Comfort Systems USA Inc (FIX) 2003 Q3 法說會逐字稿

Good morning, and welcome to be Comfort Systems third quarter conference call. (OPERATOR INSTRUCTIONS) This conference is being recorded for instant replay. And I would now like to introduce your host for today's conference, Mr. Gordy Beittenmiller, Chief Financial Officer. Sir, you may began.

Good morning everyone, and welcome to our third quarter earnings conference call. At the start here we want to remind everyone that our comments this morning, as well as what we issued in our press release, contain forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. What we say is based on the current plans and expectations of Comfort Systems USA. Those plans and expectations involve risks and uncertainties that could cause actual future activities (technical difficulty) results of our operations to be materially different from what we set forth in our comments. A more extended list of specific risks is detailed in our 10-K, our 10-Q, and our press release.

On the call this morning are Bill Murdy, our Chairman and CEO, and Norm Chambers, our President and Chief Operating Officer. Bill is going to open our remarks.

Thanks, Gordy. Good morning everyone, and thank you for participating in our call. This quarter was another quarter of steady progress for Comfort Systems. We posted improving results and comparisons, as the commercial industrial construction services sector showed more signs of a turn. While industry activity levels are still restrained, our same-store revenues, excluding a small division that we sold this quarter, were actually up 1.3 percent year-over-year. And on the operating income line, excluding modest restructuring charge, our operating margins were virtually unchanged year-over-year at 3.5 percent. Profit levels were up noticeably on a sequential basis for the second straight quarter.

Diligent cost containment in a very tough industry environment paced our profit performance. Our gross margins were down year-over-year, and sequentially as we continue to see broad lower pricing. Additionally some, a few underperforming operations also held back our aggregate gross margins this quarter, but to a lesser extent than in previous quarters. Offsetting this aggregate gross margin decline we decreased SG&A 3.4 percent sequentially, and a very substantial 11.4 percent year-over-year. While these overall income statement results really didn't meet our internal goals yet, we do believe they reflect very reasonable performance in an environment that continues to be challenging.

Our cash flow and working capital efficiency took a bit of a step back this quarter. But that was not entirely unexpected due to the normal seasonal surge of activity in the third quarter, and as it followed on the heels of two exceptionally strong cash flow quarters. Nonetheless, we aren't completely satisfied here and intend to maintain a steady focus on cash flow and capital efficiency to continue our excellent overall performance in this area.

Elsewhere on the balance sheet, we're in the process of refinancing our modest debt to provide for a more supportive credit facility. Our current facility reflects the particularly restrictive terms that were prevalent in last year's very tight credit market. Our refinancing is going well, and we expect to complete that this quarter.

Turning to the industry more generally, it is certainly a little too early to declare a return to robust activity; however, more and more positive indicators are appearing. First, favorable macroeconomic indicators seem to be outnumbering the unfavorable ones lately. And the noticeable uptick in business investment is particularly of interest to us, as this is generally a prerequisite, along with job creation, for increased facility spending. More specifically, to our industry sector, facilities construction show a bottoming pattern from June through August before registering a modest gain in September.

S. W. Dodge (ph) who is the most widely recognized industry forecaster recently reiterated its expectation of increased activity in 2004 in every major building sector in which we participate, except education, and in every region of the country. Dodge, also by the way, forecast even stronger growth in '05 '06.

Elsewhere shipments of commercial HVAC equipment showed year-over-year increases in three of the last four months, with only a slight decrease in September. And the major manufacturers in our industry also noted positive order and shipment trends, and reiterated their views that the deferral of HVAC maintenance and replacement activity over the past couple of years is generating pent-up demand that should be realized in the not too distant future.

Looking to that future, we continue to observe full year '03 results and net income from operations, excluding restructuring and non-recurring items, will be comparable with '02 in a difficult environment. And with an improving industry environment and steady progress on improving our operations, we continue to expect that our '04 results will be significantly better than our '03 results.

I would like to turn at this point to Norm Chambers, our President and Chief Operating Officer, to make some further comments on our operations.

Thanks, Bill. Good morning everyone. From an operations standpoint, this was clearly a quarter of progress, with 90 steps forward and only a few steps backward. We posted a same-store revenue gain, even though the industry is not quite out of its long slump. We increased operating margins sequentially, and held them steady year-over-year in a market that is still quite challenging for a number our regions.

This is due in no small part to the strenuous cost containment efforts we undertook earlier in the year and told you about. We added to our national account sites this quarter. And once again, I am very pleased to say improved our superb safety record.

In the step back column, we had a few operations perform below standard, although notably fewer this quarter. And as Bill noted, we did not turn our working capital as efficiently this quarter as we should have. All in all, though, a solid progress in the quarter.

