Power Solutions International, Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; comparative periods ended September 30, 2012. Financial amounts below are in millions of dollars unless otherwise noted. PSI designs, manufactures, distributes and supports power systems and aftermarket parts for industrial OEMs, operating as one business and geographic segment.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $64.6 | $51.7 | $176.3 | $149.9 |
| Gross profit | $12.4 | $8.4 | $32.7 | $25.5 |
| Gross margin | 19.1% | 16.3% | 18.6% | 17.0% |
| Operating income | $4.1 | $2.9 | $11.0 | $9.3 |
| Net income (loss) | ($10.0) | $1.8 | ($15.0) | $6.0 |
| Basic and diluted EPS | ($0.97) | $0.20 | ($1.57) | $0.66 |
Q3 sales rose 25.0%; nine-month sales rose 17.6%. Management attributed most of the increase to higher unit volumes, particularly power systems, with growth in larger power systems also improving product mix and gross margins. Operating expenses increased, including research and engineering spending to support product development and on-road applications.
Net losses primarily reflect noncash private-placement warrant remeasurement expense: $12.6 million in Q3 and $21.7 million for the nine months, versus warrant valuation income of $0.2 million and $0.7 million in the respective 2012 periods. The warrants are a Level 3 liability; their $20.1 million September 30 fair value used unobservable valuation inputs. The share-price increase was the principal driver. Excluding that warrant expense, operating results were profitable before tax, but this is not a company-reported GAAP measure.
- Cash flow, nine months: Operating activities used $6.0 million, compared with $2.6 million used in 2012. Inventory growth used $9.6 million of cash; capital expenditures were $4.3 million and the China joint venture investment was $0.5 million.
- Liquidity: Cash was $8.3 million at September 30, versus $0.5 million at December 31, 2012. Working capital was $71.4 million, up from $49.4 million.
- Debt and availability: Revolver borrowings were $12.3 million, down from $30.9 million at year-end; reported unused and available capacity was $49.4 million. The Wells Fargo facility has an initial $75 million limit, potentially increasable to $100 million, and matures June 28, 2018. Borrowing is subject to a borrowing base and covenants.
- Equity financing: In July, PSI sold 1.05 million primary shares at $35 per share. It received approximately $34.5 million before offering expenses and used $25 million to repay revolver borrowings. Outstanding shares increased to 10.48 million from 9.08 million at year-end.
Material changes versus prior periods
- Higher unit volumes and a shift toward larger power systems drove sales and margin growth in both the quarter and year to date.
- Despite improved operating income, reported results moved from net income to net loss because of the substantial warrant revaluation charge.
- Operating cash use increased year over year, with inventory, receivables and payment timing contributing to working-capital needs.
- The company replaced its $50 million BMO facility with a $75 million Wells Fargo revolving facility in June and reduced borrowings following the equity offering.
Outlook, risks and unusual items
PSI gave no specific revenue or earnings guidance. Management stated that, based on current forecasts and assumptions, cash sources and borrowing access should cover anticipated working capital and capital expenditures for at least the next 12 months. Longer-term liquidity depends on customer relationships, product acceptance and development, and potential strategic transactions. Management said the 2013 estimated annual tax rate was 37%, excluding specified items; the filing notes that the reported rate is distorted by the non-taxable warrant revaluation.
- Risks include reliance on key OEM customers and suppliers, significant inventory exposure, competition, variable sales cycles, component pricing, regulatory changes, and execution risks for new products, the in-house 8.8-liter engine, on-road expansion and the Asian joint venture.
- The joint venture agreement contemplated up to $1.2 million of PSI investment; $0.5 million had been contributed by September 30. The facility was scheduled for completion by year-end 2013.
- Management concluded disclosure controls were not effective at quarter-end because a previously disclosed material weakness in aftermarket software access and transaction monitoring had not been remediated. Security rights and monitoring tools had been added, but not operated long enough to establish remediation.
- Legal proceedings arising in the ordinary course were not expected to have a material effect. Registration-rights provisions could require liquidated damages if specified registration or resale conditions fail; the filing reports the relevant registration statements effective and no liability recorded.
- No dividends were anticipated in the foreseeable future. The company reported no material off-balance-sheet arrangements.
Important facts for investors to verify
- How much of operating and net performance is attributable to underlying operations versus the volatile, noncash warrant valuation, and how warrant fair value may change with the share price.
- Whether inventory growth converts into sales and cash, and whether operating cash flow improves as the business expands.
- Actual borrowing-base availability, covenant headroom and liquidity under the Wells Fargo facility, including its collateral and threshold-based fixed-charge coverage requirements.
- Progress and costs for product development, the in-house engine, on-road applications and the China joint venture.
- Remediation and independent effectiveness of controls addressing the disclosed material weakness.
- Potential share dilution from warrant exercises and equity compensation; compare reported share counts with subsequent filings.