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PSIX > SEC Filings for PSIX > Form 10-Q on 9-Aug-2013All Recent SEC Filings

Show all filings for POWER SOLUTIONS INTERNATIONAL, INC.

Form 10-Q for POWER SOLUTIONS INTERNATIONAL, INC.


9-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes included in this report and our audited consolidated financial statements and the related notes for the fiscal year ended December 31, 2012, and the related management's discussion and analysis of financial condition and results of operations, contained in our annual report on Form 10-K for the fiscal year ended December 31, 2012, filed with the Securities and Exchange Commission on March 12, 2013 (our "2012 Annual Report"). References to "we," "us," "our" and "our company" refer to Power Solutions International, Inc. and its subsidiaries.

The discussion and analysis below includes forward-looking statements about our business, financial condition and results of operations, including discussions about management's expectations for our business. These statements represent projections, beliefs and expectations based on current circumstances and conditions and are in light of recent events and trends, and you should not construe these statements either as assurances of performance or as promises of a given course of action. Instead, various known and unknown factors are likely to cause our actual performance and management's actions to vary, and the results of these variances may be both material and adverse. In evaluating such statements, you should carefully consider the various factors identified in this report and our 2012 Annual Report which could cause actual results to differ materially from those expressed in, or implied by, any forward-looking statements, including those factors set forth under the heading "Cautionary Note Regarding Forward-Looking Statements" at the end of this Item 2 in this Quarterly Report on Form 10-Q.

Overview

Organization

We design, manufacture, distribute and support power systems for industrial OEMs across a broad range of industries including stationary electricity power generation, oil and gas, material handling, aerial work platforms, industrial sweepers, arbor, welding, airport ground support, turf, agricultural, construction and irrigation. Our engineering personnel design and test power system solutions and components supporting those solutions. Our major engine suppliers include Perkins/Caterpillar, General Motors, and Doosan, and we source components from a variety of domestic and global suppliers. We operate as one business and geographic segment. Accordingly, the following discussion is based upon this presentation.

Net sales

We generate revenues and cash primarily from the sale of off-highway industrial power systems and aftermarket parts to industrial OEMs. Our products are sold globally, and we are a sole source power system provider of our products for many of our customers. Net sales are derived from gross sales less sales returns and or sales discounts.

Cost of sales

We manufacture and assemble our products at our facilities in Wood Dale, Illinois. The most significant component of our cost of sales is the engine cost. The remainder of our cost of sales primarily includes the cost of additional materials utilized in our finished goods, labor, freight, depreciation and other inventoriable costs such as allocated overhead.

Operating expenses

Operating expenses include research & development and engineering, selling and service and general and administrative expenses. Research & development and engineering expenses include both internal personnel costs and expenses associated with outsourced third party engineering relationships. Research & development and engineering activities are staff intensive. Costs incurred primarily consist of wages and benefits for professional engineers and amounts paid to third parties under contractual engineering agreements. Research & development and engineering consist of a Product and Application Research and Development Engineering Group and a Customer Support Engineering Group. The primary focus of the Product and Application Research and Development Engineering Group is on current and future product design, prototyping, testing and application development activities. The Customer Support Engineering Group provides dedicated engineering and technical attention to customer production support, including a direct communication link with our internal operations.

Selling and service expenses represent the costs of our OEM sales team, an aftermarket sales group and a customer support group for field service and warranty support of our products. We utilize a direct sales and marketing approach to maintain maximum customer interface and service support. Wages and benefits, together with expenses associated with travel, account for the majority of the costs in this category.

General and administrative expenses principally represent costs of our corporate office and personnel that provide management, accounting, finance, human resources, information systems and related costs which support the organization. In addition to wages and benefits, costs include public company expenses, professional services fees, insurance premiums, banking fees and other general facility and administrative support costs.

Other expense (income)

Other expense (income) includes interest expense on our revolving line of credit and other obligations upon which we pay interest, changes in the valuation of the warrants issued in the private placement that closed on April 29, 2011, as well as other pre-tax transactions which require classification in other than operating results. The change in the valuation of our private placement warrants is subject to change based upon fluctuations in the market price of our common stock which can vary significantly from period to period. Other expense (income) may also include other non-operating expenses from time to time, such as a loss on debt extinguishment and other matters which are not otherwise considered operating income or expense.


