Pioneer Power Solutions Inc (PPSI) 2017 Q4 法說會逐字稿

Good day, and welcome to the Pioneer Power Solutions Inc. Fourth Quarter and Year-End 2017 Earnings Conference Call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Brett Maas from Hayden IR. Please go ahead, sir.

Thank you, and welcome. The call today will be hosted by Nathan Mazurek, Chairman and Chief Executive Officer; and Tom Klink, Chief Financial Officer. Following this discussion, there will be a formal Q&A session open to participants on the call. We appreciate having the opportunity to review the fourth quarter and full year 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 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 would now like to turn the call over to Nathan Mazurek, Chairman and CEO. Nathan, please go ahead.

Thank you, Brett. Good afternoon, and thank you all for joining us today for our conference call. Overall, 2017 was a strong year for our company. Most of our business lines are growing and generating sustainable EBITDA. All of our business lines target robust and growing end markets and, fortunately, our solutions are in demand. Our switchgear business, however, has proven to be somewhat misaligned with our overall financial model. To be sure, the switchgear business is well positioned in rapidly growing and dynamic end mark -- end markets like distributed generation and energy storage.

From a revenue perspective, we ramped this business up from essentially 0 sales to a $20 million year business in just 4 years, validating our decision to concentrate on this particular market segment. In the near term, however, the investments this business required to continue on its growth trajectory do not align with Pioneer's overall financial and strategic goals. Consequently, we have made the decision to divest our switchgear business for the benefit of our core business and shareholders. We are pleased to tell you that we've executed a letter of intent with a buyer that, we believe, will be a more synergistic partner for the business unit and we are moving rapidly towards completing the sale. We believe that the totality of the consideration that we will receive and the ability of our shareholders to continue to benefit from the long-term prospects of the acquiring entity make this a compelling transaction for Pioneer. We will provide additional details, including the identity of the acquirer and the specific elements of the consideration once we've executed a definitive agreement.

In the meantime, our financial statements are presented in this call with the business -- with the switchgear business reclassified as discontinued operations for the current and prior periods. By focusing our efforts and resources on the profitability of our remaining core operations, we expect to generate a significant amount of free cash flow in 2018, which can be used to pay down our debt. For the first -- for the full year 2017, we reported $101.4 million in revenue from continuing operations. Our revenue level reflects a longer-than-expected transition for our new private label line of Critical Power generators.

Operating income from the -- from continuing operations for 2017 was $3.4 million, a slight decline from $3.6 million for 2016. Net loss from continuing operations was $2.7 million for the year compared to net income of $1.5 million in 2016. This loss was primarily due to a noncash charge relating to our revaluation of our deferred tax assets. Tom will provide more detail on this noncash item later in the call.

As we focus our efforts on higher-margin, new business opportunities for our continuing operations and following the sale of our switchgear business, we expect to deliver positive net income from continuing operations on a GAAP basis in 2018. For continuing operations on a non-GAAP basis, excluding depreciation, amortization, restructuring charges, stock-based compensation and other nonrecurring expenses, our adjusted EBITDA for 2017 was $8.9 million compared to $9.8 million in 2016.

During 2017, our business generated $1.4 million of free cash flow from operations, even as we supported the switchgear business and continued to make payments related to our legacy payroll tax issues. With the switchgear business sold and our legacy payroll tax issues resolved in the second quarter this year, Pioneer will be more streamlined and better positioned to generate higher profits and increase free cash flow for the balance of 2018 and beyond. We intend to utilize the increased free cash flow to reduce our debt significantly in 2018.

On the business end, I just want to recap some highlights of 2017. In 2017, we launched our own complete line of power generation equipment, designed for a broad spectrum of market segments, including prime power, standby power, agricultural, oil and gas, telecommunications and off-road applications. This move significantly expanded our product offering and addressable market for engine generators. Although the transition to our private label generations has been more uneven than we would like, we believe that we will see an increase in contribution from these generators in sales and EBITDA by the end of 2018.

