Pioneer Power Solutions - Earnings Call - Q3 2017

Transcript

Speaker 0

Good day, and welcome to the Pioneer Power Solutions, Inc. Third Quarter twenty seventeen Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn our conference over to Brett Motts. Please go ahead.

Speaker 1

Thank you, and welcome. The call today will be hosted by Nathan Masarek, Chairman and Chief Executive Officer and Tom Klink, Chief Financial Officer. Following this discussion, will a formal Q and A session open to participants on the call. We appreciate having the opportunity to review the third quarter financial results. 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 current expectations and assumptions that 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 yesterday and in the posted version of these prepared remarks, both of which apply to the content of the call. I would now like to turn the call over to Nathan Masarek, Chairman and CEO. Nathan, please go ahead.

Speaker 2

Thank you, Brett. Good morning, and thank you all for joining us today for our conference call. Our third quarter results continued to demonstrate the consistency of our earnings power and the strength of our end markets. We generated $2,500,000 of adjusted EBITDA during the quarter despite slightly lower revenue than expected. This was our seventh consecutive quarter in which we generated more than $1,800,000 of adjusted EBITDA and the second quarter in a row exceeding 2,500,000 Today, we have a stable profitable platform with a number of exciting opportunities to organically grow our revenues and earnings.

Our transmission and distribution solutions group or our T and D segment remains robust. In the liquid filled transformer portion of our business, we received significant orders for oil and gas, metals and mining applications, two key market segments that have been largely dormant since the 2014. Additionally, during the quarter, we announced a three year contract with a municipally owned power and utility provider for a large North American city for submersible transformers. We expect the contract, which became effective at the end of the second quarter, will generate up to $1,000,000 in incremental annual revenue through 2020. We began receiving orders immediately upon the award of this contract and expect to recognize about $400,000 of sales dollars in the fourth quarter of this year.

In addition, during the last quarter, we signed a thirty month contract to supply liquid filled network transformers to a large U. S.-based electrical utility. We expect this contract to generate annualized revenues of up to $2,000,000 through 2019. Initial shipments are scheduled to be delivered in the 2017. Our dry type transformer business continues to grow, primarily driven by the demand for special magnetic solutions for data center product applications.

In fact, we are actively negotiating over $45,000,000 of potential data center related product orders right now. At the same time, our traditional dry type end markets remain healthy and continue to provide us with a strong book of business quarter to quarter. In our switchgear business, we are benefiting from the growing trend to deploy microgrids and distributed energy solutions. We have successfully positioned Pioneer as a key player in this space with a proven offering, and we are being rewarded with meaningful revenue as this trend continues to grow. We are focused on managing this growth prudently, seeking an optimal product mix in order to secure margins that mirror the remainder of Pioneer's business segments.

Turning to our Critical Power segment, in August, we introduced our own private labeled line of Pioneer Critical Power Generation equipment, which we expect to become a significant source of revenue growth and margin expansion for us. Branded as Pioneer Critical Power, this complete line of engine generators ranging from nine kilowatts to two megawatts of output per generator set diesel and natural gas marks our initial foray into offering our own line of emergency and prime power generation equipment. The units, which began shipping in the 2017, significantly expands both our addressable product market and product scope. Under our prior distribution agreement, we were limited by our manufacturing vendor to a state three and a territory and a more technically limited line of engine generators. To date, we have already booked more than $1,000,000 of new orders.

The majority of these orders are expected to ship before year's end. The service side of our critical business continues to grow and indeed produce the lion's share of the division's profits. As we have stated many times before, we are focused on multi location type users, primarily retailers and self-service providers customers. Recently, however, we added a national portable power rental business and a Fortune 500 manufacturer of transfer switches to our service book of service of business. These two awards are expected to generate an additional $1,000,000 incremental annual service revenue beginning in the 2018.

