aided by the Bahnson acquisition. We continued to exercise discipline and performed very well. As we finish our work in Las Vegas -- our large work in Las Vegas, our folks perform very well in a tough environment and produced for our customers. Our electrical margins were aided by this as we finished that project and were able to convert it to a contract that allowed us to see a clear view on how we will perform on that project.

Across our scale U.S. construction business, and it is a scale, our large project execution has been exceptional over the past three years with our folks consistently beating our labor productivity estimates through depth pre-planning, pre-fabrication, the use of BIM, and just hard-nosed labor management. Further, as we've come down in our workforce over the past two years, we are now operating with what I would call EMCOR's finest labor force. We are back to our core people and our core folks produce and they want to drive productivity.

In the UK business, it performed well, and we emphasize the services market there now. We are now 75% services in the UK and about 25% construction, a marked shift from five years ago. And performance has been more predictable and steady as a result of this shift. And after adjusting for our USM deal expenses, we are seeing the impact of our corporate headquarters restructuring.

And on a year-to-date basis across EMCOR, SG&A organically dropped another $4.6 million, and if you look at this over -- since 2008 at our high point, our SG&A is down over $100 million.

I'd now like you to turn to page 5. Let's talk a little bit about USM. You know, we have executed three nice transactions over the past eight months, starting with Harry Pepper, moving to Bahnson, and followed by our largest acquisition in the past 3.5 years in USM. Each strengthened our business in an important way and each provides us with increased end market exposure. Our integration is well underway in each case.

With respect to USM, I like what I see after owning it for the past month. We said we saw synergies of at least $5 million over the next two years in cost. We have clear view on those synergies now. We also thought that USM opened up another third of the market with their interior and exterior services, something we did not provide in a significant way. That is true, and because of that, we are able to craft some unique customer solutions across the business combination. Customer response has been positive, and we can affirm, so far, that the synergies are real and that we will be able to capture that.

With that, I'll turn it over to Mark, and he will walk you through the financials.

Thank you, Tony. For those participating via the webcast, we are now on slide 6. I will begin with a discussion of our second quarter 2011 results before moving to year-to-date key financial data derived from our consolidated financial statements included in our earnings press release from earlier this morning.

Quarterly revenues of $1.4 billion in the quarter, are up 9.7% from 2010. Organic revenue growth, as Tony touched on a minute ago, in the quarter is 3.5%. Revenues attributable to businesses acquired of $79.3 million positively impacted our US mechanical construction services and our US facilities services segments during quarter two. All reporting segments other than Canada reported positive revenue growth during the quarter, inclusive of acquisition contributions. Canadian revenues declined 34% quarter over quarter due to continued reductions in demand for our services in the industrial sector. Our US facilities services segment, quarterly revenues increased 20.3% of which 14.7% of that growth was attributed to organic sources.

SG&A expenses increased $9.8 million within the quarter, inclusive of $6.4 million of incremental SG&A from those acquisitions completed during the quarter and subsequent to June 30, 2010. Quarter 2 SG&A was also burdened by the $4.5 million of transaction cost Tony mentioned pertaining to our recent acquisition of USM. As a percentage of revenues, SG&A in quarter 2 is 9.3% compared to 9.5% in 2010's second quarter. Exclusive of the aforementioned transaction costs, 2011's quarter 2 SG&A percentage would be 9% or 50 basis points lower than the comparable 2010 period.

Operating income of $49.1 million represents 3.51% of revenues and is approximately 80 basis points higher than our 2010 quarter 2 performance. Please note that our prior year's quarter was negatively impacted by a $19.9 million pre-tax noncash impairment charge pertaining to the diminution in value of certain trade names.

2011's quarter 2 operating margin excluding acquisition costs previously referenced was 3.83%. Our income tax provision for the quarter is reflected in a tax rate of 37.7%, which is greater than the 2010 quarter2o rate of 30.5% due to discrete items that occurred during 2010, specifically the utilization of certain capital loss carry-forwards last year. We anticipate that our full year 2011 rate will approximate 38%.

Cash provided by operations for the second quarter was $41.4 million, which represents an improvement over the $1.1 million of cash used in operations during 2002's second quarter. For the six month period, operating cash flow was $5.2 million compared to a negative $74.2 million in 2010. Both 2010 periods included a supplemental funding contribution to our UK defined benefit plan of $25.9 million.

