EMCOR Group, Inc. (EME) Q3 2012 Earnings Report, Transcript and Summary

Good morning. My name is Melissa, and I will be your conference operator today. At this time, I would like to welcome everyone to the EMCOR Group Third Quarter 2012 Earnings Call. [Operator Instructions] After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Mr. Gordon McCoun, you may begin your conference.

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

Thank you, Gordon, and good morning, everyone. Welcome to EMCOR Group's earnings conference call for the third quarter of 2012. For those of you who are accessing the call via the internet and our website, welcome, and we hope you have arrived at the beginning of the slide presentation that will accompany our remarks today. Please advance to Slide 2. Slide 2 depicts the executives who are with me to discuss the quarter and 9 months results. They are Tony Guzzi, President and Chief Executive Officer; Mark Pompa, our Executive Vice President and Chief Financial Officer; Mava Heffler, Vice President, Marketing and Communications; and our Executive Vice President and General Counsel, Sheldon Cammaker. For call participants who are not accessing the conference call via the internet, this presentation, including the slides, will be archived in the Investor Relations section of our website under Presentations, and you can get this at www.emcorgroup.com. Before we begin, I want to remind you that this discussion may contain certain forward-looking statements. Such statements are based upon information available to EMCOR management's perception as of this date, and EMCOR assumes no obligation to update any such forward-looking statements. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. Accordingly, these statements are no guarantee of future performance. Such risks and uncertainties include, but are not limited to, adverse effects of general economic conditions, changes in the political environment, changes in the specific markets for EMCOR services, adverse business conditions, increased competition, mix of business and risks associated with foreign operations. Certain other risks and factors associated with EMCOR's business are also discussed in the company's 2011 Form 10-K and in other reports filed from time to time with the Securities and Exchange Commission. And with that said, please let me turn the call over to Tony. Tony?

Thanks, Kevin, and good morning to everybody, and you should be on Page 3 of our presentation. We had a very solid quarter that shows the balance of EMCOR. We earned $0.59 per diluted share this quarter versus $0.47 in the year-ago period. We had revenues of about $1.6 billion, which was 8.4% overall growth and 6.4% organic growth. Our book-to-bill was over 1. Our operating margins were 4.3% versus 3.7% in the year-ago period. Cash flow was essentially the same as last year and represents good performance, especially with the strong growth in our EFS segment this quarter. We continued to show good cost discipline, and SG&A as a percentage of sales dropped to 8.4% in the quarter versus 8.9% in the year-ago period. Let me cover some highlights in the business. In our Mechanical and Electrical segments, we continue a pattern of excellent performance. We expected margins to decline some this year but are well within acceptable levels at a strong 6.9% in Electrical and 4.5% in Mechanical for operating margins. We have never look quarter-to-quarter at margins in these businesses, but look at more long-term performance and pay close attention to our mix of work. We continue to execute well on jobs won entirely in this downturn and have no unusual items affecting margins in this quarter. Bottom line, we're performing the old-fashioned way in a tough market: disciplined bidding, excellent free planning to include the use of BIM or Building Information Modeling and just good site and labor management. We also have continued to execute well on some large industrial jobs we won at the beginning of the year. In the EFS segment, we had a very good quarter at 5.3% in operating margins versus 3.2% in operating margins the previous year quarters, and we are substantially up versus our first half performance. The performance this quarter better represents the performance capability of our EMCOR Facilities Services segment. And you ask, "How did we improve this business so much, so fast, versus the first half in the prior years period? First, our Industrial business had a very strong quarter, especially in serving our refinery customers. We had the capacity available and the technical skill available to react to our customers' demand, and it paid off for us. Second, our site-based business where USM is part of our site-based business, and that's how we prefer to talk about it, had a much improved performance versus first half 2012 and versus prior year. Our legacy business moved through the contract expenses -- start-up expenses we've talked about in the first half, and our USM business showed significant improvement in a seasonally weakest quarter. We are almost at breakeven on an operating income basis in USM, and this is the seasonally weakest quarter. And we are seeing the effect of our improved business development, and just as importantly, we are seeing a pretty significant impact of our cost synergies. Clearly, we still have room to improve, but we like the trajectory, and the numbers are starting to back up the 4 indicators we have talked about and that we track. Our Mechanical Service and Government business also showed improvement. Be clear, there was not a large heat impact in this quarter. Yes, we did more repair service work but there was not much follow-on project work out of that repair service work versus the prior year. This performance validates some of our potential in our EMCOR Facilities Services segment, but we need to execute like this for more than 1 quarter to know we are back to our performance expectations. However, we do like the grade on our report card this quarter for this segment. In the U.K., we continue to perform well in our Facilities business and continue to downsize our Construction business. And really, the downsizing of that Construction business really makes up for the backlog drop year-over-year and against the year-over-year period. We like where backlog is. We wish it would grow. But with a strong organic revenue growth, we like that we had a book-to-bill over 1. We dropped year-over-year, and we talked about why with the U.K. Construction business. However, we are seeing more private sector opportunities in both our Industrial and Commercial backlog, as the amount of private sector work has moved; over 50% versus 37% in the year-ago period. How to summarize the quarter and my opening remarks? Good quarter, good balance, good execution. However, we can still improve. And with that, I'll turn it over to Mark for a detailed financial report.

