Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Powell Industries Second Quarter Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Wednesday, May 7, 2014. I would now like to turn the conference over to Karen Roan. Please go ahead. .

Thank you, George, and good morning, everyone. We appreciate your joining us for Powell Industries' conference call today to review fiscal 2014 second quarter results. We would also like to welcome our Internet participants. 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 and would like one, please call our offices 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 powellind.com, or a recorded replay will be available until May 14, 2014, 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 7, 2014, 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 relating 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 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 over the call to Mike. .

Thank you, Karen. Good morning, everyone. Thank you for joining us today to review our fiscal 2014 second quarter results. I'll make a few opening comments and then I'll turn the call over to Don to review the financial details. .

We had a solid second quarter, with good year-over-year improvements, and ended the period with one of the strongest backlogs in the last 5 years from continuing operations. We saw benefits from our process improvements and our cost savings activities, which continue to drive margins.

However, this margin improvement was partially offset by challenges in 2 areas. First, we continue to work efficiency and utilization issues in Canada as we ramp up our manufacturing operation. The hiring phase is going well, as we are able to bring in both the talent and the number of employees required.

However, the integration and productivity of such a large number of new employees has temporarily impacted our operational efficiency. Today, well over 2/3 of our employees in our production business have been with the company 1 year or less. Good progress is consistently being made and we expect to see improvement quarter-over-quarter.

Despite this, we're getting the work delivered on time and are meeting our customer delivery commitments. .

The Canadian market continues to be very strong and our facility investments are certainly strengthening our position there. Our projections for Powell Canada are increasing, and we expect to be a major player in this important region. Secondly, at the request of customers, we've had to reschedule shipments on a few large, active U.S.

projects, resulting in some revenues moving into subsequent quarters. This is the normal timing issue, which is not uncommon in a project-based business. We're working to obtain some shorter-cycle projects to fill the near-term capacity gap.

But because of these rescheduled shipments, we've seen at least $15 million to $20 million of revenues slide into next year. .

Overall, our core North American oil and gas markets remain strong with healthy quotation activity. Our outlook remains consistent with last quarter. Projects in the U.S. petrochemical market continue to move forward. Within this segment, customers appear to have adopted the approach of awarding orders in phases rather than a single large order.

The size and scope of the project opportunities have not changed but they're being executed in phases. We continue to be optimistic about this segment of the oil and gas market. .

Pipeline projects have been packed strong for the past several quarters and we anticipate more investment in this area through 2014 and well into next year. .

Regarding offshore, we continue to anticipate a pickup of activity late this year and into 2015, as customers are cautiously evaluating their commitment to these multibillion-dollar projects.

LNG projects continue to work through the early engineering and regulatory approval phases at a slow pace, but have significant potential for Powell over the next few years. We anticipate increasing activity in both the U.S. and Canada. .

I'll now turn the call over to Don to discuss the financial details. .

Thank you, Mike. Revenues increased 11% or $16 million to $162 million in the second quarter compared to the second quarter of fiscal '13. Domestic revenues increased by $2.6 million or 3% to $92 million in the second quarter compared to the second quarter of fiscal '13.

International revenues increased significantly by $13.7 million or 24% to $70 million. The increase in international revenues was driven primarily by the expansion of our operations in Canada and the timing of oil and gas construction projects. .

Gross profit as a percentage of revenues increased to 21.5% in the second quarter of fiscal '14, compared to 20.2% in the second quarter of fiscal '13. This increase in gross profit was primarily driven by margins associated with mix of projects and process and operational improvements, partially offset by the ramp-up of our Canadian operations. .

Selling, general and administrative expenses increased by $1.1 million to $22 million in the second quarter compared to the second quarter of fiscal '13, primarily due to increased personnel costs, administrative costs associated with the increased volume, as well as the growth of our Canadian business.

SG&A expenses as a percentage of revenues decreased to 13.6% during the second quarter compared to 14.4% in the second quarter a year ago..

We recorded other income of $500,000 in the second quarter, which was the amortization of the deferred gain from our amended supply agreement compared to other income of $1.7 million in the second quarter of fiscal '13, which resulted from a settlement of a lawsuit in Canada. .

