Pioneer Power Solutions - Earnings Call - Q1 2018

Transcript

Speaker 0

Good day, and welcome to the Pioneer Power Solutions First Quarter twenty eighteen Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Brett Maas from H. IR. Please go ahead, sir.

Speaker 1

Thank you, and welcome. The call today will be hosted by Nathan Masarek, Chairman and Chief Executive Officer Tom Klink, Chief Financial Officer. Following this discussion, will be a formal Q and A session over to participants on the call. We appreciate having the opportunity to review the first quarter financial results. Before we get started, let me remind you this call is being broadcast over the Internet, and a recording of the call and the text of management's prepared remarks will be made available on the company's website.

During this call, management will make forward looking statements. These statements are based on the current expectations and assumptions and are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary text regarding forward looking statements contained in the earnings release issued earlier today and in the posted version of these prepared remarks, both of which apply to the content of the call. I'd now like to turn the call over to Nathan Masaryk, Chairman and CEO. Nathan, please go ahead.

Speaker 2

Thank you, Brett. Good afternoon, and thank you all for joining us today for our conference call. While first quarter revenue and backlog demonstrate that our overall business is healthy, we are nevertheless dissatisfied

Speaker 1

with

Speaker 2

the results. During this call, I'll discuss the two primary factors which impacted our results, the steps we are taking to address these issues and the expected timeframe for improvement. In addition, I will discuss the planned sale of our Switchgear business and our strategic view regarding the remainder of our business units in light of this transaction. Our first quarter results were impacted by two primary factors. First, we experienced a less than ideal mix in both the liquid filled and dry type transformer business.

Given the wide diversity of our customers and end markets as well as our obligations under long term utility contracts, our delivered product profile can vary from quarter to quarter in terms of margin. Typically in the course of twelve months, however, this blend normalizes, enabling us to meet our profitability targets for the year. Looking over the next few quarters, as evidenced by the nature of our backlog, this mix has already begun to adjust more favorably in the second quarter, and we anticipate delivering a more typical blend of product and consequently operating margins for the balance of the year. Second, the generation equipment segment of our Critical Power business continues to underperform. This issue is expected to take several quarters to remedy.

We recognize that we were too aggressive in the initial rollout of our private of our new private label generators last August. Specifically, based on a large equipment order, which we won right at the inception of our private label generator launch, we added significant sales personnel in multiple new territories to try to meet what we expected would be strong initial demand. Wider customer adoption has taken longer than we anticipated, however, and the sales infrastructure we put in place resulted in higher costs than initial revenues could support. We are making adjustments in the sales organization to bring these costs in line with current volume levels. Order trends are encouraging, but it will take several quarters to reach the appropriate mix of revenue and expenses and to achieve the desired volume levels.

In contradistinction to equipment, the service side of our Critical Power division is robust and we fully expect our service revenue in 2018 to exceed that of 2017. Our initial two store pilot project with a large nationwide home improvement retailer is expected expand to 50 stores in the next quarter and we are optimistic about further expansion to this retailer's 2,000 plus stores based on a successful second phase. The long term trends remain favorable. Our backlog continues to grow and quotation activity in all our end markets remains strong. We fully expect our revenue and profitability to trend higher during the next several quarters.

We reported backlog from continuing operations of $30,100,000 at the March 2018. This is up sequentially from $28,900,000 at the December 2017. This backlog is based on firm orders expected to be delivered in the future, the vast majority of which is expected to be delivered during calendar twenty eighteen. Finally, during the quarter, we signed a definitive agreement to divest our Switchgear business. This transaction is an important part of our strategy to simplify our portfolio, reduce costs and focus on our core transformer business.

We expect to finalize the sale on or before June 3038. As a result of this divestiture, we expect to be a more profitable business, carry less debt, giving us greater flexibility in our efforts to create shareholder value. At the same time, and in our view, the potential for accelerated growth and profitability of the Switchgear business is enhanced by aligning its assets and capabilities with an advanced energy solutions provider such as CleanSpark. CleanSpark is a microgrid company with advanced engineering software and controls for innovative distributed energy resource management systems. Folding a specialized vendor agnostic hardware solution into its solution set provides CleanSpark with a simplified business development model, more streamlined deployment and an opportunity for rapid growth.

