Powell Industries Inc (POWL) Q2 2023 Earnings Call Transcript

Thank you, and good morning, everyone. Thank you for joining us for Powell Industries conference call today to review fiscal year 2023 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 10. The information on how to access the replay was provided in yesterday's earnings release. Please note that the information reported on this call speaks only as of today, May 3, 2023, 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. With that, I'll now turn the call over to Brett.

Thank you, Ryan. Good morning. Thank you for joining us today to review Powell's fiscal 2023 second quarter results. I will make a few comments and then turn the call over to Mike for more financial commentary before we take your questions. I'm very pleased to share that Powell delivered second quarter results that were among the best in our history as the continued execution against our strategic initiatives combined with the cyclical recovery of our core markets are driving improved margins and increased earnings along with achieving another record backlog. The momentum that started to build over the past few quarters in our industrial markets accelerated in the second quarter. Two significant awards underscored the strength of our bookings during the quarter, including an award for another large domestic LNG project, which marks three consecutive quarters of significant activity in this market sector. We were also fortunate to have received a new award for a greenfield petrochemical project during the quarter. This mega project is for a gas-to-chemical facility that will be located in the U.S. domestic market. While the strength of new orders was certainly driven by strong demand from our core oil and gas petrochemical end markets, the majority of the sectors and geographies that we compete remain very active. Notably, in addition to the commercial activity across our core industrial end markets, we also experienced continuing strength in booking activity across our utility and commercial and other industrial sectors during the quarter. Total revenue in the second quarter was $171 million, which is 34% higher than the second quarter of fiscal 2022 by market sector versus the same period in the prior year. Revenue in our oil and gas sector increased by 17%, petrochemical revenue increased by 37%, while the utility sector saw revenue jump 40%, and the newer commercial and other industrial sector saw revenue of $22 million, which is nearly four times higher compared to the prior year. This was partially offset by the traction sector, which declined by 27% compared to the second quarter of fiscal 2022, mainly due to wrapping up a large municipal project in Canada. Order activity in the second fiscal quarter was exceptionally strong as we secured $508 million in new bookings. That figure is more than three times higher than the same period in the prior year and more than double the $212 million that we saw in the first quarter of fiscal 2023, which until this quarter was our best quarter of bookings Powell has had since Q1 of fiscal 2013. Our book-to-bill ratio in the current quarter of 3x was equally strong and was the sixth straight quarter with a book-to-bill over 1. Our team delivered a gross margin in the quarter of 19.5%, which is an increase of 460 basis points compared to the same period last year. Strong project execution, volume leverage, and positive closeouts helped deliver the underlying margin growth. Moving to the bottom line, we reported net income of $8.5 million in the second fiscal quarter of 2023 or $0.70 per diluted share compared to a net loss of $1.2 million or a loss of $0.10 per diluted share in the prior year. Lastly, we ended the quarter with an order backlog of just over $1 billion, an increase of nearly 50% from the end of the first quarter of 2023 and more than double the $440 million at the same time last year. The growth is driven by improved strength across our core oil, gas, and petrochemical market sectors, and it is the first time in Powell's history that our backlog has exceeded $1 billion. That said, we are very comfortable with the size, mix, and quality of our order book. Our project backlog is well balanced across our seven manufacturing facilities and project schedules extended through fiscal 2024 and into fiscal 2025, providing us with a steady balanced cadence of future activity. The nature and scope of these projects are also core to what Powell does best in markets where we excel. Our 75-year history of success and leadership in the industry has earned us our current position in this cycle and leaves us very comfortable with our ability to fulfill our