Pioneer Power Solutions, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Financial amounts are in thousands of U.S. dollars, except per-share data, percentages, and where otherwise noted. The company manufactures and services electrical transformers and power-generation equipment. Results below reflect continuing operations unless identified otherwise; the switchgear business is reported as discontinued operations.
Financial results and liquidity
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $23,475 | $25,057 |
| Gross profit / margin | $4,428 / 18.9% | $5,567 / 22.2% |
| Operating income | $156 | $1,133 |
| Interest expense | $649 | $549 |
| Net income (loss) | $(574) | $109 |
| Net income (loss) per diluted share | $(0.07) | $0.01 |
| Cash provided by operating activities | $1,056 | $1,060 |
| Capital expenditures | $152 | $496 |
- Revenue declined 6.3%. Transformer revenue fell 1.7%; Critical Power revenue fell 32.6%, mainly because equipment sales decreased 75.8% following a reduced focus on that stream. Service revenue declined 1.5%.
- Gross margin fell 3.3 percentage points. T&D Solutions gross margin was 19.5% versus 22.3%, reflecting lower liquid-filled transformer sales and unfavorable dry-type product mix. Critical Power gross margin was 13.5% versus 21.5%.
- Operating income decreased 86.2%. T&D Solutions operating income was $1,448 versus $2,051; Critical Power reported an operating loss of $438 versus $95. Lower overall gross profit was partly offset by lower operating expenses and no restructuring expense, compared with $155 in Q1 2017.
- Interest expense increased $100, which management attributed to greater use of short-term borrowings. The company recorded a $28 income tax benefit, compared with $280 of tax expense in Q1 2017.
- Operating cash flow was approximately flat year over year. Inventory growth used $1,297 of cash, partly offset by a $2,900 increase in accounts payable and accrued liabilities. Cash was $268 at quarter-end, up from $218 at year-end 2017.
- Working capital was negative $480 at March 31, 2018, compared with positive $709 at December 31, 2017; current assets were approximately equal to current liabilities. Management reported $1,400 of available, unused revolving capacity, subject to covenants and other restrictions.
- At March 31, the company reported $5,700 outstanding under Canadian facilities and $18,500 under U.S. facilities. The balance sheet also showed $19,318 of revolving facilities, $3,385 of short-term borrowings, $4,857 of debt net of issuance costs, and $936 of bank overdrafts. Management cited total debt of $28.6 million including overdrafts and discontinued-operation liabilities.
Material changes, outlook, and risks
- Switchgear divestiture: On May 2, 2018, after quarter-end, wholly owned PCEP agreed to sell certain switchgear-business assets to CleanSpark. Consideration includes an 18-month note at 9% for the business’s net carrying value at closing; a three-year equipment lease at $7,500 per month, with renewal and purchase options; 7 million CleanSpark shares valued by agreement at $5.6 million; and two five-year warrants for 1 million shares each, exercisable at $1.60 and $2.00. CleanSpark is not assuming debt or significant liabilities. The consideration includes securities and a note; the filing does not establish their eventual realizable value. PCEP had Q1 revenue of $3,702 and income of $7, compared with revenue of $2,205 and a loss of $97 in Q1 2017.
- Backlog at March 31 was $30,126 for continuing segments, plus $5,621 for the discontinued operation, for total backlog of $35,747. Backlog can fluctuate, and the filing cautions that orders may not convert to revenue on expected timing.
- On March 28, 2018, amendments extended U.S. and Canadian credit facilities to April 1, 2020 and modified certain pricing and repayment terms. Lenders waived defaults on financial covenants existing at December 31, 2017; the company stated it was in compliance with facility covenants at March 31. The revolving facilities remain classified as current due to subjective acceleration clauses and lockbox arrangements.
- Management said cash, operating cash generation, working capital, and available borrowing capacity should fund anticipated operating needs, capital improvements, and principal repayments for at least twelve months from filing. No major capital projects or significant replacement spending were planned for 2018. The filing provides no specific revenue or earnings guidance.
- Key risks cited include dependence on Siemens and Hydro-Quebec, demand and competitive pressures, raw-material and supply-chain costs, debt covenants and refinancing/liquidity, backlog conversion, currency fluctuations, and reliance on key personnel. About 40% of Q1 continuing revenue was denominated in Canadian dollars; the company reported a $74 foreign-exchange loss versus a $61 gain in Q1 2017 and said it has not historically hedged currency exposure.
- Management reported continuing material weaknesses in internal control over financial reporting and concluded disclosure controls were not effective at March 31, 2018. Remediation actions included personnel recruitment, staff training, and review by an independent consultant.
- A lawsuit brought by Myers Power Products alleges misuse of confidential business information and seeks injunctive relief and unspecified damages. The company denies the allegations and intends to contest the case; it says litigation outcomes are uncertain.
- The company adopted several accounting standards in Q1, including ASC 606, which management said had no material financial-statement impact and no opening-retained-earnings adjustment. Lease adoption increased assets and liabilities by approximately $5.3 million and $5.2 million, respectively, at the stated adoption date, and reduced opening retained earnings by approximately $0.1 million.
Most important facts for investors to verify
- Whether the CleanSpark asset sale closes as agreed, and the carrying value, collectability, and market value of its note, shares, warrants, and lease-related consideration.
- Whether the company can sustain covenant compliance and maintain access to revolving credit, particularly given negative working capital and limited reported unused capacity.
- Whether revenue and gross margins recover, especially in Critical Power equipment and transformer product mix, and whether backlog converts as anticipated.
- Progress in remediating the material weaknesses and restoring effective financial-reporting controls.
- Developments and potential financial exposure in the Myers Power Products litigation.