It happens all too often even to the most informed investor. Management of a favored company unexpectedly lowers guidance for future quarters, sending its stock to the basement on a fast elevator. Shareholders have to make a quick decision. No, jumping up in that elevator is not going to preserve your holding. It is a strictly sell or hold decision, unless somehow the shareholder can make the math work by “doubling down.”
Last week, power conversion components supplier Advanced Energy Industries, Inc. (AEIS) cut its guidance for June 2011 quarter revenue by 10%, citing a laundry list of setbacks and impediments. Decrease in solar panel pricing is probably the greatest threat to the AEI top-line. Customers are apparently delaying orders as they wait for prices to stabilize before committing to construction projects. Permitting and financing delays also pushed some orders out. Changing incentive programs for solar power were also on AESI’s list of woes, although that has probably been a factor affecting sales all along. AEI management indicated it now expects revenue to fall in a range of $137-140 million for the June 2011 quarter.
No one should be surprised by reduced guidance. The problem was apparent as soon as the company reported its March 2011 quarter results. In the first three months of 2011, accounts receivable grew a scant 1.1%. This is understandable, given that revenue in the same period actually slipped 7.4% sequentially. The problem is that inventory grew 16.1% during this time, reaching $90.1 million. There was clearly a bottleneck in the works, with working capital sunk into inventory that did not get sold. In retrospect, management was being very optimistic in its original guidance for the June quarter that the trend at the beginning of the year would turn around.
With the ugly truth now out in the open for everyone, investors and analysts have been plugging the new guidance into spreadsheets to get a read on what will be left over for earnings in the June quarter. We are looking at the company’s balance sheet instead.
AEI designs and produces solar inverters and thin-film deposition power conversion instruments. In short, it is a manufacturer for manufacturers. It got into the business through its own designs as well as through acquisition of some key operations. A series of deals in the last couple of years has built goodwill up to $48.4 million and intangible assets to $47.5 million. The figures are significant because together, these intangibles represent 18% of the company’s total assets. A persistent and deepening erosion of sales and earnings puts both at risk of write-down at year-end 2011 or sooner.
There is more to the situation in AEI's working capital. Accounts receivable totaled $121.2 million at the end of March 2011, representing approximately 84 days-sales-outstanding. This compares to 95 days at the end of December 2010, suggesting management has improved collections from customers. Even 10 days makes a difference when sales are weak. Nonetheless, AEI operations generated a paltry $2.7 million in cash in the March 2011 quarter. Not that cash flow generation is AEI’s strong point: The company managed to convert only 4.0% of total sales to cash in the year 2010. That said, cash flow from operations has fully supported capital expenditures in each of the last three years.
AEI management has a tough row to hoe in the next few months to work down inventory and protect its competitive position in the power conversion market. There are few catalysts for upward stock price movement in this scenario and no certainty that management has a firm grasp of it. The sidelines look like a good spot for investors to stay until AEI gets the June 2011 quarter reported and into the history books. The announcement is due on July 26 after the market close.