Thank you, Tony, and good morning to everyone participating today. For those of you participating via the webcast, we are now on Slide 4. As in past quarters, I will begin with certain highlights of our third quarter 2012 results before moving to year-to-date key financial data derived from our consolidated financial statements included in both our earnings release announcement and Form 10-Q filed with the Securities and Exchange Commission earlier this morning. Consolidated revenues of $1.61 billion in the quarter are up 8.4% from 2011. Organic revenue growth in the quarter is 6.5%. All reporting segments, other than our U.K. segment, reported positive revenue growth during the quarter just ended. Revenues attributable to businesses acquired of $27.3 million positively impacted our U.S. Facilities Services and U.S. Mechanical Construction Services segments during quarter 3. Domestic electrical revenues increased 9.9%. Domestic Mechanical quarterly revenues increased 8.2%. Facilities Services quarterly revenues increased 12.7%, and our U.K. segment revenues decreased 11%. Revenue growth within the domestic construction segments can be attributed to increased activity within the industrial and commercial market sectors, while the organic growth within our domestic Facilities Services was predominantly due to higher revenues from our Industrial, Government and Commercial Services businesses. The decrease in revenues from our U.K. segment is the result of the plan for de-emphasizing their engineering and construction operations and focus on the Facilities Services business. Selling, general and administrative expenses increased $2.7 million within the quarter and that's inclusive of $2.8 million of incremental SG&A from those acquisitions completed from between September 30, 2011 to the current date. As a percentage of revenue, SG&A in quarter 3 is 8.4%, which represents a 50 basis point reduction from last year's quarter 3 percentage of 8.9%. Please turn to Slide 5. Operating income of $68.6 million represents 4.27% of revenues and compares to $56.5 million of operating income and 3.81% of revenues in 2011's third quarter. All reporting segments, other than U.S. Mechanical Construction at EMCOR U.K., reported increases in operating income quarter-over-quarter. Operating margins by reporting segment are as follows: U.S. Electrical, 6.9%, U.S. Mechanical, 4.8%; total U.S. Construction, 5.6%; U.S. Facilities Services, 5.3%; arriving at total U.S. operations of 5.5% as compared to 5% for the third quarter of 2011. And U.K. Construction and Facilities Services was flat at 1.3% for both periods presented. 2012's third quarter U.S. Mechanical Construction Services segment results were down 170 basis points quarter-over-quarter, as 2011's third quarter was favorably impacted by the resolution of uncertainties in certain Hospitality projects. Our third quarter U.S. Electrical Construction Services segment operating margin of 6.9% were improved from the year-ago quarter's 5.9% of revenues and benefited from profits recognized in several projects within the industrial, water & wastewater and institutional market sectors. Facilities Services operating margin increased due to improved performance from our Industrial Services, Commercial site-based services and Mechanical Services division. And as Tony previously mentioned, our Commercial site-based services performance within the quarter was improved from quarter 3, 2011, inclusive of the U.S. segment coming out of one of their seasonally weakest quarters. Additionally, this segment results benefited from a $3 million reduction in a liability for contingent consideration related to certain acquisition earn-out arrangements. Consistent with our second quarter performance, EMCOR's U.K. Construction and Facilities Services operating margins decreased due to their engineering division reporting an operating loss, which unfortunately offset improved operating margins from their Facilities Services operations. Our income tax provision for the quarter is reflected at a tax rate of 40.5%, which is slightly more than the 2011 quarter 3 rate of 39.4%, due to unfavorable discrete items attributable to the reduction in our United Kingdom deferred tax assets due to the reduction in inactive tax rates, as well as the finalization of the revenue Canada tax audit for pre-disposal ownership periods. Consistent with my quarter 1 and quarter 2 commentary, I still anticipate that our full year 2012 rate will approximate 39%. Cash provided by operations for the third quarter was $53.6 million, which represents a slight improvement over the $52.4 million of cash provided by operations during 2011 third quarter. For the 9-month period, cash provided by operations is $42 million compared to operating cash flow of $58.7 million. The variations in both 2012 reporting periods is due to reduction in our net over-billed contract position from year-end 2011. With regard to cash used in financing activities, we utilized $2.7 million of cash on hand to fund share repurchases within the quarter. Additionally, on a cumulative basis, we have expended approximately $51.4 million of our authorized program amount. Please turn to Slide 6. Additional key financial data on the slide not addressed during my highlight summary are as follows: Quarter 2 gross profit of $203.2 million represents 12.7% of revenues, which is up $15 million from the comparable 2011 quarter. Restructuring activities in the current quarter amounted to about $100,000 and were U.S. related. Diluted income per common share from continuing operations for the quarter is $0.59 compared to $0.47 per diluted share 1 year ago. I'm now on Slide 7. Our results for the 9-month period ended September 30, 2012, are depicted on the slide. Revenues increased 15.6% to $4.7 billion, with all reporting segments generating higher revenues in the year-to-date period. Consolidated organic revenue growth for the 9 months is 8.9%. Our U.S. Mechanical Construction and U.S. Facility Services segment generated revenue increases of 21.2% and 19.6% in the year-to-date period, respectively, from both business acquisitions to acquisitions in organic activities. Year-to-date gross profit is $577.9 million, which is higher than the representative year ago period by $58.3 million and is 12.2% of revenues. Our gross profit margins on a comparative basis are down period-over-period due to project mix, most representative within our U.S. Mechanical Construction segment. SG&A expenses of $406.7 million represent 8.6% of revenues compared to 9% of revenues for the corresponding 2011 period. Excluding transaction cost incurred in connection with the acquisition of USM from 2011's results, SG&A as a percentage of revenues would be 8.9% for the 9-month period ended September 30, 2011. The absolute increase in year-to-date SG&A expense levels is due to incremental SG&A from businesses acquired, as well as incremental SG&A necessitated by our organic revenue growth. Despite this increase, we think we have been successful in reducing the relative percentages as we continue to leverage our cost structure. Year-to-date operating income is $171.1 million or 3.61% of revenues and represents a $22.7 million increase over 2011's year-to-date performance. Diluted earnings per common share from continuing operations were $1.48 for the 9 months ended September 30, 2012, compared to $1.24 per common share in the corresponding 2011 period. On an adjusted basis, reflecting the add-back of transaction costs associated with our acquisition of USM, year-to-date diluted earnings per share for 2011 would have been $1.29. Please turn to Slide 8. EMCOR's balance sheet continues to remain strong, with sufficient liquidity as represented by of $474 million of cash, which is available to meet our current working capital requirements, as well as for organic and strategic investment opportunities, as well as being available to fund our quarterly dividend and any activity under our current share repurchase program. Changes in goodwill relate to 2012 acquisition activity and the finalization of purchase price accounting for prior acquisitions, while the decrease in identifiable intangible assets is due to year-to-date amortization expense. Total debt is essentially unchanged since December 31, 2011, and our debt-to-capitalization ratio remains low at 10.51%. EMCOR continues to do a good job of managing its enterprise risk, and our balance sheet reflects our consistent self execution. With my portion of the commentary concluded, I would like to return the presentation back to Tony. Tony, it's all yours.