Please turn to slide 7. Additional key financial data on this slide not addressed during my highlight summary are as follows. Quarter 2 gross profit of $179.8 million represents 12.8% of revenues, which is $3.4 million higher than the comparable 2010 quarter. On a gross margin basis, our current quarter was lower than 2010 margins by roughly 100 basis points due to a challenging pricing environment, particularly with small project work, as well as the lower gross profit attributes of our current project mix, which is more weighted towards the public sector.

Our $9.8 million quarterly increase in SG&A expenses is inclusive of the $6.4 million of incremental SG&A expense, including intangible amortization related to businesses acquired and the $4.5 million of transaction costs as both were previously mentioned. On an organic basis, SG&A expenses are down $1.1 million quarter over quarter which once again represents a 50 basis point reduction as previously disclosed. Restructuring expenses in the quarter were minimal.

Diluted income per common share for the quarter is $0.42 compared to $0.40 per diluted share a year ago. On an adjusted basis reflecting the add-back of transaction costs associated with our acquisition of USM, 2011 diluted earnings per share for the quarter would be $0.47.

We are now on slide 8. I will now discuss our results for the six-month period ended June 30, 2011. Revenues increased 9% to $2.7 billion with all reported segments generating higher revenues in the period other than Canada. Consolidated organic revenue growth for the six months is 3.2%. Our US facilities services revenues increased 24.7% in the six-month period of which 17% was organic. Our commercial, mechanical, industrial, and energy services divisions within the US facilities segment all experienced organic revenue growth for the first six months of 2011, as well as our US electrical construction and United Kingdom segments.

Year-to-date gross profit is $342.8 million, which is slightly higher than the representative year ago period and is 12.6% of revenues. Consistent with our quarter's results, gross profit margins on a comparative basis are down period over period due to project mix and the competitive pricing environment. Additionally, as referenced last quarter, 2010's year-to-date gross profit was favorably impacted by a $4.5 million gain associated with [our] disposition of a joint venture investment, which is reflected in our EFS segment.

SG&A expenses of $250.2 million represents 9.2% of revenues compared to 9.8% of revenues for the corresponding 2010 period, and as previously mentioned, the absolute increase in SG&A expense levels is due to incremental SG&A from businesses acquired as well as the previously referenced transaction costs. On an organic basis and consistent with Tony's commentary, SG&A spendings are down year over year.

Year-to-date operating income is $91.5 million or 3.37% of revenues. Adjusted for transaction costs incurred to date, 2011 operating income as a percentage of revenues through June would be 3.5%. Diluted earnings per common share were $0.78 for the six months ended June 30, 2011 compared to $0.72 per common share in the corresponding 2010 period. On an adjusted basis reflecting the add back of transaction costs, year-to-date diluted earnings per share would be $0.83.

We are now on slide 9. EMCOR's balance sheet remains strong with sufficient liquidity as represented by the $407 million of cash to meet current working capital requirements as well as for organic and strategic investment opportunities. Changes in goodwill and identifiable intangible assets are due to recent acquisition activity with both the USM and Bahnson transactions closing in the current year. Total debt is essentially unchanged since December 31, 2010, and our debt to cap ratio remains low at 11.14%. As stated in prior quarters, EMCOR continues to do a very good job of managing risks within this continuing difficult environment and it's fully reflected in our balance sheet.

With that out of the way, I'd like to return the presentation back to Tony. Tony?

Thanks, Mark. And we should be on page 10 now, titled Backlog. Backlog continues to increase and now stands at $3.8 billion at the end of the second quarter. In dollar terms, backlog is up $652 million or an increase of close to 21% year over year. While acquisitions executed within the last year makes up the bulk of this increase, $129 million of this new work is organic giving us an organic increase for the past 12 months of 4.1%. For the quarter, organic backlog remained level with the first quarter giving us a book to bill of 1, again, five of the past six quarters. As we have said in previous calls, backlog is slowing -- organically growing slowly and is an indicator in our view that we are continuing to slog our way over this large, recessionary bump.

USM contributed $223 million of commercial backlog mainly in the form of service contracts for retail and banking customers. For USM, as well as all of our service contracts, we only count one year of the service revenue in backlog regardless of the length of the contract or whatever spillover work comes out of it. It's just the base contract, which, by the way, on average are about three years.

As you can see from the backlog charts, looking at the colors, the yellow at the bottom, commercial backlog is up from 2010 levels almost 60% organically from June of 2010. That's a level from $366 million to $592 million. Now let's just remember it's coming from a very low base, historically, to any historical comparison. In fact, it's increased each quarter since June 2010, and part of it is the small, medium-sized project work is returning as we discussed in our discussion about our mechanical services group in our EFS segment. We are starting to see some firming there. We are starting to see a gradual increase with our [owner] customers, and a lot of that's coming as we drive a return, too many people [ran into] failure, and we're seeing a drive for more energy efficiency. However, the margins are still not what we expect because we're not having the ability to up sell like we typically do.

