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PRXG > SEC Filings for PRXG > Form 10-K on 28-Mar-2014All Recent SEC Filings

Show all filings for PERNIX GROUP, INC.

Form 10-K for PERNIX GROUP, INC.


28-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You are cautioned that this Annual Report on Form 10-K and, in particular, the "Management's Discussion and Analysis of Financial Condition and Results of Operations", contains forward-looking statements concerning future operations and performance of the Company within the meaning of the Private Securities Litigation Reform Act of 1995. You should not place undue influence on these forward-looking statements. Forward-looking statements are subject to market, operating and economic risks and uncertainties that may cause the Company's actual results in future periods to be materially different from any future performance suggested herein. Factors that may cause such differences include, among others: increased competition, increased costs, changes in general market conditions, changes in the regulatory environment, changes in anticipated levels of government spending on infrastructure, and changes in loan relationships or sources of financing, political instability or violence. Such forward-looking statements are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

The Company effected an elective accounting quasi-reorganization as of September 30, 2012. The consolidated financial statements as of December 31, 2013 and 2012 give effect to adjustments to the fair value of assets and liabilities that are necessary when adopting "fresh-start" reporting and the subsequent amortization thereof.

In this report, we use the terms "Pernix Group", "PGI", "the Company", 'we", "us", and "our" to refer to Pernix Group, Inc. and its consolidated subsidiaries. Unless otherwise noted, references to years are for calendar years.

Executive Summary

The Executive Summary in this section is intended to highlight significant information and to provide context within which to consider the Company's results of operations. During 2013 and 2012, the Company earned revenues of $73.8 million and $120.0 million, representing the two highest revenue generating years in company history. Although there was a year over year reduction in revenue and pretax income, it is instructive to view the change in the context of the general direction of growth for the Company in the past five years as it grew revenues during that period from $14.8 million in 2009 to the current levels as presented below:

Total Consolidated Revenue by year for 2009 through 2013 (in millions):

2009 2010 2011 2012 2013
$14.8 $26.2 $58.0 $120.0 $73.8

Management believes the 2013 revenue decline from record high levels to be temporary in nature and common in the construction industry reflective of the ebbs and flows due to the timing of winning new contracts. In 2013, the Company experienced a lower level of new contracts than in prior years. In early 2014, the Company has won contracts totaling over $45.5 million, more in line with our experience prior to 2013.

The Company earned consolidated pretax income from continuing operations attributable to Pernix shareholders of $0.4 million and $3.3 million during 2013 and 2012, respectively. The year over year reduction reflects the reduction in Pernix share of construction margin ($4.7 million) due to the completion and wind down of two large containerized housing projects in late 2012 and 2013. The reduction was partially offset with lower operating expenses and higher pretax income related to the Power generation segment. Further discussion regarding operating results is provided in Results of Operations.

Net (loss) income attributable to Pernix common shareholders was ($4.7) million and $0.4 million in 2013 and 2012, respectively. Included in the 2013 net income results is a $4.9 million deferred income tax expense related to an increase in the valuation allowance on deferred tax assets. This expense is a non-cash expense and has no impact on the Company's liquidity, cash flows, or on its ability to execute projects or conduct ongoing operations. Management does not anticipate this to be a recurring expense in the foreseeable future as the related deferred tax assets are fully reserved at December 31, 2013. Central to management's decision to increase the valuation allowance were its historical level of new business and change orders won during 2013 compared to the preceding two years. In early 2014, the Company has received awards totaling over $45.5 million, more in line with our experience prior to 2013. Of these recent awards, the $29.1 million award to PFL in Fiji will not impact U.S. taxable income.


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Included in the 2012 net income attributable to Pernix common shareholders is a ($3.7) million net loss from discontinued operations. There were no such losses during 2013.

Adjusting 2013 and 2012 net income to exclude the net impact of the 2013 and 2012 tax expense (benefit) that was primarily due to changes in the deferred tax valuation allowance and the 2012 losses of the discontinued operations of TransRadio and TCNMI, net income attributable to Pernix Group would have been $0.4 million ($0.04 basic and diluted earnings per share) in 2013 and $3.3 million, ($0.35 basic and diluted per share) for 2012, as explained and reconciled in the table below.

