Powell Industries, Inc. (POWL) Q3 2019 Earnings Report, Transcript and Summary

Greetings and welcome to the Powell Industries' Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a 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, Zach Vaughan with Dennard Lascar Investor Relations. Thank you sir. You may begin.

Thank you operator and good morning everyone. We appreciate you joining us for Powell Industries' conference call today to review fiscal 2019 third quarter results. With me on the call are Brett Cope, Powell's 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 webcast powellind.com or a telephonic replay will be available until August 14th. 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 August 7th, 2019 and therefore, you're advised that any time-sensitive information may no longer be accurate at the time of replay listening or transcript reading. This conference call includes certain statements including statements related to the company's expectations of its future operating results that may be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties and that actual results may differ materially from those projected in these forward-looking statements. These risks and uncertainties include, but are not limited to, competition and competitive pressures; sensitivity to general economic and industry conditions; international, political, and economic risks; availability and price of raw materials; and execution of business strategies. For more information, please refer to the company's filings with the Securities and Exchange Commission. Now, I'll turn the call over to Powell's CEO, Brett Cope. Brett?

Thanks Zach and good morning everyone. Thank you for joining us today to review our fiscal 2019 third 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. I'm very pleased to report that Powell delivered solid financial performance in our third quarter. We entered the second half of our fiscal year having built positive momentum in the first two quarters of the year and our operating teams across the company continued that momentum and executed well over the reporting period. In the quarter, we reported $136 million in revenues, an increase of 10% or $12 million sequentially. Gross profit in the quarter was $24 million or 17.5% of revenue a $4 million or 18% increase from the fiscal 2019 second quarter gross profit of $20 million. During the third quarter, we experienced alignment of several factors. These included a continued improvement in the quality of our backlog, coupled with a favorable project mix, and several of our production facilities continuing to deliver incremental efficiency gains. I would also highlight our project in engineered leadership and their contributions to our manufacturing and profitability story. Thus far we've been able to cost-effectively maximize scheduled capacity to meet the changing requirements of our customers either by moving schedules out into the right or by accommodating a customer need to shorten cycle. These requests are frequently received both pre and post-award and are adhered in the long cycle project business. Our ability to meet the constant changes while working to minimize the impact on both the business as well as our customers is a strength and a differentiation of our model at Powell. New orders in the quarter were $145 million and have contributed to our third consecutive quarter of backlog growth. At the end of our fiscal third quarter, our backlog has grown to $407 million, which is an increase of $10 million sequentially, up from our second quarter ending backlog of $397 million and an increase of $146 million versus year-end fiscal 2018. Throughout our fiscal 2019, we have seen the majority of new project activity from our domestic oil gas and petrochemical markets. We did, however, experience more activity and new awards from the utility sector in the third quarter. We also experienced stronger contributions to the backlog from our international operations for the second straight quarter supporting our divisions in both Canada and the United Kingdom. Additionally, as we have reported over the past few quarters we continue to work with our customers on engineering-only orders. The upfront engineering awards are driven by a variety of reasons, but primarily, due to the timing around full funding investment decisions. As a result we are able to stay close to our customers during early phases of project planning while continuing to work on the design of the project and utilizing our engineering capability to bridge the schedule until such time the full award is released. Looking forward as our backlog grows the market is challenging our need to increase or adjust resource planning around our people and facilities. It is important that we are committed to not only being flexible for our customers, but also to improve the utilization of our people and facilities in order to solidify our production profile and workforce efficiency. We continue to monitor the wider macroeconomic environment. Our supply chain and purchasing teams are routinely working with our supply base partners to mitigate inflationary pressures. The largest headwind that we have experienced over the last several quarters and we believe will continue in the near-term is our ability to recruit high-quality employees in an exceptionally tight labor market. If there's anything we've learned in the past, it is that our people are the lifeblood of our company. They underscore our ability to secure future projects and continue to drive new strategies to improve productivity and profitability. In turn, our workforce is continuously changing. To keep pace, we continue to hire new employees, use contractors where prudent and leverage our unique ability to ship backlog across our various facilities in order to maximize our ability to meet the needs of our customers. Inquiry activity remains robust across our operations, especially from our core industrial customers in our domestic markets. We expect the abundance of natural gas reserves within the U.S. to continue to be one of the key drivers of new project activity over the next several quarters. We are also heavily engaged with our customers and their engineering partners and several sizable greenfield projects. A couple of these projects have recently moved forward on their funding decisions while others are continuing to work through their due diligence, cost optimization and design revisions. As we shared in the last call, pressing pressures on these larger projects may increase and become more relevant as we prepare for fiscal 2020. We expect to incur some additional costs as we strategically invest in the training and development of new employees as well as our current workforce. We will continue to exercise discipline around the mix and timing of these larger projects. However, we remain optimistic that with a sustained end-market activity and a continued focus on customer satisfaction and customer loading. Powell is well positioned to successfully execute on our growing backlog for the remainder of 2019 and into fiscal 2020. With that, I'll turn the call over to Mike to provide more detail around our financial results before we take your questions.