As you move up and look at hospitality, and you have to have a really good eye to see that now, we are finishing the remaining work. Not much behind that, no surprise there, and I think we've done a very good job of being transparent about its impact on our business.

Industrial's another story, though. We are seeing a demand from our industrial customers, not only on what's in backlog, but also in our outage and turnaround work. That's mainly refining power plant energy and process markets. You know what? The spring turnaround season ended well for our industrial business and we performed well. And we performed well through the downturn, just on a lot more reduced -- on a lot reduced demand. Our refiners, those with integrated oil companies and independents, are performing deferred service work. And if you look at their crack spreads right now, they're pretty good. If you look at their utilization in the mid '80s, it's pretty good versus what it's been the last couple years. We do expect the back half of the year to be okay and pretty good, nothing like it was in '07 and '08, but better than it was in '09, and '10. But let's remember, they can make decisions on a split second to bring down the scope, although at this point we don't believe so.

We also believe that our customers, those mainly in the Gulf Coast, will benefit if we ever can get out of our own way and finish the Keystone Pipeline because that'll bring more Canadian crude down and that mix of crude into the refineriess are good for maintenance providers like EMCOR to take advantage of. It's a no-brainer investment. We hope we make it, and it'll continue to strengthen our country.

Healthcare is another thing we've done really well, and it's been a very big part of our large project execution, something we've learned how to perform very well. Out of the $676 million that's in healthcare backlog, I should note that $200 million is associated with Comstock. It's in there right now, but as we are successful closing this transaction in the third quarter, it will come out in the next quarter. For Comstock overall, the remainder is spread mainly between industrial, institutional, and commercial, but the total backlog for Comstock Canada in the reported numbers at the end of the quarter is $254 million.

Institutional backlog's about $1 billion of our backlog right now. You're seeing it from energy-conscious public building managers, college and university, the federal government. And a lot of what we do is either in the maintenance side through our EMCOR government services business, but we're also doing things for the government to save money through facility rationalization, upgrading of facilities, or just straight cost savings work. Some's simple, some's more complex. The government's been a good customer of ours and it's been a mixed bag as you look at the stimulus coming out, the actions taken in November, December of 2008 when we basically stopped some of the outsourcing that was well underway that saves the government significant money.

So it's not clear to me how this will all play out. If the government starts being an aggressive outsourcer again, which is my view, then I think EMCOR will benefit because we had projects teed up and it got stopped. I also think the kind of work we do, although not immune, I think it's good, cost-effective work for the most part that we should stay okay. But you don't know. I mean, we're in uncharted territories. I think the mix is more favorable for us than others, but clearly, it's an area we watch.

And we've also been much more disciplined over the past three years, and we continue to be disciplined. So backlog is increasing. That's encouraging. Markets remain uncertain, but I look for a general, sawtooth pattern on our backlog with a general upward bias organically.

Now let's turn to page 11, and I'll quickly go through some projects. You know, in Denver, with Trautman and Shreve, we're working for DaVita. They're putting in a new 270,000-square foot world headquarters. It's going to be a LEED Gold building, and we're helping drive that. In Pittsburgh, Scalise is installing new mechanical and high-purity piping systems for a new nuclear physics lab at University of Pittsburgh. They'll be doing the heating and cooling, the plumbing, the specialty gases, as well as the specialty air handling units and the installation and modification. You know, the sophisticated research there makes air movement and air filtration critical and also the humidity control is very important and Scalise has expertise across the board.

In Los Angeles, Dynalectric's going to be working for the City of Los Angeles to upgrade and modify the existing traffic control equipment in the Wilmington and Canoga Park districts. [Dyna] will be responsible for the replacement of all the signal controllers for both districts, as well as related installation of conduit, fiber optic cable, video, and data equipment.

In San Diego, our University Mechanical subsidiary will be doing a lot of work at San Ysidro, US land port of entry, by the way, the busiest land port of entry in the world. Dyna will be responsible for the mechanical systems for the new Head House building, a new narcotics building, as well as the prefabrication of 46 new primary booths. And again, this is where pre-fab can make a difference. They're all the same. We'll work with the design people and we'll design assist that one time. We'll pre-fab it and go connect it -- for those of us that have children that love Legos -- and connect it like a Lego kit.

