Comfort Systems USA Inc (FIX) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2010 Comfort Systems USA earnings conference call. My name is Crystal 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, today's conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Bill George, Chief Financial Officer. Please, proceed.

Thanks, Crystal. Good morning, everyone. Welcome to Comfort Systems USA's fourth quarter and year-end 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'll say today 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-K which we filed last night 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 COO. Bill Murdy will open our remarks.

Thank you, Bill. 2010 was not a pretty year for anyone in the nonresidential construction services sector. I guess don't even need the modifier nonresidential -- anybody in the construction services sector -- business services sector. However, while results were not what they've been in recent years, Comfort showed its aggregate strength and productivity. We were solidly profitable and produced excellent cash flow.

For the full year we're reporting $0.39 a share versus $0.90 a share for 2009. By the way, that $0.39 a share would have been $0.46 a share without $0.07 a share non-cash goodwill impairment charge. Revenues for the full year on a same-store basis declined about 13%, less than the sector in general, but nonetheless, a fairly steep decline. Our cash flow for the year was $33 million versus about $45.5 million for 2009.

For the fourth quarter of 2010 we're reporting $0.15 a share, or $0.17 a share without the $0.02 of the goodwill impairment, for the supplies in that quarter and that's versus $0.20 a share in Q4 '09. Q4 2010 to Q4 2009 revenues, again on a same-store basis only, declined about $5 million, less than 2%. I've been --I've mentioned revenues on a same-store basis and, of course, we're not same store with the important addition in August of ColonialWebb to our constellation of operations. For the full quarter of ColonialWebb operations, our Q4 revenues increased over 2009 fourth quarter by $58 million or 21%. Now Bill George will have more to say about the nonaccretive nature of ColonialWebb's results for GAAP EPS reporting, but suffice to say that ColonialWebb is operating as expected and is producing positive EBITDA in line with Comfort's other operations.

Backlog -- same-store backlog overall has been moving sideways in recent quarters in a fairly narrow range. Of course, it is up with the addition of ColonialWebb and you'll hear more about backlog and its components from both Bill and Brian. I'll conclude after Bill and Brian with some further remarks, but at this point would like to turn this over to our Executive Vice President and CFO, Bill George.

Thanks, Bill. We are reporting solid fourth quarter results and full year results along with very strong free cash flow. As expected, gross profit and operating income margins were generally lower due to continued challenging market conditions. As compared to the fourth quarter of 2009, total revenue increased by $58 million this quarter because our acquisition of ColonialWebb has been included for all three months. Without acquisitions quarterly same-store revenues were essentially flat with the fourth quarter of 2009. For the full year, total revenue was similar to last year. However, unlike the fourth quarter in which same-store revenue was flat, full-year same-store revenue was down $150 million or 13%. The same -- the full-year same-store decline occurred on the construction side of our business and it was broad-based.

Gross profit declined in the quarter dropping from 21.3% in the fourth quarter of 2009 to 18.1% this quarter. The decrease in gross margins was generally broad based reflecting weaker pricing overall. We also had lower relative profitability at our central Florida operation which performed very, very well but could not match its extraordinary 2009 performance. And we were negatively impacted by job underperformance in our Delaware operation. Operating income margins were 2.3% for the fourth quarter, NOI margins were 2.7%, if you exclude our small goodwill in the fourth quarter.

Our backlog this quarter decreased slightly from September 30 dropping by $21 million or 3.2%. The year-over-year increase in backlog was $68 million thanks to the acquisition of ColonialWebb in July on. A same-store basis the year-over-year change in backlog was $25 million or a 4.5% decrease. Overall, as Bill said backlog is tracking sideways but it remains strong by historical standards especially in light of industry conditions. Our SG&A expense decreased $5.6 million or 3.3% for the full year, but that decline was much larger when viewed on a same-store basis. Same-store SG&A, excluding intangible amortization expense, decreased by $24 million or 14.4%. That decrease results from disciplined cost structures and a decline in variable overhead such as bonus compensation. SG&A, as a percentage of revenues, decreased from 15% in 2009 to 14.7% in 2010. In light of the revenue decrease and SG&A decline as a percent of revenue as a testament to the discipline of our company and our regional leadership.

