Powell Industries - Earnings Call - Q1 2020

Transcript

Operator (participant)

Welcome to the Powell Industries Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief Q&A session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I'd like to turn the conference over to your host, Zach Vaughan of Dennard Lascar Investor Relations. Thank you. You may begin.

Zach Vaughan (Assistant VP)

Thank you, Operator, and good morning, everyone. We appreciate you joining us for Powell Industries Conference Call today to review fiscal year 2020 first-quarter results. With me on the call are Brett Cope, Powell's Chairman and CEO, and Mike Metcalf, Powell's CFO. There will be a replay of today's call, and it will be available via webcast by going to the company's website, powellind.com, or a telephonic replay will be available until February 12th. The information on how to access the replay was provided in yesterday's earnings release.

Please note that information reported on this call speaks only as of today, February 5th, 2020, and therefore you're advised that any time-sensitive information may no longer be accurate at the time of replay listening or transcript reading. This conference call includes certain statements, including statements related to the company's expectations of its future operating results that may be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties, and that actual results may differ materially from those projected in these forward-looking statements.

These risks and uncertainties include, but are not limited to, competition and competitive pressures, sensitivity to general economic and industry conditions, international, political, and economic risks, availability and price of raw materials, and execution of business strategies. For more information, please refer to the company's filings with the Securities and Exchange Commission. Now I'll turn the call over to Powell's CEO, Brett Cope. Brett?

Brett A. Cope (President, CEO, and Chairman of the Board)

Thanks, Zach, and good morning, everyone. Thank you for joining us today to review Powell's fiscal 2020 first-quarter results. I will make a few comments, and then I will turn the call over to Mike for more financial commentary before we take your questions. Since it has only been a short time since our year-end fiscal 2019 conference call, I'll focus on providing an overview of the current quarter, and then I'll share some general observations about our markets. We are pleased with our first-quarter results, particularly in a quarter that is one of our lighter quarters for revenue throughout our fiscal year.

As we mentioned on our last call, the first quarter of fiscal 2020 was impacted by the calendar year-end seasonality from reduced work hours through several holiday periods. From a year-over-year perspective, revenues increased to $134 million in the first quarter, which was 23% higher than the first quarter of fiscal 2019. Additionally, net income improved to $2.8 million in the quarter from a reported net loss in the prior year of $2.7 million. We attribute this financial improvement to the many commercial and operational actions that have been ongoing across the business for some time.

These include a disciplined approach of the mix and quality of our backlog as we pursue new orders, a continued focus on operating efficiencies and productivity, robust supply chain initiatives, and managing our SG&A and cost structure efficiently and effectively. As a result, when compared sequentially to the fourth quarter of fiscal 2019, the revenue decline in the first quarter reflects the seasonal impact of fewer project closeouts, as well as the timing of projects in process across our manufacturing facilities. From an orders perspective, Powell booked $137 million of new orders in the quarter. Our Canadian operation had a notable win, being awarded a large municipal contract, which will be executed over a three-year period.

During the last few quarters, inquiry activity has been active with a growing amount of our estimating resources being focused on efforts to support several larger projects. More recently, we are starting to see a number of our customers that are pushing out schedules for new bookings for mid-sized projects in the $3-$10 million range. Over the past 12 to 18 months, these mid-sized projects have helped support our revenue growth through 2019 and into the first half of 2020. These mid-sized projects are important pillars of our business model as we work to fill open capacity in the second half of 2020.

As I have noted in prior calls, the funnel of project activity supported and driven by abundant, low-priced natural gas remains active, particularly in the Gulf Coast region. We are pleased to report that Powell's product quality, people, and persistence resulted in the award of a substantial contract supporting the design, manufacture, integration, and testing of a Powell custom integrated electrical distribution solution for a large industrial complex being constructed in the United States. This project will span over three years as we design, build, and deliver multiple power control rooms in support of the project. This order will be included in our fiscal second-quarter orders and backlog reporting.