Through an equity position in CleanSpark, Pioneer shareholders will be able to benefit from the future success of this business in the hands of a more appropriate operator. Subject to market and legal conditions and Board approval, it is our intention to eventually distribute the shares and warrants to our shareholders as a dividend. In addition, it is important to note that we received approximately $10,300,000 in total consideration for a business that has historically been generating negative EBITDA for us. This suggests that the current share price of Pioneer may reflect a lower value than the value of the individual business units if they are viewed separately. With this transaction as a backdrop, we are carefully evaluating path to unlock shareholder value, including dividends and or the sale of part or all of the business units.

Unlocking shareholder value remains our most important objective. And as Pioneer's largest shareholder, I am fully aligned with this effort. Until there is something definitive to report in this regard, I will refrain from further comment on this activity. We will also not answer any questions about this process during the Q and A or about the sale of the Switchgear business as this sale is still pending. With that, let me turn the call over to Tom to discuss our first quarter results.

Thank you, Nathan, and good afternoon, everyone. Before I get started, as Nathan discussed, on May 2,

Speaker 3

we signed an agreement to sell our Switchgear business. Accordingly, this portion of our business was reclassified as discontinued operations for the first quarter reporting. The results presented in our press release and that I'm about to discuss reflect continuing operations only. Revenue was $23,500,000 for the 2018, down 6.3% compared to $25,100,000 in the first quarter of last year, with the majority of this decrease from lower sales of generator equipment. Gross profit for the 2018 was $4,400,000 or 18.9% compared to $5,600,000 or 22.2% gross margin in the year ago quarter.

The gross margin was impacted by lower sales of generator equipment and an unfavorable product mix in both of our transformer business units. Selling, general and administrative expenses for the 2018 decreased 3.3% on an absolute dollar basis to $4,200,000 compared to $4,300,000 in the 2017. As a percentage of revenue, SG and A expenses were 17.9% of revenue in the 2018 compared to 17.3% in the 2017. Additionally, in the 2017, we incurred restructuring expenses of $155,000 compared to no restructuring expenses in the current year. Finally, in the 2018, we incurred a foreign exchange loss of $74,000 compared to an income from foreign exchange activity of $61,000 in the 2017.

Operating income from continuing operations for the 2018 decreased to $156,000 compared to $1,100,000 in the 2017. Both of these amounts are inclusive of nonrecurring charges. For continuing operations, our effective tax rate for the 2018 was 4.6% of pretax income as compared to 57.6% for the same quarter last year. The change in tax rate was primarily due to The U. S.

Tax reform completed in December 2017 and the change in tax treatment for foreign sourced income. Net loss from continuing operations for the 2018 was $581,000 or $07 per basic and diluted share compared to a net income from continuing operations of $206,000 or $02 per basic and diluted share in the prior year's quarter. Adjusted EBITDA for the 2018 was approximately $1,300,000 compared to $2,400,000 in the 2017. Non GAAP diluted EPS decreased to $0.12 in the 2018 compared to $0.21 in the 2017. Turning to the balance sheet and statement of cash flows.

Including the 2014 and 2015 unpaid payroll tax liabilities being paid on an installment basis, our total interest bearing debt at March 3138 was $27,700,000 compared to $29,300,000 at December 3137. For the three months ended March 3138, we generated cash from operations of $1,100,000 compared to 2017 where we also generated cash from operations of $1,100,000 As a reminder, our final installments for the 2014 and 2015 payroll tax liabilities, which initially at balances greater than $4,000,000 will be made during the 2018. We continue to expect to generate single digit growth in revenues from continuing operations and to increase adjusted EBITDA for the full year of 2018 compared to 2017. This concludes my remarks. I now turn the call back over to Nathan.

Speaker 2

Thank you, Tom. Operator, I'd now like to open the call for questions.

Speaker 0

Thank We'll take a question from Matt Grondo with ROTH Capital Partners.