In Washington, Dynalectric DC will be responsible for the installation of all electrical systems for the new headquarters of NPR. This 426,000-square foot facility will house writing and editing offices as well as the main studio and we'll install electrical generators and UPS backup.

In Indiana, for (inaudible) Metal, [Betlem] will be doing new electrical systems at the hot strip mill. That'll be done by Hyre. And finally, here, close to Norwalk and Welsbach since the beginning of street lighting in New York, I think we've maintained a couple boroughs. It's for the street, highway, and park lights in the boroughs of Queen and Brooklyn. These are two-year contracts. Basically, we just got renewed, and that's a good news story.

With that, I'd ask you to turn to page 12, and we can talk about the rest of 2011 and the outlook we see. You know, we enter the back of 2011 here with really a solid first half in the books. Overall, margins are about where we expected. Maybe got there a little different way, but they're about where we expected. Volume's been a little stronger, and acquisitions position us well for the future. We are fortunate to be able to execute three well-timed and well-placed acquisitions.

We are seeing some improvement from a very low base in the private markets. We see some replacement demand returning. Our labor productivity is very good. Our safety record is very good. Our backlog is stable to slightly growing organically, and our expense control is intact. We have a strong and liquid balance sheet that allows us to invest in our businesses both through acquisition and organically. Based on what we see, we feel confident in bringing up the lower end of our guidance range to $1.65. However, we are going to keep the top end of the range at $1.85.

We expect revenues of at least $5.5 billion this year. That accounts for USM in and Canada out.

As I stated earlier, and for those that we get to talk to at investor conferences, I like to think of the world in things we control and things we don't control. A couple things we said earlier, we said we needed a good start on the refining season and good performance versus 2010. We got that.

We said we needed to continue to execute well in the large project area, especially as we finish some large hospitality projects. We got that and are getting that. We said we needed to continue to watch the cost line and have very good productivity. We got that, and we're going to continue to execute there. We said we needed some broad-based resumption of maintenance capital spending, especially in the small project area and to give us the ability to up sell our customers and really add value like we know how. We haven't got that yet, although it does look like demand is firming and we are seeing improvement.

We said we'd like a hot summer like we had last year. Well, it's been hot the last couple weeks, most notably last week. But if you really look at it on a year-to-date basis, the key critical areas, which would be the Northwest and Upper Midwest, the places where it's not always hot, degree cooling days are down anywhere from 15% to 20% year-to-date depending on the region. So, we really didn't get that, but we will execute well on the heat that we got.

We've had -- we've seen the return of solid organic growth in our services business. We take that as a good precursor of demand firming up and us starting to win in the marketplace more than we have over the last two years. Now we need to see the conversion on that volume take hold, which we will work hard to drive. This balance tilts a little bit to the favorable. We certainly don't think things are getting worse, and therefore, we believe we will be at the mid to top end of our initial guidance range. And we are well positioned to take advantage of opportunities as markets recover. And, the reality is, we're going to continue to work in these top markets in a very thoughtful, disciplined way to add value for our customers and to be able to continue to build our platform of not only construction offering but our platform of service offerings for our customers.

With that, we remain ready to take your questions, and I'll turn it over to Keisha. Keisha? Keisha?

(Operator instructions.) Your first question comes from the line of Alex Rygiel.

Good morning, gentlemen.

Good morning, Alex.

Tony, revenue growth, organic revenue growth is redeveloping. Backlog's picking up. Can you tell us a little bit about pricing out there in the environment, competition? Where do we stand in the cycle on that?

Well, I think people -- we're seeing more sensibility. I guess that's not a great word, but people are becoming more reasonable, our competitors, than they were certainly in 2009 and the first half of 2010. I think a lot of our competitors working just for cash flow to keep their operations going and they realize it's not such a good thing.

We also are starting to see that sort of mid-range company, the sort of $15 million to $30 million company, become not as aggressive and in some cases some very well-established companies, people are getting towards the end of their career, there's really no place for them to exit and they're starting to think about exiting their business or have exited.

So, on the construction side, pricing looks to be firming. And as the larger projects -- as we talked in the past, that gives us the most opportunity to add value right now in this kind of market.

As you go to the services market, we had more reasonable pricing, certainly, in our industrial businesses in the first half of the year. We have more reasonable pricing on our service agreement business and our site [based] businesses. And we're starting to see a firming in demand and a little bit, a tiny bit, of an uptick on the small project work, but we've got to see that carry through on a couple quarters for us to believe that it's sustained.

Based upon what you see in your backlog right now, how confident do you feel that 2011 is sort of trough EBIT margin in this cycle?

