Powell Industries, Inc. (POWL) Q3 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Powell Industries Third Quarter Earnings Call. [Operator Instructions] This conference is being recorded today, August 8, 2012. And I would now like to turn the conference over to Karen Roan with DRG&L. Please go ahead.

Thank you, Douglas, and good morning, everyone. We appreciate your joining us for Powell Industries Conference Call today to review fiscal 2012 third quarter results. We would also like to welcome our Internet participants listening to the call over the Internet. Before I turn over the call to management, I have the normal details to cover. If you did not receive an e-mail of the news release issued yesterday afternoon, please call our offices at DRG&L and we will get one to you. That number is 713-529-6600. Also, if you want to be on the permanent e-mail distribution list for Powell news releases, please relay that information to us. There will be a replay of today’s call and it will be available by webcast by going to the company’s website at www.powellind.com or a recorded replay will be available until August 15, 2012 and 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, August 8, 2012, and therefore, you are advised that time-sensitive information may no longer be accurate as of the time of any replay listening. As you know, this conference call includes certain statements, including statements related to the company’s expectations of its future operating results that may be deemed to be 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 the 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 strategy. For further information, please refer to the company’s filings with the Securities and Exchange Commission. Now, with me this morning are Tom Powell, Chairman of the Board and CEO; and Don Madison, Executive Vice President and Chief Financial and Administrative Officer. I will now turn over the call to Tom.

Thank you, Karen. Good morning, everyone. I thank you for joining us today to review the fiscal 2012 third quarter results. We had a great quarter, and we now have a new President and CEO as you probably saw in the news release issued last evening. I’m delighted that Mike Lucas has decided to join the company. As you know, the board conducted a thorough search for the position of CEO and we’re confident that he is the right person to lead the company going forward and to build on our prior achievements and obtain even more success in the future. Mike brings 27 years of professional sales, marketing, product development, operations, service and general management experience to the company. Mike has both domestic and international experience and he has industry expertise in power systems, power quality, process control, and instrumentation and in industrial automation. He’s also been active in acquisitions and the integration of newly acquired businesses. Over his career, he has been involved in product lines that relate to Powell’s products and solutions including high reliability DC power systems, industrial power supplies, switchgear, circuit breakers, and process control systems. Mike has a stellar 14-year record with Emerson. He served as President of several of their businesses, most recently as President of Emerson Network Power Energy Systems, a $1.2 billion global provider of high reliability power systems and services. We look forward to the value and leadership that he is going to bring to the company, and we’re confident we have the right team in place for the company, our employees, and our shareholders. Mike will be joining us officially on August 20. I’ll work with Michael over the next several months to ensure a smooth transition of leadership, and once we have an effective transition, I would return to my focus as the role of Chairman. Now let me make few other brief comments on the quarter. We’ve just posted our best quarter since our record year in 2009. That’s due to a great performance of our Powell employees throughout the company and I’m grateful to those people. I am very proud of them. A positive contribution by every division contributed to this quarter’s results. Simply stated, we had good projects, we had good weather, we had good productivity, and certainly we have great people. However, bookings fell off during the third quarter as many of our customers and their engineering firms are having challenges balancing their resources between planning and execution due to a shortage of engineering and other technical personnel. However, our inquiries remain strong, but we may see a temporary dip in the level of bookings activity over the balance of the year as some projects are not expected to be awarded at this point until later in the year and in the first quarter of 2013. Now, I’ll turn the call over to Don Madison to discuss the financial details.

