Power Solutions International, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. PSI designs and manufactures engines, power systems, and electrical generation systems for energy, industrial, and transportation markets. Amounts below are U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $93.1 | $138.7 | $198.2 | $254.5 |
| Gross profit / margin | $3.8 / 4.1% | $25.6 / 18.5% | $21.5 / 10.8% | $43.3 / 17.0% |
| Operating income (loss) | ($15.4) | $4.7 | ($19.1) | ($0.8) |
| Net income (loss) | ($17.7) | ($3.0) | ($18.5) | ($5.6) |
| Diluted loss per share | ($0.78) | ($0.14) | ($0.81) | ($0.28) |
| Operating cash flow | Not separately provided for the quarter | $4.0 | $2.0 |
- Quarterly sales fell 33%; six-month sales fell 22%. Q2 industrial and energy sales declined $24.2 million and $22.6 million, respectively, partly offset by a $1.2 million increase in transportation sales.
- Six-month sales declines were concentrated in industrial ($37.7 million) and energy ($18.2 million); transportation fell $0.5 million.
- Management attributed lower demand to COVID-19 disruption and weakness in oil and gas, as well as lower demand in material handling/forklifts and other industrial applications. Q2 gross margin also suffered from unfavorable mix, lower operating leverage, and higher warranty costs.
- Six-month warranty costs were $15.5 million net of supplier recoveries, including $9.9 million of charges for revisions to estimates on previously sold products. The warranty liability was $32.5 million at June 30.
- Cash and cash equivalents were $32.5 million, with a further $3.4 million restricted. Operating cash flow was positive despite the loss, supported by working-capital movements, including receivable collections; inventory increased $32.0 million in cash-flow terms.
Debt, liquidity, and balance sheet
- At June 30, the company had drawn the full $130.0 million under its new secured revolving facility; total long-term debt and finance leases were approximately $1.1 million. The facility is secured by substantially all company assets and matures March 26, 2021, with a conditional 60-day extension option.
- PSI did not meet the facility’s minimum EBITDA covenant for the six months ended June 30. The breach is an event of default if not cured or waived; PSI was discussing the breach with the lender.
- Management said it expects not to have enough cash to repay the facility at maturity without additional financing, plans to seek liquidity, and cannot assure a waiver, refinancing, or repayment. Management concluded substantial doubt exists about the company’s ability to continue as a going concern within one year after issuance of the statements.
- Current liabilities were $288.7 million, compared with current assets of $251.3 million. Stockholders’ equity declined to $10.4 million from $28.5 million at year-end 2019.
- Cash provided by financing activities was $33.4 million for the first half, primarily reflecting the new borrowings. PSI used initial proceeds to repay its former revolving facility and redeem $55.0 million of unsecured notes due June 2020.
Outlook, risks, and unusual items
- No quantified sales or earnings guidance was provided. Management described demand, oil prices, rig counts, and the effects of COVID-19 as uncertain and potentially materially adverse to results, liquidity, and asset values.
- PSI reduced its production workforce and implemented temporary cost measures, including salary reductions, suspension of the 401(k) match, and deferred R&D spending. Pay and match measures were scheduled through September 30, 2020, subject to reassessment.
- The company reported ineffective disclosure controls at June 30 and continued remediation of previously identified material weaknesses in internal control over financial reporting.
- Ongoing SEC and U.S. Attorney investigations relate to past financial reporting and revenue recognition matters. The company is cooperating; potential outcomes and losses are uncertain. The filing also describes a disputed arbitration demand seeking more than $9 million in royalties, which PSI contests.
- PSI’s primary directors’ and officers’ insurance coverage was exhausted during Q1 2020. A new policy was obtained, but it excludes ongoing or pending matters including the SEC and USAO investigations. Indemnification costs may be material.
- Other notable items include a $0.5 million debt-extinguishment loss and a $3.6 million six-month income tax benefit, substantially related to CARES Act provisions and tax adjustments. PSI identified an interim goodwill impairment trigger but concluded goodwill was not impaired at March 31; future impairment remains possible.
- Weichai, which held a majority of PSI’s shares, renewed its strategic collaboration agreement for three years. PSI purchased $12.2 million of inventory from Weichai in the first half and owed it $10.3 million at June 30.
Important facts for investors to verify
- Whether the lender waived or cured the covenant breach, and the status and terms of any refinancing or liquidity arrangements before the March 2021 maturity.
- Subsequent sales, cash generation, customer prepayments, and working-capital requirements, including the sustainability of cash-flow support from collections.
- Warranty claim trends, the basis for the large prior-period estimate adjustments, and whether supplier recoveries are obtained.
- Developments in the SEC/USAO investigations, disputed arbitration, indemnification exposure, and insurance coverage.
- Progress in remediating material weaknesses and the status of the company’s common-stock exchange listing; the filing lists no securities registered under Section 12(b) and identifies delisting and relisting as risks.