That's a tough question to ask -- answer with everything going on externally right now. You're seeing a general -- a little more conviction from our owner customers, but you're not seeing enough private money return yet to the market. I do think the range we gave for this year, Alex, is indicative of how we expect to perform at a trough, but as far as our actual reported, I'm not ready to declare that that would be the trough.

And as it relates to your range, maybe either you or Mark could answer this, obviously, you had a plus and a minus. Can you help us to think about how the core business also changed in your eyes over the last 90 days to influence your change in guidance?

I'll take a shot at it, and I'll have Mark [kick in]. What we saw in our core business-- and again, go back to the things we said had to happen for us to go to the mid point of our guidance and above. Having a good start in the refining business was important for us. Being able to continue to execute well on large projects and being able to see a clear-eyed view to the end of our large hospitality project was important to us. The pluses and minuses take you to a point. I think we feel pretty good about where are margins are right now. And I'll turn it over to Mark.

Thank you, Tony. Alex, clearly, what we've seen certainly over the last quarter and certainly through the first six months of this year is stability in our overall margin performance, putting aside the pluses and minuses that we talked about earlier on the call. I think if you look at the base business going forward, it's certainly performing within the parameters that was the underlying basis for our guidance, and we're going to continue to be as judicious as possible and manage the risk as we go forward. What we're not seeing is, as Tony mentioned -- the opportunity to up sell just isn't as prevalent as we would like it to be in this market. And we're hopeful when the broader economy gives some indication of stability that we're going to see people being a little bit more receptive to opening up their purse strings and giving us the opportunity to provide more value added for them.

And lastly, was the combination -- the addition of USM and the sale of Canada, was that a plus or a minus to the change in your full-year guidance?

A neutral.

Perfect. Thank you. Nice quarter.

Thank you.

Your next question comes from the line of Richard Paget with WJB Capital.

Hey, Richard.

Good morning, guys.

How are you?

Good. Just wanted to maybe expand a little bit on Alex's question in terms of your outlook and what's really changed over the last 90 days. I mean, earnings season has been mixed where you have some [beat and raises] but then you have some other companies lowering their expectations for the second half,. And I wondered if, in certain end markets, have you seen a change in what you thought the second half was going to look like, whether it's better, whether it's worse, whether it's neutral, if you could just comment on that.

Yes, again, go back to what I said towards the end of my commentary. It was real important for us to see the industrial markets, specifically the refining and some of the work we do around outage management for process plants and energy plants, for us to see the spring season actually happen this year. As you remember, '09 and '10 people said it was going to happen. This year it actually happened. It was also important for us to see resumption of demand for our shops in our industrial businesses, and we saw that. And then finally, real important for us to see that we could maintain our service base, grow our service base, and that small project work really was going to be at worst a neutral to us for the back half of the year. And you put all that together and I think it got us where we believe that we could bring up the lower end of the range.

Okay. Well, I know you guys are generally conservative, but -- so you probably didn't have a big rebound in the second half built in. I mean, it sounds like just based on the second quarter, the second half is shaping up as you expected. I mean, is that fair to say? Or is it incrementally better now that you have 2Q under your belt?

I mean, I -- Richard, I would have to say that as we sit here in the calendar currently that we believe that the second half of the year is going to be slightly better than what we would've thought when we provided initial guidance to the market back in February.

Okay. Fair enough. And then, maybe this is for Mark, with the divestiture of Canada, I know you said you're basically selling it at book, but, I mean, is there going to be any small gain or tax implications at all?

Yes. We -- first and foremost, beginning with quarter three reporting, Comstock Canada will be reflected as a discontinued operation in EMCOR's consolidated financial statements for both 2011 and all historical periods that are presented on a comparable basis.

With regards to the at least the estimate today of where the transaction's going to be, obviously, it has not closed yet, as Tony mentioned. And with this transaction being denominated in Canadian currency and as the Canadian dollar continues to strengthen against the US dollar, that's kind of a moving target with where we're going to end up. But, with regards to the actual book value portion of the transaction, based on our current estimates, we're selling it for a slight loss, roughly US200,000.

And with regards to tax implications, because of the tax structuring of Canada, we're going to have to resolve that structure and with the repatriation of the cash back into the United States, there is going to be a tax bill. The net impact of all the puts and takes exclusive of that $200,000 is probably an incremental $1.5 million charge. So, total charge transaction-related based on today's estimate is roughly US1.5 million to US1.6 million, and that's obviously -- does not include what the operating results for Comstock were for the first six months, which was an operating loss of just under $400,000, and that is reflected in our revised guidance that was provided in today's release.