Amortization expense nearly doubled this year, increasing to $6.2 million in 2010, from $3.5 million in 2009. Still a big number in 2009, but much bigger this year. The increase in amortization expense is due to our recent increase in acquisitions and it lowers our EPS. We continue to get good strong EBITDA and cash from the companies that create that amortization. The majority of our amortization expense is included in total SG&A.

We booked a modest goodwill impairment charge during the fourth quarter. As most of you know, when we buy a company, the purchase price that exceeds the value of other tangible and intangible assets is recorded as goodwill. We are required under GAAP to regularly test our goodwill balances to determine if recent and projected cash flows viewed in light of other valuation considerations support the value of this goodwill. This test measures a specific moment in time. It emphasizes the most recent results in near-term prospects and industry conditions. The review can result in us writing off goodwill of companies even if they have cash flowed their purchase price many times in the past and even if we view them as strong future contributors.

During the second quarter we had a goodwill impairment charge of $4.4 million relating to an operation based in Delaware that we purchased in 2008. We performed our annual goodwill impairment testing for all of our operations and, as a result, this quarter we wrote off the remaining $1.3 million of goodwill also related to this Delaware operation, based on their revised projections. There were no other goodwill impairment charges recorded this year and the write-off this year was our first write-off in five years. However, because the construction industry is cyclical, results can vary based on geography and individual company considerations. From time to time especially in tough economic conditions we may incur future goodwill impairments.

These nine cash charges reduced our reported earnings per share in the quarter in which they are booked. The impact of this particular nine cash charge was to reduce our after tax earnings per share by $0.02 for the fourth quarter and, including that $0.02 in the quarter, the total effect for the year of goodwill impairments was $0.09.

As a result of the implementation of fair value accounting, we have other intangible assets that we must regularly value and which can also offset the amount and timing of our reported earnings. Specifically, when we do acquisitions, we frequently have contingent payment liabilities, or earn-outs. We are required to value these obligations at closing and then regularly test and evaluate the value of these earn-outs. As the likely amount to be paid in the future changes, we change the value on our balance sheet and record the difference whether negative or positive as income or loss on our profit and loss statement. During the fourth quarter we recorded a gain of just under $1 million and have recorded a total gain, including the fourth quarter, of $1.6 million for the full year. You'll find that under other income.

Our ColonialWebb acquisition has performed as we expected. Their incremental revenue for the year was $93 million and the incremental operating income after the amortization, intangible assets, and other fair value adjustments was approximately $400,000. So because of the amortization we are required to book, the net impact of ColonialWebb in 2010 was very small, about $0.005. As we mentioned last quarter, because of the need to amortization intangibles we do not expect material EPS accretion from that transaction for the first 12 to 18 months. Therefore, although ColonialWebb is not likely to contribute significantly to EPS in 2011, we expect it will continue to contribute EBITDA, gross margin, and cash in proportion to its size at rates comparable to Comfort as a whole.

Our tax rate for the year was noticeably lower than usual at 31.2%. This difference was due to three things -- a shift in where earnings were generated, with proportionately more income in low tax in unitary versus nonunitary states, there were certain discrete items; and there was also an effect of the goodwill impairment. We do not know of any discrete items that will impact 2011. So, at this point we expect our full year tax rate in 2011 will be back in the usual 37% to 40% range.

We purchased 455,000 shares of our stock through our repurchase program during 2010. Our program, which began in 2007, has been funded with a portion of our excess cash flow. Thanks to the program, we have purchased -- repurchased 4.9 million shares and returned a total of $54 million to our shareholders. We have now reclaimed shares equal to 12% of our current share base and we believe that our smaller share base will be an important contributor to shareholder value when markets recover. We will continue to look for opportunities to purchase shares, especially if there are price dips. However, we're optimistic that acquisition opportunities will tend to be a better use of our investable capital in 2011. So we plan to continue to be price sensitive and opportunistic in this share purchase program.

