Limbach Holdings, Inc. (LMB) Q2 2019 Earnings Report, Transcript and Summary

Greetings! And welcome to the Limbach Holdings Second Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jeremy Hellman with The Equity Group. Please go ahead, Jeremy.

Thank you very much and good morning everyone. Yesterday, Limbach Holdings issued the announcement of its 2019 second quarter results and filed its Form 10-Q. The company will also be using a slide presentation to accompany this earnings call. The presentation can be found in the Investors section of the company Web site at www.limbachinc.com. The company encourages everyone to review the forward-looking statement disclosure on Slide 2 of the presentation. With that, I'd like to turn the call over to Charlie Bacon, CEO of Limbach Holdings. Please go ahead, Charlie.

Thank you, Jeremy. Good morning to all and thanks for joining us. Joining me today is our Chief Financial Officer, John Jordan. As Jeremy mentioned, we'll be using a presentation deck. We’ll note the page we're referencing in our commentary. We’ll begin with Slide 3. As we’ve noted previously, the company continues to benefit from the diversity of our operations and that remains a key thing for this quarter. During the first half of this year, we experienced solid revenue and new construction contract award growth in several of our regions, particularly in Orlando, Tampa, Ohio, Eastern PA, Los Angeles and our new Southeast Florida office where activity in the healthcare market appears to be accelerating further. While revenue for the quarter was down primarily due to planned reductions in the Mid-Atlantic region, during the quarter we booked four new hospital projects at attractive margins which we believe reflect the favorable supply and demand imbalance globally. One of those projects is a preconstruction work for a very large hospital in our Ohio region. Several years ago we completed another very large hospital on that same campus. It’s great to see the repeat business with that institution and general contractor. We believe that we have demonstrated to them that we are very capable of managing budgets on large complex projects through the preconstruction and engineering phase through the support of Limbach Engineering and Design Services, or LEDs as we call it. LEDs continues to be a strong differentiator for us. Our backlog includes the preconstruction base fee for this large hospital project. The actual construction value will be booked in a later period once we agree upon the contract value. Growth in the New England region was driven in part by our strategic expansion into plumbing trades in 2018, which was previously missing from our services being offered in that market. Our more expansive portfolio of services in that market has been well received by our key customers and allowed us to capture greater market share and greater share of projects spend. In Philadelphia, we secured another healthcare-related project offering full design and construction services. Looking forward to construction, revenue for the quarter declined 4.9% as compared to last year. Top line growth in several regions was not quite enough to offset the anticipated decline in revenue in the Mid-Atlantic region. However, I want to emphasize this. Our turnaround plan in Mid-Atlantic remains on track. In fact, through June 30, that operations performing ahead of management’s expectations and for the second consecutive quarter generated a profit. Progress of resolving legacy projects continues and during the quarter management closed out several legacy projects at values that represented a modest write-up from current carrying values. You may also recall we curtailed selling major projects in the Mid-Atlantic region to bring our backlog in line with our available proven Limbach craft talent. We are pleased to announce that during the quarter we’ve resumed our major project sales. This was well received by our customer base in the Mid-Atlantic region. The Washington DC market is booming and we see terrific opportunities to dramatically improve our margins and only pursue high-quality projects tied to our forecasted available craft talent. Since that setback in the Mid-Atlantic region which was driven by project delays and extreme labor conditions, we instituted our 12-month craft labor forecast against our backlog and upcoming promised work. To remind everyone, promised work is in various degrees of preconstruction engineering and budgeting and the formal bookings to backlog will occur in a future period. We’re remaining disciplined around our available project management and craft labor with growth being tied to the availability of talent. In certain markets where we have strong backlog coverage and the supply/demand curves are in our favor, we are increasing our gross profit margins and contingencies into our estimates. I should also note that we have increased our MIS spending by hiring more programmers to better automate our information with leading and lagging indicators to create more efficiency in our processes. Concerning our work on modular construction, our assigned work team continues to advance our plans to increase prefabrication. This is all part of Limbach addressing opportunities to enter manufacturing processes to reduce labor dependency in the field and continue our growth with our construction services. The service segment continues to perform extremely well in response to historic investments in our new senior management, sales resources and seasonally stronger summer months. We experienced both revenue growth and gross margin expansion and for the quarter, the service division contributed just over 40% of the company’s consolidated gross profit. For the first six months, service grew by 15.4% compared to the same period in 2018 with gross profit growing 33% and SG&A growing by 17.3%. Although revenue declined during the quarter, expanding gross margins drove growth and consolidated gross profit up 1.6 million, an increase of 10.1% year-over-year. We are on track to deliver our expected top line growth, improving sales margins and execution in the field while we are still investing in rapidly growing our service segment. For the six months of the year, service was 21.4% of overall revenue. We remain on track to reach our mid-term goal of achieving a business mix of 25% service and 75% construction. In addition to an aggressive sales effort, we’re continuing to look for ways to grow and diversify our business by adding to the menu of construction and service capabilities we offer our customers. We added plumbing in two of our regions last year, New England and Southern California. Also within our service segments specifically, we’re looking to incorporate certain technologies such as predictive analytics and energy monitoring software into our business. I don’t want to get too far ahead of myself here as we’re only in the early stages of evaluating this area. What we’re doing at this point is beta testing those systems in a small number of select locations. We have installed the predictive analytics into the Rose Bowl facility control systems as well as certain buildings at USC. Steady progress is being achieved. We believe having these systems or similar systems will potentially allow us to be out in front of our competition and support a very scalable offering to assist in our rapid service expansion. John will be discussing both segments in more detail shortly. We’ll now move on to Slide 4, which reflects strong sales activity. Booked backlog plus promised work now totals nearly 950 million which not only covers 2019 sales plan, but provides significant visibility to 2020 and 2021. For 2019, we now stand at 90% revenue coverage which is better than we expected at this point in the year. As we think about our overall business, diversification has been and continues to be a big priority. Operating across multiple industry verticals and regional non-residential construction markets position the business well for long-term growth. As mentioned in previous earnings calls, we added a new vertical with large data centers on the back of our significant award with a large data project in 2018. We successfully delivered the first phase of that project and were awarded the next phase. We were also awarded an ongoing relationship to renovate the newly constructed facility to deal with the rapid changes in Internet technologies. With the success behind us, we have built a strong resume and we are investing in resources to expand this sector. We see a huge potential in this sector for both construction, owner-direct renovations and maintenance services. As we’ve noted in the past, construction is a local and regional business. We’re much more interested in the local, regional healthcare markets than the national macroeconomic statistics and we pursue customers and end markets that are less sensitive to interest rates and economic conditions. Right now we see ample growth opportunities in our key markets of healthcare, data centers, higher education and entertainment where capital is plentiful and there’s no shortage of consumer driving demand for facility and infrastructure construction. As you are aware, we continue to enjoy continued business expansion in Orlando with the Disney theme parks. You may recall we recently read about Universal started construction of a new park named Epic Universal. We expect this will provide more opportunities for our Orlando region and will cause Disney to continue to heavy spend to compete against Universal’s expanding presence. In those regions where we experienced a decline in revenues year-over-year, either we made a strategic decision to moderate volume or the region faced a difficult year-over-year comparison due to completion of large projects last year. In general, we are seeing plenty of opportunities across all of our markets. So while the headlines of macroeconomic numbers creates some noise, we’re looking at our backlog and promised work along with the opportunity of pipeline in all of our regions, we see plenty of opportunity for growth over the next few years. Concerning our pursuit of strategic acquisitions, we ramped up our efforts earlier in the year. Several promising opportunities are being pursued. At this point, I’ll hand it off to John now for a review of our segments in more detail along with our overall financials. John?