Thank you, Tom. Revenues were $194 million in the third quarter of fiscal 2012, an increase of $53 million or a 37% improvement compared to the third quarter of last year. The higher revenues are a result of a stronger backlog of orders coming into the fiscal year. Gross profit as a percentage of revenues was 22.6% in the third quarter of fiscal 2012 compared to 15.5% in the third quarter of fiscal 2011. This increase in gross profit is primarily from higher production volumes and reduced cost on projects due to operational efficiencies. Selling, general, and administrative expenses as a percentage of revenues decreased to 13% in the third quarter compared to 14% in the third quarter a year ago, due to higher revenues. SG&A expenses were almost $25 million compared to $19 million last year, which relates primarily to increase in incentive compensation and business travel expenses. Amortization expense was $704,000, a decrease of $533,000 compared to the third quarter of fiscal 2011. This decrease is a result of lower balance of intangible assets, following the impairment charge recorded last year. Our provision for income taxes in the third quarter of fiscal 2012 reflects an effective tax rate of 34%. Our estimated tax liability on Canadian profits was offset by our tax loss carry forward in Canada. We reported net income of $12 million, or $1.02 per share for the third quarter of fiscal 2012. This compares to $73,000 or $0.01 per share in the third quarter of fiscal of 2011. For the 9 months ended June 30, 2012, revenues were $533 million, compared to $391 million in the same period a year ago. Domestic revenues increased by 17% to $308 million, while international revenues increased by $96 million or 75%, primarily due to the size and the number of international projects for the oil and gas sector. Gross margin was 18.5% for the 9 month period, compared to 18.6% a year ago. This slight decrease in gross profit margin resulted from project execution challenges on a few large projects in Canada, primarily during the first quarter, which were partially offset by our third quarter [indiscernible]. SG&A expenses were $66 million compared to $62 million for the first 9 months of fiscal 2011. It decreased as a percentage of revenues. This increase primarily relates to variable compensation expenses. Year-to-date, our provision for income taxes reflects an effective tax rate of 41% compared to 48% for the same period last year. This decrease in our effective tax rate is primarily due to our tax laws' carry forward position in Canada. For the 9 months ended June 30, 2012, net income was $18 million or $1.50 per share compared to $4 million or $0.36 per share a year ago. As of June 30, 2012, our order backlog was $433 million compared to $497 million at the end of the second quarter and $491 million a year ago. New orders were $133 million in the third quarter compared to $203 million in the second quarter and $198 million in the third quarter of fiscal 2011. As Tom noted earlier, inquiries remain good, but the timing of project awards is beginning to slip due to limited engineering and project management resources across the oil and gas sector. For the 9 months ended June 30, 2012, cash provided by operating activities totaled $6 million and investments in property, plant and equipment totaled approximately $25 million. At June 30, 2012, we had cash of $106 million compared to $124 million at September 30, 2011. Long-term debt and capital lease obligations, including current maturities, totaled $4.5 million. Looking ahead, based on our backlog and current business conditions, we expect full-year fiscal 2012 revenues to range between $700 million and $725 million, and full-year earnings to range between $1.95 and $2.20 per share. Now, let me turn the call back to Tom for a few final comments.

Thank you, Don, a good job as always. The company is in excellent shape, and we have a new CEO coming onboard to guide us going forward. The oil and gas market continues at a steady pace as we’ve seen over the past several quarters, and we’re pleased with the opportunities in our light rail transit business. Other markets such as electric utility, commercial light industrials are showing signs of improved activity. And we firmly believe that there are still a great deal of pent-up demand that exist in many of our markets. Our goal is to be prepared for additional demand and company growth. Now, in our earnings release, we announced a major commitment to expand our operations in both the U.S. and in Canada. This demonstrates our long-term commitment to our customers, and it will give us the capacity to compete and grow as we develop opportunities in these important geographic regions. As we've mentioned before, in the first quarter, we purchased 21 acres of land adjacent to our existing Ship Channel facility to allow us for future expansion, to support the offshore platform market. Currently, this acreage is used for lay down storage of raw materials such as beams and steel plate, as well as for employee parking at that facility. We’ve also purchased 2 additional tracts of industrial land, one in Houston and one in Edmonton, Canada. And we’re in the early phases of building additional manufacturing facilities for both of these locations. Site work has begun and those facilities are expected to be completed in the second half of 2013. We remain committed to investing in our operations, and we will continue to invest in our people, in our products, and on our manufacturing capabilities, enabling us to fully prepare for market conditions going forward. At this point, we will be happy to answer your questions.

[Operator Instructions] Our first question is from the line John Franzreb with Sidoti & Company.

