EMCOR Group, Inc. quarterly report, Q2 FY2016

EMCOR Group, Inc. — Q2 2016 Form 10-Q Summary

Reporting period: Quarter and six months ended June 30, 2016. The filing was signed July 28, 2016. EMCOR provides electrical and mechanical construction, facilities, building, and industrial services through approximately 70 operating subsidiaries and joint ventures in the United States and United Kingdom.

Financial performance

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Revenue	$1.933 billion	$1.653 billion	$3.678 billion	$3.242 billion
Gross profit	$274.7 million	$239.5 million	$497.8 million	$456.5 million
Gross margin	14.2%	14.5%	13.5%	14.1%
Operating income	$92.3 million	$77.7 million	$147.9 million	$133.0 million
Operating margin	4.8%	4.7%	4.0%	4.1%
Net income attributable to EMCOR	$55.4 million	$46.8 million	$89.7 million	$79.7 million
Diluted EPS from continuing operations	$0.92	$0.74	$1.48	$1.26

Management reported record second-quarter revenue, operating income, net income attributable to EMCOR, and diluted continuing-operations EPS. Q2 revenue increased 17.0%, while six-month revenue increased approximately 13.5%. Q2 operating income increased approximately 18.8%; six-month operating income increased approximately 11.2%.

SG&A increased to $181.8 million in Q2 and $349.2 million for the six months, but SG&A as a percentage of revenue improved to 9.4% and 9.5%, respectively, from 9.8% and 10.0%.
Income from continuing operations was $56.5 million in Q2 and $90.9 million for the six months. Effective tax rates including discrete items were 36.8% and 36.3%, compared with 38.0% and 37.9% in the prior-year periods.
Discontinued United Kingdom construction operations generated after-tax losses of $1.1 million in Q2 and $1.2 million for the six months.
Dividends declared were $0.08 per share in each quarter; the company expects quarterly dividends to continue, subject to credit-agreement limitations.

Segment and operating changes

Q2 revenue increased in every reportable segment except United Kingdom building services. U.S. industrial services revenue increased $108.3 million and operating income increased $15.7 million, supported by specialty field-services demand and large projects.
U.S. mechanical construction revenue increased $75.9 million in Q2 and operating income increased $5.8 million, including a $2.0 million favorable settlement related to a prior acquisition.
U.S. electrical construction revenue increased $74.4 million, including $48.3 million from Ardent, but operating income declined to $23.0 million from $25.3 million.
U.S. building services operating income increased $0.4 million in Q2 but declined $6.7 million for the six-month period, reflecting higher costs, lower snow-removal activity, weaker government-site results, and the absence of a prior-year claim settlement benefit.
United Kingdom building services revenue was broadly flat in dollars, while unfavorable pound exchange rates reduced Q2 revenue by approximately $6.2 million and six-month revenue by approximately $11.3 million.
Backlog was $3.809 billion at June 30, 2016, up from $3.771 billion at December 31, 2015 and $3.624 billion at June 30, 2015. Backlog is an industry measure, not a GAAP measure, and contracts may be cancellable.

Acquisition and unusual items

On April 15, 2016, EMCOR acquired Ardent Services, L.L.C. and Rabalais Constructors, LLC for total consideration of $201.4 million. The acquisition added $119.5 million of preliminary goodwill and $41.5 million of identifiable intangible assets and strengthened electrical, industrial, and energy-sector capabilities.
2016 acquisitions contributed $63.4 million of incremental Q2 revenue and $4.7 million of operating income, net of $1.1 million of intangible-amortization expense.
A $10.5 million loss was recognized on a Northeastern transportation project because of productivity issues and unfavorable job-site conditions. EMCOR expects the project to be completed by year-end 2016 and intends to seek recovery.
Corporate administration costs increased by $5.3 million in Q2, including $2.8 million of Ardent transaction costs and higher employment costs.
Restructuring expenses were $0.6 million in Q2 and $0.7 million for the six months. No material additional continuing-operations restructuring expense was expected for the remainder of 2016.

Cash flow, debt, and liquidity

Six-month operating cash flow was $47.8 million, compared with cash used of $6.1 million in the prior-year period.
Investing cash outflow was $250.3 million, primarily due to $232.3 million of acquisition payments and $19.0 million of capital expenditures.
Financing cash flow was $163.0 million, primarily reflecting $220.0 million of revolving-credit borrowings, partly offset by $34.1 million of share repurchases, $9.7 million of dividends, and debt repayments.
Cash declined from $486.8 million at December 31, 2015 to $443.0 million at June 30, 2016.
Total debt and capital lease obligations were $527.2 million, including $220.0 million drawn on the revolving facility and a $306.3 million term-loan balance. Net debt, using reported cash, was approximately $84.2 million.
The revolving facility has $750.0 million of capacity and expires November 25, 2018. Borrowings bore interest at 1.72% at June 30, 2016. EMCOR was in compliance with all debt covenants.
Letters of credit outstanding were approximately $109.6 million, and estimated exposure under surety bonds was approximately $1.1 billion based on project completion percentages.
Net over-billings increased to $325.2 million from $311.5 million at year-end 2015. Management stated that cash, borrowing capacity, and expected operating cash flow should be sufficient for foreseeable liquidity and capital requirements.

Outlook, risks, and contingencies

The filing does not provide quantitative full-year earnings or revenue guidance. Management cited continued demand across most domestic construction, building-services, and industrial-services markets, but noted exposure to macroeconomic conditions, non-residential construction demand, oil and gas capital spending, government contract rebids, currency movements, and commodity and fuel costs.

Construction contracts commonly use percentage-of-completion accounting, requiring estimates of total costs, project profitability, claims, change orders, and collectibility. Future revisions could affect reported results.
Accounts receivable were $1.448 billion and included a $16.5 million doubtful-account allowance, up from $11.2 million at year-end 2015.
Variable-rate debt creates interest-rate exposure; a 25-basis-point increase was estimated to raise next-twelve-month after-tax interest expense by approximately $0.8 million.
EMCOR faces government audits and investigations, litigation, insurance claims, and an arbitration involving a 2010 project explosion. Management believes these matters will not materially affect the company, but the potential loss in the explosion-related matter could not be estimated with certainty.
Goodwill and net identifiable intangible assets were $979.3 million and $510.7 million, respectively. No impairment was recorded through the first half of 2016, but weaker industrial or oil-and-gas results could increase impairment risk.
Remaining discontinued-operation obligations included approximately $0.2 million of severance and facility-termination obligations expected to be paid in 2016.

Important facts for investors to verify

Whether the $10.5 million transportation-project loss is recovered and whether additional losses arise before completion.
Ardent’s integration, recurring profitability, final purchase-price allocation, and contribution relative to the added debt.
Industrial-services demand, particularly the effect of crude-oil prices and customer capital spending on shop services and goodwill valuations.
Cash conversion and working-capital trends, including receivables, contract billings, and the ability to fund acquisitions, dividends, and repurchases.
Availability and terms of revolving credit, letters of credit, and surety bonding, including the November 2018 credit-agreement maturity.
Outcomes of litigation, government investigations, tax examinations, and the explosion-related arbitration.