Comfort Systems USA Inc (FIX) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2010 Comfort Systems USA earnings conference call. My name is Jennifer and I will be your operator for today.

At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host today, Bill George, Chief Financial Officer. Please proceed.

Thanks, Jennifer. Good morning, everyone. Welcome to Comfort Systems USA third-quarter earnings call.

Our comments this morning as well as our press releases 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 and results of our operations to be materially different from those set forth in our comments. You can read a more detailed listing and commentary concerning our specific risk factors in our Form 10-Q as well as in our press release covering these earnings.

On our call with me this morning are Bill Murdy, Comfort Systems USA's CEO; and Brian Lane, our President and Chief Operating Officer. Bill Murdy will open our remarks.

Thank you, Bill. In a challenging environment here, we are reporting reasonable results for Q3. Our $0.14 per share includes amortization of intangible assets related to the ColonialWeb acquisition that we've announced and that all of you are aware of, I believe. And our year to date of $0.24 per share includes not only amortization related to ColonialWeb but also the substantial non-cash goodwill impairment that we took in Q2.

Nonetheless of course, results are substantially down from last year on a same-store basis. There has even been a decrease in revenue.

However, on the positive side, our same-store backlog is slightly up for the first time in two years. With ColonialWeb, the backlog is up over $100 million.

Cash flow for the quarter was positive but not nearly at the prior year levels. However, our balance sheet remains very strong with $44 million in cash and we have very substantial liquidity with our unused bank facilities.

At this point, I'd like to turn the mic to Bill and Brian who will have further detailed remarks on the results from the quarter and I'll wrap up later with some forward-looking comments before we go to the Q&A. Bill?

Thanks, Bill. As Bill noted, we continue to experience the effects of a challenging environment but we remain solidly and profitable. As compared to the third quarter of 2009, total revenue increased by $16 million this quarter as we included our new acquisition, ColonialWebb, for two months. Without acquisition, same-store revenues actually decreased by $32 million from a year earlier or 11%. So acquisitions in total contributed an incremental $48 million in revenue this quarter.

The same-store decline reflects broad-based declines with the largest negative comparables coming at our Maryland and Denver operations due to a decline in large project work. Gross profit declined in the quarter dropping from 19.7% in the third quarter of 2009 to 16.4% this quarter. The decrease in gross margins was generally broad based, reflecting weaker pricing overall. Operating income margins were 2.7% for the third quarter.

Since last quarter, our backlog has increased by $132 million mainly due to the acquisition of ColonialWebb which added $105 million to our backlog. Even on a same-store basis however, backlog was up by $27 million or 5%.

After the increase this quarter, the year-over-year same-store decline in backlog was $21 million or 4%. We continue to believe that overall backlog is tracking well both by historical standards and especially in light of industry conditions.

SG&A expense including ColonialWebb but excluding amortization of intangibles decreased by $0.9 million or 2.1% for the third quarter of 2010 as compared to last year. On a same-store basis, excluding amortization expense, SG&A decreased by $6.6 million.

This sharp dollar decline in SG&A results from our efforts to maintain disciplined cost structures during slow markets and a decline in variable overhead costs such as bonus compensation. SG&A as a percentage of revenues decreased from 14.3% in 2009 to 13.6% in 2010 on lower revenues.

The majority of our amortization expenses included in total SG&A, this was $1.6 million for the third quarter of 2010 compared to $0.6 million for the third quarter of 2009. The increase in amortization expense is due of course to our recent acquisitions.

Our tax rate for the quarter was 35% and was somewhat lower than usual due to a discrete item. We expect a full-year tax rate in the range of 36 to 38%.

Our stock repurchase program was modest this quarter. We purchased 80,000 shares. Our program began less than three years ago and has been funded with a portion of our excess cash flow.

Thanks to the program, we have repurchased 4.8 million shares and returned a total of $54 million to our shareholders. We've now reclaimed shares equal to well over 12% of our current share base and we believe that our smaller share base will be an important contributor to stockholder value when markets recover.

Free cash flow was weaker than expected at $1.3 million for the quarter compared to $23 million for the third quarter of 2009. Year-to-date free cash flow remains negative at around minus $10 million.