Looking across our operations, our East and Southeast regions led the way with solid revenue gains in double-digit income increases. In Washington D.C. a noticeable amount of our record backlog began to turn through the income statement this quarter. In the Southeast we benefited from a substantial improvement in year-over-year income at our Birmingham and Atlanta units. Our South region also posted income increases driven by our Houston commercial operations and improvement in our central Florida results.

Our Midwest and West regions continue to work through some difficult challenges. Excluding an operation we sold, Midwest revenues were flat, but income was off due to some uncharacteristically substandard project management at one of our better operations. In the West, revenues were also flat, but income was down significantly, as a high level of activity in Phoenix yielded some labor efficiency problems, and as we encountered poor management in oversight in our western Colorado operations. We firmly believe that each of these shortfalls are temporary, and will be reversed in 2004.

Our controls group posted a respectable quarter led by substantial year-over-year improvement in our Boston operations, as they turned around their results following a difficult stretch in '02 and early '03.

Summing up our operations, there is no doubt that the general market conditions continue to be challenging this quarter. However, quite a few of our operations prevailed over these conditions, while our performance was also held back by numerous situations within our control.

The highlights -- the importance of local and regional operating leadership, and the ongoing need to ensure we have the best team we can field, management changes and consolidation in our western Colorado operations, and in regional leadership resulted from this process.

We also expanded the role of one of our best leaders in this quarter -- field leaders. Tom Tanner works in our East region as our East Region Vice President, and has contributed some impressive results in a very tough industry environment. He will step into the Senior Vice President of Operations role for the Company, emphasizing job loop execution and best practices training. With over 25 years of industry financial and operating experience, we think, Tom will make an even greater contribution to Comfort Systems at this level.

From an execution standpoint, we continue to expand our job group service and productivity disciplines. We spent significant time on these key areas with the majority of our operations this year. And will continue to expand and embed this process into our operating culture of our Company. As our improvements take root in our project and service cycle, from sales, estimating, contract structure through project management, we expect to see steadily growing impact in our result in 2004.

Our operations are also the frontline of our capital management. They have posted an excellent record of cash flow and working capital progress over the last couple of years. We slipped back a peg or two in this area during our busy third quarter, following two quarters of very good performance. We expect to resume our forward track in the fourth quarter and 2004.

Our national accounts team continues to build its base. Even though the quarter's results came in lower than last year, we entered the fourth quarter with more sites under management, a more talented team, continuing evidence of differentiation and acceptance of our offering in the marketplace. We expect a solid contribution to our growth from national accounts next year.

It seems like a quarter does not go by without Comfort Systems posting another safety record. Now we don't take this for granted. And it is through a lot of hard work, but our OSHA recordable rate reached a new low at almost 60 percent below the industry average. SI Goldman (ph) in Orlando, one of our largest operations, and one that does relatively complex work, has now gone more than 1.25 million man hours without a loss time accident. We are very pleased about that. Our Company manages our regional safety teams, and our Company leadership, under Andy Estrada, all share in this impressive record.

As we move forward into 2004, we have a steadily building sense of optimism. There are more and more signs that our industry is emerging from one of the longest recessions it has seen in recent memory. With every quarter we strengthen our field operating team with our day in day out work on execution and cost containment in our '04 planning. We believe we're better prepared for a new year than we have been in years. We look forward to delivering improved results in 2004.

Gordy will now take us through some of the financial information.

Thanks, Norm. As Bill and Norm have noted, our third quarter saw industry activity levels that continued to hover at historically low levels, at least without further trending downward. Nonetheless, we reported our best revenue comparisons in two and a half years with a decline of less than won percent on an as-reported basis, and an increase of 1.3 percent on a same-store basis.

This increase was driven by strong activity levels at our operations in Washington D.C. Phoenix, Jackson, Tennessee, and San Diego, offset to a lesser degree by declines in any of these operations we're scaling back, by what we believe it is a temporary decrease in revenue in our international accounts operations, and by a decline in our Salt Lake City operations.

Our backlog stood at 442 million at September 30th, down 3.2 percent sequentially. This is consistent with normal seasonal burn off in the third quarter. Excluding the effect of a $16 million project that we removed in backlog in the fourth quarter of last year, year-over-year backlog decreased 1.4 percent. That decrease is within normal quarter to quarter and seasonal ranges of variation. 89 percent of our backlog is scheduled to perform in the next twelve months. This remains at the higher end of our historical patterns.

