Power Solutions International, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; filed June 29, 2020 after a COVID-19-related delay. Amounts below are in millions except per-share data.
Business context and results
PSI designs and manufactures engines, power systems and integrated power-generation systems for energy, industrial and transportation markets. It operates as one reporting segment. Weichai owns a majority of PSI’s common stock.
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Net sales | $105.1 | $115.8 |
| Gross profit / margin | $17.7 / 16.9% | $17.7 / 15.3% |
| Operating loss | $(3.7) | $(5.6) |
| Net loss | $(0.7) | $(2.6) |
| Diluted loss per share | $(0.03) | $(0.31) |
| Adjusted EBITDA (non-GAAP) | $2.6 | $3.7 |
| Operating cash flow | $24.3 | $(0.7) |
| Capital expenditures | $0.8 | $0.8 |
Financial position and liquidity
- At March 31, cash was $0.8; current assets were $201.4 and current liabilities were $214.9, a $13.5 working-capital deficit.
- Quarter-end debt included $16.8 on the Wells Fargo revolver and $55.0 of senior notes; $55.2 of long-term debt was classified as current.
- Operating cash flow benefited substantially from a $45.6 reduction in accounts receivable, partly offset by a $16.8 inventory increase. Net cash used in financing was $22.7, primarily reflecting net revolver repayments.
- Subsequent to quarter-end, PSI replaced its prior facilities with a secured revolving facility of up to $130.0, maturing March 26, 2021, with a conditional 60-day extension. It borrowed $95.0 on April 2 to repay the Wells Fargo balance and redeem the $55.0 notes, then borrowed the remaining $35.0 on April 29. At May 31, borrowings were $130.0 and cash was $35.5, including a positive cash impact from $11.8 of customer prepayments.
- Management stated that, without additional financing, it did not expect to have enough cash to repay the new facility at maturity. The filing concludes substantial doubt exists about PSI’s ability to continue as a going concern within one year after issuance of the financial statements.
Material changes versus Q1 2019
- Sales fell $10.7, or 9%. Industrial sales declined $13.4 and transportation sales $1.7; energy sales rose $4.4. Industrial weakness reflected lower material-handling/forklift and arbor-care demand; transportation weakness included the timing effect of accelerated shipments in Q4 2019.
- Gross profit was nearly unchanged despite lower sales, and gross margin rose 1.6 percentage points, attributed mainly to product mix and pricing, partly offset by reduced operating leverage and higher warranty expense.
- Operating expenses declined $1.9, mainly from lower financial-reporting costs, no comparable severance expense, and lower incentive compensation; R&D expense increased $0.5.
- Interest expense fell $0.8. Q1 2019 included a $4.4 gain from the fair-value change in the Weichai warrant, which was exercised in April 2019 and had no Q1 2020 impact.
- The $4.0 income-tax benefit in Q1 2020 included an estimated $2.3 benefit associated with CARES Act tax provisions. PSI maintained a full valuation allowance against deferred tax assets. Although GAAP net loss improved, adjusted net loss was $0.7 versus $0.1, and adjusted EBITDA declined $1.1.
Outlook, risks, contingencies and unusual items
- PSI provided no quantified sales or earnings guidance. It cited uncertainty from COVID-19, depressed oil prices and declining rig counts; these could reduce demand, delay deliveries, impair assets and pressure liquidity. No significant supply-chain interruption or material order cancellation had occurred as of the filing, but future effects remained uncertain.
- The company reduced production staffing, cut salaried pay, suspended its 401(k) match and deferred some R&D spending; pay and match measures were expected to continue through September 30, 2020, subject to reassessment.
- Goodwill impairment testing was triggered by market conditions; PSI concluded goodwill was not impaired at March 31, 2020, while warning future impairments or related charges were possible.
- Ongoing SEC and U.S. Attorney investigations relate to prior financial reporting and accounting matters. PSI was cooperating and discussing possible resolutions; potential outcomes and losses were not estimable. Its primary $30.0 D&O insurance coverage was exhausted during Q1, increasing potential company-funded indemnification costs.
- Other legal exposures include a disputed arbitration demand seeking more than $9.0 in royalties, which PSI denies; the matter was in early stages. A separate former-employee matter settled for $1.1 in May 2020, with $0.9 to be paid by PSI from an existing reserve and the balance by insurance. Litigation reserves were $5.4 at quarter-end.
- Disclosure controls were not effective at March 31, 2020 because of previously reported material weaknesses in internal control over financial reporting. Remediation was ongoing. The filing also identified possible risks from delisting and delays in obtaining a stock-exchange relisting.
- Seven letters of credit totaled $3.0. Supplier minimum-purchase arrangements could result in approximately $5.6 of penalties if PSI stopped purchases, though it did not then anticipate penalties.
Important facts for investors to verify
- Progress on refinancing, extending or repaying the $130.0 secured facility before its March 2021 maturity, and compliance with its covenants.
- Cash generation and working-capital trends, particularly customer prepayments, receivable collections and inventory levels.
- COVID-19 and oil-and-gas demand impacts on orders, sales, margins, goodwill and other asset valuations.
- Developments and potential costs from the SEC/USAO investigations, litigation and post-exhaustion D&O insurance obligations.
- Whether material weaknesses are remediated and disclosure controls become effective.
- Warranty costs and reserve adequacy; Q1 included $0.7 of charges for estimates on preexisting warranties.