Power Solutions International, Inc. (PSIX) 2014 Q1 法說會逐字稿

Good day and welcome to the Power Solutions International first quarter 2014 earnings conference call. Today's conference is being recorded.

At this time I would like to turn the conference over to Gary Dvorchak, Senior Vice President of ICR. Sir, you may begin.

Thank you and good afternoon everyone. We are pleased that you are joining us for the Power Solutions International first quarter earnings conference call.

Speaking on the call today are Gary Winemaster, Chairman and Chief Executive Officer, Eric Cohen, Chief Operator Officer, and Daniel Gorey, Chief Financial Officer.

By now everyone should have access to a press release that went out today. If you have not received the press release it is available on the Investor Relations portion of the PSI website at www.PSIengines.com.

Before we begin I would like to remind you that the information in today's press release and in the remarks made by our executives on this call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

These statements are based on information currently available to us and involve risks and uncertainties that could cause our actual financial results, performance, prospects, and opportunities to differ materially from those expressed in or implied by these statements.

These risks and uncertainties include, but are not limited to, the factors identified in our news release and our filings with the SEC. You may access any of these filings at www.SEC.gov.

Please also note that the information provided on this call should be considered current only as of today. Except as expressly required by the Federal Securities Laws, we take no duty to update that information.

Finally, I want to mention that a replay of the call can be accessed after the call ends and will be available for approximately one year.

With that, I would like to turn the call over to the Company's Chairman and CEO, Gary Winemaster. Gary?

Thank you, Gary, and thank you everyone for joining the call.

After I review the quarter, our COO, Eric Cohen, will offer more detail on our operating highlights and Dan Gorey will discuss the details of our financial results. I will conclude the discussion of our outlook for growth.

It was gratifying to see the strong business momentum that we built in 2013 continue into this year. Our revenue and adjusted earnings exceeded our guidance and analyst expectations and we executed on key initiatives that will further drive growth into the quarters ahead.

The oil and gas end market again drove sales growth. We sell our largest, highest margin engines into this market and we expect growth to accelerate in the quarters ahead.

The economics of using free flare gas for fuel combined with the encroaching environment restrictions on flare gas gives us confidence that this growth will continue for years to come in the market.

Because of the attractiveness of oil and gas as well as other markets needing distributed power, we executed our first large acquisition which closed just after the end of the quarter on April 1. We announced the acquisition of Professional Power Products, Incorporated, also known as PPPI.

PPPI designs and manufactures large, highly customized power generation systems. They integrate OEM engines with generators, containment structures and other equipment in order to produce a turnkey power source for large scale applications. Oilfield power generation is one of their biggest markets along with industrial and technology uses.

The systems they sell are sizeable. The generators can supply between one and nine megawatts. Because of this scale we feel they are complementary to our existing genset customers and provide a world class product.

PPPI has global reach with extensive customer base which will enable us to penetrate new emerging markets around the world. Recent sales trends at PPPI demonstrate the strength of the secular trends towards natural gas and away from diesel as a primary fuel. Historically, 95% of PPPI's genset engines ran on diesel. Within the last three months, their quoting activity for natural gas powered gensets has surged with one-third of their quotes in Q1 for natural gas.

Power Solutions' expertise in natural gas powered industrial applications was a natural fit for the trends PPPI saw developing before their eyes.

In our other major future growth opportunities, on road, we continue to make progress. We remain optimistic. The on road opportunity, because we are collaborating with at least a dozen potential OEM customers as they evaluate the market potential and product needs for alternatively fueled trucks and buses. Those collaborations take a lot of time and for competitive reasons should not be discussed.

We understand that our investors desire more concrete details but our first priority has to be protecting our customer's competitive position. Having said that, Eric will offer some detail on the developing partnerships that will demonstrate the scope of this opportunity for us.

Finally, I want to mention some progress in further strengthening our senior management team which will enable us to pursue additional market opportunities outside the U.S.

We announced in April that we hired two very talented gentlemen from our competitor, Fuel Systems. Richard Nielsen is now our Executive Vice President of Global Business Development and will help PSI pursue new customers around the world. Peter Ridgen joins our team as a Senior Sales Manager for Asia and will help us finally develop markets that our JV, MAT Holdings, is poised to start production in the near future.

Let me now turn the call over to our COO, Eric Cohen, to discuss Q1 highlights. Eric?

