Apr 24, 2008
Executives
Eric Boyriven - FD Kevin Matz - EVP of Shared Services Frank MacInnis - Chairman and CEO Tony Guzzi - President and COO
Analysts
Alex Rygiel - FBR Capital Rich Wesolowski - Sidoti & Company Tahira Afzal - Keybanc Capital Markets John Rogers - D.A. Davidson Richard Paget - Morgan Joseph
Operator
Good morning. My name is Casey and I will be your conference operator today.
At this time, I would like to welcome everyone to the EMCOR Group's first quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise.
After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) I will now turn the conference over to Mr.
Eric Boyriven of FD. Eric Boyriven Thank you and good morning, everyone.
I'd like to welcome you to the EMCOR Group conference call. We're here to discuss the company's 2008 first quarter results, which were 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. Please go ahead, Kevin.
Kevin Matz
Thank you, Eric and good morning, everyone. Welcome to EMCOR Group's earnings conference call for the first quarter of 2008.
For those of you who are accessing the call via the Internet at our website, welcome and we hope you have arrived at the beginning of a slide presentation that will accompany our remarks today. Currently everyone accessing the slides should be on slide one, which is the EMCOR title slide.
During the call, instructions will be given for you to advance to the next slide. This is one of those times, so please advance to slide two.
Please advance to slide two. Slide two depicts the executives who are with me to discuss the quarter.
They are Frank MacInnis, our Chairman and Chief Executive Officer; Tony Guzzi, President and Chief Operating Officer; Mark Pompa, our Chief Financial Officer; Mava Heffler, our Vice President, Marketing and Communication; 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.
You can find us at emcorgroup.com Before we begin, I want to remind you that this discussion may contain certain forward-looking statements. Such statements are based upon information available to EMCOR's management 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 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 of the risks and factors associated with EMCOR's business are also discussed in the Company's 2007 Form 10-K, it's 10-Q filed this morning for the first quarter ended March 31, 2008, and in other reports filed from time-to-time with the Securities and Exchange Commission.
With that said, please let me now turn the call over to Frank MacInnis. Frank.
Frank MacInnis
Thank you, Kevin. Our telephone listeners can't see this I know, but, Kevin, I actually did that entire performance without moving my lips.
Good morning, everyone and welcome to our 53rd regular quarterly conference call for investors, analysts, and other friends of EMCOR Group. Today's call is being conducted as usual, by telephone and by simultaneous webcast.
And I'll be referring from time-to-time to a slide number to identify the relevant slide for webcast participants. Right now, we're still on slide number two.
The focus of today's call would be on the 2008 first quarter earnings press release and Form 10-Q that we issued and filed earlier this morning. We'll conduct this call in our customary way.
First, a discussion of the highlights of those operating results including our breakdown by segment and my comments on our quarter end balance sheet. Then, I'll discuss the evolution and the current status of our contract backlog portfolio with special emphasis on those factors that we think will be the most important to EMCOR's performance during 2008 and into 2009.
Then I'll turn the call over to Tony Guzzi, our President and COO, for his views on some notable recent contract awards around our broad and diverse company followed by some additional comments on EMCOR's role in meeting America's energy challenges. Finally, I'll talk about some of the major factors that are expected to influence EMCOR's performance during remainder of this year and into the next, including our progress towards some of our growth and performance objectives.
At that point there will be an opportunity for our listeners to make comments or to ask us questions. And you can see from slide two that a number of our senior officers are here to help with the answers.
So let's begin please move to slide three. EMCOR had an excellent first quarter, the best in our history by a significant margin.
A year ago in the first quarter of 2007, we proudly announced the record first quarter revenues and operating income and commented the 2007 had gotten off to a very good start. Our 2008 first quarter revenues grew 29% over last year's to a new record $1.66 billion, and operating income more than doubled compared to 2007 to $49.7 million.
Certainly, another very good start. On slide four, we discussed some of the highlights of our first quarter performance.
Continued strong demand in both our construction and facility services divisions led to revenue growth completely across our company. 2007 acquisitions in refinery services and mobile services led to remarkable 63% revenue growth in our U.S.
Facility Services segment. But EMCOR's organic revenue growth was also very strong at 17% overall.
Our Canadian subsidiaries stood out with organic year-over-year revenue growth of 78% based on improved demand especially in the industrial, power and healthcare sectors. Our dramatic revenue growth was more than matched by a 186% increase in operating income for the quarter to a record $49.7 million, or 3% of revenues.
All of our operating segments improved their profit performance over the prior year. U.S.
Electrical profits from operations rose 58%, U.S. Mechanical increased 32% and profits in our U.S.
Facility Services segment rose a remarkable 235% reflecting the excellent performance of the refinery, petrochemical and mobile services companies that we acquired in the last year. For more than 10 years, EMCOR has pursued a strategy of diversification of our revenue and profit sources, in order to reduce our vulnerability to individual market cycles.
This quarter's results represented important threshold in this long-term operating strategy, as U.S. Facility Services became for the first time the largest segment contributor to EMCOR’s profits with $25.5 million of first quarter operating income.
This is the major achievement for EMCOR and will be an important factor in our future revenue and profit growth and stability. Our international companies also performed well in the first quarter of 2008, profiting from a general strengthening of the Canadian economy and its well established market positions in the power, industrial and healthcare factors.
Comp stock Canada rebounded from a 2007 first quarter loss to a profit of $2.5 million. Coming off a disappointing year in 2007, our U.K.
company reported improved results in the first quarter contributing operating profits of $2.1 million. As discussed quarter ago, EMCOR management is continuing to asses various alternatives with respect to the U.K.
subsidiary. The large Rail division projects that create the U.K.
operating losses during 2007 have been completed and fully accounted for. We are extremely pleased with these excellent operating results from across our company and the continuing strong demand for a wide array of services that they reflect.