Powell's international operations continue to show signs of positive recovery versus fiscal 2019. Backlog supporting our Canadian and U.K. divisions at the end of our first quarter of 2020 was notably higher when compared to the prior year. As we navigate through fiscal 2020 and into 2021, our largest operational challenge will be recruiting and retaining high-quality direct labor in an already tight labor market. We are also actively engaging independent contractors, utilizing overtime, and leveraging our supply chain and global manufacturing footprint, shifting work to locations to balance capacity when economically viable.

We are optimistic that these tactical initiatives and strategic actions will drive improved customer fulfillment and sustainable margins throughout fiscal 2020, and we intend to remain committed to increasing our investments in R&D programs while maintaining investments in the professional development of our people during fiscal 2020. Powell continues to be a technology leader in the development and manufacture of electrical distribution products and solutions. We believe improvements to new and existing products will ensure we continue to have a broad portfolio to offer our client base.

Likewise, we know employee satisfaction and engagement directly impacts our continued success around customer satisfaction and retention. Therefore, we are actively investing in employee training and development. In summary, our immediate efforts are focused on filling open capacity in the second half of fiscal 2020 as we monitor and adjust to increasing delays in customer timelines of mid-sized projects from our core and markets.

As a significant portion of our revenue is derived from our small to mid-sized project base, we expect 2020 results to be more lumpy than usual as we continue to execute on our current backlog while also preparing for the longer term to deliver on recent larger project awards that will, for the most part, deliver after fiscal 2020. Therefore, we remain cautiously optimistic about production capacity in the second half of 2020. With that, I'll turn the call over to Mike to provide more detail around our financial results before we take your questions.

Michael W. Metcalf (EVP, CFO, Secretary, and Treasurer)

Thank you, Brett, and good morning, everyone. In the first quarter of fiscal 2020, we reported net revenue of $134 million, a $25 million or 23% increase versus the same period in the prior year. Bookings for the first fiscal quarter were $137 million, a 1.0 quarterly book-to-bill ratio, which resulted in $426 million in first-quarter ending backlog, which was a $7 million increase versus the prior quarter. Compared to one year ago, domestic revenues increased by $16 million or 18% to $106 million, driven in large part by healthy industrial and market demand.

We experienced year-over-year increased value performance across most sectors of the business, with the oil, gas, and petrochemical sectors having the most substantial and favorable impact on the results, with a 30% revenue increase over the prior year period, while utility was up 20% and traction up 67%. Compared to the same period one year ago, international revenues generated from both our foreign operations as well as export shipments from our domestic locations increased by $9 million to $28 million in the first quarter of fiscal 2020. Gross profit improved by $7 million versus the first quarter of 2019 to $22 million in the first quarter of fiscal 2020.

Gross profit, as a percentage of revenues, increased 290 basis points to 16% in the first quarter compared to a year ago. This improvement is driven by higher volume as well as favorable project mix and operating leverage across most of our facilities globally. Selling, general, and administrative expenses were $17 million in the current quarter, higher by $1 million versus the same period a year ago. However, SG&A as a percentage of revenues decreased by 190 basis points to 13% of revenue versus the same period last year. In the first quarter of fiscal 2020, we reported net income of $2.8 million, or $0.24 per share in the first fiscal quarter, compared to a net loss of $2.7 million, or a $0.23 per share loss in the first quarter of fiscal 2019.

In the first quarter of fiscal 2020, we generated $2 million in operating cash flow, and investments in property, plant, and equipment during the quarter was $2 million. Year-over-year free cash flow was lower by $9 million, driven by a reduction in the net position of our contract asset and liabilities in fiscal 1Q of the prior year. At the end of our first quarter, we had cash and short-term investments of $121 million, which was $50 million higher than a year ago and $4 million lower than our fiscal 2019 year-end position. Long-term debt, including current maturities, was $800,000.

Looking ahead to the full year for fiscal 2020, we do anticipate variability across our quarterly landscape, driven by both project timing on the larger projects as well as the softening of inquiry activity for the smaller to mid-sized projects across our oil, gas, and petrochemical end markets. Considering this, we continue to work the fiscal 2020 book-to-bill opportunities in order to utilize our planned capacity throughout the second half of fiscal 2020. With respect to the large order that Brett mentioned previously, Powell will manufacture multiple power control rooms for this order that will be designed, integrated, and tested across a period of approximately 36 months, with the majority of the project revenue generated in fiscal 2021 and 2022.