Thank you, Brett, and good morning, everyone. Overall, it was a solid quarter driven by both top line strength in our core end markets as well as from strong operational execution across the Powell global network of manufacturing facilities. With that, let me begin with a summary of our fiscal Q3 results. Bookings in the quarter were strong led by the industrial sector and market demand. New orders placed, during the third quarter of fiscal 2019 was $145 million, which was $6 million or 4% higher than a year ago and $52 million lower sequentially on a challenging comparison. Our book-to-bill ratio finished the third quarter of fiscal 2019 at 1.1, flat to the third quarter of the prior year, which positively added to the order book with backlog ending the third quarter of fiscal 2019 at the highest level in over three years at $407 million, $91 million higher than a year ago and $10 million higher versus the prior quarter. Revenues in the quarter of $136 million increased $12 million sequentially and $14 million or 11% higher versus the third quarter of fiscal 2018. We are experiencing healthy revenue trends across all of our product sectors led by the domestic industrial sector, which is providing the most significant year-over-year uplift. Domestic revenues increased by 14% or $12 million to $104 million for the third quarter of fiscal 2019 versus the prior year and the continued recovery across our key industrial end markets. International revenues generated from our foreign operations as well as export shipments from our domestic facilities, increased by 4% or $1 million to $32 million versus the third quarter of fiscal 2018, as the activity levels in our international markets are strengthening. Now looking at the fiscal 3Q 2019 revenues by sector. We experienced revenue growth across all of our business sectors versus the third quarter of the prior year. In the industrial sector, revenue increased by 6% or $6 million to $99 million in the third quarter of fiscal 2019 compared to the prior year. This positive trend is driven in large part by the continued strength of the petrochemical and oil and gas end market demand and both planned upgrades and capacity additions. Revenues from our utility sector increased by 37% or $7 million to $27 million in the third quarter of fiscal 2019 versus the same period a year ago, while revenues generated from the municipal sector were higher by 6% or $1 million to $10 million in the third quarter of fiscal 2019 versus the prior year. Compared to the fiscal third quarter of 2018, margin rates across the business improved by 240 basis points resulting in 17.5% gross profit as a percentage of revenue. Versus the prior year, gross profit increased by $5 million to $24 million on favorable plant volume and fixed cost leverage across most of our manufacturing facilities. On a sequential basis, gross profit improved by 130 basis points as we continue to benefit from higher factory utilization and favorable mix. Selling, general and administrative expenses were $17 million 13% of revenues, which was lower by 50 basis points versus the prior year and lower sequentially by 120 basis points. We continue to manage this cost flow very carefully while ensuring that the business maintains the resources necessary to execute safely and efficiently. In the third quarter of fiscal 2019, we reported net income of $5.1 million, or $0.44 per share compared to $300,000 or $0.03 per share in the third quarter of fiscal 2018. During the quarter, we reported a net gain of approximately $425,000, which was the result of non-recurring items that generated a favorable gain, which was partially offset by one-time adjustments to our leased facilities in Canada. Excluding this net gain, earnings per share on a non-GAAP basis would have been $0.40 per share. The business generated $8 million of operating cash flow in the third quarter of fiscal 2019, an improvement of $23 million versus third quarter of fiscal 2018 and has improved by $60 million year-over-year through the first nine months of fiscal 2019 predominantly driven by working capital efficiencies. Excluding restricted cash at the end of our third quarter, we had cash and short-term investments of $78 million, which was $28 million higher than our fiscal 2018 year-end position and higher by $6 million sequentially. Long-term debt including current maturities was $1.2 million. Looking forward, we anticipate continued strength and sustained end market activity as well as generating operational efficiencies driven by better plant utilization across the global landscape. We remain focused on our operational priorities as we execute on the order book and continue to deliver the anticipated productivity through the end of fiscal 2019 and into fiscal 2020. With that said, we do recognize the usual challenges of project timing and mix. However, we feel that we are well positioned to successfully execute on our backlog. In closing, we remain optimistic that with the sustained end-market activity combined with the quality of our backlog and focus on execution these variables will provide a platform for continued free cash flow and profitability performance into fiscal 2020. At this point, we'll be happy to answer your questions.