Net income from continuing operations for the second quarter of fiscal '14 was $7 million or $0.58 per share compared to $6.2 million or $0.52 per share in the second quarter of fiscal '13.

For the 6 months ended March 31, 2014, revenues increased 14% or $41 million to $334 million compared to the same period a year ago, primarily due to the expansion and ramp-up of our Canadian operations. Gross profit as a percentage of revenues was 21%, unchanged from the first 6 months of fiscal '13.

Selling, general and administrative expenses increased by $3 million to $43.7 million compared to the first 6 months of fiscal '13, primarily due to increased personnel costs, incentive compensation and administrative expenses associated with increased volume as well as the growth in Canada.

We reported other income of $500,000 in the first 6 months of '14 compared to other income of $1.7 million in the first 6 months of fiscal '13. .

Our provision for income taxes reflects an effective tax rate of 35.9% for the first 6 months of fiscal '14, which approximates the combined U.S. federal and state statutory rates, as the majority of our income was U.S. .

For the 6 months ended March 31, 2014, net income from continuing operations was $14.2 million or $1.18 per diluted share compared to $13.3 million or $1.11 per diluted share a year ago. .

New orders for the second quarter were $163 million, resulting in a backlog of $452 million. Only $3 million left from the backlog of $455 million as of December 31, 2013. For the 6 months ended March 31, 2014, cash used by operating activities totaled $7 million. Investment in property, plant and equipment totaled approximately $8.5 million. .

At March 31, 2014, we had cash of $101 million compared to $107 million at September 30, 2013. And long-term debt and capital lease obligations, including current maturities, totaled $3 million. .

Looking ahead, based on our backlog and current business conditions, we expect full year fiscal '14 revenues from continuing operations to range between $700 million and $750 million, unchanged from our previous guidance. And we expect earnings from continuing operations to range between $2.85 and $3.35, also unchanged from our previous guidance. .

Our guidance excludes the discontinued operations and associated gain on the sale of our Transdyn business. .

At this point, Mike and I will be happy to answer questions. .

[Operator Instructions] Our first question is from the line of Jon Tanwanteng with CJS Securities. .

Regarding the rescheduling of projects, are the push-outs all going to next year, or is some of that expected to fall in the current quarter? And then also, have you seen any more reschedulings in April and May?.

John, this is Mike. So far, we had, in this quarter, about $15 million to $20 million of rescheduled that just had a domino effect. So we had some slide out of Q2 into Q3, Q3 to Q4, Q4 to Q1, so it was a bit of a domino effect. So we saw about a $15 million to $20 million impact this quarter, and we believe it's about the same number for the full year.

It was 2 or 3 U.S. projects. Last quarter, we talked about we thought we had seen some stabilization in that project slip, and we did. But it's kind of back to these, I wouldn't say abnormal, they're pretty typical normal reschedules. So I think we've got it all dialed in now but it is always variable. .

I think the majority of the impact is from the same orders. It's just elongated schedule. .

Yes. .

Versus compressed schedule that we previously were working to. .

Okay, got it.

And then given that the guidance range stayed the same despite pushing that -- those projects out, is that due to the strength in Canada, or is something else going into that?.

I think what the issue there is -- the schedule changes are relatively fluid. I think there's still enough time in the year for us to work to backfill some of that work. Plus there is a lot of variability in the opportunities that we see up in Canada as we work through the efficiency issue.

So at this point in time, we're comfortable with the range, staying in that range. But clearly, at this moment in time, there's a little more headwind than we had 90 days ago. .

Okay, great. And then maybe one more. Gross margins were still very strong despite the scheduling issues.

Can we expect a step function as you normalize Canadian operations and larger projects start shipping towards the end of the year?.

Clearly, we expect quarter-over-quarter improvements in the operating efficiencies at Canada, which should drive quarter-over-quarter improvements in the aggregated results. .

And our next question comes from the line of John Franzreb with Sidoti. .