Okay, great. And then just one more. Any updates on USM's amortization expense, the intangibles and whatnot?

Well, the update is we're continuing to work through the finalization of our purchase price accounting with our external third party valuation advisors. Based on the information that we have in front of us today, there has not been a marketable difference over our initial estimates when we came to the market and announced the deal. But once we get through our internal review, then our external auditors, Ernst and Young, have to do their review and we'll obviously have this finalized sometime during quarter three.

All right. Thanks. That's all I got.

Okay. Thank you.

Great.

Your next question comes from the line of Rich Wesolowski with Sidoti & Company.

Rich, how are you?

Excellent. Good morning. How's it going?

Good morning.

Would you mind discussing further the government contract that was cited in explaining the 2Q facilities margin?

That was part of the reason. Yes, we won a large contract. We like the contract. Any time when we do these things we have startup expenses. We probably are executing about 60 days behind where we thought as far as getting the workforce right-sized and getting the service planning done where we want it. It was a very complex deal. We had the other half of the contract, so we feel confident where we can get to. But that was part of it, and then we -- if you look at it on a year-over-year basis, government incentives in these contracts have -- are lumpy, and we had some good news in the second quarter of last year.

Right. In my experience, sometimes the -- when a project is delayed early in the design phase, it has the potential to turn into a headache. Do you see that here?

No, this is a maintenance contract.

Okay.

This is a start-up maintenance contract in EMCOR government services. This is just a phase-in of the way we do business versus the people that were running it before and getting right with the government contracting officer about what expectations are for performance metrics and how we're going to do it with what improvements.

On the discussion of your commercial backlog, if I'm not mistaken, you stated 592 versus 366 in June of '10?

Yes.

Did you say that 60% of that growth was organic, or did I misinterpret that?

No, that it's 60% up versus the prior year and that was all organic in that number. And then if you add on the 220 million or so of USM, that would be added into that.

Okay. Lastly, Mark, how much of the cash do you consider truly excess cash now after the deal given your market outlook and the estimate for working capital usage in '11 and '12?

I would have to say what we really -- we get that question quite often, as you well know. My outlook hasn't remarkably changed because once again, despite the fact that we've had organic revenue growth through the first six months, we're hopeful that when market conditions truly do improve, that you're going to see more significant organic revenue growth and that's going to require some level of working capital investment.

But relative to the roughly $407 million of cash that's sitting on the balance sheet, I'd say roughly $200 million of that, I guess from your perspective, could be deemed to be excess. I would not be comfortable going below $200 million of cash on hand to meet current or projected working capital requirements, and that's obviously assuming that there's no significant acquisitions that would happen in the short term. And obviously, we're constantly evaluating, so the future will hold what the future holds in that regard.

Appreciate it. Thank you.

You're welcome.

Thanks, Rich.

Your next question comes from the line of David Wells with Thompson Research Group.

Hey, everyone.

Hey, David.

First off, quick, if you look back at your peak margins, if you were to back out the Canadian business, what -- how would that margin look versus the reported number?

Yes, David, it varies, but it's safe to assume that it's 30 to 40 basis points detrimental. So, conversely, if you look back at our peak performance, that peak performance would improve by roughly 30 to 40 basis points at the operating margin line.

Okay. That's helpful. And then just looking at the Canadian market more broadly, taking a step out here currently, does this prohibit you from re-entering it at some point or -- if the market is right, or is this a complete exit?

Well, I mean, we serve customers in Canada today through our Ohmstede business with their heat exchanger needs and some technical services. We will serve customers in our site-based business, commercial site-based business. In fact, the folks at Comstock will be happy to help us with that in the future. And USM is part of that commercial site-based business, serves customers in Canada. We don't plan on being --we wouldn't have exited a mechanical and electrical construction company in Canada. And we will have a noncompete in that area and we were more than happy to sign that for at least three years. And, you know, but there are areas on the energy side as we follow our energy customers that become much more interesting to us down the road maybe in western Canada.

That's helpful. And then with the newly acquired USM business, have you already seen some revenue synergies there or is it more -- do you see line of sight to seeing some of those things go through?

It's too early. We do know that we have customers that like the combination of what we did with their offering and that we've been able to craft a couple proposals here in the last three weeks that we wouldn't have been able to craft before. It allows us to serve that other third of the market we weren't serving before. So I think long term there will be revenue upside. I think the first thing we need to do with USM and its team is to build the confidence to win again. And that's one of the things we talked about when we bought it, and that's something we know how to do very well.