backlog with the same level of service and execution that has earned us our reputation. We have taken every dollar of our backlog thoughtfully and on schedules that we are confident we can achieve. Turning to our operational performance, I am very proud of the progress our teams are making across all of our facilities as we rise to meet the increase of market demand. Powell employees are measuring and working to improve productivity, minimizing or eliminating inefficiencies and addressing headwinds quickly and as a team to ensure that we leverage our processes, plants, and facilities optimally and in the best interest of our customers and our stakeholders, but without ever sacrificing the quality of our products, systems, and solutions synonymous with the Powell brand. The investments that we have made in the tools, processes, and our people over the last six-plus years have prepared the business to meet this increased workload. Our operational teams throughout the company are constantly working to share best practices and refine our approach to the most complex of engineered-to-order electrical substations. Their sustained efforts have increased our revenue productivity to historical highs. Further, throughout fiscal 2023, our teams continue to identify a number of incremental capital improvement projects that will facilitate both incremental capacity as well as improve production efficiency in several of our facilities. Additionally, our operational teams continue working to mitigate the effects of the inflationary cost environment and availability challenges. Key engineering components continue to create longer lead times. However, we are managing through these challenges, and where possible, factor contingencies and allowances for these components in our bidding activity. Meanwhile, prices for key commodities such as steel and copper have stabilized compared to prior periods, however, remain subject to macroeconomic volatility. Our teams work hard to ensure that these inputs do not create significant cost overruns on current and future project activity. Further to this point, our commercial teams continue to ensure that pricing initiatives are aligned to the current cost environment when and where possible in order to protect our margins, which is evidenced by our strong second quarter margin performance. The labor markets, while not presenting significant issues presently, will remain an area for our teams to exercise diligence as we plan for the next several years. Over the last few quarters, we have shared that we are currently comfortable with staffing levels as we work to support the growth and execution of our backlog. But we are attentive to our current capacity levels as that backlog continues to grow. Our human resources teams have been working extremely hard and remain closely aligned with our operational teams to forecast and plan for the future. Order activity remains robust across most market sectors. We continue to see favorable opportunities within LNG, gas pipeline, and the gas-to-chemical sector. We are also active in the renewable markets of hydrogen, biodiesel, and related biofuels such as sustainable aviation fuel, as well as carbon capture and sequestration. Additionally, we continue to take incremental steps to further improve our market channels in order to capitalize on our growth into market adjacencies within our commercial and other industrial sector. We remain acutely focused on executing against each of our strategic initiatives in fiscal 2023, which include growing our electrical automation platform, expanding our existing services franchise, and diversifying our product portfolio through both targeting tangential applications that complement our existing product offerings as well as expanding the scope of our product catalog into new electrical technologies. While we are very pleased with our fiscal second quarter and year-to-date first half financial performance as well as our positioning for the second half of fiscal 2023, we are cognizant of the fact that this is the nature of the cyclical markets in which we operate. Powell has been through more than its share of cycles over its 75-year history, but we have maintained and fortified our position as an industry leader and trusted partner to our customers because of our focused execution and diligent planning process through good years and lean years. We are confident that this culture, coupled with the positive transformational steps being taken internally at the company, will drive another strong year of improved financial performance for Powell. With that, I'll turn the call over to Mike to provide more detail around our financial results.

