Power Solutions International, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2014. Unless otherwise noted, financial amounts are in millions of dollars. The company designs, manufactures, distributes and supports power systems and custom-engineered electrical power generation systems, primarily for industrial OEMs.
Financial results and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $83.4 | $59.1 | $150.1 | $111.7 |
| Gross profit / margin | $15.4 / 18.5% | $11.2 / 18.9% | $27.3 / 18.2% | $20.4 / 18.2% |
| Operating income | $5.9 | $3.8 | $9.4 | $6.9 |
| Net income (loss) | $4.4 | $(2.1) | $6.8 | $(5.0) |
| Diluted EPS | $0.39 | $(0.23) | $0.58 | $(0.55) |
- Sales increased 41.0% in Q2 and 34.4% in the first half. Management attributed most of the growth to organic volume, particularly heavy-duty power systems and power generation demand; PPPI also contributed following its acquisition.
- Operating expenses rose, led by research and development and engineering investment. R&D expense increased 63.6% in Q2 and 80.9% in the first half. First-half G&A included approximately $0.8 million in PPPI transaction costs.
- Cash and working capital at June 30 were $5.7 million and $92.0 million, respectively. Cash was $6.3 million and working capital $77.6 million at December 31, 2013.
- First-half operating cash flow was negative $14.1 million, versus negative $5.2 million in 2013. Inventory growth used $18.5 million and receivables growth used $9.3 million, partly offset by a $11.1 million increase in accounts payable.
- First-half investing cash outflow was $46.9 million, including $44.1 million for PPPI net of cash acquired. Financing provided $60.4 million, primarily through net revolver borrowing and the new term loan.
- At June 30, revolving borrowings were $70.1 million and the term loan balance was approximately $4.9 million. The $90 million revolver had $19.4 million unused and available. Cash plus stated unused availability was therefore limited relative to total borrowings; availability is subject to the borrowing base.
Material changes and unusual items
- On April 1, 2014, PSI acquired Professional Power Products, Inc. (PPPI), a designer and manufacturer of integrated electrical power generation systems. Initial consideration was $45.4 million in cash, including acquired cash, plus contingent consideration initially valued at $8.9 million. The contingent payment is in PSI shares and depends on PPPI’s 2014 full-year operating results; its fair value was reduced to $8.0 million by June 30, generating $0.9 million of income.
- PPPI contributed $7.3 million of sales and an operating loss of $31,000 in the quarter. Acquisition accounting remains provisional; acquired assets include $23.5 million of identifiable intangibles and $22.4 million of goodwill. Inventory fair-value step-up of $0.5 million was charged to cost of sales.
- Warrant fair-value changes materially affected comparisons: PSI recorded warrant income of $0.1 million in Q2 2014 and expense of $4.2 million in Q2 2013; first-half income was $0.3 million versus expense of $9.1 million. These non-cash, non-taxable valuation changes contributed to the prior-year net loss and make reported tax rates less comparable.
- The company amended its Wells Fargo facility to increase the revolver from $75 million to $90 million and added a $5 million term loan to help fund PPPI. The credit agreement requires a fixed-charge coverage ratio of at least 1.20:1 and debt leverage no greater than 4.0:1 while the term loan is outstanding.
Outlook, risks and contingencies
- Management said existing cash sources and borrowing access are expected to cover anticipated working-capital and capital-expenditure needs for at least the next 12 months, based on current forecasts and assumptions. It stated that the full-year 2014 effective borrowing rate was expected to remain relatively unchanged from Q2; no sales or earnings guidance was provided.
- Risks highlighted include successful integration of PPPI, customer and supplier concentration, demand and product-mix variability, competition, regulatory and emissions changes, product development and on-road expansion, inventory exposure, and the ability to service debt or obtain additional capital. Results may fluctuate with customer and supplier product cycles and pricing.
- A 1 percentage-point change in interest rates would change annual interest expense by approximately $0.75 million, based on June 30 debt balances. The revolver is secured by substantially all tangible and intangible assets other than real property.
- The company reported no material off-balance-sheet arrangements and said current legal proceedings were not expected to have a material effect. A China joint venture had received $0.85 million of the company’s committed investment of up to $1.2 million; manufacturing was scheduled to begin during 2014.
- Management concluded disclosure controls were effective. PPPI was excluded from the 2014 internal-control assessment, with evaluation and implementation of controls planned during 2014 and inclusion expected in the 2015 assessment.
Key facts for investors to verify
- PPPI’s final purchase-price allocation, integration progress and full-year performance determining the contingent share payment.
- Whether operating cash flow improves as inventory and receivables convert to cash, and how borrowing-base availability changes.
- Compliance with credit covenants and the company’s ability to manage approximately $75 million of revolver and term debt.
- Underlying operating performance apart from volatile warrant and contingent-consideration fair-value gains or losses.
- Whether increased R&D spending and product-development initiatives translate into sustained organic growth and margins.