Please go to slide five. As the result of our operational performance, net income from continuing operations for the 2008 first quarter was a record $29.3 million or $0.44 per diluted share, a 154% increase over the $0.17 per share that we reported a year ago.
General and administrative expenses increased to a $140 million compare to a $112 million in 2007, but were 8.4% of revenues in the current quarter versus 8.7% last year, reflecting continued emphasis on overhead cost control despite substantial acquisition activity. The quality of our first quarter profits measured by a comparison with operating cash flow was also very high.
Although EMCOR's first quarter operations generally require a substantial working capital investment especially in new projects, cash flow from operations roughly tripled to $25 million and stockholders equity reached $915 million. Please go to slide six.
Reflecting our cash flow performance and our conservative capital management policies, our quarter end balance sheet is very liquid with leverage well within our comfort zone. We prepaid about $25 million of acquisition related debt during the first quarter, but balance sheet cash remained above $200 million and working capital remained steady.
We think that EMCOR’s strong liquid and conservative balance sheet will be a solid foundation for future growth. Please go to slide seven.
Another good indicator of future performance and growth opportunities is our contract backlog portfolio, whose evolution over the last seven years is shown on this slide. Most of our listeners already know that EMCOR accounts very conservatively for the value of projects in hand and that at least 25% of our revenues are derived from projects that are not reflected in the backlog schedule.
This slide reflects both the strength and diversity of EMCOR's market presence. Major participation and seven factors representing significant future growth opportunities; office and commercial, hospitality and gaming, industrial, which is predominantly oil and gas, healthcare, transportation, institutional, water and wastewater.
Contract backlog at quarter end was $4.39 billion, a 14.2% increase over year ago backlog of $3.84 billion. Sequentially, backlog decline very slightly about 2% from record year end levels, despite an extremely high rate of backlog burn and revenue growth during the first quarter.
Notably, our private sector office and commercial contract backlog rose slightly above 3.4% on the sequential basis despite market concerns about this sector while all our other sectors reported insignificant declines. At quarter end, private sector office and commercial, and hospitality and gaming comprised 49% of total backlog, up from 47% at year end.
The glance of the overall evolution of our contract portfolio since the last recession in 2003, show's clearly that we are a much larger, stronger and more diversified company than we were five years ago when we remain profitable despite a major downturn in the construction sector. Now, it's time to invite Tony Guzzi, our President and COO, to comment on some notable recent contract awards that illustrate the continuing market demand for our diverse array of services.
Please go to slide eight, Tony?
Tony Guzzi
Thanks, Frank. Let's start with a data center project we are performing for Xilinx in Longmont, Colorado.
Dynalectric Colorado's performing this project and they're serving as the prime contractor for this 5,000 square foot data center is include the three-storey facility to be connected to an existing office building. In addition to managing all the trades on this project, which is in our usual case Dyna will perform the installation of the electrical systems that include a new 3,000 amp service redundant to 750 kPa UPS system, a 2400 KW generator and all of the electrical distribution in piping cable.
Our other Denver-based company and the leading mechanical contractor in the Denver market, Trautman & Shreve is also on the project performing the mechanical work. And Trautman's scope includes the installation of the complete mechanical HVAC and plumbing systems.
As we've stated on our previous calls, we like data centers. They are filled with electrical, mechanical systems that are critical to the functioning of the data center.
We like it because the communication infrastructure is robust and is complicated, and unlike the data centers that were build in the earlier 2000s and late 90s. For the most part these data centers that we're building today at EMCOR are built around existing or contracted tenants or for owners.
They are non-spec facilities and that was the hallmark of the previous data centre expansion. It's a different market today.
It has more measured growth. It’s a good market for us and the level of sophistication in these data centers today is even markedly increased versus the data centers of the late 90s and the early 2000s.
Our Gibson Company in Chicago also does great data center work, but it also has diversity like all EMCOR companies do. I want to show you that with the Barney's in New York project the Gibson's performance.
Gibson is going to put in over 2,000 recessed sliding fixtures and 5000 feet a tract lighting for a fashion designer areas in Barney's of New York. Now, suffice it to say, yes, guys in EMCOR for the most part won't be shopping the designer area because we are contractors.
But a fewer of us will, right, Kevin.
Kevin Matz
Yeah. Mark and I.
Tony Guzzi
Mark and Kevin will, Tony won't. But that's where we'll be.
Just switching gears in there, an attractive feature of our fire protection business and we'll go through the other ones. Feasibility is successfully travel and Shambaugh & Son is one of the best.
They will be going from Fort Wayne home-based to Turkey Alabama to install a fire sprinkler systems for National Alabama Corporation's new 1.8 million square foot rail car manufacturing facility. Shambaugh will be installing 51 sprinkler systems which include 18,000 sprinkler heads and 80 fire host stations supported by a 0.25 million feet of pipe.
All of the pipe will be fabricated at Shambaugh's terrific Fort Wayne fabrication facility and it will be shipped and prepackaged to the job site, where it will be installed by all our team of professionals. Prefabrication under conditions create efficiencies with our field personnel and increases our level of execution.
We see this timing again throughout out mechanical operations. One of the reasons we like fire protection is design build, the trades travel well and for really significant jobs like this National Alabama job, we prefabricate the majority of it and put it together onsite.
Staying with fire protection and in the healthcare market, Dyna Michigan, where we will be installing the complete fire alarm system in the new 13-storey state-of-the-art University of Michigan, Mott Children's and Women's hospital. And in California, Chevron's Research and Technology campus in Richmond, we're doing a major renovation through our Contra Costa company, installing three new generators, the electrical substation and a new fiber optic backbone for the renovated three buildings for Chevron.
And Down in Houston, Gowan will be installing the mechanical systems for the new addition of the Texas Children's Hospital, Feign center. Gowan's scope of work will include the HVAC and our exhaust systems, which was really important in hospital.
