Powell Industries, Inc. (POWL) Q2 2015 Earnings Report, Transcript and Summary

Greetings and welcome to the Powell Industries' Second Quarter Earnings Conference Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Stephanie Smith of the Dennard-Lascar Associates. Thank you, Ms. Smith. You may now begin.

Thank you and good morning everyone. We appreciate you joining us for Powell Industries' conference call today to review fiscal year '15 second quarter results. We would also like to welcome our Internet participants listening to the call simulcast live over the web. Before I turn over the call over to management, I have the normal details to cover. If you did not receive an e-mail of the news release issued yesterday afternoon and would like one, please call our office and we'll 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 via webcast by going to the company's Web site at powellind.com; or a recorded replay will be available until May 13, 2015, 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, May 6, 2015, and therefore you are advised that time-sensitive information may no longer be accurate as of the time of any replay listening or transcript reading. As you know, this conference call includes certain statements including statements relating to the company's expectation 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 industries conditions, international political and economic risks, availability and price of raw materials, and execution of business strategies. For further information, please refer to the company's filings with the Securities and Exchange Commission. Now, with me this morning are Mike Lucas, President and Chief Executive Officer and Don Madison, Executive Vice President and Chief Financial Officer. I will now turn the call over to Mike.

Thank you, Stephanie. Good morning, everyone. Thank you for joining us today for a review of our fiscal 2015 second quarter results. I'll make a few opening comments and then I will turn the call over to Don to discuss the financial details. Through our second quarter, we realized revenues totaling $170 million, our highest revenue level of the past five quarters. Despite a softening oil and gas market, order rates remained healthy for the quarter as well at $167 million. Backlog also remained strong at nearly $500 million. While higher project costs inefficiency issues continue to impact our bottom-line results, I am very pleased with our progress in the improvements made over the recent quarter. We saw good month-over-month improvement in adjusted earnings throughout the period. There are several one-time charges taken this quarter that Don will address in more detail during his comments. We saw significant progress in our Houston operations, factory throughput, fabrication output and productivity all showed nice improvement. Although some projects had delays and customer schedule changes the impact was less than anticipated resulting in a slightly higher revenue outlook for the second half than previously expected. Furthermore, the size and scope of projects that we are currently are significantly larger year-over-year due in part to petrochemical projects. We have a robust backlog to work through going into the third and fourth quarter to this year and we are well resourced and prepared to deliver this big demand. Turning our attention to the Canadian business, as discussed last quarter, there is still an ongoing impact on project margins as we take the steps necessary to meet customer commitments. Most of the projects currently in process have already experienced much higher than planned cost. However, most of these low margin projects will complete over the next few weeks and we are beginning the engineering initial fabrication work on several new projects. Initial review of these new project shows that cost are much more in line with expectations. Although we expect second half financial performance to be a significant improvement over the first half of the year, we also see a light production load in Canada over the next few months. This timing gap as low margin projects ramp up and new projects begin will continue to impact overall profitability of the Canadian operation in the short-term. We continue to win new awards in Canada including a large $45 million pipeline project during the second quarter, but the timing of these projects and awards has most of the revenues being recognized in fiscal '16. In response to production gaps expected over the next few months, we're adjusting our workforce accordingly but we will maintain our crucial investments in professional and built people those are over the past several quarters. There is more work to do in our Canadian operation before results will be a peak performance. However, our employees are working hard and making great progress, I'm proud of our team accomplishments and fully expect to see our operational and financial goals met. While we see some recovery in oil prices, we expect that oil and gas industry will continue with reduced capital spending levels in to 2016. Orders are becoming more competitive as a result of fewer project opportunities and we're seeing increasing price pressure. Although available project prospects are expected to be flat to down over the next 12 months, we're having better than anticipated success thus for with new wins and good bookings range. We expect that orders however will slow as a result of customer spending reductions with the full magnitude in timing, and this is not yet clear. As we look at our various markets, the offshore production market has already been hit hard; we've seen no new major offshore project awards before late fiscal 2016. In U.S. petrochemical market there is still some smaller project opportunities with the bulk of the large project awards have now been issued. It is yet to be determined, what impact the low price in natural gas will have in triggering the second wave of petrochem activity. Spending in the pipeline market has been less susceptible to the price of oil, and these projects have much longer time horizons for investment returns. We booked a major $45 million project in the second quarter and still have a few additional smaller projects both in the U.S. and in Canada, that we expect to move from the engineering phase into award during the latter half to 2015. The LNG export market remains a significant long-term opportunity for Powell as LNG export is still in the early stages of development in North America. A couple of U.S. projects in particular are moving forward. We see activity and expect these projects to be competitive but this factor represents an attractive opportunity over the next few quarters. We've also seen a pickup in utility market activity, primarily in distribution, investments in this infrastructure has been restrained from the extended period but a number of utilities have now decided that they must move forward with investment. Overall, we see little significant change in our oil and gas market outlook compared to last quarter. Due to the timing lag of some of our typical project awards, we expect reduced oil and gas capital spending levels to impact our order rates later this year and on into 2016. Let me now turn the call over to Don to review the financial details. Don?

