Power Solutions International, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. The report was signed May 4, 2020, and includes material subsequent developments through 2020; those developments should not be confused with Q2 2019 operating results.
Business context
PSI designs, manufactures and sells engines, power systems and integrated power-generation systems for industrial, energy and transportation markets. It operates as one reporting segment. Sales are concentrated in North America, and a significant portion of revenue and profitability is exposed to oil and gas markets.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $138.7 million | $127.1 million | $254.5 million | $221.5 million |
| Gross profit / margin | $25.6 million / 18.5% | $18.1 million / 14.2% | $43.3 million / 17.0% | $27.9 million / 12.6% |
| Operating income (loss) | $4.7 million | $(3.5) million | $(0.8) million | $(13.9) million |
| Net loss | $(3.0) million | $(11.8) million | $(5.6) million | $(26.0) million |
| Diluted loss per share | $(0.14) | $(0.63) | $(0.28) | $(1.40) |
| Cash from operating activities | Not presented quarterly | $2.0 million | $(8.2) million |
Q2 sales grew 9%, led by industrial and transportation; first-half sales rose 15%, with growth in all three end markets. Management attributed stronger gross margin to sales growth, mix, pricing and productivity, partly offset by higher warranty costs. Q2 GAAP net loss improved by $8.8 million year over year; first-half net loss improved by $20.4 million.
Management also reported non-GAAP adjusted EBITDA of $13.0 million for Q2 and $16.7 million for the first half, versus $5.2 million and $3.2 million, respectively, in 2018. These adjusted measures exclude items including warrant losses, stock compensation, severance, and financial-reporting and government-investigation costs; they are not GAAP results.
Liquidity, debt and capital structure
- At June 30, 2019, cash was $50,000. Current assets were $206.0 million and current liabilities were $182.8 million.
- Debt at June 30, 2019 included $53.5 million drawn on the Wells Fargo revolving facility and $55.0 million of unsecured senior notes, or $108.3 million in aggregate obligations including other debt and finance leases. Available revolver capacity was $8.1 million.
- Operating cash flow was positive in the first half, but cash was nearly unchanged at $50,000. Capital expenditures were $1.5 million.
- Weichai exercised its warrant in April 2019, PSI issued approximately 4.05 million shares and received $1.6 million in cash proceeds. Weichai held 51.5% of outstanding common shares; the transaction also eliminated the $35.1 million year-end warrant liability.
- As a subsequent event, PSI reported that it borrowed the full $130 million capacity of a new secured facility in April 2020 and held cash above $45 million as of April 29, 2020. Management nevertheless said it expected insufficient funds to repay the facility at its March 2021 maturity without additional financing and disclosed substantial doubt about the company’s ability to continue as a going concern.
Material changes, risks and unusual items
- Warranty exposure: Accrued product warranty liability was $26.0 million at June 30, 2019, up from $23.1 million at year-end 2018. The first half included a $2.7 million charge for changes in estimates on prior-period warranties and $2.9 million of charges tied to supplier quality issues; PSI was seeking reimbursement.
- Reporting and controls: Disclosure controls were ineffective at June 30, 2019 because of previously identified material weaknesses in internal control over financial reporting. Remediation was ongoing. The cover page also indicates PSI had not filed all required reports during the preceding 12 months.
- Investigations and litigation: SEC and U.S. Attorney investigations concerning prior financial reporting and revenue recognition remained ongoing, with potential penalties and other consequences not estimable. The company reported litigation reserves and other legal matters; some possible losses could not be reasonably estimated.
- COVID-19 and oil-market exposure: The filing’s later-dated discussion warned that the pandemic, depressed oil prices and declining rig counts could harm demand, liquidity and asset values. PSI described cost reductions, including shorter production hours and work weeks, salary cuts, a hiring freeze, reduced R&D spending and suspension of its 401(k) match. The filing said it had not yet experienced material order cancellations or supply-chain interruptions at the time of that discussion.
- Concentration and commitments: One customer accounted for 17% of first-half sales and 19% of receivables at June 30. Three suppliers each represented at least 10% of first-half purchases. Supplier minimum-purchase arrangements could trigger approximately $4 million in penalties if purchases stopped.
Most important facts for investors to verify
- Current refinancing, repayment and covenant status of the secured credit facility, and whether the disclosed going-concern uncertainty has been resolved.
- Status and outcome of the SEC and U.S. Attorney investigations, remaining litigation, and potential uninsured costs or penalties.
- Progress in remediating material weaknesses and the timing of restored effective disclosure and financial-reporting controls.
- Whether warranty claims, supplier quality issues and customer or supplier concentration have changed materially since the reported period.
- Actual impact of COVID-19 and oil-and-gas market conditions on orders, margins, liquidity and the company’s cost-reduction measures.