Power Solutions International, Inc. (PSIX) Earnings Call Transcript

Good afternoon and welcome to Power Solutions International second quarter 2026 earnings conference call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to hand the conference over to [ Ken Janke ], VP, Corporate Controller, PSI. Sir, please go ahead.

Good afternoon and welcome to Power Solutions International's second quarter 2026 earnings conference call. I'm [ Ken Janke ], Vice President and Corporate Controller. And joining me today is Kenneth Lee, our Interim Chief Executive Officer and Chief Financial Officer. Before we begin, I would like to remind everyone that today's prepared remarks and responses to questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions, speak only as of today, and are subject to risks and uncertainties that could cause actual results to differ materially. Important factors include the timing and ultimate conversion of power systems orders into revenue, including data center-related orders, quarterly variability in product mix, and the corresponding effect on gross profit and gross margin. The cost, pace, throughput, and operational outcomes of capacity ramp-up activities at our Wisconsin operations' ability to execute operational improvement initiatives, the level and persistence of customer demand, including demand conditions in the oil and gas end market, supply chain and component availability, integration of recent acquisitions, including MTL Manufacturing and Equipment, macroeconomic, regulatory, and trade conditions, including U.S. tariffs and trade restrictions, changes in management or other personnel, and the outcome of pending or threatened litigation and other legal or regulatory matters. Additional information concerning factors that could cause actual results to differ materially is contained in the cautionary language in today's earnings release and in the factors and other cautionary disclosures in our most recent Form 10-K, subsequent 10-Qs, and other SEC filings. Those disclosures are incorporated by reference for purposes of today's call and are available in the Investor Relations section of our website and at sec.gov. We undertake no obligation to update any forward-looking statements except as required by law. We will also reference certain non-GAAP financial measures. EBITDA margin represents EBITDA as a percentage of net sales. A definition of EBITDA and a reconciliation to net income appear in today's earnings release, which is available in the Investor Relations section of our website. With that, I will turn the call over to Ken.

