POWELL INDUSTRIES INC quarterly report, Q1 FY2017

Powell Industries, Inc. — Fiscal 2017 First-Quarter 10-Q Summary

Reporting period: Three months ended December 31, 2016, compared with the three months ended December 31, 2015. The unaudited interim statements are presented in accordance with U.S. GAAP. Powell designs, manufactures and services custom-engineered electrical distribution, control and monitoring equipment for industrial, utility, transportation, oil and gas, petrochemical, mining and other markets.

Financial Results and Key Metrics

Metric	Q1 Fiscal 2017	Q1 Fiscal 2016	Change
Revenue	$110.3 million	$150.0 million	Down 26%
Gross profit	$15.0 million	$23.2 million	Down 35%
Gross margin	14%	15%	Down approximately 1 percentage point
Operating loss	$2.3 million	$2.0 million	Operating loss increased
Net loss	$0.3 million	$0.5 million	Improved
Diluted loss per share	$0.03	$0.04	Improved
Operating cash flow	$3.4 million	$24.1 million	Down $20.7 million
Capital expenditures	$0.9 million	$0.6 million	Increased

Selling, general and administrative expense declined 19% to $15.7 million, reflecting prior cost-reduction actions, but increased to 14% of revenue from 13%.
Research and development expense was $1.5 million, compared with $1.9 million in the prior-year quarter.
No restructuring or separation expense was recorded in Q1 Fiscal 2017; Q1 Fiscal 2016 included $3.8 million related to the former chief executive officer’s departure.
Income tax benefit was $1.4 million, producing an 83% effective tax rate on the pretax loss, compared with a $1.0 million benefit and a 70% effective rate in the prior-year quarter. The current-quarter benefit included a $0.3 million release of an R&D tax-credit reserve following completion of an IRS audit.
Comprehensive loss was $2.9 million, including a $2.6 million unfavorable foreign-currency translation adjustment.

Balance Sheet, Cash Flow, Debt and Liquidity

Cash and cash equivalents were $80.6 million at December 31, 2016, compared with $97.7 million at September 30, 2016. Short-term investments were $14.9 million, resulting in cash, cash equivalents and short-term investments of $95.5 million.
Total assets were $437.0 million and stockholders’ equity was $330.1 million at December 31, 2016.
Current assets exceeded current liabilities by approximately 2.9 times. Total debt was $2.0 million, down from $2.4 million at September 30, 2016; debt to total capitalization was 0.60%.
Operating cash flow was $3.4 million. Investing cash outflows were $15.8 million, primarily reflecting a $14.9 million increase in short-term investments. Financing cash outflows were $3.8 million, including $3.0 million of dividends and $0.4 million of debt repayment.
The $75.0 million U.S. revolving credit facility had no borrowings and $54.7 million of availability after $20.3 million of outstanding letters of credit. The facility expires in December 2018.
The $7.4 million Canadian revolving facility had no borrowings or outstanding letters of credit, with the full amount available. It expires in March 2018.
Approximately $31 million of cash was held outside the United States and is intended to remain reinvested internationally.

Material Changes Versus the Prior Comparable Period

Revenue declined $39.6 million, primarily because of continued project-backlog contraction and lower oil and gas customer demand. Domestic revenue declined 19% and international revenue declined 44%.
Commercial and industrial revenue declined 35% to $72.7 million, while utility revenue declined 42% to $16.6 million. Municipal and transit revenue increased 142% to $21.1 million due to project timing and increased production activity.
Backlog declined to $271.5 million at December 31, 2016, from $291.4 million at September 30, 2016. New orders were $90.8 million, down from $101.8 million in the prior-year quarter.
Gross margin declined because of lower production volume, weak oil and gas markets and lower margins on increased transit-market volume. Canadian operations improved, but domestic gross-profit declines more than offset that improvement.
Net loss improved despite lower revenue because of lower SG&A, the absence of prior-year separation costs and the related tax benefit.
Cash generation weakened substantially, primarily due to increased incentive-compensation payments and less favorable timing of project milestone collections.

Outlook, Risks and Unusual Items

Management expects near-term operating losses to continue, stating that prior and future cost-reduction efforts will not be sufficient to avoid losses in the near term. The company believes its cash, short-term investments, low debt and available borrowing capacity are sufficient to fund operations, capital improvements, research and development and debt repayments for the foreseeable future.

Depressed oil and gas prices have reduced customer capital spending, delayed or canceled projects and increased pricing pressure. A prolonged or further decline in these markets could reduce backlog, revenue and profitability.
Project schedules, customer approvals, change orders, contract claims and project close-outs may materially affect revenue recognition and gross margins. A significant portion of revenue is recognized using percentage-of-completion accounting on fixed-price contracts.
Potential liquidated-damages exposure was $2.7 million, of which approximately $1.7 million was considered probable. The company had recorded $1.5 million as a reduction of revenue; additional amounts could be payable if contractual obligations are not resolved.
Outstanding surety bonds totaled $229.4 million, with an additional $520.6 million of bonding capacity. Letters of credit totaled $20.3 million, and U.K. guarantees totaled $4.8 million under a facility expiring in May 2017.
Key risks include commodity-price and material-cost volatility, foreign-currency movements, customer credit risk, contract performance obligations, litigation, competition, skilled-labor availability, cybersecurity, regulatory and environmental requirements, and the cyclical nature of end markets.
The company reported compliance with the financial covenants of its U.S. and Canadian revolvers, its U.K. facility and its industrial-development revenue bond arrangements. Management stated that pending litigation is not expected to have a material adverse effect, although outcomes are inherently uncertain.
The company early adopted new stock-based compensation guidance in the quarter, including presentation of excess tax benefits or deficiencies in income taxes and operating cash flow.

Important Facts for Investors to Verify

Whether backlog and new orders continue to decline, particularly in oil and gas-related markets.
Whether the 14% gross margin stabilizes or deteriorates as production volume and market mix change.
The timing and collection of project milestone billings and the sustainability of operating cash flow.
The adequacy of recorded liquidated-damages accruals and the resolution of related customer claims.
Availability and covenant compliance under the revolving credit facilities and the May 2017 expiration of the U.K. guarantee facility.
The impact of foreign-currency movements on comprehensive income and equity, including the $2.6 million quarterly translation loss.
The extent to which the unusually high 83% effective tax rate and the $0.3 million IRS-related tax benefit are nonrecurring.
Management’s assumption that cash and borrowing capacity will remain sufficient while near-term operating losses continue.