Power Solutions International, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Financial statement amounts below are in $ millions, except per-share data. PSI designs, manufactures and distributes engineered power systems and aftermarket parts for industrial OEMs. It operates as one business segment.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $93.972 | $64.628 | $244.085 | $176.342 |
| Gross profit / margin | $18.628 / 19.8% | $12.372 / 19.1% | $45.954 / 18.8% | $32.725 / 18.6% |
| Operating income / margin | $7.519 / 8.0% | $4.122 / 6.4% | $16.933 / 6.9% | $11.042 / 6.3% |
| Net income (loss) | $8.431 | $(9.981) | $14.917 | $(15.008) |
| Diluted EPS | $0.68 | $(0.97) | $1.23 | $(1.57) |
- Q3 sales rose 45.4%; nine-month sales rose 38.4%. Management attributed most growth to organic volume, particularly heavy-duty power generation systems, with additional sales from acquired 3PI. Organic growth was $23.1 million in Q3 and $54.2 million year to date.
- Q3 gross margin improved to 19.8%, which management attributed to product mix and fixed-cost absorption. Nine-month gross margin was 18.8%, versus 18.6%.
- Research and development expense increased to $4.501 million in Q3 and $11.844 million year to date, reflecting engineering investment, staffing, new-engine development and pursuit of on-road applications.
- Reported profitability includes noncash fair-value income: $3.208 million from reducing the 3PI contingent-consideration liability and $0.858 million from reducing the private-placement warrant liability in Q3; corresponding nine-month income was $3.782 million and $1.190 million. These items materially affected comparison with 2013, when warrant remeasurement produced expenses of $12.605 million in Q3 and $21.658 million year to date. The gains depend on Level 3 estimates and are not equivalent to operating cash generation.
Cash flow, balance sheet and debt
- At September 30, cash was $7.602 million; working capital was $106.729 million, versus $77.621 million at year-end 2013. Current assets included $68.886 million of receivables and $83.240 million of net inventory.
- For the first nine months, operating cash flow was negative $13.450 million, compared with negative $6.017 million in 2013. Receivables and inventory growth used substantial cash; increases in accounts payable partly offset this use.
- Investing cash outflow was $49.221 million, including $44.122 million for the 3PI acquisition, net of cash acquired, and $4.749 million for property and equipment. Financing provided $63.967 million, primarily through net revolving-credit borrowings.
- Revolving-credit borrowings were $74.048 million and term debt was approximately $4.445 million, for total borrowings of about $78.5 million. PSI had a $100 million revolving facility, with $25.4 million reported as unused and available, subject to the borrowing base. Cash was $1.296 million higher than at year-end.
- The facility is secured by substantially all tangible and intangible assets other than real property and matures June 28, 2018. While the term loan is outstanding, covenants require a fixed-charge coverage ratio of at least 1.20:1 and debt leverage no greater than 4.0:1. Management reported liquidity sufficient for anticipated working-capital and capital-expenditure needs for at least 12 months, based on current forecasts and assumptions.
- A one-percentage-point interest-rate change would affect annual interest expense by approximately $0.785 million, based on period-end borrowings.
Material developments, outlook and risks
- PSI acquired Professional Power Products, Inc. (3PI) on April 1, 2014, for approximately $45.4 million cash, including cash acquired, plus stock-based earn-out consideration. The provisional total acquisition consideration was $54.3 million. 3PI contributed $6.286 million of Q3 sales and $13.558 million for the nine-month period; it reported operating losses of $0.346 million and $0.377 million, respectively.
- Acquisition accounting remains provisional. Identifiable intangible assets were valued at $23.5 million and goodwill at $23.337 million; final valuation work could change the purchase-price allocation. PSI also recorded $0.811 million of acquisition transaction costs in 2014.
- PSI increased its Wells Fargo revolver from $75 million to $90 million in April and to $100 million on September 30, and added a $5 million term loan to help fund the acquisition. Interest expense increased with higher borrowings.
- No specific revenue or earnings guidance was provided. Management cited continued investment in the business and identified customer retention, product acceptance and commercialization, acquisition integration, and future strategic spending as factors affecting longer-term liquidity needs.
- Key risks include dependence on major OEM customers and suppliers, heavy inventory investment, variable customer demand and product cycles, competition, execution and integration of 3PI, debt and covenant exposure, interest-rate sensitivity, regulatory and emissions changes, and uncertain adoption of new products and on-road applications. Management said pending legal proceedings were not expected to have a material adverse effect. Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported.
- A new revenue-recognition standard was issued in 2014 and is effective for PSI beginning in 2017; the company was evaluating its adoption approach and impact.
Important facts for investors to verify
- Whether organic demand and heavy-duty power-system sales continue, and how much reported growth reflects 3PI.
- Whether receivables and inventory convert to cash; operating cash flow was negative despite reported net income.
- Availability under the borrowing-base formula, compliance with debt covenants, and the pace of debt repayment.
- Final 3PI purchase accounting, integration performance, and the earn-out’s actual outcome; the contingent-liability remeasurement was a significant noncash gain.
- The effect of warrant-liability remeasurement on earnings and the extent to which operating results, excluding these valuation items, support reported profitability.