In light of cash flow for the quarter, we carefully reviewed our collection statistics and overall billing status. Based on our review, we concluded that the weak cash flow through nine months was a natural result of economic changes and the unwinding of the aggressive billing and collections that we were able to achieve over the last few years.

We remain strongly overbilled. We have collection statistics within normal ranges and we believe that our ability to flow cash remains fundamentally sound. We continue to expect positive cash flow for both 2010 and 2011. Before I close, I want to make a few more observations relating to our acquisition of ColonialWebb.

In connection with this transaction, we added a lot of hard assets including a substantial billing to our balance sheet. But we also added about $50 million in goodwill and $25 million in intangible assets.

The incremental revenue for the quarter was $39 million and the incremental operating income after amortization of intangible assets and other fair value adjustments was approximately $200,000. In other words, although ColonialWebb was solidly profitable during August and September, on the net income and EPS lines, their profitability is offset by the amortization of intangibles relating to [customers lists], backlog and other items.

As we mentioned in our press release regarding this deal, because of the need to amortize intangibles and similar to other acquisitions that we do, we do not expect material EPS accretion for the first year or two. We continue to expect that this fine organization will contribute EBITDA and gross margin in proportion to its size and it rates comparable to Comfort as a whole.

Finally and also of note during the quarter, as announced previously, we extended and increased our credit lines in July. As a result of this collaboration with our banks, we feel that our already favorable covenants have become even more stable.

Our new line is scheduled to expire in July of 2014. Overall we're financially sound thanks to the continued strong performance of our operating teams.

Our balance sheet is rock solid. We will continue to seek additional ways to prudently use strength to compete, improve and grow. That's all I have on financials, so I'll now introduce Brian Lane, our Chief Operating Officer. Brian?

Thanks, Bill. Good morning, everyone. First of all, I would like to thank each of our talented and dedicated team members for their efforts in this very tough market.

Performance across our operations was good this quarter in light of market conditions. We experienced good execution and solid profitability although as expected in a tough environment where we are [bidding] tighter margins, we also had write-downs on certain large fast-paced projects this quarter.

In some cases, we feel we have a valid basis to recover some or all of our excess costs. However, no anticipated recoveries are included in our results.

In the DC/Delaware area, we have restructured and combined certain of our operations. And we are also working with some low-margin backlog in that part of the country.

We're making the tough decisions to overcome our challenges in these areas. As we've said before, this is a tough market and there is almost no room for error in bidding and executing projects.

We remain encouraged by the performance of the vast majority of our operations during the quarter. The leadership provided by our operating presidents has allowed our operating companies to perform more efficiently compared to the last downturn.

The continued investments that we've made in training, project management and prefabrication have paid off with our operations being better managed today. Most importantly, our strong reputation, financial strength and commitment to our customers is helping us book work throughout the country.

In addition to solid project execution, the quarter and year-to-date results have reflected significant overhead cost reductions. Our same-store SG&A costs are down 16% both on a quarterly and year-to-date basis. We continue to monitor our costs to ensure that we have the appropriate level of SG&A costs in light of our revenue projections.

Our service operations remain steady and have helped maintain our profitability. During the first nine months of 2010, pure service made up 17% of our revenues compared to 14% for the first nine months of 2009.

We continue to invest in our service sales efforts and we have maintained our commitment to strategic investments in service and training. Our focus on safety remains a key strength of our Company and our OSHA recordable rate remains 40% below the industry average. This outstanding result is thanks to a continuing focus by our operations.

Backlog at the end of Q3 was up $132 million or 26% since June. ColonialWebb, our large acquisition in July, made up $105 million of the increase. And we also had a moderate increase in our same-store backlog.

Our Southern California operations was awarded a couple of sizable projects in Q3 including work at the San Diego airport expansion. We also had good bookings at our New Hampshire and Washington, DC operations.

Backlog in a project company can be lumpy. So it is hard to call one quarter a trend. However, an increase definitely beats another decline. And it is great to see some of our locations get some some well-deserved wins. I am cautiously optimistic that our backlog levels are now stabilizing.

The institutional markets of government, healthcare and education are active while the private sector remains weak. Continuing the trend from 2009, over the year more than half of our revenues were from institutional markets and today 68% of our backlog is institutional work.