Yes. Just sticking with the Canada theme, if I recall, last quarter it was about $2 million of inefficiency cost that you called out, Don.

Is that still the current run rate, or has it moved north or south from that?.

I think that the number is approximately the same number. It's not deteriorating and it's stabilized, given the fact of the increase of new employees coming into the business. We've brought in a lot of employees over the last 6 to 9 months.

And we're just working through that training, integration and operational effectiveness of bringing on the new employees. When you're looking at it in an overall aggregate, we're stepping back and looking at it, at this point in time, it is a little more than we had planned.

But when you're looking at it from another perspective of what we're trying to accomplish, we're not -- we're pleased with where we are. There's still a lot of hard work to get through.

When you're looking at the 6 months' impact, I would say, we're looking at somewhere, it's probably a little bit north of a 100-basis-point impact on our aggregated -- our consolidated results. .

Got it. And Mike, I guess from your commentary, it seems to me maybe the incoming order book is going to start flatlining a little more than I expected. I originally thought maybe the second half of the year, there might be a "greater wave" of order -- incoming orders.

But now with the new jobs and petrochem being parsed down smaller phases, is it more likely that we're going to see more of a steady stream or more constant order book in coming quarters than maybe a big jump, certainly in the next year or so?.

No, John. In fact, we expect to see orders much stronger in the second half, even if those have been parsed into smaller bite-size pieces. In fact, if it's not record, we expect near-record bookings levels for the full year. .

Okay, okay. So that's still the case. Okay, that's great. And one last question. You hired a guy to maybe relook at the M&A pipeline recently. Can you update us on his progress in identifying some new targets and/or new product development? I know that was also part of his job title. .

Still working it. We're putting a framework together for a little bit more strategic evaluation of those. We're building up the funnel. There's a lot of possibilities in there, still a lot more vetting to do, but nothing imminent. .

And our next question is from the line of Brent Thielman with D. A. Davidson. .

The issues at the Canadian facility, Don or Mike, how long before you think profitability gets to kind of desired or targeted levels there?.

We are looking to probably bring on another 75 to 100 employees between now and the end of the calendar year. As long as we're continuing to bring on employees of that magnitude, there is going to be some headwind that the organization is going to be dealing with as they integrate the employees.

So when you're saying when are we going to peak, it's probably going to be sometime next year.

But when you're looking at where we expect it to be at year-end, I think we're going to be pretty close, that we'll have enough -- that the scale will tilt here as we get more and more employees that have a foundation in our business, that can help assimilate the new employees. Right now, the scale is a little bit against us.

As Mike mentioned earlier, about 2/3 or more of the employees have less than a year seniority. As we get that to where 2/3 have a year-plus of experience with our company and we're bringing in 25% to 30% new employees, we'll gain momentum. The long answer is, it's probably going to be sometime in mid-'15 before you can say we're there.

But I think it will be, have a nominal impact on the business beyond the first quarter. .

Okay, very helpful. And then you talked about the LNG opportunity.

I know it's still ways out, but does this look like it has the potential to be as sizable as the petrochem market looks to be for Powell in terms of overall opportunity?.

It does. We've got a very healthy list of projects. We don't anticipate they will all be licensed nor funded. But they are sizable projects. And I would -- yes, I put it kind of equivalent at that petrochem spend that we see. .

Got you. And sorry, Don, I missed this.

But did you give the cash balance at the end of the quarter?.

Cash balance was $101 million. .

And our next question is from the line of Noelle Dilts with Stifel. .

One more question on Canada here.

You talked a lot about the employee situation, but can you talk about where you stand in terms of shifting production from Houston to Canada, if there's still more room to go on that front?.

It's been a transition process as we have integrated the employees. Today, there is still support coming out of Houston for projects that are in process in Canada. And we've talked about it. That's something that will happen, probably on an ongoing basis when you get peak loads.

The facility in Canada is smaller than what we have here in Houston and that we'll always use Houston as a backup for peak periods of time. Relative to our operating plan that we're working to right now, I would say we're over halfway through it. But there is still work being done here on an ongoing basis. .

Okay.