For eight new floors and laboratory and medical office space for pediatric research. And it builds on our great position in the Texas Medical Center.
Interestingly, the hospital wants to expand at the same time reduce its electrical loads are becoming more energy efficient. And energy efficiency is a theme that we're seeing more and more across our work, and across the country through EMCOR companies.
We're helping our customers who are struggling with the continued acceleration of energy costs not only how to be more efficient, but they have energy assurity also. At EMCOR, most of everything we do has some voice, shape or form to do with energy.
It's a mega trend that Frank has been speaking about and I've been speaking about for a long time. And we're well suited to address it now and in the future.
We like to say that our energy confidence spends from biggy and we'll talk about that literally. And if you go to the next slide, slide nine, I'll walk you through that.
EMCOR in general has seen increased demand for energy services. On our left hand side as you look at the page you see, one the generation business.
Generation for EMCOR for the most -- means combined heat and power; utility generation, where we help build the gas plant, the combined cycle plants, usually is a subcontractor mechanically and electrically and a lot of times that's in California. We also help with distributed generation and there we will do it at in a turnkey basis, where customers have decide to move of the grid and they saw their own solution either combined heat and power or they own turbine.
And we found ourselves to be quite a renewable company. We do significant renewal work on a turnkey basis whether it will be biomass boilers, fuel cells or land-fill gas.
As you move from left to right with our addition of Ohmstede build on already strong position in the refinery space. Previously, we've been in California, now we're in California and Texas.
And with Ohmstede, we had the ability to travel to support turnarounds nationwide and support equipment sales globally. Ohmstede and our California Subsidiaries helps these refineries with their capital expansions, their maintenance needs and we do more and more find ourselves managing the each section of those refineries.
As we talked about Ohmstede, we managed and played a significant role in 12 of the major 14 refineries on the Gulf Coast and with our acquisition of both Performance Mechanical and Redman, we find ourselves expanding that capability into California. Literally, this is where we sit on the right hand side of the page and that's energy efficiency.
And through our mobile services organizations and our mechanical operations for the most part, we're finding ourselves doing more and more energy efficient projects. Everything from variable speed drives, equipment change out, controls upgrades, lighting efficiency upgrades, and EMCOR has the ability to warp those package together and deliver our customers projects that will save them 30%, 20% and payback in less than four years.
We're also doing that for other performance contracting companies, where they need is to be the arms and legs to execute their projects. EMCOR also does energy consulting, where we will help customer develop energy plan.
We just did that for a major retailers across 1,000 sites and we have our EMCOR 360 project that will tell you how to run your central plant in more cohesive functional way through remote monitoring and diagnostics. And with that, I've exhausted [bigly and lowly] and I'll turn it back over to Frank.
Frank MacInnis
Thank you, Tony. We're all excited about the major role that EMCOR will play in meeting the ever increasing demand for energy services both year end and abroad.
Please go to slide 10. The quarter just passed was EMCOR's 51st consecutive profitable quarter, a record of consistency that includes several major business and market cycles.
In today's report to you and in our 10-Q and press release, we've cited facts that should be positive indicators of continued success for EMCOR, including revenue and earnings growth momentum from a record first quarter, balance sheet strength and liquidity with modest leverage and diversified backlog at near record levels despite accelerated backlog burn. Our expectations are conditioned upon a continuation of the diversified demand for our service that the first quarter showed and, of course, we need to successfully execute the project work contained in backlog.
We see a continued active market for outsourcing driven Facility Services. In fact, we've observed in past economic downturns that this sector is stimulated when our customers concentrate on their core businesses and leave the management and their facilities for maximum efficiency and energy conservation to specialists like EMCOR.
All companies have to watch costs closely in challenging times, and EMCOR will need to continue our tradition of disciplined cost control. And we're well aware that some interesting investment opportunities sometimes arise during this phase of the macro-economic cycle.
So we'll have our eyes open for additional ways in which we can accomplish our growth objectives. Please turn to slide 11.
In February, we issued revenue and earnings guidance for 2008. Even though 2007's results reflect a dramatic growth to record levels.
Our 2008 guidance indicated fairly aggressive ranges of additional growth, despite gathering economics storm clouds. Revenue growth rate of 7% to 10% to a range of $6.3 billion to $6.5 billion, and earnings growth of 12% to 23% to a range of $2.08 to $2.28 per share from continuing operations was our guidance.
Today, I am reiterating my previously issued guidance, despite the stronger than forecast growth rates we've just reported for quarter one. My comments about our guidance are as follows.
Firstly, our first quarter results, especially those from the U.S. Facility Services sector were significantly positively affected by the results from the companies acquired during the past year.
Since we haven't held them for a year as yet, we're not completely sure about their seasonality but we are reasonably that unlike most of our longer health companies are new acquisitions maybe at their strongest in revenue and earnings terms in the first and second calendar quarters. Assuming this to be true our extrapolation models and presumably of those of many of our analyst and investors may need to change to reflect less overall seasonality in EMCOR's revenues and earnings.
We expect our newly acquired subsidiaries to continue to perform very well, but possibly not at the remarkable levels reflected in first quarter. Secondly, notwithstanding our healthy backlog performance, we will need to acquire and execute an substantial amount of new backlog in order to meet our guidance targets, especially the optimistic upper ones.
Although, EMCOR is as diverse as any company in our sector, it's clear that some of the market sectors in which we operate, for example, office and commercial and hotel construction will be affected adversely by a recession or by a prolonged business slowdown short of our recession. Accordingly, for the time being at least, I think that revenue and earnings growth in the ranges suggested by our current guidance will be good performance for 2008 considering all the uncertainties surrounding the markets.
By mid-June, we'll know lot more about second quarter backlog replacement and overall market conditions. And I'll make a public comment at that time if wanted concerning our year end expectations and maybe an early look at 2009.
That's it for now. Thanks pretty much for your interest and your support.