Thank you, Gary. I want to offer more detail on several of our highest priority growth opportunities. Then I will turn the call to Dan for financial details.

Gary touched on the PPPI acquisition and how it opens a larger addressable market for us in global applications. We see a number of additional benefits to the combination as well. We expect to achieve a number of operating synergies such as savings from higher volume parts purchasing, exchanging ideas on operational best practices and broader sales opportunities both U.S. and overseas.

They have already made introductions that should lead to significant sales for us and we can provide resources to help them further service their existing customer networks. We are excited about the possibilities for PPPI and PSI as a combined firm.

PSI is learning a lot from PPPI about large systems and world markets and PPPI is gaining from the extensive resources we are contributing to their efforts.

Turning to on road which we expect to be a major driver of growth in the second half of the decade, Gary mentioned our development work. Our approach is to enter long term relationships with OEMs to understand their needs and develop engines specific to the market opportunity.

In many of our ongoing development collaborations we will use our proprietary 8.8 liter engine as a base and design the parts and interfaces in order for it to drop into an existing chassis. Our engine typically already meets a customer's specs for power and torque and the emission certification is a key value added as this frees the customer from having to do that lengthy testing.

Because our engines run on a variety of fuels, our customers can consider propane as an alternative to CNG and LNG. Furthermore, because of this flexibility within the sealed engine design, our customers can avoid the cost of multiple designs for different engines that are fuel specific.

One concrete example we can discuss is the supply deal we recently signed with Capacity Trucks. Capacity will use our 8.8 liter propane engine in docks (inaudible) yard trucks to be supplied to UPS. We expect to start shipping into this program in 2014.

Speaking of the value of emissions certification, our 8.8 liter propane is now EPA certified to meet all emissions requirements. The 8.8 liter natural gas version has passed all testing in an EPA approved facility and all the paperwork has been submitted to EPA (inaudible). We expect certification for the 8.8 nat gas engine in the near future. Keep in mind that because we hold the certification for the engine, all of our OEM customers that utilize the 8.8 will automatically avoid emissions testing. This is a huge advantage for them to get to market more quickly and inexpensively.

Finally, let me mention the progress at our China JV with MAT Holdings. We continue to build out production capacity, meaning installing equipment, hiring and training production workers and so forth. We achieved a milestone of preparing to shift our first customer order which will go next month. We expect additional Asian customer relationships to start being fulfilled from [Dalion] as we go through the year.

We are excited about our prospects to further penetrate into fast growing Asian markets which are at least 25% larger than the North American markets. With the production in China and new senior sales staff in the region, as Gary mentioned, we are well positioned to grow in that geography in the years ahead.

I will now turn the call over to our CFO, Dan Gorey, to discuss our financial results in detail. Dan?

Thank you, Eric, and hello everyone. I would like to review our operating results and financial condition in more detail and then return the call to Gary for our outlook.

Here are the details of our first quarter 2014 financial performance. Net sales for the first quarter were $66.7 million compared to $52.6 million last year. This represents a 27% year over year increase in revenue and 9% sequential growth.

Sales growth in the quarter was due to strong growth in our heavy duty power generation systems for the oil and gas end market as well as growth in forklift and aftermarket sales.

Our gross margin for the first quarter was 17.9% compared to 17.4% in the first quarter last year. This increase was due to a favorable shift in mix to greater sales of our higher margin heavy duty engines.

Operating expenses which include research and development, selling, in service, in general and administrative costs, came in at $8.4 million for the first quarter. This compares to $6.1 million in the first quarter last year. This quarter's operating expenses include transaction costs of $811,000 related to the acquisition of Professional Power Products which closed on April 1.

Current quarter operating expenses excluding the transaction costs came in at $7.6 million. As a percentage of sales, operating expenses as adjusted were 11.4% of sales this quarter. This compares to last year's 11.6% of sales and last quarter's 12.8%.

Our R&D spending in the quarter was $3.6 million, up from $1.8 million in the first quarter last year. We continue to make significant investments in R&D spending as we work on advanced technologies for future customer platforms including our on road capabilities.

Selling expense in the current quarter was $1.8 million, consistent with last year. General and administrative expense adjusted for the transactional costs of $811,000 came in at $2.2 million. This is down slightly from $2.4 million in G&A last year.