Speaker 4

Just wanted to start off with housekeeping oriented question. Could you provide the breakdown? I don't think I saw it in the release, but did you provide the breakdown between T and D Solutions and Critical Power Solutions revenue?

Speaker 3

The breakdown is approximately $2,500,000 from Critical Power with the balance coming from T and D.

Speaker 4

Okay. Got it. And then just in terms of the year over year decline in Critical Power, could you give us a little more color on sort of the drivers there? I assume maybe some one time work in Q1 last year that didn't necessarily repeat this year?

Speaker 2

No, it's really all equipment. I mean, services is about the same. It's all a decline on the equipment side of the business. Q1 of last year, we were still distributing Generac product.

Speaker 4

Okay, got it. All right, that's helpful. And then just on the rollout of the private label gensets, I know you mentioned it briefly in the prepared remarks, Nathan, but just wanted to get a sense for the changes that kind of happened since the introduction of that product. I know you guys came out the gates really strong with a nice order

what has changed? I guess, could you sum up the biggest changes that happened between then and now that sort of caused you to revise those expectations for that product a little bit lower?

Speaker 2

Yes. I think that we need to understand better why we won that kind of an order with the nature of it was. I'm not going to go into the details here, but that's what we should really be concentrating on replicating. That gives us size, it gave us margin. It was a much more negotiated value added type proposition.

I think we slipped back into bad habits of chasing kinds of the stuff that maybe some people were more comfortable with and that's a long term profitable

Speaker 3

chase.

Speaker 4

Okay. All right. Got it. And I guess, would it be fair to characterize the opportunity there as there is additional there are additional projects in the pipeline that sort of are similar to that first order? And then I guess how are you incentivizing the sales force to go after this particular opportunity?

Speaker 2

Yes. I mean, hopefully, we're incentivizing them with fear. But we've realigned the incentive. It's really more a direction, meaning we're just saying no to a lot of quotation and other activity that really doesn't lead to a value added negotiated project. It just doesn't it has to meet certain revenue and profit targets and its nature has to be one that we are really adding value to.

If you just want to go into the bid spec world and just win something by $2 you win, you really lose. So that's what we're trying to move away from. Indeed, the backlog already has some more projects that imitate the Camp Ripley project that we did back in towards the end of last year by its the nature of the product, the nature of where it's going, its application and the size of it. And that's where we've got to really push the business to go and we probably need a more concentrating focused group to do it.

Speaker 4

Okay. Okay. Got it. Just on margin pressure, I know you guys called out sort of unfavorable mix in Q1 with some lower margin transformer products. But just wondered if you could provide a little bit more color on the headwinds you faced there this quarter?

And maybe in terms of labor or freight, material cost headwinds, were those the factor in sort of lower margin?

Speaker 2

Yes. So maybe we didn't communicate it right. There really aren't there's no headwinds. It's really kind of we can't control the mix 100%. We do control what we do.

Just high distributor sales on the dry type, a lot of utility sales on the liquid filled side and that's going to drive the margins lower. The good news is that from the sales, especially the transformer part of the business, the sales are pretty much the same as last year and the end markets are strong and we see the year unfolding in an aggressive strong way. It happens from time to time that you get dealt a less than perfect hand the way the order book goes. Our capacity, like ultimately everybody, is constrained and that's how it blended out this quarter.

Speaker 4

Got it. Okay. Yes. So limited stuff you can do to control the mix quarter to quarter so that's Correct. Really the explanatory Okay.

Got it. In terms of the bookings environment, I think I'm backing into sort of an implied bookings, looks kind of flattish year over year, but still like a strong over 1x book to bill. Just wondered if you could kind of characterize sort of puts and takes on the T and D side versus Critical Power, how that sort of played out versus your expectations during the quarter?

Speaker 3

Yes. The you're right. The book to bill was stronger. We are above one. The liquid filled showed some nice orders for the quarter that were coming in to be shipped yet this quarter.

Still no real activity in oil and gas that is nonexistent sector for us right now. Perhaps with the recent increase in oil prices, there'll be something, but it will be beyond 2018. Before that, I'll have any significant impact in what we do. Dry type, really, there's not

Speaker 5

a whole lot

Speaker 3

of backlog that goes on in that environment. It's take the order today, ship it tomorrow type of environment. And so we're not seeing any significant changes in that backlog up or down. It's kind of the same old, same old. We did have some decent growth in our discontinued ops segment or I'm sorry, so that went up a little bit.

