EMCOR Group Inc (EME) 2012 Q3 法說會逐字稿

My name is Melissa, and I will be your conference operator today. At this time I would like to welcome everyone to the EMCOR Group third quarter 2012 earnings call. (Operator Instructions) Thank you, Mr. Gordon McCoun, you may begin your conference.

Thank you, operator. Good morning, everyone, and welcome to the EMCOR Group conference call. We are here to discuss the company's 2012 third quarter results, which were reported this morning. I would now like to turn the call over to Kevin Matz, Executive Vice President, Shared Services, who will introduce management. Kevin, please go ahead.

Thank you, Gordon, and good morning everyone. Welcome to EMCOR Group's earnings conference call for the third quarter of 2012. 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 a slide presentation that will accompany our remarks today. Please advance to slide two.

Slide two depicts the executives who are with me to discuss the quarter and [nine] months results. They are; Tony Guzzi, President, 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 General Council, Sheldon Cammaker. For call participants who are not accessing the call via the internet, this presentation, including the slides, will be archived in the Investor Relations section under Presentations, and you can get this at emcorgroup.com. Before we begin, I want to remind you that this discussion may contain certain forward-looking statements. Such statements are based upon information available to EMCOR management's perception as of this date, EMCOR assumes no obligation to update any such forward-looking statements.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. Accordingly, these statements are no guarantee of future performance. Such risks and uncertainties include, but are not limited to, adverse effects of general economic conditions, changes in the political environment, changes in the specific markets for EMCOR services, adverse business conditions, increased competition, mix of business, and risks associated with foreign operations.

Certain other risks and factors associated with EMCOR's business are also discussed in the Company's 2011 Form 10-K and in other reports filed from time to time with the Securities and Exchange Commission. And with that said, please let me turn the call over to Tony. Tony?

Thank you, Kevin, and good morning to everybody, and you should be on page three of our presentation. We had a very solid quarter that shows the balance of EMCOR. We earned $0.59 per diluted share this quarter, versus $0.47 in the year ago period. We had revenues of about $1.6 billion, which was 8.4% overall growth, and 6.4% organic growth. Our (Inaudible) was over one. Our operating margins were 4.3%, versus 3.7% in the year ago period. Cash flow was essentially the same as last year, and represents good performance, especially with the strong growth in our EFS segment this quarter. We continued to show good cost discipline and SG&A as a percentage of sales drops to 8.4% in the quarter versus 8.9% in the year ago period.

Let me cover some highlights in the business. In our mechanical and electrical segments, we continue a pattern of excellent performance. We expected margins to decline some year, but are well within acceptable levels at a strong 6.9% in electrical, and 4.5% in mechanical for operating margins. We never look quarter to quarter at margins in these businesses, but look at more long-term performance and pay close attention to our mix of work. We continue to execute well in jobs won entirely down in this downturn, and have no unusual items affecting margins in this quarter.

Bottom line, we are performing the old fashioned way in a tough market. Disciplined bidding, excellent preplanning to include the use of BIM, or building information modeling, and just good site and labor management. We also have continued to execute well on some large industrial jobs we won at the beginning of the year. In the EFS segment, we had a very good quarter at 5.3% in operating margins, versus 3.2% in operating margins the previous year quarters, and we are substantially up versus our first half performance.

The performance this quarter better represents the performance capability of our EMCOR Facilities Services segment. And you are going to ask, how did we improve this business so much so fast, versus the first half and the prior year's period. First, our industrial business had a very strong quarter, especially in serving our refinery customers. We had the capacity available, and the technical skill available to react to our customers' demand, and it paid off for us.

Second, our site-based business, where USM is part of our site-based business -- and that's how we prefer to talk about it -- had much improved performance, versus first half 2012 and versus prior year. Our legacy business moved through the contract expenses -- start up expenses we talked about in the first half, and our USM business showed significant improvement in a seasonally weakest performance -- weakest quarter. We are almost at break-even on an operating income basis in USM, and this is its seasonally weakest quarter, and we are seeing the effect of our improved business development, and just as importantly, we are seeing a pretty significant impact of our cost synergies. Clearly, we still have room to improve, but we like to trajectory, and the numbers are starting to back up the four indicators we have talked about and that we track.

Our mechanical service and government business also showed improvement. To be clear, there was not a large heat impact in this quarter. Yes, we did more repair service work, but there was not much follow [up] project work out of that repair service work versus the prior year. This performance validates some of our potential in our EMCOR Facilities Services segment, but we need to execute like this for more than one quarter to know we are back to our performance expectations. However, we do like the grade on our report card this quarter for this segment.

In the UK, we continue to perform well in our facilities business, and continue to downsize our construction business, and really, the downsizing of that construction business really makes up for the backlog drop year-over-year, and against the [year-over-year] period. We like where backlog is, we wish it would grow, but with the strong organic revenue growth, we like that we had a (Inaudible) over one. We dropped year-over-year, and we talked about why with the UK construction business. However, we are seeing more private sector opportunities in both our industrial commercial backlog. As the amount of private sector work has moved over 50%, versus 37% in a year ago period.

I will summarize the quarter my opening remarks; good quarter, good balance, good execution. However, we can still improve, and with that, I'll turn it over to Mark for a detailed financial report.

Thank you, Tony. And good morning to everyone participating today. For those of you participating via the web cast, we are now on slide four. As in past quarters, I will begin with certain highlights of our third quarter 2012 results before moving to (Inaudible) key financial data derived from our consolidated financial statements included in both our earnings release announcement, and form 10-Q filed with the Securities and Exchange Commission earlier this morning.