2017 results are marked by significant new contract wins and contract extensions that totaled more than $40 million. More specifically, we extended our contract with one of our largest customers, the second largest municipally-owned electrical utility in North America to supply liquid-filled transformers. This contract extension extends our previous five-year contract for an additional 5 years and is expected to generate revenue of approximately $13 million over the life of the contract. In addition, we've signed a contract with another new customer, a large electrical utility provider, to supply it [with] liquid-filled network transformers. That 30-month agreement is expected to generate annualized revenues of up to $2 million a year through 2019.

We are also expanding the use of lower cost manufacturing in Asia and Central America across all our business lines. This effort is significantly expanding our product scope and addressable market, allowing us to compete and win projects at favorable margins heretofore that were closed to us. Our efforts to increase the service segment of our business and extend our base of recurring revenue was successful as evidenced by several important contract signings. We signed a 3-year service agreement with one of the nation's largest drugstore chains to service and maintain 100% of the customers, 215 backup generator sites. Annual billings for the base agreement are expected to be a minimum of $400,000 per year, with opportunities to provide additional services and equipment. We also extended and expanded our relationship with one of the nation's largest cellular service providers, signing a 3-year service agreement renewal. Annual billings for service and preventive maintenance work on the customers' standby generators are expected to be approximately $3 million per year.

Our pilot program initiated towards the end of 2017 with a leading home improvement retailer is progressing well. The program, which is expected to lead to a significantly larger opportunities across this retailer, is approximately 2,000 store locations nationwide, utilizes our remote monitoring systems, enabling the customer to receive real-time data relating to its store-by-store backup power systems.

We began 2018 by winning a competitively bid 5-year agreement to provide network transformers to a regional regulated electrical and natural gas utility in the Midwest. Adding this customer, which serves more than 300,000 natural gas and 400,000 electric customers, further increases our growing portfolio of major utilities and reinforces our outlook for 2018. Indeed, based on the customer's internal projections and indeed, orders received to date, this utility should become Pioneer's third or fourth largest customer by the end of 2018.

Sales from all these awards are not included in our backlog until a customer provides us with a purchase order for a firm delivery of goods or services. The data center market continues to grow and provide demand for Pioneer equipment and services across the entire company. In addition, we are seeing real opportunities from blockchain and cryptocurrency mining projects. These operations require tremendous amounts of electrical energy and like data centers, generate demand for Pioneer equipment and services across all our business lines.

In sum, we serve stable and growing end markets, and I believe, we have taken the necessary steps to eliminate the drag on our 2017 earnings and positioned the company for a solid 2018.

With that, let me turn the call over to Tom to discuss our financial results in more detail.

Thank you, Nathan, and good afternoon to everyone. I'd like to clarify that the financial information being provided during this call is for our continuing operations.

2017 fourth quarter revenues of $23.6 million were down 4.4% compared to $24.6 million in the fourth quarter of last year. Gross profit for the fourth quarter of 2017 was $3.6 million or 15.3% compared to $5.8 million or 23.7% gross margin in the year-ago quarter. The gross margin was impacted by lower margins in our transformer businesses.

Selling, general and administrative expenses for the fourth quarter of 2017 decreased 9.7% on an absolute dollar basis to $4 million compared to $4.5 million in the fourth quarter of 2016. As a percentage of revenue, SG&A expenses decreased to 17.1% of revenue in the fourth quarter of 2017 compared to 18.1% in the fourth quarter of 2016.

Operating loss from continuing operations for the fourth quarter of 2017 increased to $612,000 compared to an operating loss from continuing operations of $494,000 in the fourth quarter of 2016. Both of these amounts are inclusive of nonrecurring charges.

For continuing operations, our effective tax rate for the fourth quarter of 2017 was 240.8% of our pretax loss as compared to 16.6% for the same quarter last year. The change in our income tax rate was primarily due to the effects of the tax reform completed in the United States in December 2017. This reform reduced the value of our net tax assets by $2.8 million, which was recorded during the fourth quarter of 2017. Consequently, our net income was reduced by a onetime noncash charge of $2.8 million for this revaluation.