Thank you, Brett, and good morning, everyone. In the second quarter of fiscal 2023, we reported net revenue of $171 million compared to $128 million or 34% higher versus the same period in the prior year. Commercial activity across our core industrial markets continues to be robust, recording new orders booked in the second fiscal quarter of 2023 of $508 million. During the quarter, we booked two large projects that, when combined, totaled roughly $200 million of the reported current quarter orders: one petrochemical project and an LNG project. With the exception of the traction market, commercial activity is favorable across all of our reported market sectors on a year-over-year basis, however, was driven predominantly by the gas markets within the domestic industrial sector driving the total reported bookings for the second fiscal quarter to over a threefold increase or $357 million higher versus the same period 1 year ago. On a fiscal year-to-date basis, our book-to-bill ratio is 2.4x, resulting in continued backlog growth, reporting a record high backlog of just over $1 billion in the period, which was $581 million higher compared to 1 year ago and $341 million higher sequentially. The current capital cycle and resulting demand for industrial electrical products and associated capital assets has resulted in extended lead times, partially due to capacity and supply chain challenges for select electrical components compared to 12 to 18 months ago. As a result, many of these large orders extend well into fiscal 2024 and, in some cases, fiscal 2025, ensuring our ability to execute to our committed lead times. Compared to 1 year ago, domestic revenues were higher by 54% versus the prior year to $134 million, while international revenues were 9% lower compared to the prior year driven by lower project volume across our Middle East markets versus the prior year. In total, international revenues were lower by $4 million to $37 million in the second fiscal quarter of 2023. From a market sector perspective versus the prior year, revenues across our petrochemical sector were higher by 37%, while the oil and gas sector was higher by 17% on a year-over-year basis. Additionally, we experienced strong year-over-year increases in both the utility and the commercial and other industrial sectors, increasing by 40% and 285%, respectively. The traction sector was lower versus the second fiscal quarter of 2022 by 27% as we draw close to completion on a large municipal project in Canada. We reported gross profit in the period of $33 million, an increase of $14 million in the second fiscal quarter versus the same period 1 year ago. As a percentage of revenue, gross profit increased by 460 basis points to 19.5% versus the same period a year ago, driven largely by ongoing pricing initiatives targeting persistent inflationary pressures, as well as project closeouts, volume leverage, and strong project execution across all of the Powell manufacturing and service facilities. Selling, general, and administrative expenses were $22 million in the current quarter, higher by $5 million versus the same period a year ago on an increase in variable performance-based compensation based upon the expectation for higher levels of operating performance versus the prior year. SG&A as a percentage of revenue decreased by 110 basis points to 12.7% in the current quarter due to the higher revenue base. In the second quarter of fiscal 2023, we reported net income of $8.5 million, generating $0.70 per diluted share compared to a net loss of $1.2 million or a loss of $0.10 per diluted share in the second quarter of fiscal 2022. During the second quarter of fiscal 2023, cash flow from operating activities was a positive $56 million as we generated free cash flow early in the project cycle in advance of building working capital attributable to the new projects booked into the backlog. Investments in property, plant, and equipment totaled $630,000 as we continue to leverage our liquidity position and invest in capacity and productivity projects across the business. This will continue to be a strong focus as we thoughtfully leverage our balance sheet to enhance and expand our core competencies, helping our operational teams deliver more efficiently for our customers. At March 31, 2023, we had cash and short-term investments of $163 million, $46 million higher than our fiscal 2022 year-end position. The company holds no long-term debt. Finally, during the fiscal second quarter of 2023, we amended our credit facility with our banking partner, Bank of America, increasing our facility capacity to $125 million from the previous ceiling of $75 million. As we presently utilize this facility solely for commercial letters of credit, and considering the current activity across our global market sectors, we felt that this was a prudent action in order to ensure our continued success in these markets. As we look forward to the second half of fiscal 2023 and into fiscal 2024, we remain very encouraged with where Powell is positioned. Commercial activity across most market sectors remains strong and the margin initiatives that the business has been focused on over the past 12 to 18 months are gaining traction. Operationally, we are confident in our ability to execute our growing backlog while we continue to develop plans to expand our capacity in order to deliver to our customers' expectations. Finally, the strength of our balance sheet and overall liquidity position provides the flexibility to pursue both organic and inorganic options to grow the business while also meeting increasing working capital requirements. Combined, these variables all support positive momentum for Powell's revenues and earnings for the remainder of fiscal 2023 and into fiscal 2024. At this point, we'll be happy to answer your questions.