The best news this quarter and the statistic I want to end my comments on is cash flow. Free cash flow was very strong coming in at $43.8 million for the quarter compared to $6.7 million for the fourth quarter of 2009. Free cash flow for the year was $33.5 million compared to $45.6 million in 2009. We have generated positive free cash flow for the last 11 years and we expect to continue to translate our earnings into solid cash flow in 2011. You can't fake net cash flow. Our history and recent performance in the toughest of times -- the toughest of times -- really demonstrates the quality of our field operations. The fact that we have been able to preserve our core operations, make internal investments such as service and training, and are still able to generate cash to invest gives me great confidence in our future.

We are financially and operationally sound. Our balance sheet is rock solid. We have good cash balances and reasonable debt and our unused credit lines do not expire until 2014. During 2010 we invested in acquisitions and increased shareholder value through our dividend and share repurchase programs. Every day we seek additional ways to prudently use our strength to compete, improve and grow. That's all I have on financial. 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 challenging market. 2010 was a tough year for nonresidential construction and we are glad to have it behind us. Continuing the trend from earlier in the year we had broad-based gross margin declines as we experienced challenging pricing and activity levels. Despite this tough economic climate, we closed out the year with solid performance and excellent cash flows. Most of our operations executed well, although when bidding tighter margins we have less room in error in bidding and executing projects.

As Bill mentioned, we had job underperformance at our operation based in Delaware. We have restructured this operation with new management and I expect it to turn around this year. Other than the Delaware operation, we had a good year most notably at the operations in Maine, Wisconsin, Michigan, Maryland, upstate New York, and central Florida. We also had 15 companies meet the outstanding company criteria meaning they achieved operating income levels of 8% or greater. Well done. Our operating presidents have provided valuable leadership to weather this recession.

We continue to experience pricing pressure as local and regional competitors respond to challenging conditions. However, we are committed to maintaining profitable margins. During this downturn we made a conscious decision to invest in service, energy services, productivity, and training. We used the slowdown to improve internal processes and sharpen the skill sets of field and project managers. The continued investments we made in training, project management, and prefabrication have paid off and today our operations are better managed than ever.

When we started seeing the signs of the industry downturn, we proactively took steps to cut overhead and reduce headcount. Where it made sense, we consolidated some smaller locations into existing operations to improve oversight and further cut costs. The quarter and full year results have benefited from significant overhead cost reductions. Same-store SG&A costs, excluding intangible amortization, are down $24 million or 14% in 2010 compared to 2009. We continue to monitor costs to ensure that we have the appropriate level of SG&A costs in light of current revenue projections.

Investments in service over the last few years have helped maintain profitability. Pure service, which is maintenance and repair, grew from 15% of revenues in 2009 to 18% in 2010. Today, service is engrained in our culture. We continue to invest in service sales efforts and maintain our commitment to strategic investments in service and training. Safety remains a key strength and our OSHA recordable rate is running 42% below the industry average. This outstanding result is thanks to a continuing focus by our operations.

Backlog at the end of Q4 was $618 million, down 3% from Q3. On a same-store basis, backlog at the end of Q4 was down $25 million or 4.5% since Q4 '09. The institutional markets -- government, healthcare, education are active, while the private sector remains weak. During 2010 approximately half of our revenues were from the institutional markets and today 70% of the backlog is institutional work. We saw lower levels of backlog declines during 2010 and we are cautiously optimistic that most of our markets are stablizing. Overall the Northeast and Southeast continue to be stable and, while softness continues in the West, there are signs of stability. We continue to see a lack of large project awards, but we have won our fair share and booked some sizable projects in California and New Hampshire during the last half of the year.

While industry reports signal an improvement in nonresidential construction, we feel that as a late-cycle player even if strength materializes, it will impact us later in the year and in 2012. We maintain a tight focus on project selection, estimating, pricing, and execution. We have a disciplined cost structure. These actions are prudent as we seek to minimize the negative effects of continued weakness in our markets. We have positioned ourselves to improve our competitiveness. Our strong financial position and bonding capacity remain a competitive advantage. Acquisitions remain a key strategic objective and we have a very active pipeline.

Most importantly our strong reputation, financial strength and commitment to customers is helping us book work throughout the country. I am confident in our ability to execute projects and continue to deliver solid operating results. Most importantly, we are ready for strong performance when the markets improve. Again, I would like to thank all of our 6,600 team members for their efforts. I will now turn it back over to Bill for his wrap-up and then questions. Thank you.