We do not anticipate that this specific project will have a material impact on our fiscal 2020 revenue and margin. Overall, considering our current backlog, the present level of market activity, as well as the planned ramp-up in research and development investment, we reaffirm our expectations that fiscal 2020 will be a successful and profitable year for the company. At this point, we'll be happy to answer your questions.

Operator (participant)

Thank you. We will now be conducting a Q&A session. If you would like to ask a question, please press *1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press *2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the * keys. Please ask one question and one follow-up question, and then re-queue for additional questions. One moment, please, while we poll for questions. Thank you. Our first question comes from the line of John Franzreb with Sidoti. Please proceed with your question.

John Franzreb (Senior Equity Analyst)

Good morning, Mike and Brett.

Brett A. Cope (President, CEO, and Chairman of the Board)

Hi, John.

John Franzreb (Senior Equity Analyst)

I'd like to start with the gross margin on a sequential basis. I know it's a seasonally weak quarter. Could you just kind of talk about the drop in the gross margin? How much was it seasonality? How much was it the pricing and jobs that you executed on? And how much was it the referenced higher labor costs that becoming an issue?

Michael W. Metcalf (EVP, CFO, Secretary, and Treasurer)

Yeah. John, this is Mike, I'll take that one. Project pricing and the margins that we have in our backlog are really, really flat. We don't see any impact from a pricing perspective. But as you look sequentially at our 1Q '20 versus our 4Q '19, 3Q '19, you need to bear in mind that through the second half of last year, second half of 2019, we have been ramping up variable resources to execute our backlog in the projected pipeline. And given this, we carried those resources through 1Q. And given the seasonality of Thanksgiving, holidays, and Christmas holidays, the underabsorption was slightly more pronounced. That said, I would remind you that this 1Q was our best 1Q in over five years. 2014 was the last time we actually generated a more favorable 1Q.

John Franzreb (Senior Equity Analyst)

Right, right, right. And I was a little surprised that the R&D spend was actually lower than I was projecting, put it that way. Could you talk a little bit about your ramp in R&D spend this year, what you expect the full year tally to be, and I guess add on to that your total CapEx budget for 2020, how that looks now?

Brett A. Cope (President, CEO, and Chairman of the Board)

John, its Brett. We're still committed to some of the plans we've put in place throughout last year and started executing on those. We've had a little slow start for various reasons on kind of one of the major projects has got a pause right now. We think it's temporary and look to clear that in the second quarter and get back to our plans, but still committed to the ramp-up and developing our strategic plan around the product side. On the CapEx side, no major change in terms of our run rate year-over-year, roughly about 1% of revenues, give or take. A couple of projects we're considering in the back half of this year, but we're still looking at them and evaluating them and trying to understand what is the best opportunity for spend.

John Franzreb (Senior Equity Analyst)

So Brett, would a good number for R&D be $8 million this year, or is that going to be on the high side at this point?

Brett A. Cope (President, CEO, and Chairman of the Board)

Might be a little bit on the high side, but I'll probably give you a better color next quarter once we get through this issue and understand how quick we get the products that we want to get into the pipeline developed and, more importantly, the testing, which is really where a lot of our costs come on the R&D side. The labs cost a lot of money to get the electrical switchgear tested and approved to the standards. So the timing of that is a little suspect with having it all spent at the end of this fiscal.

John Franzreb (Senior Equity Analyst)

Okay. All right. You know what? I'll get back into queue. Thanks, guys.

Brett A. Cope (President, CEO, and Chairman of the Board)

Thanks, John.

Michael W. Metcalf (EVP, CFO, Secretary, and Treasurer)

Thanks.

Operator (participant)

Our next question comes from the line of Jon Tanwanteng with CJS Securities. Please proceed with your question.