Looking at sectors, our book of business remains well diversified. The institutional sectors of healthcare, government and education increased from 33 percent last quarter to 36 percent of our revenues this quarter, while office buildings declined from 12 percent to 10 percent. 15 percent of our business was in manufacturing. Multi-family and retail comprised 11 percent each, with the balance spread among smaller miscellaneous sectors. Our backlog in quotation pipeline indicate we should begin to see a bit more activity in office buildings in coming periods.

Our gross profit declined 170 basis points as compared to last year's third quarter. This decrease resulted from lower industry activity levels and increased price competition, and from moderate execution shortfalls in three of our operations, offset to a lesser degree by improved efficiency at two of our operations.

One of the operation with shortfalls this quarter is being combined with another unit. That is our western Colorado operations referred to earlier. The other two shortfall operations are stronger operations at which such shortfalls are expected to be temporary.

Consistent with our expectations of improving activity, we do see signs that pricing may be bottoming out. Our quotation pipeline and sentiment surveys indicate no further deterioration in pricing expectations. And gross margin and backlog is 50 basis points higher than the same measure was at June 30th.

Turning to SG&A, we posted declines of 3.4 percent sequentially and 11.4 percent year-over-year. These decreases came from downsizing our energy efficiency initiative, consolidations of certain field operations, reductions in our corporate office, and in reduced bonus expense. Our cost containment efforts enabled us to offset gross margin pressure and hold our operating margins essentially flat year-over-year at 3.5 percent, excluding restructuring.

As we suggested last quarter, we reported restructuring charges of just under 1 million this quarter. These charges relate to steps we took in the first quarter of this year to downsize our energy efficiency initiative and to revitalize our national accounts strategy. This quarter's charge is primarily related to facility lease obligations that are now not necessary to support our operations. We do not expect any more significant charges relating to these restructuring steps.

During the third quarter we committed to a plan to divest an operating company, a relatively small unit in the Southeast. In connection with this plan, we recorded an estimated loss of 2.8 million, including taxes, on the discontinued operations line. The loss results entirely from the non-cash write-off of goodwill.

Our year-to-date effective tax rate increased to 49 percent this quarter, just higher than last year's 47 percent rate. These effective rates are higher than statutory rates because of the effect of certain expenses that we incur that are not deductible for tax purposes, and due to reserves that we have established in connection with the possibility that we will not be able to ultimately realize the tax benefit for certain losses we have incurred, primarily at the state income tax level.

In addition, since our current pretax profit margins are relatively low on a historical and an absolute basis, the impact of nondeductible expenses and reserves on our effective rate is magnified. We expect to realize lower tax rates in 2004.

As both Bill and Norm noted, we have posted negative free cash flow this quarter. The amount was $6.9 million, resulting primarily from slightly slower working capital turns. Year-to-date, we are generating positive free cash flow of 13.2 million, as compared to last year's year-to-date amount of 11.1 million. We expect to generate positive cash flow in the fourth quarter, and continue our strong historical record of cash flow in 2004.

Our debt levels remain modest, and our balance sheet and capital structure remains solid. Despite this, we actually had a covenant violation under our current credit agreement this quarter. This resulted in large part from very restrictive terms in our current facility that originated in last year's much tighter credit markets. This violation has been waived by our lenders.

As Bill mentioned, we are currently working on refinancing our senior lending facility to obtain more flexible terms and additional borrowing capacity. Our objective is a new facility of at least $45 million. We currently have commitments from both new and existing lenders for 40 million of this amount, and expect to reach our objective very shortly.

These commitments are subject to customary closing conditions that we expect to meet. And we expect the new facility will close in the fourth quarter. When it closes, we will write-off deferred financing costs and discounts associated with our current facility in a non-cash charge. This amount is expected to be no more than $4.7 million pretax, or approximately 8 cents a share. We expect the new facility to be a significant step forward for the Company, as it will provide us with noticeably more financial and operational flexibility.

With that we are concluding our prepared remarks. And, Janna (ph), we would like to open up the call to questions.

(OPERATOR INSTRUCTIONS) (technical difficulty)

-- total non-recurring type charges you are expecting in the fourth quarter. I know you just identified the 4.7 million that could run through your P&L. Are there any others in the fourth quarter? And then looking out into 2004 do you anticipate any of those?

Alex, the first portion of your question cut off. But I believe what you asked is, in addition to the 4.7 of potential write-off of financing costs, do we expect any other non-recurring or restructuring charges in Q4 or in 2004? And the answer to that is, we do not expect any other non-recurring items in fourth quarter or in 2004.

And based upon your backlog today, I noticed you didn't mention margins within your backlog are about 50 basis points higher sequentially. Does that suggest that your gross margins in the fourth quarter should start to show some sequential improvement? And in addition, should we start to think about modeling in 2004 gross margins improving about 50 basis points year-over-year?