And then lastly, the Critical Power backlog was pretty much flat year on year or quarter to quarter, I'm sorry.

Speaker 4

Got it. Okay. All right. So I guess last question related to the fundamental business, and then I'll sneak one more in here. But just with the backlog visibility you guys have, and I think it sounds like you have some confidence that margins sort of sequentially improved throughout the year.

Could you give us a sense for just sort of the cadence of margin improvement that we should expect going through the remainder of 2018 and just sort of how we should be thinking about modeling that improvement from sort of this mid single digit EBITDA margin in Q1?

Speaker 3

Right. Yes. So normally, in all of our segments, because of where they're located and where their customer base is, the first quarter tends to usually be the roughest, and it grows from there. There's just more activity that occurs concentrating on Critical Power to start. Service revenue tends to be soft in Q1, growing in Q2, Q3 and the beginning of Q4 because people are available.

The retail environment, we start now and we finish by the time Black Friday shows up. For the cell towers, Nobody wants to pay for ATV service or snowmobile service in order to get to them in January and February and March. So there tends to be a limited amount. We have an increased backlog in service up there, so we're expecting strong sales in the coming quarters, and those sales carry a much higher margin than the equipments do. The backlog in liquid filled is strong.

The mix seems good at this point in time. We expect in the short term, Q2 is definitely going to be a stronger quarter than Q1 in terms of Canadian dollar to Canadian dollar. What happens to the FX rate is to be determined. Can't control that. But that looks strong right now.

It looks like it will be stronger than last year anyways when we were about $02 lower than we are right now. Dry type, again, doesn't really show us a whole lot, but distribution really starts moving. The PDU world, which we struggled with in Q1, was down on sales volume. That volume looks like it will come back and we'll start to reap some projects that have been put on hold during Q1 during the last nine months of this year.

Speaker 4

Okay, that's helpful. Thank you. And then just, I guess, lastly, I know you said that no questions on the sale, I have to just I appreciate the sense of nature of the timing of the transaction, but just one high level one. Can you just give us a sense for sort of the hurdles that need to be completed here before the sale goes through by the end of the quarter, it looks like? I mean, there diligence items that are still sort of need to be ticked on CleanSpark's part?

Is it more just shareholder approval? Any sense for that would be helpful.

Speaker 2

Again, think we're not going to we're just not going to comment on it. We don't foresee right now. There's nothing that there's nothing extant that should stop us from meeting the June 30 date.

Speaker 0

We'll take our next question from Jay Harris with Acxiom Capital Management.

Speaker 5

I have another question that I know you won't answer, but I'd like you to think about it. Does CleanSpark acquisition of your division change the nature of their business? It's not clear how the business that they're buying from you will fit in with what they have been doing. So when you're ready to respond to that, I'd like to we'd all like to hear it. Thank you.

Speaker 3

Okay. All

Speaker 2

right. I mean, I think we put out a joint release and the CleanSpark folk, I'm sure, will do a great job messaging what it's about. But basically, we've penetrated from our side, we've penetrated a lot of the distributed generation customers and end markets with our hardware. They're more of a control software business and they see opportunity to really marry the hardware and software with the really differentiated product in what's a very, very fast growing undeveloped market for storage, microgrid, distributed energy resources. And I think that they will be very successful.

We hope that they're going to be very successful doing that really coming they're already well regarded and our products are well regarded and fusing them with a differentiated product in that particular market would put it in a position to reap some greater rewards than we can do by ourselves.

Speaker 5

Thank you.

Speaker 2

You're welcome, Jay.

Speaker 0

And it appears there are no further questions at this time. I'd like to turn the conference back to Mr. Maas for any additional or closing remarks.

Speaker 2

Okay. Thank you all for your time and support. This is Nathan, and we look forward updating you all again on our next call. Thank you, operator.

Speaker 0

Thank you. That does conclude today's conference and thank you for your participation.