Overall, the Northeast and Southeast continue to be stable while softness continues in the West although there are signs of stability. We continue to see a lack of large project awards and we are experiencing pricing pressure as local and regional competitors respond to challenging conditions.

However, we are committed to maintaining profitable margins. We expect that weakness in non-residential building activity will continue next year and so we are continuing a tight focus on project selection, estimating, pricing and execution. We have and will maintain a disciplined cost structure. We believe these actions will minimize the negative effects of a continued downturn.

We have positioned ourselves to improve our competitiveness in various markets. Our strong financial position and broadening capacity remain a competitive advantage and we are better positioned than some of our competitors to weather a continued downturn.

ColonialWebb has brought a new vigor and capabilities to our operations and has increased our geographic footprint and expanded our product offerings. We had a regional meeting last week for our operating companies in the Southeast which included ColonialWebb and it was great to see our operating company presidents engaged and sharing best practices, manpower resources and project opportunities.

Having reviewed cash flow with each region and operation, I believe the drop in free cash flow since 2009 mainly reflects an ordinary transition to lower overbilling and working capital levels that are characteristic of recessions. Over the next two months across our regions, we plan to focus on ensuring that our cash flow is strong as 2010 concludes. We have a history of strong fourth-quarter cash flows and we plan to continue that tradition.

I am confident in our ability to execute on our projects and continue to deliver solid operating results. We are ready for strong performance when our markets improve.

Again, and more than anything, I would like to thank all of our 6700 team members for their efforts. I will now turn it back over to Bill for his wrapup and then questions. Thank you.

Thank you, Brian. All three of us have mentioned the very challenging circumstances [that attend] our business and the non-residential construction service sector in general. Things are tough.

And while difficult, we are more than holding our own, we believe. FMI and other industry prognosticators project that non-residential construction will be down 18% for 2010, down about 13% for 2009. Our revenues on a same-store basis will be down but more like 12 as opposed to 18%, and of course much less with our new acquisitions led by ColonialWebb.

As we all mentioned, our backlog seems to have stabilized and we are encouraged that the Architects Building Index which has been a good measure of future non-resident activity in the past, that index has improved from a low of a 34.7 as an index number in Q4 of 2008 to 48.2 in Q3 of 2010 here and I understand it's even higher for October.

Most of the projections for 2011 through 2014 are positive and appear to approach the levels of 2006, 2007 and 2008 in a number of the non-residential sectors in the out years. We think Comfort Systems is well positioned for the future and that we have the internal strengths.

And Brian alluded to some of the disciplines we apply here. We have the strengths to capitalize on any improvement in the economy.

We continue to adhere to our strategy of one, doing more of what we do today in new construction and retrofit, but doing it more productively; two, building our HVAC service activities, very important; three, prudently acquiring additional operations in new areas; and four, focusing on energy efficiency which offers a vast low-cost energy resource for the country and is gaining increased attention and traction. With HVAC consuming 50% electric power in buildings, we feel energy efficiency is a very, very positive opportunity for us going forward.

At this time, I think we ought to move to Q&A. We have I believe a few questions already in the queue. So we'll turn this back over to Jennifer.

(Operator Instructions) Matt Duncan, Stephens Inc.

I commend you on an admirable job in a tough market here. The first question I've got is with regard to backlog. Brian, can you talk a bit more about what type of projects you are adding there that help the organic backlog go up 5% sequentially? Sort of what end-markets are you adding both geographies and customer type?

Matt, so geographically, we're seeing some strength in the Northeast and California specifically, and the Southeast has been stable. And the end-markets that we are seeing is heavy medical, education, particularly at the university level, and some government work.

Okay, that's very helpful. It sounds like maybe you feel like end-market conditions have at least stabilized at this point and probably sequentially aren't getting any worse. As you look out to 2011, do you think you might be able to start to see things move back in the right direction?

Bill Murdy, I know you indicated that the market forecast seems to say that that may happen. What are you guys sort of seeing and hearing that give you confidence that the business might get back to growing again in 2011?

I think it would -- because we're a bit of a late cycle player, we're not a good candidate to be the guys who call the end of the recession. I think we have optimism, but I have to say, I don't think we have much more than you have seen which is -- it certainly feels good if you are sitting here to have finally had a quarter where your same-store backlog went up.