Well, I will make a couple of comments on gross margin and backlog. Gross margin and backlog is a general indicator and not a definitive indicator. When a project goes into, or a service agreement goes into backlog, it does in at an estimated gross margin. And obviously things can change over the course of a project, change orders, both positive and sometimes negative. And at the other end of the process, ultimately realized gross profit can be different than what goes into backlog.

Now having sort of caveated it that way, we generally do realize gross profit results that are reasonably consistent with the way projects do go into our backlog. Now given that not all of our revenues turn through backlog, given that a good 40 percent of our activity is short-term projects, service agreements that happen within a quarter, if the pricing environment is still tough in the fourth quarter we won't automatically see an increase in gross margins in the fourth quarter.

Given our broad expectations, I think it is reasonable to model somewhat higher gross margins next year, but we do not, as you now, given specific or point guidance. I hope that answers your question, Alex.

Yes, it does. And one last question with regard to the third quarter. Where there any abnormal weather conditions in any parts of the country that either helped or hurt the third quarter results, or was it a typical looking quarter?

It was a fairly typical looking quarter. I can't say that we are aren't effect by weather, because we have in the past. But we certainly don't manage as if we are affected by weather. We try to overcome and kind of steady-state through whatever the weather conditions are.

David Yuschak from Sanders Morris Harris.

Congratulations again, gentlemen, on the quarter. Let me just ask a little bit about the same-store number that you produced in the quarter. I think it was 1.2, 1.3. Could you just maybe expand upon that a little bit? Given year-over-year sales were down, does that reflect discontinued operations, or can you just maybe tell us where some of the strengths were that you were seeing? Because I think as you indicated the press release, this was your first same-store sales gain in maybe two and half years, or is that not right?

That is right. And this is one of those situations where the accounting rules require fairly fine distinctions. We have sold an operation in the Midwest, a moderate sized operation, more moderate to small. And the configuration of that operation identified it as more of a division rather than -- of existing activities in the area rather than a freestanding unit. Accordingly, it did not qualify for discontinued operations accounting treatment. So the removal of that operation just comes out of our regular results. As a practical matter, to understand clearly what is going on, there is the removal of the revenues associated with that operation as a result of it being sold.

So once you exclude those revenues, we call the result same-store, and same-store is up 1.3 percent. We are doing well in Washington D.C., and we have -- we have built a strong backlog there with a particular strength in health-care. And this quarter that backlog really began to turn through for us. That certainly helped the revenue line. Activity levels were also strong in San Diego. In Phoenix, although we ran into some labor efficiency problems in Phoenix, And in our operation based in Jackson, Tennessee, which does more industrially oriented work, and also which travels a little bit more. Some good gains in those four principal areas on the revenue line.

In general, then the other parts of your operation then would you suggest there are just kind of holding their own from a same-store sales basis then?

Well, yes, but that is no small thing in this environment, Dave. Even though there are what appeared to be a lot of silver linings out there heading our way, it is still was a challenging operating environment, a challenging market environment in this quarter. In the rest of our operations, you had some ups, and you had some downs. And, as Norm mentioned, we did -- some of our operations prevailed quite nicely, but the rest of the population of our operations largely held their own in a very difficult environment.

Let's go to the gross margin again too, just to follow-up with that a bit. You had indicated in your prior conference calls to the same kind of optimistic look at the backlog from a gross margin point of view. From I hear what you're saying, it is again putting it in the backlog and then executing on it. Is that what maybe the shortfall came in, is that backlog was there at the margins you expected, but some of these execution issues were more relevant in the quarter (multiple speakers) previous quarter?

That was the factor for this quarter in gross margin. I think we had said that in our Phoenix operations, which are operating at full capacity, if not a little bit beyond full capacity, that is proving to be a challenging labor efficiency environment. But we've got a great team in Phoenix whom we expect will bring margins up in the relatively near future on a very strong base of activity.

We also mentioned that we had another operation in the Midwest that has historically quarter in, quarter out been a very solid performer for us, who took a stumble this quarter, not a significant one. And we expect that they will bounce back in their results very quickly as well.

We were disappointed in our operations in western Colorado. That was the third factor that contributed this quarter to a decline in gross margin. We have changed management both at that operation and regionally. And then that operation has been combined with one of our strongest operations, who is actually very positive about taking over the western Colorado market, and has already booked 2 to $3 million of new well-priced backlog. So we did have a few trips this quarter, nothing significant that we can't turn around in relatively short order.

Let me go to just the (technical difficulty) the business, the small task and so forth. What did debt look like in the quarter?

