Power Solutions International Stock

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 Jenke, 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 Jenke, Vice President and Corporate Controller. And joining me today is Ken Li, 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 & 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 in today's call. 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 & 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 run 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 $30.8 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 nonrecurring $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. We are 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 & 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, nonrecurring 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 period. 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 operational 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 $30.8 million during the quarter. We ended the second quarter with $70.1 million in cash and cash equivalents, and the total debt of approximately $72.6 million, including a $65 million drawn 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 & 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 our ongoing operational improvement efforts in Wisconsin, although capacity ramp-up activities and related 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 $30.8 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.

So 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 -- this 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. Eric, 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 challenge headwind on Wisconsin operations second half last year. And our gross margin in 3Q last year was like 23.9% and 4Q last year, 21.9%. And the 1Q, we made improvement, 22.9%. So since then, we implemented various operation improvement initiatives in Wisconsin, and we see improvements in productivity, efficiency, flow paths and also material availability, which enable 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 together helped us to deliver a quite 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 operation team is working with 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 -- so 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, the 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 they sell to Generac, 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 plus 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 serve our customer needs.

Okay. So -- I mean, so these are different engines or different sizes or I mean, just maybe -- if there's a way to just kind of get my arms around that a little bit, but...

Yes. I think with the diesel gensets, maybe it's similar, and -- 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 the direct 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 of this offline.

[Operator Instructions] Our next question comes from the line of Alan Lau with Jefferies.

Congratulations on the great results in the second quarter. I would like to follow up on the previous question. I wonder if there's 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. Yes.

Thank you, Alan, for the question. So, Alan, we are not providing formal guidance for the sales outlook for '26 or '27. But as you know, our part is serving the mission-critical AI data center, and the capacity for the power system for the data center is constrained. So there's a high demand for the system -- power system, which is reliable, emission-certified, and also scalable power system. So what I can see is we have high demand of our products for 2026. And our sales team is working closely with our customer to secure more orders for 2027. And the demand for our product, remember, is strong. And after we get more visibility for the 2027 sales information, and we will share with all investors, maybe in 4Q.

So my follow-up question would be -- so the margins of the second quarter have significantly improved. So we'd like to know, how would you comment on the drag from oil and gas? Because the -- in your previous remarks, it seems that the growth in data center-related products are partially offset by oil and gas. And I wonder if you would call this bottoming, or how would you describe the trends in oil and gas segment?

Yes. The oil and gas market still remains soft. In our current forecast, we assume that the softness will continue at least for this year, right? And the oil and gas products usually carry a relatively high gross margin for our products. And definitely, we grow our sales for the data center business and offsets the sales drop from oil and gas. So for this quarter, we still see quarter-by-quarter sales growth. And I will say, we are still -- we are not providing a very detailed quantitative outlook, but we still think the second half sales definitely will exceed the first half sales. And our internal expectation is the second half will be consistent with the second half we had last year.

We'll take this offline.

[Operator Instructions] Our next question will come from the line of Dilyara Sailaubayeva with Freedom Finance Global.

I just would like to know some updates on Wisconsin. Like, do you currently have enough capacity in Wisconsin to support the expected data center ramp? Or would additional capacity expansion be needed if demand continues to grow into 2027?

Okay, thank you. So, for Wisconsin, definitely I say we're making measurable improvements, right? So that's the reason we see the sales growth and also gross margin improvements. And the team put up lots of resources, adding people and also implemented some process improvement initiatives, and we added capacity. In Wisconsin, previously, we had about 150,000 square feet, right? Now, it's about 800,000 square feet. And what I can see now is, at the current capacity, we can support the current demand, and for next year, as needed, definitely, we can spend the capital to increase more capacity to serve our customers. And what I see is, over the past several months, the team did a great job, improved lots of different areas, the labor efficiency, the cost structure and also the material availability. And going forward, I will continue to expect the team to deliver more process improvements in Wisconsin, right?

Okay. So just to follow up on that. So given the sequential improvement in gross margins, how should investors think about the normalized gross margin potential of the business once your Wisconsin operations stabilize?

Yes, we saw pretty significant gross margin improvements in 2Q. And as you know, there are many things that could impact the quarterly gross margin. It could be impacted by mix, pricing and variable efficiency, fixed cost absorption, all these kinds of things. And if you see our year-to-date, the gross margin is 25.2%. And we will continue to make process improvements in Wisconsin. And also, hopefully, we can have favorable mix for the remainder of the year. I will not give you a specific number for the outlook, but I will say, in the longer term, our business goal is to have a gross margin at a 25% range.

Thank you, and I would now like to hand the conference back over to Kenneth Li for closing remarks.

