EMCOR Group, Inc. — 2018 First-Quarter Form 10-Q Summary
Business context and reporting period
EMCOR provides electrical and mechanical construction, facilities, building, and industrial services through approximately 75 operating subsidiaries and joint ventures in the United States and United Kingdom. This filing covers the unaudited three months ended March 31, 2018, compared with the three months ended March 31, 2017.
Financial performance and key metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $1.900 billion | $1.892 billion | 0.5% increase |
| Gross profit | $269.1 million | $266.3 million | 1.0% increase |
| Gross margin | 14.2% | 14.1% | 10 basis-point increase |
| Operating income | $78.7 million | $82.8 million | 4.9% decrease |
| Operating margin | 4.1% | 4.4% | 30 basis-point decrease |
| Net income attributable to EMCOR | $55.4 million | $52.6 million | 5.2% increase |
| Diluted EPS from continuing operations | $0.94 | $0.88 | 6.8% increase |
| Cash flow from operating activities | $(59.1) million | $(3.9) million | Higher use of cash |
Management stated that the quarter established company records for quarterly revenue, net income attributable to EMCOR, and diluted EPS from continuing operations. Net income benefited substantially from the lower U.S. corporate tax rate enacted under the Tax Cuts and Jobs Act. The actual tax rate on continuing operations was 27.0%, compared with 33.6% in the prior-year quarter.
SG&A increased to $190.3 million from $183.0 million, and SG&A as a percentage of revenue rose to 10.0% from 9.7%. Restructuring expense was less than $0.1 million, compared with $0.6 million in the prior-year period. The quarter included a $0.3 million net loss from discontinued operations, primarily legal costs related to final settlements of prior U.K. construction contracts.
Segment and backlog developments
- U.S. electrical construction and facilities services revenue increased to $454.8 million from $443.0 million, while operating income increased to $35.9 million from $31.0 million. Management cited favorable execution on transportation projects and stronger commercial, healthcare, and institutional activity.
- U.S. mechanical construction and facilities services revenue increased to $698.8 million from $671.1 million, including $10.2 million from a 2017 acquisition. Operating income declined modestly to $39.6 million from $40.4 million, partly because the prior-year period benefited from recovery of previously disputed contract costs.
- U.S. building services revenue increased by $14.7 million, including $9.2 million from a 2017 acquisition. Operating income increased by $2.8 million, supported by commercial and government site-based services, energy services, snow removal, and mobile mechanical activity.
- U.S. industrial services revenue declined to $185.1 million from $258.5 million, and operating income declined to $3.5 million from $17.0 million. Adverse market conditions, reduced refinery turnaround activity, lower demand for new-build heat exchangers, and Hurricane Harvey-related scheduling effects were significant factors.
- U.K. building services revenue increased to $106.9 million from $79.0 million, and operating income increased to $4.6 million from $1.7 million. New awards, higher project activity, and favorable foreign exchange contributed to the improvement.
- Backlog was $3.946 billion at March 31, 2018, up from $3.790 billion at December 31, 2017, but below $3.974 billion at March 31, 2017. Remaining performance obligations under ASC 606 were $3.604 billion, of which $2.932 billion was expected to be recognized within one year.
Cash, debt, liquidity, and capital allocation
- Cash, cash equivalents, and restricted cash declined to $354.9 million at March 31, 2018, from $469.4 million at year-end 2017.
- Operating cash use was $59.1 million, principally reflecting changes in operating assets and liabilities, including payments of accounts payable and incentive awards.
- Investing cash use was $11.8 million, including $6.6 million of capital expenditures and $2.7 million for acquisitions. The prior-year period included $81.4 million of acquisition payments.
- Financing cash use was $45.3 million, including $34.5 million of share repurchases, $4.7 million of dividends, and $3.8 million of debt repayments.
- Total debt was $307.0 million, consisting primarily of $281.0 million under the term loan and $25.0 million drawn under the revolving facility. The credit agreement expires August 3, 2021; EMCOR was in compliance with all covenants.
- The revolving facility has $900 million of commitments, subject to availability and other conditions. Approximately $109.9 million of letters of credit were outstanding at March 31, 2018, primarily supporting insurance obligations.
- EMCOR repurchased approximately 445,896 shares for $34.5 million during the quarter and had approximately $140.3 million of remaining repurchase authorization. The quarterly dividend remained $0.08 per share.
Accounting changes, outlook, risks, and contingencies
EMCOR adopted ASC 606 revenue recognition on January 1, 2018, using the modified retrospective method. The adoption reduced retained earnings by approximately $0.9 million and changed the presentation of contract assets and contract liabilities. For the quarter, reported revenue was $1.900 billion and operating income was $78.7 million; under the prior guidance, pro forma revenue and operating income would have been $1.899 billion and $77.4 million, respectively. The adoption had no impact on operating cash flow.
No formal full-year financial guidance is provided in the filing. Management expects liquidity needs to be met through operating cash flow, existing cash, and available borrowing capacity. The company described demand for nonresidential construction, building services, and industrial services as key long-term revenue drivers.
- Industrial services remain exposed to weak oil, gas, refinery, and petrochemical markets, reduced turnaround activity, and project mix.
- Goodwill associated with the U.S. industrial services segment was subject to impairment risk after a $57.5 million impairment charge in 2017. Further underperformance or higher discount rates could result in future impairment charges.
- Construction contracts involve estimates of costs to complete, variable consideration, claims, change orders, collectibility, and potential loss provisions. No significant contract estimate changes or losses were recognized in the quarter.
- EMCOR had approximately $1.0 billion of estimated surety-bond exposure based on project completion status. Reduced availability of surety bonds could limit bidding capacity and adversely affect results or liquidity.
- The company faces variable-rate debt exposure, commodity and fuel cost risk, customer credit risk, litigation, government audits, and self-insured casualty liabilities.
- Pending legal matters include claims related to a 2010 construction-project explosion. Management believes available defenses are strong and does not expect a material adverse effect, but cannot estimate potential loss with certainty.
Most important facts for investors to verify
- Whether the U.S. industrial services recovery materializes and whether refinery turnaround and heat-exchanger demand improve.
- Whether backlog conversion supports revenue growth without further pressure on operating margins.
- The sustainability of earnings growth after separating the benefit of the Tax Cuts and Jobs Act from underlying operating performance.
- Operating cash conversion, working-capital requirements, and the effect of share repurchases on liquidity.
- Future goodwill impairment risk, particularly for the U.S. industrial services segment.
- Exposure to surety-bond capacity, contract claims, customer collections, litigation, and variable-rate debt.
- The effect of ASC 606 and future lease accounting adoption on reported financial statements and comparability.