Sure. And then lastly, and then I'll jump back in the queue, but if you look at the small project business and your comments around seeing some firming there, what does it take, I guess, for that business to begin to accelerate more aggressively? I mean, do we need to see nonres put in place begin to accelerate meaningfully? I mean, is there enough nascent demand where you can see the margin expansion, you can see those projects come out? Is it more kind of a broader macro GDP type question?

Yes, well, it is a GDP type question, but it's also a question with respect to confidence in people in that I'm going to be in this facility for the long term. I'm willing to invest in this facility. Really, I mean, all of these projects save energy, and that is good, long-term payoff for me. And then I'm willing to pay for the people that are going to maintain it long-term to do this right so that my total cost of ownership actually goes down.

And really, we've had fits and starts of that over the last couple of years. We started to see some recovery in early '09, and then we had a crisis. In early '10 we saw a recovery in May. Then we started talking about Greece again and now we have our own debt problems. And what's amazing to me, David, is how quick we can go from the front page of the newspaper, or more appropriately your smartphone, to the person we, many levels down usually on these kind of projects, that we deal with being notified somewhere in between that day from the CFO to re-look at the capital budget and rethink it. And there's less of that conversation today and a little more confidence [or the] put in place that, yes, we're going to be here for a while and we have to be in business for the long term. And you're seeing that first, I think, in the industrial markets, that firming and demand.

That's really helpful. Appreciate the color there. Thanks.

Your next question comes from the line of John Rogers with D.A. Davidson.

Good morning.

Good morning, John.

Just, I guess, first thing I -- from Mark, I assume, just so I'm clear, on Comstock, how much of an impact did it have on the first six months that'll get taken out? You said $400,000 loss?

We had a $400,000 -- roughly, just over $400,000 operating loss for the first six months of this year.

Okay. All right, and after tax, nothing significant or --

Yes, I mean, there's a slight tax benefit but it's not substantial.

Okay. Okay. And then just on USM for a second, Tony, are there any significant contracts coming up for renewal or potential bid or expansion? Could you talk about that a little bit and where they -- industry or where they are?

Look, there's a good and bad of the markets they serve.

Yes.

The good and bad of it is there's always opportunities, but it means there's always somebody looking at your opportunities, right?

Yes.

Or you have good relationships. And so there's always an underlying churn in the business of anywhere from 12% to 20%.

Annually?

There's nothing unusual with that, and that is where it's always been. And quite frankly, that doesn't mean you lose them all. It means there's always something rebidding because you have a three-year cycle on it. Right?

Yes.

And we face the same dynamics in our service agreement business and our commercial site business. There are some opportunities that we're looking at now that could be substantial, and a couple of them are things they probably wouldn't have been able to pull off on their own because we're able to bring a combination of things. We have a little more credibility on the trade side, a lot more credibility on the trade side. But we also have these [route] technicians out serving multiple site locations that if we can bring the utilization up on them a little bit, we can offer a really nice, cost-effective solution to customers coupled with their vendor network. And then we have some rather large customers that really liked the offering we had at EMCOR, but we couldn't offer the interior and exterior services, and they wanted us to do that. And so now we'll be able to do that.

And still predominantly retail and, I guess, bank branches?

It's anything with a branch network.

Okay.

And there's lots of things that qualify for that. I mean, it's retail, it's banking, it's telecom. It gives us a unique platform because some of their technology for us to be able to manage multi-site things from cell towers, the list goes on. And so we looked at it not only the technology being able to help us with our core business, but also the branch maintenance business, if you're going to be in business, is something that has to be done and we took a sort of view of the world, and I think it's going to play out, is as new build, and we really didn't play into new build retail sector anyway, as new build comes down, that the money, the maintenance, and the capital, the storage you have, have to look better. And you have to make it a better customer experience. And I think that's consistent with other people that serve that market are starting to see on replacement HVAC demand and some other things. And so we think that on one sense, new store build coming down is bad for other parts of our sector because of labor absorption, but as far as this part of what we do, that could actually be a positive.

Okay. Okay. And then, lastly, just, and you mentioned this, the HVAC replacement cycle, there's been some comments out of the OEMs that that activity's picking up as part of a, I guess, normal or replacement cycle. Is that what you're seeing or --

Yes, John, and that's what you see in part of our organic growth rate in the EFS segment.

Okay. And how long does that go on?

Well, I think it should go on for a while, I mean, because it didn't do much of anything for 18 to 24 months.

Okay.