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Factors affecting comparability

We have set forth below selected factors that we believe have had, or can be expected to have, a significant effect on the comparability of recent or future results of operations:

Private placement warrants

Our quarter-to-quarter and quarter-over-quarter results can be impacted by our private placement warrant liability. The change in estimated fair value of the liability associated with the private placement warrants is primarily attributable to fluctuations in the value of our common stock during a period.

Stock-based and other executive compensation

In the latter part of the second quarter of 2012, our Compensation Committee of the Board of Directors approved, and we granted a stock appreciation rights award to our Chief Operating Officer. As a result, we have incurred non-cash, stock-based compensation expense for the full six months ended June 30, 2013, as compared to approximately one month of such expense for the same period in 2012. Further, as explained below, the recognition of the expense for the stock appreciation rights was accelerated as a result of achieving certain market conditions earlier than originally contemplated in the initial assumptions used to determine the expense and related recognition period for those stock appreciation rights.

On June 17, 2013, our Compensation Committee of the Board of Directors approved, and we granted restricted stock awards to certain employees. As a result, we incurred non-cash, stock-based compensation expense in the three months ended June 30, 2013, that was not present in 2012. We may consider making additional equity awards to our directors, officers and other employees and possibly to consultants, and if we do, we will incur additional non-cash, stock-based compensation expenses in future periods.

On July 31, 2013, our Board, upon recommendation of the Compensation Committee, adopted an amendment to the 2012 Plan to increase the number of shares of common stock available for issuance under the 2012 Plan by 700,000 shares, subject to approval by our stockholders. We are holding our annual meeting of stockholders on August 28, 2013, and our stockholders will vote on a proposal to approve the amendment.

Loss on debt extinguishment

We recognized a loss on debt extinguishment of $270,000 in the three months ended June 30, 2013, due to the write-off of remaining unamortized loan fees associated with our prior credit facility. This item was not present in 2012.

Underwritten public offering

On July 16, 2013, we closed an underwritten public offering of 2,005,000 shares of our common stock at a price to the public of $35.00 per share. We sold 1,050,000 shares of our common stock, and certain selling stockholders sold 955,000 shares of common stock, in the offering. We received proceeds, net of the underwriter's fees, of approximately $34,530,250 before deducting estimated offering expenses of approximately $200,000 that will be payable by us. We did not receive any proceeds from the sale of the shares by the selling stockholders. We used $25.0 million of the net proceeds to repay outstanding borrowings under our revolving line of credit.

Events affecting sales and profitability comparisons

Our quarter-to-quarter and quarter-over-quarter operating results (including our sales, gross profit and net (loss) income) and cash flows can be impacted by a variety of internal and external events associated with our business operations. Examples of such events include (1) changes in regulatory emission requirements (which generally occur on January 1 of the year in which they become effective),
(2) customer product phase-in/phase-out programs, (3) supplier product (e.g., a specific engine model) phase-in/phase-out programs, (4) changes in pricing by suppliers to us of engines, components and other parts (typically effective January 1 of any year), and (5) changes in our pricing to our customers (typically effective January 1 of any year), which may be related to changes in the pricing by suppliers to us. In order to mitigate potential availability or pricing issues, customers may adjust their demand requirements from traditional patterns. We may also extend special programs to customers in advance of such events, and we are more likely to offer such programs in our fourth quarter of a year in anticipation of events expected to occur in the first quarter of the next year. The occurrence of any of the events discussed above may result in fluctuations in our operating results (including sales and profitability) and cash flows between and among reporting periods.


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Results of operations

Three months ended June 30, 2013 compared with three months ended June 30, 2012

Net sales

Our net sales increased $9,023,000 (18.0%) to $59,138,000 for the three months ended June 30, 2013, compared to $50,115,000 in the three months ended June 30, 2012, of which an increase in sales volume (as opposed to price increases) accounted for approximately $8,208,000 of the year over year increase. Our power systems and related sales increased approximately $7,740,000 and parts sales accounted for the remaining $1,283,000 increase. The sales increase was primarily due to strong growth in power generation sales, driven in large part by increased demand for our larger power systems.