Consolidated revenues of $1.61 billion in the quarter are up 8.4% from 2011. Organic revenue growth in the quarter is 6.5%. All reporting segments, other than our UK segment, reported positive revenue growth during the quarter [just ended]. Revenue distributable to businesses acquired at $27.3 million, positively impacted our US facilities services and US mechanical construction services segments during quarter three. Domestic electrical revenues increased 9.9%, domestic mechanical quarterly revenues increased 8.2%, facilities services quarterly revenues increased 12.7%, and our UK segment revenues decreased 11%.

Revenue growth within the domestic construction segments can be attributed to increased activity within the industrial and commercial market sectors, while the organic growth within our domestic facilities services is predominately due to higher revenues from our industrial, government, and commercial services businesses.

The decrease in revenues from our UK segment is the result of our plan to de-emphasizing their engineering and construction operations and focuses -- focus on the facilities services business. Selling, General and Administrative expenses increased $2.7 million within the quarter, and that's inclusive of $2.8 million of incremental SG&A from those acquisitions completed from between September 30, 2011 to the current date. As a percentage of revenues, SG&A in quarter three is 8.4%, which represents the 50 basis point reduction from last year's quarter three percentage of 8.9%.

Please turn the slide five. Operating income of $68.6 million represents 4.27% of revenues in comparison to $56.5 million of operating income, and 3.81% of revenues in 2011's third quarter, while reporting segments other than US mechanical construction and EMCOR UK reported increases in operating income quarter over quarter. Operating margins by reporting segment are as follows; US electrical 6.9%, US mechanical 4.8%, total US construction 5.6%, US facilities services 5.3%, arriving at total US operations of 5.5%, as compared to 5% for the third quarter of 2011, in UK construction facilities services was flat at 1.3% for both periods presented.

2012's third quarter US mechanical construction services segment results were down 170 basis points quarter over quarter as 2011's third quarter was favorably impacted by the resolution of uncertainties in certain hospitality projects. Our third quarter US electrical construction services segment operating margins of 6.9%, were improved from the year ago quarter's 5.9% of revenues and benefited from profits recognized in several projects within the industrial [water] and waste water and institutional market sectors. Facilities services operating margins increased due to improved performance from our industrial services, commercial site-based services and mechanical services division.

As Tony previously mentioned, our commercial site-based performance within the quarter was improved from quarter three 2011, inclusive of the US (Inaudible) coming out of one of their seasonally weakest quarters. Additionally, this segment's results benefited from a $3 million reduction and a liability for contingent consideration related to certain acquisition earn out arrangements. Consistent with our second quarter performance, EMCOR's UK construction and facilities services operating margins decreased, due to their engineering division reporting an operating loss which unfortunately offset improved operating margin from their facilities services operations.

Our income tax provision for the quarter is reflected at a tax rate of 40.5%, which is slightly more than the 2011 quarter three rate of 39.4%, due to unfavorable discreet items attributable to the reduction (Inaudible) deferred tax asset due to the reduction in enacted tax rates as well as the finalization of the Revenue Canada tax audit for predisposal ownership periods. Consistent with my quarter one and quarter two commentary, I still anticipate our full year 2012 rate will approximately 39%.

Cash provided by operations for the third quarter was $53.6 million, which represents a slight improvement over the $52.4 million of cash provided by operations during 2011's third quarter. For the nine month period, cash provided by operations is $42 million, compared to operating cash flow of $58.7 million. The variations in both 2012 reporting periods is due to the reduction in our net [over build contract] position from year end 2011. With regard to cash use and financing activities, we utilized $2.7 million of cash on hand to fund share repurchases within the quarter. Additionally, on a cumulative basis, we have expended approximately $51.4 million of our authorized program amount.

Please turn to slide six. Additional key financial data on this slide not addressed during my highlight summary are as follows; quarter two gross of $203.2 million represents 12.7% of revenues, which is up $15 million from the comparable 2011 quarter, restructuring activities in the current quarter amounted to about $100,000 and were US related. Diluted income for common share from continued -- from continuing operations for the quarter is $0.59, compared to $0.47 per diluted share a year ago.

I [will move] now on to slide seven. Our results for the nine month period ended December 30, 2012 are depicted on the slide. Revenues increased 15.6% to $4.7 billion, with all reporting segments generating higher revenues in the year-to-date period. Consolidated organic revenue growth for the nine months is 8.9%, our US mechanical construction and US facilities services segment generated revenue increases of 21.2%, and 19.6% in the year-to-date period respectively, from both business acquisitions and acquisitions in organic activities. Year-to-date gross profit is $577.9 million, which is higher than the representative year ago period by $58.3 million and is 12.2% of revenues.

Our gross profit margins on a comparative basis are down period-over-period, due to project mix, most representative within our US mechanical construction segment. SG&A expenses of $406.7 million represent 8.6% of revenues, compared to 9% of revenues for the corresponding 2011 period, excluding transaction costs that occurred in connection with the acquisition of USM from 2011's results, SG&A as a percentage of revenues would be 8.9% for the nine month period ended September 30, 2011. The absolute increase in year-to-date SG&A expense levels is due to incremental SG&A from businesses acquired as well as incremental SG&A necessitated by our organic revenue growth. Despite this increase, we have been successful in reducing the relative percentage as we continue to leverage our cost structure.

Year-to-date operating income is $171.1 million, or 3.61% of revenues, and represents a $22.7 million increase over 2011's year-to-date performance. Diluted earnings per common share from continuing operations were $1.48 for the nine months ended September 30, 2012, compared to $1.24 per common share in the corresponding 2011 period. On an adjusted basis reflecting the add back of transaction costs associated with our acquisition of USM, year-to-date diluted earnings per share would have been $1.29.