We are also actively bidding two large cell tower opportunities representing about $8,000,000 of additional service revenue beginning the 2018. Finally, another new business win for the Critical Power business during the quarter was our selection by a leading home improvement retailer for a pilot program to provide a remote monitoring solution for the retailer's emergency power systems. The initial pilot program, which is expected to lead to a significantly larger opportunity across the retailers, approximately 2,000 locations nationwide, utilizes our proprietary solution to enable comprehensive asset management for on-site power generation. These solutions enable real time tracking as well as extended tracking and trend identification over weeks and months and provide remote test start and stop capabilities for on-site power systems. Integral to the solution is the utilization of our network operations center that can help to anticipate and identify potential failures or overloads before they occur through remote monitoring, often before a customer is even aware of the issue.

We have not yet received a second purchase order following this pilot program, adding to our initial rollout with this retailer, but we fully expect a second purchase order before the end of this year. Despite these tailwinds, we did experience some short term challenges during the last few months that suppressed an even potentially stronger quarter than the one we achieved. The first was related to weather. Hurricane Harvey impacted shipments into Houston where our largest distributed generation customer had a hurricane related shutdown, halting shipments to them for approximately a month. This situation is now behind us, and we were back to shipping approximately $1,000,000 each month to this particular customer.

In addition, the hurricane shut down the Port Of Houston, temporarily halting our ability to source product through this key point of access. This situation too has been resolved. We estimate the lost revenue due to this weather was between 2,000,000 and $3,000,000 in the quarter to Pioneer. Third, we experienced unexpectedly high demand from our largest utility customer for a large number of lower priced, lower margin, small pad mounted transformers, which utilized an outsized portion of our manufacturing capacity in our liquid filled transformer unit, decreasing production of higher margin products temporarily through the third quarter and into the first part of the fourth quarter. We have now returned to a more typical product mix at this facility.

Lastly, we observed we absorbed a nonrecurring charge at our dry type distribution transformer operation in Canada. This $873,000 charge related to the write off of obsolete parts inventory, which we are now sourcing from our partner in India. Since we are no longer actively manufacturing the product codes associated with these parts and components and are instead much sourcing at a much lower cost, we scrapped the material in place and booked a one time material charge. This charge reflected as part of cost of goods sold had a one time two ninety three basis point impact on our reported gross margin as well as a negative impact on our net income. Nevertheless, demand for our Custom Power Solutions is strong and our growth and profitability performance and outlook remain robust.

I will now turn the call over to Tom Klink, our Chief Financial Officer, to discuss our financial results and review our 2017 full year guidance and underlying assumptions. Thank you, Nathan. Good morning, everyone. Twenty seventeen third quarter revenues of $29,800,000 were up 1.4% compared to $29,400,000 in the third quarter of last year. Gross profit for the 2017 was $5,400,000 or 18.3% compared to $6,500,000 or 22.2 percent gross margin in the year ago quarter.

Included in our cost of goods sold, as Nathan mentioned, was an $873,000 non reoccurring charge related to the write off of raw material inventory. This reduced our gross margin by approximately two ninety three basis points. Selling, general and administrative expenses for the 2017 decreased 5.6% on an absolute dollar basis to $5,000,000 compared to $5,300,000 in the 2016. As a percentage of revenue, SG and A expenses decreased to 16.9% of revenue in the 2017 compared to 18.2% in the 2016. Operating income for the 2017 decreased 51% to $599,000 including these non reoccurring expenses compared to $1,200,000 inclusive of non reoccurring charges in the third quarter twenty sixteen.

Our effective tax rate for the 2017 was 226.5% of pretax income as compared to 17.9 for the same quarter last year. The change in tax rate was primarily due to additional expense for assessment by tax authorities in Canada, a

Speaker 3

true up of our provision to

Speaker 2

the income tax returns filed this quarter for 2016 and state income taxes on deemed dividends. Lastly, we absorbed a nonrecurring charge at our TriType Transformer oh, wait, I'm sorry. Net loss for the quarter was $764,000 or $09 per basic and diluted share compared to net income of $322,000 or zero four dollars per basic and diluted share in the prior year's quarter. The decrease was due primarily to the impact of additional income tax expense as I just described. Adjusted EBITDA increased to $2,500,000 during the quarter or 8.4% of revenue compared to $2,100,000 or 7.1% of revenue in the 2016.