Thanks, Charlie. Good morning, everyone. I’ll pick up the review on Slide 5. As Charlie noted, the planned reduction in Mid-Atlantic revenues massed growth elsewhere and our backlog continues to give us visibility when it comes to top line growth. Overall, our second quarter revenues declined 4.9% to 132.8 million from 139.5 million in 2018. To give that some additional context, our revenues in Mid-Atlantic were 13.4 million lower in the second quarter of 2019 compared to the second quarter of 2018. So absent that, revenues from our other nine regions was up 6.7 million or 6.2% year-over-year. Year-to-date consolidated revenues, including Mid-Atlantic, increased 2.5% to 266.7 million as the diversity of our operations overcame the managed softness in Mid-Atlantic. Due to generally improved execution and a business mix richer in service work, gross margins in the second quarter improved 180 basis points to 13.1% despite the net write down to 1.6 million in the quarter. We expect write ups and write downs in each period which is normal course. We certainly want to see more write ups than write downs. In the quarter, our Southern California branch faced some setbacks on a few projects, including some in their new plumbing offering which was added in 2018. While we are disappointed with the outcomes, we have corrected our approach to our plumbing services in that market and we expect improvement in the coming quarters. We are pursuing open change orders and claims on a few of the Southern California projects and we expect recovery in a future period. Historically, our recognition of contract amounts related to change orders that are in the approval process with the customer and claims have turned out to be conservative and in almost all cases have maintained the book margin or produced upside in future periods. With respect to SG&A expense, which increased in the second quarter year-over-year, in light of the market environment and extreme demand for talent, we recommended to our compensation committee that we make certain retention payments to some of the non-senior management employees during the quarter. We can’t afford to lose any of our top performers. The total increase in SG&A was approximately 3.4 million during the quarter as compared to the same quarter in 2018, with 1.1 million being attributed to the retention payments. The remaining SG&A increase was due to increased incentive accruals of 1.2 million compared to the year-to-date June 2018. The remaining SG&A increase is mainly due to the normal increase in wages and additional staff for project execution, project cost controls and better mining analysis of our project data to help us ensure better gross profits in the future. I’m now on Slide 6. Mirroring the comments I just made regarding our consolidated revenues, several of our regions saw solid growth in the second quarter and that strength served to offset the impact of the recalibration of activity levels in the Mid-Atlantic region. Year-to-date, construction segment revenues were essentially flat at 209.6 million. Our second quarter segment revenues were 104.9 million or down 7.7% compared to the prior year. Again, this is primarily due to the planned reduction in the Mid-Atlantic which is offset by growth in the other regions, notably Orlando, Tampa and New England. I want to focus a bit more on the activity in our Orlando region where we were awarded three more hospital projects in the quarter. Although we don’t disclose backlog by region, I will make the general comment that Florida has build a solid pipeline in the healthcare and now the technical work, including the ongoing strong relationship with Disney and those jobs have attractive gross profit profiles. Construction segment margin was 9.9%, which was up from 8.4% last year. The biggest contributing factor to the year-over-year improvement was the stabilization to the Mid-Atlantic region which recorded a profitable quarter versus incurring a loss last year. Construction segment gross margin was negatively impacted by the net $1.6 million write downs from the project that had a material amount of gross profit adjustment. As a reminder, we benefitted from the consolidated net write-off in the first quarter of 1.7 million, so we’re still positive for the year when it comes to write-offs and write-downs, all of which is part of the normal course of operations. On Slide 7, our service segment continues to grow nicely with revenues increasing 7.9% from the prior year period as revenues came in at 27.8 million. Year-to-date segment revenues were up 15.3%. Michigan and Eastern Pennsylvania regions led second quarter growth in the service segment offset by reduced activity levels in Mid-Atlantic and Ohio. Sales activity of quick-hitting revenue producing projects since the end of the second quarter has been very robust in a few regions, especially Ohio which supports our expectation that the second half of the year will produce better results than the first half. As of June 30, our maintenance base was 14.7 million which was up approximately 10% from the prior year. We think that sets up well for pull-through revenue which normally carries the highest margin of any work we do. As a reminder, the third quarter tends to be a very good quarter for us as the summer months often lead to emergency air conditioning repair work. Service segment gross margin in the second quarter expanded to 25.1%, up 70 basis points from the 24.4% last year. Segment gross margin continued to benefit from the combination of improved pricing and volume. Last quarter, we introduced a rolling fourth quarter average gross margin metric as our service margin can vary somewhat quarter-to-quarter simply due to the variability and the timing of the pull-through projects and spot work. As of the second quarter, the rolling average ticked up slightly to 22.6% and 22.5% in the first quarter. Moving to Slide 8, we summarize a few key year-to-date income statement and balance sheet items. On a year-to-date basis, operating income has improved to 3.9 million as of June 30 compared to a loss of 900,000 as of June 30, 2018. Net income of 600,000 year-to-date for 2019 is a $2.3 million improvement over the net loss of 1.7 million as of June 30, 2018. Year-to-date earnings per share of $0.08 compares favorably to a loss of $0.51 per share last year at the end of the second quarter. These improvements are directly related to the improved gross profit results and despite the increased SG&A related to the retention payments and increased incentive amounts. Our working capital position is at 41.6 million, up from 35.5 million at the end of the first quarter and 22.9 million at the end of 2018. Our current ratio is 1.29 as of June 30. During the quarter, we instituted new cash control measures in all regions. The controls more closely link all disbursements with project performance and collections. These measures have produced positive results since being instituted in mid quarter and expect to continue to be effective and result in better cash generation going forward. There’s nothing drawn on the revolver at June 30 and the term loan balance remains at $40 million. Our new credit facility, which we’ve previously described and closed on in April, does not require any amortization in the first 18 months and we have no expectation of making any prepayments. We also remain in the net over-billing position of 10.5 million which is a positive for cash positioning. As you are aware, we filed our S-3 shelf registration a few weeks ago which after undergoing review by the SEC was declared effective last week. We view the S-3 as a proper move for both short-term and long-term capital raise activities to support organic and acquisition growth. At this point, I’ll hand the call back to Charlie. Charlie?

Thanks, John. Turning to Slide 9 and some final thoughts. First, we are on track to hit our operating and financial goals for the year. To that end, we are reaffirming guidance for the year which is for revenues of approximately 560 million and adjusted EBITDA of 22.5 million. Diversification continues to be a primary focus for us as diversity has set us up well for continued growth. Second, I want to return to the topic of retention payments we incurred in the quarter. Those of you that followed Limbach for some time know that last year we had one region that really struggled and that weighed on our business overall. The struggles of that one region did impact business decisions we made at other branches, especially when it came to variable compensation. At a time when the economy was growing nicely and our industry was also doing very well, we had to go to the employees in those other nine regions and inform them we did not make our annual bonus payments. Within that one branch that struggled, we have many outstanding employees that did their jobs admirably day-in and day-out representing Limbach very well. Our management team and the Board of Directors places a great deal of emphasis on our corporate culture with worker safety being a paramount concern but also the day-to-day worker happiness and satisfaction. We want to attract top talent in our industry and have those folks be proud to come to work in a Limbach truck, wearing a Limbach hardhat every day. We just finished our annual employee survey known as the We Care survey and despite the setback of not paying bonuses, we had the highest employee participation at 81% and received the best numerical score in the 15 years we have conducted the survey. With unemployment being as low as it is in our industry in a booming market with high demand for talent, we are proud of our Limbach team; great people that care about our business and our customers. As we move past the issues we faced last year, we felt it was important to do the right thing by those employees that made – and we made the retention payments for a small percentage of non-senior employees. It was simply the right thing to do. Those lower level managers are an invaluable part of our company and they need to know that. Now, we as the management team and our Board, we are also very active and aware of the impact that this would have on our bottom line for the quarter. At the end of the day, our people are our most valuable resource and our investment in training and keeping quality people is vital for the long-term growth of the company. I’ll conclude by noting that even with this added expense, we are reaffirming our guidance for the year both top and bottom line. Operator, at this point, I would like to open up the conference for questions.

Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions]. Our first question today is coming from Alex Rygiel from B. Riley FBR. Your line is now live.

Thank you. Good morning, Charlie and John; very nice quarter.

Good morning.

Charlie, it definitely sounded like your backlog is “understated.” Could you dig into that a little bit further so we can better appreciate what you mean by commitments and what the timeline of those commitments is going to be as it comes through your P&L?

Sure. We’ve always, since we went public, commented on each earnings call about our promised and probable figures. So this particular quarter it’s roughly 400 million of additional commitments we have from customers where we haven’t agreed upon the final construction price yet, but we’re working our way through preconstruction and engineering basically negotiating the deals. Once we have a firm fixed number and we have the paperwork in hand, we’ll book those projects. Historically, we haven’t seen anything fall out of bed that’s already promised. Generally we’re committed. What’s happening in our marketplace right now is you have a lot of customers out there that have woken up, mainly the building owners, that the traditional process of designing something, putting it out for bid and then having construction happen is a flawed process. What happens in just about every project you have an owner who has a desire to build something, they hire the design professionals and design professionals are also – they create great things and we’ve got to go build them. We love that. But from a budget management perspective, the client – the building owner has a general view of what it’s going to cost and they’re thinking about financing at a certain number. But when they go through that first round of budgeting where they actually bid the project, they find out they’re way over budget. And quite frankly we love that because our engineering group comes in and then we reengineer the project and get it back into budget. But what’s happened is owners are now waking up that that process is flawed. Why not bring Limbach in early and have them work with the architects, with the owner, with a general contractor if they have one onboard, because sometimes we’re hired before the general contractor and we help establish the design, the budgets and our reputation for putting together a design and a budget and holding to that budget, we’re famous for it. So our Limbach Engineering and Design services, or LEDs as we call it, just continues to impress and of course our project managers and our preconstruction managers continue to impress building owners. As a result, building owners like Bedrock up in Detroit came to us and said, look, we’d like to talk to you about coming on early. So in fact they did that and I hate to call it this but this is kind of what I refer to it as, they arranged for shotgun marriage, meaning the general contractor doesn’t procure us, the general contractor is told you got to use Limbach. And that’s where we want to get to and continue advancing our company. So I think what you’re going to hear us continue to say – well, we’ll say it each call, promised and probable is worth X. I can see that continuing to grow as we continue to build our reputation. So does that help provide a bit more color as to how we refer to that – as you refer to understated backlog?

Sure, it does; very helpful. And could you also comment on sort of the longer-term outlook for the margin profile of the two businesses? Obviously construction’s had some years in the past that was, call it, mid-single digits driving towards higher single digits. Services business is already in that high single digit range. So long term, could you bracket some ranges for those two segments and where you think margins can get to?

Let me break each one down. First of all with construction, we see more opportunity there and what we’re doing right now where we have in particular regions a pretty solid backlog for the future and where we see a solid pipeline, we’re increasing our pricing. It’s basic supply and demand theory, right. And we have labor and the general contractors need that labor. So in one particular case, we just reviewed two projects in one of our regions and we looked at their backlog and we basically said to them, look, we see opportunity here and let’s push the envelope. So we increased the margin by 200 basis points and we’ll see how that plays out. Maybe we won’t land the work and we may have to rethink that, but if we secure the work that’s great and that should flow through to our bottom line. So there’s the opportunity where we’ve been pricing – I don’t want to say how we’re pricing our construction parts publicly, but we do see opportunity for improvement there whether it’s 100 basis points, 200 basis points, we see that opportunity in front of us in a number of regions. On the service side, we’re pushing pretty hard – we actually went through a bit of a transformation in our company. Service was a slower portion of our business years ago. And when you look at the difference between construction and service, service margins are much higher. Now we actually moved some of our great construction people over to our service side of the house, but quite frankly they were used to the lower margins in construction. So we had to kind of get those guys thinking, look, you don’t price things at X%, you basically price it at that number when it comes to service type work. So we see a constant improvement in the service side. Our two Chief Operating Officers and our Executive Vice President for Service who’s responsible for expansion and improving the margins, the drumbeat is constantly being pounded, like let’s raise the margin, raise the margin, raise the margin. Clearly, there’s so much opportunity out there right now, why not? So we’re working that to a higher number. The other thing – you heard us talk about some of the technologies we’re starting to implement. Predictive analytics we think is going to be very important in the future, will separate us and be able to help our customers with their buildings, do better forecasting on their capital expenditures for change-outs, renovations to equipment, replacement of equipment and that’s what services is all about in older buildings. And we see that as being a scalable model. We’re not exactly sure how to price it yet, but we’re working through our beta test that I mentioned at the Rose Bowl and at USC on several buildings called the Gateway buildings at USC. And we expect that to help us better understand how we can lift margins. So we think it will be a benefit to the customer because they are going to have better data at their fingertips and we think there’s an opportunity to improve our bottom line results by having those types of technologies employed. Does that answer or help answer the question?

Very helpful. Thank you.

Thank you.

Thank you. Our next question is coming from Zane Karimi from D.A. Davidson. Your line is now live.

Hi. Good morning, gentlemen.

Good morning.

So you talked a little bit about backlog there and the growth opportunities, but how far into 2020 do you have visibility with the current backlog status?

Geez, I don’t have that at my fingertips in terms of a percent cover. What I can tell you is that we’re actually entering our planning process right now. We kicked it off two weeks ago. It’s a three-year planning process that we do. Our goal around September when the plans are due in and we start our review process, getting ready for the future Board presentation, we want to see 65% coverage of our forecasted revenue for next year. John, I don’t know if you could comment any further. I just don’t have any figures because we just haven’t done that work yet. Can you add any other color to that or respond to that question differently here?

Yes, to your point, Charlie, we really haven’t gotten that deep into it yet but we can see with the burn that’s going to occur in 2019 for the coverage coming from the existing backlog, it does give us considerable coverage sitting here in the middle of August for 2020. We just haven’t scheduled out that far yet at a global level. The branches do revenue burn on a project-by-project basis, so we have the data. We just haven’t collected it all into the planning process as Charlie was referring to. But as we go through that process over the next four to six weeks, we will be able to quantify that in the future.

The other thing I’ll just throw [ph] one there, but the promised work that we talk about, there’s some terrific work there that will be burning up some in 2020 but a lot of it’s given us backlog coverage for '21 and '23. The big, big hospital project we landed we’re in preconstruction on that and engineering, we will really resolve that final cost figure probably to the middle of next year, maybe even to the third quarter, maybe a year from now. It’s that big of a job, it’s huge and we’re really excited about that. But that will give us some very nice coverage going into '21, into '22 and a little bit into '23. So we’re starting to see visibility way beyond '20, which is great to have that visibility.

Yes, it sounds great there. And then you talked about a little bit about Orlando, Tampa and New England, but in particular can you point to a certain region where you’re experiencing the fastest growth and are you seeing a slowdown in any region? And then with regards to the Mid-Atlantic progression, how is the ramp up in activity in the Mid-Atlantic progressing and how are you managing the growth there?

So let’s just talk about where the fastest growth is happening. Right now I’m blown away with Florida. It’s just absolutely amazing what’s going on down there. Just last week I read another article that in St. Petersburg, a developer just presented a $2 billion redevelopment of an area just south of the main business district. And we’re seeing the whole Tampa waterfront is being redeveloped by Jeff Vinik who’s the owner of the hockey team and he’s doing an amazing thing to regrow or basically just redevelop Tampa. It’s amazing what’s going on down there. You got the whole Central Florida area going crazy with all the theme parks. There’s a massive spend at Disney and I mentioned Epic Universal. And then you finally have Southeast Florida, we opened up an office which we refer to as the West Palm Beach office, but it’s really Boynton Beach. And we decided to open up the office there last year which we did this year to really get a foothold in Southeast Florida. And we don’t do any condominiums. We just won’t touch those with a 10-foot pole, but healthcare, higher education it’s amazing the opportunities that are in front of us. We’re not playing in the transportation area down there, but that’s another market for us. All the airports are going crazy down there with redevelopment. So it’s kind of a backup sector, if you want. But I want – and I could comment on Detroit. It’s amazing what’s going on up there with the rebirth of Detroit. Columbus, let me just go there for a moment. I was there three weeks ago and I met with our number one customer in that market. That particular customer has in backlog over $1 billion of work and they went and told me that they have commitments for another $1 billion. This is just in Columbus. And on top of that there were three more towers that were being proposed in downtown Columbus. It’s amazing. I’ve never seen anything like that. When we had the conversation, they already awarded us that large hospital project, we’re doing that large data center project with them, they started talking to us about what other jobs we wanted, basically talking about handing us work and I’m simplifying that. They would actually have to – they go through a process, but we’d compete for it. But clearly we’re viewed as one of the best-in-class contractors there. Now, with all that said, what we’re focused on right now on the construction side of our house is growing our construction business tied to our availability of talent. That 12-month rolling view of craft labor and project management is mission critical to our future. We were burnt bad in Mid-Atlantic last year, we’re not going to repeat that. So while you hear about all these great growth comments, we’re being very, very disciplined and quite frankly we are lifting our margins because supply and demand curves are in our favor, we are one of the best-in-class contractors out there and general contractors want us, they need us. So they are aware of this coming and – actually we had that conversation with that particular executive. But we’re going to remain disciplined. Now in Mid-Atlantic, we’re doing exactly what I just said. We’re remaining extremely disciplined. So my previous comments on labor down there between 175 to 225 craft is our sweet spot. We’re actually down to about – the last number I heard which was last month, we’re down to 163 craft and I felt really good about that. We opened up the spigot. There is a few nice projects that we’re looking at right now that gives us backlog for '20 and '21 into '23. So we’re going to be very, very disciplined in what we take on. The new leadership team that we installed down there are doing an excellent job. I’m very impressed with what they’re up to. So it will remain – the key word is discipline. Let’s control growth and let’s maximize the margin. A longwinded answer but I hope that provides some color on markets, growth and discipline.

Okay. I appreciate that. And one last one, if I may. How do you feel about M&A today? I know you mentioned it a little earlier and when do you begin getting comfortable with new opportunities?

Yes, so we started – after we got through what we had to get through in '18, we entered '19 with a plan to get back into the marketplace looking at opportunities and Matt Katz who’s our Executive Vice President in charge of Acquisitions and Capital Markets, he continued to keep things warm through '18. But as we entered '19, we got aggressive on some different opportunities. We have several different companies we’re looking at that we like. We think strategically we’re still interested and looking at the Southeast and also we’re intrigued with industrial and that’s on the heels of the work we did last year on the other opportunity that unfortunately we couldn’t get the closure on. But industrial gets us closer to the owner, closer to the owner which is a big driving strategic play here at the company, be it service or having those owner direct relationships with a shotgun marriage, as I mentioned earlier, but industrial tends to be quick-hitting, in and out plant type work and we’re very intrigued with that. We do a bit of that right now in certain regions but we think that might be an opportunity for us to – a better toehold by looking at an acquisition. So we’ve got some different things in play. I’m not going to put a timeline on anything, but we are definitely on the hunt.

Thank you.

Thank you. Our next question today is coming from Gerry Sweeney from ROTH Capital Partners. Your line is now live.

Good morning, Charlie. How are you doing?

Good morning, Gerry. Good. Yourself?

I’m doing well. Thanks. Just wanted to touch a little bit more on the margin front and specifically your guidance. Taking a look – we’ve talked about client demand, pricing going up, et cetera, but by maintaining your guidance for the rest of the year, specifically on the EBITDA side, it sort of implies maybe a step up in margins in the second half of this year. How do we look at that and is that a fair sort of view that I’m taking on?

Yes. Well, first of all I just want to – again, we thought it was the right thing to do in Q2 to make the retention payment and we felt comfortable doing that with maintaining guidance based on how things are looking for the company in terms of our backlog coverage and also the pipeline. In regards to margin, when you actually dissect last year 2018 and we look at the second half of '18 and pull out Mid-Atlantic where we took our hit, it was a remarkable second half. We did extremely well. John, I don’t want to misstate a figure, but if you remove Mid-Atlantic from last year’s second half, do you have that number available?

As far as the gross margin percentage?

Gross margin percentage and actual number or I don’t know if we can share that.

I’ll do some research, Gerry, and we can circle back on that.

Okay.

But we did extremely well last year and there’s no indication that we’re not going to have a repeat of what we did last year. Across the board we’re performing extremely well. We obviously had the big hiccup last year, but we’ve got a lot of opportunity in the business right now for upside and we expect to see some upside coming to the business this year. So we’re comfortable with reconfirmation of guidance.

Okay, great. That’s it from my end. I really appreciate it. Thanks.

Okay, Gerry.

Thank you. [Operator Instructions]. Our next question today is coming from Mark Henry from Midwood Capital. Your line is now live.

Hi. Good morning. Thanks for taking my questions. I’ve got a few. Just starting with free cash flow. So you guys burned about 16.8 million through the first half of this year and on the last earnings call you said that you expected to generate between 10 million and 15 million for the full year which implies 27 million to 32 million of free cash flow generation in the back half of the year on only $15 million EBITDA. I guess what gives you confidence that you’ll be able to generate this level of free cash flow? And if you use that to pay down debt could get you from 3x trailing that leverage to under half a turn of leverage by the end of the year. Just want to understand the confidence in the free cash flow build through the back half.

Go ahead, John.

Yes, from a free cash flow, we continue to monitor that on a regular basis and it will be towards the lower end of that range that was provided in the first quarter. As far as how it’s going to be generated, we are expecting significant cash generation in the second half of the year. I made reference to some revised policies and procedures that we have in place. There are several projects that are over-billed that will continue to be over-billed which will continue to produce positive cash flow. The service business growth in the second half produces additional cash. With the excess cash, we really don’t have any plans to retire the debt early. There’s some terms in the current credit agreement that make it pretty expensive to pay it off early. So any free cash flow that would be generated would be reinvested in the organic growth of the business to continue to push the business forward.

Okay. I’m just looking at – so you said you’re going to be at the low end of the guidance. That implies $27 million of free cash flow. And then I look at your stock today, you guys have a $45 million market cap. So that’s very significant generation of cash relative to the market cap. Okay. And then number two, I guess on the write downs, looks like you guys took a $1.9 million write down on three construction projects in Southern California and just given the track record of all the write downs last year which really thrust your stock, how can you give the investment community comfort that this is not the start of another stream of write downs like we saw in the Mid-Atlantic?

Look, one was – the reason that we took a hit in Southern California it had to do with our plumbing expansion. So we got into plumbing out there like we did up in New England which went extremely well. Southern California, we started pricing some work back in 2018 and when we look at that pricing, we realized that it was probably a bit on the light side. We started getting into plumbing and it got a bit aggressive to get our market share going. We’ve since corrected that and the projects that we took the lower margins on and priced the labor a bit less than we should have, they’re nearing completion, they’re just about done. We took the pain through the books during that period. We also have another project out of LAX. It’s called the Midfield Terminal project. That project is a mega project. We’ve done many, many projects out of LAX. And historically we’ve done extremely well. That one project has faced some delays and those delays were because they’re going to expand the Midfield Terminal, there’s another terminal that goes adjacent to it. But as a result they had to slow down the project. They went through some redesigns. There were some cost impacts to that. So we had to take a conservative view in terms of our cost to complete that project, which is nearing completion through the books. It wasn’t a large portion of that hit. It was actually minor in nature. But we also have a claim in for that, for future recovery. So we’re pricing that right now, working with the general contractor who’s working with the end customer to get that all resolved. So the plumbing, that took a bit of a hit. We’ve changed our pricing strategies out there. That’s all been corrected. That work is just about complete, so the pain has been put through the books. And as far as LAX is concerned, we have a pretty good track record of positive recovery out there. We just need to work our way through the process.

Okay. And then just one last one for me. Can you guys quantify the dollar amount of cash that you guys expect to come into the business from change orders in the back half of the year?

John, I think that’s a tough figure to put on the table because some of it’s in our control, some of it’s out of our control. John, do you have a response to that?

Yes. Mark, as far as cash to come into the business from change orders, that’s really a job-by-job situation that in some cases is somewhat out of our control. It would depend on the timing of the change order approval for us to bill and that approval needs to go not only through the customer but also through the end user. I can say that we do have a fair amount of money out there in change orders, but we are continuing to convert them. There is a big push in all the regions to push change orders to contribute to the cash generation that we were speaking about earlier. We’re working through that process right now. So to try to quantify it that’s a statistic that we typically don’t track. But in general we do look for 80% of our projects to produce gross margin gains which from what they were booked at, which would indicate additional cash generation. But to try to quantify that for dollars for the second half, we really don’t track that statistic.

Okay. And just one last comment for me. So assuming no cash in change orders and assuming you guys generate the free cash flow that you guys expect for the back half, the stock is trading at 3x EBITDA. You’ve got peers trading at 7x to 9x EBITDA. How do we get from a 3x multiple to an 8x multiple? What does management believe it has to do to get that multiple in the public market?

Look, we took a hit last year no doubt because of what happened and we paid the price. So I was happy to see the recovery of the share price since we got through that news and we continue to trend the way we expect it to trend coming out of that hole. So I think we have to build confidence back up in the market. And two, we are looking at continued expansion organic but we’re also looking at certain acquisition activity which was always the play on being a public company. We need to leverage some of our overheads here at the company. We do expect here in the midterm we want to north of $1 billion in revenue. A piece of that clearly is continued organic growth but we’re also looking to not do a rollup but do a nice steady flow of strategic, I call them surgical acquisitions, and those are in play. So we continue to work that. And when we’re ready with the right deal, we’ll announce. But we’re going to continue to do what we said we were going to do both organic as well as on the acquisition front.

Okay, great.

Mark, just to clarify one thing. You were asking about cash generated from change orders and then you made the comment you’re assuming no cash from change orders [indiscernible] that’s a process that needs to work through negotiations with the owner and the general contractor to get resolution. But the change orders, cash generation, billing, collections is a normal process. So there will definitely be cash generated in the second half of the year through change orders. The claims on a couple of the big projects we’ve assumed no cash generation, no margin contribution from those in the second half of the year. I just want to clarify to make sure that we weren’t confusing some terms there.

All right, great. Thank you so much for taking my questions and good luck.

Thank you, Mark.

Thank you.

Thank you. Our next question today is coming from Mike Hughes from SGF Capital. Your line is now live.

Just a few follow-up questions on the last caller’s question. So what percent of your revenue in the quarter was from the plumbing business in Southern California?

Oh, geez. John, I don’t have that figure?

We don’t have that plumbing broken down, but Mike I would say it’s a pretty small percentage of the total --

…which is less than 5%?

Yes. I would say less than 5% of the total company’s revenue for the quarter.

Okay. So the write downs in Southern California as a percentage of plumbing revenue were very, very material, correct?

Yes, they were.

Okay. And I thought you had these issues behind you, so is there anything that we should take away from Southern California process, changes you’ve made so this doesn’t happen again?

Yes, that’s exactly what we’ve done. Our COO has been spending quite a bit of time out in California just looking at that particular plumbing situation. We have some very good talent out there. But what the price the projects in 2018, they just got too aggressive on kind of what we call our mix of crews, meaning you’re a full blown craft worker who’s been in the business for 20 years, very experience, makes for higher wage and then you have the apprentices that come in and you put that crew mix together and then you price it that way. What we found out is they were getting too aggressive on figuring too many apprentices and as a result we had to refigure our pricing. So what we’re doing going forward is we’ve increased our pricing on plumbing out there. We can’t do it as cheap as we thought we could and it was a bit of a learning curve and it was expensive no doubt, but we’re excited about the future out there in terms of now that we have both mechanical piping which is chilled water piping, such as that, sheet metal and now the plumbing it provides a three-trait package which is much more attractive in that marketplace which will allow us a nice steady growth by selling all three traits as opposed to just two traits. So we had to do the pricing correction, it was a mistake. It shouldn’t have happened, but we fixed it.

And when did you realize there was an issue there?

A couple of months ago during the quarter and that’s when we did a full blown review of the remaining plumbing work that they have in their backlog and we made adjustments and changes.

Okay. I guess I just have one remaining comment. There was a large sale of your stock in late May and I think two of the individuals were on your Board. Given you recognized this problem a couple of months ago that sale does not look good. That’s just my comment.

Yes, I guess when you take a look at timing, the changes that we had to do in what we had to adjust for was normal process, meaning we identified there was an issue. We do our homework and then the management does what it has to do and we recorded it properly and that’s all been confirmed with all the reviews that we have to do in our company to produce our earnings with the stringent oversight we have, it was all does properly.

I’m not questioning whether you’ve done anything improper. I’m sure the quarter really is what you just reported. The sale of the stock in late May does not look good given it involved two directors in this quarter is materially short of street expectations. That’s my only point and I appreciate your time. Thank you.

Thank you. That does conclude today’s question-and-answer session. I’d like to turn the floor back over to management for any further or closing comments.

Thank you. I appreciate all the questions this morning and I want to thank everybody for joining us. I’m quite pleased with our operational improvements in 2019. We’ve made some small investments across the business to allow our growth to continue and improve our margins in this heated market. We want to take advantage of this boom we’re enjoying, apply smart growth with our construction tied to available craft labor. Continue our rapid expansion of our service segment. And we look forward speaking with you again on the third quarter. Thank you for your interest and your participation today. All the best.

Thank you. That does conclude today’s teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.