Business Context and Reporting Period
EMCOR Group, Inc. filed an unaudited Form 10-Q for the three months ended March 31, 2014. The company provides electrical and mechanical construction, building services, facilities services, and industrial services through operations in the United States and United Kingdom.
Reportable segments include U.S. electrical construction and facilities services, U.S. mechanical construction and facilities services, U.S. building services, U.S. industrial services, and U.K. construction and building services. Segment results were restated to reflect the new U.S. industrial services segment, which includes RepconStrickland, Inc. (RSI), acquired in July 2013.
Key Financial Metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Revenue | $1.599 billion | $1.568 billion | Up 2.0% |
| Gross profit | $215.2 million | $191.1 million | Up $24.1 million |
| Gross margin | 13.5% | 12.2% | Up 130 basis points |
| Operating income | $69.4 million | $51.3 million | Up $18.1 million |
| Operating margin | 4.3% | 3.3% | Up 100 basis points |
| Net income attributable to EMCOR | $41.3 million | $30.2 million | Up $11.1 million |
| Diluted EPS | $0.61 | $0.44 | Up $0.17 |
| Operating cash flow | $(24.3) million | $(95.1) million | Improved by $70.8 million |
Selling, general and administrative expense increased to $144.9 million from $138.5 million, and represented 9.1% of revenue versus 8.8% in the prior-year quarter. The income tax provision was $25.5 million, with an effective tax rate of approximately 38.2% including discrete items.
Liquidity, Debt and Capital Resources
- Cash and cash equivalents were $406.7 million at March 31, 2014, down from $439.8 million at December 31, 2013.
- Total debt was $349.9 million, including a $345.6 million term loan, $4.2 million of capital lease obligations and other debt. There were no borrowings under the $750 million revolving credit facility.
- The term loan and revolving facility mature on November 25, 2018 and had an effective interest rate of 1.40% at quarter-end.
- Letters of credit outstanding totaled approximately $87.9 million. The company had $3.37 billion of backlog, compared with $3.36 billion at December 31, 2013 and $3.42 billion at March 31, 2013.
- Net cash used in investing activities was $6.3 million, including $8.1 million of capital expenditures. Net cash used in financing activities was $2.9 million, including $5.4 million of dividends and $4.4 million of long-term debt repayments.
- The company paid a regular quarterly dividend of $0.08 per share and had approximately $122.5 million remaining under its share-repurchase authorizations; no shares were repurchased during the quarter.
Material Changes Versus the Prior Comparable Period
- Revenue growth was primarily driven by $119.0 million of incremental revenue from 2013 acquisitions, including $110.5 million from RSI, and higher U.S. electrical construction revenue. Excluding acquisitions, revenue declined across most segments.
- U.S. industrial services revenue increased $86.4 million to $232.0 million, while operating income increased modestly to $23.4 million. RSI contributed $7.3 million of operating income after identifiable-intangible amortization, but the segment margin declined from an unusually strong 15.6% to 10.1%.
- U.S. mechanical construction revenue decreased $28.1 million, but operating income increased $8.0 million to $19.1 million. The prior-year period included an $8.2 million loss from a southeastern U.S. project.
- U.S. building services operating income increased $7.4 million to $20.3 million, despite a $7.1 million revenue decline, primarily due to improved profitability and higher snow-removal activity.
- U.K. revenue decreased $20.8 million to $98.2 million following the planned withdrawal from U.K. construction operations. Operating income was broadly unchanged at $1.3 million.
- Gross margin improved partly because the first quarter of 2013 included a significant project write-down. Restructuring expense declined to $0.9 million from $1.4 million.
- Operating cash flow improved substantially, primarily due to lower accounts receivable and income-tax payments, partly offset by lower accounts payable.
Guidance, Outlook, Risks and Unusual Items
- Management did not provide formal numerical earnings or revenue guidance in the filing. It stated that current cash, borrowing capacity, and expected operating cash flow should be sufficient for foreseeable liquidity and capital-expenditure needs.
- Management remains selective in bidding and intends to accept work it believes can be performed at reasonable margins. Demand for non-residential construction, macroeconomic conditions, interest rates, government policy, and contract mix remain important revenue and liquidity drivers.
- Restructuring obligations were $3.9 million at March 31, 2014, with most expected to be paid during 2014. The company expects approximately $0.8 million of additional restructuring expense through 2014.
- The company expects to contribute an additional approximately $4.6 million to its U.K. defined-benefit pension plan during the remainder of 2014.
- Material risk areas include fixed-price contract cost overruns, collectibility of receivables and unbilled contract assets, commodity and fuel costs, variable-rate debt, availability of surety bonds, litigation, government-contract audits, and potential impairment of goodwill or intangible assets.
- Surety-bond exposure was approximately $0.9 billion based on project obligations. A reduction in bonding capacity could materially affect bidding, revenue, profitability, and liquidity.
- The filing discusses a California wage-and-hour class-action lawsuit involving a subsidiary and independent janitorial contractors. Management believes it has valid defenses, but an adverse class certification and outcome could result in significant damages.
- The company sold a U.S. building-services subsidiary in January 2014 for approximately $1.1 million and recorded a $0.6 million loss.
- No goodwill, trade-name, or other identifiable-intangible impairment was recognized. Management noted that weaker future performance, particularly in U.S. industrial services, could increase impairment risk.
- The company reported no material impact from ongoing government disputes and investigations, but litigation outcomes cannot be predicted with assurance.
Investor Verification Checklist
- Verify the sustainability of margin improvement, particularly excluding the prior-year project write-down and other acquisition-related effects.
- Assess RSI integration, recurring demand in refinery and petrochemical markets, and the decline in U.S. industrial-services margin.
- Monitor backlog conversion, cancellations, project estimates, unbilled contract assets, and the net over-billed position of $266.9 million.
- Review term-loan amortization, variable-rate exposure, credit-agreement covenants, and available revolver capacity.
- Evaluate the potential financial impact of surety-bond availability, litigation, government audits, insurance liabilities, and the California janitorial-services lawsuit.
- Confirm future restructuring cash payments, pension contributions, dividends, and any subsequent share repurchases or acquisitions.