5% is a nice amount for it to go up. It's nothing crazy. Now these things are lumpy, so it's hard to -- as Brian says, it's hard to draw a trend from that. But I would say we feel better now than we felt a couple weeks ago and I think, Brian, I think we've seen okay bookings since the end of the quarter as well.

We have had a strong October that has continued on from what we saw in the third quarter.

One thing, Matt, while everybody -- including myself -- is looking at all the various results since the political contest across the country last night, one of the things I was focusing on was school bond issues.

And every one of them I saw (inaudible) which indicates even in this kind of economy, the education sector is going to move forward. We've got four or five new big schools being built here in the Houston area.

I think that's going to continue and I don't see the healthcare sector slowing at all and the government, especially the military piece, is going to move forward. Where we have concern is where we have had concern for a long time -- retail, lodging, office.

There was just so much overbuilding that those sectors simply are not going to come back fast. And the weakest part of the country for us is the West where obviously we got way ahead of ourselves.

And on the commercial side of the business, we at least are going to have the curse and blessing of easier comparables.

Okay, two more things for me and I'll get back in queue. Looking at a couple of things on margins, first on the gross margin, it was down about 40 basis points sequentially. That may just be noise, it may be mix, it may be ColonialWebb. Can you talk some about sort of the ebb and flow of gross margin?

A good -- those 40 basis points, nearly half would be accounted for by averaging in ColonialWebb and that's not to say that ColonialWebb's gross margins are lower than ours. It's because some of the amortization gets pushed. Most amortization runs through the SG&A line, but a good chunk of it runs in the -- hundreds of thousands of dollars in the quarter will run through cost of goods sold kind of lines.

And so at the end of the day, part of that is just the averaging in of ColonialWebb. The other 20, 25 basis points I think is just -- I don't know, just within the margin of error. I think we're at this level probably for the rest of the year, the [6 million of the mid 16s] hopefully the upper 16. But we typically do have an increase in profitability in the fourth quarter over the last several years. I'm not sure we can count on that this year. I'm certainly hoping for it.

Last thing I've got is on SG&A. Bill, remind me what you said the ColonialWebb SG&A expenses were this quarter first?

Well they averaged into -- wait a minute -- the ColonialWebb -- you're talking about -- I'm sorry, I was thinking of gross margin. What do you mean, the ColonialWebb SG&A expenses?

How much of your total SG&A costs was from ColonialWebb? I'm trying to get a sense what the base business did from the Q2 to the Q3?

In raw dollars, it was about $5 million.

Okay, so you guys are still doing a really good job managing that line. I'm curious, are you on the organic business or have there been further headcount reductions or what are you guys doing to manage that line?

Shrinkage.

Shrinkage basically. But in terms of headcount reductions, we've been pretty stable quarter to quarter, but just looking for efficiencies everywhere we can.

Okay. Thanks, guys.

John Rogers, DA Davidson.

A couple of things. First of all, when you talk about the organic growth, have you gone back and looked at ColonialWebb's business? Are they seeing the same things?

When you say organic growth, you mean same-store?

Yes.

Same-store backlog?

Yes.

I think their same-store backlog was down slightly. During the period time we were -- they have a larger average project size and so they would be slightly more affected by a decline in large project work. Even if their revenues don't decline, they're going to see a disproportionate decline in backlog just because they have a larger average project size.

That being said, their backlog's still at very strong levels and it hasn't -- I think it's plus or minus a handful of millions. I don't think there's been precipitous declines.

Now like us, if you look back six months or a year and you start to go back a ways, the drop off from their peak is very similar to ours. It's almost proportional to ours. So you know, a big drop from the peak that they saw let's say a year and a half ago. Just you could set it next to ours and it would look very similar.

I'm just trying to understand the slight uptick we're seeing and I realize you guys feel a little bit about it better about it but are still cautious. I'm just trying to understand how widespread this is or is it just, I don't know, something odd this quarter that lifted (multiple speakers)

I would say that ColonialWebb, the one quarter experience ColonialWebb would be contraindicative. It went the other way slightly.

Okay, secondly, I guess, Bill, for you is in terms of the amortization schedule, does that drop off steeply in I guess second and third quarter of 2011.

That's a very astute question and the answer is not as much as usual. Until about a year ago, whenever we back valued backlog, we put a large, large value on backlog.

