Quanta Services Inc
NYSE:PWR

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Earnings Call Transcript

Earnings Call Transcript
2018-Q2

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Operator

Greetings and welcome to the Quanta Services Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Kip Rupp. Please begin.

K
Kip A. Rupp
Quanta Services, Inc.

Thank you, and welcome everyone to the Quanta Services second quarter earnings conference call. This morning we issued a press release announcing our second quarter results, which can be found in the Investors & Media section of our website at quantaservices.com. Additionally, we have posted a summary of our 2018 outlook and commentary that we'll discuss this morning in the Investors & Media section of our website. Please remember the information reported on this call speaks only as of today, August 2, 2018, and therefore you're advised that any time-sensitive information may no longer be accurate as of any replay of this call.

This call will include forward-looking statements intended to qualify under the Safe Harbor from liability established by the Private Securities Litigation Reform Act of 1995. These include all statements reflecting Quanta's expectations, intentions, assumptions, or beliefs about future events or performance, or that do not solely relate to historical or current facts. Forward-looking statements involve certain risks, uncertainties, and assumptions that are difficult to predict or beyond Quanta's control and actual results may differ materially from those expressed or implied.

For additional information concerning some of these risks, uncertainties, and assumptions, please refer to the cautionary language included in our press release issued today, along with the company's 2017 Annual Report on Form 10-K, and its other documents filed with the Securities and Exchange Commission, which are available on Quanta's, or the SEC's, website.

You should not place undue reliance on forward-looking statements and Quanta does not undertake any obligation to update such statements and disclaims any written or oral statements made by any third-party regarding the subject matter of this call.

Please also note that we will present certain non-GAAP financial measures in today's call, including adjusted diluted EPS, backlog, and EBITDA. Reconciliations of these measures to their most directly comparable GAAP financial measures are included in our earnings release.

Lastly, if you would like to be notified when Quanta publishes news releases and other information, please sign-up for e-mail alerts through the Investors & Media section of quantaservices.com. We also encourage investors and others interested in our company to follow Quanta IR and Quanta Services on the social media channels listed on our website.

With that, I would like to now turn the call over to Mr. Duke Austin, Quanta's President and CEO. Duke?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Thanks, Kip. Good morning, everyone, and welcome to the Quanta Services second quarter 2018 earnings conference call. On the call, I will provide operational and strategic commentary before turning it over to Derrick Jensen, Quanta's Chief Financial Officer, who will provide a detailed review of our second quarter results. Following Derrick's comments, we welcome your questions.

We posted a solid second quarter and are pleased with our results for the first half of this year. Second quarter revenues were a record $2.66 billion and GAAP and adjusted diluted earnings per share were $0.48 and $0.59 respectively. The second half of this year is strengthening as our base business activity seasonally increases and our larger pipeline projects ramp into construction, which should result in top line growth and margin expansion. We ended the quarter with record 12-month backlog of $7.4 billion with each segment at record 12-month backlog levels as well.

Due to our first half results and strengthening levels of activity for the second half of the year, we are maintaining our full year earnings per share guidance. Our larger pipeline project activity is increasing considerably, but we are still in the early stages of execution. Thus, we continue to take a prudent approach to setting our guidance, but believe there is opportunity to outperform if we execute well through project risk contingencies.

The larger pipeline projects are expected to account for approximately 10% to 15% of consolidated revenues this year. This type of work is the most difficult to forecast. At the end of the second quarter, Quanta had more than 37,000 employees who worked nearly 40 million man hours during the first six months of the year, and we are well on pace to finish the year with record man hours. These data points are indicative of record levels of activity in our end markets and the strong demand for Quanta's capital program solutions, which provide cost and quality certainty to our customers.

As we have discussed previously, there is a shortage of craft skilled labor in our North American markets at a time when our customers are expanding their capital and operating budgets to record levels. Quanta has incrementally invested more than $100 million in various initiatives over the past five years to attract and retain what we believe is the best workforce in our industry.

We are focused on safety and training and have executed on industry-leading strategic initiatives such as the development of our world-class training facility in Texas and the recent acquisition of Northwest (sic) Lineman College. Our dedication to our employees has made us the preferred employer in the industries we serve and our ability to enhance our customers' profitability by efficiently deploying skilled resources to the field is a differentiator that provides us with the opportunity to increase market share.

Our Electric Power operations continued to execute well from both a top line and margin perspective. The strong performance in the quarter was driven by solid execution across our operations. And our execution on the Fort McMurray West Transmission Project, the largest project in Quanta's history remains excellent.

We continue to have a positive near and long-term outlook for our Electric Power segment as our customers continue with their grid modernization programs to accommodate a changing fuel generation mix towards natural gas and renewables, address aging infrastructure, strengthen systems for resiliency against extreme weather events and support long-term economic growth. For example, the U.S. Energy Information Administration or EIA recently reported that major U.S. utilities have increased investment on the electric distribution system by 54% over the past 20 years from $31 billion to $51 billion annually.

During the same timeframe, investment in transmission infrastructure nearly doubled. We expect these trends to continue for some time as our customers' multi-year transmission and distribution capital budgets continue to increase.

Last week, AEP announced that due to regulatory challenges it was terminating its effort to build Wind Catcher Generation Tie Line for which Quanta had been awarded the EPC contract. While this is disappointing, we remind the investment community that this project was not reflected in our guidance or backlog nor was it a driver shaping our positive multi-year outlook. It would have been a nice project to have, but it was not one that we have to have. It is unfortunate when good projects like Wind Catcher and Northern Pass do not receive the required regulatory clearance to move forward, but it is not a negative for Quanta as it may appear. These projects were for longtime customers with whom we have strong strategic relationships.