Okay. I just want to thank everyone who joined the call today, and I appreciate your continued interest in PSI. And we look forward to giving you another update for the next quarter's meeting. Thank you.

This concludes today's conference call. Thank you for participating, and you may now disconnect. Everyone have a great day.

Good afternoon, and welcome to Power Solutions International First Quarter 2026 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to hand the conference over to Ken Janke, VP Corporate Controller, PSI. You may begin.

Good afternoon, and welcome to Power Solutions International's First Quarter 2026 Earnings Conference Call. Joining me on today's call are Dino Xykis, Chief Executive Officer; Ken Li, Chief Financial Officer; and Dorothy Du, General Counsel.

Statements made in today's discussion as well as information provided from time to time by Power Solutions International, Inc. will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied.

Among the factors that could cause actual results to differ materially are the timing and ultimate conversion of Power Systems orders, including data center-related orders, quarterly variability in our product mix and corresponding gross margins, the cost, pace and outcome of capacity ramp-up activities at our Wisconsin operations, demand in the oil and gas end market, supply chain and component availability, macroeconomic, regulatory and trade conditions, pending litigation and regulatory inquiries and the other risks and uncertainties described in our most recent annual report on Form 10-K, our quarterly reports on Form 10-Q and other filings with the SEC, all of which are incorporated by reference for purposes of today's call. The company undertakes no obligation to update any forward-looking statements, except as required by law.

We will also reference certain non-GAAP financial measures on today's call. Reconciliations to the most directly comparable GAAP measures are available in our earnings release and SEC filings.

With that, I will turn the call over to Dino.

Good afternoon, everyone, and thank you for joining us. We appreciate your time today and your continued interest in PSI.

For many of you, this is the first earnings conference call you have heard from PSI since our December 2024 uplisting to the NASDAQ stock market. I will start with a brief overview of our company and will then turn the call over to Ken to walk through our financial performance and our outlook.

Company overview. Power Solutions International founded in 1985 and headquartered in Wood Dale, Illinois designs and manufactures emission-certified engines and integrated Power Systems across natural gas, propane, diesel, gasoline and biofuels. The company has produced more than 1.5 million engines over its history and operates manufacturing and engineering facilities across Illinois, Wisconsin, Texas and Michigan. PSI serves OEM customers across Power Systems, industrial and transportation end markets, including data centers, standby power, oil and gas, material handling and specialized vehicles.

Over the past several years, PSI has improved profitability, reduced its debt, strengthened its balance sheet, refinanced its credit facility and uplisted to NASDAQ in December of 2024. In 2025, the company was added to the Russell 3000, Russell 2000, Russell Microcap and MSCI USA Small Cap Indices.

The first quarter. Turning to the quarter. As Ken will describe in more detail, our first quarter results were below the strong prior year period, which had benefited from significant growth in our Power Systems business. The year-over-year declines in sales and profitability primarily reflected softer oil and gas demand, the timing of certain power system shipments and elevated production costs associated with the capacity ramp-up in our Wisconsin operation.

At the same time, demand related to data center application remains solid and gross margin improved sequentially from the fourth quarter of 2025, owing it in part to the company's efforts to improve operational efficiency in Wisconsin, but partially offset by unfavorable product mix.

With that, I will turn the call over to Ken.

Thank you, Dino, and good afternoon, everyone. I will walk through our financial performance for the first quarter, then provide some operational context and update on liquidity and our outlook framework for the balance of the year.

Net sales for the first quarter were $128.6 million, representing a decline of approximately 5% year-over-year. This decrease was primarily driven by lower sales in our Power Systems end market, reflecting uneven customer ordering patterns and continued softness in the oil and gas market. These declines were partially offset by growth in our industrial and transportation end markets.

Gross profit for the quarter was $29.4 million compared to $40.3 million in the prior year, and the gross margin was 22.9% compared to 29.7% in the prior year period. The year-over-year decline in gross margin reflects a less favorable product mix in the period, including lower contributions from oil and gas products, together with elevated production costs associated with capacity ramp-up activities supporting data center-related applications.

On a sequential basis, gross margin was approximately 100 basis points higher than the fourth quarter of 2025, which we believe shows early progress in reducing operational inefficiencies. So the gain was partially offset by an unfavorable product mix in the first quarter.

We caution that the capacity ramp-up activities at our Wisconsin operations are continuing, and we expect elevated product costs raised to that ramp-up to persist with the trajectory of any further sequential improvement subject to product mix, slow cost and other operational factors.

Operating expense were $18 million, up approximately 15% year-over-year, reflecting continued investments in research and development to support new product initiatives as well as increased selling and administrative expense to support growth.