But the way that the actuarial analysis works, the relative margins of backlog drive the value of backlog. So if you look in our notes, you'll see that the ColonialWebb backlog only had $500,000 or $600,000 of value and there was a much larger value put on the customer list.

These things are like a balloon the way these guys who do this valuation analysis work. If you squeeze one part of it, another part gets bigger.

So we have a big value on the customer list, a big value on the trade name. Now the trade name goes off over 25 years and it really isn't much of a factor, just your timing of it.

You would think that might be the case on the customer list because it's a 15-year amortization, but it's a declining amortization. So the answer to your question is if you were to look at the amount that we will amortize this quarter versus the amount we will amortize late in 2011, it's a big difference.

It's half, but it's still pretty substantial and will stay substantial for a few years. So there's a big drop off but not what you are used to.

I'm sorry I had to give you such a complicated explanation, but it's actually very different from what you (multiple speakers) this is a new pattern I think you'll see in companies like ours right now for acquisitions.

Then just last question. Brian, I think you mentioned that business activity was -- or bookings were still holding up pretty well going into October. Any comment just on pricing in the market or what you're seeing there? I mean, has it stabilized?

I believe it has stabilized. Still very competitive, it seems to be rocking along the bottom at the moment.

I say we have stabilized at a new and uncomfortable normal.

Okay, okay. But I guess that would imply that hopefully we've hit a bottom here in terms of margins?

One nice thing is you don't see people coming in and bidding work at a loss nearly as much thinking oh, if I can just get through six months, things will be great. I think that our competitors have recognized that that's not a good strategy.

Clinton Fendley, Davenport.

First on the backlog, the nice increase sequentially here, you've explained it is due to California and Maryland and kind of work in and around education and healthcare. Does that mean that we've got pretty good margins implicit on that work given these vertical segments?

I think the margins are the margins that we're getting now which are much lower. They're not good or anything we would've called good until now.

But they're not give-away margins. They're margins we can make money at. We got to go execute to do it, but I don't think there's a recovery in pricing implied by this.

And I should also say, we mentioned the places where we pick up the biggest jobs but for our backlog to be up because we're constantly burning, we run through a couple hundred million of revenues in a quarter, obviously most of that -- more than half of that goes through backlog, we're booking work everywhere.

So we named some big pieces. But as Brian said, you should also understand it's not just one or two places. You had booked good stability in the Southeast and you had some pickups in California and in the Northeast, as Brian said. So that's an important thing to sort of just keep in mind.

Bill, for the fourth quarter, always it's a big quarter for cash collections. Any obstacles that might be different this year as we think about the extended period of the downturn that we have been through?

I think that we will have the usual proportional increase in the fourth quarter. The big obstacle is we are earning a lot less money. So the absolute numbers that we're headed towards, they're not going to be -- they're going to be proportional to the lower earnings.

So you won't see the eye-popping numbers you've seen over the last couple quarters. But I think we have every reason to expect solid cash flow in the fourth quarter and to be cash flow positive for the year.

I think as we've said, people who have been around this for a while, we've said in those downturn years, sometimes your cash flow is less than your earnings but it's because there's a little bit of a change in your -- frankly your ability to collect, your ability to extract advantageous terms.

Okay, that's helpful. And I apologize if I missed this, but the large increase that we saw in the other income line item, what was that attributable to?

That's a really interesting question. And that's a line item you're going to see from time to time over the next -- forever. Starting at the beginning of last year, when you did an acquisition that included an earnout, you were required to make a very math-based estimate of the value of that earnout, put it on your books as a liability and then you have to reassess it every quarter.

And when you reassess it, once again, you have to document that with some math and stuff that you have ready for the SEC if they ask. When you reassess it, what you expect to pay out over the next several years, there's frequently going to be a difference and that difference now has to run through the income line.

So what you're seeing there is there was a pickup of income but it reflected a judgment by us that with the extension of the recession, some of the acquisitions that we did let's say nine months or a year ago, we will probably pay out less on their earnout. They have earned less money this year.

When we bought a company a year ago, we thought maybe the recovery would've come by now. We backed that into our estimate of what we would have to pay on their earnouts. It now looks like we'll have to pay less on those earnouts when we do that analysis and so we bring money through the income line to reflect the change in the value of that earnout.