Great. Thanks, Mark. Let's talk about backlog. You should be on Page 9. Backlog in the third quarter stands at almost $3.4 billion, which is $98 million above quarter 2's level, which means we had a book-to-bill of over 1 for the quarter. On a year-to-date basis, backlog is down $160 million, $163 million, and all of that decrease came from the U.K. operations. In fact, domestically, we're up year-over-year. Total backlog is up from year end, and we continue to see demand from the Commercial and Industrial sectors, with a little bit of offset in reduced productions in the public sector work. We will remain disciplined with what we bid, and of course, we've got to work with what the market gives us. Backlog development looks pretty good right now. Commercial, Hospitality and Industrial, real private sector work -- remember, we talked about health care somewhere in the middle, we've talked about it more like public sector, it's about 50% of that $3.4 billion total; 1 year ago, it was 37%. As Mark pointed out, we've got almost 16% revenue growth year-to-date, and total backlog, you can see it's up about 1.6%, so basically flat. Obviously, we're providing more work outside of traditional backlog. We continue to perform more fast-paced work, obtained and completed within a quarter. And also, we're working on some pretty technically advanced projects in the Industrial sector that have never really been in backlog as we work off of a purchase order and a unit price. We're executing well on these projects, and they're owner-direct, time-sensitive and complicated, and they need to be completed as quickly as possible. We hit the ground running here. Like I said, we work on a purchase order basis. We're working on the design, design/assist and the build construct. And they have an immediate need to get this facility up, and they like to hold the decision-making. Sometimes they end up in backlogs towards the end of the job and sometimes they don't. We have the skill sets, experience and flexibility required to accommodate this type of fast-paced schedule. Either way, it's great work and uniquely suited for us. As you look at the third quarter bar chart, it's easy to see the increase in Industrial backlog, which is pink. Kevin, one day we'll figure out why it's pink. Industrial backlog is up approximately $280 million from September 30, up from $240 million year end and over $630 million. It represents 19% of our backlog. I'd like to just point out on this chart -- just everybody, take a step back and look at this. What you can see is a company that's nimble and agile as it moves through an economic cycle and keeps invested ahead of what the next trend and next uptick will -- we either do that through acquisition or organic investment and capability building. You can see that Commercial was very strong in 6 and 7, and Hospitality, they both came up. You see the increase in Commercial come up. Some of that came from investment. You can see that Hospitality -- look, we did tremendously well supporting the gaming market, mostly in Las Vegas, and it came down and we executed that work in a terrific manner for our customers. Health care is not going to disappear much like Hospitality did. But it's episodic and people are right now trying to figure out what is going to go on with the health care law. Clearly, we'll need some more acute-care facilities, and that's where this backlog really increases. But you can see Industrial, and we've got ahead of the Industrial curve. We have a terrific team operating. Remember, the acquisition with Ohmstede? It's nowhere near where it was, but backlog is creeping its way back up. And the only thing in backlog here in that part of our business is the new stock build. The repair work and the field service work are not in backlog because it's usually finished within a quarter or it's done on a unit price basis. But it goes beyond the investment we've made in the refinery sector and it goes to, it speaks to the investments we've made organically in companies like Shambaugh & Son and the terrific performance they can do on the food process work. But beyond that, with Southern Industrial, with Bahnson and some long-term EMCOR stalwarts like Contra Costa and PMI, which was bought now a long time ago, almost 5 years ago. So what it shows is an agile team and institutional market remains strong for us and was added to the organic growth of EMCOR Government Services and the addition of Bahnson. We like our backlog mix. We like our ability to invest and grow, and it's been a pretty good story here. And it really speaks to our ability to win in a difficult marketplace but not a marketplace without opportunity. And with that, I'd like you to turn to Page 10 and 11, and I'm going to give you a wrap up on this call so you can ask some questions. We're going to go ahead and raise guidance to $2 to $2.10 a share. Basically, we're bringing the bottom end up $0.20 and the top end up $0.15. We're going to raise revenue guidance to around $6.4 billion. And everybody's going to ask about visibility. I have about as much visibility as everybody else has, and it's about 120 to 180 days at most. You know, we've quit worrying about that here at EMCOR. We might have been some of the first people talking about almost 5 years ago, we're going to worry about what we can worry about and operate in the environment that we have. And how do you do that? You do that because you're flexible. So in this period of economic decline, slow growth and uncertainty, we've focused on the fundamentals and we've blocked out areas we can't control, but we're very aware of them. I don't control things like government regulation, environment, customer uncertainty. I can try to help customers feel less uncertain about the things EMCOR is going to do with it. What do our folks control? We control cost, bidding discipline, planning, investment, restructuring, productivity and safety. So it makes setting guidance difficult. And you've seen us move up through the year. Because visibility in a market like we've been for the last 4 years, is a lot like San Francisco on a late July evening, really foggy. However, when you're in that environment, you get stronger and we've learned to be more flexible and more responsive than at any time in our history. We're carefully balancing keeping the right resources so we can respond to our customers as they look for immediate execution on highly complex tacts once they've decided to move ahead. And we don't plan on letting those customers out. We can do that because we have the skilled operators. And these folks are terrific, these men and women. They're close to their markets and they're close to their customers, and that's both at our business unit level and also in our field subsidiary level. We can say that the smarts and nimbleness of our field leaders have made EMCOR a success in a tough and uncertain market. I know for the team sitting around this table right now, we're appreciative of that. However, we can't help but imagine what we could do in an economy with a little bit of tailwind and a real growth trajectory. And with that, Melissa, I'd like you to open up for questions.