Now, it's time for you to ask questions or to give us your comments, and Casey is here to tell you how to queue. Thank you.
Operator
Thank you. (Operator Instructions).
Your first question comes from the line of Alex Rygiel with FBR Capital.
Frank MacInnis
Good morning, Alex.
Alex Rygiel - FBR Capital
Good morning, Frank. An outstanding quarter congratulations.
Frank MacInnis
Thanks very much.
Alex Rygiel - FBR Capital
Are you surprised at the high level of profit from Ohmstede in the first quarter?
Frank MacInnis
No, we're not. I know you looked at the Form 8-K/A that we filed in December.
That it was [and still is] possible to derive anticipated Ohmstede margins from that filing . We are very pleased with Ohmstede management and with the performance of their market and customers.
They are fulfilling every hope that we had for them and we hope and expect that they'll continue to do so.
Alex Rygiel - FBR Capital
When you look at your backlog and your projects that were added to backlog in the first quarter, were there any change that was immaterial that you noticed to suggest that the profit margins embedded in that new backlog is materially higher and/or lower than what had been in backlog in the past?
Frank MacInnis
No, Alex there wasn't. Many times before on these quarterly calls we've talked about EMCOR's nature as a late phase company.
I think that if there were changes taking place and they make up for the inherent profitability of backlog contracts, you would see it elsewhere first before it visited EMCOR. So, the first part of my answer to your question is no.
There is no indication so far. I think it is a valid assumption that a backlog was acquired during the recent period at more or less rates equal to the prevailing operating margins for construction and facility services during that period.
That makes us confident and optimistic. I'd also like to say, however, that we're at the front-end of our market.
That being engineering and construction management and front-end project managers. They are on construction sites before we get there and are involved in the planning and the design phases of such projects.
We're seeing traffic reports out of that. We look at the Jacob's report and Floor is talking about a big earnings improvement, I'm not seeing erosion of profit opportunities on the front-end of projects either.
I read all the same papers that analyst and investors do and I know or at least I think I know what's going on out there. But we see it in our margin and backlog opportunities at least so far.
Alex Rygiel - FBR Capital
And now for the tough question.
Frank MacInnis
I hate tough questions.
Alex Rygiel - FBR Capital
Your first quarter '08 was about 25% ahead of your first quarter '07. If we assume that your second, third and fourth quarter in '08 are flat to '07, that gets us to the low end of your range.
It's sounds like you're being very conservative with your guidance.
Frank MacInnis
The first word out of my mouth, Alex, after I began to see preliminary indications of our first quarter results were that this is going to put some pressure on me to improve guidance. So thank you for filling my prophecy.
I can see very well how good these are. This is truly a breakout quarter that reflects once again the transformational nature of our presence in the oil and gas and of the industrial market.
We're very pleased with that, with the investment that we made, with the management that we acquired at Ohmstede and another oil and gas sector companies. And we like very much being a higher margin a company than we have being for many years.
You know me, I don't think there is any significant benefit to EMCOR to leap just yet, but we'll be watching this carefully. I will look at backlog a replacement very carefully in the next couple of months and I think that by June, we'll no more not only about 2008 which looks pretty good, but also about 2009 which I know is a high on the list of analyst and investors concerns right now.
Alex Rygiel - FBR Capital
I do have one last question. The June quarter sometimes can be influenced by the timing of summer weather as it impacts some of your quicker shorter turn maintenance work.
Can you comment on what kind of variable that could create depending on when summer starts and when it doesn't? Could that add or hurt earnings by 5%, 10%, 15%?
Frank MacInnis
Alex, I think that the potential is less than it was in the past. We use to talk about mobile services at this time of year, for example and the possibility, the cool wet spring I forgotten which spring that was '04 or '05 somewhere in that area, where our cool wet spring had the result of significantly impacting the commissioning of HVAC systems turning them on for the summer months for example.
And we saw a significant drag on both revenue and profitability since those are very high margin operations, those call out services in those years. Anymore -- we've found that as our mobile services operations have achieved true scale -- and especially since our customers call our requirements have a great deal to do with energy efficiency even more so perhaps on the weather that those operations would become much less seasonal or cyclical that may used to be in the past.
Then, they basically become strong all year around. So I am going to say to you that a cool second quarter will influence earnings and margin a little 5%, 10%, if that -- if the outside…
Tony Guzzi
…in that sector only?
Frank MacInnis
In that sector, yes.
Tony Guzzi
I mean with our base where it is now and start to see the effects in the overall company and plus we've gone into the warm weather states a lot more as with our acquisition of MSI in Florida, and our expansion of the operations in California. We are now double the size and with their systems.
With all those together put us in markets that are less dependent like we used to be just dependent on the northeast that we're not anymore.
Alex Rygiel - FBR Capital
That's very helpful thank you.
Frank MacInnis
That's a very good point. Thanks, Tony
Tony Guzzi
Thanks, Alex.
Alex Rygiel - FBR Capital
Thank you.
Operator
Your next question comes from the line Rich Wesolowski with Sidoti & Company.
Rich Wesolowski - Sidoti & Company
Hi.
Frank MacInnis
Hi, Rich.
Rich Wesolowski - Sidoti & Company
Frank, if you look at your backlog chart, the commercial with the best performing sector which was surprising at this point in cycle, can you reconcile that with your general push towards the more defensive healthcare institutional etc?
Frank MacInnis
Well, first of all, we don't go out and get work for just of the sake of having it. We would only accept commercial and office construction work that met our profit margin parameters, So we're not hitting hard the commercial and office sector just to have a strong statistical base.
Having said that, we try to retain a balance year around and we're real very happy right now with the proportion of our project work that is represented by non-cyclical sectors like healthcare, like our public sector transportation work, certainly our government services division, water and wastewater looks pretty good. Let me say a word about water and wastewater, since it's just come to mind.