However, it's important to understand, that's because they earned less money in the current year, so it's offsetting a negative. So ironically when you see that number, when you see a positive on that line, in a sense it's bad news.

And when you see negatives on that line in the future, in a sense it's good news. It means that our acquisitions are doing well. And keep in mind that we only pay our acquisitions a percentage of profits after a threshold.

So I would rather have negative numbers on that line generally speaking. It means I'm getting a multiple of that money up above the line. So I'm sorry to be complicated about that, I just don't know how to explain that without going into that level of detail.

So it's safe to assume that these adjustments will continue to be made through the remainder of the earnout period then?

Yes and in fact, we are about to -- we're marking this to market every quarter. In fact we are about -- well marking it to our estimate every quarter. We're about to have to do that with the ColonialWebb earnout which has another zero on it.

Now I don't really expect big changes there. I think we have baked in some interesting things. But if we were to for example suddenly begin to see a recovery in the economy early next year, one of the interesting things that could happen is that could force us to reassess the earnout and assume we might have to pay more.

You could see a quarter where we had a negative but the positives would come over the next several quarters as they earned the additional money we expect them to earn. So I just say that to lay the groundwork for the fact that when you guys see numbers on the lines, negatives are good and positives are bad.

So none of the 669 is related to ColonialWebb then?

No, it's the old acquisitions we did last year, the guy in Raleigh and we re-looked at Nashville. It's those guys.

And when we -- obviously when we gave the math types, the evaluation types the information to do those estimates last year, they asked us for economic forecasts and economic forecasts a year ago looked very different than the kind of economic forecasts you would hand them this year. And you generally want to hand them published economic forecasts in case they have to justify those to the SEC and obviously our auditors like that better and stuff. So, there's your -- I'm sorry to have to go into these weeds, but I do think it's worthwhile (multiple speakers) it's going to be important.

No, that's okay. It's helpful. Is it going to affect the tax rate going forward from here, how we should think about that?

I don't think it affects it meaningfully. And let me just say on the tax rate, we will probably end this year a couple percent lower than we have the last couple years. That is due entirely to discrete items.

We had a big accrual to return difference this quarter, big -- couple hundred thousand dollars but it matters in a quarter, the math of quarter. So if you're thinking about next year, the range we're going to show is 38 to 40% again.

We don't -- even though our tax rate will be a couple percent lower this year, nothing that's happened suggests that that is a new trend or phenomena. We're probably going back to what you have seen for years from us after this year. We just had a couple of lucky -- a couple of positive developments here and there and some state taxes mainly.

Great, then last question. You guys talked about the sharing of ideas, personnel at yourself Southeast conference. Any potential for ColonialWebb to maybe impact to your just effectiveness or even opportunities as we think about kind of the DC, Maryland or Delaware regions going forward?

Yes, we're very optimistic both on the product offerings that they have and some of their capabilities. It would be more I believe south of Washington, DC in the Southeast where we're going to see some I think immediate opportunities.

Saagar Parikh, KeyBanc Capital Markets.

This is Saagar Parikh with questions on behalf of Tahira Opsahl. Nice quarter, gentlemen. First question related to your service ops. I'm just wanted to get some more insight.

I saw that your backlog -- last quarter you guys had mentioned that 72% of it was related to institutional while this quarter, you guys mentioned that 68% of current backlog is institutional. I wanted to see where the decrease in institutional went. Was it services or was it related to non-residential?

It would be all non-residential construction. Virtually all of our backlog is particularly right is non-residential construction. An awful lot of our service numbers run through -- 17% aren't even project based. So they never hit backlog ever and then the others are -- they have such a small average project size that they have very little effect on sort of the mix of our backlog.

So the shift was more related to increased non-residential work?

Yes, yes and it was -- it's just some bookings that were -- did not fit into those categories, probably one or two, frankly.

And then acquisitions going forward, we heard from a couple of your peers that private equity firms are making multiples higher to bid on. Just wanted to get your sense, since you guys are seeing more competition out there at higher multiples and what end market you would be looking for.

We have not seen any activity from private equity in the HVAC new construction and services sector, not to say that there might not be. I don't think it's a particularly attractive area for them.

