Argan, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended July 31, 2018; comparisons are with the corresponding 2017 periods. Financial amounts are in U.S. dollars; figures below are in millions unless otherwise stated.
Business context
Argan provides power-plant engineering, procurement and construction (EPC) and related services, industrial fabrication and field services, and telecommunications infrastructure services. Power industry services accounted for 77% of Q2 revenue and 82% of six-month revenue. The reporting period reflects the wind-down and commissioning of several large power-plant projects.
Financial performance and liquidity
| Metric | Three months ended July 31 | Six months ended July 31 |
|---|---|---|
| Revenue, 2018 | $136.7 | $278.0 |
| Revenue, 2017 | $259.8 | $490.3 |
| Gross profit, 2018 | $30.7 | $46.2 |
| Gross margin, 2018 / 2017 | 22.5% / 19.8% | 16.6% / 18.7% |
| Operating income, 2018 | $20.3 | $26.1 |
| Net income attributable to Argan stockholders, 2018 | $17.0 | $21.8 |
| Diluted EPS, 2018 / 2017 | $1.08 / $1.72 | $1.39 / $3.03 |
| Operating cash flow, 2018 / 2017 | Six-month: $(58.5) / $34.6 |
Q2 revenue fell 47% year over year and six-month revenue fell 43%, primarily as major power projects moved beyond peak construction. Q2 gross margin improved, with management citing solid execution and favorable project close-out adjustments; the six-month margin declined, reflecting earlier cost pressures and an arbitration award. Six-month SG&A was $20.0 million, down slightly from $20.3 million. The effective tax rate was approximately 27.5% for the six-month period, versus approximately 36.2% a year earlier.
At July 31, cash and cash equivalents were $165.8 million and short-term investments were $196.0 million. Working capital was $313.4 million. The company had no revolving-loan borrowings under its $50 million credit facility, although approximately $18.5 million of credit was outstanding under the facility, primarily supporting APC. The company reported compliance with financial covenants. Total liabilities were $142.0 million.
Operating cash use reflected project working-capital movements: contract-in-progress changes used $44.2 million, accounts receivable used $19.9 million, and reductions in accounts payable and accrued expenses used $18.7 million. Collection of customer retainages provided $46.3 million. Investing activities provided $110.4 million, mainly from net maturities of short-term investments; dividends paid were $7.8 million. The company declared two quarterly dividends of $0.25 per share during the six-month period.
Material changes and notable items
- Power-services revenue declined 56% in Q2 and 49% for the six-month period. Industrial-services revenue increased 64% in Q2 and 32% year to date; telecommunications revenue declined in both periods.
- Project backlog was approximately $429 million at July 31, up from $379 million at January 31. Remaining unsatisfied performance obligations were $193.6 million; approximately 80% was expected to be recognized in the six months ending January 31, 2019. These measures differ in definition and should not be treated as interchangeable.
- Adoption of ASC Topic 606 on February 1 had an immaterial retained-earnings effect and no material effect on reported operating results. Prior-period results were not restated.
- A TRC subcontractor dispute was settled for a $0.9 million payment, generating a $1.4 million gain because amounts accrued exceeded the settlement. Separately, GPS paid approximately $5.2 million plus interest and arbitration fees to settle a subcontractor dispute; most of the amount had been accrued by April 30.
Outlook, risks and contingencies
Management expected GPS revenue to decrease significantly in fiscal 2019 as existing EPC projects reach completion, with a transition from late-stage projects to early-stage new work. It was cautiously optimistic about renewed growth in fiscal 2020 and later, contingent on new project awards and ramp-up. This is management commentary, not quantified company guidance.
GPS had signed contracts for the 475 MW Reidsville project and the 1,600 MW Chickahominy project, but had not received a limited or full notice to proceed on the new projects discussed. Chickahominy was excluded from backlog; management said it expected the Reidsville notice to proceed before fiscal year-end. Potentially selected EPC opportunities totaling more than $1.5 billion were also described, but management cautioned that projects could be delayed, changed or not built.
Risks include project delays or cancellations, uncertain electricity demand and regulatory and energy-market changes, pipeline approval delays and protests, cost overruns on fixed-price contracts, and customer and project concentration. Variable consideration, change requests and liquidated damages may also affect recognized revenue and profit. Argan generally does not hedge foreign-currency translation or commodity-price exposure. Management stated that available liquidity and expected operating cash flows should meet foreseeable business needs; acquisitions or unplanned requirements could require additional financing. The company reported no other current legal matters expected to have a material financial effect. Disclosure controls were considered effective, and no material change in risk factors was reported.
Investor verification priorities
- Track completion, remaining costs and final margins of the large EPC projects, including the effect of labor, subcontractor and arbitration costs.
- Confirm whether Reidsville and Chickahominy receive notices to proceed, whether reported backlog converts to revenue, and the timing of the broader prospective project pipeline.
- Monitor working-capital needs, operating cash flow, retainage collections and the quality and collectability of contract assets and receivables.
- Assess customer and project concentration, potential contract claims or liquidated damages, and exposure to commodity prices, foreign exchange and power-market changes.
- Verify the sustainability of dividends and liquidity, including credit-facility usage and covenant compliance.