Thank you, Mike. Revenues increased 5% or $8 million to $170 million in the second quarter compared to the second quarter fiscal '14. Domestic revenues increased by $29 million or 31% to $120 million in the second quarter. The increase in domestic revenues was primarily driven by our backlog of petrochemical projects. International revenues decreased by $21 million or 29% to $50 million. The decrease in international revenues was driven primarily by the substantial completion of a large project last year. Gross profit as a percentage of revenues decreased to 14.3% in the second quarter of fiscal '15 compared to 21.5% in the second quarter of fiscal '14. This decrease in gross profit was primarily driven by the margins associated with the mix of projects in process and continued inefficiencies and incremental cost associated with the expansion and stabilization of our Canadian operations. Selling, general and administrative expenses decreased by $2.6 million to $19 million in the second quarter. Primarily due to reductions performance based compensation partially offset by increased personnel and administrative cost associated with the expansion of our operations in Canada. SG&A expenses as a percentage of revenues decreased to 11.4% in the second quarter compared to 13.6% in the second quarter a year ago. And the second quarter of fiscal '15, we incurred approximately $1.3 million or $900,000 net of income taxes in restructuring and separation cost. We've recorded provision for income taxes of $6.4 million compared to provision of $4.1 million in the second quarter of fiscal '14. The effective tax rate for the second quarter was 237% compared to an effective tax rate of 37% in the second quarter of fiscal '14. In the second quarter of fiscal '15, we recorded a $9 million valuation allowance against our Canadian deferred tax assets, which is partially offset by the release of a $4.1 million R&D tax credit reserve on the closing of an IRS audit The net impact of these two items was $4.9 million, increase to our tax provision and a corresponding $4.9 million reduction through net income. I would like to take a moment to discuss these two tax issue in more detail. First the income tax valuation allowance, you may recall in fiscal 2010 we recorded valuation allowance in Canada. This was a result of a first year loss following our acquisition. Following a period of time, we turn the business around and we’re generating profits. As a result, we were able to reverse the valuation allowance at the end of fiscal '13. As we move into our new Canadian facility, we encountered high operating cost as we work to higher trained and stabilized a much larger workforce on an aggressive schedule driven by market demand. As a result, we have been operating at a loss and will require to re-establish our valuation allowance. Once we return to a position of consistent profitability, we will be able to reverse this allowance. The second item is an R&D reserve. A few years ago, we engaged a third-party consultant to review our R&D expenses and our tax position related to as R&D tax credits. Based on the outcome of this study, we determined that we should [remain] prior year returns and claim larger credits going forward. We parse the reserves for a larger tax credit position until we completed an IRS audit. This audit was completed this past quarter allowing us to release a $4.1 million reserve. In the second quarter of fiscal '15, we reported a net loss from continuing operations of $3.7 million, $0.31 per diluted share, compared to net income of $7 million or $0.58 per diluted share a year ago. Excluding the second quarter, tax adjustments and restructuring costs, net income of the second quarter of fiscal '15 was $2 million or $0.17 per diluted share. For the six months ended March 31, 2015, revenues increased 3% or $11 million to $323 million, compared to same period a year ago. Gross profit as a percentage of revenues was 14% compared to 21% in the first six months of fiscal '14. This decrease in gross profit is primarily due to cost associated with our Canadian operations, as well as the overall mix of projects. Selling, general and administrative expenses decreased by $3 million to $40 million compared to the first six months of fiscal '14, primarily due to a reduction in performance based compensation and overall cost saving measures. At the six months ended March 31, 2015, we incurred approximately $1.3 million or $900,000 net of income taxes in restructuring and separation cost. And we recorded provision for income taxes of $5.4 million for the six months ended March 31, 2015 compared to the provision of $8 million the same period a year ago. Included in current year provision as Canadian tax valuation allowance which is partially offset by the release of an R&D tax credit reserve I discussed earlier. For the six months ended March 31, 2015, we reported a net loss from continuing operations of $3.9 million or $0.33 per diluted share, compared to net income of $14.2 million or $1.18 per diluted share a year ago. Excluding the tax and restructuring charges that occurred in the second quarter net income for the first-half of fiscal '15 was $1.8 million or $0.15 per diluted share. New orders for the second quarter were $167 million compared -- resulting in a backlog of $499 million, compared to a backlog of $506 million at the end of the prior quarter and $452 million a year ago. At March 31, 2015, we had cash of $56 million compared to $103 million at September 30, 2014. For the six months of fiscal '15, cash used by operating activities totaled $4 million and investments in property plant and equipments totaled approximately $29 million. Through March 31st, we repurchased 171,000 shares at an average price of $33.60 per share for a total of $5.8 million. Amounts remaining available under the company’s current share repurchase authorization totaled $19.2 million which is scheduled to expire on December 31, 2015. During the same period, we paid dividends totaling $6.3 million. And long-term debt and capital lease obligations prudent current maturities totaled $3 million at March 31, 2015. Looking ahead, based on our backlog and current business conditions, we expect full year fiscal '15 revenues to range between $625 million and $675 million, unchanged from our previous guidance. And we expect adjusted earnings to range between $1.25 and the $1.50 per share compared to our previous guidance of $1.25 to $1.75 per share. Our earnings guidance excludes tax adjustments and restructuring charges. We reported $900,000 of restructuring cost in the second quarter and we're currently evaluating additional restructuring that may be needed to in line our operating cost with market conditions. At this point Mike and I will be happy to answer your questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Please ask one question and one follow up and then re-queue for additional questions. The first question is from John Franzerb from Sidoti & Company. Please go ahead, sir.