Operating income for the first quarter was $3.5 million compared to $3.1 million last year. Adjusted for transaction costs, operating income was $4.3 million or 6.5% of sales compared to 5.9% in last year's first quarter.

Interest expense was $99,000 in the current quarter compared to $194,000 last year due to a higher level of borrowing last year.

Other income and expense includes the revaluation of our warrant liability. As a reminder, our April 2011 private placement included warrants, the liability for which we are required to carry on our balance sheet at fair value. Each quarter the change in value must be run through the income statement. This is a non-cash item that for GAAP accounting purposes impacts the bottom line.

This quarter we booked non-cash income of approximately $233,000 resulting from a decrease in the estimated fair value of the warrant liability. The value of these warrants will change regularly so you should expect to see valuation adjustments, both positive and negative, in future quarters. Therefore, we encourage investors to look at our results both with and without the warrant revaluation in assessing our performance on quarterly basis.

The GAAP fully diluted income per share was $0.19 in the current quarter compared to a loss of $0.32 a year ago. We are moving the effects of the warranty valuation and transaction costs. Our adjusted EPS was $0.24 in our current quarter. This compares to $0.21 in our first quarter last year.

Now let's discuss the balance sheet and liquidity. Our balance sheet is solid with $87 million in working capital which includes about $4 million in cash. We have about $56 million in shareholders' equity as of March 31. Our credit facility had borrowings of $26 million as of quarter end. This leaves $49 million available. We are in good standing with the bank and in compliance with all covenants. We believe cash generated from operations as well as availability on our line of credit will be sufficient for all near term operating and capital needs.

On April 1 the Company closed on the acquisition of Professional Power Products. We acquired all of the outstanding stock for an initial cash purchase price of $46 million. In addition, we will issue to the sellers between $5 million and $15 million in our common stock based upon PPPI's 2014 operating results.

In connection with the transaction and to facilitate the purchase we entered into an amended and restated agreement with Wells Fargo, our bank, to increase our line of credit to $90 million.

That concludes my comments. Let me now turn the call back to Gary to discuss our outlook. Gary?

Thanks, Dan. For some time we have been offering an outlook for 2014 revenue of $310 million to $330 million which represents growth of 30% to 38%. Our strong start to the year this quarter reinforces our confidence in that outlook.

Oil and gas demand remains very strong and the NACCO Material Handling Group deal is ramping. Naturally, with the PPPI acquisition we need to update the outlook to reflect their incremental revenue. PPPI is a $30 million to $40 million a year type business right now. We do expect growth over time and we think this can be an $80 million business in two years. However, as we integrate their operations now we want to remain conservative. As such, our new outlook for the range of sales of at least $330 million to $360 million for 2014.

Now Operator, let's open the call to questions.

(Operator Instructions) And our first question comes from Philip Shen from ROTH Capital Partners.

I'd like to start off with the Power Systems Group. I was wondering if you could provide us the latest outlook for this business. Last quarter you talked about $75 million of revenues in '14. Ostensibly, with PPPI acquisition, through the balance of the year, that is another $25 million to $30 million. What kind of revenues for this business could we see now in 2014?

Are you talking about the oil and gas opportunities?

I am, yes.

We gave guidance of $75 million last year for 2014. I think we feel very confident that that is a $90 million opportunity for us this year. With the acquisition of PPPI, I think it is very complementary. It stacks on top of the business that we have today and I think what we are trying to do is integrate it into our business plan. I think we are very confident that we will realize the same volumes that they had last year and I think going forward we feel very bullish that we will grow that business, as I said, to $80 million in the next two years.

In terms of the on road business, was wondering if you guys could provide a bit more color on the development activity? I know you can't comment on the partners but perhaps you can comment on some of the timing of potential partnerships. Could we perhaps see something in 2014 or is it more likely a 2015-type event?

I think we can, Phil. I think we are going to see earlier than expected some revenue in 2014 and we alluded to one supply agreement right now with Capacity with the end customer being UPS. That is an exciting opportunity. On top of that there are some new opportunities that have joined our pipelines of projects that we are working on. One thing we can also mention too is, and wasn't in our earlier comments, was that there is now an agreement to supply an engine to a significant Chinese OEM. It is an engine and a transmission so it is a complete powertrain package and that is in China. Beyond just North America we see China as kind of starting to ramp up in terms of demand and opportunity. That would start to realize, as well as North America, in 2015 as well.