Jonathan Tanwanteng (Managing Director)

Good morning, gentlemen. Thank you for taking my questions. First of all, congrats on the large order being booked. I was just wondering what the size of that is and the current margin profile of that, if you're willing to disclose it, or at least a ballpark.

Brett A. Cope (President, CEO, and Chairman of the Board)

Hey, John, its Brett. So as you know, a lot of our contracts, most of them, have pretty strong confidentialities. This does as well. I can tell you the job is in excess of $100 million. It's in line with my quarterly comments in terms of the U.S. market being gas-driven, and it's a competitive job, but I don't think anything out of the ordinary in terms of what we've been running the last couple of quarters in terms of pricing.

Jonathan Tanwanteng (Managing Director)

Great. And then just in terms of how many more projects like this you're tracking and have the capability to handle as it starts to fill in your factories?

Brett A. Cope (President, CEO, and Chairman of the Board)

There are a number of projects that we continue to support with the estimated resources and track, and like a lot of folks, we're watching the fundamentals out there in the macro environment. Again, not just the cost side of gas, but where the final product of the facility is headed, but there are more than a couple that we're working through for the next 12-24 months from a capacity standpoint. John's earlier question on CapEx would be one of those questions. We've still got some opportunity in some of our facilities to do some investment to handle additional capacity, but right now, for the ones we're tracking, we feel good that we can handle anything that comes our way.

Jonathan Tanwanteng (Managing Director)

Got it. Thank you. And then just on the mid-sized projects that you were mentioning that pushed out, is there any fundamental reason for that to be happening when you talk to your clients? Are they citing anything specific? And also, can you describe the number of projects that actually were pushed out to the right and kind of where they fell into the calendar?

Brett A. Cope (President, CEO, and Chairman of the Board)

We're still watching the number, but in terms of the reason, no. I've been talking to a lot of people as well as other companies in our space. Consensus seems to be sort of a pause. There's no real fundamental driver, whether the macro things that are going on in the last few months are already having an effect. Oil's down a little bit. Macro demand is changing. Seems to be for the short term. So there doesn't seem to be a long-term reason for it, but there's clearly something in the market that us and some others that operate in this space are experiencing right now.

Jonathan Tanwanteng (Managing Director)

Okay. Got it. And then in terms of the way the year is going to shape up, given this uncertainty, last year you had kind of a pretty straight shot from $110 million to call it $150 million in revenue. Are you going to see much more lumpiness this year compared to what you saw last year in terms of getting to the year-end number?

Michael W. Metcalf (EVP, CFO, Secretary, and Treasurer)

Yeah. I think the answer to that is yes, John. I mean, the second half, as Brett alluded to, it's still taking shape with the softness that we're seeing in the inquiry levels. And I think as we try to utilize the pipeline and get the book-to-bill in for really what we're talking about now is probably late 3Q, 4Q volume to fill that plant capacity. It will be a little choppier.

Jonathan Tanwanteng (Managing Director)

Okay. Got it. And just one final one. On the backlog exiting Q1, how much of that was scheduled to liquidate this year?

Michael W. Metcalf (EVP, CFO, Secretary, and Treasurer)

Probably about two-thirds of it.

Jonathan Tanwanteng (Managing Director)

Okay. Great. Oh, sorry. One more question. You mentioned the large project taking place over 36 months in 2021 and 2022. Is it biased to any specific year, more in 2021 or 2022?

Michael W. Metcalf (EVP, CFO, Secretary, and Treasurer)

Yeah. That's still to be defined, John. But I mean, as we get further into the project, that'll be a little clearer. But right now, it's definitely between 2021 and 2022.

Jonathan Tanwanteng (Managing Director)

Okay. Thank you.

Operator (participant)

Our next question comes from the line of John Braatz with Kansas City Capital. Please proceed with your question.

Jonathan P. Braatz (Partner)

Good morning, Brett and Mike.

Brett A. Cope (President, CEO, and Chairman of the Board)

Good morning.

Jonathan P. Braatz (Partner)

Brett, in your press release, you talk about you want to begin leveraging the commercial pipeline to help offset the cyclical nature of the core end markets. Can you talk a little bit about those commercial markets, the commercial pipeline, what you're working on, how you think it can evolve over sort of a two to three-year period, and how much sort of cyclicality can you drive out of the corporate at the corporate level?