I guess, I really want to focus on the increase in capacity, Tom. It’s really a sizable nut considering what you’ve been spending in recent years. Could you talk a little bit about what end markets or product lines are driving that capacity expansion and any more color that would be very helpful?

Well, we’re a leading manufacturer, as you know, of medium and low voltage switchgear and custom-engineered electrical solutions. Our model includes the engineering and construction of power control rooms -- you may refer to them as electrical house -- as a means to support total solutions for our clients and to enhance our ability to further penetrate the market. Also, the trend towards modularization is continuing around the world, and we continue to see a move away from stick-built construction and more towards prepackaged, even pre-tested solutions at the factory. And then the product is moved out to the field and connected. A number of our oil and gas clients are further striving to compress project schedules. This trend further supports our model of prepackaged solutions, a 100% tested at the factory and shipped to site for plug and play. We’re very protective of our base business. And larger greenfield projects often cause us to consider a much larger order size to accommodate that footprint. Simply stated, we needed the space to improve on our performance through our customers. I don’t know if that answered your question, but that's the best I can do.

Well, so on the product side, how about the end market side? Are there new customers that you’re lining up beyond the oil and gas sector that we should be cognizant of?

Sure.

John, I mean clearly, yes, but when you stop and think about it, this year, we’re projecting we’re going to do in excess of $700 million revenue. That’s basically the strongest performance the company has ever had. Even if you discount the growth that we’ve experienced in Canada due to the acquisition in Canada, we’re looking at probably delivering 95% plus or minus of the revenues and the strongest year in the history of the company, primarily on the back of the oil and gas sector. If all industries were hitting on the same level that we saw in 2009, we would be having real problems and what we’re doing is we’re trying to prepare for that going forward. Right now, you’ve been through our facilities; we are currently landlocked at all of our domestic and international facilities. We have expanded here in our Mosley facility since 1964 probably, what, Tom, 5, 6 times?

7.

And that we even brought in an outside firm to look and say, "can we get further utilization out of our existing footprint?" And the bottom line was that the cost of trying to squeeze more capacity and capability into our existing footprint just wasn’t practical. So, we’ve come to the conclusion that to support internal growth, which is the key part of our strategy, it’s time to make that new investment in the real estate. The 3 pieces that we have are all strategic to our business. One is the offshore platform business, and we had the opportunity to acquire the adjacent land, which was ideal for its future expansion, which we’re confident that we’ll utilize over the next -- or start utilizing it and make this year much more productive, because otherwise we have been looking at offsite storage areas and bustling employees back and forth, moving material back and forth. That has really benefited us even in the current year, but over the next 5, 10 years that’s going to allow us the opportunity to continue to grow at that market. But when you’re looking at the Canadian market, we’ve had strong acceptance of our products in Canada, the solution that we provide. The bottom line is that the clients in Canada are fully expecting us to provide the same solution in the same manner that they are used to from Powell out of our Houston-based facilities. So, we’re looking at basically creating the same capabilities on a smaller scale, and to do that we needed a footprint to manage to do that. And then finally, here in Houston, like I say, we looked at trying to expand our Mosley complex. Our current complexes, both of them are land constrained and from an efficiency and an operation standpoint, we looked at least these facilities. There weren’t any available that met our unique operational needs. So there was good industrial property about 4, 5 miles from our current facility, and we’ve made the decision to move forward with, so that’s where we see it going over the next 5 to 10 years.

It’s good to know that you had meant to support all that. Just as a follow-up question in a different tact, recoveries from Powell Canada, were there any in the quarter? Can you update us on progress on that front, if there were any?

Yes. There were no unusual recoveries in the quarter. We’re continuing to pursue the claim that we have in Canada. I don’t think it’s appropriate for me to comment on it at this point in time, other than we are in the process and still optimistic about the ultimate outcome.

[Operator Instructions] And our next question is from the line of Brent Thielman with DA Davidson.

Yes. Tom or Don, is there any way you could help us understand maybe from a revenue potential perspective the productive capacity you are adding with the $75 million investment?