We actually sought a somewhat of an increase in our smaller sized and quicker turn business this quarter. I would not say it is a major swing, but it was a clear increase. And the way we measure that, for example, is when you look at the amount of our work in our total backlog that is project sized $1 million or higher versus project sized $1 million or lower, the project sized $1 million or lower increased their proportion of the backlog several points this quarter.

That correlates both with a greater amount of faster turn work, as well as a little bit better project diversification. We can't cut it any finer than that at this moment, you know, out into regions or sectors or things like that, but we did see that data move in a somewhat positive direction this quarter.

One last question. Energy, Bill, there are some discussions about putting some incentives into play that could create some tax advantages for commercial industrial and so forth to make buildings a little more energy-efficient, which would tie nicely into the underspending that has been going on.

What kind of feedback are you hearing in lobby groups so forth and so on about the potential of that happening, being very specifically focused on this area that could help you guys?

Dade, we have actually looked into that. And in the current energy bill, which is stuck in the Congress and is very likely not to be acted on, there isn't anything significant. There are some things in some tax legislation that might benefit the industry. But we don't see anything specific that is aimed at HVAC, or that could be used by HVAC equipment installation, service, etc., even if it related to energy efficiency in either the energy bill or the tax legislation that we have seen.

The various industry associations are, of course, interested in that, and that has been a long-time interest. There are savings to be garnered by retrofitting HVAC, as we know. But I think those settings are significant enough as a driver without tax benefits that they may happen anyway. And there is certainly, as we have mentioned, that the pent-up demand out there on the deferred maintenance side, for doing a lot of that in the HVAC area. But there is no -- as we can tell, nothing of specific -- of a specific nature in either the tax or the energy legislation.

Alan Weber, Robotie (ph) Company.

How many operating subsidiaries do you have now?

Slightly more than 50.

50? And so in each quarter you're going to have some that do a little better than you thought, or a little worse? That is just kind of the norm. But I was wondering, even with that, in the quarter anyway to guess or estimate the amount of lower earnings or additional costs to some of the areas that you thought performed less than you would expect, or you think are really going to be corrected quickly? What that impact would've been?

Well, as a little dangerous to get into, but here's how I would respond to that. You're right. With 50 plus operating units, you're going to have some do better than you expect, and some do not as well as you expect. In this difficult industry environment you generally see a little bit more on the downside than you will on the upside.

We have steadily improved that ratio each quarter, and it was noticeably better this quarter than last quarter. I will say that the operations that performed substandard, or had variance to expectations, did so to the extent of low 7 digits at the operating income, or EBITDA line.

Now I will hasten to add that you shouldn't add some low 7 digit number automatically to estimates or models for upcoming quarters. So that is not a prediction that we will wipe out negative surprises altogether beginning with this quarter. But we're making steady progress. We do not expect to do have -- I should say it is our goal, and we think is achievable, not to have any loss operations. We will have people that are always somewhat off the standard, but we're steadily improving our execution and in our variations. So that is what I would say in response, Alan.

Just another word on it as well. One of the key areas that we, our operating companies, our regional Vice President see as having significant impact in our performance is the whole notion of job loop and productivity piece. We really have begun to see this taking hold. We know that our operational organizations are keen to improve. They have demonstrated this in the safety department. And we are absolutely certain that with the amount of time and energy that we going to invest in this thing, that we will see some positive results.

And we expect to get a return on that time and investment during 2004. So I think as you go forward, and if we deliver on what I'm saying we're committed to, then you'll start to see it drop out quarter on quarter.

I'd like to add one other structural thing here too. It is very important to notice that with the disposition of the assets, i.e., 19 operations we made last year, our averaged project size has reduced very substantially. Those companies had project that were very large. We right now have over 4,000 projects ongoing, a little over 200,000 on those projects, the length three months.

And that is a portfolio that provides you less opportunity to make a big mistake than one with projects where we had an average size 18 months ago of 400,000, and had some very large projects. So that is a structural thing that you can just do the math on, that will reduce the probability that the large mistakes, or mistakes at all, will hurt us.

And just two follow up questions. On the national accounts side, you said it was a little bit lower in the third quarter, and you seemed somewhat optimistic. Can you just kind of run through what you're doing, and other than just the industry, or is that the reason for the optimism?

I would be happy to. One of the things that we saw coming out of last year was a change in Kmart's contracting philosophy as they came out of bankruptcy. And we had performed a fair amount of work for them through our previously structured national accounts approach.

Now that all but went away during the course of this year. And we were able to largely replace a good deal of that during the course of this year. But we have a value proposition that includes the controls piece, and it includes monitoring of facilities, call center dispatch, preventative maintenance and retrofit and repair. And we're clearly getting traction with the addition of some than 2,000 additional sites that we now have under contract since the last time we had this analyst call.