Gross profit

Our gross profit increased $2,352,000 (26.6%) to $11,184,000 for the three months ended June 30, 2013, from $8,832,000 in the three months ended June 30, 2012. Our gross profit increased primarily due to the previously discussed increase in sales. Gross margin increased to 18.9% for the three months ended June 30, 2013, compared to 17.6% for the same period in 2012, primarily due to a product mix shift in favor of engines with a higher gross margin in the three months ended June 30, 2013.

Research & development and engineering

Research & development and engineering expense increased $481,000 (26.6%) to $2,289,000 in the three months ended June 30, 2013, as compared to $1,808,000 in 2012. We incur expenses connected with our professional engineers and amounts paid to third parties for contract services associated with our research and development activities. Compensation and benefits increased $317,000 in the three months ended June 30, 2013 as compared to the same period in 2012 as we added staff to support product development activities, including development activities associated with pursuing on-road applications for our products. Other research & development and engineering expenses increased an aggregate of $164,000 in the three months ended June 30, 2013 as compared to the same period in 2012, principally related to development activities, recognition of deferred emission expenses and other costs directly associated with engineering. As a percentage of net sales, research & development and engineering expenses increased to 3.9% for the three months ended June 30, 2013, compared to 3.6% for the same period in 2012.

Selling and service expense

Selling and service expenses increased $506,000 (32.0%) to $2,089,000 for the three months ended June 30, 2013, from $1,583,000 in the three months ended June 30, 2012. Wages and benefits increased $146,000 in the three months ended June 30, 2013 as compared to the same period in 2012 as we have increased our staff to pursue growth opportunities, as well as to support the increase in sales. Warranty expense increased $185,000 in the three months ended June 30, 2013 as compared to 2012 as our sales continue to increase. The remaining expenses increased across multiple categories, none of which was individually significant, as we pursue additional opportunities and support our existing customers. As a percentage of net sales, selling and service expenses increased to 3.5% in 2013 compared to 3.2% for the same period in 2012.

General and administrative expense

General and administrative expenses increased $918,000 (44.8%) to $2,966,000 for the three months ended June 30, 2013, from $2,048,000 in 2012. Wages and benefits increased $708,000 in the three months ended June 30, 2013 as compared to the same period in 2012. Of this increase, $394,000 was attributable to an increase in the compensation expense associated with the stock appreciation right granted to our Chief Operating Officer in June 2012. This additional expense arose from (i) a full three month's expense in 2013 as compared to one month in 2012 and (ii) $241,000 of accelerated stock compensation expense arising as a result of the achievement of the market condition earlier than projected in the stock appreciation rights assumptions made at the time the stock appreciation right was granted. The remaining $314,000 increase in wages and benefits in the three months ended June 30, 2013 was attributable to an increase in administrative staff to support our growth. Public company expenses also increased approximately $160,000; such costs were principally attributable to an increase in franchise taxes, our application to be listed on NASDAQ (which became effective on May 28, 2013) and various other public company expenses. As a percentage of net sales, general and administrative expenses increased to 5.0% in the three months ended June 30, 2013, from 4.1% for the same period in 2012.


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Other expense (income)

Interest expense decreased $49,000 (16.9%) to $241,000 in the three months ended June 30, 2013, as compared to $290,000 in 2012. The decrease in interest expense was primarily attributable to a decrease in the weighted average borrowing rate on our bank debt from 2.41% in the three months ended June 30, 2012 to 2.25% in the three months ended June 30, 2013. Holding all other variables constant, we believe that for the full year of 2013 our effective interest rate will remain relatively unchanged from 2012.

We recognized a loss on debt extinguishment of $270,000 in the three months ended June 30, 2013, due to the write-off of remaining unamortized loan fees associated with our prior credit facility. The remaining unamortized loan fees were required to be expensed when we replaced our credit facility effective June 28, 2013, and repaid the balance outstanding under our prior credit agreement. See "Liquidity and Capital Resources - Credit Agreements" below for further discussion regarding the refinancing of our prior credit facility with a new lender.

Private placement warrant expense (income) increased $5,257,000 to $4,207,000 in expense in the three months ended June 30, 2013 as compared to $1,050,000 of income in the three months ended June 30, 2012. This increase was attributable to a change in the estimated fair value of our private placement warrants. The change in estimated fair value of the private placement warrants was primarily attributable to an increase in the trading price of our common stock period over period.

