Hammond Power Solutions Inc.

Good morning, ladies and gentlemen. Welcome to Hammond Power Solutions third quarter 2024 financial results conference call. Certain statements that will be discussed in this conference call will constitute forward-looking statements. The forward-looking information in statements included in this discussion are not guarantees of future performance and should not be unduly relied 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 those anticipated and described in the forward-looking statements. Such information and statements involve 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 are not limited to, such things as the impact of general industry conditions, fluctuations of commodity prices, industry competition, availability of qualified personnel and management, stock market volatility, and timely and cost-effective access to sufficient capital from internal and external sources. The risks 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 no assurance that such expectations will prove to be correct. Accordingly, listeners should not place undue reliance upon any of the forward-looking information discussed in this call. I would now like to turn the call over to Adrian Thomas, CEO of Hammond Power Solutions. Please go ahead, Mr. Thomas.

Thank you, operator, and good morning, everyone. Welcome to Hammond Power Solutions' third quarter 2024 financial results conference call. Joining me today is Richard Ballering, our chief financial officer. Hammond Power Solutions has continued to make significant strides in progressing our strategic goals and developing capacity for the future. The tailwinds of electrification evident in the first half of the year have largely continued through the second half. We continue to see the electrification of our power systems, the reshoring of manufacturing to North America, support for the renewal and expansion of infrastructure, and the growing need for power and data to run our economies globally. Our continued confidence in The long-term demand of our products, combined with sustained project quotation activity, led us to announce an additional $20 million investment in our capital program in August. These investments will be made over the course of 2024 and 2025 to expand production in Mexico to build custom power transformers. The new facility will remove capacity bottlenecks by adding more than $100 million in revenue capacity to our custom product lines. The new factory is expected to be operational in early 2026. In parallel, we expanded our product portfolio with the acquisition of Micron Industries, which closed in the second week of October. The addition of Micron will improve our ability to serve US and North American customers from their facilities in the US, as well as provide us with access to a broader set of original equipment manufacturer customers, where we can look to expand our sales of power quality products and other products in our portfolio. Micron is highly aligned with Hammond Power Solutions as it has a strong reputation for high quality products and service and brings a wealth of relationships within our OEM markets. The Micron team also brings technical product innovation and a highly skilled labor force that will complement our custom and stock product offerings for future growth. To support these initiatives, we continue to expand our distributor sales channel in North America And consequently, our sales have shown a year-over-year growth of 6.9% compared to the third quarter of 2023 and a year-to-date growth of 10.9%. Booking momentum continued through the third quarter with an increase in backlog driven primarily by custom products related to project activity. We saw the product mix continue to shift towards custom products, a trend we've been experienced for several quarters now, mainly driven by the increasing activity in emerging sectors. In parallel, we saw a slower overall market for standard products in the United States, mainly driven by broad weakness in commercial construction and general industrial markets over the summer, which by some data points is down as much as 13% in 2024. This trend was prevalent throughout the quarter, resulting in slightly lower shipments as compared to the second quarter and is expected to continue into the fourth quarter. As anticipated, MESTA shipments began to gain momentum in the third quarter with a large induction heating order starting to ship. We continue to see power quality gain momentum with increased MESTA sales and strong quotation activity and active harmonic filters. Outside North America, Indian sales increased by 15% in the third quarter compared to prior year driven by domestic renewable shipments. With that, I would like to hand the call over to our Chief Financial Officer, Richard Ballering, to provide some context to our financial results. Richard?

