Powell Industries - Earnings Call - Q2 2020

Transcript

Operator (participant)

Welcome to Powell Industries' second quarter earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Should anyone require operator assistance, you may press star zero on your telephone keypad. It is now my pleasure to introduce your host, Mr. Zach Vaughan with Dennard Lascar Investor Relations. Thank you, sir, and you may begin.

Zach Vaughan (VP)

Thank you, Operator, and good morning, everyone. We appreciate you joining us for Powell Industries' conference call today to review fiscal year 2020 second 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 May 13th. 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, May 6th, 2020, and therefore you are 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 Cope (President and CEO)

Thanks, Zach, and good morning, everyone. Thank you for joining us today to review Powell's fiscal 2020 second 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. Let me start by saying how proud I am of every member of our team across the company. Our top priority has been, and has always, the safety of our employees. The COVID-19 pandemic has created a lot of fear and uncertainty around the globe, and it has required us to learn, communicate, and implement new practices at Powell to ensure the continued safe operation of our facilities.

Beginning in early March, we have held daily conference calls with our executive team to review and assess the state of our operations, share critical learnings, and take any necessary steps to address operational needs and plan for contingencies. During each call, we cover three critical elements: protecting the health and well-being of our employees and their families, collaborating closely with our customers in support of their projects and service needs, and working with our suppliers to discuss improvements in safe work practices and early mitigation of any identified supply chain challenges. Across our seven manufacturing facilities, we have implemented social distancing practices. We have adjusted shift hours, increased the frequency and cleaning of factory and office facilities, and instituted remote work options for those roles that support our manufacturing operations. We have improved and updated our screening procedures for visitors and the incoming supply of raw materials and equipment.

We have adjusted procedures around business travel, and we will continue to review any updated guidance from our local and government officials, along with industrial best practices in the coming months. I'll share more about the specific impacts of the coronavirus later in my remarks, but let's turn to our second quarter results. Powell experienced strong activity for new orders of $301 million in new bookings in the second quarter, an increase of 119% from $137 million in the first quarter and up 53% from $197 million in the second quarter of fiscal 2019. The $301 million in new awards sets a new company record for bookings performance in a single quarter. At the end of the second quarter, backlog was $566 million, also a new company record.

Our second quarter-ending backlog includes the sizable contract mentioned on our last call, a substantial award to support 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. Powell will design, build, and deliver multiple power control rooms in support of the project. This contract will convert to revenue over a three-year period. Second quarter revenues increased to $152 million, which was up $28 million, or 22% higher than the second quarter of fiscal 2019. We had solid margin performance across most of the business. Gross profit as a percentage of revenues for the second quarter was 19.6%, an increase of 340 basis points from the same period last year and 330 basis points sequentially. Additionally, net income improved to $7.4 million in the quarter from $958,000 in the prior year.

We attribute this financial improvement to our continued focus on operational initiatives that have been ongoing across the business for some time. This includes a continued focus on operating efficiencies and productivity and a disciplined approach to the mix and quality of our backlog as we pursue new orders. Now I'll share some of what we are experiencing as a result of the global pandemic. First, Powell has designated an essential manufacturer providing critical electrical distribution solutions across many industries and geographies, and we remain committed to providing our products and services to the best of our ability during this time, and as a supplier to industrial manufacturing plants, utilities, and light rail transportation infrastructure, our products and solutions provide our customers with the safe and reliable distribution of electrical power. Second, as we have experienced in past cycles, we have received multiple requests to adjust project schedules.

While we have not experienced projects being canceled outright, a number of our customers have pushed out schedules for roughly a dozen or so projects, most in the $1-$3 million range in size. Most of these requests are affecting backlog originally planned for our fiscal fourth quarter, resulting in schedules being moved to the right and pushing planned revenue from fiscal 2020 into 2021. And finally, on the supply side, we have been very successful planning mitigation strategies across our supply chain, where for the large part, we have not experienced any disruption around the supply of raw materials and third-party equipment. We have experienced a supply chain challenge from a partner in Mexico, where we performed some sub-assembly work. We've had to temporarily move these operations back into each of our facilities in the U.S., Canada, and the United Kingdom.

