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Item 7. Management’s Discussion and Analysis

2024-11-20 compared with 2023-12-06 · 91 added, 90 removed, 132 unchanged (58% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations for the twelve months ended September 30, 2023 compared to the twelve months ended September 30, 2022 should be read in conjunction with the accompanying consolidated financial statements and related notes.

We have elected to omit discussion on the earliest of the three years covered by the consolidated financial statements presented.

Refer to Item 7.

Management's Discussion and Analysis of Financial Condition and Results of Operations located in our Form 10-K for the fiscal year ended September 30, 2022, filed on December 6, 2022, for discussion of the fiscal year ended September 30, 2021, the earliest of the three fiscal years presented.

The following discussion and analysis of our financial condition and results of operations for the twelve months ended September 30, 2024 compared to the twelve months ended September 30, 2023 should be read in conjunction with the accompanying consolidated financial statements and related notes included in this Annual Report.

For discussion and analysis of our financial condition and results of operations for Fiscal Year 2023 as compared to Fiscal Year 2022, please refer to Part II, Item 7.

“Management's Discussion and Analysis of Financial Condition and Results of Operations” in our Form 10-K for the fiscal year ended September 30, 2023, filed with the SEC on December 6, 2023.

Any forward-looking statements made by or on our behalf are made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995.

Readers are cautioned that such forward-looking statements involve risks and uncertainties, and the actual results may differ materially from those projected in the forward-looking statements.

For a description of the risks and uncertainties, please see “Cautionary Statement Regarding Forward-Looking Statements;

Risk Factors” and “Part I, Item 1A.

For a description of the risks and uncertainties, please see “Cautionary Statement Regarding Forward-Looking Statements” and Part I, Item 1A.

“Risk Factors” included elsewhere in this Annual Report.

Executive Overview

We develop, design, manufacture and service custom-engineered equipment and systems that distribute, control and monitor the flow of electrical energy and provide protection to motors, transformers and other electrically powered equipment.

We are headquartered in Houston, Texas and serve the oil and gas and petrochemical markets, which include onshore and offshore production, LNG facilities and terminals, pipelines, refineries and petrochemical plants.

Additional markets include electric utility, light rail traction power as well as mining and metals, pulp and paper, data centers and other municipal, commercial and industrial markets.

Revenues and costs are primarily related to custom engineered-to-order equipment and systems and are accounted for under percentage-of-completion accounting, which precludes us from providing detailed price and volume information.

Our backlog includes various projects that typically take a number of months to produce.

We are headquartered in Houston, Texas and primarily serve the oil and gas and petrochemical markets, the electric utility market, and commercial and other industrial markets.

Beyond these major markets, we also provide products and services to the light rail traction power market and other markets that include universities and government entities.

We are continuously developing new channels to electrical markets through original equipment manufacturers and distribution market channels.

For additional information on the markets we serve, see “Markets” in Part I, Item 1 of this Annual Report.

In Fiscal 2024, we reported revenues of $1.0 billion, net income of $149.8 million, and generated $108.7 million in cash from operating activities.

As of September 30, 2024, we had total assets of $928.2 million.

Our backlog was $1.3 billion as of September 30, 2024, of which approximately $849 million is expected to be recognized as revenue during our fiscal year ending September 30, 2025.

Although current commercial activity remains active in most of the markets that we compete in, we remain attentive to the macro environment and geopolitical events that may have an impact on future market activity.

Oil and gas and petrochemical markets.

Our order activity remains strong in these markets.

The North American market is responding to increased international demand for LNG and gas-to-chemical processes utilizing low-cost gas feedstocks.

We believe the fundamentals of the U.S.

natural gas market, through abundant supply and low cost, will continue to support investments in LNG, related gas processing, and petrochemical processes, and as a result, will continue to sustain our order activity associated with such markets.

In addition to the traditional crude oil refining and other oil and gas downstream processes, we have recently expanded our end markets into hydrogen production, carbon capture as well as alternative fuels, such as biofuels and sustainable aviation fuel, in response to the demand for clean energy.

Electric utility market.

Aligned with our strategy of end-market diversification, we seek to continue our focus and growth in electrical distribution substations, while also addressing a resurgence of power generation investment in this market.