Thank you, Adrian. As Adrian mentioned, we continued to post year-over-year sales growth in what was a challenging market for a large portion of 2024. Although we saw a softening of standard product in the third quarter versus the previous quarters in 2024, overall sales in the distribution channel were more resilient. mainly due to the relatively stronger configured and custom product sales. While U.S. sales continue to grow at a more subdued pace, sales in Canada, while also down slightly versus the second quarter of 2024, remain strong year over year. As with the two previous quarters, demand in Canada is being driven across a broad range of segments, including healthcare, data centers, public infrastructure, EV charging, mining, and utilities. Margins reached 33.8% in the quarter and 32.8% on a year-to-date basis. The increase in the quarter was mainly the result of a more favorable product mix, driven partially by the shift to more configured and custom products. Selling and distribution expenses were 10.5% of sales, down from 11% in the third quarter of 2023. General and administrative expenses, excluding share-based compensation, were 7.3% of sales, down from 7.6% in the third quarter of 2023. Share-based compensation in the quarter was $6.9 million, compared to $2.7 million in the third quarter of 2023. Adjusted EBITDA, which excludes the impact of foreign exchange gains and losses and share-based compensation, was at $34,377,000 in the quarter, or 17.9% of sales. which is up from the third quarter of 2023, which was at 14.3% of sales. It is also the highest quarterly adjusted EBITDA figure posted in 2024. The higher adjusted EBITDA is a result of higher gross margins and improved operating leverage. EPS in the quarter was $1.37 versus $1.21 in the third quarter of 2023. EPS improved despite the higher share-based compensation realized in the third quarter of 2024. Capital spending was at $13.5 million in the quarter and $30.9 million year-to-date. We continue to invest as planned in our previously announced capital expenditure program. Inventory increased in the quarter to $131 million, mainly due to the implementation of our new consolidated warehouse strategy and to a lesser degree due to slowing sales of stock product. Net cash at the end of the quarter was $32 million, and net working capital as a percentage of sales increased slightly to 17.6% on a sequential basis. Despite seeing slightly lower sales in the quarter versus the second quarter of 2024, we were pleased to see stronger margins due to product mix offset some of the shortfall. Our strength in providing custom products to our customers appears to have brought added value in terms of improved margins in the quarter. Thank you all for calling in this morning. I will now hand the call back to the operator for questions.

Thank you. As a reminder, if you would like to ask a question, please press star 11 on your telephone. You will then hear an automated message advising your hand is raised. If you would like to withdraw your question, please press star 11 again. We also ask that you wait for your name and company to be announced before you proceed with your question. One moment for the first question. And our first question for the day will be coming from Matthew Lee of CG. Please go ahead. Your line is open.

Hey, morning, guys. Thanks for taking my question. Maybe we can start on the demand side for standard transformers. I know the press release and you mentioned called out softness for commercial construction and industrial markets over the summer. But, you know, it feels like the U.S. economy has been pretty robust. So are there any specific items, you know, maybe the election or something else that are impacting overall demand right now in the U.S.? ?

Hey, Matt. It's Adrian. Thanks for the question. Yeah, I think if you remember back in quarter two, I mentioned we expected the market to be primarily the standard products go into what we term commercial construction and sort of light industrial, so things like warehousing, large commercial buildings, things of that nature. And so I think there's likely a number of contributors to that, potentially the election, potentially interest rates and people expecting interest rates to decline and maybe holding off before they start projects on that basis. So we were seeing some signs of that and we saw that continue through the summer. um yeah on the flip side we do see within the us different regions having activity uh why the regions are are less active and so i think you know just our broad coverage of the geography and our ability to participate in every market kind of allows us to uh to maintain um activity in that sector but um you know in contrast we're seeing the project markets uh particularly things like data centers and other sort of heavy industrial projects being fairly active, and you saw that in our makeshift to sort of custom versus standard.

Right. Okay, maybe a follow-up to that. I mean, you know, you're building out capacity for standard pretty meaningfully this year. You know, does this incremental slowdown in demand cause you any concern regarding the ramp-up of revenue or still in the capacity as it comes online? Yeah.

The capacity announcements that we've announced have been for large custom. So the new facility that we announced just recently in Monterey, that'll come online in early 2026, that's really to address large custom. We added some equipment for custom into Mexico as ready. The Monterey Tree, or the small products plant, that came on in June, That was a mix of planning for the future and reshoring. It is producing already, and we expect it will ramp up next year.

Okay, that's helpful. Thanks. I'll pass the line.

Thank you. One moment for the next question. And our next question will be coming from Rupert Mayer of National Bank. Your line is open.

Hello, good morning, everyone. In your comments, it sounds like the lower construction activity and standard product sales are partly related to seasonality. I'm wondering if you can talk to us about how we should think about the seasonality in the business.

So I think it's a little hard to tell because the trajectory has been for the most part upward over the past three years. How much of that decrease was due to seasonality is, I think it's difficult to say, Rupert. I think it's probably more driven by more general economic trends than seasonality. Now, having said that, over the past few years, the fourth quarter sales have been typically stronger. So we'll have to see how that bears out in the fourth quarter.