There is some concern that I've read about being expressed by public sector analyst with respect to the availability of funding of public capital projects because of declining tax revenues and/or the inability of municipalities and states to issue a bond. We find that in general our water and wastewater projects are funded out of specifically earmarked funds derived from water distribution and sale revenues, so that there doesn't seem to be any shortage of funding for the urgently required and continuing need for upgrading of the U.S.
Water Distribution System. We are very fundamentally aware of the importance of the maintaining our hedge within EMCORE at all times in terms of our significant involvement in defensive as you put it, that is, non-cyclical or countercyclical segments of the market while try to derive as much profit as possible from our historically high margin activities in the private sector commercial and office and hospitability and gaming segments.
I think in the first quarter, we succeeded in maintaining a very nice balance between the two sides of our business and that's we will be describing to do for the next few quarters.
Rich Wesolowski - Sidoti & Company
Okay. Secondly, if you take out the aggregate acquisition effect of the first quarter, your gross margin was about a flat at 10%, is that what we should expect going forward.
I mean, you're going to get kick because of Ohmstede, et cetera, coming in while there is some amount revenue. But is this as high as we're going to get on the organic gross margin?
Frank MacInnis
To be honest with you. I don't pay as much attention to gross margin as I do to EBIT margins because gross margin can be so susceptible to fluctuation based upon the location from which the revenue is derived.
As an example, a New York City project will require gross margins 3 or 4 percentage points higher than a Denver or a Las Vegas project just because of the overhead that it has to cover. So you could artificially inflate gross margin by deriving more project work in any particular calendar quarter from a high gross margin sector without actually improving your bottomline at all.
I've often said that increased gross margin is always good, declining gross margin is not always bad. And if you think about it I think that's the way it is.
We think that the margin performance that we exhibit in the first quarter has to be considered in light of our very conservative accounting policies that's, for example, require that we recognize no income on newly began projects until they are at least 20% complete. This is a unique accounting policy, a uniquely conservative accounting policy, we believe within our entire sector.
It means that we have very few write downs because we don't take profits on projects, unless and until, we've got a pretty good idea at the 20% level about these efficiency of our allowances for costs, for contingencies. We've made the buys with respect to our materials and major components and supplies.
And we've got a feel for what the relationship with the customer is like and what the site problems if any are. And so at that 20% point, we can make a decision.
Now, the practical result of that is that in the first quarter, we just don't book as much income, we match our revenue with cost and this has the effect of depressing first quarter net margins. So I think that our first quarter performance in light of that policy is even more significant in terms of achieving 3% EBIT for the quarter.
Rich Wesolowski - Sidoti & Company
Okay. And finally, looking at say 7.5% of your SG&A cost in this segment, can you discuss the degree to which that's variable in a different business segments, let's say, for electrical and mechanical turndown sometime within the 18 to 24 months.
How effectively you can take those cost in?
Frank MacInnis
We feel that we've done a very effective job of maintaining the variability of our labor cost. We talked in the past about the discipline with which we control overhead cost, by the same token we have said.
I typically get a counter intuitive kind of a reaction from my listeners when I tell them that our union affiliations are very significant benefit to EMCOR, especially in challenging economic times. Because a modern union contract results in those union labor cost being completely variable.
In a nutshell, the day that you don't need a union employee any longer, back here as she goes to the union hall with no exposure to severance cost with no exposure to a pension fund or to a health plan or any thing of the kind. This is what I call complete variability of cost and enables EMCOR to be very quick, very nimble and very decisive in reducing cost in response to market and activity downturns.
Rich Wesolowski - Sidoti & Company
Thanks, Frank.
Frank MacInnis
You bet.
Operator
Your next question comes from the line of the Tahira Afzal of Keybanc Capital Markets
Frank MacInnis
Good morning, Tahira
Tahira Afzal - Keybanc Capital Markets
Good morning and many congratulations on your quarter
Frank MacInnis
Thank you. We're very proud of it.
Tahira Afzal - Keybanc Capital Markets
I guess my first question is in regards to your backlog. I mean, I went back and I looked at first quarter of '07 and your bookings for first quarter '07 trended up by around $200 million sequentially.
This year they're down to $200 million sequentially. And I was wondering what is pretty change from the first quarter of last year on the sequential basis versus this year.
Frank MacInnis
First of all, I never want to disagree with the thorough way at which you analyze our accounts, but I think we are down a $100 million sequentially over the two quarters from the last quarter of '07 to this current quarter. I'm extremely positive about the pace of bookings between the last quarter of '07 and the first quarter of '08.
In order to do a complete and thorough job of understanding the pace at which we've been replacing backlog you really have to make an assumption concerning the proportion of our revenues that in the current quarter that were derive from backlog jobs as opposed to outside of backlog and EMCOR is a strange bird in this regard. In that, unlike many of the large project companies in this sector, EMCOR derives at least 25%.
I believe closer to 30% of our revenues from projects that are not in backlog. But there is some seasonality to that as well to add the complexity.
So that in any given analysis of whether or not, we're accelerating or decelerating our backlog replacement, part of the work of analyzing new work bookings requires that you understand with some degree of specificity exactly how much backlog we burned off as opposed to driving revenue, for example, from projects that were so small that they didn't reach the backlog schedule. Tony, any comments?
Tony Guzzi
Yeah, I mean our bookings of new business was pretty good in the first quarter. As Frank said a lot of it never makes it's sway in the backlog.
An example of that is not only our small project work, it has a lot of this energy efficiency upgrade in the mobile service group but also at Ohmstede. We're learning.
There is a quarter or so over EBITDA coming out of Ohmstede and it not being tied as much the backlog other than the equipment side. All the turnaround work we do is substantial, especially in March and February, and never makes it's sway into backlog.
Our profit model is a little different as Frank talked about the seasonality and the extrapolation models we're using in the past. still goes the same for backlog.
We have a big profit engine outside of our normal backlog view in two our faster growing businesses. It doesn't show up in backlog the same way they did.