Please turn to slide eight. EMCOR's balance sheet continues to remain strong, with sufficient liquidity as represented by $474 million of cash, which is available to meet our current working capital requirements as well as for organic and strategic investment opportunities, as well as being available to fund our quarterly dividend and any activity under our current share repurchase program. Changes in good will relate to 2012 acquisition activity, in the final (Inaudible) of purchase accounting for prior acquisitions. While the decrease in identifiable and tangible assets is due to year-to-date amortization expense.

Total debt is essentially unchanged since December 31, 2011, and our debt to capitalization ratio remains low at 10.51%. EMCOR continues to do a good job of managing its enterprise risk, and our balance sheet reflects our consistent (Inaudible) execution. With my portion of the commentary concluded, I would like to turn the presentation back to Tony. Tony, it's all yours.

Great, thank you, Mark. Let's talk about backlog, you should be on page nine. Backlog at the end of the third quarter stands at almost $3.4 billion, which is $98 million above quarter two's level, which means we had (Inaudible) of over one for the quarter. On a year-to-date basis, backlog is down $160 million -- $163 million, and all of that decrease came from the UK operations, in fact domestically, we are up year-over-year.

Total backlog is up from year end, and we continue to see demand from the commercial and industrial sectors, with a little bit of offset and reduced [reductions] in the public sector work. We are going to remain disciplined with what we bid, and of course we have to work with what the market gives us. Backlog development looks pretty good right now, commercial, hospitality and industrial, real private sector work -- remember, we talked about healthcare somewhere in the middle, we talk about it more like public sector, it is about 50% of that $3.4 billion total, a year ago it was 37%.

As Mark pointed out we have got almost 16% revenue growth year-to-date, and total backlog you can see is up 1.6%, we are basically flat. Obviously, we are promoting more work outside of traditional backlog. We continue to perform more fast-paced work obtained and completed within a quarter, and also we are working on some pretty technolog -- technically advanced projects in the industrial sector that have never really been in backlog as we work off a purchase order and unit price. We are executing well on these projects, and they are owner direct, time sensitive, and complicated, and they need to be completed as quickly as possible.

We hit the ground running here, like I said, we work on a purchase order basis, we are working on the design, design assist, and the build [and] construct, and they have an immediate need to get this facility up, and they like to hold the decision making. Sometimes they end in backlog towards the end of the job, and sometimes they don't. We have the skill sets, experience, and flexibility required to accommodate this type of fast-paced schedule. Either way, it is great work, and uniquely suited for us.

As you look at the third quarter bar chart, it's easy to see the increase in industrial backlog, which is pink. Kevin, one day we will figure out why it is pink. Industrial backlog is up approximately $280 million from September 30, up to -- up from $240 million at year end. At over $630 million, it represents 19% of our backlog.

I would like to just point out on this chart. Just everyone take a step back and look at this. What you can see is a company that's nimble and agile as it moves through an economic cycle, and keeps invested ahead of what the next trend and next uptick will be. We either do that through acquisition or organic investment, and capability building. You can see that commercial is very strong, in 2006 and 2007, and hospitality, they both came up, you see the increase in commercial coming up, some of that gain from investment. You can see that hospitality -- look, we did tremendously well, supporting the gaming market, mostly in Las Vegas, and it came down. And we executed that work in a terrific manner for our customers.

Healthcare is not going to disappear much like hospitality did. But it is episodic, and people are right now are trying to figure out what is going to go on with the healthcare law, clearly we will need some more acute care facilities, and that is where this backlog increases.

You can see industrial, and we got ahead of the industrial curve, we have a terrific team operating. Remember the acquisition of Ohmstede, it is nowhere near where it was, but backlog is creeping its way back up, and the only thing in backlog here in that part of our business is the new shop build. The repair work, and the field service work are not in backlog, because it is usually finished within a quarter, or it's done on a unit price basis.

But it goes beyond the investment we have made in the refinery sector, and it goes to, it speaks to the investments we made organically, in companies like Shambaugh & Son, and the terrific performance they can do on the food process work, but beyond that, with Southern Industrial, with Bahnson, and some long-term EMCOR stalwarts like Contra Costa, and PMI, which was bought a long time ago, almost five years.

So what it shows is an agile team, and the institutional market remains strong for us, and was added to through the organic growth of EMCOR Government Services, and the addition of Bahnson. We like our backlog mix, we like our ability to invest in growth, and it's been a pretty good story, here. And it really speaks to our ability to win in a difficult marketplace, but not a marketplace without opportunity.

And with that, I'd like you to turn to page ten and 11, and I am going to give you a wrap up on this call, so you can ask some questions. We are going to go ahead and raise guidance to $2.00 -- $2.10 a share. Basically, we are bringing the bottom end up $0.20, and the top end up $0.15. We are going to raise revenue guidance to around $6.4 billion.

everybody is going to ask about visibility, I have got about as much visibility as everybody else has, and it is about 120 to 180 days at most, but, you know, we quit worrying about that here at EMCOR. We might have been some of the first people talking about almost five years ago, we are going to worry about what we can worry about, and operate in the environment that we have. And how do you do that? You do that because you are flexible.

So in this period of economic decline, slow growth, and uncertainty, we focused on the fundamentals and we have blocked out areas we can't control, but we are very aware of them. I don't control things like government regulation, environment, customer uncertainty. I can try to help customers feel less uncertain about the things EMCOR is going to do with them. What do our folks control? We control cost, bidding discipline, planning, investment, restructuring, productivity, and safety.