Brett A. Cope (President, CEO, and Chairman of the Board)

I think for the timeframe you asked about, John, the next two to three years, we're going to be predominantly still driven by the core oil, gas, petro-chemical market. If you look back a couple of years ago during the last downturn and some of the things we did on the R&D side, as well as geographical expansion, I'm going to pick on East Canada, an area where we historically didn't have a sustained organic footprint. We, over the last couple of years, have methodically continued that process. Some of our product development has underscored what I'll call more of the commercial utility, transmission generation, as well as general access to those commercial markets. Now, there's two things here. One is the product side.

I do think there's room to go here to continue that, what we've learned, continue building on those cycles that we've done in East Canada and other parts of the world. But there's also the part of access to some of these channels. So I'm not going to tell you I can come in and chase every building that's being built all over the world that has medium voltage or even low voltage in the bottom of the building. But there are markets on the industrial space, within the municipal space, that I think we can do better than we're doing today with, underscored by some of the products that we have today and that we want to develop in the pipeline.

Jonathan P. Braatz (Partner)

Is that going to require a different marketing or sales force? Will it require an additional level of new investment to reach those markets?

Brett A. Cope (President, CEO, and Chairman of the Board)

Yes. Definitely, channel management is something that we've been working on the last couple of years here at Powell. We do have a growing group to handle that channel that's separate from our historical direct sales group. And then as far as adding into the model, something we're talking about with the board. And is that an opportunity to accelerate it? It is definitely a conversation we're actively having.

Jonathan P. Braatz (Partner)

Okay. All right. Thank you.

Brett A. Cope (President, CEO, and Chairman of the Board)

Bet.

Operator (participant)

As a reminder, if you would like to ask a question, press *1 on your telephone keypad. Again, please ask one question and one follow-up. Our next question comes from the line of John Franzreb with Sidoti. Please proceed with your question.

John Franzreb (Senior Equity Analyst)

Yeah, Mike. I just want to talk a little bit about M&A. What are your thoughts about maybe buying some smaller assets that may extend your product reach into something tangential to what you're doing? I know you're putting money into R&D to expand your opportunity pipeline, but maybe another business that is close to the core but not exactly the core of what you do. I got to imagine that some of the assets are pricing a lot better today than they were a year ago.

Michael W. Metcalf (EVP, CFO, Secretary, and Treasurer)

Yeah. I guess the way I'd answer that, John, is from a capital allocation perspective, a few points. Our maintaining a very strong balance sheet with minimal leverage is very important, and it's an attribute that we value. Secondly, as we assess our capital allocation framework, R&D is a big part of that, as Brett spoke of previously. And then third, to your point, if an opportunity arises that enables the business to grow inorganically through an accretive tuck-in investment, we're certainly all ears. But really, the maintenance of the strength of balance sheet is of utmost importance to us.

John Franzreb (Senior Equity Analyst)

Okay. All right. That's what I was wondering. Thank you, sir.

Michael W. Metcalf (EVP, CFO, Secretary, and Treasurer)

Okay. Thanks.

Operator (participant)

Thank you. We have reached the end of the question and answer session. Mr. Cope, I would now like to turn the floor back over to you for closing comments.

Brett A. Cope (President, CEO, and Chairman of the Board)

Thank you, Christine. Overall, despite the effects of seasonality, we are pleased with our first quarter performance. Over the last several quarters, our operational teams are executing well, successfully and prudently, meeting the challenge of our growing backlog. While near-term visibility of mid-sized projects has become slightly more challenging for the remainder of our fiscal 2020 planning. The value and strength of Powell's people, products, and world-class facilities have again demonstrated our sustained value proposition, as evidenced by our recent large project awards. I would like to thank our valued customers and our supplier partners for the continued trust and support of Powell. We appreciate your continued interest in Powell and look forward to speaking with you next quarter.

Operator (participant)

Ladies and gentlemen, this does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.