So, we expect to continue to have opportunities to partner with them on future projects. We believe our involvement with projects like these strengthens our relationship with our customers and positions Quanta to grow with them. Additionally, we see opportunities for larger transmission projects picking up not slowing down. There are more than $3 billion in aggregate contract value of larger electric transmission projects and various stages of tender in North America that we are pursuing.

Some of these projects could be awarded by the end of this year. We will maintain the bidding discipline and risk profiles necessary to safely execute these projects and provide cost certainty to our customers. We do not expect to win all these projects but we believe we are well positioned on all of them. Our end markets are strengthening and we continue to believe we're in earlier stages of an upward multi-year cycle. In addition to growing opportunities for larger transmission projects, demand for our base business where it continues to grow. Small and Medium transmission and substation projects as well as distribution work remains very active and large multi-year MSA proposal activity is at an all-time high.

Within our Electric Power segment our communications operations performed largely as expected during the second quarter with growth led by our U.S. operations. Importantly, we continued to believe we have the opportunity to exit this year with operating income margins achieving high single digit levels. We continue to make inroads with customers as they deploy capital for fiber-to-the-home and business, long-haul fiber, 4G wireless backhaul and the early stages of 5G.

More of them are turning to Quanta for our turnkey execution capabilities, performance and ability to quickly deploy resources. In many cases, we are viewed as a strong alternative to our competitors. In fact, two cities we were recently awarded for fiber deployments were removed from others by our customers and given to Quanta due to the quality and timeliness of our work and execution for them in other cities. Rather, we're seeing some companies rebidding fiber deployments in certain of the markets, not due to price but to try to gain access to better resources and execution capabilities. We believe this provides opportunity for Quanta going forward.

As 5G wireless networks are deployed, there are significant fiber backhaul requirements. We believe 5G also creates opportunity for our electric distribution operations, since many of the 5G small cells will be deployed on the electric utility poles and other electrical infrastructure. This puts Quanta in a unique position to provide electric and telecom services to the communications industry.

Turning to our Oil & Gas segment; we generated greater than expected revenues during the quarter, primarily driven by base business activity and our industrial services, natural gas distribution and pipeline integrity operations. As mentioned at an investor conference in June, we experienced minor delays on a certain larger pipeline projects that shifted work and project sequence from the second quarter to the third quarter. As a result of the mix of work in the segment caused by these shifts, the strategic decision to reduce certain activities within our offshore operations and challenges on a now complete midstream project in the quarter, segment margins were pressured. However, we expect a meaningful increase in operating margins for the second half of this year.

As disclosed in our press release this morning, during the quarter we shuttered our pipeline inspection research and development operation and took a charge associated with the exchange of a construction barge for an industrial property.

We will continue to look for ways to optimize our Oil & Gas segment operations to push our margins to the high single-digit level on a full year basis. It is worth noting that Stronghold had a record quarter in first half of the year from both a top line and margin perspective. Stronghold is fully integrated into Quanta, and we could not be more pleased with the addition of such an excellent management team and high quality organization.

Further, we are beginning to see some of the growth synergies we highlighted when we announced the acquisition, such as leveraging their downstream storage tank construction and maintenance capabilities into our midstream customer relationships. We continue to expect Stronghold to achieve their financial targets for this year and have increased confidence in their opportunity for profitable growth over the coming years.

Our larger pipeline projects are ramping significantly in the third quarter, and we expect to have all of our large diameter spreads in the Lower 48 utilized this quarter and into the fourth quarter. That said, recent developments subsequent to the end of the second quarter associated with the Atlantic Coast Pipeline project or ACP causes us to believe some portion of our 2018 work could get pushed into 2019, which is prudently reflected in our guidance. However, additional work awarded to us on Line 3 in Canada, which we recently announced, as well as other projects are expected to backfill that potential slippage this year.

Looking forward, we see opportunity for robust overall pipeline market in 2019 and beyond. As natural gas mainlines from the Marcellus and Utica shales are built and placed into service over the next couple of years to provide market access. We believe natural gas production will grow and our midstream operations in the Appalachian region will experience increased activity.

We are seeing multiple pipeline opportunities driven by LNG and petroleum export development in the United States and Canada, and believe we are well-positioned to benefit from these growing markets. Additionally; increasing oil and natural gas production in Texas is outstripping available pipeline capacity. We're actively building midstream infrastructure in West Texas and a number of other pipeline projects in various stages of permitting and development to move oil and gas from West Texas to market.

We have strong midstream and mainline pipeline capabilities and are actively pursuing these opportunities. That said, we are diversifying and building our base oriented services, which we expect to be the majority of our Oil & Gas segments revenues this year. We believe doing so results in a more stable and consistent business profile over time that is less dependent on the timing and cycles of larger pipeline projects.

Quanta has strategically focused on diversifying its operations across service lines and geographies in a very deliberate manner. This approach has designed to help mitigate many aspects of our risks in our business, including customer, project, permitting, geographic, execution, weather and other risks. We believe Quanta's diversity, scope and scale and capabilities are unique in our space and set us apart both operationally and as an investment. Quanta is a construction led infrastructure solutions provider and we believe our portfolio of companies, services and geographic diversity position us to profitability grow through various cycles over time.

