Power Solutions International, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Dollar amounts below are in millions unless noted. The statements reflect The W Group’s historical business following the April 2011 reverse recapitalization; they were retroactively adjusted for the August 2011 1-for-32 reverse split.
Business context
The company designs, manufactures, distributes and supports customized power systems and aftermarket parts for industrial original equipment manufacturers. Products serve applications including power generation, oil and gas, material handling, construction and agriculture. Engines are sourced from third parties; the company says it is a sole-source provider for most customers. It operates as one business segment.
Financial performance
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Net sales | $42.8 | $27.2 | $109.5 | $70.6 |
| Gross profit | $6.6 | $4.1 | $19.0 | $11.2 |
| Gross margin | 15.3% | 15.1% | 17.4% | 15.9% |
| Operating income | $2.3 | $1.1 | $7.2 | $2.6 |
| Net income | $1.9 | $0.4 | $3.5 | $0.8 |
| Basic and diluted EPS | $0.19 | $0.05 | $0.38 | $0.10 |
- Q3 sales rose 57%; management attributed most of the increase to higher volume, especially alternative-fuel systems, including shipments to Asia, and aftermarket parts. Q3 alternative-fuel large-system sales were partly affected by supplier engine-delivery delays.
- For the first nine months, sales increased 55%, led by alternative-fuel systems and Asia-based customer shipments. Management cited broader customer demand and economic improvement as additional contributors.
- Gross margin improved year over year for the nine-month period, which management attributed to higher production volume and a broader product mix. Q3 margin improved only modestly; lower-margin product mix raised material costs.
- Nine-month operating expenses were $11.8 million versus $8.6 million; general and administrative costs rose partly because of public-company, transaction and refinancing costs, and increased staffing. Q3 G&A was $1.4 million versus $0.8 million.
Cash flow, balance sheet and liquidity
- For the nine months, operating cash flow was negative $2.6 million, versus positive $4.6 million in 2010. The principal working-capital use was a $10.4 million increase in accounts receivable, partly offset by a $4.4 million increase in accounts payable.
- Investing cash outflow was $0.7 million, primarily for property and equipment. Financing cash inflow was $3.3 million, reflecting the private placement and refinancing, offset by repayments, transaction costs and other financing activity.
- Cash was reported as zero at September 30, 2011 and December 31, 2010. Under the credit arrangements, collected cash is swept against the revolving credit line; the company borrows as needed for disbursements.
- Working capital was $17.4 million, up from $6.3 million at year-end 2010. Accounts receivable increased to $26.7 million from $16.3 million; inventory was $32.6 million versus $32.2 million.
- At September 30, the company had $17.2 million outstanding on a $35.0 million Harris revolving facility, with $17.8 million available. The facility matures April 29, 2014, is secured by substantially all assets, and carries prime-based or LIBOR-based rates. The company reported covenant compliance for its most recent required reporting period.
- Long-term debt and capital lease obligations totaled $0.07 million, compared with $7.9 million at year-end 2010; the prior term loans were repaid in April. Total liabilities were $46.3 million and stockholders’ equity was $19.0 million.
Material changes, outlook and risks
- The April reverse recapitalization and $18.0 million preferred-stock-and-warrant private placement changed the company’s ownership and capital structure. Preferred shares converted into common stock on August 26 following the reverse split and Delaware reincorporation. The company also replaced its prior credit agreement and repaid its term loans. A $0.5 million loss on debt extinguishment was recorded in the nine-month period.
- The private-placement warrants are recorded as a liability and measured using Level 3 fair-value inputs. Their value declined from $2.9 million at issuance to $2.2 million at September 30, producing $0.7 million of noncash income for the nine months. Q3 other income included a $0.6 million warrant fair-value benefit.
- No specific revenue or earnings guidance was provided. Management said, based on its forecasts and assumptions, that operating cash generation and access to credit should be sufficient for anticipated working-capital and capital-expenditure needs. It expected interest expense to remain below prior-year levels, partly due to lower borrowing rates.
- Management highlighted risks from economic conditions, customer and supplier concentration, engine availability and component pricing, product mix, alternative-fuel market demand, regulatory changes, long sales cycles, inventory exposure, and the ability to manage growth. Public-company compliance costs are expected to add expense.
- Liquidity and working capital depend in part on receivable collections; some customers have payment terms up to 150 days. Registration statements covering the securities subject to investor registration rights became effective in August and September, resolving the disclosed effectiveness-related liquidated-damages contingencies. The company said ordinary-course legal proceedings were not expected to materially affect results or financial condition.
- On October 31, 2011, after quarter-end, the company bought and cancelled 830,925 shares from its CEO for $4.25 million, funded by an additional draw on the credit line. The filing reported $23.5 million drawn and $11.5 million remaining available immediately afterward.
- Disclosure controls were deemed effective at September 30, 2011, but the company had not yet completed its first annual assessment of internal control over financial reporting under Section 404. It noted that this assessment could identify deficiencies or material weaknesses.
Important facts for investors to verify
- Whether receivable growth, extended customer payment terms and the resulting negative operating cash flow persist or reverse.
- Current line-of-credit availability, covenant headroom, borrowing rates and the impact of the post-quarter-end $4.25 million draw and share repurchase.
- Whether strong sales growth and improved year-to-date gross margins continue, particularly given supplier engine-delivery delays and product-mix sensitivity.
- The assumptions and potential earnings volatility associated with the Level 3 warrant valuation and the warrants’ anti-dilution provisions.
- Progress on public-company controls and the outcome of the first Section 404 internal-control assessment.
- The comparability of reported per-share results, given the reverse split, preferred-stock conversion and large changes in weighted-average common shares.