Can you give us a sense for the size of the revenue impact in '14 from this partnership?

Just for some competitive reasons, the customers that we are working with haven't wanted us to share revenues but I think as we get into -- number guidance -- but as we get towards the end of 2014 we will be able to shed a little more light on what is going on.

One more for me and I will jump back in queue. You've had a nice acquisition with PPPI. What else is brewing out there on the acquisition front? I know you can't share any names or details but perhaps you can give us a small window into what might be next, if anything.

We are always looking at acquisitions. I think our philosophy is that you should always be evaluating make versus buy or what you can acquire versus grow organically and so I think there are multiple opportunities that we are looking at. It's really more defined right now by what strategically fits in than something that can -- it could grow our customer base or support our existing customer base. We somehow leverage and take their technology and leverage into what we are doing so I think everything we are looking at is very synergistically complementary. Obviously can't share any more on specific details but we are actively looking still.

And we will now go to Walter Liptak from Global Hunter.

I wanted to ask about just the way the quarter trended and it sounds like the LNG accelerated. Was it accelerating throughout the quarter and how are things trending as you get into the second quarter for the business overall but specifically the LNG markets?

The business continues to trend very favorably I think as Gary commented earlier, Walt. We are extremely excited about the business. As I indicated, as I think we indicated in our press release, quarter over quarter the business doubled and we saw sequential growth in Q1 compared to our Q4.

Margins continue to be strong. It's our highest margin category. I think as Gary alluded to, we doubled revenues last year from $30 million to $60 million. We are targeting $90 million and believe that is very doable this year so we couldn't be more excited and we've got some larger engine families coming on later in the year, we believe, that should accelerate that and then we've got PPPI that potentially can play into that. We couldn't be more enthused about that leg of our growth and it is trending favorably.

I would also like to add that we have just recently received probably one of the largest drop-in orders in the oil and gas space that we have had in the history of the Company. I think the market is aware of the quality of the product that we are providing and I think that it is responding very favorably to some of the new innovations that we are providing in the marketplace.

I wonder about -- the growth rate was a little bit better than I expected for core V6. Are you expecting revenue growth in total to accelerate?

If we look at where we are and I think when we talked about some of the guidance for '14 we still are very bullish in tracking as we thought. When we look out to what we see for '15, we will eventually give guidance for '15 but '15 is more, I believe will be more exciting than '14. We've got some very long term programs that we have been working on that will be realized next year and give us every indication that things will continue.

I guess what I am trying to get at is with the guidance, it sounds like you are being conservative with the revenue numbers and with the PPPI revenue coming in. Is there anything that cannibalizes revenue on the acquisition or is it just purely being conservative and not taking up the revenue guidance by 30 to 40 --?

No, nothing is cannibalized. It is actually just the opposite. It is very synergistic. In fact, there has been, as I alluded to, there has been some new opportunities on the engine side they have introduced to us and we have introduced some new customers to them so if anything, it is ramping but I think as you know, with almost any acquisition there is a period of integration so what we are trying to do is just be conservative knowing that during that period of integration that is might not be operating as efficiently as you can so we are just trying to be conservative during that integration period.

And then a last one, Dan, would be for you. The G&A declined to $2.2 million excluding those deal related charges. Was there anything one-time in there or are we operating now at a lower run rate of G&A?

I think we had some things that played in our favor. Having said that, I think we -- it was a combination of things. We tightened our belts a little bit. We insourced legal to a certain extent. That saved us money. Share-based payments went down. Some consulting went down. Some of it was timing and somewhat a little unusual. I don't know that we ought to particularly ascribe a $2.2 million run rate to G&A. Having said that, I think we are making progress again in tightening our belts and as I think we have discussed before, G&A along with selling are two categories that have really matured. There is no great expectation that we are going to be expanding much. It is just watching the pocketbook. So it did come in fairly favorable this year but I think we are going to see improvement over the run rate that we saw last year.

Our next question will come from Rob Brown from Lake Street Capital Markets.

I just wanted to follow-up. You talked about this before but the Perkins business coming in later in the year, the higher horsepower products, could you just give us a sense in the oil and gas market, what that addresses and what areas that can (inaudible)?