[Operator Instructions] Your first question comes from the line of Alex Rygiel with FBR.

Tony, a couple of questions. First, as it relates to your guidance of $2 to $2.10. That does suggest that the fourth quarter's $52 million to $62 million. And you did $59 million in the third quarter. Traditionally your fourth quarter is the strongest, although your business has changed a little bit over the last couple of years. But what is it that gives you some caution that suggests that EPS in the fourth quarter could be down a little bit from 3Q?

Alex, for us, it's mainly macro. Our customers, with all the uncertainty and the way people have reported in the last 2 weeks, big industrials, you wonder if they're going to abruptly turn off the spigot. They can tend to overreact now. It can go from the CFO to the shop form within 2 days now. I don't think that's going to happen, but I think it's a little bit of caution on our side that it could happen. But right now, we see a pretty good business in the fourth quarter. We'd like a little bit of weather to help us. Normal weather patterns would help on the facilities side. But execution is pretty strong across-the-board right now. But it's just caution to macroeconomics, Alex.

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

We are making much more progress to those good days. Look, let's talk about the business overall through the cycle. The business is bigger than we described, and we can send everybody back to the December 2007 8-K that really will outline the business in detail. But look, this is a really good business, and especially a really good business in a good cycle. This is a business that can operate mid-teens, and it goes beyond just Ohmstede on an EBITDA margin basis. We're not back to those levels yet. We need a little more volume, and we need a little more mix to get there. So the way to think about it is, if 100% was 2008 and 2010 was 40% or 30%, we are making progress going from 30% or 40% to 100%. We're not even -- we haven't even achieved a gentlemen's fee yet there, Alex.