Thank you, [ Ken ], and good afternoon, everyone. Thank you for joining us. Before we review the second quarter results, I would like to briefly address the leadership transition we announced on July 27. Richard Hu will become PSI's Chief Executive Officer on August 17. Richard brings more than 25 years of global industrial leadership experience, including 6 years at BorgWarner, most recently as Vice President and General Manager of the Americas region for its Turbo and Thermal Technologies business units, where he led a multi-billion dollar operation and a global team of approximately 3,900 employees across the United States, Mexico, and Brazil. We look forward to welcoming him and working with him as PSI continues to execute its strategy. I will continue to serve as Interim Chief Executive Officer until Richard begins and will continue as Chief Financial Officer following the transition. Now, let me turn to our second quarter results. 2Q financials. Before I walk through the detailed financials, I want to briefly review the quarter. On a sequential basis, the second quarter showed a meaningful improvement in several key metrics. Sales of $152.5 million increased 18.6% from the first quarter, and the gross margin improved approximately 420 basis points to 27.1% from 22.9%. The gross margin improvements reflect in part the early benefits of ongoing operational improvement efforts in Wisconsin and was partially offset by unfavorable product mix. The strong operating cash flow also enabled us to reduce total debt by approximately $38.8 million during the quarter. Compared to the second quarter of 2025, net sales reflects the timing of certain power systems shipments and the softened demand in our oil and gas business. Gross margin reflects a lower mix of oil and gas products, together with elevated production costs associated with capacity ramp-up activities at our Wisconsin operations. Year-over-year comparisons in net income were also significantly affected by a non-recurring $29.2 million, or $1.27 per diluted share, tax benefit in the prior year period, related to the release of a valuation allowance. Demand for our data center power solutions remains strong. Based on our current production schedule, we expect the second half 2026 sales to exceed the first half 2026 sales as larger power systems orders move into production. Although shipment timing and quarterly results may vary. The remainder of our remarks will cover results by end markets, gross margin drivers, operating expenses, cash flow and balance sheet, and updates on MTL and our outlook. Net sales for the second quarter of 2026 were $152.5 million, a decrease of $39.4 million, or 21%, compared to the second quarter of 2025. Sequentially, sales increased 18.6% from the first quarter of 2026, exceeding our prior expectation that the second quarter revenue would be generally consistent with the first quarter. The year-over-year decrease was primarily driven by lower sales of $34.6 million in the power systems end markets, $3.0 million in the industrial end markets, and $1.7 million in the transportation end markets. Within our power systems end markets, the year-over-year decline primarily reflects the uneven order patterns and the shipment timing for data center-related products, together with continued softness in our oil and gas business. We continue to see strong demand for our data center power solutions, and based on our current production schedule, we expect the second half of 2026 sales to exceed the first half of 2026 sales as larger power systems orders move into production and are recognized as revenue. At the same time, the timing and ultimate volume of revenue recognized from that demand remains subject to customer scheduling, manufacturing flow paths, supply chain factors, and other variables, and we are not predicting any specific level of data center revenue in any future period. Gross profit for the second quarter of 2026 was $41.4 million, compared to $54.1 million in the second quarter of 2025. Gross margin was 27.1% in the quarter, compared to 28.2% in the prior year period. On a sequential basis, gross margin improved approximately 420 basis points from 22.9% in the first quarter to 27.1% in the second quarter. The improvements reflect in part the early benefits of our ongoing operational improvement efforts in Wisconsin, and was partially offset by unfavorable product mix in the quarter. Encouraged by that progress, for the first half of 2026, gross margin was 25.2%. I want to be clear about the outlook on gross margin. Our capacity ramp-up activities in Wisconsin are continuing, and we expect elevated production costs to persist. The trajectory of any future sequential improvements will depend on product mix, flow paths, and other operational factors. We are not providing a specific gross margin outlook for 2026 at this time. Over the longer term, our goal is to focus on business opportunities that can support gross margin at or around the 25% level. Research and development expenses were $5.1 million in the second quarter, compared to $4.6 million in the prior year period. The increase was primarily driven by higher R&D program expenditures to support new programs in 2026 and the recovery of R&D costs from certain customers in 2025. Selling, general and administrative expenses were $12.1 million in the second quarter, a decrease of $4.6 million, or 27%, compared to the second quarter of 2025. The decrease was primarily attributable to lower compensation expense related to the revaluation of previously awarded stock appreciation rights, as well as lower costs associated with employee incentive programs, partially offset by incremental selling and administrative expenses associated with MTL Manufacturing and Equipment. Total operating expenses were $17.4 million in the quarter. Operating income was $23.9 million compared to $32.5 million in the second quarter of 2025. Interest expense was $1.6 million in the second quarter, compared to $1.7 million in the prior year period, reflecting lower overall effective interest rates. Income tax expense was $5.6 million in the second quarter of 2026, compared to an income tax benefit of $20.1 million in the prior year period. As noted at the outset, the prior year second quarter included a $29.2 million, or $1.27 per diluted share, non-recurring tax benefit, related to the release of a valuation allowance on deferred tax assets. That one-time benefit is the primary driver of the significant year-over-year difference in net income, and investors should keep that context in mind when reading the year-over-year comparison. Net income was $16.9 million, or $0.73 per diluted share in the second quarter of 2026, compared to net income of $51.2 million, or $2.22 per diluted share in the second quarter of 2025. On a sequential basis, net income increased $9.6 million and diluted earnings per share more than doubled from the first quarter. EBITDA for the second quarter was $25.7 million, compared to $34.1 million in the prior year. EBITDA margin was 16.9% compared to 17.8% in the prior year period. On a sequential basis, EBITDA nearly doubled from $13.2 million in the first quarter, while EBITDA margin improved 670 basis points from 10.2% to 16.9%. The sequential increase reflects the higher sales and gross profit in the second quarter, together with lower operating expenses. Turning to cash flow, we generated $56.6 million of operating cash flow in the second quarter, compared to $20.2 million in the prior year period. For the first half of 2026, operating cash flow was $75.7 million, compared to $25.5 million in the first half of 2025, with favorable working capital movements and operating improvements contributing to the year-over-year increase. Capital expenditures were $0.8 million in the second quarter and $2.7 million for the first half of the year. Strong cash flow enabled us to reduce total debt by approximately $38.8 million during the quarter. We ended the second quarter with $70.1 million in cash and cash equivalents, and total debt of approximately $72.6 million, including a $65 million draw on our revolving credit facility. Total debt was approximately $103.4 million as of March 31, 2026. As of December 31, 2025, cash and cash equivalents were $41.3 million, and total debt was approximately $96.6 million. Our balance sheet is solid and we believe our current liquidity position is sufficient to meet our anticipated cash needs. MTL updates. On January 9, 2026, we acquired MTL Manufacturing and Equipment Inc. MTL's operations contributed positively to our consolidated net income in the second quarter. The acquisition expanded PSI's vertical integration by adding in-house manufacturing capabilities for components used in power generation products, including fuel tanks and enclosure assemblies. We believe these capabilities will enhance supply chain control and manufacturing flexibility and support our future growth. 2026 outlook. Given ongoing variability in order timing and market conditions, we are not providing formal full-year guidance at this time. Based on our current production schedule and information available as of today, we expect the second half 2026 sales to exceed the first half 2026 sales and to be approximately in line with sales in the second half of 2025 as larger power systems orders move into production and are recognized as revenue. The timing and ultimate volume of these shipments remain subject to customer scheduling, manufacturing flow paths, supply chain factors, and other variables, and there can be no assurance that those orders will translate to a uniformly strong second half. Continued softness in oil and gas end markets is expected to weigh on quarterly revenue trends. Capacity ramp-up activities at our Wisconsin operations, and the related cost effects on gross margin are expected to continue. Key takeaways. Let me close our prepared remarks with 3 key takeaways from the second quarter. First, we delivered a meaningful sequential improvement in revenue and gross margin. With sales up 18.6% from the first quarter and gross margin improved approximately 420 basis points. The gross margin improvements reflect in part the early benefits of ongoing operational improvement efforts in Wisconsin, although capacity ramp-up activities and elevated costs continue. Second, our financial position is stronger. Operating cash flow of $56.6 million in the quarter enabled us to reduce total debt by approximately $38.8 million. We ended the quarter with roughly balanced cash and debt and increased financial flexibility to support our growth. Third, demand for our data center power solutions remains strong. Based on our current production schedule, we expect the second half of 2026 sales to exceed the first half of 2026 sales as larger power system orders move into production. Although shipment timing and quarterly results may vary, we remain focused on operational execution and converting that demand into revenue. With that operator, we are ready to open the line for questions.

