PPSI

Business Context and Reporting Period

Company: Pioneer Power Solutions, Inc. (formerly Sierra Concepts, Inc.)
Reporting Period: Fiscal year ended December 31, 2009
Business Overview: The Company is a North American designer, developer, and manufacturer of liquid-filled power, distribution, and specialty electric transformers. Operations are conducted primarily through its wholly-owned subsidiary, Pioneer Transformers Ltd., based in Granby, Quebec, Canada.
Corporate Structure Change: On December 2, 2009, the Company completed a share exchange with Pioneer Transformers Ltd. The transaction was accounted for as a recapitalization. The Company discontinued its former shell business and succeeded to the transformer business of Pioneer Transformers Ltd. as its sole line of business.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total revenue decreased 7.5% to $40.6 million. On a constant currency basis, revenue decreased approximately 1%, driven by a decrease in transformer unit volume offset by higher average prices per unit.
• Margin Expansion: Gross margin percentage increased significantly from 20.5% to 29.2%. This was attributed to a favorable shift in sales mix toward larger utility units, more efficient manufacturing, lower material costs, and the translation effect of a strengthening U.S. dollar on Canadian-denominated costs.
• Profitability Surge: Net earnings more than doubled to $5.1 million. This increase was driven by higher gross margins, stable operating expenses, the absence of the $0.7 million non-operating write-down of advances to limited partners recorded in 2008, and lower debt service costs.
• Liquidity Improvement: The Company repaid its entire bank indebtedness of approximately $4.1 million during 2009. Cash and cash equivalents increased from $368,000 to $1.56 million. Working capital increased by $7.2 million.
• Backlog Reduction: Sales backlog decreased 16.6% to $16.5 million from $19.8 million. New orders placed in 2009 were $35.0 million, a 12.9% decrease from 2008.

Guidance, Outlook, Risks, and Unusual Items

Outlook and Strategy

• Expansion: The Company commenced a plant expansion in September 2009 to add 6,000 square feet, with completion expected in November 2010. The project budget is approximately $1.7 million.
• Market Focus: Strategy focuses on internal growth by migrating sales toward highly-engineered, value-added products (power, network, and subsurface transformers) and potential acquisitions to expand market share or geographic reach, including the Chinese market.
• Capital Resources: Management believes working capital, funds from a new $9.5 million credit facility (currently undrawn), and operating cash flows are sufficient for the next 12 months.

Risks and Contingencies

• Customer Concentration: Hydro-Quebec Utility Company accounted for 39.6% of sales in 2009. A significant reduction in orders from this customer could materially adversely affect results. Long-term contracts expire in 2012.
• Raw Material Volatility: Raw material costs (steel, copper, aluminum) represented 64% of revenue. While escalation clauses exist in 40% of contracts, unanticipated price increases could impact profitability.
• Currency Fluctuation: The Company reports in U.S. dollars but operates primarily in Canadian dollars. A depreciation of the Canadian dollar negatively impacts reported revenue.
• Related Party Transactions: Significant transactions occurred with Provident Pioneer Partners, L.P. (controlling shareholder) and its limited partners, including dividends paid ($2.7 million in 2009) and executive service fees.
• Stock Liquidity: Common stock trades on the OTC Bulletin Board with limited liquidity. There is no assurance an active market will develop.

Investor Verification Checklist

• Customer Dependency: Verify the status of the long-term contract with Hydro-Quebec Utility Company and the likelihood of renewal beyond 2012.
• Debt Covenants: Confirm compliance with the new $9.5 million credit facility covenants (minimum debt service coverage ratio of 1.25, minimum current ratio of 1.20).
• Capital Expenditures: Monitor the progress and cost of the $1.7 million plant expansion project scheduled for completion in late 2010.
• Related Party Fees: Review the nature and necessity of executive service fees paid to entities controlled by the majority shareholder (Nathan J. Mazurek).
• Backlog Conversion: Assess the risk of order cancellations given the 16.6% decline in backlog and the competitive nature of the industry.
• Stock Ownership: Note that Provident Pioneer Partners, L.P. (controlled by the CEO) beneficially owns approximately 79% of the outstanding common stock.