Operating income for the quarter was $11.4 million compared to $20.6 million in the prior year period. Net income was $7.3 million or $0.32 per diluted share compared to $19.1 million or $0.83 per diluted share in the prior year. Adjusted EBITDA was $13.9 million, reflecting the same underlying operational dynamics impacting profitability.

Turning to cash flow. We generated $18.7 million of operating cash flow in the quarter, more than doubling compared to the prior year period and driven primarily by favorable working capital dynamics.

From a balance sheet perspective, we ended the quarter with $45.1 million of cash and cash equivalents and approximately $103.4 million of total debt. Our balance sheet remains solid, and we continue to generate positive cash flow.

From a liquidity standpoint, we are well positioned. Our cash generation, combined with access to our $135 million revolving credit facility provides flexibility to support our operations and ongoing investments. We believe our current liquidity position is sufficient to meet our anticipated cash needs for at least the next 12 months.

Turning to our priorities for 2026. Our team is focused on operational execution, ongoing margin recovery, reliable delivery against the customer commitments and consistent communication with our investors. Given ongoing variability in order timing and market conditions, the company is not providing formal full year guidance at this time.

Based on current visibility, the company currently expects second quarter 2026 revenue to be generally consistent with the first quarter on a sequential basis. The company anticipates strong sales growth in the second half of 2026, approximately in line with sales in the second half of 2025 as larger power system orders move into production and are recognized as revenue.

However, the timing and ultimate volume of those shipments remains subject to customer scheduling, manufacturing slow parts, supply chain factors and other variables. There can be no assurance that those orders will translate to a uniformly strong second half.

Continued softness in the oil and gas end market is expected to weigh on quarterly revenue trends, and the capacity ramp-up activities at the company's Wisconsin operations and their related cost effects on gross margin are expected to continue.

We continue to see ongoing demand for power infrastructure, particularly in data center and distributed power applications and to invest in our manufacturing footprint and product platforms in support of that demand. Converting that demand into revenue depends on the operational and the market factors I have described, and we will continue to update investors as the year progresses.

With that, operator, please open the line for questions.

[Operator Instructions] Our first question comes from the line of Eric Stine with Craig-Hallum Capital Group.

I'm wondering, so on Q1, if you're able to, could you just give a little detail on specifically Power Systems and maybe not exact, but talk about kind of the contribution from oil and gas. Clearly, that is something that you've talked about since late last year, have seen it not really a surprise. But curious how do we view that and then also view that you are ramping up the enclosure business.

And then curious what that enclosure business, are you expecting more of a ramp-up in Q2? What kind of goes into your Q2 view as well?

So Eric, for the Power Systems, the 1Q sales is about $96 million and versus last year, like $107 million. And as we mentioned, we start to notice the softness in the oil and gas later last year, right? And this softness extended to 1Q this year. So most of the sales decrease this quarter versus last year 1Q is driven by the Power Systems, the oil and gas, the softness and also the uneven customer demand for other data center-related products.

So we -- right now, in the near term, we still assume that oil and gas will remain soft throughout the year. And if there's some pickup, definitely, it will be favorable for the sales and also margin perspective, right?

Now for the Wisconsin operation, the company adding resource to support the Wisconsin operation, and we are doing a lot of process improvements, time study. We see some notable improvements in the cost structure, labor overhead in the manufacturing cost if we compare this quarter versus 4Q last year. And the improvement is also reflected in our margin -- gross margin improvement, 100 basis points this quarter versus last quarter, right?

Now for the orders regarding to the data center products, as we indicated in the press release, we anticipate strong activity in the second half and this is based on some order we already received. So now we expect the second half sales will be the same level as we had last year for the second half. But again, the actual shipment timing and volume is subject to the customer schedule, our slow cost and also the supply chain, right?

Yes. No, of course. So then if I think about second quarter, I mean, are you -- because obviously, you're coming out of this period where you're now starting to ramp up the enclosure business after doing -- you've got a number of ongoing improvements, so I get that. But if you're looking for a flat sequential quarter, looking for Enclosure growth, I mean, that would imply that you are expecting further weakening of oil and gas in Q2. Curious if that is your intention or -- because I mean, it sounds like you haven't really seen an improvement there and don't expect to even if oil is certainly has appreciated given what's going on in the Middle East, but it sounds like you don't necessarily think that, that has a positive impact anytime soon.

You're right, Eric. Even though the oil price is very high, and we are not seeing a significant ordering for oil and gas products. So for the second quarter, we expect it will be the same level as Q1.

Okay. I may have missed it, but just on gross margins, can you talk about -- I don't know if you said it, but I think you might have said that you expect that you're starting to see a little bit of improvement given all the steps that you took in Q4 and early in Q1 and then expect continued improvement throughout the year. And I'm not sure if you gave any indications of the magnitude.