Thank you. [Operator Instructions] Our first question comes from the line of John Franzreb with Sidoti. Please proceed with your question.

Good morning, Brett and Mike.

Good morning.

Brett, I was wondering, if you could just characterize the opportunity pipeline today versus say three months ago. Is it better? Is it worse especially in light of the moves we're seeing in oil and maybe the global economic conditions? What are your thoughts as far as what the outlook is now versus has been?

I would say, our outlook probably hasn't really changed that much in the last three months. We're more cognizant of the macro conditions that are kind of going on and we cannot – not pay attention to it, haven't seen it really materialize in the inquiry site yet. We talked last quarter about the base business what's the status of that. The funnel looks reasonably healthy John looking out, but we are cognizant of what's going on and looking for any sign of how that might impact the future. So –

Okay. And you're talking about the improved quality backlog. What end markets are pricing better than they were again versus three months ago?

Yeah. So, no real big change in price from recovery last year, the overall – that trend that we saw coming out of the downturn from 18 months ago was sort of sustained. So it's not getting any worse. A little bit more weary of the large projects as they get competitive here in the fall moving to early 2020. I think as we've shared in the comments today and even the previous calls, our expectation also draw a little bit more pressure because there's just gravity. Gravity plays a role in this big job. Lot of people come to play. So –

Okay. And it sounds also like in your prepared remarks you talked about labor being tight. It is going to be narrowing the investing in existing plays, but it sounds like having more. Is that temper – should that temper are expectations on the slope of a gross margin recovery into 2020?

It's something we're managing our way through. It's predominantly in Gulf Coast region. There's a lot of up pull-out labor from various sectors by the way. So we are managing through it fairly well, but it is a headwind that with we think continues for the next couple of quarters if not beyond it or a year or so, if you look at the projections on construction trades from New Orleans down through the Gulf Coast of Texas.

Okay. I'll get back into queue.

Thanks, John.

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

Hey, guys. This is Stefanos Crist calling for Jon. Congrats on the quarter.

Thanks, Stefanos.

Thanks, Stefanos.

Can you guys talk about the implied margins in the orders out into backlog during the quarter? And if they're improving compared those to what you've been executing on and from last quarter?

Yes. I think, Stefanos as Brett just alluded to in last question, the sequential price we aren't seeing any degregation or accretion in price quarter-over-quarter versus last year clearly as we burned through the backlog from last year. Yes, we are seeing year-over-year price but really I think price has kind of flattened out at this point and we don't expect it to increase accretively much more from here.

Got it. Thanks. And how much closer are we to larger project awards especially in the LNG side, or if there's any other petrochemical or offshore prospects on the horizon?

From our prepared comments the couple that are out there we've got the shell we talked about in past call. The one in Canada could have met LNG. The other one that's -- has moved forward is the Exxon-Qatar Petroleum Golden Pass project that has been awarded to engineering firms and they are moving from the design side to full EPC mode. So those are probably in the queue for the next couple of quarters and early next year. And the other one that had a nice announcement in the quarter was Chevron Phillips also teaming up with Qatar Petroleum on two projects one of them in lease, but also one here in the Gulf Coast. They announced an $8 billion cracker moving forward. So -- again that's going to be out of time from us. That's a little behind the Exxon job but those are public releases on announcements of the job and then there's acuity element that they're still trying to figure where they're going to go.

Thanks, guys.

[Operator Instructions] Our next question comes from the line of Jon Braatz with Kansas City Capital. Please proceed with your question.

Good morning, everyone. Brett, I'm wondering you talked a little bit about the difficulties getting qualified labor and so on. Is that impinging at all upon your ability to bid on projects? Have you had to just say no because you don't have the labor resources at all?

No, it hasn't affected our ability to bid or we so far found a way through it. We have --while we work to forecast and hire our teams into the company Jon, we also have the option of using contractor partners some that have been with us for 20 years and trying to help us find the qualified resources for this especially for the specialized trades on our integration side of our substations. So those present a little bit of cost challenge…

Yes.

In the short term. And we're trying to get a better long-term plan together that address it if it continues but hasn't really affected our ability to bid at all.

