Powell Industries, Inc. — Fiscal 2012 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended June 30, 2012; filed August 8, 2012. The interim financial statements are unaudited. Powell designs, manufactures and services engineered-to-order electrical-energy and process-control equipment for transportation, environmental, energy, industrial and utility markets.
Financial Results and Position
| Metric | Three months ended June 30, 2012 | Three months ended June 30, 2011 | Nine months ended June 30, 2012 | Nine months ended June 30, 2011 |
|---|---|---|---|---|
| Revenue | $194.1 million | $141.4 million | $533.0 million | $391.2 million |
| Gross profit | $43.8 million | $21.9 million | $98.5 million | $72.6 million |
| Gross margin | 22.6% | 15.5% | 18.5% | 18.6% |
| Operating income | $18.3 million | $1.2 million | $30.2 million | $7.1 million |
| Net income | $12.1 million | $0.1 million | $17.8 million | $4.2 million |
| Diluted EPS | $1.02 | $0.01 | $1.50 | $0.36 |
- Third-quarter revenue increased 37.3%, while nine-month revenue increased 36.3% year over year.
- Third-quarter gross profit increased approximately $22.0 million, supported by project mix, higher production volume and lower completion costs from operational efficiencies.
- Third-quarter selling, general and administrative expense increased to $24.8 million from $19.4 million, primarily because of higher short- and long-term incentive compensation; SG&A declined to 12.8% of revenue from 13.7%.
- Effective tax rate was 33.6% in the third quarter and 40.9% for the nine-month period. Canadian losses could not generate a tax benefit.
- Electrical Power Products generated $186.3 million of third-quarter revenue and $41.7 million of gross profit. Process Control Systems generated $7.8 million of revenue and $2.2 million of gross profit.
Cash Flow, Liquidity and Debt
- Cash and cash equivalents were $106.8 million at June 30, 2012, down from $123.5 million at September 30, 2011. Approximately $7.1 million was held internationally.
- Operating cash flow for the first nine months was $6.5 million, compared with $25.2 million in the prior-year period. Working capital consumed cash, particularly the $35.4 million increase in costs and estimated earnings in excess of billings.
- Capital expenditures were $25.5 million, compared with $4.1 million in the prior-year period, primarily for land and facility expansion in the United States and Canada.
- Total debt and capital lease obligations were $4.5 million, compared with $5.4 million at September 30, 2011. Debt represented 1.5% of total capitalization.
- No borrowings were outstanding under the $75.0 million U.S. revolver or the approximately $9.8 million Canadian revolver at June 30, 2012. Availability was $33.9 million under the U.S. facility and $9.8 million under the Canadian facility after letters of credit.
- Outstanding letters of credit totaled $41.1 million. Performance and maintenance bonds totaled $222.7 million, with $377.3 million of additional bonding capacity.
- Management stated that available cash and borrowing capacity should fund anticipated operations, capital improvements, expansion and debt repayments for the foreseeable future.
Material Changes Versus Prior Comparable Period
- Profitability improved substantially: third-quarter net income rose from $0.1 million to $12.1 million, and nine-month net income rose from $4.2 million to $17.8 million.
- International revenue nearly doubled in the third quarter to $88.6 million from $44.6 million; domestic revenue increased 8.9% to $105.5 million.
- Nine-month gross margin was essentially stable at 18.5% versus 18.6%, despite project execution challenges in Powell Canada. Third-quarter gross margin expanded to 22.6% from 15.5%.
- Backlog was $433.5 million at June 30, 2012, down from $443.0 million at September 30, 2011 and $491.4 million at June 30, 2011. Third-quarter orders were $133.0 million versus $197.7 million in the prior-year quarter.
- Capital spending increased significantly to support expansion, while operating cash flow declined because of higher business activity and the timing of billing milestones.
- The company reported that previously disclosed material weaknesses in Powell Canada’s financial close, revenue recognition, cost accumulation and service-contract processes were remediated as of June 30, 2012.
Outlook, Commentary, Risks and Unusual Items
- Management expects long-term demand from energy, power-generation and distribution infrastructure, offshore production, Canadian Oil Sands, environmental controls and transit infrastructure, but timing and pricing of projects remain difficult to predict.
- Orders received during the first nine months were $525.1 million, down approximately $75.3 million from the prior-year period.
- Large Powell Canada projects experienced scope changes and cost overruns. The company is pursuing recovery of certain costs through customer change orders, but stated that recovery is not assured and is recorded only when approved.
- The business is cyclical and capital-intensive. Risks include economic and financial-market conditions, backlog cancellations or adjustments, fixed-price contract volatility, raw-material costs and availability, competition, offshore drilling regulation, international events, skilled-labor availability, litigation and operational disruptions.
- The company plans approximately $75 million of investment in land, buildings and equipment for U.S. and Canadian expansion, funded with cash.
- Commodity-price increases may reduce margins because fixed-price contracts can limit the ability to pass through higher costs. The company does not currently hedge commodity-price exposure.
- Foreign-currency exposure is managed partly through forward contracts. The June 30, 2012 notional amount was $0.7 million, with a net derivative asset of approximately $10,000.
- A $1.2 million gain on the sale of a Kazakhstan investment benefited the prior-year nine-month period and did not recur in fiscal 2012.
- Ordinary-course litigation and claims were not expected by management to have a material adverse effect, although outcomes remain uncertain.
Investor Verification Checklist
- Verify the sustainability of the third-quarter gross-margin improvement and whether Powell Canada project overruns or recoveries affect future periods.
- Review backlog conversion, new-order trends, project cancellations and the concentration of backlog in large petrochemical and offshore projects.
- Monitor operating cash conversion, underbillings of $87.0 million, net underbilled contract position of $33.6 million and working-capital requirements.
- Confirm the timing and funding of the approximately $75 million expansion program and its effect on cash balances and revolver availability.
- Assess exposure from $41.1 million of letters of credit, $222.7 million of performance and maintenance bonds, and related customer or surety claims.
- Confirm that the remediated Powell Canada internal-control deficiencies remain effective and that revenue recognition estimates for long-term contracts are reliable.
- Evaluate exposure to raw-material inflation, fixed-price contracts, foreign-exchange movements, regulatory changes affecting offshore drilling and cyclical customer capital spending.