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

Based on what we know right now, we'll have a de minimis impact from sequestration because we're not in a program [indiscernible]. We come out with an annual budget. The second point is, for most of the business on the maintenance side, the government's been in break fix mode for at least 5 years and as our very seasoned gentlemen that runs our Government Services business said, "Once you get to break fix, it's hard to go below that." On a Construction side, these are funded projects. It would be hard to see how they would be part of sequestration. Based on the advice we've gotten, most of it's going to happen on the program product side.

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

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

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

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

No, actually I didn't say that. I said the Ohmstede shop business has been good. The Ohmstede field business came back. The Ohmstede shop business has been good for at least 1 year. It's maybe weak compared to where it was -- it's not even weak compared to where it was 2007. It's rebounding nicely. And could it? Yes. I mean, the building materials for a heat exchanger in a chemical plant is lot less than the building materials for heat exchangers in a refinery. That being said, our field service operations could operate those plants someday, and we have expanded Ohmstede's ability to operate and do repairs beyond just refinery and they are servicing some chemical plants for those plants to get up and running. But in a broader sense, Adam, any time technical labor is being absorbed and a highly skilled technical labor, which is what will build those chemical plants and ethylene crackers, that is a good day for EMCOR. Because as a demand for welders, pipefitters and electricians, instrumentation technicians, as the demand for that increases, which it has in the last year now -- there's still an unhealthy level of trade unemployment in the market. But as those plants come online, that's a good thing for EMCOR.

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

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

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

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

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

Okay. If I add up the share of backlog in commercial, industrial and hotels, it's about half the pie versus just more than 1/3 of the backlog 1 year ago. All else equal, should we not expect that change to push your operating margin higher in 2013?

We've got to really get after the mix of work because part of what happens when you do the bigger industrial work, you work as a prime contractor, and so we may get more margin dollars. The percentage may be a little more. You've seen some of that in our Mechanical business year-to-date. It's good work. We like it. It's because we're a prime; it doesn't mean it has a lot more risk, but when you pass-through other subcontractors, which we typically don't do in our work, you have less ability to mark it out. So that's a phenomenon we'll be fighting as we go into next year. And look, key to us is to continue to improve in the EFS margins which, I said, we've got to see more than 1 quarter on the tape before we believe that.

Okay. Then, along a similar vein but looking maybe a little further out, in the Construction specifically, your combined electrical mechanical margin, which I'll call your Construction business, if you look back to '05 and '07 when Construction was great, it was between 4% and 6%. And in 2012, you're going to run between 5% and 6%, the upper half of that range. What's different between then and now that you'll be able to post these numbers in a poor construction economy? And does that mean we can expect EMCOR to exceed its former construction margins when the cycle eventually does grow shorter?

I'm not sure about the latter comment on "exceed", but here's what I'll tell you was happening in '04 and '06: we were having a hangover. And we had taken a lot of that work in the downturn, and man, it was painful working out of it. I think it -- you were following us then, it was slow on the uptake, as you know. It's part of what you're seeing in the Mechanical service business. Now even though it's only a handful of jobs, it depresses margins for a while as you work through the jobs and get them completed. On the construction side, we had more than our fair share of that. We like where this business is performing now. Anything over 5% is really good performance. I think mix of work has helped, but also, as mix of work is you take larger jobs, you get more margin dollars and sometimes you don't get as high a margin percentage. But it's really good work, absorbs a lot of overhead, and it's big numbers. Working capital fine, but that one, to me, was [indiscernible]...

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

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

No.

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

Tony, could you just expand a little bit more on a prior question on the Facility side? You gave a good recap of the kind of puts and takes for the quarter and why margins were where they were. But with USM basically breakeven now and at a seasonally weak quarter and a stronger seasonality for that business coming up, I mean, what should be the short-term range that we should think about for margins? And then, now that you've had that business for about 1 year now, what -- just remind us of what your outlook of the margin range, going forward, when things are firing on all cylinders?

We're behind where we thought we'd be. I haven't backed off at all, but I think it won't be dilutive to EFS margins long term. And we expect to operate EFS at 5% long term. So both those hold true. The caution you'll hear from us is, we weren't performing for 1 year, at least, where we thought we should be in EFS. And so we're going to let more than 1 quarter run before we declare victory, and make sure that we can hold this mix and make sure that, clearly, that the small project execution has gotten better and that we continue to see the improvement in USM we have. We tend to be cautious on that stuff, Richard, and we're going to keep that stop.

All right. But still, I mean, at north of 5% here in USM and not even breakeven, I mean, that's just -- the math suggests it should be.

It's a little under 5% when you correct for the earnout. Very strong quarter in Industrial, which should happen in the fourth quarter again. No visibility yet on the confirmed turnaround season for the first quarter, we need that to still be strong. We need a little bit of snow. Just last year, we got none. And we need continue to make sure that we don't over-invest in contracts in the front end of it; and keep the project mix where it should, then we should be in good shape. We think we've made a giant step this quarter in seeing that. We need a couple more steps behind that to make sure that we've actually done that.

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

Or you can badger me for the next 10 minutes.

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

All right, Richard, I'm not taking the bait. But I will...

Personal views aside.