Mike, I just would like to ask you a question about Canada and your opinion of the staffing only there as it stands today. Are you satisfied with the composition of the employees you have there, do you think there is no more work to be done? Are you trying to get more senior staff embedded there? Can you just kind of give us an overview of what your thoughts are in Canada right now? That will be helpful.

John, I think it is pretty stable right now; we have made a lot of changes over this past year in key management position and senior professional positions, supervision. So we've had a lot of work on that over this past year. I think the quality of our team is very solid today. We are making some adjustments just because of the volume in this short period we're going to have of light load but we're pleased with our teams. It's actually for now two year, we do have half of dozen ex-pats from Huston operation, currently working in Canada in a variety of roles from estimating to project management to operations to engineering. So, and they're on various lengths of assignments, but it is also supported with a pretty solid ex-pat team.

And will those guys will be returning any time soon or what's the length of the contract?

That has been ranged from six month assignment to two years that is scattered over the next few quarters.

And I guess unrelated, you talked about your expectations of orders dropping off just on macro conditions. I know in the last downturn, the orders dropped as low as $100 million per quarter. Based on your quotation activities with customers, what kind of level of degradation are you expecting from the current $164 million level? Are you thinking like, $125 million is a stabilized level? Do you have any kind of thoughts about, how much downside, there is?