I'm just not aware of anything going on. We don't see them as we talk to other companies. And candidly, the kinds of opportunities we're looking at -- 20 million, $30 million companies -- are not targets for those kinds of pools of money anyway.

As far as your question related to what we're looking for, we are staying in the middle of our fairway, if you will. We continue to decide and re-decide that the HVAC mechanical plumbing sector is where we want to be and it's a rich vein and we want to continue to stay there. So we're not going to go far afield from that at all.

Sounds great. Thank you very much.

Adam Thalhimer, BB&T Capital Markets.

Good quarter. I wanted to ask about -- kind of step back and talk about the cycle a little bit. When I look at some of the McGraw-Hill forecasts, they forecast an increase in -- well it's kidn of interesting.

They forecast an increase in private non-res starts in 2011 and actually a little bit of slippage in institutional starts. Does that kind of jive with how you see the world shaping up in 2011?

I noticed that. And that is -- it's not surprising but if you still do -- the reason we still continue to emphasize what we emphasize is if you compare absolute levels, there's still a mind-boggling disparity.

The work is still going to be on the institutional side. However, they do have a couple of the institutional categories wandering sideways and down a little bit and you would see a little bit of recovery in things like manufacturing and one or two areas.

But from a very -- from the lowest level in my career too, the second lowest level by just a little bit. So I think -- I guess I would say, yes, the trends there -- I guess you would kind of expect that when you get down at the bottom, things start to bounce around.

What I think -- the one interesting thing is there's not a dollar increase on the institutional side. They didn't show one for last year either.

So what's really happened during this recession is institutional has stayed where it was in aggregate and everything else has gotten worse and it's made institutional look pretty great.

(inaudible) increase from base question and FMI for instance, that area is flat to slightly up over the next couple of years. So a different opinion even (inaudible)

What would we need to see to see a turn in private non-rest? Is it office vacancy rates coming down from 18% back to 12%?

In my opinion, it's the same things that create really non-IT capital investment. It requires private businesses who are cash rich to decide that it's time to invest in an incremental way. And I think it just -- what that would require is I think the 70% of the economy that is consumers to give them at least a reason to think yes, we better at least keep our plant in shape, there's going to be an opportunity to make money. I think things have steadied out and I just think we need a little bit of animal spirits.

Well that's actually a good point. Bill Murdy, I think you gave an example probably two or three quarters ago of a guy, a client who you were pitching on an upgrade and you were able to show him hey, your payback here on an HVAC upgrade is like two or three years. It's something very favorable and he still wouldn't do it because he didn't want to spend the money. Are you seeing clients, customers being more open to capital projects with the economy (multiple speakers)

That was an energy efficiency project and we're certainly seeing a lot more interest there. Pulling the trigger is another situation. That's what you are alluding to here. I think we need just some more evidence of upturn in the economy and Bill is right, if the economy is 68%, 70% consumer, he needs to get a lot more confidence to increase spending.

All right, maybe we're getting a little too 50,000 foot here. But to bring it back down a little bit, have you guys made any comments -- I think coming into the quarter, there's supposed to be some impact from a hot summer. Did that in fact happen?

We had a very, very good summer in the service business. Our margins were up and it was very strong. So it did happen.

It happened and is that -- with things cooling off a little bit, has that service business come down a little bit or has that strength actually been maintained?

It is seasonal but likely up in the northeast. We have a heating load and we will be switching to doing some of that work. But it is seasonal and it does taper off a little bit here in the winter months.

Well, guys, thanks for entertaining my economic questions.

There are no further questions at this time. I will now turn the call back over to Bill Murdy for closing remarks.

Thank you, Jennifer. I just want to thank everybody on the call. Thank you especially to our people out there working diligently in very tough circumstances.

I think to reiterate, I think we are well positioned for the future, we just need the future to get here. I think that's the hope that we have. So thank you all for being on the call. We'll see you in three months. Thank you. Bye.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day. 60% and natural gas was 40% of our total sales. We had we have a strong liquids contribution from our three core areas which are as you probably know Cana, the premium Permian basin and the Gulf coast area.

Our third quarter exploration and development capital was $296 million bringing our capital year to date two $725 million. Returns from this year's drilling program looked very solid. Our cash flow year-to-date