What it addresses is it is really a poll from our customer. Our customers have been very pleased with our initial product line which goes up to 22 liters and 430 kilowatts on a standby basis and then what they started asking for is larger applications and larger sizes and more power and so really the Perkins relationship addresses the needs and the asks from our customers and so that fills in a product range all the way up to over one megawatt and the first target market for that is primarily power generation. However, that is a really long runway for us but with that, there are some other opportunities in some adjacent markets for that product.

Your new China program that you are talking about, would this be manufactured in your new China facility, the JV there or would this be U.S. product shipped to China?

If we are talking about the on road opportunity, this would be a U.S. product that is shipped to a Chinese OEM.

And then lastly, on the outlook, what is sort of the NACCO business that is implied in your new outlook? How much of the business there, how much is NACCO in that (inaudible) if you break it out?

I would have to say that we are not in a position to talk about customer specific volumes and revenues. I would say that we are a strong partner with NACCO and that we have been given the one to eight ton lift truck business and we value their partnership and their privacy so I think it is difficult for us to say anything regarding your question.

No problem, I understand. Thank you.

(Operator Instructions) We will now go to Eric Stine from Craig-Hallum.

Just starting on PPPI and I know there is going to be a little bit of integration but talking about it longer term, can you talk about some of the synergies you are seeing, whether the impact or how soon you could see things from bringing them to your CAT relationships or just other synergies? That would be helpful.

Maybe I will bifurcate it into top line and then bottom line so on the revenue side, the synergies, what we are seeing is they, as I've mentioned before, they've got really contacts and relationships around the world and some of those global opportunities they are bringing over to us and these are entities that are looking for engines or looking for our solutions so that has been helpful. At the same time, we have relationships with, be it CAT or GE or other areas, that we can bring to them to bear and so I think on a revenue side that has been very helpful.

On the cost side, we have really deep purchasing and volume penetration right now and so we are getting, I think we are buying probably just as best as anyone out there on the engine side and for some of our components and a very strong purchasing team and so we are able to take some of the parts that they are buying and components, combined with our purchasing leverage and just really drive down some bottom line savings on cost.

On top of that there are some best practices that we are learning from them and they are learning from us on the operations side which help improve the bottom line there.

In terms of when we can expect to see these -- these are the opportunities that mature -- we would expect to see toward the end of this year both some cost realizations as well as some new sales arriving from these synergies.

Maybe you could just shift into oil and gas, I know this is kind of tough to call but just any thoughts -- you have in the past called up some of the customers that are adopting your solutions. Just thoughts on how early you are into their footprints and then secondarily, I know you have talked in the past about timing of C1D2 certification and just curious what you feel that does to your market opportunity.

If you look at where we are in the adoption, I think we are early in the runway. If you look at our volume, although it is ramping it is probably around 3,000 units a year on the heavy duty engine side of things. There are one million wells out there and each -- it's a little under a one-to-one ratio for engines to wells so if you look at the TAM, the total addressable market for engines in the oil and gas space is immense and we are just in a very early runway of opportunity for us and so we think we have a long way to go.

In terms of your latter question, it does, with that type of certification, spark resistant, it does open up some new opportunities for us and again, that has been polled by our customers asking for us to bring them those solutions (inaudible).

Last one for me, just an update I think -- in the past you have started to disclose the number and potential size, maybe that is too much detail but just other forklift customers beyond the NACCO contract, it seems like those are likely late '14, 2015 events.

We currently have relationships with the three largest and probably most of the top ten forklift manufacturers in China, the three largest in Korea. I would say that we are working hard to win their business. Some of those, like Hyundai, are currently in production but we are very confident that those other companies that we have relationships with will come over to the products that we have.

As they expand -- we have talked about what we do organically and one of the strengths of our Company is because we touch so many different players in each segment of these marketplaces, the organic opportunity for us to hit our guidance numbers is really without developing a lot of new customers. It is expanding inside of those customers and with the products that we have, we feel we have an advantage over our competitors and I think we will realize that in 2014 and there will be more press releases as the year comes to an end.

Is it safe to say the new-hires that you mentioned previously are helping (inaudible) that lift. Thanks a lot.

We will now go to Alex Potter from Piper Jaffray.

I was wondering if you could just disclose first of all the total number of engines you sold in the quarter and if you are willing to hazard a guess at the number of engines you think you are going to sell for the whole year?

