Rapid growth does not always pave the way to profitability, writes Blueprint Bob.

When a company doubles in size inside a year, then either the growth is going to be extremely profitable, or it is laying the groundwork for a big, big problem down the track.

That, it seems, was a major factor in the collapse this week of mid-ranking engineering contractor, Henry Walker Eltin, along with managerial and board incompetence and the parallels with failed car parts maker, Ion become more apparent.

Ion, you might remember collapsed late last year in a sudden and surprising fashion. Ostensibly profitable, Ion’s sudden slide followed a realisation from its banks that the numbers being reported to it were not stacking up.

The expansion in the car parts business was putting too much strain on the company and eating into working capital. Plants and contracts were losing money or not making the returns projected.

Ion was a company eating itself. So too was HWE.

From what’s been heard from within the company, the growth in staff from 600 to 1200 in 2004 was amazing. Even towards the end of last year when the share price fell after profit downgrades were revealed, new staff (contractors and full time) were still being employed.

Contracts in the Yallourn Valley and in Western Australia (Telfer, the big Newcrest mine expansion) were absorbing more staff numbers and management time, especially Telfer. That was a $50 million contract for HWE’s Simon Engineering subsidiary. It encountered losses from industrial action, strikes and absorbed a lot of resources.

Two head offices in the Sydney suburb of Ryde for HWE and Simon Engineering were another sign of poor controls. That was only resolved late last year when the pressures started mounting.

Management instability was another factor. The founding shareholders, including chairman Neville Walker, lived in Darwin, but the company was run from Sydney, with major business in WA, Victoria, a bit in NSW and Queensland and a major new contract in Indonesia that absorbed a lot of money preparing for its commencement.

It didn’t help with some Sydney staff realizing that the company would eventually contract and shift its focus to Darwin, with head office ending up north, because of the size and importance of the Indonesian contract.

That undermined morale.

This diversified, far flung structure didn’t have the management sinews in place to enable it to run normally. Senior managers were constantly flying interstate from Sydney trying to resolve issues.

The departure of CEO Bruce James late last October after a profit downgrade earlier in the month, set the company’s share price sliding, although it had been weakening for much of the preceding month or so.

Then another query in early December and then the recapitalisation plan with Glencore that fell apart late last week when HWE could not get new finance facilities from its bankers.

But investors wondering about the problems of the company and the understanding the board and management had of the problems, should read this briefing that Neville James, the chairman, gave to the market at the time of the Glencore deal was announced in December.

It was overly optimistic in the extreme, gave no idea of just how parlous the company’s state was, especially in its relationship with the banks.

More worrying was his claim that apart from the $6 million cost of the Glencore deal and refinancing, profit was still on track.

“There has been no material change to our management accounts and profit expectations from operations. However, we have incurred a one-off cost of approximately $6 million relating to bank negotiations and extensions,” Mr Walker told Corporate File in an open briefing on December 12.

That’s clearly not the case and it is a touch of Pollyanna about it.

The appointment then withdrawal of Ernst and Young as voluntary administrators this week is another sign of managerial incompetence.

Ernst and Young did some auditing and tax work for HWE in the recent past, and there are suggestions part of a bill remains unpaid.

That the board did not realise this conflict of interest (and Ernst and Young) deserves some further investigation by ASIC at least, if only to reinforce on boards and accounting firms the need to know the rules in these circumstances (and to get the right legal advice!).

The biggest contract is the KPC coal mining deal in Indonesia that that’s worth more than $1.2 billion over its life. It is due to start shortly, but it is hard to see it starting on time, or at all, unless there’s a quick decision on HWE’s future or the contract is sold off.

The future of bonds HWE had to put up to win the contract (and to cover the mine owners against this short of eventuality) is also of considerable interest to the Administrators.

Staff report considerable uncertainty since Monday. The stop start nature of the two administrations has created considerable unhappiness. Company bills have stopped being paid, credit cards for example.

Staff have been assured that all entitlements are there that people can take holidays and return. Many people are off looking for jobs and have been since the problems emerged in December.

It seems staff had a better appreciation of the clouded future of the company than the board would admit to.

Which is often the case!