And then can you just comment a bit on the offshore market, what you're seeing in terms of activity and potential opportunity there in the pipeline?.

Yes, some very good opportunities. I think consistent with what we said last quarter, there's 2 or 3 shorter-term projects that we could see booked late this year or early next year, ranging from $20 million to $70 million. I think we'll get at least one of those here in the next -- before year-end. But there's 2 or 3 that are fairly close.

And then some that could happen late in '15. But a nice pipeline, 2, 3 projects in the $20 million to $70 million range. .

And our next question is from the line of Cezary Nadecki with Schroder. .

oil and gas, pipelines, petrochem and LNG.

Specifically to orders for the rest of the year, could you kind of rank them or kind of qualitatively describe where majority of your optimism is and kind of how they fall out in order?.

Okay.

Sorry, what was your first question?.

My first question is on the 3 projects that got pushed out a little bit, could you describe a little bit? I'm assuming they're all petrochem, but I'm not sure. .

Yes, they're all petrochem, they're all U.S. About half of it was in the offshore business. The other half was in our electrical products business. And it was just some reschedule of milestones by the customers, not atypical to what we typically see in this project business. Sorry, did you say petrochem? They were oil and gas. They were not petrochem.

Offshore, in oil and gas. .

Okay. They were all oil and gas, okay. .

Yes. So market-wise, trying to take a piece at a time here. So on the petrochem side, we are seeing that unfold as we thought. We had about $60 million or so in bookings this quarter. We're probably about $80 million to $90 million in bookings for petrochem year-to-date.

There's still some more projects that we'd expect to see close this year and into next year. Oil and -- sorry, pipeline has been very healthy for the last several quarters. So that's continuing on. And there is -- we think that's still a growing market into '15. LNG is a lot farther out, as we said.

We've got one small order in the $20 million -- mid-sized order in the $20 million range so far from LNG. But most of those are going to be mid-to-late next year. And then offshore, again, I think I quantified that best we can.

There's 2 or 3 projects we think will book late this year, early next year, highly likely to get at least one of those into this year. That will be in the $20 million to $70 million range. .

And just one follow-up on that oil and gas.

If you were to book those projects, could you give us some kind of sense of growth in those orders year-over-year for the second half? And what are we looking at for oil and gas, specifically?.

I think I'll stick with the other comments we said. If it unfolds as we expect, we'll have record bookings for the company or certainly near-record bookings for this year, primarily driven by North American oil and gas. .

Because if we think about oil and gas, should we think about it as number of rigs as the driver here? Is that how we should think about it, or is there some other way of thinking about it?.

the onshore, pipeline, LNG, petrochem, offshore, those 4 or 5 segments so... .

Keep in mind, we're late cycle. Most of the projects that we are bidding and/or working on, our projects are the -- one of the last specifications to come out for bid and one of the last major projects to be delivered.

So most of the work that we will be working on -- we'll be having opportunities on over the next 6 months are projects that are being processed within the engineering firms. .

[Operator Instructions] Our next question is from the line of Tom Spiro with Spiro Capital. .

Tom Spiro, Spiro Capital.

Just a follow-up on Canada, and given that we have so many relatively inexperienced new staff up there, are we intensifying our quality control efforts up there? And Don, are we adjusting the warranty reserves at all?.

Absolutely. We are -- clearly, in our business, everything is inspected by the company before shift, and the vast majority of our projects are actually witness-tested by the client.

So the majority of the issues that we encounter during a startup like we are speaking of with the relative new employees occur in incremental costs in the efforts of rework as opposed to field issues. But yes, we are very diligent from an inspection and test standpoint.

And additionally, that we're providing even more resources from an oversight and support standpoint from our Houston organization to help in the training of that area specifically, as well as the balance of the business. .

And warranty reserves?.

Warranty reserves, we are conservative. But just to say that we expect significant increases as a result of product being shipped out of Canada, we really don't, because of the level of testing that we do prior to ship. .

[Operator Instructions] We have a follow-up question from the line of Cezary Nadecki. .