Alex, I don't have that data in front of me and we typically don't disclose the unit engine sales by quarter.

Okay, fair enough. How about this one -- how many Perkins engines do you think you are going to sell this year? Do you think you will get meaningful volume there? Is that something you might be willing to disclose or (inaudible)?

Historically, we have had a long, long term relationship. Are you talking about the Perkins gas or Perkins diesel?

I guess you can just do Perkins gas for right now.

Those products, we are in development. The 600 kW unit will be the first one that comes out and then at the end of the year we will have the 1.2 megawatt units available for sale so I think that we are going to obviously place some prototypes. We have two units that are going into enclosures on the large product which are already sold to customers. I think we will go out as we did with the Doosan product and make sure that it is applied properly and it meets our expectations.

I think the reason that we have had such good success with the Doosan product is that we made sure that it was right before we ramped up and we will do the same thing with the Perkins product. We are very confident it is going to be a great part of our product line and I think that the initial indications in the testing is that it has achieved and exceeded some of our expectations. We are bullish but I really can't say how many units we are going to sell in that 23 to 61 liter business.

I was wondering if you could comment a little bit on gross margin also. It was up year over year, down on a sequential basis. Presumably, that is as a result of the NACCO contracts or NACCO volume ramping up and that from a mix shift standpoint, kind of pulling margins down. I guess the questions are a, is that an accurate assessment and b, should we expect that trend to kind of continue and have downward trending gross margin over the next couple quarters or do you think that (inaudible) put out?

As we discussed I think on our Q4 call, Alex, first of all let me just say that our high margin categories like (inaudible) oil and gas continue to perform very well and those margins are holding up well. I think we discussed in the past that the material handling business tends to be a little bit lower in gross margin than some of our other businesses and particularly with respect to a new sizeable order. You wouldn't have the maturity of the supply chain that you would need in order to really achieve the kind of targeted margins we are looking for.

We've got one of the best procurement guys we think in the business that is absolutely all over any -- all existing business but particularly new business where you've got again, you've got prototype parts and you've got low quantity components that you have been acquiring.

We are busy improving margins and would expect to see improvement in those margins throughout the year. It's the way that this business operates and it isn't that the business doesn't make sense. It makes immense sense and it is very lucrative but that is the name of the game. It starts a bit lower and you work your way up.

Our next question comes from Greg McKinley from Dougherty.

Could you comment on your PPPI acquisition? These are gensets that are going to be of larger scale than the customer base you typically sell your engines into. Who would be the engine supplier for these gensets and is there any opportunity for you -- is there any synergy to working with a new engine OEM or is that maybe not the case here?

You are absolutely correct. They do supply a market that is larger than our existing customer base and typically, they will work with people like Caterpillar or GE or Cummins, other engine manufacturers and they are open. The way PPPI is positioned is what they do is essentially do integration. They'll work with an OEM or that OEM's dealer and take your engine, they'll integrate it with a generator and add some electronics, things like switchgear and other components and sometimes put an enclosure around it or sometimes not, and maybe add a fuel tank to it or not but they will kind of integrate a complete system and so they are very open and trying with working with any OEM around the world that produces engines. That is their model.

And I think, Greg, it really is a neutral position. We are not competitive with the suppliers of those engines. Really, it is supporting them, giving them what is recognized as a world class product in a very specialized application.

Maybe on your heavy duty segment for a second, the 22 to 61 liter segment, as your customers evaluate your solutions versus others, what are their other options out there in the market or is this market really a lower volume, highly engineered product that hasn't drawn either the engineering or technical investment to be able to produce a product like you are currently offering?

If we look at the product that we have today, from eight to 22 liter, I think one of the things that makes it ideal is that it has the ability to run on wellhead gas. It has the ability to have explosion-proof ignitions. It has a lot of different components that I think are -- the customer is able to order those from us rather than have to up-fit that stuff in the field. We give them a mature, developed product that suits their applications and it doesn't require after-treatment or aftermarket add-ons to address those application requirements.

Okay, that's helpful. Generally speaking on an OEM basis you don't really see customized product rolling out the production line. It requires some sort of up-fit in the field?

Historically, that is what we have seen and I think that is why we have been advantaged and that is why we have had so many of the big oil companies working with their service providers to specify our engines.