Congratulations on an eye-opening quarter. I'd like to start with the quarter in and of itself. Presumably, revenues and the margin profile of this business were locked in six to nine months ago. So I'm curious if there was anything unusual in the quarter as far as revenue or cost equation or excess project closeouts that drove the stellar results in the March quarter?

Yes. John, this is Mike and I'll address that. First, if you look at the year-to-date margin, we're just under 18%, 17.7%. And it has a few drivers behind it. First, we've been managing both cost and price here for the last 12 to 18 months. We're beginning to see that exit backlog. So we feel very confident we've got the inflation component under control via our pricing levers. Secondly, the mix of projects that are in backlog today has been pretty fortunate to build the backlog on the industrial side, which carries a little more favor in terms of margin. And then third, all of our seven facilities are pretty well balanced from a backlog perspective. As that backlog converts to revenue, we will generate and are generating pretty good volume leverage across the system. So we anticipate the backlog will continue to support a similar level of profit.

And I guess this is a good problem to have, but do you have the capacity and the personnel to support a $1 billion backlog? Or are you going to have to significantly increase your CapEx and your hiring practices to get to the end of the line here?

John, it's Brett. We absolutely have the capacity for this. We've been planning this for years in terms of the investments in the tools, processes, and systems. More recently, we've taken the order and worked with our customers and their engineering partners to lay out the schedules to be predictive and credible in what we could deliver, supporting the brand. We've also identified that we will see an uptick in CapEx over Q3 and Q4, just to handle some of the laydown area for additional substations. And then we've identified some productivity increases. We've been methodical about keeping our machinery up to speed, up to date, and attending to all the maintenance. We'll do some additive pieces here and there. But we definitely have the capacity to handle this, and we feel good that there's still room to grow.

Okay. And Brett, it sounds like you're enthusiastic about what you're still bidding on out there. Can you talk about the sustainability of the booking profile? I really don't expect $500 million in orders. But what kind of opportunity pipeline remains out there? And how long do you think it will last?

I am optimistic, John. If you look at the second quarter, Mike gave some color around the two large orders, roughly $200 million of the total of $500 million. So certainly, timing broadened this significant performance in terms of the booking piece. But as we look forward, there is still active bidding. We've talked about the gas market, there's a lot of activity going on. I think that certainly through the balance of this calendar year and possibly into next year, if things still haven't shut off, we're right in the middle of that market that we know well.

Sort of going back to the previous question. Order flows are good, business is strong. Does that put you in a better position to be more selective on the projects that you want to bid on? And may we even see better margins because you can be more selective?

John, let me address this, and then Mike can add his input. One point I want to emphasize is that during this cycle, particularly on the gas side, we are observing all the projects in our primary markets of the U.S., Canada, and the U.K. quite positively. From a market share standpoint, we have the opportunity to evaluate these projects and engage in discussions with customers and engineering teams. We are not being selective about whether to bid; rather, we collaborate with customers and engineering teams to identify the best approach for each project. Thus, we are particular about how we engage based on our capabilities and the integration requirements.

I lost my train of thought. Mike, you mentioned that in the gross margin for the quarter, there were some favorable closeouts. Was that significant at all?

No. If you look quarter-over-quarter, John, it was about flat. Nothing unusual. The projects we booked 12 to 18 months ago are exiting and closing out, nothing unusual in that whole process. So it was really, as I said, we're starting to see some of the cost actions, pricing actions that we've diligently worked on over the last year and a half, along with great project execution flowing through the system.

So, looking ahead, does the gross margin look more reflective of the second quarter number versus the year-to-date? Because you did mention the year-to-date of 17.7%. So going forward is the second quarter number more reflective than the first half?

No, I would look at the first half number as kind of the litmus test and then layer in all of the initiatives that I laid out that will be accretive. I think that will be accretive to the 17.7%. As we've communicated in the past, we're really targeting and aspire to be in the high teens as we exit our fiscal year.

Thank you, Kate. Our second quarter delivered solid performance with sequential improvements in both our top and bottom line and year-to-date through the first half of our 2023. Our employees have and continue to do a tremendous job. The resilience of Powell is on display through the first half of our fiscal 2023. I could not be more proud to be part of this incredible team. I would like to thank our valued customers and our supplier partners for their continued trust and support of Powell. The quality of our backlog combined with the strength of our balance sheet provides solid momentum as we head into the second half of our fiscal 2023. With that, thank you for your participation in today's call. We appreciate your continued interest in Powell and look forward to speaking with you next quarter.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.