Thanks, Brian. Relating to one of Brian's comments here. Everybody on this call, I think, is well aware of the fact that construction in general, nonresidential construction specifically in our case, has declined very substantially -- from peak to what we think is trough has been 25% to 30%. We are 25% to 30% lower on put-in-place construction, 2010 versus 2006. We think the shape of the curve -- this relates to something Brian said -- is probably like a bathtub as opposed to a V. We think we're in a trough and we may stay there for a while.

While there, Comfort continues to execute on its strategy of, one, doing more of what we do currently and doing it more productively; two, focusing on growing the service repair, replacement, and retrofit side of our business and that shows up in current results, of course; three, focusing on energy efficiency in both new construction and retrofit, it's a part of everything we do now; and four, prudently acquiring high-quality operations, especially in jurisdictions where we are not currently located.

I think we've demonstrated all of the foregoing this year and while a very difficult economy frustrated our efforts a bit, we believe that our actions to preserve and indeed improve our fundamental strength will result in our continuing to be and increasing force in the HVAC/mechanical contracting service businesses. And when the economy strengthens, we should be in a very good position to do very well and be an attractive stockholder. With that said I'd like to turn things over to Crystal to see if we can conduct a question-and-answer session. Crystal?

Certainly.

(Operator Instructions) .

Our first question comes from the line of Rich Wesolowski with Sidoti & Company. Please

Thanks, good morning.

Hi, Rich.

The 4Q gross margin number was one we weren't expecting to see for, a year or longer. Would you consider the 18% a typically good fourth quarter given the mix of projects in your backlog, or were there a few uncommonly strong completions that boosted the margin?

I think there's two things. One, within a quarter, there's variability for us. A quarter is a short period of time on the scale of building buildings. So some of it was just good results in the quarter. I think another effect you're seeing is we have a smaller average project size. Smaller projects have higher gross margin. They usually have a little more SG&A involved proportionate to their size. So one of the things you're seeing, I think, is the effect a little bit of project mix. So it's a combination of a good quarter and project mix.

Okay. Has your outlook for construction and service activity changed materially within the last few quarters?

I don't think so, Rich. We-- it's not that we're pessimistic. We just haven't seen enough evidence to be optimistic. I think, as I said, we're in a trough here. Listening to CNBC this morning -- and the only sector where there was a continuing decrease in unemployment was construction. And there's some positive indicators. The Architects Building Index is up which means there's work out there in the pipeline somewhere, and we sense things getting better, but we can't nail it down and so we're not saying we're projecting an upturn here. Brian mentioned -- what he said was, I think, that what we'll -- if we see an upturn it, will be later in the year and in 2012.

Okay. And finally, would you say there have been any large shifts or meaningful shifts in market share for recurring service contracts during the recession? And if so, would you say Comfort has gained or lost any meaningful share?

On the service side of the business, Rich, I'm pleased to report that we've increased our maintenance base and increased our service revenue. So we've taken share and have really done a good job on the service side of the business.

One interesting dynamic inside that, too, is that if you talk to our operations, there are different levels of maintenance contracts ranging from very, very bare bones doing the minimum, all the way up to full coverage. And, over time, a lot of people, even who kept maintenance contracts, reduced their levels. And so if -- where we've seen -- continue to see stability and overall increases in our maintenance base, that's pretty impressive in light of the fact that some of the existing customers that you kept -- we measure it by revenue -- you're getting less revenue from. In order even to keep a maintenance base stable right now, and even if you're not losing too many customers, you've got to be selling because you're getting less revenue per customer just because of the way their purchasing decisions are working. You would think that when things get better, you'd have an opportunity move back up that ladder.

You would say that the service market as a whole has shrunk during the recession but by a lesser degree, of course, than construction?

Yes, I would -- yes, I think you're right.

Okay, thank you.

Our next question comes from the line of Matt Duncan with Stephens. Please proceed.

Morning, guys. This is Jack Atkins on for Matt. Congrats on a great quarter here.

Thank you.

My first question, guys, relates to your end markets. I was wondering if you could talk for a minute, just kind of go into some detail about your various geographies and end markets. And maybe, if you could kind of give us a sense for if you're seeing any rays of hope out there to think that maybe over the next six to nine months some work could start flowing forward for you guys here.