Are those trends continuing into the fourth quarter so far with the first month done?

well uh it's still a little early to say um to be honest and i think i think that probably the best thing to do is just to sort of try to keep an eye on some of the metrics that we're seeing coming out for the uh you know for the economy more broadly you know things like commercial construction industrial investment i think right now should track it should track reasonably uh well with those elements

So offsetting that loss of momentum, you did talk about the strength in the custom products, but also some comments on growing distribution channels. I'm wondering how much growth can you see in your distribution network and how much more market share do you think you can take in the standard products in the U.S. over the coming quarters?

So as you know, we talked for some time about adding distributors and branches. And so when you do that, there is a ramp up time. So getting the branch familiar with your products, training salespeople, ramping in products. So a bulk of the work here is growing what I would say in branch sales at the people that we have onboarded. And so we Despite economic conditions, we would expect those in-branch proportion of spend to increase as we ramp them up onto our product lines.

Okay, so still a focus to grow that distribution network. Very much.

We still believe that there's opportunity to grow distribution sales in the U.S.

So looking at the custom products, products and the backlog. You've got some strength there. Backlog's up 4% quarter over quarter. As you grow, as you add capacity for custom products, do we anticipate we should see a lower backlog as you reduce lead times? And as a follow-up to that, how much market share do you think you're losing because of long lead times? How much business do you think you can capture by shrinking lead times?

Multiple questions there, Rupert. So if you think about backlog, I guess we think about good backlog and bad backlog. So good backlog is customers that have entrusted us with projects and the delivery is out in the future. And then there's bad backlog, which is customers needing products faster than we can get it to them. From that end, with our capacity increases, what we've been doing is reduce the amount of bad backlog in our system. We do believe that there's customers that need products faster, particularly OEMs. And so we've been focused on these new capacity additions to help serve them better. And we do believe that their sales are related to how fast they can get their products into the industry. So we do think that's impacting some of our order rates, particularly in sort of the OEM business, less so in the commercial project business only because there's other supply chain bottlenecks. Did I answer all your questions?

I was just wondering then, as you add capacity, that backlog number should come down, I imagine. Is that a fair comment? Yeah. And how much more... or how much business do you think you are losing today because you don't have that capacity when you need it?

I wouldn't be able to quantify a number, but again, I would say we believe we have the ability to be more competitive with faster lead times on the OEM business, so I think that's where we'll see gains, and I think we have seen some declines in that. I think out of lead time competitiveness, on the large, longer cycle projects we don't think is affecting us.

Very good. I'll get back to you. Thank you.

Thank you, Rupert.

Thank you. One moment for the next question. And our next question will be coming from Jim Byrne of Ackerman Capital. Your line is open.

Yeah, good morning, guys. Just maybe an update on the MESTA plant expansion. You highlighted MESTA was starting to ramp up in terms of sales, but maybe just give us an idea of how that expansion is going and that the MESTA sales should kind of reach back to more normal levels in the next few quarters.

Yeah, so we're happy to see that activity, and I think we believe that there is more opportunity certainly for power quality and the equipment that we build in MESTA. We do have, even without the expanded factory footprint, we do have the opportunity to add labor and ships, so there's no near-term constraint on capacity in MESTA. Long-term, we've had some delays. with permitting and engineering. So we're looking at the schedule there, but we don't expect that to have any impact in terms of what we can produce this year and next year in accordance with demands.

Okay, and then when we think about kind of the overall sales capacity, I know, I can't remember if it was before this $20 million announcement or the previous $20 million, you would hope to get to kind of 900-ish by sort of the end of 2025. I mean, is that still the right number in terms of an annual run rate in the timeline around that? I mean, you mentioned the $100 million expansion in Mexico by early 2026. So, I mean, does that get us to the billion-dollar run rate in early 2026? Is that kind of what we should be thinking about?

Hi, Jim. It's Richard, and yes, that last statement is correct. So with this last tranche of investment that we just announced for large custom power, late 2025, early 2026, that should take us over a billion dollars.

Okay, perfect. And then maybe one for you, Richard. The gross margins continues to show strength. you know, is this where you anticipate them to be now, you know, around that 34% range, or is this still kind of abnormally high?

Yeah, a little higher than we were expecting, Jim. I think, you know, I mean, the reason I think it's the most part is just because it makes this change. And those standard products that are more price sensitive than the less common items. And when I say less common, I mean configured products, custom products, but also some of the B and C items that are stocked items. They typically have higher margins. So that's what's really driving those margins. So, yeah, a little higher than we were anticipating because we weren't anticipating that kind of a shift.