And we had a salesforce and an operational team there that is scalable. And that provides us with a firm belief that over the next couple of years, this will turn out to be a substantial piece of our business, and a substantial piece of our growth. What we like about it is that it complements our local operations. What we like about it is that it provides an offering to those multistate, multiregion customers who wish to outsource all or part of their HVAC services. When we combine that with controls and monitoring, it really is a value proposition that resonates very powerfully from our competitors.

What is roughly the revenues of the national accounts in aggregate?

National accounts in aggregate will be something less than $30 million this year. And we are expecting, as I say, growth -- considerable growth in 2004 on both the top line and the bottom line.

You made a comment to 2,000 sites. Is that like subcontracted work that you have like with subcontracted -- that you can do? Is that what that is?

Right. Those are sites that are owned by retailer's that have contracted us to provide maintenance or maintenance and repair on a regular basis. The obvious attraction at work is that to the extent that we can continue to provide a service that a customer sees value from, then we are there to participate in the cases where retrofit of equipment, and the whole notion of the lifecycle equipment, needs to be repaired and fixed. And that is a good place for us to be.

In this 2,000 sites, you can do that with your internal -- is some of that subcontracted out?

So that it is subcontracted, but our model is increasingly self performance. And self performance is absolutely critical to us. We have reduced the number of associate companies that we work through and limited that to improve our quality control. And we will always have some, but the model calls for continued and increased self performance over the next couple of years.

Two other questions, if you don't mind. One was on the refinancing. I think you said it was going to be -- you-all can get a $45 million facility. Is part of that now (technical difficulty) start making acquisitions again?

Not necessarily. I think that's the whole answer. We don't have an acquisition plan, don't have an acquisition program in mind. That is not to say that opportunistic extensions, expansions of our in-beam (ph) operations wouldn't be something that we would look at.

But we're not acquisition oriented. As Norm alluded, we're oriented on garnering the available increase in productivity and thus probability in an our existing operations, along with the growth that the growth that will come from those existing operations in a better and more robust economy.

My last question is, I have asked this before. When you look out, not a projection for next year, but when you look out several years, what do you see as the operating margins goal, or what you think is reasonable or doable or that kind of a thing? As you look of the company today, the industry today, and like that?

Well, That is a good question and before we look forward let's look back. The operating income has been -- was in 1999 6 percent. And that is achievable again. We are a little over 2 in very difficult industry conditions. And we're talking about significant increases '04 over '03. And you might expect that that -- since we are not acquiring that mostly derives from increase in net operating income. Where we get to the 604, no. But there is progress toward that.

If the 6 percent is a fair comment, but you make it seem as though you should be a much better Company today than you were in '99. And I don't know if the industry has changed so you are better company, but 6 becomes unrealistic for other reasons? (multiple speakers) becomes a goal.

99 has been the apex of all things in this industry forever. We're not sure. But I think what is a little bit lost on everyone here is how difficult the last two years, 24 months, 30 months have been in the industrial, commercial construction, construction services sector. We are all sort of blinded by the fact that there has been all this residential activity going on. But commercial industrial has been down. Every curve you look at, every study you look at, now has proven -- we knew it going through it. And frankly, we thought about it going into it, and that is why we divested ourselves of certain properties in order to deal with that.

Evan Marwell (ph), Criterion.

Could you give a little bit more detail on what happened with regards to the working capital this quarter?

In the first two quarters of the year we expanded our -- I think the best way to say it is we accelerated our performance on contractual billing terms. There is a term that is used in the industry called overbillings, and we always worry that people will think that that is an accounting irregularity. It is not. It is the mark of good contact management in the project business. And it essentially reflex negotiating contract billing schedules that move a little more quickly and recognized a little more value deployed earlier in the project versus when you are actually incurring hard costs on the job site.

We accelerated our billing, or got more overbilled, in the first and second quarter. We also took a couple of days off receivables in the second quarter, in particularly, and I think in the first quarter. In the third quarter, that is traditionally our busiest time of the year, so you generally have headwind on working capital. Your operations are generally -- you're putting capital into projects a little faster than you're pulling it out of projects.

We experienced that this quarter. And after a strong push on it in the first six months, I think that our operations just caught their breath a little bit on receivables. Receivables days when down by 1 day. I'm sorry, actually increased by 1 day, meaning they take a step back by one day. And our net overbilling retreated just a little bit. Neither increase was significant, but applied against our busiest activity level of the year in this quarter. That took us backward a step. But we're very focused on ensuring that we keep positive cash flow and good working capital management front and center. We think you'll see positive cash flow in Q4 and for '04 as a whole.