Net loss from continuing operations for the fourth quarter of 2017 was $4.5 million or $0.51 per basic and diluted share compared to a net loss from continuing operations of $177,000 or $0.02 per basic and diluted share in the prior year's quarter. The impact of tax reform, I just discussed, reduced earnings per basic and diluted share by $0.32 in 2017.

Adjusted EBITDA for the fourth quarter of 2017 was approximately $595,000 compared to $2.6 million for the fourth quarter of 2016. Non-GAAP diluted EPS decreased to $0.05 in the fourth quarter of 2017 compared to $0.21 in the fourth quarter of 2016.

Turning now to the full year financial results. Revenues for the full year 2017 were $101.4 million, up 1.8% or $1.8 million from $99.6 million in 2016. Breaking this down by segment, T&D Solutions revenue increased $5.2 million or 6.4% compared to 2016. This increase was driven primarily by an 8.8% increase in sales from our U.S. operations, led by significant growth in our low-voltage general-purpose products, partially offset by a 2.8% decrease in sales from our Canadian operations. Critical Power solutions revenue decreased $3.5 million to $15.1 million or 18.7% for the full year 2017 compared to revenue of $18.5 million in 2016. Equipment sales were down $4.3 million year-over-year, and service revenue was up $800,000 due to an increase in our service business with multi-location customers.

For the full year 2017, our gross profit was $20 million or 19.7% of revenue compared to $22.1 million or 22.2% of revenue in the year-ago period. The decrease was driven primarily by lower margins in our dry-type transformer business due to the write-off of raw material inventory of $873,000 that was not relocated during our move from Canada during 2017.

As a reminder, the raw material inventory was not relocated due to a review of allowable raw materials and components used in the manufacturing of finished goods pursuant to our safety files for the products being produced.

SG&A expenses were $16.7 million in both 2017 and 2016. As a percentage of revenue, SG&A decreased from 16.8% in 2016 to 16.5% in 2017. Operating income from continuing operations in 2017 decreased to $3.4 million compared to $3.6 million in 2016. Our effective tax rate on income from continuing operations for the full year 2017 was 414.4% compared to 38.9% for 2016. The increase in the tax rate reflects a recognition of a valuation allowance on foreign tax credits, the impact of the Tax Cuts and Jobs Act legislated in 2018 -- '17, I'm sorry, and the anticipated partial repatriation of foreign subsidiary income in the first quarter of 2018.

The net loss from continuing operations for 2017 was $2.7 million or $0.31 per basic and diluted share compared to an income of $1.5 million or $0.17 per basic and diluted share in 2016. The decrease was primarily due to the impacts in our effective income tax rate as I just described. The impact of the tax reform reduced earnings per basic and diluted share by $0.32 per share in 2017.

Our adjusted EBITDA for 2017 decreased to $8.9 million compared to $9.8 million for 2016. Lastly, our non-GAAP diluted EPS decreased to $0.81 per share, down from $0.89 per diluted share in 2016.

Turning to the balance sheet and statement of cash flows. Our total debt at December 31, 2017, was $29 million compared to $28.1 million at December 31, 2016. We've just completed an amendment and extension of our credit agreements with Bank of Montréal. This agreement extends the maturities of our bank indebtedness to April 2020, allowing us to reclassify portions of our debt as long term. For the 12 months ended December 31, 2017, we generated cash from operations of $1.4 million compared to 2016, where we used cash in operations of $9.5 million.

Turning to our outlook for 2018. We expect full year revenue growth in the high single digits when compared to 2017 revenue and expect to improve our adjusted EBITDA for the year when compared to 2017. Additionally, the final payments of our legacy tax issues will be made in the second quarter of 2018. After the second quarter of 2018, the payments previously made to the IRS for legacy tax issues will be repurposed to pay down interest-bearing debt with the Bank of Montréal. Finally, the new tax laws has changed the way the company is taxed when moving cash from Canada to the United States, eliminating the deemed dividend tax we have occurred in the past for these movements. In the future, we'll be taxed on foreign income when it is earned, greatly reducing the fluctuations in our tax rate going forward.