Non GAAP diluted EPS increased to $0.21 in the 2017 compared to $0.17 in the 2016. Turning now to the nine month financial results for the period ended September 3037. Revenues for the nine months were $88,000,000 up 2.4% or $2,100,000 from $85,900,000 in the comparable period of 2016. Breaking this down by segment, T and D Solutions revenue increased $3,800,000 or 5.3% compared to the first nine months of twenty sixteen. This increase was driven primarily by an increase in sales of our dry type transformer product lines in The U.

S. And a modest increase in sales of the automatic transfer switches. Critical power revenue decreased $1,800,000 or 13.2% for the nine months ended September 3037 to $11,600,000 compared to $13,400,000 in the same period in the prior year. Equipment sales were down $3,100,000 year over year and service revenue was up $1,300,000 due to an increase in our service business with multi location customers. For the nine months ended September 3037, our gross profit was $17,500,000 or 19.9% of revenue compared to $18,600,000 or 21.7% of revenue in the year ago period.

As a reminder, the $873,000 non reoccurring charge related to inventory was incurred during the current period. Year to date SG and A expenses were $14,500,000 compared to $14,900,000 in the year ago period. As a percentage of revenue, SG and A decreased from 17.3% in the first nine months of twenty sixteen to 16.4% in the first September of twenty seventeen. Operating income for the first September of twenty seventeen decreased to $3,400,000 compared to $3,700,000 in the first September of twenty sixteen. Our effective tax rate for the nine months ended September 3037 was 36.9% of earnings before tax as compared to 45.3% for the first September of twenty sixteen.

The decrease in the effective income tax rate was primarily due to realized foreign exchange loss in Canada. Net income decreased $678,000 or $08 per basic and diluted share, down from $1,100,000 or $0.12 per basic and diluted share in the year ago period. The decrease was primarily due to impacts in our effective income tax rate, as I just described, as well as lower revenue related to hurricane and the mix of products shipped during the quarter. Our adjusted EBITDA for the first nine months of twenty seventeen increased to $7,100,000 up from $6,200,000 for the first September of twenty sixteen. Lastly, our non GAAP diluted EPS increased to $0.58 per share, up from $0.52 per diluted share in the comparable 2016 period.

Turning to the balance sheet and statement of cash flows. Our total debt at September 3037 was $31,800,000 compared to $28,200,000 at December 3136. For the nine months ended September 3017, we used cash from operations of $473,000 compared to the prior year period where we also used cash in operations of $8,900,000 Turning to our guidance, we are reaffirming our revenue guidance and updating our net income outlook based on year to date results, expected shipments in the fourth quarter and non reoccurring charges we have taken this year. Our guidance is based on expected business trends and current composition of the order backlog, excluding the impact of any potential acquisitions and any significant fluctuations in foreign currency exchange rates. For 2017, we expect to come in at the low end of our guidance range for revenue, which is $120,000,000 We expect net income between 1,800,000.0 and $2,000,000 for the year.

This represents diluted earnings per share between $0.18 and $0.23 based on 8,700,000.0 shares outstanding. On a non GAAP basis, we are expecting to generate adjusted EBITDA of between 10,000,000 and $11,000,000 and non GAAP EPS between $0.83 and $0.93 per share. This guidance assumes no further acquisitions, a foreign currency exchange rate of $0.74 per Canadian dollar, an effective tax rate of 28% and a share count of approximately 8,700,000.0 shares. And we also exclude the effect of any restructuring, non reoccurring and non cash charges arising out of our cost optimization plans. This concludes my remarks.

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

Speaker 0

We will take our first question from Matt Caranda from ROTH Capital Partners. Please go ahead.

Speaker 4

Hey guys, this is Brad Noss on for Matt.