So it makes guidance -- setting guidance difficult, and you have seen us move up through the year, because visibility in a market like we have been for the last four years is a lot like San Francisco on a late July evening; really foggy. However, when you are in that environment, you get stronger, and you have learned to be more flexible and more responsive than an any time in our history. We are carefully balancing keeping the right resources so we can respond to our customers as they look for immediate execution on highly complex tasks once they decide to move ahead, and we don't plan on letting those customers out.

We can do that because we have the skilled operators and these folks are terrific, these men and women. They are close to their markets and close to their customers. That's both at our business unit level, and also in our field subsidiary level. We can say that the smarts and nimbleness of our field leaders have made EMCOR a success in a tough and uncertain market. And I know for the team sitting around this table right now, we are appreciative of that. However, we can't help but imagine what we can do in an economy with a little bit of tailwind and a real growth trajectory. And with that, Melissa, I would like you to open it up for questions.

(Operator Instructions). Your first question comes from the line of Alex Rygiel with FBR.

Morning, all. Tony, a couple questions. First, as it relates to your guidance of [210], that does suggest the fourth quarter's [$0.52 to $0.62], and you did [$0.59] in the third quarter, traditionally your fourth quarter the strongest, although your business has change add little bit over the last couple of years.

What is it that gives you some caution i that suggests that EPS in the fourth quarter could be down a little bit from 3Q?

Alex, [for us] it is mainly [macro]. Our customers, with all the uncertainty and with the way people have reported in the last two weeks, big industrials, you wonder if they are going to abruptly turn off the (Inaudible), they can tend to overreact now. It can go from the CFO to the shop foreman within two days, now. I don't think that's going to happen, but I think it is -- a little bit of caution on our side that it could happen. Right now we see pretty good business in the fourth quarter. We would like a little bit of weather to help us, normal weather patterns would help on the facility-side, but execution is pretty strong across the board right now, but it is just caution to macro economics, Alex.

Very helpful. Secondly, as it relates to the refinery turnaround market. A couple of years back you made a few acquisitions; Ohmstede, Performance, Redman. It seems like it brought in probably about $200 million of annual revenue from the refinery turnaround market. I know during the recession that number dipped, but where do we stand today on that? And where do we stand on the profitability of that business from the time you acquired it versus the trough? Are we back to the good days?

We are making much more progress through those good days. Look, let's talk about the business overall through the cycle. The business is bigger than you described. We can send everybody back to the December 2007 8-K that really will outline the business in detail. But look, this is a really good business, and an especially really good in a good cycle. You know, this is a business that can operate mid-teens, and it goes beyond just Ohmstede on an EBITDA margin basis. We are not back to those levels, yet. We need a little more volume, and we need a little more mix to get there. So the way to think about it is if [100%] was 2,008, and 2010 was 40% or 30%, we are making progress going from 30% or 40% to 100%, but we are not even -- we haven't even achieved a gentlemen's (Inaudible) there yet, Alex.

Perfect. And then lastly, the federal sector. There is a little bit of concern with regards to sequestration, the president claims it isn't going to happen, Congress clearly needs to act to make something happen, you have a little bit of exposure to the federal government as it reads to the DOD and construction activity. Can you comment on that, maybe try to quantify the percentage of your business that might have some exposure to sequestration, and what your customers are saying with regards to the outlook?

Based on what we know right now, we would have a de minimus impact from sequestration, because we are not in the program (Inaudible). We come out with an annual budget, second point is, for most of the business on the maintenance side, the government has been in break/fix mode for at least five years, and as our very seasoned gentleman that runs our government services said, once you get to break/fix, it is hard to go below that. On the construction side, these are funded projects, it would be hard to see how they would be part of the sequestration. Based on the advice we have gotten, most of it is going to happen on the program or product side.

Very helpful, thank you very much.

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

First I wanted to ask on your facilities services margin, which [I know there's some puts and takes in there], but let's just call it got back to roughly 5%. Why wouldn't that be a good run rate going forward, particularly considering that your site-based business in the quarter was still weak?

Well -- look. Is that our aspiration? I don't even know if it is that much of an aspiration, that is our expectation for that segment. However, when you perform like we have for the past year, I don't feel good about taking one mark on the report card, and saying that's now the trend. But if we can keep this mix and get improved performance from our site-based business, then we are certainly going to do better than we have in the first half of this year. And 5% is what we have been saying, and most people have us (Inaudible), and that may be a good caution to do anyway. Because I think you need to see a couple more prints on the tape until we feel good about it. But we certainly like the performance we had in third quarter and it is the right mix of work that went through there in the third quarter, also.

Okay, thanks for that. And then we have seen a lot of reports about increased chemical plant construction in the US, and I wonder if that's something that could help your -- the Ohmstede shop business, which you say is still a little bit weak.

No, actually, I didn't say that. I said the Ohmstede shop business has been good, the Ohmstede field business came back. The Ohmstede shop business has been good for at least a year, it's maybe weak compared to where it was -- it's not even weak compared to where it was in 2007. It's rebounding nicely. You (Inaudible), yes. The bill of materials for a heat exchanger in a chemical plan is a lot less than the bill of materials for heat exchangers in a refinery. That being said, our field service operations could operate those plants some day, and we have expanded Olmstead's ability to operate and do repairs beyond just refinery and they are servicing some chemical plants.