Okay, okay. Going back to the LNG sector, I think, the difficulties with China the trade issues with China LNG was going to be a big player in the Chinese trade. And are you seeing at all any push out of LNG projects because there is a lack of agreement with us and China? Are you seeing any delays in any LNG projects until some type of resolution -- or if there is a resolution in the Chinese-U.S. trade issues?

So Jon personally speaking I haven't. I am not -- I don't know what happens behind closed doors with our customers and what they're talking about. I mean certainly it is something you cannot think about and forecast out into how long they think these facilities will supply into those markets. The only item, I have heard is more short-term really related to tariffs in steel. Some of these other operations trying to sell up where the structural steel is going to come from for their process build-out securing that on the spot market of long-term agreements coming from multiple countries. I know that's a real concern. Some of these facilities and what they're trying to do is shore up their return calculations. But I haven't heard anything on the supply side and production agreements and where all the cargos are going to go.

Okay. Well, thank you very much.

Our next question is a follow-up question from John Franzreb with Sidoti. Please proceed with your question.

Yes. I guess two questions kind of interrelated here. Firstly, as you said this in your prepared remarks, I apologize, but what was the free cash flow for the quarter? And secondly in regards to your guidance you kind of said you are going to deliver solid operating cash flow through the remainder of 2019. What does that mean? And when is it going to take for you to reinstate guidance? What kind of operating conditions do you need to have that confidence level going forward?

Yes, John. So free cash flow for the quarter and I did touch on it in the opening remarks. So operating cash flow for the quarter was $8 million and we had about $1.2 million of CapEx. It's a little better than $9 million for the quarter. So really, really strong performance from a free cash flow standpoint.

Okay. And the second part of the question?

Could you repeat that second part?

So John, yeah, we know we're going to spend it since the downturn, and as we -- we're about to start out fiscal 2020 budgeting. It is a conversation we have, and there's still a lot of unknowns in the timing in these larger jobs. So while we recovered on the base business that continues to be strength in the order book in the third quarter. It's just a few jobs over in double-digits in terms of award. The bigger jobs present -- while they are taxing their funded chase and certainly more fund to win, they present a whole another challenge to plan the business. So, we'll look at it hard and chase just about it, and we're talking to the Board about it. But as we get into Q4, we'll look to update you and talk about it from…

Yeah. And I think John, as we go through Q4, and we continue to build the order book, we'll get better definition of what 2020 looks like. Our 4Q convertibility as we exit 3Q is relatively defined at this point. Q -- 4Q 2020 is still taking shape.

I mean, yeah, in light of the fact over the last two quarters in the backlog levels relative to we saw in 2016, I know it's kind of a push from where we were in 2015. I would assume that give you some level of confidence of what the outlook looks like going forward, but maybe I'm just reading too much into it.

It does. But the strength is still domestic operations, and it's not as consistent still. Even though we had a better international quarter in the third -- early second and third in terms of backlog, still, let's say, more of the certainty in those markets in the domestic Gulf Coast area.

Okay. All right. Thanks for taking my follow-up guys. Appreciate it, good quarter.

Our next question is a follow-up from Jon Braatz with Kansas City Capital. Please proceed with your question.

Mike, your tax rate has bounced around a little bit. How should we think about the tax rate going forward?

Yeah. Year-to-date, we're at a 22% ETR. Discrete 3Q we ended, I think it's about 14%. And really what that was generated from Jon is our Canadian facility and the impact of the offsetting tax liability there. So, I think when we look at the total year, we're going to come in right around where we are on a year-to-date basis.

Okay. And do you think as you look out towards next year, how would you see that -- the tax rate changing versus this year?

I don’t -- I don't anticipate we'll see any substantial changes in tax rate for next year. We're still holding in the low 20s.

Okay. Thank you much.

All right.

Mr. Cope, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Thank you, Christine. Overall, it was a solid third quarter, and we are pleased with our operational performance across the organization. We delivered productivity and efficiency and our teams have done a tremendous job on improving operating cash flow throughout fiscal 2019. Current backlog provides excellent momentum as we plan fiscal 2020. Current activity in our core end markets positions us well for sustained growth and value creation. While we are encouraged by the current level of client engagement, there is lingering uncertainty around the timing of the order cycle process as customers begin planning 2020 projects. I would like to again, thank our teams for their disciplined, reliability and for demonstrating quality execution. Thank you for your participation. We appreciate your continued interest in Powell, and I look forward to speaking with you next quarter.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines, and have a wonderful day.