We believe this is a short-term efficiency headwind for the business, and we are working closely with our supplier as local labor leaders in Mexico, along with the Mexican government and other business leaders, continue to work constructively to ensure safe conditions for all employees. Specific to the North American electrical market, Powell is the only company headquartered in the United States that builds AC medium voltage breakers in North America. Two of our brands have over 80 combined years of successful, reliable performance in the medium voltage market, and both are made in the United States right here in Texas. We will continue to support our customers' infrastructure with creative solutions to extend and protect their existing capital investments and provide superior service to help them manage through the cycle.

While it is too early to forecast the ultimate impact of these events, we do expect to experience reduced activity for new orders for the balance of the fiscal year from our core oil, gas, and petrochemical markets. As we have started the second half of our fiscal 2020, we have acted quickly to adjust our fixed costs, and as we navigate through the second half and into 2021, we will continue to monitor and adjust variable costs throughout each of our operations. If necessary, we will prudently take additional steps to preserve liquidity as we continue to manage our SG&A and cost structure efficiently and effectively. The last down cycle for our business started in mid-2015. However, we did not experience the full effect until our fiscal 2017. Since then, we've executed our playbook to systematically strengthen and build our business.

We have steadily increased profitability in the past two and a half years, and our second quarter results demonstrate the sustainability and strength of our brand. The Powell team has successfully navigated all downturns for the past seven years, and we are confident we will navigate this challenge as well. With that, I'll turn the call over to Mike to provide more detail around our financial results before we take your questions.

Michael Metcalf (EVP and CFO)

Thank you, Brett, and good morning, everyone. First, I will address the current quarter results and then move to year-to-date. Revenues for the second fiscal quarter of 2020 increased 22% to $152 million compared to last year's second quarter of $124 million. Orders for the second fiscal quarter were $301 million, a 53% increase versus the prior year, and higher by $163 million sequentially. Second quarter orders' results were favorably impacted by the January award for the large industrial project that Brett had mentioned. This puts our total year-to-date book-to-bill ratio at 1.5. With this award, our reported backlog at the end of the second fiscal quarter was $566 million, $140 million higher versus the same period in the prior year. The second quarter of fiscal 2020 represents the highest backlog level in Powell's history.

Powell's fiscal 2020 second quarter revenues across all of our geographies strengthened when compared to the same period last year. Domestic revenues increased by $24 million, or 24%, to $121 million, while international revenues generated from both our foreign operations as well as export shipments from our domestic locations increased by $4 million, or 16%, versus the prior year to $31 million in the second quarter of fiscal 2020. Revenues from our industrial sector had the most significant impact on the business versus the prior year. Revenues generated from our oil, gas, and petrochemical sectors in the second fiscal quarter were $99 million compared to $79 million in the same period a year ago. Revenues from utility customers were $24 million, a 19% increase versus the prior year, and traction and other revenues combined to total $28 million, a 13% year-over-year improvement.

Gross profit in the second fiscal quarter of 2020 improved by $10 million versus the first quarter to $30 million on a 13% sequential volume increase, as well as strong execution across the Powell manufacturing footprint. Gross profit, as a percent of revenues, continues to improve, increasing by 340 basis points compared to one year ago, to 19.6% of revenues in the second fiscal quarter, driven by both strong variable cost productivity and operating leverage across the production facilities. Selling, general, and administrative expenses were $19 million in the current quarter, or 12.3% of revenue. This was higher by $1 million versus the same period a year ago. Overall, SG&A as a percent of revenues decreased by 160 basis points versus the same period last year on higher volume.

In the second quarter of fiscal 2020, we reported net income of $7.4 million, or $0.64 per share, compared to net income of $958,000, or $0.08 per share in the second quarter of fiscal 2019. Now looking at our year-to-date results, revenues increased 23% to $286 million versus the same period a year ago. Domestic revenues increased by 21%, while international revenues grew 28% versus the prior year. Gross profit, as a percent of revenues, increased by 310 basis points to 18% of revenues, favorably impacted by increased volume and productivity initiatives across the manufacturing facilities. Selling, general, and administrative expenses were $36 million, 12.6% of revenue, which was a 170 basis points improvement on a prior year comparison.