Bill, is Q3 -- should we normally expect to see negative working capital?

Normally, Evan, yes. It is not an ironclad pattern. But normally, the second and third quarters reflect higher seasonal activity levels, ramping up to the season and use of working capital. Certainly there have been second and third quarters in our past, including this year's second quarter where we have had positive cash flow. But the general pattern is the second and third quarter use more working capital. And the fourth and first quarter harvest more working capital.

In terms of the 4.7 million write-off for next quarter, is that a cash cost or is that --?

That is a non-cash charge. Those are costs that were incurred or cash that was outlaid -- laid out last year when we refinanced. And if we refinance to a new facility than those charges, which are which are substantially deferred on the balance sheet for amortization, will be written off in a non-cash charge when we refinance.

(OPERATOR INSTRUCTIONS) Jeff Beach, Stifel Nicolaus.

Can you comment on recent trends in orders, meaning, September, October, November activity levels, bidding, and what customers are saying regarding a little bit -- back on geographic regions whether there's some additional regions you're seeing more positive comments coming out of? Whether there has been a shift between new construction or new construction plans versus the retrofits service type business?

You mentioned the size of the projects are down from the disposition. But are the size of the projects also down because of a market shift? Can you give us a little flavor for what is happening right now in the market going out into 2004 that is giving you some optimism?

Right. I would be happy to. For me it is important to compare it with 2002, because as we watched the decline in spending in the non-residential piece, the non-residential piece, I'm sure, you know was down 17 percent in 2002. So as I look at our -- at really all of our financial and backlog numbers, it is important for me to see improvement so that I can convince myself that we are coming out of the trough, and are seeing and delivering the results we should be.

Having said that, our backlog, I feel, continues to be strong. As Gordy said, we were up 50 basis points sequentially. We have a measure which we have which is annualized -- you know, OI per employee, that kind of internal piece. And we keep track on that company by company.

The East has been strong. The East region has performed year on year and sequentially really incredibly well. That is largely driven by some areas that are strong, and it would be surprising to some that they are. Places like Syracuse, places like Portland Maine. As Bill had mentioned, and Gordy had mentioned, we're particularly strong in the Washington D.C., the Baltimore, the Northern Virginia piece. We have had real good performance there.

And our backlog looks to be holding its own in the East. We have just coming off good there. And whether we repeat exactly along those lines remains to be seen, but still quite strong for us. The Southeast probably has some of our higher optimism. And our folks down there have been snake bit by some pretty tough times, but we're seeing good performance. We're saying the awarding of some good work. And for me, good work is where we are in competitive positions on our plan-and-spec work, which is generally priced driven, where there are fewer competitors, lessening competition. We're seeing a little of that.

But I really would like to see the design build side. Where we are actually brought into projects, early-stage, and able to level leverage up our value engineering. And some of the things we do on the prefab site which differentiate us. And we're seeing strong movements in both sides. And so the Southeast looks encouraging.

The South, we had some weakness late last year and early this year. We've got some very good companies here in the South. And we continue to be very optimistic about the level of work, and our ability to perform it well. Again, we see an increase across all of our business in the service and the retrofits maintenance piece. We like that.

We like to balance between new construction and the service and retrofit peace. We feel that we can add value there and we do. In the Midwest, we have all said the Midwest has struggled the most. But yet we have some of our better -- you know companies there as well.

We are beginning to see anecdotally in our pipeline of sales opportunities a slight improvement. But I frankly think we're still sometime before we're going to be working our way out of the market conditions in the Midwest. But again, I would expect to see some improvement in 2004 over 2003.

And then the area that is given us probably our greatest challenge this year has been the West. And both from a standpoint of probably suffering the most from taking on work at lower margins last year, and working through that, but also we're seeing some indications of our ability to win work in slightly less competitive deals. And again they have great expectations that the backlog that we have there will support some considerable growth next year, both on the service, as well as a new construction side.

So in summary, new construction is kind of 50 percent of what we do. And the service repaired and retrofit side, it is about 50 percent. We have in addition to the regions, we have the two sectors which is the facilities automation side. That is fairly small, but remains quite profitable. And we expect that to continue where the backlog supports that. And in national accounts council, which I've spoken to at some length, we really like what we see there terms of traction that we are getting in the backlog we're building. That is kind of a general approach. I hope it helps you to get some flavor for it.

One follow up. There's some a seasonality to this business, when you see encouraging signs, can you read a whole lot into that the end of this year? Or maybe the reverse, can you read even more into it going into the end of the year like this, and hearing plans for increased construction that gives you more optimism?

