Pioneer Power Solutions, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017; filed August 11, 2017. The company manufactures and services electrical transmission, distribution and on-site power equipment. Its reportable segments are Transmission & Distribution (T&D) Solutions and Critical Power. Financial amounts below are in millions of U.S. dollars unless noted.
Financial performance
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Revenue | $30.9 | $29.9 | $58.2 | $56.5 |
| Gross profit | $6.0 | $6.3 | $12.1 | $12.1 |
| Gross margin | 19.3% | 20.9% | 20.8% | 21.5% |
| Operating income | $1.6 | $1.4 | $2.8 | $2.5 |
| Net income | $1.3 | $0.2 | $1.4 | $0.8 |
| Diluted EPS | $0.15 | $0.02 | $0.17 | $0.09 |
Interest expense was $0.6 million in Q2 and $1.1 million in the first half, up from $0.3 million and $0.6 million, respectively, as average borrowings and use of short-term borrowing increased. Income tax benefits of $0.4 million for Q2 and $0.1 million for the first half, versus tax expense in 2016, materially supported higher net income. Management attributed the tax change primarily to use of foreign tax credits and reconciliation of 2016 tax expense.
For the six months, operating cash flow was $2.1 million, compared with cash used of $12.0 million in 2016. The 2017 result included a $4.6 million increase in accounts payable and accrued liabilities, partly offset by a $4.0 million inventory build. Investing cash outflow was $0.9 million, including $0.9 million of capital expenditures; financing cash outflow was $0.8 million. Cash was $0.3 million at June 30.
At June 30, total debt was reported as $28.1 million. Current liabilities were $47.4 million and current assets $52.0 million, yielding working capital of $4.6 million and a current ratio of approximately 1.1. Unused revolving-credit capacity was $1.5 million, subject to facility restrictions and covenants. The company reported compliance with its financial covenants at quarter-end.
Changes versus the prior comparable periods
- Revenue increased 3.2% in Q2 and 2.9% in the first half. T&D revenue rose 8.6% in Q2 and 7.1% in the first half, led by transformer sales. Critical Power revenue declined 23.1% and 18.2%, respectively, as equipment sales fell despite growth in service revenue.
- Gross margin narrowed in both periods. Management cited lower margins in T&D dry-type transformers and switchgear. Critical Power margins improved as sales shifted toward higher-margin services.
- Operating income increased, helped by higher T&D operating income and lower consolidated operating expenses. Critical Power recorded operating losses of $0.2 million in Q2 and $0.4 million in the first half.
- Net income improved substantially, but the improvement was driven principally by the tax benefit; higher interest expense partly offset operating-income gains.
- Backlog was $39.6 million at June 30, up from $37.8 million a year earlier. T&D backlog declined year over year, while Critical Power backlog increased.
Prior-period results were reclassified for expense-classification inconsistencies: certain expenses moved from operating expenses to cost of goods sold, increasing reported 2016 gross profit by $0.139 million for Q2 and $0.084 million for the first half.
Liquidity, debt, outlook and risks
- In March 2017, amendments to the U.S. and Canadian BMO facilities increased revolving capacity and extended key revolving maturities to July 31, 2018. The U.S. term facility also has a $4.438 million balloon payment due July 31, 2018; a Canadian facility has a $0.352 million balloon payment due the same date.
- Management stated that working capital, available borrowing capacity and operating cash generation should fund anticipated operating needs, capital improvements and debt principal payments for at least the next twelve months. No quantified revenue or earnings guidance was provided. The company reported no major capital projects planned for 2017.
- Management identified demand and economic conditions, competition, dependence on Siemens orders, raw-material and supply costs, backlog conversion, currency movements, debt covenants and refinancing, and key-personnel retention among risks. The company has material Canadian-dollar exposure and reported no historical currency hedging.
- Material weaknesses in internal control over financial reporting remained unresolved at June 30, and the CEO and CFO concluded disclosure controls were ineffective. Remediation included additional accounting staff and training, review with an outside consultant, and consolidation of production locations; management cautioned that remediation was not complete.
- The company continued to record interest on past-due payroll-tax obligations and received waivers of certain interest and penalties. It is defending a California lawsuit alleging misuse of confidential business information; damages sought are unspecified and the company said it would contest the matter.
Important facts for investors to verify
- Whether the tax benefit and positive operating cash flow are repeatable, particularly given the working-capital contribution from higher payables and accrued liabilities.
- Ability to sustain T&D margins and improve Critical Power profitability as its equipment sales have declined.
- Liquidity and refinancing plans for the July 2018 credit-facility maturities and balloon payments, including covenant headroom and availability of revolving capacity.
- Progress in remediating material weaknesses and the effect of any further financial-reporting corrections.
- Backlog conversion, customer concentration and Siemens-related order exposure, as well as the outcome and potential financial impact of the pending lawsuit.