Commercial and other industrial markets.

We have experienced strong growth in these end markets driven by a mix of factors including increased investment in commercial and light industrial facilities for the production of various goods, the expansion of data centers and cloud computing, as well as the growing demand in industrial applications to support new technologies driving the energy transition.

We are cautiously optimistic regarding the anticipated investment across AI applications that may drive data center growth and subsequently power generation demand.

Business Environment

The markets in which we participate are capital-intensive and cyclical in nature.

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Schedules may change during the course of any particular project, and our operating results can, therefore, be impacted by factors outside of our control.

Within the industrial sector, specifically oil, gas and petrochemical, the demand for our electrical distribution solutions is very cyclical and closely correlated to the level of capital expenditures of our end-user customers as well as prevailing global economic conditions.

The North American market is responding to increased international demand for LNG and gas-to-chemical processes utilizing low-cost gas feedstocks.

As a result, the business has been awarded a number of large LNG and petrochemical contracts that have had a positive impact on our backlog.

One element of our strategic focus is to strengthen our project portfolio beyond our core oil, gas and petrochemical end market sectors.

Diversification efforts outside of our core oil, gas and petrochemical end markets have resulted in an increase in backlog across the utility and commercial and other industrial sectors.

Over the past year, these efforts have contributed to a strong backlog of projects coming into Fiscal 2023 and near record levels going into Fiscal 2024.

Various factors resulting in global economic uncertainty negatively impacted our results over the previous two years.

Uncertainty and demand disruptions resulted in considerable volatility across commodity markets.

We experienced supply chain disruptions driven predominantly by availability and cost volatility across our raw materials, components and labor force.

All of these factors contributed to the lower margins realized in Fiscal 2022 relative to prior oil and gas cycles.

Commodity prices have stabilized in Fiscal 2023;

however, we continue to experience supply chain delays for specific engineered components and continue to work with our suppliers in order to meet our customer commitments.

Additionally, we have adjusted our product pricing, delivery schedules and bid validity dates with our customers in response to the increased cost environment and supply chain delays, and as a result our gross margins have been improved in Fiscal 2023.

Our operating results are impacted by several factors such as the timing of new order awards, project backlog, changes in project cost estimates, customer approval of final engineering specifications and delays in customer construction schedules, all of which contribute to short-term earnings variability and the timing of project execution.

Our operating results also have been, and may continue to be, impacted by the timing and resolution of change orders and the resolution of potential contract claims and liquidated damages, all of which could improve or deteriorate gross margins during the period in which these items are resolved with our customers.

Disruptions in the global supply chain have negatively impacted and may continue to negatively impact our business and operating results due to the limited supply of, delays for and uncertainty in the timing of the receipt of key component parts and commodities.

We continue to remain focused on the variables that impact our markets as well as cost management, labor availability and supply chain challenges.

We are subject to inflation, which can cause increases in our costs of labor, indirect expenses and raw materials, primarily copper, aluminum and steel.

Fixed-price contracts can limit our ability to pass these increases to our customers, thus negatively impacting our earnings and operations in future periods.

During Fiscal 2024, we experienced commodity price volatility, in addition to the ongoing supply chain delays for specific engineered components that have been persistent.

We are working closely with our suppliers to meet our customer commitments.

In response to the increased cost environment and supply chain challenges, we strive to effectively manage our product pricing, delivery schedules and bid validity dates with our customers, as well as improve factory efficiencies and project execution, and as a result our gross margins have been improved in Fiscal 2024.

Results of Operations

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Revenue and Gross Profit

Revenues increased by 31%, or $166.7 million, to $699.3 million in Fiscal 2023, primarily driven by the increase in project backlog resulting from a recovery of our core oil, gas and petrochemical markets.

Revenues increased by 45%, or $313.0 million, to $1.0 billion in Fiscal 2024, primarily driven by the increase in project backlog resulting from large contracts awarded during Fiscal 2023 and strong bookings throughout Fiscal 2024.

Domestic revenues increased by 52%, or $288.6 million, to $846.5 million in Fiscal 2024.

International revenues increased by 11%, or $13.8 million, to $141.4 million.

International revenues increased by 17%, or $24.5 million, to $165.8 million in Fiscal 2024.

