Argan, Inc. — Q3 FY2019 Form 10-Q
Reporting period: Three and nine months ended October 31, 2018; fiscal year ends January 31. Figures below are unaudited. Argan provides power-generation and renewable-energy services, industrial fabrication and field services, and telecommunications infrastructure services.
Financial performance
| Metric | Three months ended Oct. 31, 2018 | Nine months ended Oct. 31, 2018 |
|---|---|---|
| Revenue | $116.5 million, down 50% year over year | $394.5 million, down 45.5% |
| Gross profit and margin | $29.5 million; 25.4%, versus 16.2% | $75.7 million; 19.2%, versus 17.9% |
| Operating income | $18.4 million, down 33.4% | $44.5 million, down 54.9% |
| Net income attributable to Argan shareholders | $32.4 million; diluted EPS $2.07 | $54.2 million, down 16.5%; diluted EPS $3.46, versus $4.11 |
| Operating cash flow | Not reported for the quarter | $(99.1) million, versus $(22.7) million |
| Cash and short-term investments | $314.8 million at Oct. 31, including $155.8 million cash and $159.0 million short-term investments | |
| Working capital | $339.6 million, up from $301.8 million at Jan. 31 |
Cash from operating activities was pressured by a $79.6 million use of cash from contracts in progress, including reduced customer advance billings as major projects neared completion. Other uses included higher receivables and other assets and lower accounts payable and accrued expenses. Net maturities of short-term investments provided $152.0 million; cash dividends paid were $11.7 million and capital expenditures were $7.4 million.
Argan had no revolving-credit borrowings. Its facility permits up to $50 million of borrowing through May 2021; $15.5 million of credit was outstanding under the agreement, primarily supporting APC activities, and the company was covenant-compliant. The company also reported a separate $0.4 million letter of credit for TRC. No material funded debt was reported.
Changes and notable items
- Revenue fell substantially as four large power-plant projects reached substantial completion and moved from peak construction into commissioning and close-out. Power services revenue declined 58% in the quarter and 52% year to date.
- Industrial fabrication and field services revenue grew 45% in the quarter and 37% year to date; TRC and APC each reported record nine-month revenue. Telecommunications revenue declined 6% in the quarter and 11% year to date.
- Quarterly gross margin improved, partly because project close-out adjustments benefited current-period results; the prior-year quarter had included higher-than-expected labor and subcontractor costs.
- Quarter and year-to-date net income benefited from $16.5 million of prior-year research and development tax credits, contributing $1.05 to diluted EPS. The nine-month income tax benefit was $4.5 million, compared with $37.7 million of tax expense in the prior-year period. The company reported that the credit recognition followed completion of its review and remains subject to IRS examination; $5.3 million of identified credits remained unrecognized.
- A subcontractor dispute settlement generated a $1.4 million gain. Separately, GPS paid approximately $5.2 million, plus interest and arbitration fees, to resolve a subcontractor dispute; most of the amount was charged to cost of revenues.
- ASC Topic 606 was adopted effective February 1, 2018. Management said its effect on current-period operating results was not material.
Outlook, risks and contingencies
- Management expects FY2019 revenue to remain in transition as existing EPC projects wind down and new projects take time to ramp up. It anticipates adding EPC projects to backlog in the first half of calendar 2019, but gave no quantified revenue or earnings guidance.
- Project backlog was approximately $365 million at October 31, versus $379 million at January 31. Remaining unsatisfied performance obligations were $129.7 million; about half was expected to be recognized in the quarter ending January 31, 2019, with the balance during FY2020. Backlog and obligations may change due to cancellations, deferrals or scope revisions.
- GPS had been selected for potential EPC projects totaling more than $1.5 billion, but had not received limited or full notices to proceed; management cautioned that projects may not be built. The first five listed power projects were expected to contribute materially less revenue in FY2019’s fourth quarter as they approached completion.
- Management cited soft electricity demand, project financing challenges, renewable-energy growth and storage, regulatory uncertainty, and pipeline delays or protests as factors that may defer or reduce new gas-fired power-plant opportunities. It nevertheless described the longer-term outlook for gas-fired generation as favorable.
- A November 15, 2018 EU court ruling led the UK to suspend capacity payments and cancel its next capacity auction. This may reduce future APC opportunities and could delay or halt the InterGen Spalding project; the owner had indicated construction should continue as scheduled. The TeesREP project was not affected by the ruling.
- Other exposures include customer and project concentration, fixed-price contract cost overruns, variable consideration and liquidated damages, foreign-currency movements, and unhedged commodity-price changes. Four power-service customers represented approximately 62% of quarterly revenue; the first seven power projects accounted for approximately 68% of quarterly revenue.
- Management stated that available liquidity and expected operating cash flows should meet foreseeable needs, including bonding requirements. Acquisitions or significant unexpected cash needs could require additional financing.
Important facts for investors to verify
- Whether tax-credit benefits are sustained following the IRS review, and the timing and collection of the expected tax refunds.
- Progress, notices to proceed, financing and schedules for prospective EPC projects, and the conversion of backlog and performance obligations into revenue and cash.
- Completion and close-out economics for major power projects, including final costs, claims, retainages and potential liquidated damages.
- The impact of the UK capacity-market suspension on APC’s Spalding project and future business.
- Operating cash flow and working-capital trends as project advance billings decline and growing subsidiaries require additional working capital.