This concludes my remarks. I now turn the call back over to Nathan.

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

(Operator Instructions) And our first question today will come from Matt Koranda of Roth Capital Partners.

This is Brad Noss on for Matt. I just wanted to talk about the sale of the switchgear business for a second. You mentioned that you're working quickly to try to close it. But can you just talk about sort of the expected time line for the closing of the sale and sort of what hurdles are left in the process that need to be completed? And then, also, just how you came about finding this party, if you searched them out or if they came to you?

Right. So I mean, the quick answer is that, that we expect to sign a definite agreement with them by the end of April and close no later than the end of June. That would be the latest. I think, we'll be probably close earlier. There really should be no big hurdles for us. They might have some internal share -- I don't want to call them hurdles -- may take a little bit longer than would it take us given shareholder approval possibly. But other than that, we don't expect to move off this particular timetable. Last year, when we decided to market ourselves really the switchgear business, I approached several people or companies I thought would be likely suitors, some in the business, some private equity firms holding businesses similar, talk begets other talk. This, in particular, was a company that I reached out to. We'd had previous discussions with them, really business collaboration type discussions. And they made the most compelling offer for us and that's who we are moving ahead with.

Okay. Thanks for the color. That's helpful. And then, just looking at your growth outlook for 2018, can you just talk about sort of how that's comprised of growth in T&D Solutions versus Critical Power? And also, just sort of what the cadence of growth looks like through the year as your different contracts ramp up?

Brad, this is Tom Klink. We're expecting the Critical Power solutions to be relatively flat this year as the generator solutions take hold out there. So we're not expecting any significant growth from there. We're expecting the majority of the growth to come from the transformer side of things, more towards the back half of the year than the front half of the year, as the contracts Nathan mentioned take a hold and take root towards the second half of the year.

Okay. That's helpful. And then, just for the quarter, with the headwinds in gross margin, I think you mentioned that it was from the transformer business. But can you expand on that a little bit, if there was continued effects from hurricane or the lower-margin pad-mounted liquid transformers, you're selling to a utility customer? Or what specifically caused those margins this quarter?

Yes, Brad. I mean, it was -- I don't want to lay it all at -- on the business that I'm particularly responsible for the liquid-filled, but a lot of it was there. We had a good revenue or an okay revenue quarter. The mix was not as favorable to us as usual. There was a lot of utility contract work that we have no choice, but to take. It hurts us twice. Those are not just the lower-margin type products for us, but they're lower ticket prices for us. So we occupy tanking slots and manufacturing capacity of which is limited for us, that's a good part. We occupy it with a lower revenue, lower-margin slot than -- I then can't really do anything about that. The positive is that we have a lot of utility contracts and we're busy, busy and will be, and will never go wanting for work for the next several years. But the mix did not hit us, especially, favorable -- especially, in this past fourth quarter.

Okay. And I think that was sort of similar to Q3. But do you see any sort of continuing trend into the beginning of '18 from that...

Yes. You're exactly right. It was very similar to Q3. Exactly correct. It's a little -- it's somewhat better so far. I haven't looked at March. Actually, I was looking carefully at January and February this morning. The mix is a little bit better. It's still not as favorable as January, February of 2017. January, February, March of that particular period.

Okay. Got it. And then just maybe one more from me here. I believe that you're working on approximately $8 million, and I think, it was 2 different cell tower service contracts. But can you just update us on how those negotiations have progressed and also the timing on those?

Right, Brad. You don't forget anything. So those were 2 large ones. One, we completely lost based on price, although, we went down very, very low. We were edged out. The other, initially, we also lost on price. We were #2. That has come unraveled for the group that won it. So the cell tower -- the cell-service provider has come back to us actually right now. So that one's still hanging. So one has gone, and one we're still working on.

Okay. And that second one, do you have any expectations for the time for a decision and then how long after that you might actually see revenue from that, if you do win it?