Yes. And I will tell you this, I can just tell you what happened. Not what my personal views are or whether it was the right thing or wrong thing. When the 2008 election happened, EMCOR was teed up for pretty significant increase in our Government business. And why was that going to happen? It was going to happen because we had competed and won against the government on some substantial outsourced contracts where the government would save substantial money and it was very good business for EMCOR. And it wasn't a matter of union, non-union or anything like that. We were going to bring some efficiency because we've run facilities like these. And we were going to be able to not have peak workforce there all the time. We were going to able to augment that with people we can bring in and also, through a different mix of scrap because we've done it before. An example is, you don't need overly skilled chiller mechanics if you can call your local company and have the best chiller mechanics in the market come in and just do the task at hand, versus have them standing by for something to catch, probably could happen. We don't worry about that as much because of who we are and the product we have. But that level of work, which were 3 sizable contracts and would have had substantial impact on us between November 2008 and February 2009, were eliminated. I learned a lot about how the Senate can work. Much more than I really care to, on how individual senators can push their own agendas through individual blocks on funding. And we actually employed a lobbyist, and Shelly got a lot smarter than he ever did politically, which is an upgrade. I mean, it happened. We really, really, really pursued this. So that was a negative. I expect almost regardless of who wins -- one will make it happen than the other. The government will go back to realizing it can't employ people and overpay them for things that the private sector can do better. I think we're going to head that way regardless. And that you actually want, especially DoD employees, they're in uniform doing the task, they relate to war fighting and protecting us and not to some of the facilities and logistics that someone like us can handle better. I think the other thing that will open up for us is, regardless of who wins, I think we have a real chance here, a real chance to have an uptick in a rationalization of almost another round of BRAC. And that will be good for us. We do very well in that kind of work. Now going to health care. We're all getting older. Laws like HIPAA, which require privacy and if you go to a new hospital, you notice everybody has their own individual room. The older hospitals can't handle the equipment, and so they're going to be updated and we're going to be building new ones. We expect that to continue. There's a little pause here. There are some jobs on the boards. I'm not sure they're being held up necessarily just because of the health care law, but I think people are making sure they get the design right. And they're going to be able to have the health care facility of the future. I hope that I answered your question and gives you a little flavor, what could happen.

Okay. And then, if any -- with the transportation, water infrastructure, would there be any difference, in your opinion?

No, what we're positioned on are good things. Infrastructure-wise, we continue to compete. Those things can be episodic and then they last for a while. An example of that is the work we're doing with the New York DEP. Those opportunities come up and then they last for 5 or 6 years. And we're well positioned in the key markets to be able to take advantage of that work.

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

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

Well, Industrial will be a bigger part because of the investments we've made over the last 5 years, and some of that, you're seeing the fruition of the investments we made. By nature, our project business is lumpy. Any dang time you put a job in there over $15 million or $20 million, it creates lumpiness. This is more than a couple of jobs that made that happen. And so we have good sector diversity in our Industrial business and we invested -- and it's not only sector diversity, we have good geography, geographic diversity. So yes, it's something we like. There are a couple themes that we're big on. We like the fact that we service refineries in the Gulf Coast to California and some of the Mid-Continent. We like the fact that we have power plant maintenance capability in the Southeast. We like the fact that we have design/build capability and food processing plants. We like the fact that we are well positioned in the Southeast, and we think there'll be a re-shoring of some manufacturing as it comes back from overseas. It's more cost competitive here. We like the fact that cheap natural gas is going to happen. It's going to support really competitive -- the large process industries like paper, pulp, steel and others where we are mining, where we are positioned to help them do maintenance and some construction. So it was something that we've been building for a while now, and it's something that we'll continue to build on and we like the flexibility that we have to service the industrial market.

Okay, that's helpful. And then as a follow-up. I understand your opening remarks, that hot weather was a big impact in Q3 '12. Can you add a little bit of color there? Were there more or less cooling days this year than last? Is there any other way to think about, I guess, why there wasn't a big impact?

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

Yes, okay. And then, just one last question. I mean, thinking about the trend towards more private sector work, is that benefiting your margins right now at all? Are you getting, kind of, incremental margins on those jobs for efficiency or speed, or even the private guys being a little more tight on their spending?

Well, everybody's tighter than they were in 2006 and '07 because you had -- when you have trade unemployment that's still as high as it is and it could be north of 15% or 20% in some markets, you're not going to get the pricing you could. That being said, it's nowhere near as bad as it was in 2009 and 2010.

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

Tony, just going back to your comments when you talked about the backlog patterns over the last, I guess, 6 years. If we were to look at this chart, going out and thinking about these markets over the next 2 years, is it the commercial industrial markets that could have the opportunity to substantially be the drivers to the cycle? And then as a follow-up on that, do you have to do anything structurally, either acquisitions, expansions to position yourself to take advantage of that?