Speaker 2

Hey Brad, how are you?

Speaker 4

Good. I just wanted to first start with the margins during the quarter and I guess specifically the inventory write down. But what was the catalyst for recognizing the inventory write down this quarter? And then is there any expected recovery or salvage value in the future from these write downs?

Speaker 2

The catalyst for taking the write down is as we completed the relocation of our production of these products to both our lower cost provider in Asia as well as Reynosa and, reviewed the methods and files with which we use them, and build under. It was determined that rather than build out this product, it was a better option to, scrap out the product. The amount that you see is, net of any scrap value realized.

Speaker 4

Okay. That's helpful. And then just if we adjust out the inventory write down, it looks like gross margins were still a touch lighter than we would have expected and a little bit lighter than Q3 of last year. Can you just sort of talk about the impact to margin from the mix of the lower margin pad mounted transformers from the utility customer and what you think try to quantify what you think that impact had on your margin?

Speaker 2

Yes, this is Nathan. I don't know what impact as a percentage or as a point it had on the margins. But you basically it's our second largest customer overall. It's our largest utility customer period and been with us for a very long time. So there was nothing I can do with their demand, but you're basically selling using a tanking slot for a $9,000 proposition that typically is going for a $35,000 proposition with similar labor and overhead.

How many units it was and so forth, we can go back and do that analysis. But it suppresses the revenue and then the margin of our liquid filled business. So it did it in the third quarter and that's even that hangs over a little bit into the fourth quarter.

Speaker 4

Okay. That's helpful. And then just in regards to looking at 2018 and the types of contracts that you're currently winning as well as the increase in service and the benefit from the private label engine generators. I mean, what sort of level of gross margin expansion do you think is possible as we look to 2018?

Speaker 2

Matt, we're or Brad, I'm sorry. Well, we're just in the process of going through the planning process for 2018. So I I don't have a definitive number for you as to what we can expect. Now the service expansion will require us to open up a few nodes as Nathan calls them for service locations. There will be some additional fixed cost as a result of that.

The other expansions we're talking about will not require any additional fixed cost. So we would expect gross margin enhancement out of everything. To what extent, I can't say at this point.

Speaker 4

Okay. That's still good detail there. And then thinking about the hurricane impact, I guess, the potential opportunities there, have you sized the opportunities in Puerto Rico from the potential rebuild of the electrical grid there? I thought about what products would see the most benefit? And then additionally, looking at Irma and Harvey impacting the pipeline for your backup power, what are you seeing there?

Speaker 2

Right, so this is Nathan. So there's a lot of layers to that. Overall, they have the obvious or the more apparent, effect is that certain businesses up for equipment. Things get destroyed, people need equipment, they need it in the short term and they need it in the medium term so things get rebuilt. So that's having a positive effect really across all our equipment in South Florida and in the Houston area, which is way more industrialized and has bigger effect on us than Florida typically does.

From a service point of view, we have a service business located in Miami and that business is full out, busy, really through the 2018. We had to actually move service people from Minnesota to Florida to help them handle, the workload that they're being given. In Puerto Rico, we have an affiliate service group. They're not our people, but they work, you know, closely with us, especially on some of the, on our large drugstore chain that we deal with from a service point of view. Puerto Rico is slow to do anything, primarily there's a huge money issue there.

So those groups that have the money, like the resorts and other parts and drug companies and so forth are getting work done. The rest of Puerto Rico is really waiting for somebody to pay for all this equipment and service to get done. So I don't know if that helps. The last thing I would add is that, you know, from a deeper, longer term perspective, if this weather in, you know, what happens in Houston and Florida that changes the behavior of industrial utility and even commercial industrial and commercial customers to to grid harden or to pay more attention to emergency power or to pay more attention to their electrical, usages, and distributed generation and things like that, that's a big benefit to us. In particular, you know, our number one distributed generation customer, which is headquartered in Houston, they had done we had done together with them a whole bunch of supermarkets in Houston prior to the hurricane.