When you are looking at the short-term opportunity, clearly this will free up the opportunities for probably somewhere in the neighborhood, again, I want to quantify it. When you’re looking at the footprint, there is probably easily $0.25 million additional business that we’ll be able to do. Short term, we’re looking to say, how can we reduce some of our lease cost, so that would reduce that to a degree that we’re able to reduce some of our lease expenses. But then, if you are looking at the horizon, there were probably more machinery equipment. There’s other constraints that this a major step as for spreeing up -- some of the major constraint that we have is our current footprint. I think it’s more important to look at as well that in both, all 3 of the properties we have, I would say, at the current development that we’re planning, we’ll probably utilize no more than 50%. So, when you are looking at the ability to grow in an efficient manner, to continue to do like we’ve done here at Mosley over the past 40 years, we’re going to be well positioned to productively and efficiently add capacity as needed over the next 20 years.

Okay. And then, I guess you made the comments around the bookings and obviously backlog is a little lower this quarter, although clearly you’re sending a signal with the announcement on the capacity front. What kind of gives you the confidence we could see sort of a bookings rebound in the first half of next year?

We mean, our confidence is clearly based on the inquiries, where we are in the project planning, where we have active discussions going on that - in having understanding of what’s elongating the process is clearly a human resource constraint issue within our client base.

[Operator Instructions] And our next question is from the line of George Gaspar, a private investor.

Regarding your order trend in the last quarter, was there any change in the specific product interests within that order trend and how did the international versus domestic end up in that order level for the quarter?

A number of the larger projects are shipping internationally. Oil and gas, of course, as you know, is very active, and we need additional space for that to perform for the customers. Transit light rail is up, utilities are headed up with aging facilities and the potential of converting coal to natural gas for some of these utilities, a lot of interest in ethylene and other products in the chemical world. And then commercial, I’ll admit, and light industrial is flat and somewhat struggling with the economy. Municipalities, well, it depends on if Obama gives them some more money, we’ll get something in there. And mining is steady. So from all indications, we have to expand to be able to handle this work effectively and efficiently for our customers.

Okay. And the follow-up on the order interest in terms of what’s going into power generation. Are you noting any new opportunities coming out of the Far East, for example, like this Indian situation -- India situation? It would seem like there’s going to have to be a huge uptick in power generation expansion there. Can you hook into that from your point of view here or is that not a possibility?

George, let me answer that and I’ll let Tom add additional color. When we’re looking at the utility sector, it is very geographic and unique throughout the world. Our strength clearly is in North America, as well as in the U.K. where we have a physical presence. In geographic regions where you don’t have a physical presence, it’s very difficult to capture a significant share of the utility sector. So, when you’re looking at the Far East without the physical presence, it’s unlikely that Powell is going to capture any meaningful share.

I see. Okay. Well, you mentioned North America, then you mentioned a lot about Canada and your interest in expanding there. Do you see the Canadian market opportunity in power generation area also?

It’s clearly something that we’re focused on, that is to say, we expect it to have significant growth in the near term. I would say it’s much in the same situation as what we see here in the States.

Well, we have had interest, George, and closed some projects in Canada where they’re having to add some generation, and also in the transit industry in Canada. So, we’re not just focused on oil and gas in Canada. There are other opportunities as that whole infrastructure has to build up.

Okay, okay. Yes, it seems like, I mean the interest in the oil sands continues to bubble pretty good, and I’m sure there has to be a backup on the power side there?

Right.

Our next question is from the line of Jon Braatz with Kansas City Capital.

Question on your physical expansion, the $75 million investment. Obviously it will add capacity. What kind of impact might we see would free up improve -- I would just say improve productivity, does it have -- do you think it’ll have a positive effect on the gross margins in this and just the sales opportunity, or the revenue opportunity?

Jon, clearly with the footprint that we have been working under this last year, there have been inefficiencies. There’s impact from a weather standpoint.

And outside.

From having to do some of the work on the outside. We have actually put engineers and better things out in the factory, product development. I mean, we are beginning to stack on top of one another, both from a factory operation standpoint, as well as from an engineering and project management support. So, clearly we’re anticipating that the fact that we’re building a facility that is specified and designed for our products from day one, compounded with the inefficiencies that I think we’re experiencing over this past year, I believe you will see a benefit from a cost structure standpoint, operating cost structure in addition to a capacity availability issue.