Our international revenues include both revenues generated from our international facilities as well as revenues from export projects generated at our domestic facilities.

Revenue from our core oil and gas markets (excluding petrochemical) increased by 27%, or $57.9 million, to $273.1 million in Fiscal 2023, and petrochemical revenue increased by 42%, or $27.6 million, to $94.2 million in Fiscal 2023.

Revenue from our utility end markets increased by 29%, or $36.0 million, to $158.4 million in Fiscal 2023.

Commercial and other industrial market revenue increased by 84%, or $47.5 million, to $104.0 million driven by an increase in traditionally non-core markets such as data centers, university projects and other miscellaneous applications.

Revenue from all other markets combined increased by $14.5 million to $41.5 million in Fiscal 2023.

These increases in revenue were driven by improved market conditions and our strategic effort to diversify our business.

Revenue from our traction market decreased by 37%, or $16.8 million, to $28.1 million in Fiscal 2023.

In Fiscal 2024, revenue from our core oil and gas market (excluding petrochemical) increased by 53%, or $144.1 million, to $417.2 million in Fiscal 2024;

petrochemical market revenue increased by 97%, or $91.4 million, to $185.6 million;

revenue from our electric utility market increased by 18%, or $28.1 million, to $186.5 million;

commercial and other industrial market revenue increased by 44%, or $45.9 million, to $149.9 million;

and revenue from all other markets combined increased by 23%, or $9.6 million to $51.1 million.

These increases in revenue were driven by improved market conditions in most of our end markets, increased capital spending in our core oil, gas and petrochemical markets, as well as our strategic effort to expand our business into electric utility and commercial and other industrial markets.

Revenue from our light rail traction power market decreased by 22%, or $6.1 million, to $22.0 million in Fiscal 2024 due to less project volume in this market.

For additional information on the markets we serve, see “Markets” in Part I, Item 1 of this Annual Report.

Gross profit increased by 85%, or $125.5 million, to $273.1 million in Fiscal 2024.

Gross profit as a percentage of revenues increased to 21% in Fiscal 2023 as compared to 16% in the prior year.

This increase in gross profit was favorably impacted by the higher volume levels across the manufacturing facilities driving key factory efficiencies, strong project execution as well as, effectively managing product pricing that corresponds to current cost levels.

Additionally, project cancellations contributed $4.3 million to gross profit in Fiscal 2023.

Gross profit as a percentage of revenues increased to 27% in Fiscal 2024 as compared to 21% in Fiscal 2023.

This increase in gross profit is attributable to the higher volume levels across all of Powell's manufacturing facilities generating favorable volume leverage, strong project execution, and continuing effort to improve factory efficiencies while also managing product pricing that corresponds to current cost levels.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by 11%, or $8.0 million, to $78.8 million in Fiscal 2023, primarily due to increased variable performance-based compensation.

Selling, general and administrative expenses, as a percentage of revenues, decreased to 11% in Fiscal 2023, compared to 13% in Fiscal 2022, based upon leveraging our cost structure on the increase in revenues.

During Fiscal 2022 we recorded other income of $2.3 million related to a gain on the sale of a small, non-core, industrial valve repair and servicing business within our Canadian operations as well as the sale of an excess parcel of land in the U.S.

We did not record other income in Fiscal 2023.

Income Tax Provision (Benefit)

We recorded an income tax provision of $14.4 million in Fiscal 2023, resulting in an effective tax rate of 21%, compared to an income tax benefit of $3.9 million in Fiscal 2022 at an effective tax rate of negative 40%.

Selling, general and administrative expenses increased by 8%, or $6.1 million, to $84.9 million in Fiscal 2024, primarily due to increased compensation expense and higher spending on infrastructure improvements.

Selling, general and administrative expenses as a percentage of revenues decreased to 8% in Fiscal 2024, compared to 11% in Fiscal 2023, resulting from higher revenues on our existing cost structure.

Income Tax Provision

We recorded an income tax provision of $46.2 million in Fiscal 2024, resulting in an effective tax rate of 24%, compared to an income tax provision of $14.4 million in Fiscal 2023 at an effective tax rate of 21%.

In Fiscal 2024, the effective tax rate was favorably impacted by the estimated Research and Development (R&D) Tax Credit and tax benefits related to the vesting of restricted stock units.