We are for the most part a mid-to-small project company. We have lumpy jobs like we put in last quarter and first quarter like Venetian and one or two wastewater treatment plants.
It's just a matter of timing whether those jobs come in first quarter, second quarter or beginning of third quarter.
Tahira Afzal - Keybanc Capital Markets
And in terms of your Facilities management business, I went through your 10-Q briefly and it seems that your Facilities management business organically grew at around close to 5%. And I was wondering if you could comment on the longer term trends of growth in that business are going forward.
Frank MacInnis
Yeah. We saw a good growth in our Mechanical Mobile Service business, we saw a very good growth in our government business, 20% plus and we saw a very good growth at Ohmstede.
Obviously it's new to us where we get the whole work that you are. We know what they did last year in the first quarter and they had good organic growth.
The area they didn't grow as fast this quarter and there is a couple reasons for it. It is our commercial site base business.
One is, as you know, third quarter of last year, we exited our relationship with CBRE, CB Richard Ellis, on the facilities joint venture we had with them. Now, on a comparison basis, they are both out of the numbers.
But we had infrastructure, and that had been part of our sales channel previously. So, we have had to retool our sales channel, refocus our organization for that segment of the market that we'll attack, and we're now getting the pickup from that as we go into second, third and fourth quarter.
So, double-digit growth in all sectors except commercial site-based, and that was actually down and you could say by design as we refocused the organization absolutely on our joint venture with CB Richard Ellis.
Tahira Afzal - KeyBanc Capital Markets
Would it be fair to say that you can see once the retooling is done in totality that you could see growth in facilities management for higher level?
Frank MacInnis
Yes, I think we'll double. I think we can do double-digit growth on an annual basis for as far as we can see.
And I'd just point out the higher margin sectors always growing are the fastest. And we've done that by design.
Tahira Afzal - KeyBanc Capital Markets
Okay, great. That's good to know.
Just had a couple of other questions. Number one, in terms of your debt went down, it seems that you've managed to wind out a sufficient amount of your debt.
And I was just wondering what in terms of your net income line in terms of your interest income, should we expect something of a tapering trend going forward? I know that you've had some expenses still due to the debt from Ohmstede and had commented that you'd see it winding down by the end of the year.
Is that still a doable option for you?
Frank MacInnis
It's Frank, T.
Tahira Afzal - KeyBanc Capital Markets
Sure.
Frank MacInnis
We certainly expect operating cash flows to continue to be robust and to support the plans by continued reduction of our acquisition-related debt during the remainder of this year. And that is what we will do, of course, absent major transactional opportunities.
But we are open to the possibility of an additional investment that will help to enhance the continued improvement of our margins. I mentioned earlier that we really like the opportunity to be a higher-margin company.
Our long-term success in electrical and mechanical construction has enabled us to do this. We are proud of that.
And we think that the opportunity to invest additional money in the higher margin businesses that have transformed our operations over the last year or two together with a continued emphasis on the facility services sector, which I think is going to be a very important help for us in weathering whatever economic terms are going to effect all companies in the next year or so. I think it's extremely important.
I know I stressed it on the call, but I will do it again right now. I think it's very significant that our facility services business was our largest single segment contributor to operating profits in the first quarter.
That's very important in light of its relative involvement ability to our recessionary downturns.
Tahira Afzal - KeyBanc Capital Markets
And, Frank, if you look at the beat that you have seen versus your own internal numbers, you've said that it did come on stronger than you expected. Was all that strength concentrated on the Ohmstede side or did you see the rest of your business also perform a little better than expected?
Frank MacInnis
You mean in the facility segment, T?
Tahira Afzal - KeyBanc Capital Markets
Yes, well, basically outside of Ohmstede.
Tony Guzzi
From our view, we had terrific performance in our core electrical and mechanical construction business. We look at margins year-over-year and not sequentially.
Frank went through the reasons why that's the accurate way. Both electrical and mechanicals margins were up, and we believe we maintained the discipline that we've had.
Mobile services continued its expansion. Air systems integrated it nicely.
And that combined with our existing footprint had made us the largest mobile service company in California. We saw a good penetration in our government services business.
We just announced the Millington contract. So across the board right now, we are pretty pleased with performance.
Canada had nice margin enhancement for this time of the year for them. That would have been an annual number for them as far as margin.
We expect them to continue to perform well. Out of the woods on the U.K.
I think this cost focus coupled with the bidding disciple, coupled with, as Frank said, moving to different sectors over the last two to four year, five years, 10 years had allowed us to really start to benefit from balance. And we are happy with that balance right now.
We are always going to have our hiccups and really take top projects. That's the business we are in.
But right now, our team is executing extremely well across the board.
Tahira Afzal - KeyBanc Capital Markets
Okay. Thank you, Frank.
And I actually had this one last question, and then I'll pass it on. And that is if you look at your business and you look at, as you have explained, your bookings and your walk-in work, in terms of your business that typically or what you foresee will fall or slowdown faster going forward if the economy and the non-residential side continues to slow down, would it be the walk-in work or would it be your backlog?
Frank MacInnis
Well, my own guess, T, is that it will be backlog, because that's where the jobs that reflect customers' capital allocation decisions are by and large located. Our walk-in work, as you put it, is typically, if it's not in our customers' maintenance CapEx budgets, it's just in their cost of operations.
And as I mentioned earlier, an increasing proportion of that work is based on the continued improvements in energy efficiency of customers' facilities, the payback for which is extremely short and therefore a very good investment for our customers, especially if they are not inclined to layout the significant capital required for major upgrades or even new facility construction. So, I think that the impact is likely to be so called backlog projects.
Tahira Afzal - KeyBanc Capital Markets
Okay. Thank you very much.
Frank MacInnis
You bet, T.
Operator
(Operator Instructions) Your next question comes from the line of John Rogers with D.A. Davidson.