I assume you probably wouldn’t want to quantify that opportunity, would you?

Not at this point in time.

Next question is from the line of John Reilly with ACK Asset Management.

In talking about the addressable market, you mentioned ethylene plants. We know that there hasn’t been a build of this type of plant in the number of years, decades. Could you just tell us what your opportunity is on plants? I know that there are 5 targeted, maybe some get built. Just walk me through what your opportunity on an ethylene plant is?

Well, let me just speak a little bit broader into the chemical/petrochemical market. Clearly there is a huge amount of planning and activities and discussion going on right here even in the Greater Houston area, to looking at expanding in this area, given the natural gas situation, as well as just the overall need for additional products in that area. We’re expecting or the industry is expecting to make significant amount of investments along the Gulf Coast, but I think the excitement will be somewhat tempered and that’s why it’s difficult to tell you a number or dollar value is because of the resource issues. So, when we get into building and expanding in the petrochemical area, we’re going to be bumping it up against the same engineering project management resources constraints that we have in the balance of the oil and gas sector. So, we see, I mean, a significant investment in that area in the coming 3 to 5 years, but the rate of investment I think will be tempered by human resources.

And where would your content be? Would it be in the switchgear or in what other areas?

It’s basically going to be the same type of infrastructure from a power management standpoint, switchgear motor control, integrated solutions moving on to brownfield facilities. And, when you’re looking at brownfield expansion of existing plants due to the safety concerns of construction workers, the modular building like we provide, the integrated solution in the factory, minimizing the construction content on a facility is the ideal approach and we think we’ll be very well positioned to capture a big portion of that market.

And is there a way to frame the opportunity per facility for Powell, the amount of switchgear, because we haven’t seen these things built in such a long time?

Well, again it gets back to the size of the expansion. I mean, it would be very comparable to a major expansion in refining. And now with energy consumed in a petrochemical facility, the amount of energy consumed in a refinery are not materially different. We have projects in refining that have gone from - as well as the teens up to $50 million projects. On the larger expansions, I mean, a $50 million award to Powell would not be unusual or unexpected.

Got it. And then there’s been obviously lack of developed investment in new power, in gas, in North America, although everybody is talking about it and everybody is waiting for the cycle to come. When in your expectation or when do you think that these awards and people will actually start moving on some of the natural gas fired facility production?

John, we’ve had this conversation before, predicting the market, I wouldn’t even begin to guess. We know it’s going to happen, it’s inevitable. The facilities are aging. They are today, from a regulatory standpoint, the challenges to expand into the coal-fired is probably not going to happen. But from an economic standpoint, from a regulatory standpoint, my fear is that from a U.S. perspective is that until we really start seeing rolling brownout, I’m afraid we’re not going to get serious.

Right, right, right, okay. I really appreciate it. Thanks, guys. Really - and one last question. I mean, obviously gross margins, I think you’re pretty close to what your prior peak was on the quarterly basis and we know we’re not straight lining in that type of improvement. You had a great quarter.

Thank you.

Although I’d love to. How do we think about gross margins? I see - I can build into what’s your guide is, so how -- where can we see gross margins in this cycle? I mean, could it be a 25% gross margin business? How should we think about gross margins?

To get to a 25% gross margin in the near term, I don’t think is realistic, given that we’re living in an environment where it’s basically one market that’s driving growth. We’ve talked about it before, to really get the market going from a price standpoint and the competitive pressures to start subsiding a little bit, all markets need to strengthen so that all manufacturers in this space have their primary markets beginning to hump. And I don’t see that happening in the near term.

Okay. Well, I’m just, I mean, it was great to see you with the 22.5.

Our next question is from the line of Tom Spiro with Spiro Capital.

It’s Tom Spiro, Spiro Capital. So, how is Canada is doing? I know we’ve had some challenges up there. Could you give us an update?