Let me try this from two standpoints. I'll give you an operational view, and Gordy will give you a financial view, and I think they will tie in. Our backlog gives us a certain level of granularity and visibility for the next couple of quarters. Okay? And it is in all engineering and construction. It is somewhat more difficult to forecast out that second six months.

But we look to the kinds of conversations we're having, the kinds of engineering, architectural work that is coming along, and it is providing us with -- we're not jumping through the moon here or jumping through the moons in terms of the great turn in the marketplace. But we're definitely saying signs that support the idea that there will be some good work here for us to do throughout 2004.

I would add only a little bit to what Norm said. Our quotation activity is higher right now than it was at the same time a year ago. Quotation activity, generally given the size of our projects and the turn and timeline of them, will turn into revenues to some degree. Obviously you don't get everything you quote, but we will turn into revenues middle of next year, second half.

Discussions that you're having now with engineers, architects, developers, GCs will turn into revenues in the middle of next year and second half. What is in backlog right now gives us a general sense of direction more near-term. So going back to, again, quotation levels, sentiment surveys and discussions, those are the things that are giving us some sense of silver lining for next year.

David Yuschak, Sanders Morris Harris.

I just wanted a little more color on the acquisition side, because I think, Bill, you said that you really didn't think acquisitions were going to be an important part of that beefed up credit facility, because given the magnitude of that credit facility, one would tell you, maybe you're a lot more optimistic needing that kind of capital for working capital uses next year.

But I'm just wondering what kind of conditions would you think you would need to become a little more upbeat on adding growth through external opportunities?

Let me say one thing first, Dave. The level of credit facility we're talking about also includes the letter of credit facility that we need to support self-insured liabilities and workers comp, auto insurance, etc. So not all of that $45 million is working capital, as you would normally look at it. In fact, --.

What would be the separation of those two items?

Less than half would be working capital really. Maybe a little more than that.

But on your other question, what conditions would be necessary? We're very, very much focused here on productivity, as Norm went into. And we're not anti-acquisition. We just see so much opportunity to grow what we have at the top line and bottom line without having to acquire. If there are opportunities, we're not going to -- if there are opportunities, we will look at them as they are important -- as they fit. I think that is the best way I can state it. But I don't want you to think that we've got a program. And on the other side, I don't want you to think that we would deny ourselves the opportunity to expand our operations in an organic fashion that might include acquisition of adjunct operations.

And then on the credit facility, are the terms going to be loose enough that you can become a share buyback -- a particular buyback initiative there versus what kind of restrictions you've got on the facility as it exists today?

The current market, even for an improved facility, for companies of our size and configuration is supportive of share buybacks. And so a new facility based on the commitments that we have would not allow us immediate flexibility to buy back shares.

However, that is the kind of thing -- I think the group of lenders that we're putting together in a new facility will look more favorably on that than certainly what has come out of the tough markets over the last couple of years. And if we post the kind of results in general that we are describing going forward, I expect we will have share buyback flexibility, but we will not have it on day one.

I would think given the potential for 2004 free cash that that should help you considerably in putting together something like that. One other question, and Norm, you discussed in a little detail. The trend you're seeing in design builds versus plan-and-spec, I would imagine design builds has to have bottomed by now. And I'm just wondering as you see the landscape looking ahead, can that ramp up pretty decently if you get a more positive environment?

Yes, it can, Dave, and it appears to be. But I think that one of the things I didn't really stress, and I think it is important because even in a plan-and-spec that is generally more price driven than design build, which is sometimes more value driven -- all of our companies have incredible relationships. And I would say that the majority of of work that we did is relationship-based, meaning people that we work for time and time again, that value, the quality of work that our folks do -- and even though we kind of force it into plan-and-spec or design build, the relationship piece usually stands by us quite well in terms of being able to negotiable, and being able to provide some value that we can get some margin for.

But we like the mix we have. We probably would expect to see an increase in the maintenance repair piece. It seems to be a lot of, as Bill said, pent-up -- repair that hasn't been done over the last couple of years. And we're starting to see that shakeout. We measure for every dollar of preventative maintenance how much revenue we're getting on the repair side, and that number seems to be increasing. So we will see whether that holds in 2004.

(OPERATOR INSTRUCTIONS) At this time I show no further questions. I would like to turn the meeting back over for any final comments.

I just want to thank everyone for joining us on the call. If we can answer further questions, we would be happy to by phone. We are cautiously optimistic here, as we have stated, about '04. And think in a very difficult environment that your Company here is in very good shape. So thank you very much.

Thank you very much for participating in today's conference call. Have a great day. You may now disconnect.