Okay. So, if we kind of think then that, you know, the slowdown or the softer demand on the standard product will continue for the next quarter or two, then the upside and margins, I guess, is maybe sustained for the next short period, you know, one or two quarters, then we should maybe think of this higher range.

Yeah, I think if all other things being equal, the answer to that would be yes. I think the piece that we don't know is for those more price-sensitive SOC items, what does the future hold for that in the short term? And so that could potentially lead to some margin compression on certain products. So I just think you need to keep that in the back of your head as well.

Okay, that's it for me. Thanks, guys.

Thank you. As a reminder, if you would like to ask a question, please press star 1-1 on your telephone. And at this time, one moment, please. There's one more follow-up from Rupert. One moment. There's a follow-up question from Rupert Mayer from National Bank. Please go ahead.

Thank you. I'm wondering if you can give us an update on the M&A market. So you have talked about being interested in acquiring more power quality companies. Can you talk about how your pipeline may have changed over the last few months and what the outlook is for further consolidation in this market?

I guess what I can say, Rupert, is we continue to be active. We have a desire to build out that portfolio. As I think I've shared before, we see it generally fragmented across North America. We're looking beyond North America for opportunities to get the right technologies so that we can build up that portfolio. So I guess the short answer is it continues to be active. And when we have news, we'd be happy to share it.

All right. Very good. Thank you. I'll leave it there. Thank you. One moment for the next question. And our next question is going to come from Matthew Lee of Fiji. Your line is open.

Hey, thanks. Me again. Maybe just a question on the storm that you're seeing in the southeast U.S. that's taking a lot of the electrical infrastructure. Does that drive an increase in demand for transformers when they replace things that are damaged? And, you know, are you seeing any of that blow through your demand?

So, great question, Matt. And I don't know, I read something or I saw that Florida has something like 55,000 line workers stationed there to support reconnecting power after the storm went through. And I think that's like almost half the line workers in the US or something. I think what we'll see is there will be sort of a stage one, which is sort of emergency rebuilds, and then there's sort of stage two, which is a longer rebuild, and that longer rebuild takes some time. But I think it will create construction activity in Florida, but it'll take some time because there will be first the cleanup, and then there will be the construction projects, and they'll follow for the most part. the sort of timelines of construction projects. So I think it will, but it'll be a little bit more drawn out versus what you might expect. And we're doing what we can with our partners there to make sure that there's stock available for people that need to get running. So doing what we can to support the region. But I think what you'll see is a small blip in emergency rebuild and then a longer term sort of structured rebuild.

That's helpful. And then maybe any type of commentary you're seeing from the distributors, your customers on 2025 demand. I mean, are they pretty optimistic about demand bouncing back post-election as rates come down or, you know, any type of commentary that would be helpful?

So this is anecdotal from different distributors I've spoken to. I think there's an expectation that... You know, regardless of who gets into the White House, once the election is over, it'll create some stability. There's excitement, I would say, over lowering interest rates that they expect as for construction. So I would say there's a cautious optimism for 2025. And, you know, they saw, and we saw it in some of the public disclosures, but we saw it from talking with our distributors as well. They saw similar sort of general construction declines in Q3 that we saw. So it seems to be a pretty broad market scenario. And they're, I would say, cautiously optimistic for 2025.

That's helpful. Thanks.

Thank you. And one moment, please, for the next question. And we have a follow-up question that is coming from Jim Byrne of Acumen Capital. Your line is open.

Yeah, thanks, guys. Maybe just talk about India briefly, if you wouldn't mind. Just what are you seeing in market conditions there? Obviously, numbers were up in the quarter, but maybe just kind of the short to medium view of demand in that market.

So, as we progress in India, we've been focused on certain key sectors or dynamics, which is renewables, export market, supporting our global OEMs and services work. And that was really our focus on prioritizing profitability in India over sales. So, we continue to follow that strategy. We saw some good uptick in renewables. In India, we still see renewable activity fairly active there, which is a positive sign for the products that we make there. So we'll continue to manage that business to be accretive, Jim, and I think we're in sectors that we do expect to grow over time.

Okay, that's great. Thanks, guys.

Thank you. And now I would like to go ahead and turn the call back over to Adrian for closing remarks. Please go ahead.

Thank you, operator.

Human Power Solutions is a leading enabler in the global push for electrification, global urgency to limit climate impact through electrification, combined with the need for electricity to support the world's growing need for power and data are driving significant tailwinds benefiting our business. And I look forward to updating all of you on our full year 2024 progress early next year. Thank you.

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