Typical cycle is at least three to five years in that and, of course, it got muted the last time and hopefully there's a lot of pent-up demand. And I think it just comes with a conviction of yes, this space is going to be occupied and I'm going to be -- if you're on the commercial real estate side, you want to know that it's going to make a difference, the comfort and everything else that goes on and the energy efficiency to those with triple net leases. If you're on the owner-occupied side, you're starting to get to the conviction of what your core facilities are going to be now after two years of slogging, and so you're going to be willing to invest in those core facilities.

Okay. Great. Thanks. Appreciate the color.

Your final question comes from the line of Tahira Afzal with KeyBanc.

Good morning, gentlemen. Nice quarter.

Thank you, Tee.

I guess first question is if I go back and I look at your segments, the margins that were really supposed to [pull] up in the cycle, if I remember correctly, were supposed to be the facilities services one and back in '08, they were close to 7%. What's -- really what we're seeing is that the construction margins have really held up pretty well and the facility margins have come under pressure. So going forward as you look at 2012 onward, or even into the second half of the year, how should we view margins? When is the margin expansion going to come as the construction cycle picks up again?

Well, I mean, you're right. Our construction performance through the cycle has been exceptional, especially led by the large project execution. On the services side, we're coming off a low in our industrial business. They performed okay through that, just didn't have enough volume, and we saw the resumption in the first half here, a pretty good performance in our industrial businesses, most notably in the refining business.

The part that's been more problematic coming back versus 2008 has really been the mechanical services business and really with an emphasis on the small project margins. We're a high-value player here, a value add player, and we like to help customers think about how to reduce their costs overall and help them plan their maintenance budgets. And Tee, you need a maintenance budget to help them plan to be able to add that value. And we're finally starting to see some of those opportunities in front of us, albeit slowly recovering. And we also had to do some things to protect our customer base with small projects and we did it and we really didn't suffer from it on a true dollar basis, but we suffered from it on a margin basis. And as that margin resumes, resumption comes back or as that project volume comes back, we're well positioned to take advantage of it.

All right. Okay. Thank you. But, I mean, it would -- it seems like maybe the facilities services margins ended up being perhaps a little more cyclical than you perceived and I assume that would also be positive as the cycle picks up you could see some expansion there?

Yes. I mean, look, the refining business was more cyclical than anybody believed.

Right.

And the mechanical service business is more cyclical this time than I've seen it in the 15 or so years I've been around it. So, yes, and I think right now at this point in the year our facilities margins should've been 70 to 100 basis points higher than what they are right now.

Got it. Okay. And then just going to the replacement cycle, Tony, if you're looking at utilities, they're on the brink of fulfilling [material] CapEx cycles from just talking to the other E&C companies that do a lot of the CapEx [build-out]. That typically translates into rate cases and subsequently higher electricity rates down the line. Have you heard any of your commercial clients come to you and say -- hey, we need to start thinking about this and replacing our units because energy prices might potentially be going up. Or is it still too early for that?

I think it's a little early for it, Tee. We have seen a firming in demand. We are able to have the discussion about energy efficiency again here over the last six months when no one wanted to hear about it for the 18 months before that. So, yes, I think it's coming back into the market and again, go back to what I said. I think people first have to come to the decision that this is a space that they're going to occupy for the next five to ten years. Once they get through that decision, then you can have the energy efficiency discussion and then the company, their company, is willing to start dedicating maintenance capital to get the long-term total operating costs of that building or that industrial facility or that campus down.

Got it. Okay. And last question on the facilities services side, now that you do have more of the softer retail versus some of the heavy commercial retail in your mix, does that typically cyclically turn up a little faster? For example, when we look at retail markets, they move a little faster than some of the E&C markets. And so you do expect that CapEx to perhaps lead the CapEx on your heavy commercial side?

Yes.

All right. And you think you will be able to leverage your acquisition towards that?

Yes.

Okay. That was pretty definite, Tony, so I'll take that as a yes?

Yes.

Thank you. That's all from me.

Okay.

Congratulations. Great quarter.

Yes, thank you.

Thank you, Tee.

I would now like to turn the call over to management for any closing remarks.

Well, thanks to everybody for dialing in today. Thanks for your interest in EMCOR. We've had an eventful first half of the year. We've made a couple nice acquisitions that strengthen our business. We have -- we are saying goodbye to some friends that have been with us for a long time, but I think it's definitely a win-win transaction. And we continued to show discipline and resolve in what are very uneven and choppy markets, albeit upwardly biased, a little more positive than they've been the last two years. So, with that, thank you and everybody be safe.

This concludes today's conference call. You may now disconnect.