Business Context and Reporting Period
EMCOR Group, Inc. filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2013. The company provides electrical and mechanical construction, building services, industrial services, and United Kingdom construction and facilities services through approximately 70 operating subsidiaries and joint ventures.
During the third quarter, EMCOR completed the $460.7 million acquisition of RepconStrickland, Inc. (RSI), a provider of turnaround and specialty services to North American refinery and petrochemical customers. RSI and certain reclassified businesses were included in a newly created United States industrial services segment. Prior-period segment information was restated accordingly.
Financial Results and Key Metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Revenue | $1.629 billion | $1.606 billion | $4.754 billion | $4.735 billion |
| Gross profit | $206.3 million | $203.2 million | $579.0 million | $577.9 million |
| Gross margin | 12.7% | 12.7% | 12.2% | 12.2% |
| Operating income | $54.1 million | $68.6 million | $141.5 million | $171.1 million |
| Operating margin | 3.3% | 4.3% | 3.0% | 3.6% |
| Net income attributable to EMCOR | $26.7 million | $39.6 million | $77.9 million | $100.2 million |
| Diluted EPS | $0.39 | $0.59 | $1.14 | $1.48 |
Revenue increased 1.4% in the third quarter and 0.4% for the nine-month period. Operating income declined approximately 21% in the quarter and 17% year to date. Net income attributable to EMCOR declined approximately 33% in the quarter and 22% year to date. Higher SG&A, acquisition-related costs, restructuring expenses, project losses, and unfavorable comparisons with unusually strong 2012 industrial-services results reduced profitability.
SG&A was $149.7 million, or 9.2% of revenue, in the third quarter, compared with $134.5 million, or 8.4%, in the prior-year quarter. Nine-month SG&A was $427.9 million, or 9.0% of revenue, compared with $406.7 million, or 8.6%.
Cash Flow, Debt, Liquidity, and Capital Allocation
- Cash flow from operations was $68.0 million for the first nine months of 2013, compared with $43.0 million in the prior-year period.
- Investing cash outflow was $467.2 million, primarily reflecting $448.9 million for acquisitions and related contingent consideration, including RSI.
- Financing activities provided $238.6 million, including $250.0 million of revolving-credit borrowings.
- Cash and cash equivalents declined from $605.3 million at December 31, 2012 to $444.0 million at September 30, 2013.
- Revolving-credit borrowings increased to $400.0 million from $150.0 million at year-end. The facility has $750.0 million of committed capacity, expires November 21, 2016, and permits potential expansion to $900.0 million.
- The revolving facility bore interest at 1.68% at September 30, 2013. Letters of credit outstanding were approximately $78.9 million.
- Backlog was $3.393 billion at September 30, 2013, compared with $3.374 billion at December 31, 2012 and $3.382 billion at September 30, 2012.
- EMCOR paid $8.1 million of dividends and repurchased $5.0 million of common stock during the first nine months. Approximately $43.6 million remained authorized for repurchases.
Material Changes Versus the Prior Comparable Period
- United States electrical construction revenue increased to $340.5 million in the quarter and $984.4 million year to date; quarterly operating income improved to $24.0 million, while nine-month operating income was essentially unchanged at $68.1 million.
- United States mechanical construction revenue rose 3.9% in the quarter but declined 2.9% year to date. Operating income declined to $27.4 million in the quarter and $56.8 million year to date, primarily due to losses on two southeastern U.S. projects totaling $4.2 million in the quarter and $22.6 million year to date.
- United States building services operating income increased to $23.3 million in the quarter and $52.9 million year to date, supported by energy services, mobile mechanical services, and commercial site-based services.
- United States industrial services operating income declined to $0.3 million in the quarter from $11.1 million, because the prior-year quarter benefited from three non-recurring turnaround projects contributing $49.9 million of revenue. Year-to-date operating income increased to $26.3 million from $22.6 million.
- United Kingdom construction and facilities services revenue declined to $103.5 million in the quarter and $331.5 million year to date. Year-to-date operating income shifted to a $2.1 million loss from $9.1 million of income in the prior-year period.
- Restructuring expenses increased to $2.5 million in the quarter and $9.6 million year to date, principally from the decision to withdraw from United Kingdom construction operations. The company expects an additional $3.3 million of restructuring expense through 2014.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- Management stated that it remains selective in accepting work and seeks projects that can be performed at reasonable margins. The filing does not provide specific earnings or revenue guidance.
- Management expects current cash, operating cash generation, and available borrowing capacity to satisfy short-term and foreseeable long-term liquidity needs.
- Key risks include demand for non-residential construction, competitive pricing, project execution, customer creditworthiness, contract cancellations, changes in surety-bond availability, variable interest rates, commodity and fuel costs, and foreign exchange movements.
- Surety-bond exposure was approximately $0.8 billion based on estimated exposure assuming defaults on all covered contractual obligations. A reduction in bonding capacity could materially affect bidding, liquidity, and operations.
- The filing describes an arbitration-related claim arising from an explosion at a project. Management believes it has meritorious defenses and cannot estimate any potential loss with certainty; it does not currently expect a material adverse effect.
- Goodwill increased to $829.3 million and net identifiable intangible assets to $550.8 million, principally because of acquisitions. No impairment was recorded through September 30, 2013; the October 1, 2013 impairment testing had not yet been completed.
- The company recorded a $2.6 million insurance recovery in the first quarter and $6.0 million of net reversals of contingent-consideration liabilities during the first nine months. RSI transaction costs were $4.7 million in the quarter and $6.1 million year to date.
- The effective tax rate, including discrete items, increased to 46.4% in the quarter and 41.5% year to date, partly because of United Kingdom operating losses and United Kingdom tax-rate changes.
Investor Verification Priorities
- Verify RSI’s post-acquisition revenue, profitability, integration progress, amortization burden, and final purchase-price allocation.
- Assess whether losses on the two southeastern U.S. projects are contained and whether further contract losses or write-downs are possible.
- Monitor United Kingdom restructuring costs, remaining obligations, and the financial effect of exiting construction operations.
- Reconcile the $400.0 million revolver balance, covenant compliance, interest-rate exposure, and remaining liquidity after the acquisition.
- Evaluate goodwill and intangible-asset impairment risk, particularly in United States industrial services and other acquisition-related reporting units.
- Review backlog quality, cancellation provisions, customer concentration, unapproved change orders, receivables, and net over-billings.
- Track surety-bond capacity, pending litigation and government matters, tax examinations, and potential uninsured or self-insured claims.