You know, all those were working and were great and were featured on the news and so forth. So they've gotten a tremendous amount of mileage out of it and so have we. All the disaster recovery people and FEMA and so forth were using these supermarkets as their headquarters because they were not affected. They had power and water and air conditioning all during this crisis. So if that has a longer term effect, which we're hoping through our customers and distributed generation will that only really propels and impels our equipment and service business into 2018 and further.

Sorry for the long answer.

Speaker 4

No, that's helpful. And just looking at the backlog, it looked like there were at least by my calculations, there was a decline in orders year over year as well as sequentially. But I was just wondering if you can get some more color on orders there and if there might be some timing that's at play and anything else that may impact that cadence of orders?

Speaker 2

Yes. I mean it was a little bit, you know, what you say is correct. I mean, you're not dealing with a lot. We don't we don't see any abatement that the distributed generation customers that we're dealing with as opposed to giving us the big orders all at once have been rolling them out or parsing them out in smaller bits. So we don't get that big $3,000,000 order for transfer switches that like we did a year ago.

The rest that you know, really, the backlog is emblematic of our switchgear and liquid fill business. The rest of the business doesn't really operate on much of a backlog. It's a much more here and now for most of the service work that we do, which is up this year. We don't it doesn't reflect itself in any kind of backlog number for us. So, you know, if the decline was if the decline was steeper, it would be important.

If if an increase would be higher, it would be more significant. But it's pretty much steady as she goes right now.

Speaker 4

Okay. That makes sense. And then just maybe one last housekeeping item for me. I know you had I think you had ran through the numbers or Tom did earlier, but if you could just just real quick break down the revenues from T and D versus Critical Power as well as just the sub segments there for Transformers and Switchgear and equipment for service? Yes.

Speaker 2

Transformers for the quarter were about $21,500,000 that's combined liquid filled and dry type. To split that further approximately $8,200,000 from dry type, balance from I'm sorry, 8,200,000.0 from liquid filled, the balance from dry type. I said that backwards. Switchgear was $4,300,000 of sales. Critical power, the breakdown on there, 3,900,000 in volume was $2,700,000 of service and $1,300,000 $1,200,000 due to rounding of equipment.

Speaker 4

Okay, got it. Thanks guys. I'll step back in queue.

Speaker 0

Our next question comes from Sigee Eggart from GEO Investing. Please go ahead.

Speaker 3

Hi, guys. Thanks for taking my questions today. My first question is regarding the service business in Critical Power, and you commented that you expect it to double during 2018. Do you see the higher margin service component in Critical Power trending up relative to equipment sales over time? What are actually the reasons that you see for that trend?

Speaker 2

Yes. We definitely see it trending up. We're in a good spot there in the service business right now. A lot of the large cell service providers, one who is our customer is asking us to expand our footprint with them. That's part of it.

Part of it is some of the other self-service providers that we finally have taken some root in. We're just, you know, success begets success. We're doing good jobs for the self-service providers that we service right now and continuing to push and, you know, that's our validation and, you know, we know how to do it and we're continuing to push with the others. That's, you know, it that's what it is right now.

Speaker 3

Okay. My next question is about the newly launched line of power generation equipment. Can you give us some and I think you already mentioned here on the call that you got $1,000,000 new orders from that new line. Can you give us some color on how the customer receives your newly launched product line? And is there a lot of demand for customization?

Speaker 2

That's a multilayered question. So the response has been very strong. Our goal with the equipment business and our goal in having our own line of power generation equipment was not just to put our names on things and feel good about it. The idea was to take a business that was constricted by territory and really not contributing any earnings to us at all and try to reverse those situations, both making an earnings contributor and a growing more dynamic business. We're trying to concentrate the areas, the way it falls out, is that the areas where there's more customization, where there is prime power type opportunities, more negotiated type opportunities, which we're finding more success and higher margin and that's where we're gonna continue to gravitate.