Just as a follow-up on oil and gas, can you just describe a little bit where the growth is? Is it downstream? Is it upstream? Because I was a little thrown off by your comment that you're so late in the cycle. .

Well, I think what Don meant is late in a project cycle. So they will do the process design first. And of course, they have to nail down how many pumps and what the electrical demands are going to be before we can size our equipment. So not late in the economic cycle, late in the project cycle. .

Okay.

But it's still related to drilling, right? Or am I off on that?.

No, we really don't do much on the exploration side. So on the drilling side, it's after the wells are drilled and then are put into production, we have some applications on that upstream side on the gathering. So the smaller pipelines, the gathering systems, the tank farms where that would be gathered, so that's really where we pick up.

So it is late after the exploration side. We don't do much on exploration, it's the production piece. .

And we've heard from the big E&P companies kind of mixed messages about the offshore project.

Is that affecting you in any way? Should we think about that longer term?.

You have read over the last year a couple of Gulf projects being canceled, but we still are optimistic about it. They may not be all of these projects get funded, but there is front-end engineering work going on and we're expecting to see orders still this year on those. .

Relative to business volume that we've been able to obtain in the last 2 years, we're looking at the next 2 years as being an up period relative to where we are. .

[Operator Instructions] We have another follow-up from Noelle Dilts. .

Just a little bit more color on the petrochem orders. I'm curious if the $80 million to $90 million in bookings you've seen year-to-date, what you would say the kind of average order size is. And if -- I understand you're expecting these to come in, in smaller pieces, but if you expect any change in that order size. .

I still stick with what we talked about. These have the potential to be large orders for us, which would be well north of $25 million to $30 million. The $60 million we got this quarter, almost all of that was in 2 orders. So they averaged $25 million to $30 million. The first quarter, we had $20 million, $25 million or so in bookings.

Those were smaller phases. So I would say, we're $5 million to $10 million orders first quarter, $20 million to $25 million orders the second quarter. I don't think we're going to see $50 million orders. They're going to be more in that range. .

Okay, great. And then just a little bit of -- a couple of questions on some of your smaller markets.

But can you talk about what you're seeing in IEC product? And then also, if there's been any acceleration in the distribution market on the utility side?.

Okay. First, the IEC market. Our IEC business this year is going to show some very nice growth. We don't think that's market-related. We have won a couple of nice projects in our IEC business. We still see that market as flat at best, maybe slight growth. But it's going to be more in the 0 to 2 range, basically flat.

And probably, not much change in that over the next year. Your second area was utility. Utility, we've got a little very modest growth in our business this year, but we are also planning for that to be a flat market as well, at least in the U.S. over the next few quarters.

A lot of pent-up demand, but we just don't see it in our space, on the distribution side, being cut loose yet. .

We're seeing a few projects, but most of them are relatively small, $1 million to $3 million range. .

Okay.

And then just back on IEC, are there any geographies that are showing particular strength?.

It's the oil and gas area, so Mid-East and Central and Eastern, a little bit in Eastern Europe. .

And I'm showing no further questions. I'll turn the call back to management for closing comments. .

Well, thank you, everyone. And just before we conclude the call, I'd like to just briefly summarize what I think are some of the key points from the quarter.

Despite some revenue shifting into next year as a result of some of these customer-driven schedule changes, we are at near-record level backlogs and we've got a very strong bookings outlook for the second half of the year, and we're confident we're going to be able to deliver the revenues in a back-end loaded year.

We continue to work our margin improvements from operational process improvements and cost savings activities. We're getting great traction there. It will be partially offset with some of the short-term efficiency issues in Canada. We're still very optimistic about our core North American oil and gas markets.

Our outlook remains robust near term, driven by pipeline and petrochemical, and longer term by offshore and LNG. And we're really pleased about how we're positioned today. Strong market outlooks, our new capacity and facilities online and I think uniquely positioned with some capabilities to engineer, manufacture and manage some very complex projects.

So we feel good about the future of Powell. We appreciate you joining us this morning, for this call and this update, and we'll talk to you next quarter. Goodbye, everyone. .

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect..