EMCOR Group, Inc. — 2017 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; balance-sheet comparisons are to December 31, 2016, and operating comparisons are primarily to the same periods in 2016. EMCOR provides electrical and mechanical construction, building services, and industrial services through approximately 75 operating subsidiaries and joint ventures in the United States and United Kingdom.
Financial Highlights
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Revenue | $1.887 billion | $1.923 billion | $5.674 billion | $5.602 billion |
| Gross profit | $295.1 million | $268.0 million | $835.9 million | $765.9 million |
| Gross margin | 15.6% | 13.9% | 14.7% | 13.7% |
| Operating income | $106.5 million | $86.1 million | $282.1 million | $234.0 million |
| Operating margin | 5.6% | 4.5% | 5.0% | 4.2% |
| Net income attributable to EMCOR | $64.6 million | $51.5 million | $174.0 million | $141.3 million |
| Diluted EPS from continuing operations | $1.09 | $0.85 | $2.93 | $2.33 |
- Q3 revenue declined 1.9%, while nine-month revenue increased 1.3%.
- Q3 operating income increased approximately 23.7%; nine-month operating income increased approximately 20.6%.
- Q3 and nine-month gross margins expanded by 170 and 100 basis points, respectively. SG&A was $188.6 million, or 10.0% of revenue, in Q3, compared with 9.4% in the prior-year quarter.
- Net cash provided by operating activities was $238.3 million for the nine months, versus $128.9 million in 2016. Capital expenditures were $26.1 million and acquisition payments were $82.7 million.
- Cash and cash equivalents were $480.5 million at September 30, 2017, compared with $464.6 million at December 31, 2016.
- Total debt was $413.9 million, including $125.0 million drawn on the revolving facility and a $288.6 million term loan. Approximately $111.8 million of letters of credit were outstanding under the credit facility.
- The $900.0 million revolving facility and $400.0 million term loan mature on August 3, 2021. EMCOR was in compliance with all debt covenants at September 30, 2017; the effective borrowing rate reported at that date was 2.24%.
Material Changes Versus the Prior Comparable Period
- Construction strength: Q3 revenue increased $68.3 million in United States mechanical construction and facilities services, and operating income increased $18.6 million. United States electrical construction operating income increased $15.7 million.
- Industrial services weakness: Q3 revenue declined $93.4 million and the segment reported a $4.8 million operating loss versus $14.6 million of operating income in Q3 2016. Nine-month operating income declined to $16.6 million from $66.6 million.
- Hurricane Harvey: The hurricane deferred turnaround projects and may lead to cancellations, reducing industrial-services revenue and leaving overhead underabsorbed.
- Building services: Q3 revenue declined $23.6 million, primarily due to non-renewed rebid contracts and lower energy-services project activity, although operating income increased $2.9 million.
- United Kingdom: Q3 revenue increased to $85.9 million from $73.0 million, but nine-month revenue declined to $244.1 million from $251.3 million, partly due to unfavorable British pound exchange rates.
- Acquisitions: Two companies were acquired in 2017 for total consideration of $84.8 million, adding fire-protection/alarm and mobile mechanical-service capabilities. Acquisitions contributed $34.7 million of incremental Q3 revenue and $1.3 million of incremental operating income, net of related intangible amortization.
- Contract recovery: Nine-month 2017 results included $18.1 million of gross profit from recovery of previously disputed costs on a project completed in 2016. The prior-year periods were adversely affected by $6.9 million of Q3 and $17.4 million of nine-month losses on a transportation project.
- Backlog: Backlog was $3.963 billion at September 30, 2017, compared with $3.903 billion at both December 31, 2016 and September 30, 2016.
- Share repurchases: EMCOR repurchased approximately 1.4 million shares for $88.6 million during 2017 through September 30. Approximately $77.0 million remained authorized at quarter-end, and the board subsequently authorized an additional $100.0 million.
Outlook, Risks, Contingencies, and Unusual Items
- No formal quantitative revenue or earnings guidance is provided in the filing. Management states that current cash, operating cash flow, and available borrowing capacity are expected to be sufficient for foreseeable liquidity and capital requirements.
- Management expects operating cash flow to remain the primary liquidity source. Net over-billings were $396.8 million at September 30, 2017, but working-capital needs can increase on long-duration construction contracts and industrial turnaround work billed in arrears.
- Key risks include non-residential construction demand, energy and oil-and-gas market conditions, contract cancellations, customer collectibility, project-estimate revisions, commodity and fuel costs, variable interest rates, foreign-exchange movements, and availability of surety bonds.
- Aggregate estimated exposure under surety bonds, assuming defaults on all then-existing covered contractual obligations, was approximately $1.1 billion. Management reported adequate current bonding capacity but cautioned that reduced availability could materially affect operations and liquidity.
- Legal proceedings include claims related to a 2010 construction-project explosion and other matters. Management believes existing defenses are meritorious and outcomes will not be materially adverse, but the potential loss in the explosion matter cannot be estimated with certainty.
- Discontinued United Kingdom construction operations generated a $0.7 million nine-month loss, primarily from legal costs related to final contract settlements. Remaining assets and liabilities are expected to be settled in the ordinary course, with potentially immaterial additional effects.
- The company adopted deferred-tax-balance-sheet and goodwill-impairment presentation guidance. It expects to adopt the new revenue-recognition standard on January 1, 2018 using the modified-retrospective method; no material overall impact is expected, although revenue recognition for certain shop-services contracts may accelerate.
- No goodwill or identifiable-intangible-asset impairment was recognized through the first nine months. Management had not yet completed its October 1, 2017 impairment testing and identified United States industrial services as particularly sensitive to weaker future performance.
- A 100-basis-point increase in interest rates was estimated to increase after-tax interest expense by approximately $2.5 million over the next twelve months.
Most Important Facts to Verify
- Whether Hurricane Harvey-related industrial-services project deferrals become cancellations and whether the segment recovers from its Q3 operating loss.
- The sustainability of margin expansion after the one-time or unusual $18.1 million contract-cost recovery and the comparison benefit from prior-year transportation-project losses.
- Progress on integrating the 2017 acquisitions and the resulting revenue, margin, and intangible-amortization contribution.
- Backlog conversion, cancellations, contract estimates, and the collectibility of accounts receivable and unbilled contract assets.
- Available revolver capacity after borrowings and letters of credit, compliance with debt covenants, and exposure to rising variable interest rates.
- Results of the October 1, 2017 goodwill and intangible-asset impairment testing, particularly for United States industrial services.
- Developments in the explosion-related arbitration, government investigations, surety-bond capacity, and other contingencies.