EMCOR Group, Inc. quarterly report, Q2 FY2019

EMCOR Group, Inc. — Form 10-Q Summary

Business context and reporting period

EMCOR is a U.S.-focused provider of electrical and mechanical construction, facilities, building, and industrial services, with operations in the United States and United Kingdom through approximately 80 operating subsidiaries and joint ventures. This unaudited Form 10-Q covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.

Financial performance and position

Metric	Q2 2019	Q2 2018	Six months 2019	Six months 2018
Revenue	$2.324 billion	$1.954 billion	$4.483 billion	$3.854 billion
Gross profit	$346.4 million	$290.8 million	$655.1 million	$560.0 million
Gross margin	14.9%	14.9%	14.6%	14.5%
Operating income	$120.0 million	$99.7 million	$222.3 million	$177.7 million
Operating margin	5.2%	5.1%	5.0%	4.6%
Net income attributable to EMCOR	$84.0 million	$70.8 million	$156.4 million	$126.2 million
Diluted EPS from continuing operations	$1.49	$1.21	$2.77	$2.15

Q2 revenue increased 19.0%; six-month revenue increased 16.3%.
Q2 operating income increased 20.4%; six-month operating income increased 25.1%.
SG&A was $226.2 million in Q2 and $432.4 million year to date. SG&A margin was 9.7% in Q2 versus 9.7% in the prior year and 9.6% year to date versus 9.9%.
Income tax rates, inclusive of discrete items, were 28.3% for Q2 and 27.9% for the six months, compared with 27.2% and 27.1%, respectively, in 2018.
All reportable segments increased revenue in Q2 and year to date. The strongest Q2 revenue growth was in U.S. industrial services, up approximately 60.6%, followed by U.S. electrical construction and facilities services, up approximately 18.7%.
Q2 segment operating income increased in every segment except U.S. mechanical construction and facilities services, where operating income declined to $54.0 million from $57.4 million and margin declined to 6.6% from 7.9%.

Cash flow, debt and liquidity

Cash, cash equivalents and restricted cash declined by $150.4 million during the first six months to $215.8 million at June 30, 2019; unrestricted cash and cash equivalents were $213.4 million.
Operating cash flow was an outflow of $42.2 million, compared with an outflow of $32.7 million in the prior-year period, primarily because organic growth increased working-capital needs.
Investing cash outflow was $85.8 million, including $64.0 million for acquisitions and $22.5 million for capital expenditures.
Financing cash outflow was $22.2 million, including $9.0 million of dividends, $7.6 million of long-term debt repayments, and $2.2 million of finance-lease repayments. No common stock was repurchased during the period.
Total debt was $294.8 million, including $262.0 million under the term loan and $25.0 million drawn under the revolving facility. The $900.0 million revolving facility and $400.0 million term loan mature on August 3, 2021. Approximately $109.0 million of letters of credit were outstanding.
EMCOR reported compliance with all credit agreement covenants. Management stated that cash balances, expected operating cash flow, and available borrowing capacity should provide sufficient short-term and foreseeable long-term liquidity.
The January 2019 adoption of ASC 842 added $233.2 million of operating lease right-of-use assets and $245.1 million of operating lease liabilities at June 30, 2019; management said adoption did not affect liquidity, earnings, or debt covenant compliance.

Material changes versus the prior comparable period

Three 2019 acquisitions were completed for total consideration of approximately $64.4 million. Acquired companies contributed incremental Q2 revenue of $72.8 million and incremental operating income of $5.2 million, inclusive of related intangible amortization.
Remaining performance obligations increased to $4.226 billion at June 30, 2019 from $3.964 billion at December 31, 2018 and $3.673 billion at June 30, 2018. Approximately $3.568 billion was expected to be recognized within one year.
U.S. industrial services benefited from normalized demand after prior-year cancellations or deferrals of maintenance activity and from improved field and shop performance. Six-month operating income also included a $3.6 million recovery from a legal settlement.
U.S. mechanical construction results were pressured by project mix, early-stage manufacturing projects, and completion of certain transportation and hospitality projects.
Corporate administration expense increased to $27.1 million in Q2 and $49.7 million year to date, primarily due to higher employment costs, incentive compensation, professional fees, and information-technology initiatives.
The prior-year $0.9 million intangible-asset impairment charge did not recur in 2019. Discontinued U.K. construction operations produced no income or expense in 2019, compared with losses of $0.2 million in Q2 and $0.5 million year to date in 2018.

Outlook, risks, contingencies and unusual items

The filing does not provide specific quantitative revenue or earnings guidance. Management described demand and backlog as favorable and expects liquidity to remain adequate, but noted that results are not necessarily indicative of the full year.

Key operating risks include non-residential construction demand, macroeconomic conditions, interest rates, government economic policy, project execution, customer creditworthiness, contract claims and change orders, and the timing of billings on long-duration and industrial turnaround projects.
Revenue recognition depends substantially on estimates of contract costs, progress toward completion, variable consideration, claims, pending change orders, and collectibility. No significant contract-cost estimate changes or contract losses were recognized in the periods presented.
Contract assets were $179.4 million and current contract liabilities were $544.3 million at June 30, 2019. Accounts receivable were $1.947 billion, net of a $15.3 million allowance for doubtful accounts.
Surety bonds are material to the construction business. Estimated exposure assuming defaults on all then-existing bonded obligations was approximately $1.3 billion. A reduction in bonding availability could materially impair bidding capacity, liquidity, earnings, or cash flow.
EMCOR faces variable-rate interest exposure on $287.0 million of credit-agreement borrowings; a 100-basis-point rate increase was estimated to raise next-twelve-month after-tax interest expense by approximately $2.1 million.
Potential liabilities also include self-insured claims, legal proceedings, government audits and investigations, income-tax examinations for 2014–2017, and future goodwill or intangible-asset impairment. Management did not believe these matters were currently expected to have a material adverse effect, but litigation outcomes are uncertain.
Restructuring obligations remaining at June 30, 2019 were $0.7 million; no material additional restructuring expense was expected during the remainder of 2019.

Important facts for investors to verify

Whether strong revenue growth and the $4.23 billion backlog convert into operating cash flow, given year-to-date operating cash usage and significant working-capital requirements.
The sustainability of U.S. industrial services’ recovery and the $3.6 million legal-settlement benefit included in year-to-date results.
Margin performance in U.S. mechanical construction, where project mix reduced operating margin despite revenue growth.
Acquisition integration, purchase-price allocations, amortization, and the contribution of the three 2019 acquisitions.
Availability and terms of the revolving credit facility and surety bonding capacity as the August 2021 credit agreement maturity approaches.
Exposure to fixed-price construction contracts, customer collections, claims and unapproved change orders, commodity costs, fuel costs, and variable interest rates.
Future impairment testing for goodwill and intangible assets, particularly in U.S. industrial services, where the filing identifies relatively less valuation cushion.