rainmanker1 wrote: PHM recently reported its Q3/FY16 results, which were essentially in-line with expectations. Revenue was $32.3 million, down slightly from the $33.8 million reported in Q2/FY16 but was up slightly in US$ terms as the C$ had strengthened sequentially.
The clear highlight, in our opinion, was gross margin that came in at 72.2%, up 360 basis points versus Q2 and up 730 basis points from Q1 demonstrating that the company’s culling of its low margin business (ie. the shutting down of Logimedix) is paying dividends. We believe this is a good sign that we have seen the bottom and the turnaround has begun.
SG&A, however, had yet to see the effects of its cost cutting program, most notably head-count reductions. As such, SG&A was still very high and did not allow the higher gross profit to fall to EBITDA, which was $1.2 million in the quarter.
Given the impact of head-count reductions (management guided to ~$2 million lower per quarter or ~ -15%) and the cleaning-up of A/R, which has resulted in much higher than normal levels of bad debt expense (19% of revenue v/s 8-10% normalized), we believe we will see Q4/Q1(Dec 2016) overheads come down dramatically, which should enable EBITDA to return to mid-double digit levels (ie. 15-18%). If these two costs are reduced as itemized above, such a revenue result as was just reported would generate ~$6 million in EBITDA or a $24 million annualized run-rate.
From a balance sheet perspective, cash dropped to $7.8 million from $16.2 million in Q2/FY16. At first blush, this is clearly a negative, albeit we would note that working capital ended the quarter at $31.4 million, actually up from $26.3 million. The continued negative cash flow continues to concern us albeit management indicated on the conference call that it has finally turned cash flow neutral and expects to be generating positive cash flow in Q1/FY17.
Becoming cash flow positive would be the final of The Big Three pieces of the turnaround: a) increase gross margins, b) reduce overheads, c) improve cash flow cycle by reducing DSO’s.
If investors did not have a history with the company, we would think the shares would rally based on the attainment of the first leg of the turnaround, ie. increase gross margins. However, recognizing the history, we believe investors will likely wait to see in the financial statements at least the achievement of the second leg, ie. overhead reduction and EBITDA margin expansion. When investors see that (likely late December/early January), we believe the shares have the potential to rally significantly. Upon investors seeing actual free cash flow generation and cash on the balance sheet increasing, we believe the multiple gap between PHM and such industry peers as Savaria Corp (SIS – T, not rated) will narrow significantly as the turnaround would be complete.
Trading at 0.5x revenue and 0.5x book value and the first leg of the turnaround in the books, risk-return is skewing more positively. Maintain Buy and $0.60 target price.