EMCOR Group, Inc. — Fiscal 2016 Form 10-K Summary
Business context and reporting period
EMCOR filed its audited annual report for the fiscal year ended December 31, 2016. The company provides electrical and mechanical construction, building services, and industrial services through approximately 75 operating subsidiaries and joint ventures. Approximately 96% of revenue was generated in the United States and 4% in foreign countries, primarily the United Kingdom. EMCOR employed approximately 31,000 people at year-end.
Revenue mix was approximately 34% new construction, 21% renovation and retrofit, 31% building services, and 14% industrial services. United Kingdom construction operations remain discontinued; United Kingdom building services continue as an operating segment.
Financial performance and key metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Revenue | $7.552 billion | $6.719 billion | 12.4% increase |
| Gross profit | $1.038 billion | $944.5 million | 9.9% increase |
| Gross margin | 13.7% | 14.1% | Down 40 basis points |
| Operating income | $308.5 million | $287.1 million | 7.4% increase |
| Operating margin | 4.1% | 4.3% | Down 20 basis points |
| Income from continuing operations | $185.3 million | $172.6 million | 7.4% increase |
| Net income attributable to EMCOR | $181.9 million | $172.3 million | 5.6% increase |
| Diluted EPS from continuing operations | $3.02 | $2.72 | 11.0% increase |
| Diluted EPS including discontinued operations | $2.97 | $2.72 | 9.2% increase |
| Operating cash flow | $264.6 million | $266.7 million | 0.8% decrease |
Segment revenue increased in all reportable segments except United Kingdom building services. United States mechanical construction and facilities services was the largest segment at $2.662 billion of revenue, followed by United States building services at $1.792 billion, United States electrical construction and facilities services at $1.704 billion, United States industrial services at $1.067 billion, and United Kingdom building services at $326.3 million.
Cash and cash equivalents were $464.6 million at December 31, 2016, compared with $486.8 million at the prior year-end. Net cash used in investing activities was $270.7 million, including $232.9 million for acquisitions and $39.6 million for capital expenditures. Net cash used in financing activities was $9.4 million.
Total debt and capital lease obligations were approximately $423.3 million before unamortized debt issuance costs, consisting primarily of $125.0 million drawn on the revolving credit facility and a $300.0 million term loan. Total liabilities were $2.356 billion and total equity was $1.538 billion.
Backlog increased to $3.903 billion from $3.771 billion, with management estimating that approximately 84% of 2016 year-end backlog would be recognized as revenue during 2017. Backlog is not a U.S. GAAP measure and includes contracts that may be canceled or modified.
Material changes versus the prior comparable period
- Revenue growth was driven primarily by higher activity in domestic construction, industrial field services, and mobile mechanical services. Acquisitions contributed $250.8 million of incremental revenue.
- EMCOR completed the $201.4 million acquisition of Ardent Services and Rabalais Constructors in April 2016. Ardent contributed $158.5 million of revenue and $8.1 million of operating income, net of related amortization, during 2016.
- Operating income improved despite higher corporate costs, including $3.8 million of Ardent transaction costs, higher incentive compensation, software costs, legal costs, and non-income-related taxes.
- Three construction projects generated aggregate losses of $47.3 million: $19.4 million on a transportation project and $18.3 million and $9.6 million on two mechanical construction projects. Management intends to seek recovery for these losses.
- Gross and operating margins declined because of the project losses. Excluding their stated impact, the filing indicates that operating margin was negatively affected by approximately 0.7 percentage points.
- United Kingdom building services revenue declined 13.6%, partly because of unfavorable British pound exchange rates following the United Kingdom’s decision to exit the European Union.
- Goodwill increased to $979.6 million from $843.2 million, primarily due to acquisitions. No goodwill impairment was recorded, but EMCOR recognized a $2.4 million non-cash impairment charge related to a subsidiary trade name.
- EMCOR repurchased approximately 1.5 million shares for $88.6 million during 2016 and had approximately $165.6 million of remaining repurchase authorization. The regular quarterly dividend was $0.08 per share.
Guidance, outlook, commentary, risks, and unusual items
Management did not provide a specific 2017 revenue, earnings, or margin guidance figure in the filing. Management stated that current cash, available revolver capacity, financing alternatives, and expected operating cash flow should be sufficient for short-term and foreseeable long-term liquidity needs.
The August 2016 credit agreement provides a $900 million revolving facility and a $400 million term loan, expiring August 3, 2021. EMCOR was in compliance with its debt covenants at year-end. Variable-rate debt exposure was approximately $425 million; a 100-basis-point increase in interest rates was estimated to increase after-tax interest expense by approximately $2.6 million over the next twelve months.
Material risks include cyclical demand for construction and maintenance services, government spending and contract cancellations, fixed-price contract cost overruns, labor availability and union actions, commodity and fuel prices, customer credit and collection risk, project claims and disputes, surety-bond availability, self-insured casualty exposure, environmental and safety liabilities, foreign exchange movements, cybersecurity incidents, and goodwill or intangible-asset impairment.
Approximately 55% of employees were represented by unions, and EMCOR participated in approximately 200 multiemployer pension plans. The filing states that potential withdrawal liabilities cannot be determined and could be material. Contributions to multiemployer pension plans were $167.3 million in 2016.
Surety-bond exposure based on the percentage of completion of bonded projects was approximately $1.1 billion, or about 29% of year-end backlog. Contractual obligations totaled approximately $2.148 billion, including debt, operating leases, purchase obligations, other long-term obligations, and uncertain tax positions. Letters of credit outstanding were approximately $91.9 million.
Discontinued United Kingdom construction operations generated only $0.3 million of revenue in 2016 but produced a $3.1 million after-tax loss, primarily from legal and warranty costs related to completed projects. The filing also reports an underfunded United Kingdom pension plan with a $49.5 million deficit at year-end.
Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2016.
Investor verification items
- Verify whether the three loss-making construction projects were fully resolved and whether claimed recoveries were ultimately collected.
- Assess the sustainability of the 2016 margin profile excluding unusual project losses and the effect of acquisition-related amortization and costs.
- Review Ardent’s post-acquisition performance and the increased goodwill and intangible-asset balances.
- Monitor backlog conversion, cancellations, change orders, claims, retainage, and the net over-billed position of $358.5 million at year-end.
- Evaluate liquidity after acquisition spending, share repurchases, dividends, and scheduled debt repayments under the 2021 credit agreement.
- Assess exposure to multiemployer pension underfunding, surety-bond requirements, self-insurance claims, litigation, and government-contract compliance.
- Monitor the United States industrial services segment, which held approximately 39.3% of total goodwill and had limited valuation cushion under certain adverse impairment assumptions.
- Review the future effects of the pending revenue-recognition and lease-accounting standards, particularly for shop-service arrangements and operating leases.