But for those plants to get up and running -- but a broader sense, Adam, any time technical labor is being absorbed, and a highly-skilled (Inaudible) labor, which is what will build those chemical plants and (Inaudible) that is a good day for EMCOR. Because as the demand for welders and pipe fitters and electricians and instrumentation technicians, as a demand for that increases, which it has in the last year now, there is still an unhealthy level of trade unemployment in the market. As those plans come on line, that's a good thing for EMCOR.

Okay. Well, Tony, congrats again. Thank you.

Your next question comes from the line of Wes Louskiwith Sidoti and company.

Hi, Rich.

Mark had mentioned a $3 million pretax reversal of the earn out. Can you confirm that that's USM, and whether it was in cost of sales or SG&A?

It was not USM, because there was no earn out arrangement pursuant to that transaction. And it is all of that amount is in the EFS segment, and it went through SG&A. It was a reduction of SG&A expense.

Great. The industrial backlog was the real mover in the quarter, really breaking out a range that it held for three years. How much of the industrial is in refineries versus anything else, and are refineries the area that really prompted the 3Q jump?

We had good revenue growth. From the refinery business, in 3Q, most of that work that prompted that revenue jump was not backlog driven. Our backlog up a little bit in the refinery business, that is broad-based. It is power, pharmaceutical, and food processing is really what caused the jump.

Okay, if I add up the share of backlog in commercial, industrial, and hotels, it is about half the pie versus just more than a third of the backlog a year ago. All else equal, should we not expect that change to push our your operating margin higher in 2013?

We've got to really get after the mix of work, because part of what happens when you do the bigger industrial work, your work as a prime contractor, and so we may get more of margin dollars, that the percentage maybe a little more, you are seeing some of that in our mechanical business year-to-date. It is good work, we like it. That's because [we're the] prime doesn't mean it has a lot more risk. When you pass through other subcontractors, which we typically don't do in our work, you have less ability to mark it up. That's a phenomenon we will be fighting as we go into next year. Look, key to us is to continue to improve in the EFS margins, which I said we have got to see more than one quarter on the tape before we believe that.

Okay, along similar vein, but looking maybe a little farther out, and in construction specifically, your combined electrical/mechanical margin, which I will call your construction business, if you look back to 2005 and 2007, when construction was great, it was between 4% and 6%, and in 2012 you are going to run between 5% and 6%, the upper half of that range. What's different between then is now, that you will be able to post these numbers in a poor construction economy, and does that mean we can expect EMCOR to exceed its former construction margins when the cycle eventually does grow stronger?

I am not sure about the -- the -- the latter comment on [exceed], but here is what I will tell you was happening in 2004 and 2006; we were having a hangover. We had taken a lot of bad work in the downturn, and man, it was painful working out of it. I think you are (Inaudible), it was slow on the uptick, because it is part of what you are seeing in the mechanical service business, now even though it is only a handful of jobs, it depresses margins for a while as you work through the jobs and get them completed.

On the construction side, we had more than our fair share of that. We like where this business is performing, now. Anything over 5% is really good performance. I think mix of work has helped, but also as mix of work as you take larger jobs and get more margin dollars, and sometimes you don't get as high of margin percentage, but it is really good work, it absorbs a lot of overhead and it is big numbers. (Inaudible), but that, to me, was --

Rich, the only thing -- this is Mark. The only thing I would add to Tony's comment, is also back in that historical period, we did have a number of subsidiaries that were not operating profitably, and those businesses have either been restructured or they have been removed from the portfolio. So they definitely had a downward pull on overall margins, and we aren't experiencing that to that extent in today's scenario. And certainly with the right economic mix, we would like to think that all of the businesses in that segment are going to perform at profitable levels, and at profitable levels no worse than where we are currently performing.

Lastly, just to be clear, you haven't seen any real increase in pricing in any specific market within the last year, have you?

No.

Great, thank you very much, I appreciate it.

No problem.

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

Tony, can you just expand a little bit more on a prior question on a facilities side. You gave a good recap of the puts and takes for the quarter and why margins where they were, but with USM basically break even now in a seasonally weak quarter, and a stronger seasonality for that business coming up, what should be the short term range that we should think about for margins and then, now that you have had that business for about a year now, what -- just remind us of what your outlook of the margin range going forward with things are firing on all cylinders?

We're behind where we thought we would be. I haven't backed off at all, but I think it won't be dilutive, [TFS margins] long-term, and we expect to operate EFS at 5% long-term. So both of those hold true. The caution you here from us is we weren't performing for a year, at least, where we thought we should be in EFS. So we are going to let more than one quarter run before we declare victory, and make sure that we can hold this mix, and make sure that clearly that the small project execution has gotten better and that we continue to see the improvement in USM we have. We tend to be cautious on that stuff, Rich -- Richard, and we are going to keep that style.

All right, but still, I mean it -- north of [5] here, and USM not even break even, the map suggests it should be.

It is a little under [5] when you correct for the earn out. Very strong quarter industrial. Which should happen in the fourth quarter, again. No visibility yet on the confirmed turnaround season for the first quarter, we need that to still be strong. We need a little bit of snow. Just last year we got none. And we need to continue to make sure that we don't overinvest in contracts in the front end of it, and keep the project mix where it should be, and we should be in good shape. We think we have made a giant step this quarter in seeing that. We need a couple more steps behind it to make sure we have done that.

All right, well I guess I'll just let you continue to be conservative.

[Laughter] Or you can badger me for the next ten minutes.

I should have known the answer. Okay, and then on -- with the healthcare business, you mentioned that maybe there was a pause in the market as people are looking for certainty on what is going to happen with the healthcare laws are there any other things that we should look at with the election coming up that if it went Democrat or Republican, that would potentially impact some of your end markets.