We use pretax income from continuing operations attributable to Pernix Group, Inc to evaluate our performance, both internally and as compared with our peers, because this measures exclude certain tax items (primarily pertaining to changes in the valuation allowance) and discontinued operations that may not be indicative of our core operating results, as well as items that can vary widely across different industries or among companies within the same industry. Additionally, these measures provide a baseline for analyzing trends in our underlying business. We believe this non-U.S. GAAP financial measure provides meaningful information and helps investors understand our financial results and assess our prospects for future performance. Because non-U.S. GAAP financial measures are not standardized, it may not be possible to compare these financial measures with other companies' non-U.S. GAAP financial measures having the same or similar names. This financial measure should not be considered in isolation from, as substitutes for, or alternative measures of, reported net income from continuing operations, diluted earnings per share from continuing operations and net cash provided by operating activities, and should be viewed in conjunction with the most comparable GAAP financial measures and the provided reconciliations thereto. We believe these non-U.S. GAAP financial measures, when viewed with our U.S. GAAP results and the related reconciliations, provide a more complete understanding of our business. We strongly encourage investors to review our consolidated financial statements and publicly filed reports in their entirety and not rely on any single financial measure.

The following table presents a reconciliation of net income attributable to Common Stockholders of Pernix Group, Inc. to non-GAAP pretax income from continuing operations and non-GAAP basic earnings per share from continuing operations attributable to Common Stockholders of Pernix Group, Inc:

Non-GAAP net income and basic earnings per share attributable to Pernix Group, Inc. Common Stockholders reconciliation:

                                                      For the          For the
                                                    Year Ended       Year Ended
                                                     December         December
     (in thousands, except per share data)           31, 2013         31, 2012

     Net income attributable to Common
     Stockholders of Pernix Group, Inc.          $     (4,680)    $         422
     Plus:
     Losses attributable to TransRadio and
     TCNMI sold in 2012                                      -            3,663
     Less:
     Net impact of income tax expense
     (benefit)                                           5,041             (773)
     Non-GAAP Pretax Income from continuing
     operations attributable to Common
     Stockholders of Pernix Group, Inc.          $         361    $       3,312

     Non-GAAP Basic earnings (loss) per share
     attributable to Pernix Group, Inc.          $        0.04    $        0.35
     Non-GAAP Diluted earnings (loss) per
     share attributable to Pernix Group, Inc.    $        0.04    $        0.35

     Basic weighted shares outstanding               9,403,697        9,403,697
     Diluted weighted shares outstanding             9,403,697        9,403,697

After adjusting for these nonrecurring items, financial performance was positive in both periods. The construction backlog has decreased year over year from $67.9 million to $37.1 million. Management is keenly focused on bidding on and winning new contracts on a stand-alone basis as well as with our strategic partners. In early 2014, the Company has entered into new contract awards totaling over $45.5 million thereby restoring and in fact exceeding the backlog that existed as of December 31, 2012. Of these new awards, $29.1 million is not U.S. taxable as it is a PFL project and as such is taxable in Fiji. Pernix will also continue to explore acquisition and co-investment opportunities in both business segments to obtain additional backlog, expand our customer base and optimize the use of our tax loss carryforwards.

Although the revenue from our Power generation segment represents just 7.9% and 4.3% of consolidated revenue, in 2013 and 2012, respectively, it consistently accounts for a significant portion of the Company's pretax income from continuing operations.


