Power Solutions International, Inc. — 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011. The filing was signed March 30, 2012. The company designs, manufactures, distributes and supports customized power systems for off-highway industrial equipment OEMs, primarily using alternative-fuel spark-ignited engines and third-party-sourced engines.
Financial results
Amounts below are in millions of dollars unless otherwise indicated.
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Net sales | $154.969 | $100.521 | +54.2% |
| Gross profit / margin | $26.428 / 17.1% | $16.627 / 16.5% | Margin +0.6 percentage points |
| Operating income / margin | $9.805 / 6.3% | $4.066 / 4.0% | Improved |
| Net income | $4.061 | $1.569 | +158.8% |
| Cash from operations | $(0.973) | $3.924 | Declined |
| Cash used in investing | $(1.570) | $(0.583) | Higher outflow |
| Cash from financing | $2.543 | $(3.341) | Improved, reflecting financing transactions |
- Growth and margins: Sales rose $54.4 million, principally from higher alternative-fuel power-system volumes. Management attributed growth to a full year of sales to Asia-based customers, large power systems introduced in 2009, new customers and stronger existing-customer demand. Cost of sales increased 53.2%, slightly slower than sales; higher volume and a broader product mix lifted gross margin.
- Expenses and earnings: Operating expenses increased to $16.623 million from $12.561 million, including higher engineering, selling and service, and public-company costs. Interest expense fell to $1.340 million from $2.131 million, but 2011 included a $0.485 million debt-extinguishment loss and $1.146 million of other expense, including private-placement warrant and transaction-related costs. The effective tax rate rose to 40.6% from 18.9%, partly due to nondeductible transaction and warrant expenses and higher Illinois taxes.
- Cash conversion: Despite $4.061 million of net income, operating activities used $0.973 million, mainly because receivables increased $12.992 million as sales grew. Accounts payable and accrued liabilities partly offset that cash use. Capital spending and other investing uses totaled $1.570 million.
- Liquidity and debt: At year-end, cash was zero under the lender’s cash-sweep arrangement; working capital was $14.2 million, up from $6.3 million, and current assets were $66.0 million against current liabilities of $51.8 million. The balance sheet reported $19.666 million outstanding on the revolving line, $0.064 million of other long-term debt and no material term-loan balance. The $35 million facility had $15.3 million of availability at year-end. On March 20, 2012, the facility was amended to $50 million, extended to March 20, 2017, and cash was no longer automatically swept; the filing reported approximately $23.9 million of principal outstanding at that date. The company said expected cash sources and borrowing access would meet working-capital and capital-spending needs for at least twelve months.
- Revenue mix and concentration: Approximately 59% of 2011 sales were emission-certified products (49% certified by the company and 10% diesel systems certified by the engine supplier), 12% aftermarket parts and 29% non-certified systems. One customer accounted for 15% of sales, down from 19% in 2010 and 25% in 2009. General Motors, Perkins/Caterpillar and Doosan engines were associated with approximately 64%, 10% and 13% of 2011 sales, respectively.
Material changes, outlook and risks
- Capital and corporate transactions: The April 2011 reverse recapitalization made the operating business public; the company raised $18 million gross in a private placement of preferred stock and warrants. The preferred stock converted into common shares following the August reverse split and Delaware reincorporation. In October, the company repurchased 830,925 shares from CEO Gary Winemaster for $4.25 million, funded by a revolving-credit draw; the shares became treasury stock. The filing reported $3.270 million of private-placement warrant liability at year-end.
- Operating plans: Management described plans to expand sales to existing and new OEM customers, grow international markets and aftermarket activity, and develop hybrid systems and an 8.8-liter fuel-flexible engine for off-road and on-road applications. It also planned to consolidate operations into newly leased Wood Dale facilities. These are strategic intentions, not quantified financial guidance; the filing provides no clear numerical revenue or earnings forecast.
- Key execution and market risks: Growth depends partly on alternative-fuel adoption and stricter emissions rules; either demand or regulation may develop differently than expected. Other material exposures include customer and supplier concentration, long and variable OEM design cycles, inventory and receivables needs, component-cost and fuel-price changes, competition, and dependence on third-party engine suppliers. The 8.8-liter engine is the company’s first internally developed engine, and on-road certification, acceptance, warranty and liability costs are uncertain.
- Facility and financing risks: The company operates production in the Chicago area and identified disruption risk from its planned facility consolidation and possible rapid growth. The credit facility is secured by substantially all assets and restricts certain debt, acquisitions, capital spending and dividends. No cash dividends were anticipated in the foreseeable future.
- Contingencies and controls: Management said pending legal proceedings were not expected to have a material adverse effect. The company had not completed its first Section 404 assessment of internal control over financial reporting, planned one for year-end 2012, and could not assure that it would find no deficiencies. Management concluded disclosure controls were effective at December 31, 2011. The auditor issued an unqualified opinion on the financial statements but did not audit internal-control effectiveness.
- Market and governance: Shares traded over the counter with limited trading activity and substantial bid-ask spreads. As of March 20, 2012, Gary and Kenneth Winemaster beneficially owned approximately 50.15% and 31.8% of shares, respectively, giving the brothers significant voting control. The company also disclosed related-party arrangements, including tax services from a director’s accounting firm and compensation to the CEO’s and senior vice president’s father for consulting services.
Most important facts for investors to verify
- Whether sales growth converts to operating cash flow, especially as receivables and inventory grow; review customer payment terms and collections.
- Customer and supplier concentration, including the 15% sales exposure and the dependence on three engine suppliers.
- Availability, covenant terms, borrowing costs and actual utilization of the amended $50 million credit facility.
- Execution costs and production continuity during the facility consolidation, and the 8.8-liter engine’s certification, launch, quality and warranty performance.
- The effect of warrants and their anti-dilution provisions, the CEO-related share repurchase and other related-party transactions on equity value and governance.
- Results of the planned Section 404 internal-control assessment and whether any deficiencies or material weaknesses are identified.