I think we should expect stability, maybe a little downdraft, but probably stability for the most part, because we are on the maintenance side in the institution. But let me try to talk to -- I think transportation and water & wastewater are what they've always been. They're going to come up and down and we may win a big job, and that will filter through the numbers over 3 to 5 years. I think institutional is a little more stable than it is for a lot of people because we have a pretty heavy maintenance base in there. Our health care, I would expect it, maybe 1 year from now, 1.5 years from now to start to expand a little bit again. So you go to your question, John, do I expect industrial, commercial to be more of a driver? Commercial's always a driver of our business in a good cycle. Compared to other cycles, industrial will be more of a driver this time than it has been in the past.

And...

And as far as acquisition?

Yes.

When I think of acquisitions I always think of, we've got 6 great places we can still invest at EMCOR. We will always make a good electrical and mechanical construction acquisition. We're good at it. There's people that would have preferred to borrow it, we can make a fair deal on both sides, and we still have some geographic white space where we'd like to put a big contractor in place to do mechanical or electrical construction to serve the world market. On the Industrial side which, for the most part, resides in our Mechanical segment, and the Construction side, we will continue to look out of there. You saw Southern, you saw Boston, we will continue to look out of there. Electrically, I think it's the same story as what we were talking about on the Mechanical side. We still have some white space to fill in. As you move to the right, think of the business units that make up the Facility segment, they're all -- have basically the same theme. They work directly for owners 80% of the time. They have a base contract, for the most part, where they keep in contact with those owners, and they do project work on top of that. And if you look at those businesses, we have -- the site-based business where USM is, there's not a whole lot more acquisition we would need to make there any time soon. We need to grow organically from where we are today, continue to integrate and start to see the kind of success of -- rate of improvement we saw in the third quarter. I don't want to call it, necessarily, success yet. It's a rate of improvement we'd like to see. As you go out, you look at the Government business, we would look to buy capability there. We don't need to do anything grand. The buying capability will allow us to expand the scope of the work that we would bid. So logistical services, cleaning services for health care and medical facilities would be something we would look at. We will always look to build our higher margin intelligence work there. Going out further in Mechanical Services, I think it's the same comment as I had on Electrical and Mechanical. We still have a little bit of white space on the map that we would fill in by buying a significant Mechanical Service contractor. And then finally, Industrial, we would always look at Industrial Service contractors. An example of something that happened, we didn't buy a company, but we had looked for a while that we need to add cleaning capability for the bundles. And Ohmstede, we thought about -- we did a make-versus-buy analysis essentially, and we added probably the best cleaning stand in the ship channel, and we expect that to really pay off going into the next turnaround season next year. So that's how we think about acquisition. We don't really need to step out and do anything crazy but we have nice businesses we can grow and invest in organically and through acquisition.

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

Yes.

So if it's running at breakeven now, how far away are we from getting back to those levels? I mean, is that something we'll see in 2014, '15, or do you think it's going to happen sooner?

We need to make some progress to get there, right? So it needs to happen sooner. I look out, I think your timeline is about right to get to the full run rate. We need to get that season where we have normal weather before we feel comfortable really, to comment on it, because we got our teeth kicked in a little last year on some of our assumptions on the weather and its impact.

Okay. But relative to your earlier comments about the aspirations or--

And expansion.

But I mean, it should be higher than the 5%, if that just starts contributing.

It could, but again, we need to put more than one grade on the report card. And we've got -- Shelly made an A one time in math. [indiscernible] He wants to correct my writing all the time, so he must have done pretty well in English.

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

I missed a little bit of the call because of technical difficulties so I apologize if this has been asked. But on USM, can you just speak a little bit to this business development side. I know you had 2 large contract wins early in the year. Have there been any additional wins? And then, how's the pipeline looking on that side?

It actually is better than winning 2 large contract wins. What we really wanted to do is stem the renewal -- the loss of customers, improve the renewal rate, and we can put a check mark there. The guys I work with are never happy until you get to 90 percent plus. We're not there yet, but we're certainly a lot better than we were. So that's more important even than the contract wins were. Second thing was, can you add existing sites and grow with your existing customer base? Again, that's the lowest risk way to grow. And can you add additional services? So what we're starting to say is, so if we had a customer where we were doing 400 sites, and we're starting to add 40, 50 sites a quarter to them, that's the best way of growing the business, and we're starting to see real progress there. Our content management's gotten better. We made a couple of key hires and promoted some internal folks. It's amazing, you get into a business that you didn't know and maybe it was struggling, you start to learn there are people that really want to step up and work with you for the long term. And so some people have seen their horizons expanded, and they responded in an outstanding manner. And finally, were starting to do much better job of linking our procurement side, which is critically important, to what we promised the customer and make sure that we are sourcing appropriately to the margin expectations that we have for that account. So business development has not only improved from a new customer acquisition, but more importantly, from a customer retention and customer penetration perspective.