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There are two significant recent developments in the power segment that significantly impact its future performance. First, in February 2014, PFL received an award to add 36MW (approximately 48% increase) of capacity to the Kinoya diesel power station. In addition to providing construction margins from the construction project, the Company anticipates operating and maintaining the additional capacity along with its existing capacity for this customer through 2023, to be in line with our current long term concession deed. PFL has accounted for $0.8 million and $0.7 million of Pernix consolidated pretax income during 2013 and 2012, respectively. Second, VUI is currently awaiting a decision by the Vanuatu judiciary regarding a potential re-tender of the long term concession deed to operate and maintain the diesel and hydro power operations in Vanuatu. In addition, during March 2014, URA issued a decision on the electricity tariff as it pertains to VUI operations. The terms of the ruling may result in lower revenue to VUI coupled with increased responsibilities for street lighting maintenance and an opportunity to share in efficiency savings related to the hydro operations in Vanuatu, along with other measures. VUI has the opportunity to file a notice of grievance to the Commission on or before April 12, 2014; however, it is VUI's intention to operate under the decision and reduce costs to maximize the man-month fee to the extent allowed by the Court under the terms of any settlement accepted by the Court. If a retender is completed and VUI is not awarded the concession deed or if the VUI is unable to sufficiently reduce operating costs under the new tariff ruling, it could have a material and negative impact on the Company's income, cash flows and financial condition. VUI accounted for $1.0 million of Pernix consolidated pretax income in 2013 and 2012. VUI has received high ratings from the Utilities Regulatory Authority of Vanuatu for work performed under the MOU to date but the Company does not know the likelihood of a successful retender bid by VUI or the financial impact of the new tariff ruling.

Industry experts predict that construction in emerging markets will make up more than half of the global construction market by the end of this decade. In light of its experience, Pernix is uniquely qualified to perform in emerging markets which can be more remote and logistically challenging environments. The combination of growing demand to supplement or replace aging power generation equipment, growing demand for power in non-OECD countries and demand to improve power efficiency through the use of new power technologies presents a wealth of opportunities for construction and distribution of power. Pernix Group's power segment is well positioned to pursue these opportunities which are expected to be smaller in size and fit well with our agile organizational structure.

Our revenue is dependent on our ability to attract and retain qualified and productive employees, identify business opportunities, allocate our labor resources to profitable markets, align with strategic partners, secure new contracts

and renew existing client agreements among other factors. Moreover, as a professional services company, maintaining the high quality of the work generated by our employees is integral to our revenue generation.

Our costs consist primarily of the compensation we pay to our employees, including salaries, fringe benefits, the costs of hiring subcontractors and other project-related expenses, the costs associated with maintaining and operating diesel power plants (fuel related costs) and sales, general and administrative costs.

Critical Accounting Policies and Estimates

Our financial statements are presented in accordance with accounting principles generally accepted in the United States of America (GAAP). Highlighted below are the accounting policies that management considers significant to understanding the operations of our business.

Basis of Presentation

The consolidated financial statements include the accounts of all majority-owned subsidiaries in which control does not rest with other entities, as well as joint ventures which are determined to be variable interest entities and in which the Company is the primary beneficiary. During 2013 and 2012, the variable interest entities and related financial results are not material. All inter-company accounts have been eliminated in consolidation. The Company effected an elective accounting quasi-reorganization as of September 30, 2012, which eliminated its accumulated deficit in retained earnings and accumulated other comprehensive income (loss) against additional paid-in-capital. The consolidated financial statements as of December 31, 2013 and 2012 reflect the adjustments to fair value of assets and liabilities that were recorded in connection with the implementation of the quasi-reorganization and subsequent amortization thereof. TransRadio and TCNMI results are presented as discontinued operations in the 2012 consolidated statement of operations. See Notes 1, 2 and 8 in our notes to our consolidated financial statements.


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Revenue Recognition

We offer our services through two operating business segments: General Construction and Power Generation Services which are supported by the Corporate segment. Prior to March 28, 2012, the Company also operated the RF Transmitter Design, Installation and Service segment. Revenue recognition for each of the non-corporate segments is described by segment below.

General Construction Revenue. Revenue from construction contracts is recognized using the percentage-of-completion method of accounting based upon costs incurred and estimated total projected costs. Our current projects with the United States Government are design/build contracts with fixed contract prices and include provisions of termination for convenience by the party contracting with us. Such provisions also allow payment to us for the work performed through the date of termination.