Right. So like in some sort of totalitarian regime, you know that they could say whatever they want. They don't have to live by it. So I mean, they were supposed to have a final decision March 20, so we're past that. But soon.

(Operator Instructions) Our next question will come from Joshua Horowitz of Palm Global Fund.

What was the negative effect on adjusted EBITDA from the switchgear business over the last 12 months or 2017?

The negative effect on an adjusted EBITDA from the switchgear business, Josh, was about $5.9 million.

We expect to get all that back now that that's been shed or do we think about EBITDA going forward or free cash flow going forward?

Yes. No, we do expect to get that all back. Obviously, we will continue to do our best as long as we own it to minimize those losses. In fact, we're taking steps and have taken steps during the first quarter now to reduce some of the cash outflows that were required for that business. And once the sale is completed, we expect those cash outflows to cease to exist and improve.

I think it was $2 million to $3 million of revenue was supposed to be pushed into Q4 from the hurricane last time you guys reported. Did that ever happen?

It was pushed into Q4. But subsequently, there was additional business that was pushed into Q1. Most of this was in the switchgear business as it related to our large customer down there of automatic transfer switches. So...

Okay. Having a hard time hearing you guys. Maybe somebody put it on mute. That's better. So when you consider the sale of switchgear, can I ask -- did the board consider strategic alternatives for the whole company given the lack of liquidity in the stock and the fact that this sort of operates like a private company given the composition of the board, the fact that, you, Tom, you're on the board. I mean, I don't really think that's a great corporate governance practice. Just the whole thing sort of feels increasingly like a private enterprise. So when you looked to sell switchgear, did the board look at saying, "Hey, we're not getting any benefit from being public, why don't we just sell the whole thing?"

Right. So that's something, Joshua. This is Nathan. Whether public or private, we're trying -- we have fiduciary duty too. To the shareholders, we're trying to do our best to unlock the value. I am the largest shareholder, so that benefits me as well. Absolutely, we're always looking as to what the best course of action does it really make sense. We think we're getting a very compelling offer for switchgear and that definitely opens up, streamlines the company, and puts it in a more -- I don't know, a cleaner position to potentially sell itself. But other than any other -- anything else, is that -- does that help answer or you have any other corporate governance issues you want to raise?

No. Am I to understand that the board took a look at the business and said switchgear is hurting us, we're going to sell it or was the process more along the lines of maybe we ought to look at selling the whole company. And it's going to be a lot cleaner and a lot easier absent switchgear, so why don't we get rid of that first. If you could guide us towards what -- which of those 2 paths you guys took, that would provide tremendous insight.

Yes. I don't know if I can recollect accurately all the give-and-take amongst the various board meetings, what evolved into what. Definitely, you have a business that's not conforming to your basic financial model, so we look at that. Are we always looking to maximize our value when is it a good time to sell, when is it a good time to be the acquirer, we're always looking at that. I don't know if they exclude being on parallel or synthetic tracks.

Look, I don't think anyone has any doubt that you guys are working hard. I guess -- our concern is that nobody cares or ever will care, right? I mean, it feels like we've all been stuck in this thing for quite some time. And there are very few investments or alternatives that we -- could have been in that wouldn't have performed better. And it just seems like the liquidity is only getting worse and worse as the days go on. And certainly, it's not a board, especially, with the CFO being on the board. I have never seen that before. That appears, at least from the outside, and I could be wrong, and I'll give you the benefit of doubt, that appears to be working towards maximizing the value. Now the switchgear sale is definitely a great step in the right direction. I just -- I'd like to see you guys consider a process now that, that has been shed or when it is shed, to maximize value for everybody.

Okay. I appreciate -- I personally and sincerely appreciate your comments, Joshua.

And there are no further questions at this time. (Operator Instructions) And there are no further questions.

Okay. Thank you all for your time and support, and we look forward to updating you again in our next call.

And ladies and gentlemen, this does conclude today's conference. We thank you for your participation. You may now disconnect.