These items were offset by state income tax expense, certain non-deductible items, and the tax impact of U.S.

global intangible income.

In Fiscal 2023, the effective tax rate approximated the U.S.

federal statutory rate.

The favorable impacts of the estimated Research and Development Tax Credit (R&D Tax Credit) and the release of the valuation allowance previously recorded against the U.K.

The favorable impacts of the estimated R&D Tax Credit and the release of the valuation allowance previously recorded against the U.K.

net deferred tax assets in the amount of $1.9 million were offset by state income tax expense, certain non-deductible items and the tax impact of U.S.

global intangible income.

In Fiscal 2022, the tax benefit primarily resulted from the release of the valuation allowance previously recorded against the Canadian net deferred tax assets in the amount of $5.9 million and the estimated R&D Tax Credit.

The tax benefit was partially offset by certain non-deductible items, the tax expense related to the gain on the disposition of a small, non-core division of our Canadian operations and the tax impact of U.S.

global intangible income.

In Fiscal 2024, we recorded net income of $149.8 million, or $12.29 per diluted share, compared to net income of $54.5 million, or $4.50 per diluted share in Fiscal 2023.

This increase in net income is primarily due to the increase in bookings which led to an increase in revenues coupled with increased project margins.

The order backlog at September 30, 2023 was $1.3 billion, a 118% increase from $592.2 million at September 30, 2022.

This increase in backlog is driven primarily from our oil and gas markets, including LNG, petrochemical, utility and commercial and other industrial markets.

Bookings, net of cancellations and scope reductions, increased by 94% in Fiscal 2023 to $1.4 billion, compared to $718.6 million in Fiscal 2022, primarily driven by continued strength from our core oil, gas and petrochemical markets, including several large LNG and petrochemical projects.

Recently we have seen a cyclical recovery across our core oil, gas and petrochemical markets combined with increased global demand for cleaner-burning fuels as well as related processes utilizing lower cost gas feedstocks.

Our order activity in most of our core markets has been strong and includes multiple large LNG and petrochemical projects.

This elevated project activity has increased our backlog to approximately $1.3 billion.

Diversification efforts outside of our core oil, gas and petrochemical end markets have also been a positive catalyst, helping to drive the increase in backlog.

This strong backlog of projects, which incorporates pricing and productivity initiatives in response to persistent inflationary pressures, should continue to support an increasing level of revenue into Fiscal 2024.

Approximately $648 million of the backlog is expected to be recognized as revenue within the next twelve months.

We do not anticipate our backlog will continue to grow at the same pace as we have recognized in the last twelve months, which included several large LNG and petrochemical projects booked throughout Fiscal 2023.

Disruptions in the global supply chain have, in the past, negatively impacted our business and operating results due to the limited availability resulting in uncertainty in the timing of the receipt of key component parts and commodities.

We continue to remain focused on the variables that impact our markets as well as cost management, labor availability and supply chain challenges.

This increase in net income is primarily due to higher revenues coupled with improved gross profit margins, as well as our disciplined cost structure.

The order backlog, which is our remaining unsatisfied performance obligations, represents the estimated transaction price for goods and services for which we have a material right, but work has not been performed.

The order backlog at September 30, 2024 was $1.3 billion, consistent with our backlog at September 30, 2023.

Bookings, net of cancellations and scope reductions, decreased by 24% in Fiscal 2024 to $1.1 billion, compared to $1.4 billion in Fiscal 2023.

Despite strong bookings in Fiscal 2024, the decrease in bookings was due to a normalization of the oil and gas sector with fewer large orders awarded in this sector during Fiscal 2024.

Liquidity and Capital Resources

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Cash, cash equivalents and short-term investments increased to $358.4 million at September 30, 2024, compared to $279.0 million at September 30, 2023.

The increase in cash, cash equivalents and short-term investments was primarily driven by the increased project volume and favorable timing of contract billing milestones on some of our large projects.

We typically allocate a significant percentage of the progress billing to the early stages of the contract.

These favorable billing milestones along with our increase in project backlog are the primary drivers for the increase at September 30, 2023.