All right, Richard, I am not taking the bait.

I know, personal views aside.

I will tell you this, I can tell you what happened, not what my personal views are, or whether it was the right thing or wrong thing. When the 2008 election happened, EMCOR was teed up for a pretty significant increase in our government business. And why was that going to happen? It was going to happen because we had competed and won against the government on some substantial outsourced contracts, where the government would have saved substantial money, and it was very good business for EMCOR, and it wasn't a matter of union, nonunion or anything like that. We were going to bring some efficiency, because we had run facilities like this, and we were going to be able to not have peak work force there all the time, and we were going to be able to augment that with people we can bring in, and also through a different mix of craft because we had done it before.

An example is you don't need overly skilled chiller mechanics if you can call your local company and have the best chiller mechanics in the market come in and just do the task at hand, versus have them standing by for something that catastrophically could happen. We don't worry about that as much, because of who we are and the breadth we have. Well that level of work, which were three sizable contracts, and would have had a substantial impact on us, between November 2008 and February 2009, were eliminated. I learned a lot more about how the Senate can work, much more than I really cared to, on how individual senators can push their own agendas through individual blocks on funding, and we actually employed a lobbyist, and [Shelly] got a lot smarter than he ever did, politically, which is an upgrade, it happened, we really pursued this. So that was a negative.

I expect almost regardless of who wins, one will make it (Inaudible) than the other, the government will go back to realizing it can't employ people and overpay them for things that the private sector can do better. I think we will head that way regardless, and that you actually want, especially DOD employees that are in uniform doing these tasks that relate to war, fighting and protecting us, and not to some of the facilities and logistics that someone like us can handle better. I think the other thing that will open up for us, is regardless of who wins, I think we have a real chance here, a real chance to have an uptick in a rationalization of almost another round of rack. That will be good for us, we do work -- very well in that kind of work.

Now going to healthcare, look, we are all getting older. Laws like HIPAA, and -- which require privacy, and to go into a new hospital, you will notice everybody has an own individual room. The old hospitals can't handle the equipment. And so they are going to be updated, and we will be building new ones. We expect that to continue. There's a little pause here. There are some jobs on the boards. I am not sure they are being held up necessarily just because of the healthcare law, but I think people are making sure they get the design right, and able to have the healthcare facility of the future. I hope that answers your question and gives you a little flavor of who could happen.

Okay, and then any -- with the transportation, water, infrastructure, would there be any difference?

No. Anything -- we're positioned on are good thingsInfrastructure-wise we continue to compete. You know, those things can be episodic and then they last for a while. An example of that is the work we are doing with the New York DEP, those opportunities come up and then they last for five or six years, and we are well-positioned in the key markets to be able to take advantage of that work.

All right, thanks, that is all I have got.

Thank you, Rick.

Your next question comes from the line of Nick Thompson Research Group.

So, looking at industrial backlog up that [$280] million year-over-year, is that really just some big jobs and lumpiness in those sectors? I guess you mentioned power, pharmaceutical, and food processing, or is it not lumpiness, and that's the new run rate you are looking for and you are expecting industrial to be a bigger part, obviously in combination with the stuff that go straight through your backlog.

Well, industrial will be a bigger part because of the investments we have made over the last five years, and some of that you are seeing the fruitions of the investments we made. You know, by nature a project business is lumpy. Anything -- time you put a job in there over $15 million or $20 million, it creates lumpiness. This is more than a couple of jobs that made that happen. And so -- we have good sector diversity in our industrial business, and we invested -- and it is not only sector diversity, we have good geography -- geographic diversity. So yeah, it is something we like.

There are a couple of themes that we are big on. We like the fact that we service refineries in the gulf coast of California and some of the mid-continent. We like the fact that we have power plant maintenance capability in the southeast. We like the fact that we have design build capability of food processing plants. We like the fact that we are well positioned in the southeast, and that we think there will be a reshoring of some manufacturing as it comes back from overseas, it is more cost-competitive here. We like the fact that cheap natural gas is going to happen, and it is going to support really competitive large process industries like paper, pulp, steel and others, where we are mining and we are positioned to help them do maintenance and some construction. It was something we have been building for a while now, and it is something that we will continue to build on, and we like the flexibility that we have to service the industrial market.

Okay that's helpful. And then a follow up. I heard you saying in your opening remarks that hot weather wasn't a big impact in Q3 2012. Can you add a little bit of color there? Were there more or less cooling days this year than last, is there any -- any other ways to think about why there wasn't a big impact?

I think they were up some. I think it tailed off towards the end of the year pretty substantially. You looks at it overall, maybe it is worth $0.01 to $0.015 to us, something like that. That's a lot of technician hours, but what didn't happen is we didn't have a lot of equipment replacement, and that's consistent with what you heard I think from the OEMs over the last couple of weeks.

Yeah. Okay, and then just one last question, thinking about the trend towards more private sector work, is that benefiting your margins right now at all? Are you getting kind of incremental margin on those jobs through efficiency, or speed, or everybody the private guys being a little more tight on their spending?

Well, everybody is tighter than they were in 2006 and 2007, because you had -- when you have trade unemployment that is still as high as it is, and it can be north of 15% o 20% in some markets, you aren't going to get the pricing you could. That being said, it is nowhere bad as it was in 2009 and 2010.

All right, well, thanks that's helpful.

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

Good morning, John.

Good morning. Tony, just going back to your comments when you talked about the backlog patterns over the last, I guess, six years. And if we were to look at this chart going out, and thinking about these markets over the next two years, is it the commercial industrial markets that could have the opportunity to substantially be the drivers this cycle? Then as a follow up on that, do you have to do anything structurally, either acquisitions, expansions, to position yourself to take advantage of that?

