EMCOR Group, Inc. — 2011 Q3 Form 10-Q Summary
Business context and reporting period
EMCOR is a provider of electrical and mechanical construction and facilities services serving commercial, industrial, utility and institutional customers, primarily in the United States and United Kingdom. This unaudited Form 10-Q covers the three and nine months ended September 30, 2011, compared with the corresponding 2010 periods.
All periods reflect discontinued-operations accounting for the Canadian construction segment, which was sold on August 2, 2011. The company operates through U.S. electrical construction and facilities services, U.S. mechanical construction and facilities services, U.S. facilities services, and U.K. construction and facilities services segments.
Key financial metrics
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Revenue | $1,482.2 million | $1,220.1 million | $4,095.5 million | $3,551.2 million |
| Gross profit | $188.3 million | $171.4 million | $519.6 million | $492.0 million |
| Gross margin | 12.7% | 14.1% | 12.7% | 13.9% |
| Operating income (loss) | $56.5 million | $(168.2) million | $148.4 million | $(97.3) million |
| Operating margin | 3.8% | (13.8)% | 3.6% | (2.7)% |
| Net income attributable to EMCOR | $40.8 million | $(175.6) million | $94.2 million | $(126.7) million |
| Diluted EPS from continuing operations | $0.47 | $(2.60) | $1.24 | $(1.92) |
Operating results improved substantially versus 2010 because the prior-year periods included non-cash goodwill and identifiable-intangible impairment charges of $226.2 million in the third quarter and $246.1 million for the first nine months. Excluding those charges, 2011 operating income decreased by approximately $1.5 million in the quarter and $0.4 million year to date.
Cash and cash equivalents were $476.4 million at September 30, 2011, down from $710.8 million at December 31, 2010. Nine-month operating cash flow was $58.7 million, compared with cash used in operations of $29.7 million in 2010. Investing cash flow was $(294.3) million, primarily reflecting acquisitions, while financing cash flow was $0.2 million.
Total debt was $153.4 million, consisting primarily of $150.0 million outstanding under the revolving credit facility. The facility has total commitments of $550.0 million, expires in February 2013, and had approximately $78.6 million of outstanding letters of credit. The reported borrowing rate at September 30, 2011 was 2.99%.
Backlog was $3.54 billion at September 30, 2011, compared with $2.88 billion at September 30, 2010 and $3.11 billion at December 31, 2010, excluding Canadian backlog. Approximately $0.64 billion of the year-over-year increase came from acquired companies.
Material changes versus the prior comparable period
- Revenue increased 21.5% in the third quarter and 15.3% for the first nine months. Acquired businesses contributed approximately $145.4 million and $289.8 million, respectively.
- U.S. facilities services revenue increased by $161.1 million in the quarter and $339.9 million year to date, driven by acquisitions, industrial services demand, government services and mobile mechanical work.
- U.S. mechanical construction and facilities services revenue increased by $85.1 million in the quarter and $136.8 million year to date, including contributions from a 2011 acquisition.
- U.S. electrical construction and facilities services revenue declined in the quarter but increased for the nine-month period. Quarterly operating income declined to $17.1 million from $25.4 million.
- Gross margin declined to 12.7% from 14.1% in the quarter and to 12.7% from 13.9% year to date. Management attributed the pressure to competitive bidding, project mix and a greater proportion of lower-margin public projects.
- SG&A increased in dollars but declined as a percentage of revenue to 8.9% from 9.3% in the quarter and to 9.0% from 9.7% year to date.
- On June 30, 2011, EMCOR acquired USM Services Holdings for total consideration of approximately $255.0 million, using cash on hand. The preliminary allocation included $133.5 million of goodwill and $134.4 million of identifiable intangible assets.
- On August 2, 2011, EMCOR sold its Canadian subsidiary for approximately $17.2 million plus an expected $0.1 million and received approximately $26.4 million in repayment of intercompany indebtedness. The sale produced a $9.0 million after-tax gain.
- Goodwill increased to $566.8 million from $406.8 million at year-end, and net identifiable intangible assets increased to $380.6 million from $245.1 million, principally because of acquisitions.
Outlook, commentary, risks and unusual items
Management stated that cash balances, expected operating cash flow and available borrowing capacity should be sufficient for foreseeable liquidity needs and capital expenditures. The company expects facilities services contracts to provide a more predictable cash-flow stream than construction activities.
Management continues to be selective in bidding because of intense competition and seeks projects that can be performed at reasonable margins. Demand for industrial-services turnaround, specialty call-out and shop work improved, while certain mobile mechanical, government and commercial site-based operations experienced margin pressure.
- Future margins remain exposed to competitive bidding, project execution, public-sector project mix, customer demand and changes in construction activity.
- Construction contracts use percentage-of-completion accounting, requiring estimates of total costs, claims, change orders, collectibility and completion margins. Changes in estimates could affect future results.
- Surety-bond availability is a significant risk. Estimated exposure based on bonded projects was approximately $1.3 billion, and reduced bonding capacity could limit bidding or adversely affect financial results and liquidity.
- The revolving credit facility contains financial and operating covenants restricting, among other matters, dividends, repurchases, acquisitions, investments, indebtedness and capital expenditures. Renewal risk exists when the facility expires in February 2013.
- The company is exposed to variable interest rates, foreign currency movements, commodity prices and fuel costs. A 25-basis-point increase in interest rates was estimated to increase after-tax interest expense by approximately $0.2 million over the next twelve months.
- No goodwill or identifiable-intangible impairment was recorded during the first nine months of 2011, but the October 1, 2011 impairment testing had not yet been completed. Future impairment charges remain possible if projections, margins, growth assumptions or interest rates deteriorate.
- EMCOR declared a $0.05-per-share dividend and authorized a stock repurchase program of up to $100.0 million; no repurchases occurred during the final five days of the quarter.
- The company reported lawsuits and proceedings seeking amounts ranging from a few thousand dollars to more than $10.0 million. A previously disclosed U.K. arbitration claim was settled with mutual releases on March 31, 2011.
- A subsidiary is contesting a proposed $15,000 MSHA assessment related to citations arising from a 2010 mine accident that resulted in an employee death; the citations were abated.
Most important facts for investors to verify
- Whether revenue growth from USM and other acquisitions translates into sustainable operating income after amortization and integration costs.
- Whether gross-margin pressure continues, particularly in public-sector and competitively bid construction work.
- The results of the October 1, 2011 goodwill and intangible-asset impairment testing.
- Cash conversion, working-capital requirements and the effect of acquisition spending on liquidity.
- Compliance with revolving-credit covenants and refinancing or repayment plans before the February 2013 maturity.
- Availability and pricing of surety bonds, letters of credit and other collateral arrangements.
- Exposure to unapproved change orders, claims, customer collectibility, self-insurance liabilities and pending legal matters.
- The extent to which the $3.54 billion backlog represents acquired backlog versus organic awards and the expected margin profile of that backlog.