Yes, it is a difficult range to predict right now, we are seeing the activity in the quotation levels come down but there are a couple of sizable projects in there that can swing that result pretty significantly. So, it is -- and our order rates are holding up certainly longer than we anticipated and even in here through April, our oil and gas business, we don't have everything in from April yet, but even it looks like through April, the oil and gas size is holding up a little stronger and little longer than we anticipated. So, that is still too hard to call.

The next question is from Noelle Dilts from Stifel. Please go ahead.

I appreciate all of the color, Mike on the end markets that you gave, I did want to dig into that a little bit more. So, first on the orders, this is tying into the last question, but you know when you think about some of these orders declining, can you talk about how much of that decline you're expecting just from the upstream market firstly and then petrochemical versus maybe a little bit of a pick-up in say pipeline and maybe even LNG export? I just want to better understand how you're looking at that balance of demand from these markets as we move forward?

Yes, so we're in kind, couple of these comments might be little redundant, of course offshore is really quiet right now; we've not seen any activity therefore while production has certainly slowed on the upstream side. Pipeline is still holding in there, in my prepared comments, we see that a little less susceptible, we've won some nice size projects and we see some smaller opportunities both in the U.S. and Canada, we think we'll go ahead and move forward. If you combine some of the downstream, refining and petrochem we had a pretty descent quarter in refining in petrochem, nothing big in there. But that was holding up fairly well as we said we think we're past that peak and expense but there is still some descent size small projects in there and then we've seen a little pickup in the utility which we think will run for a while particularly on the distribution side.

So, I guess I should have asked that in a different way. I mean, if you looked at it just more quantitatively, how much do you think say downstream is down or will be down as we move forward, that would be the first question? And I guess tied into that, how much of that is price versus volume?

We sold the upstream production related investments tailing off early last year. So really looking at what period of time that you're comparing it to, if you're comparing it to the most recent couple of quarters, I would say that the upstream investments were smaller and have been relatively stable and I don’t think it's going to deteriorate significantly below what we’ve seen in the last couple of quarters, but clearly down from early last year. When you're looking at the pipeline, I think they are holding steady and they are going to be lumpy as all projects are in our business. But we think that they will continue into '16 at a fairly -- I'd say strong, but a fairly good rate, I mean we’re not really expecting a seasoned tail-off. I think the biggest thing that we’re seeing there is some isolated large projects, but we’re becoming much more dependent upon small to mid-size projects as the market softens relative to where we were 18 months ago. So when you're looking at the overall markets, none of them have gone to zero and like Mike say we’re actually seeing some pick up in this non-oil and gas areas.

And then can you just comment on how the Canadian facility expansion is progressing and where you stand on that?

Basically the facility was turned over to us around the end of the quarter. There is a small [cashless] items that are going through, some of it is weather related for outside grounds work that needs to be completed, but basically the facility is finished, we are already moving operations into that new expansion, it is in stage four at the end of March with the exception of some small hold backs, we feel about $1 million and $2 million to finalize the expenditure on the expansion.

The next question is from Mr. Jon Tanwanteng from CJS Securities. Please go ahead.

So if you look through the gross margins in the quarter, what was that we expected to be at this time and if not, why not, and then given the gaps in increased pricing pressures, you guys mentioned before I'm wondering if and when you expect to get back to a gross margin plus 20%?

I think when you're looking at the quarter, we were pleased with the improvements that we saw through the quarter that the results was at weighted average and we saw positive trends. And the trend probably ended up a little bit better than where we thought it might have ended -- look at it at the end of December, but was not -- it was in the range of where we were hoping to be. But clearly I would say that we were pleased with the results and a progress made not that where we need to be. So anything I'd say we’re little bit ahead of where we thought we might be at the end of the first quarter.

And then does the prospects of getting back to 20%?

I am sorry Jon, can you repeat it please?

And then the prospects for getting above back above 20% given the gaps in the pipeline and the Canadian work and the increased pricing pressure as you talked about before?

So clearly when you look at our guidance, we are going to be popping up against 20% gross margin in the second half of the year at least on certain months for sure that it clearly is going to be a little more skewed in the near-term towards our U.S. operations where we have a much stronger second half backlog. We do expect to see half-over-half improvements in Canada. But with the light production load that creates a new hurdle for them that we're going to have to work our way through the backlog that we have is actually growing with the orders that we booked in the second quarter. But as Mike mentioned most of that doesn’t actually hit the manufacturing floor until late in the fiscal year.