In summary, the first half of the year was solid and the second half of the year is strengthening. We're executing well in our strategic plan, which is allowing us to expand our capabilities to capture and perform a larger proportion of our customer's capital and operating spend. While project permitting and regulatory challenges remain, we continue to have a positive multi-year view of our end markets and believe we have strengthened our opportunities for multi-year growth.

As highlighted in our earnings release this morning, over the past several quarters, we have repurchased $254 million of common stock under our $300 million stock repurchase program. We are committed to generating value for our stockholders through operational growth, profitability improvement and the return of capital.

We are focused on operating the business for the long-term and we'll continue to distinguish ourselves through safe execution and best-in-class field leadership. We will pursue opportunities to enhance Quanta's core business and leadership position in the industry and provide innovative solutions to our customers. We believe Quanta's diversity, unique operating model and entrepreneurial mindset is the foundation that will allow us to continue to generate long-term value for all our stakeholders.

With that, I will now turn the call over to Derrick Jensen, our CFO for his review of our second quarter results. Derrick?

D
Derrick A. Jensen
Quanta Services, Inc.

Thanks, Duke, and good morning, everyone. Today we announced record second quarter revenues of $2.66 billion, a 20.7 increase as compared to the second quarter of 2017. Net income attributable to common stock was $74.4 million or $0.48 per diluted share compared to $63.8 million or $0.41 per diluted share in the second quarter of 2017. Adjusted diluted earnings per share, a non-GAAP measure was $0.59 for the second quarter of 2018 compared to $0.50 for 2Q 2017. This year's net income and earnings per share figures all represent records for Quanta's second quarter performance.

Certain items impacted the second quarter of 2018 and were reflected as adjustments in Quanta's adjusted diluted earnings per share attributable to common stock calculation. These items had been disclosed in today's earnings release. The net favorable impact of which was $0.01 per share on GAAP diluted earnings per share.

Electric Power revenues increased to 20.7% when compared to the second quarter of 2017 to $1.57 billion with double digit or near double digit growth across all sub-segments of our Electric Power services. This increase was primarily due to higher customer spending associated with both transmission projects and distribution related services including continued favorable progress on a large transmission project in Canada.

Additional contributors were an increase in communications infrastructure services of $21 million, approximately $20 million in revenues from acquired businesses, $13.6 million of incremental Emergency Restoration Service revenues and approximately $10 million in revenues related to more favorable foreign currency exchange rates.

Operating margin in the Electric Power segment increased to 9.3% in the quarter as compared to 8.7% in the second quarter of 2017. This increase was primarily due to higher segment revenues including the previously mentioned large transmission project, on which we continued to perform favorably as well as incremental Emergency Restoration Services.

Aggregate communications infrastructure services operations, which are currently included within our Electric Power segment had slight losses for the quarter but performed incrementally better than the first quarter of 2018. We expect profitable operating performance for our aggregate communications operations for the rest of the year, with margins improving sequentially through the fourth quarter.

As of June 30, 2018 our remaining performance obligations were estimated to be approximately $5.58 billion, approximately 80% of which is expected to be recognized in the 12 months subsequent to June 30, 2018. Also as of June 30, 2018 12-month non-GAAP backlog for the Electric Power segment was a record $4.3 billion, which is up slightly from the first quarter and was an increase of 17% when compared to the second quarter of last year. Total backlog for the segment was $7.1 billion, which was an increase of 6% when compared to 2Q 2017.

We believe these increases reflect the continued strength of our end markets and opportunities which Duke referenced in his comments.

Oil & Gas segment revenues increased 20.7% when compared to the second quarter of 2017 to $1.09 billion. This increase was primarily due to incremental acquisition revenues of approximately $195 million contributed by Stronghold which, as mentioned by Duke, was ahead of our expectations.

Revenues were also higher from increased numbers of smaller transmission and distribution projects, however, these increases were offset by lower contributions of larger oil and gas pipeline projects. As a reminder, many of our larger pipeline projects last year were performed in the front half of the year which contributed favorably to the second quarter of 2017. For 2018 the majority of large diameter pipeline work will begin in the third quarter and continue into the fourth. This has a substantial impact on the comparability of quarters.

Also, as we discussed on a webcast at a June investor conference, certain large diameter pipeline projects we had previously expected to begin mobilizing on in the second quarter were delayed to the third quarter due to the timing of permitting.

Operating margin for the Oil & Gas segment decreased to 4% in 2Q 2018 from 7.5% in 2Q 2017. As previously discussed, this quarter's lower contribution of larger project revenues negatively impacted resource utilization and pressured margins. Additionally, operating income and margin were negatively impacted by harsh weather conditions experienced on a midstream project in the Northeast, which has been completed, as well as slight negative impacts from projects where change orders were not yet deemed probable for recognition.

Lastly, as disclosed in today's earnings release, the charge associated with the construction barge and severance and restructuring cost impacted this segment for a combined $4.6 million. These decreases were partially offset by the earnings of Stronghold, which we acquired in July 2017. As of June 30, 2018 12-month non-GAAP backlog for the Oil & Gas segment was $3.2 billion, which was an increase of 19% compared to the first quarter of 2018 and an increase of approximately 86% when compared to 12-month backlog at last year's second quarter.

Total backlog for the segment was $4.4 billion, which was an increase of approximately 80% when compared to total backlog at last year's second quarter. We continue to see the opportunity for additional awards and expect our backlog levels can remain strong. Corporate and non-allocated costs decreased $4.2 million in the second quarter of 2018 as compared to 2Q 2017, primarily due to the favorable impact of a $6.3 million change in the fair value of contingent consideration liabilities during the three months ended June 30, 2018 and a $3.8 million decrease in professional fees primarily related to lower information technology costs.