We believe that our strong working capital position, available borrowings under our credit facility and available cash and cash equivalents should be sufficient to support our future operating activities, capital improvements and research and development initiatives for the foreseeable future.

On March 31, 2023, we entered into a second amendment (the Second Amendment) to our credit agreement with Bank of America, N.A.

This increase in cash, cash equivalents and short-term investments was primarily driven by our improved earnings due to increased project margins and volumes, partially offset by working capital allocated to projects in our order book, capital spending, as well as dividend payments.

We believe that our cash, cash equivalents and short-term investments, as well as available borrowings under our U.S.

credit facility, will be sufficient to support our future operating activities, working capital requirements, payment of dividends and capital spending, as well as research and development initiatives for the next twelve months and beyond.

On October 4, 2023, we entered into a third amendment (the Third Amendment) to our credit agreement with Bank of America, N.A.

(as amended, the U.S.

The Second Amendment increased the revolving credit facility, which is available for both borrowings and letters of credit from $75.0 million to $125.0 million.

As amended by the Second Amendment, the U.S.

Revolver states the lesser of $50 million or 50% of available cash may be deducted from the amount of letters of credit outstanding (not to be less than zero) when calculating the consolidated funded indebtedness, which is a component of the consolidated net leverage ratio.

We have the option to cash collateralize all or a portion of the letters of credit outstanding, which would favorably impact the consolidated funded indebtedness calculation and the consolidated net leverage ratio.

The Third Amendment which added Texas Capital Bank as Syndication Agent and a lender, increased the amount of the revolving line of credit from $125.0 million to $150.0 million, and extended the expiry date to October 4, 2028.

The aggregate commitment of $150.0 million consists of $100.0 million committed by Bank of America and $50.0 million committed by Texas Capital Bank.

As amended by the Third Amendment, the lesser of (a) $60 million, (b) 60% of available cash, and (c) the aggregate face amount of the issued but undrawn letters of credit that are not cash-secured shall be deducted from consolidated funded indebtedness, when calculating the consolidated net leverage ratio.

option to cash collateralize all or a portion of the letters of credit outstanding, which would favorably impact the consolidated funded indebtedness calculation and the consolidated net leverage ratio.

On June 26, 2024, in connection with the expected discontinuation of the publication of the Canadian Dollar Offered Rate (CDOR), we further amended the U.S.

Revolver by entering into a Canadian benchmark replacement conforming changes amendment with Bank of America, N.A.

that added and amended certain terms related to the replacement of the CDOR as a benchmark rate with the forward-looking term rate based on the Canadian Overnight Repo Rate Average.

On September 24, 2024, in connection with the expected discontinuation of the publication of the Bloomberg Short-Term Bank Yield Index Rate as administered by the Bloomberg Index Service Limited (BSBY), we further amended the U.S.

Revolver by entering into a conforming changes amendment with Bank of America, N.A.

that added and amended certain terms related to the replacement of the BSBY as a benchmark rate with the Secured Overnight Financing Rate (SOFR) as administered by the Federal Reserve Bank of New York.

As of September 30, 2024, there were no amounts borrowed under the U.S.

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Revolver as of September 30, 2024.

We are required to maintain certain financial covenants, the most significant of which are a

consolidated net leverage ratio of less than 3.0 to 1.0 and a consolidated interest coverage ratio of greater than 3.0 to 1.0.

Our most restrictive covenant, the consolidated net leverage ratio, is the ratio of earnings before interest, taxes, depreciation, amortization and stock-based compensation (EBITDAS) to funded indebtedness, which includes letters of credit.

An increase in indebtedness or a decrease in EBITDAS could restrict our ability to issue letters of credit or borrow under the U.S.

For further information regarding our debt, see Notes G and H of Notes to Consolidated Financial Statements.

On October 4, 2023, we entered into a third amendment to the U.S.

Revolver (the Third Amendment) with Bank of America, N.A., and Texas Capital Bank has agreed to join as an additional lender under the U.S.

The Third Amendment increased the amount of the revolving line of credit from $125.0 million to $150.0 million and extended the expiry date to October 4, 2028.

For further information regarding the Third Amendment, see Note G to Consolidated Financial Statements.

Approximately $77.7 million of our cash, cash equivalents and short-term investments at September 30, 2024 was held outside of the U.S.