For the six months ending March 31, 2020, net income was $10.2 million, or $0.87 per diluted share, compared to a net loss of $1.7 million, or $0.15 loss per diluted share a year ago. Year-to-date free cash flow totaled $4 million. This was driven by $7 million through operational cash flow, while investments in property, plant, and equipment was $3 million. At the end of our fiscal second quarter, we had cash and short-term investments of $121 million, $36 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 forward, while the current environment is exceptionally challenging, we have entered into this cycle with a strong balance sheet and ample liquidity, a healthy backlog, as well as a disciplined approach to cost management.

Based upon anticipated market conditions in the near term, in addition to the timing of our existing backlog and order outlook, we expect that revenues will soften in the second half of fiscal 2020 as new customer orders slow across our core industrial end markets. We do, however, reaffirm our expectation that fiscal 2020 will be a profitable year for Powell. At this point, we'll be happy to answer your questions.

Operator (participant)

Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star one on your telephone keypad. We do ask that you please limit yourself to one question and one follow-up question. Our first question comes from the line of John Franzreb with Sidoti & Company. Please proceed with your question.

John Franzreb (Senior Equity Analyst)

Good morning, guys. Surprisingly good quarter.

Brett Cope (President and CEO)

Good morning.

John Franzreb (Senior Equity Analyst)

Can you talk a little bit about the order intake in April for your smaller equipment? Kind of compare it to how it was versus March. Give us some kind of context, maybe, on what may be the trough, maybe, of the small order cycle.

Brett Cope (President and CEO)

John, good morning, it's Brett. So coming out of second quarter as the global pandemic effects started sort of scattering folks, and we were focused on our people around the world as a lot of our customers and suppliers were, things softened at the end of March and sort of trailed into April. A little early to tell exactly how this is going to continue on through the second part of the year, but definitely softer as we came out of the second quarter.

John Franzreb (Senior Equity Analyst)

So you still had incoming small orders in April?

Brett Cope (President and CEO)

We did.

John Franzreb (Senior Equity Analyst)

I'm kind of curious about.

Brett Cope (President and CEO)

Yeah, we did. Yeah. There are a number of orders that had momentum being a long-cycle business. A lot of our projects started even the smaller base business orders. I talk about $1 million-$3 million in size. Those start a number of months out, six months out. And so some of what you find at the end of the second quarter, just finding signatures, people are displaced, people are working from home, geographically dispersed. So some of that trailed off. That was some of the reasoning. So just a whole host of different things that are hitting a lot of us in this space and just trying to find people was part of the issue.

John Franzreb (Senior Equity Analyst)

Makes sense, Brett. And the total order intake for the quarter, the $300 million, excluding the one large industrial order, what was the balance of the order intake?

Michael Metcalf (EVP and CFO)

John, as we've alluded to on prior calls, the large order that we were awarded in January. We booked it in this quarter. It's reflected in the backlog. It was greater than $100 million. As we've communicated, we're under a strict confidentiality covenant with our customers, so we're not at liberty to discuss the specifics of this contract. But as Brett alluded to, and we spoke about last call, our industrial end markets are softening, and we've been seeing that over the last four to six months. It is a dynamic environment out there as we work through it.

John Franzreb (Senior Equity Analyst)

Yeah. What I was going for there was what's the orders ex that business, ex that one job, so I get a better picture of, call it the normalized order intake. You've been averaging roughly, whatever it is, $140 million a quarter for the last two years.

Michael Metcalf (EVP and CFO)

Yeah. I would offer this, John. To your point, I mean, if you go back two, three quarters, we were doing somewhere in the $150-$175 million. It's less than that.

John Franzreb (Senior Equity Analyst)

Okay. I'll get back into it with you guys. Thanks.

Operator (participant)

Thank you. Once again, ladies and gentlemen, if you'd like to ask a question, please press star one on your telephone keypad. Our next question comes from the line of Jon Tanwanteng with CJS Securities. Please proceed with your question.

Yes. Hi, good morning. It's Pete Lucas for Jon.

Brett Cope (President and CEO)

Hi.

Just, I guess, on the new orders that you are seeing, you mentioned still getting some in April. It may be too early to comment, but anything you could say about where you're seeing bid margins now versus what is in backlog?

Nothing's really changed in the short term. Again, I think it's a little early. If I kind of go back a couple quarters, we've shared that we've kind of held price throughout most of 2019 and into 2020. I think the backlog heading into the change, if you want to change, that we're really seeing a change in the cycle. All signs don't look positive. But the backlog heading and the quality of the backlog is very solid. The trailing orders we're getting still reasonable, but looking forward, it would be hard to press to say there won't be more focus on that as if things start to dry up a little bit, there'll be a lot more competition for what's out there.

Helpful. Thanks. And also, in terms of the existing backlog, you mentioned a few things getting pushed out to the right there and probably impacting, I think you said fourth quarter, pushing things from this year to next. How long do you think that the current backlog should keep you profitable, and where do you see holes that you may need to fill in for that schedule? And then also, in addition to that, you talked about the delays that you mentioned, but have you seen any cancellations in the existing backlog?

Let me take this, Brett, Pete. Let me take the first part, and I'll ask Mike to jump in for what I missed here. Yep. We've got a number of customers that called over the last six to eight weeks and said, "Hey, we need to make some adjustments." Again, I think a lot of the comments I heard were dispersion of people, changes in trying to get folks to site, and just planning, so that has created some of what we had laid in for the fourth quarter. It's getting pushed out into, stretched out into 2021 over various. It's not all just one. You move it two months or one month. It's kind of a variable piece, so it's created a hole in the fourth quarter, so we have made some adjustments in the cost structure to account for that here recently.

As far as cancellations, no, not really seeing that. Right now, it's been just mostly delays on the existing backlog and then just trying to kind of per my John Franzreb's question, we're a little early, but we're trying to get a feel for what the rhythm will be here as folks are spinning back up and the projects that we had in the funnel heading into this, as the U.S. started to lock down and the globe really started to lock down, as it starts to loosen up a little bit, we're looking to see where all that stands, and it's a little early yet here, early in the third quarter.

Michael Metcalf (EVP and CFO)

Yeah. Pete, this is Mike, just an additional color on that with respect to some of the couple specific questions you had. With respect to the exit rate, the margin exit rate on our current backlog, currently, we feel really good about where we are. The order book's healthy. The quality of the customer base in that order book's healthy. The terms are decent. What we talked about last call was filling out with some book and bill, filling out the second half of the year. Clearly, with the dynamics that Brett just explained, stuff pushing to the right and the macroeconomic environment, we do anticipate a softer second half going into closing out the year.

Very helpful. Thanks. And last one from me, just trying to put it in context. You mentioned prior downturns. Is it fair to say that given the backlog you have in hand and the reduced exposure to upstream compared to the last downturn, that you're better insulated now and maybe won't see the same magnitude of impact on revenue as earnings compared to last time oil had come in?

Brett Cope (President and CEO)

Pete, this is Brett. I think going into this change, I would agree that the unknown here is the length. So if you look at the mix and overall quality of the backlog, as opposed to, say, compared to 2016, as we were rolling into 2017, 2017 being our down year on the last cycle, definitely a better backlog mix and quality. The uncertainty here is, will what we're seeing across the globe on the demand curve and the supply side and what's playing out there, how long will this take? So that's a deep we're all going to watch that closely as we progress next couple quarters, but the sooner things get back on track, then that'd be good for all of us.

Great. Thank you guys very much.

Okay.

Operator (participant)

Thank you. Ladies and gentlemen, this concludes our questions. Oops. I'm sorry. It appears we do have a follow-up from John Franzreb with Sidoti. Please proceed with your question.

John Franzreb (Senior Equity Analyst)

Yeah. Just on that last topic on the book-to-bill side of the business, can you kind of give us some context? What's the lowest annualized revenue you generated from short-term book-to-bill business? So we can kind of put it in context.

Michael Metcalf (EVP and CFO)

Yeah. I'll take that one, John. If you look back, say, five years through different cycles, the last oil and gas downturn in 2015, 2016, 2017, and you look at where we ended our backlog and our exit rate coming into the next year, and then subsequently what the book and bill volume of that is, the first part of that, I would range it anywhere from as you sit there with our backlog, and there's a lot of variables, things pushing out to the right, etc., a lot of different project dynamics, but in general, the math would tell you probably 70%-80% of your backlog as you enter years convertible in the next year, and on top of that, you'd add anywhere from probably $40 million a quarter type of number from a book and bill standpoint on top of that.

That's what historical book-to-bill.

John Franzreb (Senior Equity Analyst)

Averages it.

Michael Metcalf (EVP and CFO)

Yeah, that's average. That's.

John Franzreb (Senior Equity Analyst)

And what would be the?

Michael Metcalf (EVP and CFO)

Go ahead.

John Franzreb (Senior Equity Analyst)

Go ahead. So what's the trough number on that 40? The 40 is kind of an average per quarter. What's the worst? Do you have any sense of what the worst was?

Michael Metcalf (EVP and CFO)

No, no. It is, it ebbs and it flows. The 40 is essentially about what we did around 2015, 2016, the last downturn, and during the peaks, it'll be north of that.

John Franzreb (Senior Equity Analyst)

Okay. That's helpful, and you said that if conditions get worse, that you may consider some sort of restructuring actions or cost savings initiatives that are, I guess, more fixed than variable. I'm kind of actually surprised that, I guess, coming out of a downturn recently, that you have that much wiggle room to actually cut costs. Where would that be? Because that kind of caught me by surprise.

Brett Cope (President and CEO)

Yeah, so John, we did in early May take action both on the fixed indirect structural side of the house, so kind of your indirect pieces and your SG&A, as well as taking cost out of the variable, so it really spanned across all elements of the business. When you think about the different product lines that we have at different locations, it really was a wide initiative, but yeah, we did just recently announce an action in early May.

John Franzreb (Senior Equity Analyst)

How much in annual cost savings would that generate?

Brett Cope (President and CEO)

Roughly, it will generate on an annualized basis, probably $5-$6 million on the indirect or fixed cost side and about the same on the variable cost side, and that's an annualized number.

John Franzreb (Senior Equity Analyst)

Perfect. Great. That's very helpful. Thank you, guys. I appreciate the color. Thank you.

Michael Metcalf (EVP and CFO)

Okay. Thanks, John.

Operator (participant)

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

John Franzreb (Senior Equity Analyst)

Morning, Brett. Mike.

Brett Cope (President and CEO)

Hey, John.

John Franzreb (Senior Equity Analyst)

On the large project, the $100 million plus project, you've done projects like this before often. Is there anything unusual or different about this project that would maybe heighten the risk profile at all compared to other large projects you've done in the past?

Brett Cope (President and CEO)

Hey, John, Brett. No. It's a big project for us, but in terms of the makeup, it is what we would affectionately around Powell called meat and potatoes. It fits us just perfectly. And the revenue profile, sometimes we see the $50 or $60 million offshore jobs. We always talk about a year and a half. This has sort of a three-year lay-in right now. So it is something that is right up our alley, so.

John Franzreb (Senior Equity Analyst)

Okay. Is the revenue flow more of a back half of the three-year time horizon or front half, or is it equally just across all periods?

Brett Cope (President and CEO)

No, not a back half. A lot of our projects start off with a lot of engineering. This one has a lot of engineering, so we'll take some of that here in the second half, but it's more we'll see a fair amount next year and a fair amount into the following year, so I'd call it kind of 50/50 at this point. Now, that could change, but that's kind of what we're seeing essentially as we lay out the schedule.

John Franzreb (Senior Equity Analyst)

Okay. Will there be any substantial working capital bill to support this project that might impinge on sort of the free cash flow?

Michael Metcalf (EVP and CFO)

Yeah. I mean, this is Mike. From a cash flow perspective, since we booked the order in January, John, we anticipate upfront milestones kicking in here in 2020. And we will build working capital next year, but we've modeled the project such that we're trying to stay cash neutral on this one.

Operator (participant)

Thank you. Ladies and gentlemen, this concludes our question and answer segment. I would like to turn the floor back to management for closing comments.

Brett Cope (President and CEO)

Thank you, operator. I would like to thank all of our talented employees for their enthusiasm and exceptional service to our customers. Our second quarter results demonstrate that our teams at Powell are driving to deliver superior execution and also continue to improve our efficiencies throughout our operations. While we continue to work challenges around factory loading, project timing, and project mix in the fourth quarter of this fiscal year, we believe we are well positioned to deliver on our growing backlog. Powell continues to be in a strong financial position. Our balance sheet provides us with significant optionality, flexibility, and confidence to support the second half of fiscal 2020 and into 2021. With that, thank you all for your participation on today's call, and we appreciate your continued interest in Powell and look forward to speaking with you next quarter.

Operator (participant)

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.