So we are slowly moving away from our old sort of bid spec type operation of just trading equipment or trading dollars. This case where we received the largest single order really in the history of the business was a prime power application. It was custom. It was tier four final. It was the ability to meet both the emissions and sound level requirements that the customer had and deliver on the dates that they needed it, that is enabling us to ship the order actually this month now in November.

And that's those are the kinds of opportunities that we're going to be seeking throughout the territories that we're going to to be to be looking for business.

Speaker 3

Alright. So so I understand that this was pretty much the type of order that you were aspiring, you know,

Speaker 4

a high customer base. Exactly.

Speaker 2

This this would be, yes, this would be the paradigmatic type of situation that we look for.

Speaker 3

Alright. Great. Okay. That's great to hear. That's all my questions.

Congratulations again on a solid quarter, guys.

Speaker 2

Thank you, Siggy.

Speaker 0

Our next question comes from Michael Potter from Monarch Capital Group. Please go ahead.

Speaker 5

Hey guys. Another solid quarter, lots of good opportunities it seems that we're executing on and hopefully in front of us as well. Nathan, just I want to follow-up on, I guess, the lost revenue. I shouldn't say lost revenue, but the revenue that we weren't able to realize in Q3 from the hurricane in Houston. How much was guess how much revenue did we lose out on from product not being able to get into the Port Of Houston or us unable to ship product to the other customer also in Texas?

Speaker 2

Right. So we're estimating probably about $3,000,000 give or take is about what we lost out, which for us is a lot. Mean, that's a 10% differential on our quarterly sales. So that's a pretty substantial amount for us. We are working I'm sorry, go ahead.

Speaker 5

Sorry, ahead. Yes. And

Speaker 2

we are working I mean, we're in the midst of our fourth quarter and we are working day and night really to make up for that. So we are looking for a record fourth quarter both in revenue and in EBITDA going forward. I mean, those things are not, you know, use the word earlier and you know, they're not lost. They were they were missed during our third quarter. So, you know, the deferred to the fourth quarter, and we were actively recapturing them as we speak.

Speaker 5

So the $3,000,000 will be over and above what our budget was for the quarter? Correct. So we're going to make up for it. We didn't lose it, and it should be made up for I mean, I'm assuming the bulk of it the bulk of that $3,000,000 in orders has already been shipped?

Speaker 2

I would say it's about midway, especially the transfer switches that we're shipping at the Houston. We can only make four a week and we're trying to increase that as we try to make up for what was on hold. But yeah, we we're in the we're in the midst of it, and we fully expect to recapture it in the fourth quarter.

Speaker 5

Okay. It's

Speaker 2

not being deferred. It's not lost, and it's and we don't expect any hangover into the 2018 either.

Speaker 5

All right. Excellent. And can you give us a little sense of the are we seeing continued consolidation in our sector? There's been a lot of consolidation. Obviously, you have acquired a lot of companies over the years.

I would assume, though, that there's continued consolidation going on in the sector. And I'm assuming at our size at this point, we're becoming an attractive target ourselves.

Speaker 2

That would be true. There is a lot of consolidation. You know, on the big level, you have the big announced deal where ABB is buying GE's electrical business. So, you know, the big get bigger. And definitely, you know, we are we are, of course, in the industry and, you know, we have been a very, very busy or serial acquirer in the past, haven't the last year or so, two years.

But yes, we think that we are very attractive. We think that even parts of our business are very attractive. We're in end markets. If you look at distributed generation, if you look at critical power, if you look at the data center, parts of our business for the reasons that we like them, we think, and I think we have some validation too, we think that they're found attractive, by others as well.

Speaker 5

Okay. Terrific, guys. I'll get, back in the queue. Thanks.

Speaker 2

Thank you, Michael.

Speaker 0

There appears to be no other questions at this time.

Speaker 2

All right. Thank you all for your time and your support, and we look forward to updating you again on our next call.

Speaker 0

This concludes our conference for today. Thank you for your participation. You may disconnect.