Hammond Power Solutions Inc. (HPSA) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Hammond Power Solutions 2023 First Quarter Financial Results Conference Call. Certain statements that will be discussed in the conference call will constitute forward-looking statements. The forward-looking information and statements included in this discussion are not guarantees of future performance and should not unduly rely upon. Forward-looking statements will be based on current expectations, estimates and projections that involve a number of risks and uncertainties, which could cause actual results to differ materially from the anticipated and described in the forward-looking statements. Such information and statements involved known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated in such forward-looking information and statements. These factors include, but not limited to, such things as the impact of general industry conditions, fluctuations of commodity prices, industry competitions, availability of qualified personnel and management, stock market volatility and mostly in cost-effective assets to sufficient capital from internal and external resources. The risk [ just outlined ] should not be construed as exhaustive. Although management of the company believes that the expectations reflected in such forward-looking statements are reasonable, it can give an assurance that such expectations will prove to have been correct. Accordingly, listeners should not place undue reliance upon any forward-looking statements information discussed in the call. I would now like to turn the call over to Bill Hammond, Chairman and CEO of Hammond Power Solutions. Please go ahead, Mr. Hammond.

Thank you, operator, and good morning to everyone. Welcome to Hammond Power Solutions First Quarter Financial Results Conference Call for 2023. Joining me today is Richard Vollering, our Chief Financial Officer. For today's call, I'll start out with some high-level commentary on the quarter and our business. From there, I will hand it over to Richard for a review of our first quarter results and financial highlights, after which I'll outline what we expect for the balance of 2023 before turning it over to the analysts for any questions. A month-and-a-half ago, we reported we had finished the year with very strong results. I am pleased today to report that the tailwinds we benefited from in 2022 have been strong to start 2023, and we see them persisting for the balance of the year. Sales and profits are both higher as our business continues to experience growth in our key markets here in North America and in India. We are experiencing the combination of a favorable product mix and high factory utilization, which both drive gross margins to industry-leading levels within the transformer market. Our biggest growth engine in the quarter has been our U.S. distributor channel. Quotation activity is up significantly over both Q4 and the same quarter a year ago. Our booking rates remain high as diverse markets like renewable power generation, EV recharging, energy storage, data center construction, silica chip manufacturing, industrial expansions, power quality and institutional projects like hospitals and industrial buildings drive our year-over-year growth. The expansion of our U.S. and Mexican distributor networks continues with the addition of new distributors and more branches, which we expect will contribute to our growing distributor platform and provide further growth opportunities in the months and years ahead. Turning to our Indian operations. We continue to see increased volumes and delivered a record first quarter. We continue to see expansion in our domestic business in industrial sectors like cement manufacturing, food and beverage, pharmaceuticals, steel production, marine power, hospitals and solar power generation. As we announced late last year, we are in the process of planning and executing a significant expansion of our production capacities throughout North America. This additional $40 million will be deployed over the next 2 years and will add capacity to accommodate sales growth of $250 million over the next 5 years. These investments are being made in both existing plants as well as construction of a new manufacturing facility to build small products in Mexico. Our expansion program started late last year, and we are already benefiting from those early investments. In addition to giving us the capacity to be more aggressive in growing our business and market share, it will also allow us to reduce our lead times and improve service to our OEMs and distributors. I will now hand the call over to Richard to provide details on our financial progress. Richard?

Thank you, Bill, and good morning, everyone. We achieved a new record of $171 million in sales in the first quarter, which is 34% higher than the first quarter of 2022. Sales were higher in part due to the recognition of shipments from India produced and shipped in 2022 and by the stronger U.S. dollar. Excluding these items, sales were approximately 22% higher than Q1 2022. Of that increase, we estimate that 9% is due to organic growth. The sales increase was mainly driven by growth in the U.S. distribution channel, but we also saw growth in our OEM, private label, LatAm, Mesta and India businesses. We saw a small decline in Canada, mainly attributable to the timing of shipments and the fact that the Canadian market has generally been weaker than that of the U.S. Gross margins were 32% in the quarter versus 29% in the first quarter of 2022. We attribute these strong margins to high factory throughput, a favorable product mix as well as the lingering effects of last year's price increases. Selling and delivery expenses were higher in Q1 2023 due to higher freight and commissions as a result of the higher volumes. General and administrative expenses were primarily higher due to the effect of the higher share price on long-term incentive programs. EBITDA in the quarter was $24,145 or 14% of sales compared to $14,458 or 11% of sales in the first quarter of 2022. Net income in the quarter was $15,726 million, and the earnings per share were $1.32, an increase of 83% versus the Q1 2022 EPS of $0.72. Our net cash position fell to $7.1 million in the quarter, mainly due to higher working capital requirements as a result of shipments in invoicing being weighted towards the end of the quarter. Capital expenditures were $2 million in the quarter, which we expect to ramp up during the course of 2023 as we add capacity. We have started 2023 off on the right foot with strong sales and margins and sustained demand. The growth in the quarter was across a number of channels, products and geographies, and we believe that this diverse sales profile, along with prudent price and supply chain management and improving execution in terms of service levels have all combined to produce these strong results. Thank you.