I'll say something very general and turn it over to Brian. One encouraging thing is we have seen some greater activity in the west. It certainly has been the weakest area for us -- Phoenix, San Diego, et cetera. We've seen some rejuvenation in those markets. Nothing to set any records, but we've seen some comeback there. Brian, you might want to comment on other areas.

Right. Jack, particularly in the Northeast and the Southeast, Eastern Mississippi, we've had very good bookings in January and February. What we're seeing there is still the same profile we've had before from the medical, government, and education sectors. Increased activity, projects getting a little bit bigger. So, in terms of end market strength Northeast and Southeast -- Bill hit the West which is improving but still pretty slow -- but the east side of the Mississippi is hanging in there, for sure.

Okay. That's helpful and then, Bill George, just to touch on the gross margin in the fourth quarter for a moment. Looking out to 2011, specifically towards the first quarter, I know you guys had a good gross margin performance in the fourth quarter. Do you expect, going forward, the gross margins will kind of fall back into that 16% to 17% range, or do you think something north of 17%, 18% is sustainable?

Well, I never expect a first quarter to have good gross margins. It's a tough quarter and, we're scratching our head a little bit about some really, really bad weather shutdowns, some jobs probably lowered productivity. I don't know that it's enormous, but in a small quarter that can have a decent effect. I think that the first quarter will be within, sort of, the relative step ranges that you've seen, that you saw last year. I think it will certainly -- it's always been a step down from the fourth quarter and I would absolutely expect it to be a step down from a fourth quarter that's as strong as this. So the question is can we control our SG&A? And I think we can be profitable, but we're in a time like this that's -- we're probably happy with just being -- profitable in the first quarter.

And then thinking about the full year, are you seeing anything in the pricing in your backlog to indicate to you guys that maybe gross margin would be meaningfully higher or lower than the 17% that you guys put up?

I'll comment on that and then see if Brian wants to say anything. I think that we -- we really aren't seeing anything in the sense of stuff actually coming into numbers. There are atmospherics that are better, but even that, assuming we begin to book work. Any work we start to do this year, even if the recovery starts to come through will be at the beginning of that work. We'll load it with margins that are conservative. We don't take profits out of job until we are very, very sure we have them. So you put all of that together, I think you -- I think 2011's going to be a lot like 2010. I'd love to see backlog start to build later in the year, but I just think we're going to be happy to be solidly profitable, flow some cash, do some acquisitions and, if we do that, it's going to be a great year for us because of what it will mean for the future.

Okay. That's helpful and then last thing, looking at the SG&A line, you guys saw pretty substantial increase in SG&A sequentially on a modest increase in sequential sales. I was wondering if you could maybe comment on how we should think about the SG&A line in 2011 either on sort of a dollar terms or as a percentage of sales.

If I had to take -- set the over/under I'd make it equal to this year with one difference and that is we will have the full-year effect of ColonialWebb. Keep in mind we had a $1.00 increase this year but that was ColonialWebb. It was a $1.00 decrease if you take out the actual -- they got to have a certain amount of SG&A to run their company and they're a pretty big horse to come into the barn. So I think what you'd see is a continuation of what you saw more in the third or fourth quarter. So some additional SG&A dollars in the first and second quarter, although with revenue. So I would expect the SG&A percentages to be similar. So I guess having said all of that I'm coming around to a similar SG&A percentage on slightly bigger revenues and sort of based off of what you saw.

I'm just trying to wrap my arms around how to think about SG&A as a percentage of sales, given you've got amortization flowing through that line with the acquisition of ColonialWebb. As a percentage of sales how should we think about that, then?

I'll be honest with you. When I was talking about SG&A, I was talking about it without giving -- not worried about amortization. Most amortization flows through the SG&A line. Most of our amortization is from ColonialWebb so, the rate it was flowing through in the sixth quarter -- I mean, sorry, in the fourth quarter is the rate you're going to see. Sorry, didn't tell you guys about our sixth quarter, but no. It's similar to the rate. You're going see it flow through -- the amortization part of that flow through at rates very similar to the fourth quarter because most of the amortization that we put on the books for ColonialWebb related to customer lift. And although that comes down a little each quarter because it is -- it isn't a straight line amortization. It stays pretty high for the first 18 to 30 months.

