Power Solutions International, Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; filed August 7, 2015. PSI designs, manufactures and supports power systems for industrial OEMs and on-road markets. Amounts below are in millions of dollars except per-share data.
Key financial results
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $94.6 | $83.4 | $180.8 | $150.1 |
| Gross profit | $17.4 | $15.4 | $33.8 | $27.3 |
| Gross margin | 18.4% | 18.5% | 18.7% | 18.2% |
| Operating income | $4.5 | $5.9 | $8.5 | $9.4 |
| Net income | $4.9 | $3.9 | $3.5 | $6.3 |
| EPS, basic / diluted | $0.46 / $0.18 | $0.37 / $0.34 | $0.32 / $0.32 | $0.59 / $0.53 |
| Operating cash flow | Not separately presented | Not separately presented | $(38.2) | $(14.1) |
Financial position and liquidity
- At June 30, cash was $6.1, working capital was $162.0, and total assets were $331.7. Net inventory was $121.6, up from $93.9 at year-end 2014.
- Revolver borrowings were $105.2 against a $125.0 facility, with $17.4 available under the borrowing base. Borrowings carried stated rates of 1.68% on the LIBOR-based balance and 3.25% on the prime-based balance.
- PSI issued $55.0 of unsecured 5.50% Senior Notes due May 1, 2018, receiving $53.5 net of issuance costs. The term loan was repaid in April. Balance-sheet debt carrying values were $105.2 on the revolver and $53.6 on long-term debt, net of issuance costs.
- Investing cash outflow was $38.7, including $34.2 for acquisitions, $3.4 for property and equipment, and $1.0 for a joint venture. Financing provided $76.5; cash declined $0.4 over the six months.
Changes, acquisitions and management commentary
- Q2 sales increased 13.5%; management attributed about $9.1 of the $11.3 increase to acquisitions and $2.2 to organic growth. For the first half, sales grew 20.4%, with $15.8 organic growth and about $14.9 from acquisitions.
- First-half gross margin improved to 18.7%, which management attributed principally to higher sales of heavy-duty power systems. Operating income declined in both the quarter and half-year as operating expenses rose, especially research and development and engineering costs.
- Q2 net income increased despite lower operating income, helped by $2.9 of noncash income from revaluation of private placement warrants and a lower tax provision. For the first half, warrant revaluation instead generated $0.7 of expense. Warrant valuation is stock-price-sensitive and can make reported earnings volatile.
- Operating cash use worsened year over year, principally reflecting inventory investment and a $27.5 cash use from reducing accounts payable. Management said inventory was built, including strategic engine-block purchases, to support expected sales.
- 2015 acquisitions were Buck’s (March), Bi-Phase (May 1) and Powertrain Integration (May 19). Their provisional aggregate consideration was approximately $9.7, $4.3 and $29.1, respectively. The Powertrain amount includes $8.2 of contingent consideration; Bi-Phase includes $0.5 of estimated earn-outs. Purchase-price allocations remain provisional.
- PSI reported $180.8 of first-half sales and a $4.5 operating loss for acquired 3PI; its Q2 operating loss was $2.3. Management said 3PI’s results were included for six months in 2015 versus three months in 2014.
Outlook, risks and contingencies
- No quantified revenue or earnings guidance was provided. Management said forecast cash sources should cover anticipated working-capital and capital-expenditure needs for at least the next 12 months; longer-term liquidity depends on customer relationships, product acceptance and development, and acquisition or joint-venture spending.
- The Senior Notes indenture requires a mandatory offer to repurchase the notes in 2017 if PSI does not certify both trailing-four-quarter EBITDA of at least $35.0 and an EBITDA-to-fixed-charges ratio of at least 3.25 to 1.0, subject to the indenture’s terms. The revolving facility also has borrowing-base limits and covenants.
- Management estimated that a one-percentage-point interest-rate change would alter annual interest expense by approximately $1.6. The filing identifies risks including customer and supplier concentration, inventory exposure, product and regulatory changes, competition, acquisitions, and access to capital.
- Legal proceedings in the ordinary course were not expected to have a material adverse effect. PSI was undergoing federal and state tax audits; management did not expect a material impact, but the ultimate result was undetermined. Acquisition earn-outs and fair-value allocations involve estimates and could change.
- Management concluded disclosure controls were effective. It planned to evaluate acquired-company controls during 2015, with those operations expected to enter the scope of its internal-control report for 2016.
Important facts for investors to verify
- Whether inventory converts to sales and cash, and whether operating cash use moderates as supplier payments and working-capital needs normalize.
- Acquired-business contribution to growth and profitability, particularly 3PI’s operating losses; final purchase allocations and earn-out payments.
- Revolver availability under the borrowing base, total debt service, and the ability to meet the Senior Notes’ 2017 financial tests or fund a mandatory repurchase.
- The impact of warrant remeasurement on reported earnings and diluted EPS; Q2 diluted EPS was materially below basic EPS, and warrant valuation effects varied between periods.
- Comparability of 2014 results: PSI revised certain 2014 quarterly figures for 3PI consideration and related tax accounting, and stated the revisions were not material.