EMCOR Group, Inc. annual report, FY2018

EMCOR Group, Inc. 2018 Form 10-K Summary

Business Context and Reporting Period

EMCOR provides electrical and mechanical construction, building services, and industrial services through approximately 80 operating subsidiaries and joint ventures. The company employed approximately 33,000 people at December 31, 2018. Approximately 95% of 2018 revenue came from the United States and 5% from foreign operations, substantially in the United Kingdom. The filing covers the fiscal year ended December 31, 2018; quarterly information is included but this is an annual Form 10-K, not a standalone quarterly filing.

Revenue mix: approximately 61% construction, 28% building services, and 11% industrial services.
Reportable segments: U.S. electrical construction, U.S. mechanical construction, U.S. building services, U.S. industrial services, and U.K. building services.
Construction operations in the United Kingdom were discontinued in 2014 and are presented as discontinued operations.

Key Financial Metrics

Metric	2018	2017	Change
Revenue	$8.131 billion	$7.687 billion	+5.8%
Gross profit	$1.205 billion	$1.147 billion	+5.1%
Gross margin	14.8%	14.9%	-0.1 percentage points
Operating income	$403.1 million	$328.9 million	+22.9%
Operating margin	5.0%	4.3%	+0.7 percentage points
Income from continuing operations	$285.9 million	$228.1 million	+25.4%
Net income attributable to EMCOR	$283.5 million	$227.2 million	+24.8%
Diluted EPS from continuing operations	$4.89	$3.83	+27.7%
Net cash provided by operating activities	$271.0 million	$366.0 million	-26.0%

SG&A was $799.2 million, or 9.8% of revenue, compared with 9.9% in 2017. The income tax rate on continuing operations was 27.6%, compared with 28.5%, primarily reflecting the Tax Cuts and Jobs Act. Discontinued operations generated a $2.3 million after-tax loss in 2018.

Segment and Operating Developments

U.S. mechanical construction revenue increased to $3.020 billion and operating income increased to $219.4 million.
U.S. building services revenue increased to $1.875 billion and operating income increased to $93.8 million, supported by energy services, government work, mobile mechanical services, and snow removal.
U.S. industrial services revenue increased to $865.6 million and operating income increased to $28.2 million as turnaround activity recovered from Hurricane Harvey-related disruptions.
U.K. building services revenue increased to $414.9 million and operating income increased to $15.9 million; favorable currency translation contributed to the improvement.
U.S. electrical construction operating income declined to $139.4 million from $150.0 million. A Western-region transportation project incurred $10.0 million of losses, partly due to contract scope issues.

Cash Flow, Debt, Liquidity, and Capital Allocation

Cash, cash equivalents, and restricted cash declined to $366.2 million at December 31, 2018 from $469.4 million at year-end 2017.
Operating cash flow was $271.0 million. Investing cash usage was $117.7 million, including $72.1 million for acquisitions and $43.5 million for capital expenditures.
Financing cash usage was $253.0 million, including $216.2 million of share repurchases, $18.6 million of dividends, and $15.2 million of debt repayments.
Total debt was $295.8 million, consisting primarily of $269.6 million under the term loan and $25.0 million under the revolving credit facility. The term loan and revolving facility mature or expire in 2021.
The company had a $900 million revolving credit facility, of which $25 million was drawn, and approximately $109 million of outstanding letters of credit. The company was in compliance with all debt covenants.
Remaining performance obligations were $3.964 billion, with approximately 83% expected to be recognized as revenue during 2019.
EMCOR repurchased approximately 3.1 million shares for $216.2 million during 2018 and had approximately $158.5 million of remaining repurchase authorization at year-end. The regular quarterly dividend was $0.08 per share.

Material Changes Versus the Prior Comparable Period

Revenue growth accelerated to 5.8% from 1.8% in 2017, with revenue growth in every reportable segment.
Operating margin improved despite a modest gross-margin decline. The 2017 period included $57.8 million of non-cash goodwill and intangible-asset impairment charges; 2018 included only a $0.9 million impairment charge.
Industrial services recovered from Hurricane Harvey-related project deferrals and cancellations in 2017, although its operating margin remained below the construction segments.
2017 benefited from an $18.1 million recovery of previously disputed contract costs; 2018 included the $10.0 million transportation-project loss.
Accounts receivable increased to $1.774 billion from $1.608 billion, and contract assets increased to $158.2 million from $122.6 million, contributing to lower operating cash flow.
EMCOR adopted ASC 606 on January 1, 2018 using the modified retrospective method. The reported 2018 results include the adoption effects; the filing presents pro forma amounts that would have been revenue of $8.117 billion, operating income of $396.4 million, and diluted continuing-operations EPS of $4.81.
Four companies were acquired in 2018 for total consideration of $71.3 million, generating $90.1 million of incremental 2018 revenue when combined with the 2017 acquisitions.

Outlook, Commentary, Risks, and Unusual Items

Management stated that cash generated from operations, existing cash, and available borrowing capacity should be sufficient for short-term and foreseeable long-term liquidity needs. The filing does not provide a specific 2019 revenue, earnings, or margin guidance range.

Demand depends on non-residential construction, customer capital spending, government appropriations, refinery activity, and broader economic and credit conditions.
Fixed-price contracts expose the company to labor, material, fuel, productivity, estimating, scope, and execution risks. Revenue is frequently recognized using cost-to-cost estimates, so revisions can materially affect results.
Commodity prices, particularly copper and steel, fuel costs, labor shortages, adverse weather, natural disasters, and project delays may pressure margins.
Government contracts may be terminated, rebid, renegotiated, or delayed and are subject to audits, regulatory requirements, and potential suspension or debarment.
Approximately 57% of employees were represented by unions. EMCOR contributes to approximately 200 multiemployer pension plans and stated that potential withdrawal liabilities cannot be determined and could be material.
Surety bonding is important to the construction business. Estimated exposure under surety bonds, assuming defaults on all covered contractual obligations, was approximately $1.1 billion.
The company is substantially self-insured for several liabilities, including workers’ compensation, automobile, general liability, and healthcare claims. A 10% increase in estimated insurance liabilities would have resulted in approximately $16.2 million of additional 2018 expense.
Goodwill and identifiable intangible assets totaled approximately $1.479 billion at year-end. The U.S. industrial services reporting unit had the smallest disclosed fair-value cushion, increasing sensitivity to weaker markets or lower forecasts.
In January 2019, an arbitrator denied all claims against an EMCOR subsidiary related to a 2010 construction-site explosion.
Adoption of the new lease standard on January 1, 2019 was expected to add approximately $200 million to $225 million of assets and liabilities without materially affecting liquidity or earnings.

Investor Verification Checklist

Verify whether remaining performance obligations convert into revenue and profit at expected margins, particularly the $3.964 billion backlog.
Monitor operating cash conversion, accounts receivable, contract assets, retainage, and collection of disputed or unapproved change-order amounts.
Assess execution and final profitability of fixed-price construction projects, including the transportation project that generated the $10.0 million loss.
Track U.S. industrial services demand, refinery turnaround activity, oil prices, and the risk of future goodwill impairment.
Review debt maturities, variable-rate exposure, letters of credit, surety capacity, and compliance with credit-agreement restrictions on repurchases, dividends, and acquisitions.
Evaluate potential multiemployer pension withdrawal liabilities, self-insurance estimates, litigation, government-contract exposure, and environmental contingencies.
Reconcile reported 2018 results with the ASC 606 pro forma presentation and assess the balance-sheet impact of ASC 842 lease adoption.