Revenues recognized under the percentage-of-completion method require applying a percentage (actual costs incurred through the reporting date divided by the total estimated costs to complete the project) to the fixed contract price. The Company only uses approved contract changes in its revenue recognition calculation. This method of revenue recognition requires that we estimate future costs to complete a project. Estimating future costs requires judgment of the value and timing of material, labor, scheduling, product deliveries, contractual performance standards, liability claims, impact of change orders, contract disputes as well as productivity. In addition, sometimes clients, vendors and subcontractors will present claims against us for recovery of costs they incurred in excess of what they expected to incur, or for which they believe they are not contractually responsible. In turn, we may also present claims to our clients, vendors and subcontractors for costs that we believe were not our responsibility or may be beyond our scope of work. The Company will include costs associated with these claims in its financial information when such costs can be reliably identified and estimated. Similarly, the Company will include in revenue amounts equal to costs for claims, where the outcome is probable that the claim will be found in the favor of the Company. Our estimates, assumptions and judgments are continually evaluated based on known information and experience. However, the actual amounts could be significantly different from our estimates. Costs and estimated earnings in excess of amounts billed to customers are recognized as an asset. Amounts billed in excess of costs and estimated earnings are recognized as a liability. The Company will record a provision for losses when estimated costs exceed estimated revenues. To mitigate risks associated with cost overruns, the Company may employ fixed price contracts with subcontractors.

Unbilled accounts receivable (costs in excess of billings) are assets that represent the contract revenue recognized to date using the percentage-of-completion accounting method but not yet invoiced to the client due to contract terms or the timing of the accounting invoicing cycle. Billings in excess of costs on uncompleted contracts represent the billings to date, as allowed under the terms of a contract, but not yet recognized as contract revenue using the percentage-of-completion accounting method.

Cost of Construction Revenue. Cost of construction revenue consists of direct costs on contracts, including labor and materials, amounts payable to subcontractors, direct and certain indirect overhead costs, equipment expense (primarily depreciation, maintenance, and repairs), interest associated with construction projects, and insurance costs. The Company records a portion of depreciation in cost of revenue. Contracts frequently extend over a period of more than one year. Revisions in cost and profit estimates during construction are recognized in the accounting period in which the facts that require the revision become known. Losses on contracts are provided for in total when determined, regardless of the degree of project completion. Claims for additional contract revenue are recognized in the period when it is probable that the claim will result in additional revenue and the amount can be reasonably estimated.

Power Generation Service Revenue. The Company receives a combination of fixed and variable monthly payments as compensation for its production of power. The variable payments are recognized based upon power produced and billed to the customer as earned during each accounting period.

RF Transmitter Design, Installation and Service Revenue. Any revenues associated with TransRadio contracts are included in the loss from discontinued operations for the year ended December 31, 2012. See Note 8 in the notes to our consolidated financial statements regarding this discontinued operation. Contracts for TransRadio products and services generally contained customer-specified acceptance provisions. The Company evaluated customer acceptance by demonstrating objectively that the criteria specified in the contract acceptance provisions were satisfied and recognized revenue on these contracts when the objective evidence and customer acceptance are


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demonstrated. Certain TransRadio contracts required training services separate from acceptance of provisions and are generally provided after the delivery of the product to the customer. These services were a separate element of the contract that is accounted for as revenue was earned. The amount attributable to services is based on the fair value of the services in the marketplace and is typically stipulated separately with the customer.

Claims Recognition

Claims are amounts in excess of the agreed contract price (or amounts not included in the original contract price) that we seek to collect from customers or others for delays, errors in specifications and designs, contract terminations, change orders in dispute or unapproved as to both scope and price or other causes of unanticipated additional costs. The Company records contract revenue related to claims only if it is probable that the claim will result in additional contract revenue and if the amount can be reliably estimated. In such cases, the Company records revenue only to the extent that contract costs relating to the claim have been incurred. The amounts recorded, if material, are disclosed in the notes to the financial statements. Costs attributable to claims are treated as costs of contract performance as incurred.

Stock Based Compensation

We recognize the expense associated with stock option awards over the period during which an employee, director or consultant is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period). The related option awards for employees and directors are classified as equity and as such are valued at the grant date and are not subject to remeasurement thereafter. Estimates are revised if subsequent information indicates that forfeitures will differ from previous estimates, and the cumulative effect on compensation cost of a change in the estimated forfeitures is recognized in the period of the change. The option valuations are performed using a fair value Black Scholes model. Option valuation models require the input of highly subjective assumptions, and changes in the assumptions can materially affect fair value estimates.