And SG&A was actually pretty tight. Is that the run rate that we should be using going forward and how is that tie into what you're doing in Canada with the reduced rate?

As a percentage of revenues it's probably a little bit low, we’d say that you're going see second half better than the first-half but only the modest amount relative to revenues.

The next question is from Alicia Johnson from D.A Davidson and Company. Please go ahead.

I was wondering if you could give me a little bit of detail about maybe those future restructuring initiatives -- to the value that you are evaluating, is that most of them are related to like Canadian employment or is there some off going on in there?

When we’re looking at and we’ve already taking actions to adjust and make adjustments in our operating cost based on the backlog that we’re doing it trying to do it from a very pragmatic perspective, we’re looking at locations, the location markets that we served or looking at the existing backlogs and the anticipated backlogs that we're going to need to be delivering. But yes, when you're looking at the area that has the most challenging, it is the Canadian market and that’s because of the shortfall that we’re having in the backlog or with the balance of the year and it's a tough decision as to how much those resources that we've got that have really become coming effective that we need to preserve, to make sure that we are not restarting when we see the backlog pick up against this fall. We're looking at some all the places, we're looking at several things to what do we really need and how do we size the business for fiscal '16 and we're still in the process of that analysis, but really expect to be through the vast majority of it in the current quarter.

And then, kind of my other final question. The guidance is applying a little bit stronger second half, are you saying this is going to be a little bit equally weighted between the two quarters? Are you thinking there's really going to be a ramp closer to the end of the year?

Clearly we're seeing less movement in our less movement to out in the schedule requirement based on the customers' product and construction scheduled. At this point in time, I'd say that there is the forecast risk is with offset of our liabilities predict at the second versus -- actually the third versus the fourth would be materially different but at the end of the day, I'm sure there will continue to be some schedule adjustments. But I do expect to see significant improvement we're expecting planning for a significant increase in load in our third quarter. So between the two they would be roughly flat.

The next question is from John Franzreb from Sidoti & Company. Please go ahead.

Mike, can you just talk about Houston and where you stand as far as production -- production efficiencies and is that all behind us now?

I think that are significantly behind us. We've seen some good month over month over month improvements throughout the quarter. We're running at some pretty high outlook levels in that business now our contract resources are up or again it simply out in the parking lot areas and factory scope. So, we'll have -- those issues pull a bit on productivity but substantially better than where we were the first quarter and you know remember in the first quarter we were pointing to some of these some efficiencies and productivity around the new business system implementation. I would say that is substantially behind us at this point.

And Don, I thought I heard you correctly, the cash position was 56 million at the end of this quarter, was that right?

That is correct, at the end of March.

I was under the impression that cash collections were improved in the beginning of the quarter and it seems like it's strained down again. Can you just, -- what's happened there to cash flow?

Forward dealing with right now is that there are several large projects moving through our area and as we've talked in the past -- we tend to be -- cash becomes lumpy and as project near completion, we tend to go cash flow negative and so we're seeing more volatility as a result of the size in the projects in our cash, we've ranged over the last 90 days from a lower 50 to high 75, a lot of it depends on just where we are in that billing milestone and where we are in the collection process, but it's the size of the project that are causing the volatility.

So is there any change in the capital expenditure budget at all this year?

Basically, we will complete the expansion of our external facilities another $1 million to $2 million for the full year we're probably spending as we've discussed in the past somewhere between $5 million and $10 million to maintenance CapEx half of that's been spent, we still have normal. Lot of its focused on efficiencies and cost savings but that effort is still continuing within all of our businesses.

There are no further questions at this time. I'd like to turn the floor back over to the management for closing comments.

I just wanted to say thank you all again for joining us for our second quarter. We've got a lot to get done in the third quarter and fourth quarter; we're continuing our focus on project executions and operations. And that's where we'll be focused over the next two quarters. We look forward to talking to you again next quarter. Thank you for joining us.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.