Clearly, we had a profitable quarter this past 3 months. We have - our full expectations is that it’s going to continue in the fourth quarter and get stronger. We will end the year in a situation where the last 9 months of the year will be a net positive. But at this point in time, without recovery of the plane that we are currently pursuing related back to the first quarter, we will end up at a net loss for the year. Next year, we’re optimistic. Going forward, the market continues to be strong. And I think that we have turned the corner from our ability to execute. The next - the challenge that we’ll have this coming year in Canada, and I’m sure we’ll be talking about it from time to time, is what impacts the relocation and introduction of a new facility is going to have on the operating results for the year. And we’ll be looking at that and talking about that more in our fourth quarter call.

Well, it’s nice to hear that things are improving.

Yes, they are. And we’ve given them a lot of support out of Houston and fabricated the materials and product. When this new facility is done, we will be able to do fabrication directly -- more fabrication directly in Canada and not have to support them so strongly from Houston, which has -- there have been some constraints in that area.

In fact efficiencies and in fact, transportation costs, when you’re building components in one plant and shipping them 2,000 miles, it creates unique challenges.

Just to go back to the gross margin for one moment. Don, was there anything of a non-recurring nature in that gross margin or was it clean?

It was clean. Again, it’s all project related. So, it’s a mix of projects and where they are in the cycle. That, I mean, keep in mind as a project related business, you’re going to see peaks and valleys and we are very pleased with the last quarter’s performance, but there were no one-time anomalies that I would highlight that impacted the quarter.

On prior calls, Don, you mentioned, our backlog contained some pretty low margin stuff that we booked a year or 2 ago. Have we washed most of that through now or is there still much of that to go?

No, basically when we -- relating back to our conversations early in the fiscal year, that backlog has now basically been shipped. There is still a mix of business in our backlog, but when you are looking at the business that have considered out of norm on the low side that has introduced a shipped decline.

And how does pricing look today versus a couple of quarters ago, from 50,000 feet -- has it changed much over the last couple of quarters?

I would say, no. Pricing continues to be very competitive. Again, this is a predominately a one sector that is driving the growth in our markets that the competition is still very strong for the available business in the oil and gas sector. We’re trying to maintain prices, but I can report that we are losing some business on price that we could go out and probably obtain if we were willing to drop to the level that we are seeing in the marketplace.

Well, thanks much and good luck on - with respect to these ambitious growth plans. It’s very exciting.

[Operator Instructions And our next question is a follow-up from the line of John Franzreb with Sidoti.

Yes. Going back to George’s question, did you give you the percentage of international sales that are in the backlog?

I don’t have that at my fingertips, John, but I can tell you it is projects that are either being produced or destined for international locations is higher to-date than it has been at any time in the near future or I mean, Tom is guessing, it’s probably - it’s 40% or maybe even north of 40% at this point in time.

Okay. Great. That’s helpful. And in your press release you mentioned some of the opportunity that was based on improved aftermarket demand. Can you kind of describe how much of your business is aftermarket related and maybe what that comment means? What are we thinking here in terms of aftermarket type sales?

I’m not sure what the comment in the press release relates to, I don’t have it here. When you are looking at aftermarket sales in general that means it’s historically been a low double-digit piece of our business. And it’s an area that we have. Okay, I got. I think it’s the comment now. You’re looking at the expansion standpoint? From an expansion standpoint, yes, clearly we have a vision and a strategy to growing our aftermarket installation, commissioning, supporting not only our products manufactured here, but other products of the pile and growing that business. Part of our constraint from a management team standpoint is our ability to manage the engineering resources and the project management resources that are needed to support the people in the field and that is one of the areas that we’ll get some benefit with the new construction.

And at this time, there are no further questions in queue, I’d like to turn the call back over to management for closing remarks.

Well. Great. Thank you for joining us today and we look forward to talking to you in the next quarter. I will not be on that call, but will end up being Mike Lucas and Don Madison. So, as always, we appreciate your interest in Powell, and have a great day. Thank you.

And ladies and gentlemen, that does conclude our conference for today. If you’d like to listen to a replay of today’s conference, please dial 303-590-3030, and enter the access code of 4553728. We would like to thank you for your participation. You may now disconnect.