See Note 19 in the notes to our consolidated financial statements for additional information pertaining to the stock based compensation plans.

Income Taxes

Valuation Allowance. Deferred income taxes are recorded using the asset and liability method whereby deferred tax assets and liabilities are established for the difference between the financial reporting and income tax basis of assets and liabilities, as well as operating loss and tax credit carry forwards. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment of such changes to laws and rates. In accordance with the quasi-reorganization requirements tax benefits that existed at the date of the quasi-reorganization but that were not recognized at the date of the quasi-reorganization will be recorded directly to equity.

Deferred tax assets are reduced by a valuation allowance when, in our opinion, it is more likely than not that some portion or all of the deferred tax assets may not be realized. Whether a deferred tax asset may be realized requires considerable judgment by us. In considering the need for a valuation allowance, we consider a number of factors including the future reversal of existing temporary differences, future taxable income exclusive of reversing temporary differences and carry forwards, taxable income in carry-back years if carry-back is permitted under tax law, and prudent and feasible tax planning strategies that would normally be taken by management, in the absence of the desire to realize the deferred tax asset. Whether a deferred tax asset will ultimately be realized is also dependent on varying factors, including, but not limited to, changes in tax laws and audits by tax jurisdictions in which we operate.

We review the need for a valuation allowance at least quarterly. If we determine we will not realize all or part of our deferred tax asset in the future, we will record an additional valuation allowance. Conversely, if a valuation allowance exists and we determine that all or part of the net deferred tax asset is more likely than not to be realized, then the amount of the valuation allowance will be reduced. This adjustment will increase or decrease income tax


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expense in the period of such determination. As noted above, in connection with this quarterly analysis as of September 30, 2013, the valuation allowance was increased to fully reserve for all deferred tax assets, resulting in a 2013 deferred tax expense of $4.9 million. Central to management's decision to increase the valuation allowance during the 2013 third quarter was the level of new business and change orders won during the first nine months of 2013 compared to the prior year period. The reduction of new business won year over year, when considered along with other positive and negative factors, contributed to management's decision to increase the valuation allowance as of September 30, 2013 and to retain a full valuation allowance as of December 31, 2013. The valuation allowance may be reduced if and when additional new business, tax planning strategies and other factors collectively support such a reduction from the fully reserved status.

The valuation allowance adjustment in 2012 resulted in an income tax expense of $0.6 million during 2012, consisting of a $0.8 million deferred benefit from continuing operations and a $1.4 million deferred expense on discontinued operations and presented as such. As of December 31, 2013 and 2012, our gross deferred tax assets total $27.3 million and $28.2 million net of a valuation allowance of $27.3 million and $23.3 million ($0.0 and $4.9 million net) on a post quasi-reorganization basis, respectively. The valuation allowance incorporates a full reserve on the deferred tax asset generated by the October 12, 2012, sale of TCNMI by the Company that resulted in a taxable loss of $51.7 million. The federal and state deferred tax assets arising from this loss on sale of TCNMI approximates $22.5 million and is fully reserved for through the valuation allowance resulting in a zero net impact on our deferred tax assets, net as of December 31, 2013.

Undistributed Non-U.S. Earnings. The results of our operations outside of the United States are consolidated for financial reporting; however, earnings from investments in non-U.S. operations are included in domestic U.S. taxable income only when actually or constructively received. No U.S. Federal or State deferred taxes have been provided on the undistributed earnings of non-U.S. operations of approximately $0.8 million and $1.6 million in 2013 and 2012, respectively because we plan to permanently reinvest these earnings overseas. If we were to repatriate these earnings, additional taxes would be due at that time. However, these additional U.S. taxes may be offset in part by the use of foreign tax credits. U.S. Tax liabilities are recorded from our earnings due to operations in Vanuatu as there are no income taxes in Vanuatu and Pernix Group periodically repatriates these earnings.

Foreign Currency Translation

The Company's functional currency is the U.S. dollar. Results of operations for foreign entities are translated to US dollars using the average exchange rates during the period. Assets and liabilities for foreign entities are translated using the exchange rates in effect as of the date of the balance sheet. Resulting translation adjustments are recorded

as a foreign currency translation adjustment into other accumulated . . .

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