IES Holdings, Inc. quarterly report, Q2 FY2017

IES Holdings, Inc. — Q2 FY2017 Form 10-Q

Reporting period: Quarter and six months ended March 31, 2017; amounts are in U.S. dollars unless stated otherwise. Financial statements are unaudited. IES provides communications infrastructure, residential electrical installation, commercial and industrial contracting, and industrial infrastructure solutions.

Financial performance

Metric	Q2 FY2017	Q2 FY2016	Six months FY2017	Six months FY2016
Revenue	$203.7 million	$160.0 million	$395.8 million	$310.7 million
Gross profit / margin	$31.8 million / 15.6%	$27.8 million / 17.4%	$67.0 million / 16.9%	$55.4 million / 17.8%
Operating income	$1.6 million	$2.5 million	$8.6 million	$7.6 million
Net income attributable to IES / diluted EPS	$0.5 million / $0.02	$2.2 million / $0.10	$4.4 million / $0.20	$8.0 million / $0.37
Operating cash flow	Not presented quarterly	Not presented quarterly	$2.7 million	$18.3 million

Quarterly revenue rose 27.3%, but gross margin fell 1.8 percentage points and operating and net income declined. For the six-month period, revenue increased 27.4% and operating income grew, while net income fell substantially; the company attributed higher tax expense partly to a prior-year valuation-allowance benefit and the release of a valuation allowance in FY2016.

Liquidity, debt and cash flow

• Cash and cash equivalents were $20.8 million at March 31, 2017, down from $33.0 million at September 30, 2016. Operating cash flow of $2.7 million and financing outflows did not cover $14.5 million of investing outflows, including the Freeman acquisition.
• Long-term debt was $29.4 million, drawn under the revolving credit facility; the weighted-average borrowing rate was 2.99%. The company reported $6.6 million of letters of credit and $40.7 million of excess availability at March 31.
• Current assets were $215.3 million and current liabilities $140.3 million. The filing reports liquidity of $61.5 million, a 15.4:1.0 fixed-charge coverage ratio and trailing-twelve-month EBITDA of $36.2 million at March 31.
• On April 10, 2017, the company amended and restated its credit facility: maximum capacity increased from $70 million to $100 million and maturity extended to August 2021. The amendment introduced a minimum EBITDA covenant, raised minimum liquidity requirements and increased the required fixed-charge coverage ratio to 1.1:1.0.

Material changes and segment trends

• Communications: Q2 revenue increased 56.7% to $61.7 million, driven by data-center, distribution-center and structured-cabling work. Segment gross margin declined to 15.1%, partly due to project inefficiencies and a higher mix of lower-margin cost-plus work.
• Residential: Q2 revenue increased 27.2% to $67.9 million, mainly from multi-family projects delayed in FY2016 and growth in Texas single-family work. Gross margin was 22.9%, down from 23.9%.
• Commercial & Industrial: Q2 revenue increased 2.1% to $55.3 million, but gross margin dropped to 4.8% from 9.6%; the segment recorded a $2.6 million operating loss. Labor overruns, accelerated customer schedules and employee turnover affected four projects. Management expected the jobs to be largely complete in Q3 FY2017, with margin effects continuing through completion; potential recovery claims had not been recognized as income.
• Infrastructure Solutions: Q2 revenue increased 43.5% to $18.8 million, primarily reflecting acquisitions. Gross margin declined to 22.8%, including production inefficiencies at Technibus on a higher proportion of isolated-phase bus projects.
• Backlog was $335 million at March 31, versus $341 million at September 30, 2016. Management cited completion of large Communications projects and increased work on delayed Residential multi-family projects. Backlog is not a guarantee of revenue or profit.
• IES acquired Freeman Enclosure Systems and affiliate Strategic Edge on March 16 for maximum consideration of $12.1 million, comprising $11.7 million paid at closing and $0.5 million contingent consideration. Preliminary purchase accounting included $3.8 million of goodwill.

Outlook, risks and unusual items

• No quantified company-wide revenue or earnings guidance is provided. Management noted seasonal fluctuations, project timing and customer-facility outage schedules can make interim results unrepresentative of full-year results.
• Key operating exposures include fixed-price project-estimation risk, labor availability and costs, project delays and overruns, construction demand, commodity prices, customer collections and acquisition integration. Days sales outstanding rose to 64 from 60 at September 30, 2016.
• Capstone litigation was remanded to the trial court on indemnity claims relating to work performed by former subsidiaries. The underlying owner’s claim against Capstone is $10.4 million plus fees and costs. IES said it expects to prevail, has not recorded a reserve because loss was not considered probable or reasonably estimable, and filed a further summary-judgment motion in April 2017.
• Tontine and affiliates held approximately 58% of outstanding common stock. A change in ownership could affect the use of tax-loss carryforwards and trigger provisions in credit, surety and severance arrangements. The company’s NOL Rights Plan is intended to deter ownership changes, but effectiveness is not assured.
• The company reported compliance with its credit covenants at March 31. A future covenant breach could make debt immediately due. Floating-rate debt exposes IES to interest-rate increases; management estimated a one-percentage-point increase would add approximately $0.3 million to annual pretax interest expense at the period-end debt level.
• Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

• Whether Commercial & Industrial project overruns are resolved on the expected schedule and what margins result through completion.
• Whether Communications and other segments can sustain revenue growth while recovering gross margins.
• Cash conversion, receivable collection trends and working-capital demands as cost-plus work and acquisitions expand.
• Compliance with the amended facility’s minimum EBITDA, liquidity and fixed-charge coverage covenants.
• Final Freeman purchase accounting, contingent consideration and acquired-business performance.
• Developments in the Capstone matter, any potential project-cost recoveries, and any change in the company’s estimated exposure.
• Any Tontine share sales or ownership changes that could affect tax attributes or contractual change-of-control provisions.