John Rogers - D.A. Davidson
Hi. Good morning.
Tony Guzzi
Hi, John.
John Rogers - D.A. Davidson
Some of the projects that you went through, Tony, were timed about on recent awards and I think frankly you've been referring to. It's a lot of upgrades or retrofits of existing facilities.
Maybe that's just by design. But I am curious if you were to look at your business right now, how much of it could you classify is new construction, retrofits and then I guess just maintenance type work.
Tony Guzzi
At any given time, about half of what we are doing is new construction or major upgrade.
John Rogers - D.A. Davidson
And has that changed?
Tony Guzzi
Yes, it's down. That's down from 60%, 65% probably going into the last cycle with addition of Ohmstede, so anywhere from 45, 50 new construction and major retrofit where you basically are shutting down the building and restacking it and other things.
Maintenance service is going to be about 35% of our revenues. These are places where we have long-term customer relationships.
As Frank talked about, we're part of the maintenance planning for the year in the capital. It's not all service contracts, but we basically know what we're going to do for the year, and we've been doing it for a long number of years.
Our service contracts are in there. And as you know, in our backlog, we only put one year in the service contracts even if it might be a three to five-year contract.
And we don't assume any extras off of those service contracts when we think about backlog. So 45, 50, maybe a little less than 45 new construction, major retrofit, 35% service and the balance we'd call is retrofit projects that we're going to add on.
We may a relationship with the customer, but we don't have a steady presence.
John Rogers - D.A. Davidson
Okay.
Frank MacInnis
I think, John, that it's important to note that given the choice between a greenfield construction project involving numerous trades alike the excavators and the foundation guys and girls and the steel people and the glass people and the like as opposed to a retrofit project involving a much more significant portion of the cost being expended onto systems that we install and maintain, we would, generally speaking, prefer the latter. It's a simpler job for us.
The work that we do is generally speaking on the critical path, and it's just another risk removed for us if we're in a position where the retrofits restacking project revolves around our systems. It has the same attraction that Tony mentioned earlier in connection with our data center work.
Data centers are just really simple boxes crammed with stuff and the stuff is pretty much what we install and maintain. So the significance of that is that, our services typically comprised between 60% and 80% of the overall cost of a data center and we're in position of real authority and responsibility on those projects and that's one of the reason why they tend to pay us pretty well.
Tony Guzzi
And I think that when we like new construction are in a mission critical environment where people value time. That's why we like hotel gaming and why we like Las Vegas and native American gaming.
And that's why we like [home stuff]. It matters.
John Rogers - D.A. Davidson
Relative to the last, I mean lot of your segments have been or divisions have been around a lot longer, but in the previous downturn -- economic downturn, I mean it showed up in your numbers, I mean, fairly quickly and we're not seeing the impact now. And I guess I am trying to figure out not only whether you have any in terms of what's really different this time.
It's just that the commercial industrial markets, they won't have the excess capacity that they did previously or any sense there?
Frank MacInnis
Well, John, I think that the period leading up to the last recession was one of creation of a large bubble of non-residential facilities. We saw major projects are being driven by financing availability risen by demand.
And so we had lot further to fall the last time and that the 2002 and 2003 recession was extremely abrupt. We saw reductions in construction activity of 30% to 40% in many of our markets, a huge, very damaging, very difficult downturn in which by the way we remain profitable but it was a tough one.
This time around I just don't see anything like the excesses of the dotcom error, for example, or the construction of so called [feature] buildings that have been put because the [bunny] was there and not because there any demonstrable demand. So I think that spending in the non-residential construction sector has been very restrained and responsible and incremental in the post recessionary period that followed upon the last recession.
I think some lessons were learned and I assure you that there is no non-residential bubble out there that we course bound to the obvious residential bubble that exist. For the same reason, that the non-residential one existed last time and that on the residential side, there were lots of finance-driven projects that were not in response to demonstrable demand.
Tony Guzzi
Right. And you said our operations have been around for long time and as we do reviews around the country and we talk about the differences to a company especially our major subsidiaries, we became very enamored like most people did with [tech] from 1999 to 2002 and we were probably drawing too much of our earnings from that sector.
And that sector went down hard and quick like Frank said. We've done a much better job this time, a keep in diversity than our customer base.
And our acquisition program has really added the diversity in our customer base by getting into oil and gas in a bigger way with Ohmstede. Our service acquisitions like [politics] and air systems notably and now MSI down in Florida, and then also expanding our footprint in the fire protection, which we like for a whole lot of reasons that are different than just traditional mechanical contracting.
I think we learned those lessons, although reliance was on one sector. Although, the margins were terrific and life was good, I think it's one of those cases where not only at group level but more importantly at our subsidiary level.
People said, "I'm going to do extra amount of work for this type of customer. And I'm going to make sure keep all the irons in fire across this expansion."
Frank MacInnis
John, I have one other comment about your reference to our historical performance and if I'm correct and the year that I believe you're looking at. We had a very significant loss in our U.K.
operation that year. That was a project loss that happened very quickly.
That significantly impacted our overall performance that year.
John Rogers - D.A. Davidson
Okay. Frank, the U.K.
operations, you're comfortable with the structure of those now and I mean, any other further restructurings there?
Frank MacInnis
We need to reduce costs some more. But there is an absence of badness reflected in the first quarter U.K.
results. We consider both remaining divisions.
Now that the rail division is finished, the construction division on the one hand and the facilities management business on the other, which by the way was one of the pioneers in that business back in the early 80s are both well managed and operated well at the first quarter. So it's been long and argues process, but I think we do have that absence of badness there.
Although to be fair, the results are still not what we would like. The operating profit for the quarter was 1.1%, which is not enough.
But it's certainly better than previously. And we are pleased with that.
okay.
John Rogers - D.A. Davidson
Thank you very much and congratulations on the quarter.
Frank MacInnis
Thank you, John.