That's great. Thanks for the color. I appreciate it.

I'd model it off the third and fourth quarter really, even on that line.

Okay. Thank you.

Our next question comes from the line of Tahira Afzal with KeyBanc. Please proceed.

Morning, gentlemen. Congratulations on a very strong quarter.

Thank you.

Just a couple of questions. Bill, you talked about not really seeing material evidence of an inflection or turnaround right now in terms of construction activity in the commercial side. Would love to get a sense what key indicators you really focus on. Do you focus on the amount of bids, the competitive dynamics? What are the things we should be focusing on other than what we hear from sponsors, et cetera to really get a gauge that inflection is now sort of more underway?

Well, we don't have any special crystal balls here. You start at the top, we look at what FMI is projecting, what McGraw-Hill is doing. On average, people are talking about, high single-digit increases in starts, low single-digits increases in put-in-place. We're not saying that that's not possible for us, but it's going to be in smaller projects. We know that. It's going to be in the institutional sector.

We, like others, are concerned about what -- do things happen in the institutional sectors, especially schools, vis-a-vis state and local budgets? So it is just a very, very difficult thing to gauge here. We've got a backlog, and as Brian said, we have had some good bookings in the recent month here, but it doesn't indicate that there's a climb out of this trough yet.

Tahira, one thing that we're, in a sense, we're just reminding people that we're a late-cycle player, right? We actually -- we sense what's going on in the market and it's going to help us, but, it helps us a little later. That's just the fact.

Got it. Okay. And, I guess, investors when I talk to them have already started looking at 2012. I guess the two things to consider at this point would be, obviously, really risk to that stable piece that you've laid out for 2011. What would you consider to be key risk? And then, number two, really in terms of 2012, do you start to see that growth coming back up? Has your visibility really improved on the trajectory being more growthy as you go into 2012 based on what right now?

2012 -- there will be a booking season this summer where I am very optimistic. I think we all are that we'll start to book work and if that happens, that will be good for 2012. What you'll see is you'll see activity levels -- if it materializes the way it typically does, now this is a really special recession. It's been really, really bad. But what you would see if it materializes the way it typically does is, you would see activity levels rise first maybe going into 2012, but certainly in 2012 if you start to see those bookings. Margins will come up more slowly because good construction companies don't count their chickens before they're hatched. They load jobs and they get in there and they do work and they see what the weather's like and how much bedrock there was under the ground and what -- how the general contractor is controlling the job and they make sure they can make good margins and then they start to pull the profits out when they become apparent and clear. So, I guess I would say we're optimistic '12 will be a much better year. I think you'll see that sooner on the top line. The bottom line might stay a little more proportional for a while before it starts to move up and the pricing starts to pull through.

Got it. But I guess you'd start to see that on the margin side just because you've brought down your costs, you will perhaps start to see some operating leverage kick in next year as the top improves?

You know, --

That's the math.

That is the math, yes. That's why I'm here.

We agree.

Fair enough. Thank you very much. That's all I had.

Thanks.

Our next question comes from the line of John Rogers with D.A. Davidson. Please proceed.

Hi, good morning.

Hi, John.

Good morning, John.

A couple of things. First of all, how much risk is there to the institutional market given that it's such a big portion right now? Is there anything out there that could cause that to slow in your mind?

I would say --

Is it hanging on anything or --

It's flattened. It's going to be an offset, to some extent. Keep in mind, when we say the words institutional market, we're talking about government, education, healthcare. Probably the biggest risk to those three is going to be government and the part of education that's highly government dependent. I think if you read -- I guess, if you read the commentary insight that McGraw-Hill prognostication, what you'd see is they think that some weakness in those areas is going to offset some strength that will come back into private, but private has been so low that there's a lot of room for improvement on that side if it would just -- the only place you've seen it so far is manufacturing, but that's -- to me that's pretty encouraging.

Yes. I guess I'm just thinking about is -- those two markets potentially cross.

No. I mean it's definitely going to -- there's going to be an offset there and there's going to be a competition. Will one drop by more than the other is willing to go up, I think -- I think that the other has a lot of room for -- the private side has a lot of room for improvement.