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

You always have to be careful in anything in this economy calling it, it's going to sustain from here on out. Because customers are showing the ability to make decisions. And that's why you hear the caution in our voices. I mean, you can say in some ways we're like a battered child as a service provider, right? People have made promises to us and they haven't kept them and then we react to them. And so we don't believe everything. We don't staff the full way up now until we see the demand, and we want to make sure we keep our best technical capability on board. All that being said, we are very, very optimistic about our technical capability and the product offering we have that we've expanded with the extension of this watchstand. And we've shown in the third quarter, when customers need us to respond and other people can't respond, that Ohmstede and EMCOR and EMCOR Services and EMCOR Construction Services have the ability to respond to that demand.

Okay. On the U.K. business, you've de-emphasized the construction part of that business. Is there another leg down here or are you largely complete with that downsizing? And can you just comment on, kind of, where you see run rate, U.K. revenues leveling out?

I think the revenue run rate you're getting close to. I think, the mix, we're going to continue to push more towards Services. As we push the mix more towards services, we should start seeing the margin uplift that we expect. This business, actually, has probably had its best 2 or 3 years sustained. But that team has higher aspirations for itself, and we have higher aspirations for them.

Your next question comes from the line of Saagar Parikh with KeyBanc Capital Markets.

A lot of questions have been answered. I know USM has been beaten down with questions. So Tony, what really surprised you in the quarter? What surprise you, overall, from what you were thinking 3 months ago on the earnings call or 6 months ago? What changed in the last 3 to 6 months that makes you more positive on the future?

Well, it makes me more positive, for sure, for the rest of the year. What makes me more positive for the rest of the year? One is, we've got performance to-date that's pretty good. A good strong organic growth, good drop through, SG&A under control which, we don't usually have a big problem with that, but we are actually performing -- any time we can be in the mid-8s, we're doing pretty good on SG&A. Sector composition; it's over 50% private, we like. What's surprising in the quarter is the level of work we did in our Industrial field business. We knew we were going to do more this year than we did last year, but I think our performance from the folks in the field, had the customer even had given us more than they would other contractors. We responded. And when you respond, the customer responds. I think what surprised me, and I think it surprised Mark and also Kevin, is the synergies really started to take hold in USM. You saw it on the cost side. So what we said we saw happening, and we said this is what was going to happen, we started to see that really start to happen. I think we continue to see, on the Government side, good strength where we can help the customers keep their facilities running in a break fix mode that they've been at, and we continue to win important new customers. So regarding the surprise, then, I'd say pretty simply, less impact from the heat, more impact from Industrial, more fall-through on synergies and we really did turn around those contracts like we thought we would from the first half.

Great. And then to follow-up on your cash allocation. I know you guys have around $48 million or so remaining in share buybacks. You have the dividend in place. I know you talked -- answered Tom's question with a detailed answer with what you're thinking on -- or where you could look at acquisitions. Just asking question more broadly and on looking at those 3 aspects. There have been dividends, share buybacks, acquisitions. Where would you focus here or where are management and the board focusing their priority right now?

The priority, always, is just to create value, right? And you create value in a number of different ways. The best thing you can always do is to invest in working capital and with the marginal amount of CapEx that we put in this business, then look for opportunities to make yourself -- and restructuring to make yourself more efficient. To give your folks better things to work with, to give them other arrows in their quiver, always the best thing to do on an organic basis. To bag the right resources to be able to grow your business organically. That's always the best thing to do. Second-best is to build new capabilities through acquisition or that augment what we already have. And we talked about that. So they would be always the first 2 priorities, but always sticking to what we know how to do. And then you have to say, okay, if I have cash and I am not going to need it for the first 2 anytime in the near-time horizon, do we buy back shares or do we have a dividend? We have both now and we've made pretty good progress on the buyback. For our cost-more shareholders, that will never be enough. I think the world's littered with people who buy back shares at the wrong time. And we're a midsized cap company, and we tend to be careful of that. And on the dividend side, we have a dividend now. And that's a big step for us and we'll let it run here for the next year, and we'll see where it stands, with more things as time progresses. You put it all together, we have a good capital allocation strategy. Let's be clear, this business should never run -- be run at high leverage. It's just not what it is. Even on a good day, at mid single-digit margins, you don't lever up. And we do need a couple of hundred, $250 million balance sheet to respond to working capital. And of course, we're big users of surety credit. And the surety likes to see that cash sitting there. And we're one of the best surety credits out there, and it's a real stress for us to never have to worry about whether we have to bond a job. So put all that together, yes to all, Saagar.

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

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

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

Thank you, Melissa. Look, I appreciate you all getting on the call this morning. Pretty good quarter. We've got a lot of work to do. I just temper everybody all the time, I mean, anybody that says they have great visibility in the environment we're working in right now either knows something that we don't know -- you're either 1 of 2 things if you say you have great visibility. Either work with something with tremendous backlog that has great program characteristics to it or you just prefer to talk about things you don't know anything about. We don't fall in either one of those categories. So we'll stick to what we know. We'll operate well, be flexible and show our ability to move between different markets. I thank you for interest in EMCOR, and I hope everybody has a safe day. Bye.

This concludes today's teleconference. You may now disconnect.