I think we should expect stability, maybe a little (Inaudible), but probably stability for the most part, because we are growing on the maintenance side, instit -- in the institutional. Let me talk top down. I think transportation, water, and water waste are what they have always been. They are going to come up and down, and we may win a big job, and that will (Inaudible) us through the numbers over three to five years. I think institutional is a little more stable than it is for a lot of people because we have a pretty heavy maintenance base in there. Healthcare, I would expect it maybe a year from now, a year and a half from now start to expand a little bit again. So you go to your question, John, do I expect industrial and commercial to be more of a driver? Commercial is always a driver of our business in a good cycle. Compared to other cycles, industrial will be more of a driver this time than it has been in the past.

As far as acquisitions. When I think of acquisitions, I always think -- we have six great places we can still invest at EMCOR. We will always make a good electrical and mechanical construction acquisition. Way are good at it, there are people that we are the preferred buyer with, we can make a fair deal on both sides, and we still have some geographic white space where we would like to put a big contractor in place to do mechanical or electrical construction (Inaudible) market.

On the industrial side which, is for the most, part resides in our mechanical segment, the construction side, we will continue to look down there. You saw Southern, you saw Brahnson, we will continue to look [down] there. Electrically, I think it is the same story as what we are talking about on the mechanical side. We still have some white space to fill in. As you move to the right you think of the business units that make up the facilities segment and they are all -- have basically the same thing; they work for directly for owners, 80% of the time, they have a base contract for the most part where they keep in contact with those owners, and they do project work on top of that.

And if you look at those businesses, we have the site-based business where USM is, there is not a whole lot more acquisition we would need to make there any time soon. We need to grow organically from where we are today, and continue to integrate and start to see the kind of success of rate of improvement we saw in the third quarter. I don't want to call it necessarily success, yet. It is a rate of improvement we like to see. As go out and you look at the government business, we would look to buy capability, there. We don't need to do anything (Inaudible), but buying capability will allow us to expand the scope of the work that we would bid. So, logistical services, a cleaning services for healthcare, and a -- a medical facilities would be something we would look at. We will always look to build our higher margin, intelligence work there.

Going out further mechanical service, I think it is the same comment as I had on electrical mechanical. We still have a little bit of white space on the map that we would fill in by buying a significant mechanical service contractor. And finally industrial, we would always look to add industrial service contractors, an example of something that happened, we didn't buy a company, but we had looked for a while, did we need to add cleaning capability, for the bundles and Ohmstede, we thought about -- we did a make versus buy analysis, essentially, and we added the best cleaning stand in the ship channel, and we expect that to really pay off going into the next turnaround season next year. So that's how we think about acquisition. We don't really need to step out and do anything crazy, but we have nice businesses we can grow and invest in organically, and through acquisition.

And just on the USM business. When you acquired that business, and sort of the expectations there, I can't remember I have to go back to the slides, but I believe it was in kind of the mid-single digit margin expectations on that business.

Yes.

So if it's running at break even now, how far away are we from getting back to those levels? Is that something we will see in 2014-2015, or do you think it is going to happen sooner.

We need to make some progress to get there, right, so it needs to happen sooner. I think your time line is about right to get to the full run rate.

Okay.

We need to get to a season where we have normal weather, before we feel comfortable commenting on it. Because we got our teeth kicked in last year on some of our assumptions on the weather and its impact.

Okay, but relative to your earlier comments about the aspirations or expectations. But it should be higher than the 5% if that just starts contributing.

It could. Again, we need to put more than one grade on the report card.

Okay.

[Shelly] made an A one time in math, but that doesn't -- (Multiple Speakers) Then he went into law.

He loves to correct my writing all the time, so he must have done pretty well in English.

Thank you.

Your next question comes from the line of Noelle Dilts with Stifel Nicolaus

Hi, good morning. Thank you for taking my call. I missed a little bit of the call, because of technical difficulties, so I apologize for this has been asked. On USM, can you speak a little bit to the business development side. I know you had two large contract wins early in the year. Have their been any additional wins, and then how is the pipeline looking on that side?

It actually is better than winning two large contract wins.

What we really wanted to do was stem the loss of customers and improve the renewal rate and we can put a check mark there. The guys I work with are never happy until you get to 90% plus, we are not there yet, but we are certainly a lot better than we were. So that's -- that was more important even than the contract wins were. Second thing was can you add existing sites and grow with your existing customer base? Again, that's the lowest risk way to grow and can you add additional services. So what we are starting to say, is if we had a customer we were doing 400 sites and we started to add 40, 50 sites a quarter to them, that's the best way to grow in the business, and we are starting to see real progress there. Our (Inaudible) management has gotten better. We have made a couple of key hires, and (Inaudible) some internal folks, you know we -- it's amazing, you get into a business that you didn't own, and maybe it was struggling, you start to learn the people that really want to step up and work with you for the long-term, and so some people have seen their horizons expanded, and they have responded in a outstanding manner.

And finally, we are starting to do a much better job of linking our procurement side, which is critically important to what we promised the customer, and make sure that we are sourcing appropriately to the margin expectations that we have for that account. So business development has not only improved from new customer acquisition, but more importantly from customer retention and customer penetration perspective.

Okay, great, that's really helpful. Secondly, on Ohmstede, in the first quarter you talked about deferrals of work -- I know some of that came into the second quarter -- but can you comment on the third quarter strength, and if -- if some of that reflected a performance of pent up demand, or if you think this is a sustainable level that can improve from here?