Income tax expense

Our income tax expense increased $106,000 to $1,239,000 in the three months ended June 30, 2013, as compared to $1,133,000 for the same period in 2012. We have estimated an interim effective income tax rate of 37% for 2013, excluding,
(i) the 2012 federal research tax credit, and (ii) the impact of any change in the valuation of the private placement warrants. The change in the valuation of our private placement warrants is a non-taxable transaction. Given the subjectivity and volatility of the valuation of the private placement warrants, we are unable to estimate the annual impact of the change in the private placement warrants and the corresponding effect on our effective tax rate for the full year. Accordingly, we include the effect of the change in the valuation of the private placement warrants, when known, in the period in which it occurs. Due to the significance of the change in the valuation of the private placement warrants on income, which resulted in a pre-tax loss for financial statement purposes, and its exclusion from the computation of income taxes, our actual income tax rate for the three months ended June 30, 2013, is not a meaningful calculation. The income tax rate for the three months ended June 30, 2013, excluding the expense due to the private placement warrants was 37.0%.

Our reported income tax rate was 27.7% for the three months ended June 30, 2012. Excluding the income associated with the private placement warrants, our effective income tax rate was 37.2% for the three months ended June 30, 2012.

Six months ended June 30, 2013 compared with the six months ended June 30, 2012

Net sales

Our net sales increased $13,527,000 (13.8%) to $111,714,000 in the six months ended June 30, 2013 compared to $98,187,000 for the same period of 2012, of which power system sales accounted for $11,428,000 of the increase, with the remaining $2,099,000 increase attributable to sales of aftermarket parts. Sales volume (as opposed to price increases) accounted for $11,997,000 of the increase in the six months ended June 30, 2013, as compared to the same period in 2012.

Gross profit

Our gross profit increased $3,292,000 (19.3%) to $20,353,000 for the six months ended June 30, 2013, from $17,061,000 in the comparable period of 2012. Our gross profit increased primarily due to the previously discussed increase in sales volumes. As a percentage of net sales, gross margin was 18.2% for the six months ended June 30, 2013, compared to 17.4% in the same period of 2012. The higher gross margin in the six months ended June 30, 2013, as compared to the same period in 2012 was attributable to a product mix shift in favor of engines with a higher gross margin.

Research & development and engineering

Research and development and engineering expense increased $525,000 (14.9%) to $4,060,000 in the six months ended June 30, 2013, as compared to $3,535,000 for the same period in 2012. Wages and benefits increased $496,000 as we increased headcount in connection with our engineering development and support activities, including development activities associated with pursuing on-road applications for our products. The increase in other research & development and engineering expenses in the six months ended June 30, 2013 as compared to the same period in 2012, principally related to development activities, recognition of deferred emission expenses and other costs directly associated with engineering, none of which was individually significant (or significant in the aggregate). As a percentage of net sales, research & development and engineering expenses were unchanged at 3.6% in the six months ended June 30, 2013 and 2012.


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Selling and service

Selling and service expenses increased $684,000 (20.8%) to $3,969,000 in the six month period ended June 30, 2013, from $3,285,000 in the comparable period of 2012. Wages and benefits increased $197,000 in the six month period ended June 30, 2013 as compared to the same period in 2012, as we have increased our staff to pursue growth opportunities, as well as to support the increase in sales. Warranty expense for estimated claims also increased $197,000 in the six months ended June 30, 2013 as compared to 2012 as our sales continue to increase. Other expenses, including product allowances and travel and trade show expenses, have also increased in the six months ended June 30, 2013 as compared to the same period in 2012 in support of our growth initiatives and to support our existing customers, none of which was individually significant. As a percentage of net sales, selling and service expenses increased to 3.6% in the six months ended June 30, 2013, compared to 3.3% for the same period in 2012.