Thanks, Richard. In closing, quotation activity, improving bookings and increasing backlog look to extend their strong run into at least the back half of 2023. Looking ahead, HPS remains cautiously optimistic for the future as there are many macroeconomic trends favoring the electrical industry, including onshoring, investment in renewable energy, infrastructure, electrical vehicle charging, semiconductor production and natural resources, all of which the company participates in. Tempering this optimism is the possibility of a general economic decline as a result of rapidly rising interest rates, which could affect one or more of the factors noted above. We believe our market-leading products and service, our customer and geographic diversification provide a competitive advantage in all market conditions. Thank you, and I will now turn the call over to the operator to take questions. Operator, please.

[Operator Instructions] Our first question comes from the line of Matthew Lee of Canaccord.

I wanted to start on the Canadian side. Obviously, there is some capacity issues according to the [ part of ] a year ago. Are you [ saying that ] to be made up in Q2 like you've done in India? Or is there just generally demand [ witnessing ] in the Canadian market relative to last year?

Matt, Richard here. Yes, I think it's a bit of both of those things. I think a lot of it was really just due to the timing of shipments. It's not as if we've seen any severe drop-off in bookings in Canada. But I would say, generally speaking, Canada hasn't been as quite as strong as the U.S. So I think from our perspective, it's really just something to keep an eye on, but I don't think we see that as a significant threat going forward.

Do you still expect the Canadian market to see year-over-year growth in 2023?

Modest growth, yes.

Okay. Great. And then when you think about the run rate in the U.S. business, you reached $100 million in the quarter for the first time this quarter. Is that range kind of sustainable given your improved channel distribution, just assuming no pullback in FX?

Yes. I mean I think -- I mean even now, I think demand is remaining strong. And yes, I mean, I think as we've talked about a lot in the past, it is an area that we've been focused on growing. And we still think we have opportunities there to grow in terms of adding distributors. Bill, if you want to add anything to that.

Yes, Matthew. We believe that the additional capacity that we are in process of putting in place will allow us to be more aggressive in terms of going after business that we may have shied away from because we're trying to support a number of strategic pillars as well as, I would say, traditional customers and markets. So we're quite confident that, a, the trends that we referred to will continue to fuel our growth. And we believe that if we can reduce our lead times and improve our service in terms of service from the largest inventories of dry transformers in North America that we'll be able to not only continue our positive trends but also continue to take market share in a number of areas in terms of through the distributor business at the OEM level as well as private label. So we're cautiously confident at this point in time. We're obviously mindful of what's happening with the U.S. banking industry and things like that. But again, as we've said, we believe that the diversification that we have in terms of geography, channels and markets will help us even if things slow.

Okay. Great. And then maybe just one more for me. In your [ kind of ] commentary, you kind of mentioned SG&A growth relating to strategic investment. Can you just kind of help us understand what type of investments are included under that umbrella?

Yes, that would include things like the Mesta acquisition, which obviously comes with -- so on SG&A, we've been investing in the Mexican market in terms of sales resources, trying to build the business out there. So those are sort of the 2 key ones as well as some other sort of internal things. We've been focused on our learning and development programs internally. We've been focused on our -- improving our ERP system so that we can run our business effectively as we scale up.

Our next question comes from the line of Jim Byrne of Acumen.

Richard, maybe just one for you on the gross margin. It's obviously been very strong in the last couple of quarters. It seemed to me they're kind of running well ahead of, I think, the 28%, 29% number that you've talked about in the past. Is this kind of the potential new run rate we should expect going forward? Or what do you think about on the gross margin side?

Yes, in the short term, I think we believe that's the case. And we think that's the case because we -- as I mentioned, we'll still benefit from some of the lingering effects of the price increases. Demand remains strong. So as I said in the short term, we believe that's true. Looking out to 2024. There might be some factors that caused them to moderate back into that 27% to 30% range. And one, of course, is the prospect of a recession and a resulting pullback in demand. Of course, that's still a little bit foggy for us, but we'll see what happens. And then the second is that factory utilization should decline as we expand to support future growth. And of course, longer term, offsetting this is the higher volume we'll be able to achieve and to focus on our higher-margin businesses like induction heating, which should help the overall margin increase over time.

Okay. That's great. And then maybe just back on some of the capacity constraints. You mentioned the Canadian side is kind of constrained at these levels of sales. You said you're seeing some improvements. Can you kind of either quantify that or where are those capacity improvements starting, I guess, here in the second quarter?

So we've got our key investments. And I'll just remind everybody that the 2 sort of broad groupings of investments that we're looking at is, are one buying machinery and equipment to fill in the existing bricks and mortar. And the second is building new facilities, one in Mexico and then expanding our Mesta facility. So in the first category, by machinery and equipment, that can happen fairly quickly. And we expect that to start to take effect in the second quarter. And that will help our facility here in Guelph, as well as our Mexican facilities in the short term. Longer term, with the new factory in Mexico and the Mesta expansion, we won't really see the benefits of those until 2024, but the middle of 2024.

All right. That's great. Richard, and maybe just last one on, you mentioned the dramatic increase in AR. Is that nothing unusual there? Do you expect that to come back to you in the next couple of quarters?

Yes. Yes, that's -- I don't think there's anything really concerning there. It was really just the timing of a lot of the shipments and invoicing in the quarter. It's just very back-end weighted at all.