Partially offsetting these favorable impacts were $6 million in higher compensation related cost associated with increased personnel to support business growth, annual compensation increases as well as higher stock-based compensation based on increased forecast attainment of multiyear performance targets.

In aggregate, consolidated revenues increased $456 million or 20.7% when compared to the second quarter of 2017. Consolidated operating income increased to $13.2 million or 12.1% compared to the second quarter of last year and adjusted EBITDA, a non-GAAP measure grew 11.7% or $20.8 million to $198.6 million. For the second quarter of 2018, cash flows provided by operating activities were $156.5 million and net capital expenditures were $74.2 million resulting in $82.3 million of free cash flow. This compares to negative free cash flow of $45.9 million for the second quarter of 2017.

This improvement was primarily due to the timing of cash payments on AP and accrued liabilities and in part due to lower working capital requirements related to lower levels of ongoing large diameter oil and gas infrastructure projects. DSOs were 74 days at June 30, 2018 compared to 76 days at year end and 80 days at the end of last year's second quarter. These decreases were primarily due to the timing of cash collections associated with two larger electric transmission projects, one of which experienced billing delays in prior periods and the other has favorable advance billing terms in the current quarters.

During the quarter, we repurchased 600,000 shares of our common stock for $20 million, based on the trade dates of the transactions and subsequent to quarter end we repurchased 300,000 additional shares of our common stock for $10 million. With these repurchases we have acquired a total of 5.9 million shares of our common stock for $203.9 million in 2018.

Under our current $300 million stock repurchase program we have acquired an aggregate of 7.2 million shares of our common stock for $253.9 million leaving approximately $46.1 million remaining unused of our repurchased authorization. At June 30, 2018 we had $120 million in cash. We had $840 million of borrowings outstanding under our credit facility and $440 million in letters of credit and bank guarantees outstanding leaving us with $650 million in total liquidity as of June 30, 2018.

Turning to our guidance, we now expect consolidated revenues to range between $10.35 billion and $10.75 billion. This increased range contemplates Electric Power segment revenues of $6.15 billion to $6.35 billion. Within this segment we see revenues to be the highest in the third quarter and the fourth quarter to be sequentially lower due to typical seasonal trends.

We believe operating margins will grow to double-digits in the third quarter and fourth quarters. We continue to expect full year 2018 operating margins for the Electric Power segment to range between 9.5% and 10% with our communications operations continuing to be slightly dilutive to overall segment margins.

We now see Oil & Gas segment revenues ranging from $4.2 billion to $4.4 billion. We expect revenues and margins will strengthen in the third quarter, aided by the expected increased revenues from large diameter pipeline construction activities and continued improvement in our gas distribution and base business with fourth quarter revenues declining moderately or remaining comparable to the third quarter.

We now anticipate Oil & Gas segment operating margins between 5.4% and 6.4% for the year. This margin expectation reflects the $4.6 million in charges recorded in a segment during the second quarter. We anticipate net interest expense for the year to be approximately $33 million. As we have previously discussed, our other expense line item includes the deferral of a portion of the profit from construction activity on projects in which we have investments. We now expect the other expense line item to range between $35 million and $45 million for the year, primarily due to better than expected production uncertain of those projects.

We are projecting our effective tax rate for 2018 to be between 29% and 29.5% for the year. These operating ranges result in net income attributable to common stock of between $320 million and $382 million, and adjusted EBITDA of between $825 million and $926 million for the full year of 2018.

Due to our year-to-date share repurchase activity, we are now assuming around 154.9 million weighted average shares outstanding for the year. We are reaffirming our range of GAAP diluted earnings per share attributable to common stock for the year to be between $2.07 and $2.47, and anticipate non-GAAP adjusted diluted earnings per share attributable to common stock to be between $2.55 and $2.95.

Our forecasted non-GAAP measures are estimated on a basis similar to the calculations of historical adjusted diluted earnings per share presented in our release.

Please review the outlook expectations summary on our website for additional details. We believe our expected results for the year continue to reflect our opportunities for growth and our commitment to maintaining our strong balance sheet and financial flexibility. We feel we are operationally and financially well-positioned and continue to focus on our ability to execute on strategic initiatives.

This concludes our formal presentation, and we'll now open the line to Q&A. Operator?

Operator

At this time we will be conducting a question-and-answer session. In the interest of time, we ask that you please limit yourself to one question and one follow-up question. Our first question comes from Noelle Dilts of Stifel. Please proceed with your question.

N
Noelle Christine Dilts
Stifel, Nicolaus & Co., Inc.

Hi. Good morning, and congratulations on the quarter.

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Good morning.

N
Noelle Christine Dilts
Stifel, Nicolaus & Co., Inc.

So my first question is entirely related to Oil & Gas, there are a few parts here, but you commented that you expect all of your spreads to be utilized here over the next couple of quarters. Is that even if some of the work on Atlantic Coast pushes into 2019 as you referenced?

And then the second part here is, is given this acceleration in the mainline pipeline activity and the tightness we should see in the market over the next two quarters, are you starting to see better terms, conditions and pricing on contracts? And also are you at all concerned about the availability or cost of labor in any regions?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Yeah. Thanks, Noelle, for the comments. In general, I think that the – I'll start with the spreads. I think as far as where we sit today even with the push at ACP, we will be fully utilized, we're fully mobilized out in construction. Now, the sequencing of where we're at is certainly different than we expected. But that's – so it's a back half story. We thought we would be farther along in the first half and we're not, but we're starting now and we're starting to move forward over there just some of the work would push into 2019 on ACP.

