Power Solutions International, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; comparisons are with the three months ended March 31, 2011. Unless otherwise noted, dollar amounts are in millions. The company designs, manufactures, distributes and supports power systems and aftermarket parts for industrial OEMs, operating as one business and geographic segment.
Financial performance
| Metric | Q1 2012 | Q1 2011 | Change / context |
|---|---|---|---|
| Net sales | $48.1 | $31.4 | Up 53.3%; management attributed most of the increase to volume, including $16.0 million of additional power-system sales. |
| Gross profit / margin | $8.2 / 17.1% | $6.0 / 19.1% | Profit rose 37.6%; margin declined with product mix, partly offset by higher production volume. |
| Operating expenses | $5.2 | $3.7 | Higher R&D, selling and service, and general and administrative costs. |
| Operating income | $3.0 | $2.3 | Up from the prior-year quarter. |
| Net income | $1.15 | $1.06 | Up 8.4%; Q1 2012 included $0.6 million of non-cash warrant remeasurement expense. |
| Basic and diluted EPS | $0.13 | $0.13 | Per common share; share counts differ substantially between periods following the 2011 transactions and preferred-stock conversion. |
| Operating cash flow | $3.3 | $2.2 | Inventory growth used $8.8 million; cash generation also benefited from higher accounts payable and customer collections. |
| Capital expenditures and investing cash flow | $0.35 used | $0.31 used | Primarily property and equipment purchases. |
Financial position and liquidity
- At March 31, 2012, cash was $0.16 million, accounts receivable $27.6 million, inventory $42.2 million and total assets $79.2 million. Inventory rose $8.8 million from year-end, mainly from building engine-block and component stocks in anticipation of demand.
- Working capital was $36.0 million versus $14.2 million at December 31, 2011. The increase largely reflects reclassification of the $19.7 million revolving-credit balance from current to long-term after the March credit-agreement amendment, rather than an equivalent increase in underlying liquidity.
- Revolving borrowings totaled $20.8 million; the company reported $27.1 million of unused availability under its $50 million facility. It reported compliance with financial covenants at quarter-end. The facility is secured by substantially all company assets.
- The March 20 amendment increased the facility from $35 million to $50 million and extended maturity to March 20, 2017. It also reduced the unused-line fee, lowered the LIBOR margin range, and ended the automatic cash sweep. At quarter-end, $2.8 million of borrowings bore interest at 3.25% and $18.0 million at a rate reported as 2.24%.
- Management said current cash sources and borrowing capacity should meet anticipated working-capital and capital-expenditure needs for at least the next 12 months. The company had no material off-balance-sheet arrangements.
Material changes, outlook and risks
- Sales growth was volume-led, but lower gross margin shows sensitivity to product mix. R&D expense rose 74.1%, including added engineering staff and prototype and component costs for new power systems.
- Interest expense declined to $0.23 million from $0.63 million, reflecting lower average borrowings and borrowing rates. Conversely, the fair value of private-placement warrants increased by $0.59 million, recorded as other expense. The warrant liability was $3.86 million at quarter-end and is valued using significant unobservable inputs; its non-deductible expense contributed to a 47.3% quarterly effective tax rate versus 36.2%.
- The company did not provide numerical revenue or earnings guidance. Management cited demand expectations in explaining the inventory build, while cautioning that quarterly results can vary with customer and supplier product transitions, emissions requirements, pricing and product mix.
- Key stated business risks include dependence on OEM customers and key suppliers (including Perkins/Caterpillar for a substantial majority of diesel-system revenue), competition, inventory exposure if demand weakens, component-price increases, warranty and product-liability claims, regulatory changes, and execution risks for new products and the company’s first in-house engine block. Alternative-fuel market development and expansion into on-road markets are also uncertain.
- Management expected pending legal proceedings in the normal course of business not to have a material adverse effect. Disclosure controls were judged effective at March 31, 2012, but the company had not yet completed its first annual Section 404 assessment of internal control; it planned to assess controls at year-end 2012 and warned deficiencies or material weaknesses could be identified.
Important facts for investors to verify
- Whether the demand anticipated in the inventory build materializes, and whether inventory can be converted into sales without write-downs or margin pressure.
- How product mix and pricing affect gross margin as sales expand.
- Actual borrowing availability, covenant headroom, interest rates and working-capital requirements under the amended credit facility.
- Future warrant fair-value changes and their effects on reported earnings and the effective tax rate; the valuation depends on unobservable assumptions.
- Progress on new products, in-house engine development, supplier diversification and the planned year-end internal-control assessment.