Okay. And is there anything inherently different in terms of the profit potential margin potential between those two segments?

I don't think so.

No. Historically, John, this is Brian, historically it's been pretty much the same if you look over time.

The wild card is the destruction of capacity over the last couple of years. The question is will we get the scarcity sooner because, scarcity leads to pricing and it only takes a little bit of pricing -- apart from whatever might be happening to commodities, which isn't a huge part of our cost of goods sold, the uncontrollable part of commodities. Pricing kind of heads straight for our bottom line. So I think that the wild card -- normally I'd be more concerned, but after a couple years of capacity destruction I wouldn't be surprised if you see pricing strengths come a little earlier than -- a little sooner than usual to that cycle.

Okay. And just -- it's a ways out. Presumably we're going to get this upturn at some point. Do you see initially lower margins than margin compression as that starts? I mean given your conservative manner in terms of booking work, larger project work?

Not lower.

Not lower. It's just that we won't raise. I don't see -- look, strength, any kind of support's going to help some. It just might not help -- it just might -- the real help might be a little slow coming, but I absolutely -- I can't imagine that net strength coming into the market lowers our margins. It might lower our cash balances if we start to make a little bit of an investment in working capital. If you saw a margin effect, the only scenario where I would see that being a logical thing to have happen absent some unknown shock or something is if project size got a lot bigger a lot faster because bigger projects have smaller -- have larger gross margins -- I mean, sorry, have smaller gross margins.

Right. Okay. And lastly, in terms of potential for an upturn versus the last couple of cycles that we've seen, for the mechanical construction business are there any different secular trends here? I mean and I don't know whether it's related to green energy and -- or green projects or energy efficiency or more fire protection or, I don't know, changes from copper to plastic plumbing, anything like that, that we should just be thinking about or that you're thinking about?

Yes. John, the energy efficiency drive is real. There's just no doubt about that. It's real for all of us in the HVAC mechanical sector. We don't have any more, any lead or special sauce, but it's going to raise the level of the water in the bathtub for everyone. I think that's very important.

The other side of our business, of course, is the retrofit side. There is just -- the logic is and the evidence is there is a tremendous amount of future retrofit business. The equipment in place is getting older. It's getting less efficient. It needs to be replaced, upgraded. There's been a lot of technology brought to this area that's not being utilized yet to garner energy efficiency and so that's why this is a good business for the future regardless, and that's why we're sticking to our core business here as well.

The only other thing I'd throw in here is, we certainly do sink or swim with the overall construction economy. There's no doubt about that, but I think we have some real disciplines in place, that they're working for us. We're not reaching too far for projects. We don't have the pressure on revenue growth here. Yes, we're getting share, especially in the service sector, but we're not pushing hard to get every job. In fact, if we're bidding -- if we're afraid of losing a job, we're bidding too low. So we've got some disciplines in the system that help.

Great, thank you.

Our next question comes from the line of Clint Fendley with Davenport. Please proceed.

Thank you. Good morning, gentlemen. Your same-store commentary success that the mid-Atlantic, Virginia, Delaware has been tough lately. How's the pipeline of activity been for ColonialWebb?

ColonialWebb's pipeline is very good, Clint. It's a big animal to feed, but we're seeing good opportunities there. Where there was three years ago, no, but they've got an excellent sales force. They're all over that marketplace. So they're still seeing things to work on.

And I guess any change in your thought? I know Bill George, you mentioned when thinking about their SG&A, it's sort of a big horse to get into the barn. I mean, any changes on the run rate from their SG&A contribution to 2011 and beyond?

I think they have a very, very well run company and I think changes in SG&A are very incremental for that company. Our goal with a company hike that is to preserve its productive capacity that can make so much money when things get a little bit better and we're closer to that things getting a little bit better. I will say on the backlog side if you would look at our mid-Atlantic operations -- well, let me put it this way. If you just removed our two Virginia companies, the rest of the country as a whole, their backlog increased a little bit going to year-end. So the backlog -- there was some drop in backlog in Virginia and I would say that is natural because those are -- they're two large companies there who have a much larger average project size. They're typically going to trail the companies with a smaller average project size. Their trip through the business cycle will trail, by some number of months, the company as a whole. So it's not unexpected that you would see, sort of, them coming through that cycle after other -- after the rest of us might come through it.

