Powell Industries, Inc. — Fiscal 2014 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended June 30, 2014. Powell designs, manufactures and services custom engineered-to-order electrical power management and control equipment for energy, industrial, utility and transportation customers. The filing was dated August 6, 2014.
Business Context and Reporting Period
- Operations are capital-intensive and cyclical, with demand affected by energy prices, customer capital spending, economic conditions, regulation and project timing.
- Powell completed the relocation to its new Canadian facility in late 2013. The Canadian production ramp created inefficiencies, material shortages, longer delivery times and higher costs.
- Transdyn was sold on January 15, 2014. Its results are presented as discontinued operations, and comparative periods were reclassified.
Financial Performance and Key Metrics
| Metric | Q3 FY2014 | Q3 FY2013 | 9M FY2014 | 9M FY2013 |
|---|
| Revenue | $150.8 million | $171.7 million | $485.0 million | $464.6 million |
| Gross profit | $29.6 million | $36.6 million | $99.7 million | $98.5 million |
| Gross margin | 19.7% | 21.3% | 20.6% | 21.2% |
| Operating income | $4.7 million | $12.1 million | $26.5 million | $29.4 million |
| Income from continuing operations | $2.9 million | $9.1 million | $17.2 million | $22.8 million |
| Net income | $2.9 million | $9.3 million | $26.8 million | $23.5 million |
| Diluted EPS | $0.24 | $0.78 | $2.23 | $1.96 |
- Q3 revenue decreased 12.2%, primarily from project schedule delays and timing. Domestic revenue declined 15.6% and international revenue declined 7.3%.
- Nine-month revenue increased 4.4%, primarily due to Canadian expansion and increased international revenue.
- Q3 operating income fell 61.2%, while nine-month operating income declined approximately 9.8%. Higher SG&A, lower revenue and weaker project margins were the main factors.
- Q3 SG&A increased to $23.0 million from $20.2 million, or 15.3% of revenue versus 11.8%. Bad debt expense, personnel, travel and strategic growth costs contributed to the increase.
- The Q3 effective tax rate was 43.1%, compared with 24.8% in the prior-year quarter. The filing attributes the increase primarily to discrete tax items and nondeductible executive compensation. The nine-month effective tax rate was 37.3% versus 26.5%.
- Q3 included no discontinued-operation income. Nine-month discontinued-operation income was $9.6 million, including an $8.6 million after-tax gain on the Transdyn sale.
Cash Flow, Balance Sheet, Debt and Liquidity
| Metric | June 30, 2014 | September 30, 2013 |
|---|
| Cash and cash equivalents | $87.8 million | $107.4 million |
| Total assets | $508.3 million | $530.9 million |
| Total liabilities | $133.2 million | $175.7 million |
| Stockholders’ equity | $375.1 million | $355.2 million |
| Total debt and capital leases | $3.2 million | $3.6 million |
- Operating activities used $14.6 million in the first nine months, compared with $88.7 million provided in the prior-year period. Working-capital consumption included increases in receivables and contract underbillings, lower payables and accrued liabilities, and temporary invoicing delays related to the Business Systems reimplementation.
- Investing activities provided $3.6 million, including $14.8 million of Transdyn-sale proceeds, partially offset by $11.3 million of capital expenditures.
- Financing activities used $9.9 million, including $9.0 million of cash dividends. Dividends were $0.75 per share for the nine-month period, versus none in the prior-year period.
- The U.S. revolving facility provides $75.0 million of capacity, with $53.9 million available after letters of credit. The Canadian facility provides $9.4 million, with $9.3 million available. No borrowings were outstanding under either revolver.
- Letters of credit totaled $21.2 million. Performance and maintenance bonds totaled $330.2 million, with additional bonding capacity of $269.8 million.
- Management stated that available cash and borrowing capacity should be sufficient for anticipated operations, capital improvements, expansions and debt repayments.
Material Changes Versus the Prior Comparable Period
- Q3 revenue and profitability weakened substantially because of project delays, project mix and Canadian facility ramp-up problems.
- Nine-month revenue grew, but gross margin and continuing-operations earnings declined.
- Cash flow shifted from a substantial operating inflow to an operating outflow, primarily from working-capital timing and contract billing matters.
- Transdyn was disposed of, generating $9.6 million of nine-month discontinued-operation income, including the sale gain.
- Powell amended its GE supply agreement. GE paid $10.0 million upon execution and agreed to pay an additional $7.0 million over three years subject to conditions. Powell recorded $1.0 million of other income during the first nine months from amortization of the deferred gain.
- Backlog increased to $477.4 million at June 30, 2014 from $452.2 million at March 31, 2014 and $437.9 million at September 30, 2013. Q3 orders were $171.7 million, and nine-month orders were $526.5 million.
Guidance, Outlook, Commentary and Risks
- Management did not provide specific quantitative revenue or earnings guidance in the filing.
- Management described the long-term outlook as positive, supported by energy demand, infrastructure replacement, oil and gas production, refining projects and Canadian oil sands-related opportunities.
- Near-term timing and pricing remain difficult to predict. Large-project awards, engineering approvals, change orders and project close-outs may shift revenue and gross margin between periods.
- Canadian operations may continue to experience production inefficiencies, material shortages, delivery delays, higher costs and gross-margin deterioration.
- Fixed-price and percentage-of-completion contracts expose Powell to cost overruns, penalties, estimate changes and volatility in reported results. Raw-material price increases may not be fully recoverable.
- Backlog may be adjusted or canceled and is not necessarily indicative of future earnings. Customer credit and contract receivables are exposed to economic and industry conditions.
- Other risks include cyclical demand, competition, international currency and regulatory exposure, litigation, skilled-labor availability, enterprise-resource-planning implementation issues and the ramp-up of new facilities.
- Disclosure controls and procedures were deemed effective. The new Business Systems went live in early May 2014, with continuing post-implementation monitoring and process modifications.
Investor Verification Points
- Verify whether Canadian facility productivity and utilization improve without further material margin or delivery impacts.
- Track conversion of the $477.4 million backlog into revenue, cash collections and gross profit, including project cancellations, change orders and estimate revisions.
- Reconcile operating cash flow with receivables, contract underbillings, payables and the effects of the Business Systems implementation.
- Separate recurring operating earnings from the $8.6 million after-tax Transdyn sale gain and the $1.0 million GE supply-agreement-related other income.
- Monitor tax rates, particularly the elevated Q3 effective rate and the expiration or availability of favorable tax items.
- Review obligations associated with $21.2 million of letters of credit, $330.2 million of performance and maintenance bonds, and facility financial covenants.
- Assess the effect of project timing, fixed-price contracts, commodity costs, customer credit quality and cyclical energy-market demand on future results.