You always have to be careful as anything in this economy, (Inaudible), it is going to sustain from here on out --

That's true.

Because customers have shown the ability to make decisions. That's why you hear the caution in our voices. You can say in some ways we are like a battered child as a service provider. People have -- people have made promises to us and they haven't kept them. And then we react to them. And so we don't believe everything, we don't staff the full way up now, until we see the demand, and we want to make sure we keep our best technical capability onboard. All of that being said, we are very, very optimistic about our technical capability, and the the product offering that we have that we have expanded with the exception of this wash stand. And we have shown in the third quarter, when customers need us to respond, and other people can't respond, that Ohmstede and EMCOR, and EMCOR Services and EMCOR Construction Services have the ability to respond to that demand.

Okay. And the UK business, you know, you have de-emphasized the construction part of that business. Is there another like down here, where you largely complete with that downsizing, and can you just comment on where you see run rate UK revenues leveling out?

I think the revenue run rate you are getting close to. I think the mix we are going to continue to push more towards services. As we push the mix more towards services, we should start seeing the margin uplift that we expect.

This business, actually, is probably had its best two or three years sustained. But that team has higher aspirations for itself, and we have higher aspirations for them.

Okay, great, thanks a lot.

Your next question comes from the line of cig bar fa reek with key bank.

Good morning. Well, congrats on a first quarter, first of all.

Thank you.

A lot of questions have been answered, I know USM has been beaten down with questions. So you know, Tony, what really surprised you in the quarter? What surprised, overall, from what you were thinking three months ago on the earnings call, or six months ago, what changed in the last three to six months that makes you more positive on the future?

What makes me more positive for sure for the rest of the year. What makes me more positive for the rest of the year, one is we have performance to date that is pretty good. Good, strong organic growth, good drop through, SG&A under control. Which is -- we don't usually have a big problem with that, but we are actually performing -- any time we can be in the mid eight's, we are doing pretty good -- on SG&A. Backlog composition, is over 50%, private we like. What surprised me in the quarter is the level of work we did in our industrial field business. We knew we were going to do more this year than we did last year, but I think our performance of the folks in the field, had the customer even give us more than they would to other contractors. We responded, and when you respond your customer responds.

I think what surprised me and I think it surprised Mark, and also -- and Kevin, is the synergies really started to take hold in USM and you saw it on the cost side. So what we said we saw happening and we said this is what was going to happen, we started to see that really start to happen. I think we continue to see on the government side good strength, where we can help the customers keep their facilities running in a break/fix mode that they have been at. And then we continue to win important new customers. So we go to the surprise end, I'd say pretty simply, less impact from the heat, more impact from industrial, more follow through on synergies and we really did turn around those contracts like we thought we would from the first half.

Great. And then to follow up on your cash allocation, I know you guys have around $48 million or so remaining in share buy backs. You have the dividend plays I know you talked -- you answered John's question with a detailed answer with what you are thinking on that, because everybody can look at acquisitions, what -- just answering the question more broadly, and looking as those three aspects dividends, shared buybacks, acquisitions -- where would you focus your -- or where is management and the board focusing their priority right now?

Look, the priority is always just to create value, right? You create value a number of different ways. The best thing you can always do is to invest in working capital and marginal amount of CAPEX that we put in this business that look for opportunities to make yourself and restructuring to make yourself more efficient, to give your folks better things to work with, to give them other arrows in their quiver are always the best things to do on an organic basis. To add the right resources to grow your business organically, that's always the best thing to do. Second best is to build new capabilities through acquisition, or to augment what you already have, and we talked about that. So they would be always the first two priorities, and always sticking to what we know how to do. Then -- then you have to say okay, if I have cash, and I'm not going to need it for the first two any time in the near time horizon, do we buy back shares, or do we have a dividend, we have both now. And we have made good progress on the buy back, for a class of our shareholders that will never be enough, but I think the world is littered with people that buy back shares at the wrong time, and we are a mid-size cap company, and we tend to be careful with that.

And on the dividends side, we have a dividend now, and that's a big step for us, and we let it run here for the next year and we will see where we stand and what the board thinks as time progresses. Put it all together, we have a good capital allocation strategy. Let's be clear, this business should never be run at high leverage, that's just not what it is. Even on a good day, mid-single digit margins, you don't lever up. And we do need $200 million to $250 million on our balance sheet to respond to working capital, and of course, we are big users of surety credit. And you know, the surety likes to see that cash sitting there, and we are one of the best surety credits out there, and it is a stretch for us to never have to worry about whether we have to bond a job. So put all that together, you have to do all of it, Saagar.

Okay, and then one last question for Mark. Mark, for USM, how money of the intangible expenses roll off in 2013 from 2012.

The change in annual amortization as a reduction of about $4.5 million for calendar 2013.

All right, perfect, thank you very much.

You're welcome.

We have no further questions at this time, I would like to turn the call back over to management for any closing remarks.

Thank you, Melissa. Hey, look, appreciate you all getting on the call this morning. Pretty good quarter, we have got a lot of work to do. I just -- tough for everybody all the time. Anybody that says they have great visibility in the environment we are working in right now, either knows something that we don't know -- you are either one of two things if you have great visibility, you are either working with something with tremendous backlog, that has great program characteristics to it, or you just prefer to talk about things you don't know anything about. We don't fall in either one of those categories, so we'll stick to what we know, cooperate well, be flexible and show our ability to move between different markets. I thank you for your interest in EMCOR, and hope everybody has a safe day. Bye.

This concludes today's teleconference, you may now disconnect.