Also, Clint, ColonialWebb has a very large service component to it which is -- really helps their profile going forward.

And you guys talked about, just company wide, your gain that you've had on your share of services. Have you seen any material degradation in your margins on that work?

We just looked at that a few days ago and it's -- the margins have been pretty consistent what they've been over the last few years in the service side of our business. So it's been very stable.

By the way, having looked at that with Brian, I think some of that was increased from improvement offsetting headwind from the economy. I think we had some of our operations who have really been going through a process improvement and improving. Overall our margins have been -- have held up in that area, but I don't think that's because they haven't come under pressure from ambient conditions. I think that they've been able to offset that by -- there's a lot of really, really good operational discipline and work happening in many of our service departments across the United States. What Bill said was true and what Brian said was true, about this has been a focus for us and it's really becoming an important part of the culture and the story.

Thanks, guys.

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

Great. Good morning, guys, nice quarter.

Morning, Adam.

I just wanted to ask you, as it relates to the way your stock is trading and the valuation you're trading at, it would seem to me to imply that the market is -- you're really forward-looking or assume that you guys are being conservative on the outlook, i.e. you've gone through an awful non-res downturn. The downturn has been a V and it feels to me like the market is, in your valuation, assuming that upturn will be a V even though you guys are kind of telling the market to assume that it's more flattish, more U-shaped, more of a long haul to a recovery. And I just wonder, Bill, George, in the past you've talked about the cost to build a building and now commodities prices are going up, some cost is going up. I mean, are there people on the sidelines, are there companies on the sidelines that are looking to build a building or is financing getting better? I mean what's the scenario where you do get a V-shaped recovery?

Well, Adam, we'll certainly take the V if you can arrange it. It's not necessarily that we're conservative. I think we're -- and we're not pessimistic. We're just evidence-based. We want to see it before we say much about it. The indications are there. As to the stock multiple -- the multiple in the stock and everything else --clearly that there's a lot of discounting in the future. We'd like to think it's because we're pure play in a very interesting sector and we're doing well at what we do, as well. And that when and if the economy returns, we're right there to take full advantage, but other than that I don't -- Bill is the economist here. Maybe he has got some words.

Playing amateur analyst which you're a professional analyst, there are a couple of other things --

Very professional.

Yes. We pay a yield, right? So, at a time like this if you've got a reliable yield, that can't hurt. We find that we flow enough cash that we think we can do as much acquisitions as we can handle and still reward our shareholders with a dividend. And then I think also -- I think that at least some people who buy our stock think we have some reliability, but we have a very small volume and float, and if you wait to get in until after everything is clear it's not a real easy stock to get into. Unfortunately volumes for everybody are down. If you already had small volumes, your volume is going to be very, very low. So it just may be, to some extent, people are willing, if they feel comfortable, that it's going to work out for them later, they're willing to get in a little early. I don't know.

Well, another thing an evaluation could be telling you is that your earnings potential in the upcoming cycle is going to be much better than last cycle. I mean can you broadly talk about whether that might be the case?

I think you've heard a lot of phrases today about --

Very broadly.

Yes. I think you've heard a lot of phrases today about how we think we're really preparing for the next upturn. We think we're preserving capacity and when other people aren't. We think we're improving our operations. We think that there is a secular trend towards scarcity in the productive capacity that we represent. We think we're building real strong cultural loyalty with a workforce that will allow us to provide a service that's getting more valuable over time. So, I think you -- I think what you're describing -- clearly the people in this room believe that.

And all that adds up to a lot of operating leverage here. Any of these cuts we've made are based on current conditions. Some are based on making the operations more productive on a permanent basis.

Yes. Okay. Thanks a lot for the color, guys.

Sure. Thank you.

That's that does include today's question and answer session. I would like to turn the call back to Mr. Bill Murdy for closing comments.

Okay. We thank all of you for attending, with the exception of Bill George's inadvertent disclosure of our secret weapon, the fifth and sixth quarters, we are what we are here. So thank all of you and we'll see you next quarter on this call. Thank you.

Ladies and gentlemen, that concludes today's conference. Thank you so much for your participation. You may now disconnect and have a great day.