So the 1Q gross margin, 22.9% and the 4Q was 21.9%. So it's about 100 basis point improvement, right? But we -- as I said, we did see some notable improvements for our Wisconsin operation. And going forward, we expect the gross margin will be flat or slightly better than 1Q.

Again, this is also subject to the product mix and also our cost structure improvement. And the 1Q, the gross margin was kind of negatively impacted by product mix. Usually, our oil and gas products carry a high gross margin. So this is impacted by the oil and gas also for the 1Q.

Okay. Last one for me. Just curious, I mean, I know you're about a quarter in or a little bit over, but just would love some thoughts on the MTL acquisition, some of the benefits you're seeing, why you did it? I mean, it's pretty straightforward, but I would just love you to kind of give your thoughts on that acquisition in its early days.

Sure. So we completed the MTL acquisition on January 9 this year. And MTL specialized in fabrication, welding, painting and assembly of metal components, and it also make the data center parts. And MTL has been PSI supplier for a long time, more than 10 years. They have been supplying us the fuel tank, right? And this acquisition definitely help us to vertically integrate our supply chain, help us to reduce the lead time and also PSI can have access to its UL certification.

So since the acquisition, the integration is underway, and we are exploring different opportunities to leverage the MTL asset base. to help us to do other fabrication for the data center with the components. So the revenue contribution from MTL is expected to be pretty modest in 2026. And in the near term, the team focus will be on the operational execution, slow part coloration and production consistency.

Our next question comes from the line of Alan Lau with Jefferies,

So I would like to understand more on the growth outlook, especially from the Enclosure business as the company ramps up the production. So I would like to know if you might share what's the capacity in dollar terms for the Enclosure business? And are you getting orders from major clients?

Thank you, Alan. So Alan, we serve our customer mainly in 3 kind of industry end markets, basically industrial power system and also transportation. And for the power system, we provide the products, microgrid, standby power, prime power and also data center-related products like Enclosure. So in our financial statements, we do not break down the sales related to the Enclosure business. So it's within our power system in the power system, the end user market.

So we will say, we received some orders from our customer, and we anticipate strong activity in the second half of the year, and we expect the second half sales will be at the level we had in second half last year, right? And we still have some pretty solid demand from our customers, our products. And certainly, as I said, the actual shipment timing and the volume still subject to the customer schedule and our capability, how successful we can convert the orders to sales.

Understood. So I'd like to follow up on oil and gas because -- so you mentioned that you expect second half of the revenue will be similar to last year. So I would like to know if it's in terms of absolute terms, which means because second half last year, I think the revenue in total is roughly 4 billion. So are you -- do you mean you expect second half revenue is approximately at $4 billion level?

So the second -- right now, our kind of general outlook in the second half sales will be similar last year second half, right, because we anticipate a strong demand for our products and activity in the second half, right? So that's our outlook, based on the orders we have right now from our customer and also our forecast.

So what's the mix of oil and gas in second half last year?

Alan, we do not provide the mix information, particular products in the end market group, yes.

We have never provided that, that split. It's under policies, yes.

So then I would like to know if -- like any major clients that -- I understand maybe a bit sensitive, but like any major orders you get from hyperscalers or key contractors for hyperscalers?

We do not name individual customers. We never have.

Yes. We do not provide information on any specific customers, yes.

Understood. So would you share the update on gas engine because I think this gas engine for prime power is an upcoming trend. So I wonder if you might share updates on that front.

Yes. So the PSI, we provide a very broad portfolio of engines, right, starting from 1-liter all the way to 88-liter and 110-liter, and we are using multiple fuel cells such as gas, propane, gasoline, diesel and biofuel. So we spend R&D to develop the products, right? For the 1Q, we spent about $4.8 million, and we continue to spend R&D to develop new products and emission certification, and also develop a special application for our customers, right?

So what I say is there are definitely activities going on, on the gas side. And we are working to develop the products to meet the industry demand. That's what we are doing. And I will say the current -- we have a lot of current engineering activity includes ongoing work related to the emission compliance, thermal management, packaging optimization and all kind of customer-specific application requirements. And we're also doing R&D to develop a larger diesel engine for the data center market.

So by bigger diesel engines, I wonder if it's above 3 megawatts.

I'm sorry, could you repeat the question again?

I wonder if the bigger diesel engines are above the typical 2 to 3 megawatts.

So I think right now, we have 88-liters. It's above 3 megawatts, yes.

Thank you. This concludes the Q&A session. Thank you all for your participation. This does conclude today's call. You may now disconnect.