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Operating Activities

Operating activities provided net cash of $182.6 million during Fiscal 2023 and used net cash of $3.6 million during Fiscal 2022.

Cash flow from operations is primarily influenced by the timing of milestone payments from our customers, project volume and the associated working capital requirements, as well as payment terms with our suppliers.

This increase in operating cash flow was primarily due to the increase in project volume and the favorable timing of contract billing milestones, although partially offset by the increases in accounts receivable and inventory.

Inventory has increased to support our increased backlog and stock levels to help mitigate global supply chain risks.

Operating activities provided net cash of $108.7 million during Fiscal 2024 and provided net cash of $182.6 million during Fiscal 2023.

Cash flow from operations is primarily influenced by project volume and margins, as well as working capital requirements, the timing of milestone payments from our customers, and payment terms with our suppliers.

The decrease in operating cash flow was primarily due to working capital impact as we allocate capital to the projects in the order book, partially offset by higher net income resulting from increased project volume and improved project margins.

Investing Activities

Investing activities used $26.6 million of cash during Fiscal 2023 compared to $6.5 million of cash provided in Fiscal 2022.

The increase in cash used in investing activities during Fiscal 2023 was primarily due to the timing of cash used to purchase short-term investments.

Investing activities used $21.9 million of cash during Fiscal 2024 and used $26.6 million in Fiscal 2023.

The decrease in cash used in investing activities during Fiscal 2024 was primarily due to lower net purchase of short-term investments, partially offset by higher capital spending on property, plant and equipment in Fiscal 2024.

During Fiscal 2024, our purchase of short-term investments was $9.7 million compared with net purchase of short-term investments of $18.8 million in Fiscal 2023.

In July 2024, we made a cash purchase of land and buildings in Houston, Texas for $5.6 million to help further facilitate executing the current backlog as well as planning for modest future volume growth.

In addition, we acquired intellectual property in December 2023 for a total consideration of $0.5 million, of which $250 thousand was paid in cash.

Financing Activities

Net cash used in financing activities was $13.1 million during Fiscal 2023 compared to $13.3 million during Fiscal 2022, which primarily consisted of approximately $12.4 million and $12.2 million of dividends paid in the respective years.

Net cash used in financing activities was $19.3 million during Fiscal 2024 compared to $13.1 million used during Fiscal 2023.

The increase in cash used in financing activities was primarily due to cash payments related to shares withheld in lieu of employee tax withholding, largely driven by the significant increase in our share price during Fiscal 2024 compared to Fiscal 2023.

Planned Capital Spending

We have planned capital spending of approximately $11 million on a facility expansion project at our products factory in Houston.

We expect to complete the expansion project by mid-Fiscal 2025.

We have spent $1.5 million on the expansion project in Fiscal 2024.

Other Commercial Commitments

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More than 3 years 1,064

Total long-term commercial obligations $ 96,681

Total commercial commitments $ 70,987

We also had surety bonds totaling $426.8 million that were outstanding at September 30, 2024.

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We had no significant off-balance sheet arrangements during the periods presented.

Effects of Inflation

We are subject to inflation, which can cause increases in our costs of labor, indirect expenses and raw materials, primarily copper, aluminum and steel.

Fixed-price contracts can limit our ability to pass these increases to our customers, thus negatively impacting our earnings and operations in future quarters and years.

Critical Accounting Estimates

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We evaluate our estimates on an ongoing basis, based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances.

There can be no assurance that actual results will not differ from those estimates.

There can be no assurance that actual results will be consistent with those estimates.

We believe the following accounting estimates to be critical in the preparation and reporting of our consolidated financial statements.

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We bear the risk of cost overruns in most of our contracts, which may result in reduced profits.

Whenever revisions of estimated contract costs and contract values indicate that the contract costs will exceed

estimated revenues, thus creating a loss, a provision for the total estimated loss is recorded in that period.

Whenever revisions of estimated contract costs and contract values indicate that the contract costs will exceed estimated revenues, thus creating a loss, a provision for the total estimated loss is recorded in that period.

See Note E of Notes to Consolidated Financial Statements for disclosures related to changes in contract estimates.

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What changed 10-K

Item 7. Management’s Discussion and Analysis