As far as terms, we have good terms, we're confident in what we've done and how we de-risk the work. I won't get into details on them, but we're happy with our contracts, we're working with our clients. It's a daily barrage of something going on from a regulatory standpoint on most of our work in the Northeast, so we continue to work with our clients. But I'm optimistic that we're going to get this pipe built this year and we're going to have a good projects on all of them. And we're real excited about what we're doing on our large diameter pipe.

And as far as availability of people, one of our companies is 100 years, the other one is real close to it. So the amount of people and resources and if we rely strictly on execution, I love our chances. So we have really, really good longstanding people and superintendents and people want to work for us, so we're excited about with that as well.

N
Noelle Christine Dilts
Stifel, Nicolaus & Co., Inc.

Great. And then I wanted to shift over to the communications work, some interesting comments there. So, first, your expectation that you'll kind of exit the year at high single digits margins, maybe doesn't sound new, but you sounded a little bit more confident overall in that business. Is that a function just of the natural acceleration of some of these programs that you've been awarded or is it a function of picking up the cities that you referenced? And then if you could comment on you talked about your quality and timeliness. What do you think you're doing better than others?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Yeah, Noelle, I think a couple of things. When we got in the business, we knew there was a void. Until you get in the business and you start talking to clients, you don't understand how big it is or how big the void may be. After time in the business, we've talked with clients at the very highest level, and they're really – from our standpoint, our ability to put craft skill labor in the field is exceptional.

And so they recognize this; they recognized our ability to get work done, and done timely and cost certainty on the work. So that being said, I think we're set up to do that, as well as anybody or better than anyone, and they recognize it. So when we talk to them, when we're talking about those things. I think our acquisition of Northwest (sic) Lineman, our training, they see that, they've recognized that. So when we go in and say where are you going to get your workers from, they realize that we have a training facility we're working with them to put resources in the field and craft skilled labor in the field and we're not just talking about it.

So we're actually out executing. We're executing on our strategy and the communications. I really like where we sit. I would say that some of the drag and it is – the amount of cities that people are asking us to take, we have to be cognizant of getting people in the field. But at the job level, we're doing really, really well. I think we'll get scale out of these offices very quickly. And as far as the macro market, it's really good. I want to be clear that it's not about the market. The market's really good and there's a lot of work out there and people are doing really well, and I'm confident. It's just this is where we're at in our marketplace for us, and where we're going. And it's all about getting those craft skilled labor guys to the field and construction started.

Operator

Our next question comes from Tahira Afzal of KeyBanc. Please proceed with your question.

T
Tahira Afzal
KeyBanc Capital Markets, Inc.

Hi, folks.

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Good morning, Tahira.

T
Tahira Afzal
KeyBanc Capital Markets, Inc.

So, Duke, first question is let's strip out all these large projects that permitting wise make things work, move around, can you talk a bit about the baseload business in terms of your expectations at the beginning of the year and what you said in guidance and how that is performing and how that has influenced your guidance at this point in the middle of the year?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Yeah. Tahira, on the baseload business on the gas side, it's exceptional. We talked about the Stronghold contributions in the first half of the year. They've done – they beat our expectations, record year for them, done really, really well. I think it's overshadowed a bit by the larger projects and the timing so you have a mix of work that's not normal, so you're seeing some. In the Oil & Gas segment, it's not somewhat the margin profile a bit. And I think that will clear up in the second half.

But as far as the baseload work, we're exceeding our expectations on every level and every service line. Telecom's a little bit behind on the margins, but it's minute and it's due to the fact that we're ramping in multiple cities that we didn't think we would be ramping in. On a job level, we're right on track and that'll clear up and be better in the second half of the year. So, as far as I see it, our baseload business, we're growing high-single digits to double digits like we said we would. We're operating the company just like we said we would. I don't see any pause in it.

If you look at the CapEx, OpEx budgets of the companies that we serve, they continued to grow. You continue to hear multiyear, 10-year type work on grid modernization on gas replacement. We continue to see it, hear it from every customer we talk to, that comes out daily if you listened to earnings reports yesterday out of utilities' customers, there was one that said 10-year build, we're in year one. So and it's a large customer around the Northeast, I'm not going to get in their business but you're welcome to look around and see who announced yesterday. But, no, we're really excited about the business.

T
Tahira Afzal
KeyBanc Capital Markets, Inc.

Hey, that's good to hear, Duke. And I guess second point, when I look at your guidance; on the upper end which you've kept intact, that really showcases a very healthy earnings power on a quarterly basis close to a dollar and cash EPS. Is that something you can sustain and grow in a sense going forward beyond 2018?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

I mean Tahira, I think the business is set up like we said we publicly stated what we think from a growth profile on our base business, how these major projects layer in. You know that's something that it's very difficult to predict, if you look at it over time. But the macro markets there the bigger projects are there, where not – 90% or 85% of our businesses is this baseload work, that 15% gives us the most trouble in forecasting, and the most trouble in giving you clarity, but the macro market and those big jobs are out there, that we're not a large project on the other side of the world company, those jobs happen to be there, those jobs are there all the time. They've been there for the last seven or eight years, and they're getting bigger and we're executing on them.

On West Fort McMurray in Canada is a great example of a big project that we're executing on. East-West Tie that we've announced, it's on and on and on, it layers onto that 85% that we're doing really well. And our MSA business is only getting bigger. The multi-year MSA work is out there and it continues.

Operator

Our next question comes from Andrew Kaplowitz of Citi. Please proceed with your question.

A
Alan Fleming
Citigroup Global Markets, Inc.

Hey, guys. Good morning. It's Alan Fleming on for Andy. Duke it seems that the amount of environmental pushback at the state and local level regarding big pipelines is as high or maybe even higher than it's been. Does this surprise you in the context of what expectations were when the Trump administration took office and what do you think you can do to protect yourself from the volatility in that market?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

I would say in general I see it a little different. We're mobilized on every one of our jobs – not one job is canceled. In the past administration, we had jobs canceled; we had jobs not get there. So we're mobilized on every job. Now, when you get there, there's still some state environment kind of rules and regulations that get challenged. And so we're working through those. It's nothing that's stopping the job. It's just ways that we need to de-risk ourselves and mitigate issues in the field with our client. We knew that going into it, our guidance reflects that. But I feel really good about where we're at and we get better every day, it continues to clear up every day.

We have better contract terms today than we've ever had for Texas. I'm excited about the work out there. I continue to believe the administration is wanting jobs created and work to go in the field and we're starting to see some of that – ACP is going; Mount Valley, there was a good court ruling yesterday on it. Lots of projects are getting good rulings. There is some noise in them, but they're minor, it makes a lot of news but it's not a major deal in the field.

A
Alan Fleming
Citigroup Global Markets, Inc.

Okay. And just on Stronghold, I mean you said it was running ahead of expectations or what you've thought in the first half of the year. You didn't raise guidance there. So, is that just some conservatism or do you think that the high end or even higher of that $575 million to $600 million revenue guidance is achievable now with what you've seen through the first half of the year?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Yeah, the guidance in the Gas segment has everything to do with our large diameter pipe. We're about 25% in the season. As we work through the season this year, that's where the prudency in our guidance is, as stated in the call, in my script. We have prudency built into our guidance due to where we're at from a seasonality standpoint in big pipe, we're very early. And we're 25% into it. That's not normal from a season standpoint. We would typically be farther along, but due to some of the delays and getting to the Right of Way and our Canadian build coming in; it's a late build this year. So I think as we get through the third quarter, you're not seeing the underlying – we can look at the guidance, we can look at where we're at on big pipe as we work through contingencies.

Also when you look at, you can't see the strength because of where we sit with big pipe of Stronghold in our other companies, but we would say $600 million is achievable. And they're exceeding expectations from a margin profile.

Operator

Our next question comes from Chad Dillard of Deutsche Bank. Please proceed with your question.

C
Chad Dillard
Deutsche Bank Securities, Inc.

Hi, good morning, guys.

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Good morning.

C
Chad Dillard
Deutsche Bank Securities, Inc.

So, I'm just trying to understand the moving parts behind the guidance raise. Revenues are raised by about $300 million, but we're only seeing call it $6 million of EBIT increase. That would imply like a 2% margin on those revenues, which is in my mind – I mean I thought it would be a little bit higher. Maybe you can unpack what's going on there?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

We're in the early stages of our large diameter pipe, 25% into it. We took a prudent approach to the guidance on the back half and I'll let Derrick comment on the numbers.

D
Derrick A. Jensen
Quanta Services, Inc.

Yeah, it's also because when you think about from an Oil & Gas perspective, you saw some of those revenues coming in here in the second quarter versus our original expectations. But then we had some of the headwinds here in the second quarter, so that ate up some of that margin contribution.

The rest of it's coming in the back half, from an Electric Power perspective a little bit higher; overall though our margin guidance has remained intact. We did a little bit stronger in the second quarter. Looking at the back half of the year though what we're just saying is, is that we have no reason to change our overall Electric Power expectations, but those expectations when you look at the first half of the year, we've done quite well, so to that end we're just being a little bit prudent in the margins for the back half the year there.

And then the last, there's still that $100 million implied increase to the back half of the year, which as Duke spoke about is largely due to the new awards, but to the extent that of those new awards we haven't even begun to execute on those, those won't really start until here in the month of August. And we've got to be thinking about how we go through the winter type work. So to that end that's the prudency that Duke's referencing.

C
Chad Dillard
Deutsche Bank Securities, Inc.

Got it. That's helpful. And then just moving over to telecom; you mentioned that you're seeing progress towards high single-digits as we exit the year. Just trying to get a sense for how we should think about those segment margins as we head into the following calendar year? Are we at a kind of like sustainable run rate from 4Q and can we kind of drag that into 2019?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

I mean my expectation for the telecom businesses in 2019 to operate at parity to the electric margins.

D
Derrick A. Jensen
Quanta Services, Inc.

I will say and I would expect that there'd be a level of seasonality to that like you see in Oil & Gas and Electric Power generally speaking, but to Duke's point we'd see and look at the overall contribution via parity.

E
Earl C. Austin, Jr.
Quanta Services, Inc.

We're ramping, so I hedge a bit to say that if we ramp, continue to ramp on major cities and things of that nature, you could have some timing differences, but in general it'll be a good thing long-term. So, we're able to ramp fairly quickly. Our curriculum and the things that we've done from our college and such things we're able to get people to the field much quicker, which was a design and why we invested so much in training because we can get people to the field much quicker than we have in the past. So we're excited about it.

Operator

Our next question comes from Steven Fisher of UBS. Please proceed with your question.

S
Steven Michael Fisher
UBS Securities LLC

Thanks. Good morning. On the large electric transmission side, last quarter I think you said you were set to finish up the 2 to 3 projects you had in backlog by mid-2019. Is this Site C large enough to keep that business steady in the second half of 2019, or do you still need to book more in that large site you mentioned $3 billion of bids outstanding and if you do need to book some more of that, how confident are you, you can do it?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

I think if you look at Canada Site C is a nice project, we have East-West Tie which is a large project. So those two backfill some of West Fort McMurray; West Fort McMurray finishes up in the early part of the year I guess mid-part of the year. So in general, there is projects that we have been awarded both Site C and East-West Tie. But there's a multitude of projects coming out of Canada that are large in nature that we're looking at today that are in tender phases. And also in the U.S., us being geographically diverse, let's just look at a lot of different large projects, if you go back in time the company's been on as many as 10. We're doing what we're doing with one; so there's many, many projects out there and I can't say enough about how large the MSA build of these CapEx and OpEx budgets are. We don't announce them every day; we just never have as a policy, but they're out there and they're large and they're multi-year.

S
Steven Michael Fisher
UBS Securities LLC

Okay that's helpful. And then on the Oil & Gas side, can you maybe just talk a little bit more about the timing of the potential contingency releases you have on some of these pipelines you're working on. And I think we see some of those by the end of the third quarter or are those going to be more pushed into the fourth quarter?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

We evaluate our progress monthly on all our work and as we get through, as we operate through what we believe is contingencies we'll let them out or not. It's just we need to operate through that. It's a tough part of the world to work in, West Virginia in that area is we've got a lot of work in the hills and the mountains. And so, we'll be prudent about how we do it. We're going to get through that and we want to make sure that we get through it and I'm not in any hurry. We're going to get through the work and we'll let you know as it progresses.

D
Derrick A. Jensen
Quanta Services, Inc.

The other point being as is that each one of those items is done on a project by project basis. Each project is very unique and so we have to evaluate the contingency progression across each of those projects, irrespective of the passage time.

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Yeah. I would agree with Derrick's comment. Each one of those jobs are bid differently and they have different kind of contract. So, we'll have to look at each one of them.

Operator

Our next question comes from Andrew Wittmann of Robert W. Baird. Please proceed with your question.

A
Andrew John Wittmann
Robert W. Baird & Co., Inc.

Hey, great. Thanks, guys for taking my question. I wanted to ask about actually Western Canada, this is an area where production is actually increasing there, basis differentials have blown out. There's been some big pipelines sort of that you guys have passed on that have gone to other contractors. But I just wondered, given that this hasn't been a particularly active market for you in the last couple years, I don't think. Is it starting to improve in your outlook and could that be a contributor as we move into 2019, if there's anything specifically that you're looking at there to help boost the pipeline business?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Yeah. I mean, I think when you look at Western Canada, the Montney region and your takeaway LNG, both coastal and trans-mountain.

Those are both really, really nice projects. It takes a lot of capacity whether we build them or not. And the risk profile of some of that larger work out there is tough and we stay pretty disciplined, we stay real disciplined onto our models on bidding and again we don't win them all. But with the resources going out and the way it's working in the mining region, I do think that if those projects go, even if they don't go, you'll see work coming out of that shale basin it's prolific there, probably as good as the Permian.

So if we can get it to market, I believe, you'll see a lot of Midstream and a lot of large diameter pipe just going to bigger lines in the load centers. We see that there's record usage of power in BC, I believe yesterday. So lots of things going on in BC that we see; we need some good regulation up there that allows energy to go forward, the market itself to go forward. I think when you look at it, you look at the oil sand differentials and things that are happening. Pipes necessary, they're behind and they've got to catch up. So I really like the future there. We see a lot of good opportunities in Canada. In LNG it's only a plus.

A
Andrew John Wittmann
Robert W. Baird & Co., Inc.

Right, great. And then Duke – no, actually Derrick, if you could just talk a little bit about the contingent liability release. I think maybe you said the segment, but I don't know if you did, if you could just refer to kind of why would segment which acquisition if that's tied to an acquisition, any color there would be helpful?

D
Derrick A. Jensen
Quanta Services, Inc.

Yeah. I think you're referring to the change in the earn-out expectation. A lot of that's actually driven. We call that the project, the Midstream project itself that had some headwinds this quarter, a lot of its tied to that individual project for that individual acquisition, which we have to go through and assess the probability, EBITDA realization and in this particular case it's a cumulative calculation, so with this particular shortfall was from our standpoint really impacted our ability to say that, that liability was now currently probable. So, it's a mainly for midstream type work in the Northeast.

Operator

Our next question comes from Jamie Cook of Credit Suisse. Please proceed with your question.

J
Jamie L. Cook
Credit Suisse Securities (NYSE:USA) LLC

Hi. Good morning. First question I think you said in your prepared remarks that this year mainline pipe will represent 10% to 15% of total revenues. Is there any way you can help us with like what your assumptions are in the back half of the year versus the first half or where that stood relative to 2017. So, we can better understand the margin implications and then the other thing besides the weather issue in the Northeast, you called out I think a change order or something like that. Can you just quantify the impact on the margins for me and just timing of that? Thank you.

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Yeah. Jamie, I think in general I would say, I'll let Derrick quantify – run the numbers, but in general we're behind, we're 25% into it I would say and if you look if you go back inversely to 2017, we were probably more like 75% something like that well ahead of where we're at today. I don't know the exact math, but it's at least 60%. So, call it 60% so we're that far behind as far as I'm concerned. And in general, if 2017 was much more frontend loaded than this year, we're way back loaded in the back half. We're real close from the way we're forecasting to last year on big pipe. And I do think as we get forward, we'll exceed the amount of big pipe this year than we did last year.

So, I'll now let Derrick comment to the numbers.

D
Derrick A. Jensen
Quanta Services, Inc.

Yeah. To that extent I mean one of the things I comment too is that it's a little bit like 2016 if you think about the back half of 2016 versus the front half of 2016. That's kind of a comparable what you're seeing here 2018, which is almost exactly the opposite of what you saw for 2017. And then, I guess relative to the margin dynamics here for the second quarter, part of it was the push out against our original expectations of the timing of some of the work which we referred to both in the June investor conference, as well as our prepared remarks.

We had a little bit of the weather impacts on the midstream project, I'd say that's probably a 70 basis point to 80 basis point impact to the quarter. As well it's not as though actually that was the only place we had some weather impacts, we actually did have some weather impacts in Australia, as well as some level of breakup impact. But the larger portion of which was the midstream project, we had the charges in the quarter which is about $4.6 million.

And then lastly on the change order recognition, I'd say that, that probably impacted the quarter profitability by again maybe the 50 basis point, 60 basis point, 70 basis point range. So, all of those things kind of aggregate are representative of the difference in our expectation.

J
Jamie L. Cook
Credit Suisse Securities (NYSE:USA) LLC

Okay. That's very helpful. Thank you I'll get back to queue.

Operator

Our next question comes from Adam Thalhimer of Thompson Davis. Please proceed with your question.

A
Adam Robert Thalhimer
Thompson Davis & Co., Inc.

Hi, good morning, guys. Can you give us a little more color on large transmission biding, and is the best chance for incremental awards, you think that's pushed out to 2019?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

I wouldn't say that, I think it's constant. We see large products daily and again we see big projects and we're, some of them are in tender phase, some of them are in negotiation phase, some of them will be in 2019. It's all over the place, but we referenced about a $3 billion type in house. We're looking at bidding, negotiating type number on big transmission projects and that's the number. Where they're at and how long they take, it just – I can't tell you. I know that we're negotiating then we're not going to put a timeline on it. But the markets there, in the MSA market that we don't talk about – that we don't talk about, or we don't say it's a big project, those MSAs are in the billions of dollars, they're not little bitty MSAs. So I want to be clear.

D
Derrick A. Jensen
Quanta Services, Inc.

Yeah. One other incremental point, I think it's worth noting that they're – relative to our revenue, guidance as it stands here today, we do not need any additional large awards in either Electric Power or Oil & Gas to come through relative to our current guidance. So anything would be incremental for this year at this stage.

A
Adam Robert Thalhimer
Thompson Davis & Co., Inc.

Okay. Understood. And then you referenced taking share in telecom, would you say you're taking share from public players, private players or both?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Yeah. We don't look at – I don't look at it like that. I mean, I know what we're doing, I know the cities are, I can't tell you exactly who the market was or who we took them from, I have no – I don't know. I'm worried about us and how we execute and that's all I'm worried about. I have no idea.

Operator

Our final question comes from Brent Thielman of D.A. Davidson. Please proceed with your question.

B
Brent Edward Thielman
D.A. Davidson & Co.

Great. Thank you. Hey, Duke, with some of the kind of continued slippage in ACP schedule into 2019, and just kind of considering the stated capacity, how do you think and plan for life, ACP, in other words is this schedule kind of continues to shift right a bit, does that impact how you pursue or kind of bid for the next inevitable large job out there today?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

Look, I think in general what we ACP goes into 2019 for us too, we have some I think a couple of spreads to work or more in 2019 for ACP as well. So where it's a long – it was a two year project to begin with. We tried to forecast some of the work in 2018, and some of the work in 2019 because that's when we were kind on our schedules. But when we look at that I mean it's a couple spreads that'll be there for two years. We are picking up incremental work at times that doesn't meet the threshold to make the news every day. But we do pick up incremental work, we're still building work – we're still building midstream work, we can move crews on and off those projects to do other things. It's just when you start talking about the mountains of West Virginia and North Carolina only a certain amount of people can do that. And, we tend to shy away from anything that's risky like that unless we have the right kind of superintendents to run them and right now if it's Mountain work we're booked.

B
Brent Edward Thielman
D.A. Davidson & Co.

Yeah. Okay. And then Fort McMurray just given the size of that project and then it runs I think you said earlier mid next year, could we see margin contribution from that job pick up even further it sounds like it's executing well or are you kind of running it at optimal levels on that job today?

E
Earl C. Austin, Jr.
Quanta Services, Inc.

We're doing really well in that job. We we're executing like we should, we got to work through the winter here. And look there's opportunity for us to continue to execute well there, there's more opportunity on that job for sure. We'll see where it goes. We take a – we look at it quarterly, monthly we look at it all the time about where we're at. Some of the things that get de-risk as we de-risk that job. We look at it and evaluate what's it going to take to finish it and then bring it in here. I think it's more of getting through the winter here in the second half.

Operator

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back to management for closing remarks.

E
Earl C. Austin, Jr.
Quanta Services, Inc.

I'd like to thank all of the guys in the field for the work that they've done and in dire conditions, hot conditions, it's tough work, so thanks to them. And thank everyone for participating in our second quarter 2018 conference call. We appreciate your questions and your ongoing interest in Quanta Services. Thank you. This concludes our call.

Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.