Operator
Your final question comes from the line of Richard Paget with Morgan Joseph.
Richard Paget - Morgan Joseph
Thanks.
Frank MacInnis
Hi, Richard.
Richard Paget - Morgan Joseph
I just want to get back to the sequential backlog. Looking at the bar chart without having the numbers in front of me it seems sequentially the declines happened in water and wastewater and transportation.
I know Frank already addressed there are some concerns about those markets, but you're not necessarily seen anything. So should we attribute this sequential downturns lumpiness or seasonality or how should we think about it?
Frank MacInnis
I'm going to let Kevin give you some details concerning the performance of individuals sectors in just a second. I've characterize it as such many times in the past.
You can certainly assume that water and wastewater, for example, will continue to be lumpy. It's just the nature of the [bees] that tend to have a higher proportion of larger individual projects than is the case elsewhere in our company.
Aside from the rather surprising and encouraging use, our office and commercial segments grew 3.5% sequentially during the quarter. The rest of the sector performance that I am looking at is completely unsurprising to me.
$100 million of backlog reduction spread among six large economic sectors is $10 million or $15 million per sector, which represents one or two good size projects out of more than the 1,000. So I am really not inclined to overreact to this as indicative of a trend or anything of the kind.
Kevin, you got some numbers?
Kevin Matz
Yes, Richard, I'll just give you a few numbers again. Frank mentioned that commercial was up about 3.4%.
Healthcare is about flat. Institutional, which is down a little bit about 5% or so, but that $30 million is just going to be really one project, as Frank talked about.
Hospitality and our gaming sector, flat; the industrial side, down about 5% of $25 million; transportation, down about $25 million of that large sector; and water waste for the treatment, as Frank talked about, on some of the lumpiness, that was down about $40 million. It is still a good distributed backlog.
Frank MacInnis
I've got to say, Richard, that given the headlines of that you read everyday in the national press about the reticence of American businesses towards spending capital on anything these days, that the replacement of backlog at the pace we've done it, especially in the quarter of record revenue burn is pretty good performance. And I reiterate I don't think that the mildly negative trends, 2% downturn, is just not very significant from a -- is anything to hang your head on as far as a continuing trend to be extrapolated in this concern.
Richard Paget - Morgan Joseph
A lot of these projects that I guess are hitting your backlog now were probably financed last year, Now that their credit crunches are really hitting in the first quarter, maybe going forward that's one you should expect to see. Is that fair to say?
Frank MacInnis
Yes, I think that it is certainly fair to say that EMCOR is a late phase company. For example, if there is trouble coming for EMCOR down the road, then you should be able to look at companies right now that are around the front end of these projects and say, "My goodness, look at that.
Jacobs is down 12% in terms of revenues from North American projects." But as I mentioned earlier in the call, the problem is that that's not the case, and the revenue in earnings reports from the guys who are in the front end of those projects are finished.
When we install and complete and begin to manage the systems, their results are real good. And they are talking about growth prospects and analysts are upgrading them to buys and projecting significant earnings growth.
So, everything you say is right except that it doesn't seem to be translated into trends within our industry so far. And I think that that may be attributable in part at least to what I mentioned to you earlier.
And that is that there hasn't been any huge build-up of a bubble that has led to rose over capacity in any of the sectors in which we are operating, even the office and commercial, which I believe is the most vulnerable to an early downturn in response to a recessionary trend.
Richard Paget - Morgan Joseph
Okay. So with Jacobs' backlog being up 50% year-over-year, that would I mean a pretty good '09 for you guys?
Frank MacInnis
That's what I am talking about. And on the other side of the coin, you get a report like the architect's billing index, which came out yesterday, which was very negative, but there is a disconnect for me in reading that report, which I have to take into account.
It's one of the things that we look at in connection with how cautious a note that we should sound as far as the future revenue and earnings. So we read that, and it's a very negative report, but it seems to be oddly out of sync with what we see in terms of actual results from good companies in our space.
Richard Paget - Morgan Joseph
Okay. And then just finally, in Canadian business, I mean it's seems like you guys have run on together a couple of pretty solid quarters.
I mean what should our margin expectations be for that business now that it's going at a good space?
Frank MacInnis
Well, I think it's a much better business than it was. They've done a lot of work in terms of recasting of management and restructuring of the company's operating structure.
This was by concentrating on the eastern market and the Greater Toronto area and the western market set on the Alberta oil and gas market and related markets. And that was the right thing to do.
I mention during the body of my call that it doesn't hurt that the Canadian economy, which is largely commodities based. It has profited from the worldwide demand for commodities.
We are seeing well-healed customers spending money aggressively in large chunks in order to substantially increase capacity. That's what our Canadian company does.
It's primarily an industrial construction company with a strong presence in power and automotive and steelmaking and now in healthcare as well. We liked our position very much.
I think that they are well managed and would expect them to continue to show better margins as the time goes long.
Richard Paget - Morgan Joseph
So, ideally, could margins get to be similar to US or is there just a different structure that this will be a 3% margin business where it's --?
Frank MacInnis
Well, it's hard to tell. It's a lumpy business like water and wastewater.
It's comprised of larger projects, smaller in overall number, so that one or two projects can significantly impact the company's result for a year or even for a couple of years. That's a difficult call.
I'd be hard pressed to speculate that they could dramatically increase their margins, certainly not up to Ohmstede levels or anything of the kind. But I think they can do better than they have been doing, which in the current quarter was I think 2.5% EBIT.
Canada can do better than that.
Richard Paget - Morgan Joseph
Okay. Thanks.
Frank MacInnis
You bet, Rich.
Operator
I will now turn the conference back over to management for closing remarks.
Frank MacInnis
Terrific. Well, thank you all for your attention, for your interest and for your support of EMCOR and watch this phase for interesting future developments.
Thanks very much.
Operator
Thank you for participating in today's conference. You may now disconnect.