[Operator Instructions] Our first question comes from the line of Eric Stine with Craig-Hallum Capital Group. Your line is open. Please go ahead.

Maybe we could just talk a little bit more in depth about Q2. I mean, clearly it came in ahead of your internal projections. So maybe some clarity, because you still got softness in oil and gas, how far you are through the ramp in the enclosure business. And I would guess that goes hand in hand with the gross margin improvement, which is a level that we haven't seen in several quarters and is a level that you achieved back when oil and gas was strong and it's your highest margin business. So I'm just trying to get my arms around how that improvement came about in Q2, both revenues and margins.

Yes, [ Alex ], thanks for the question. So if you compare the Q2 sales, $152 million versus Q1, $128 million, the total increase is about $24 million. And I would say most of the increase is from the power systems. And definitely the Wisconsin operation increased the production and the sales. And if you look back at the past performance, we started to have some challenges ahead on Wisconsin operations second half last year. And our gross margin last year was like 23.9%, same for last year, 21.9%. And the 1Q we made it to 22.9%. So since then we implemented various operation improvements initiatives in Wisconsin and we see improvements in productivity, efficiency, flow paths, and also material availability, which enables us to increase the production and also sales for enclosures. And also, when we produce more, it has positive impacts on the fixed cost absorption. So definitely, Wisconsin gross margin is also improving. So all of these focus helped us to deliver a quiet improvement in the second quarter. But going forward, we continue to see, I would say, softness in the oil and gas. We're not seeing any sign for significant improvement. But we do have some larger custom orders for the AI data center product. And the team is working on transforming the order into production and sales. So we expect the second half sales will exceed the first half. And our internal expectation is the second half will be consistent with the second half last year. But our sales team is working closely with our customer to generate more sales initiatives and supply chain to make sure on-time delivery and material availability. So we are doing our best to increase or improve sales in the second half, and we try to exceed our expectation.

And then maybe, I guess, for my follow-up, just more on the competitive front in that data center enclosure business. And frankly, this is a question that I've been getting increasingly from investors, shareholders, and not. And that is, I know that you got Generac and they're using the Baudouin engines, and clearly that's a Weichai engine, but you got PSI also uses a Weichai engine. So I'm just kind of curious if you can speak to the differences between what is being used by you and your competitors in terms of size, price and performance. And I am also curious what that means for your future product roadmap.

Yes, we serve different customers, right? Weichai engine, Baudouin, they sell the engine gensets to Generac, and we sell to a different customer. And I, frankly, I'm not so clear which type of engine gensets. But I think there's some difference. And we deal with different customers. We work with our customers very closely. As you might know, there's some trend change on the AI data center power system. Historically, the data center used the utility grid, then press the diesel genset as standby. And right now the trend is more towards using gas gensets for prime, and use the diesel for standby and the battery for instantaneous response. So we focus on our product development and the customer need.

These are different engines or different sizes or maybe if there's a way to just kind of get my arms around that a little bit.

Yes, I think it was the diesel gensets, maybe it's similar. But we are also working on potentially gas gensets. And we have different customers. They sell to Generac. We sell to a different customer. So I don't think we're in competition. And based on our meeting with our customer, we see a strong demand for our products for this year and also for next year.

Okay. I guess I'll just take the rest offline. Thank you.

Thank you, [ Alex ]. One moment for our next question. Our next question comes from the line of Alan Lau with Jefferies. Your line is open. Please go ahead.

I would like to follow up on the previous question. Any guidance into 2027, especially given that we are in the second half of 2026 and there seems to be progress in gas engines as well. So I wonder if there's any color into 2027.