General and administrative

General and administrative expenses increased $1,592,000 (41.8%) to $5,404,000 in the six months ended June 30, 2013, from $3,812,000 in the comparable period of 2012. Wages and benefits increased $1,168,000 in the six months ended June 30, 2013 as compared to the same period in 2012. Of this increase $601,000 was attributable to an increase in the compensation expense associated with the stock appreciation right granted to our Chief Operating Officer in June 2012. This additional expense arose from (i) a full six month's expense in 2013 as compared to one month in 2012 and (ii) $241,000 of accelerated stock compensation expense arising as a result of the achievement of the market condition earlier than projected in the stock appreciation rights assumptions made at the time the stock appreciation rights were granted. The remaining $567,000 increase in wages and benefits in the six months ended June 30, 2013 is attributable to an increase in administrative staff to support our growth. Public company expenses also increased approximately $195,000; such costs were principally attributable to an increase in franchise taxes, our application to be listed on NASDAQ and various other public company expenses. As a percentage of net sales, general and administrative expenses increased to 4.8% in the six months ended June 30, 2013, from 3.9% for the same period in 2012.

Other (income) expense

Interest expense decreased $82,000 (15.9%) to $435,000 in the six months ended June 30, 2013, as compared to $517,000 for the same period in 2012. The decrease in interest expense was primarily attributable to a decrease in the weighted average borrowing rate on our bank debt from 2.49% in the six months ended June 30, 2012 to 2.22% in the six months ended June 30, 2013.

We recognized a loss on debt extinguishment of $270,000 in the six months ended June 30, 2013, due to the write-off of remaining unamortized loan fees associated with our prior credit facility that we replaced on June 28, 2013.

Private placement warrant expense (income) was expense of $9,053,000 in the six months ended June 30, 2013, as compared to income of $457,000 for the same period in 2012. The increase in expense was attributable to a change in the estimated fair value of our private placement warrants. The change in estimated fair value of the private placement warrants was primarily attributable to an increase in the trading price of our common stock period over period.

Income tax expense

Our income tax expense increased $42,000 to $2,206,000 in the six months ended June 30, 2013 as compared to $2,164,000 for the same period in 2012. Our income tax expense in the six months ended June 30, 2013 included a $100,000 benefit for the federal research tax credit expected to be realized for the year ended December 31, 2012. Such amount was recorded in the first quarter of 2013 and not during 2012 because the enactment of the legislation providing the federal research tax credits for 2012 was not signed into law until January 2, 2013, and generally accepted accounting principles prohibit retroactive application of tax law changes. As described above, our interim effective income tax rate for 2013 is 37% excluding (i) the 2012 federal research tax credit and (ii) the impact of any change in the valuation of the private placement warrants. Due to the significance of the change in the valuation of the private placement warrants on income, which resulted in a pre-tax loss for financial statement purposes and its exclusion from the computation of income taxes, the actual income tax rate for the six months ended June 30, 2013, is not a meaningful calculation. Our reported effective income tax rate for the six months ended June 30, 2012 was 34.5%.

Excluding the expense/(income) associated with the private warrants, our effective income tax rate was 35.4% and 37.2% for the six months ended June 30, 2013 and 2012, respectively.

Liquidity and capital resources

Our cash requirements are dependent upon a variety of factors, foremost of which is the execution of our strategic plan. We expect to continue to devote substantial capital resources to running our business. Through June 30, 2013, our primary sources of liquidity have been and continue to be cash flows from operations, principally collections of customer accounts receivable and borrowing capacity under our credit facility. On June 28, 2013, we replaced our existing $50.0 million credit facility with BMO Harris Bank N.A. with a $75.0 million credit facility with Wells Fargo Bank, National Association. Our new and prior credit facilities are described further below under "Credit agreements". On July 16, 2013, we completed a public offering in which we sold 1,050,000 shares of our common stock at $35.00 per share that resulted in net proceeds to us of approximately $34.3 million after underwriters' fees and estimated expenses associated with the sale of these shares. We used $25.0 million of our net proceeds to reduce the outstanding balance on our revolving line of credit, and the remaining proceeds will be used for working capital and other general corporate purposes, which may include capital expenditures and acquisitions.


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Based on our current forecasts and assumptions, we believe that our sources of cash, namely the sales of our power systems and aftermarket products and access to borrowings on our existing or future credit facilities, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures over at least the next twelve months. Although we believe our existing sources of liquidity will also be sufficient on a longer-term basis, that will depend on numerous factors, including the following: the continuation of our existing customer relationships and our development of new customer relationships; market acceptance of our existing and future products; the success of our product development and commercialization efforts and the costs associated with those efforts; and the costs associated with any future acquisitions, joint ventures or other strategic transactions. Accordingly, in the future we may pursue . . .

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