Lastly, Dan, maybe just talk a little bit about how you are looking at R&D investments as the year progresses versus maybe some of the levels we saw last year, please.

I think I talked a little bit about some being in G&A which we believe are much more mature and probably we will see potentially some market expansion down the road as a result of those categories being much more fixed.

I think when we are talking about R&D it is a little different. I think it is running somewhere around 5% to 6% of revenue. I would expect it to kind of fall within that range. In order to continue to grow the business as we have grown it and to continue to grow it to our expectations and our shareholders, we are going to need to make significant investments. My sense is now that it is in that range that we are talking about, that we have run over the last couple of quarters.

(Operator Instructions) We will now go to Rudy Hokanson from Barrington Research.

My questions have to do with PPPI and that is, while you have a number of synergies and you are sharing, is it essentially being allowed to standalone with its facility and its management team and run alongside of PSIX or is there more nuts and bolts integration in terms of any movement of facilities or personnel?

It is being run as a standalone and so we have the trust and confidence in management there and the senior management is all staying on. The relationship though is that where they can support us and add resources and synergies, they do and if there are some direct areas where we can help support them and add resources, we do it there but on a day to day operation, they are really running as a standalone and we expect them to continue to remain where they are with their employees and continue to grow the business.

One way to look at it is when we went through this acquisition with the senior team there, we mapped out ahead of time where the opportunities were and so together, we started the acquisition and then you kind of call the play and we are all running it right now. They know what they need to do and we are there to support them and make sure they are successful.

So if you decide to go with larger engines, as they are already international -- for instance, with the joint venture in China, would they then be overseeing something there or is there nothing in the plans for getting them to that part of the market yet?

The JV in China was really set up to address our forklift OEMs. We currently supply the Chinese OEM, forklift OEM's product for the export market. They wanted us to get into domestic solution and since we are buying that base Mitsubishi engine in China, we set up the JV really to support the Chinese material handling OEMs. That is really the first direction for the JV.

At the same time, the purpose is really to eliminate some cost in freight rather than bring the engines back and then ship them all the way back. It allows us to be competitive in that domestic market and provide a more sophisticated solution.

As China comes about, at what point, and this I guess is for Dan, at what point will you be having an equity line and how do you expect that to start fitting into forecasts for 2014 or 2015 if you are going to be starting to have some results in 2014?

Eric may want to comment on this. I think we are on track to be recording some revenue. We have already shipped some initial product. Right now, it is largely not material, at least as of the close of the first quarter but there will be as this reaches materiality. We will probably break out a separate line item related to our investment in the China JV.

Our next question comes from Ross Silver from Vista Partners.

Just a question as it relates to competition within the oil and gas segment, could you just talk a little bit about that and maybe provide sort of a rough sketch of the current penetration rate of natural gas engines on some of these rigs that are in the field currently and where that may go?

I think the penetration rate, as I alluded to, is still fairly small. It is a very large marketplace and as such, I think there are going to be niches where various people compete and can take large parts of the market.

One thing that kind of differentiates us from the competition is the other large engine systems typically you've got to -- they've got to be field certified so it means that the factory produced an engine, it goes to a site and then subbed to that site to get certification and that incurs time and expense and delay and then if they need to move it to a new site, you need to recertify for that site.

We are really out there with a more unique solution in our power range which is really to -- we provide a pre-certified engine so you can actually get our engine at the site and it is already certified and you can kind of plug it in and you are ready to go and so that type of environment, there is very little or not much that I know of, direct competition.

We will now go to Greg McKinley from Dougherty.

Just one follow up on the larger engine manufacturers that would supply engines into the PPPI gensets, is there an opportunity there for PSI to collaborate with them to have powered generation presence or engine presence in that offering in addition to the genset control solutions you are going to bring with PPPI? Have I thought that correctly?

It's really a different market. Where PPPI plays is at a different power level and for different applications than our existing customer base so just for an example, they might take a locomotive engine and integrate that into a system that produces anywhere from up to five megawatts or maybe put them together up to nine or ten megawatts and that might be used to power an island or for peak shading in some application in the world. They are really integrating almost miniature power plants. It is a much different model and end markets than what we would play with with our engine which are much smaller.

Also Greg, with all the customers that we sell to in all the different markets, we have been able to remain neutral. I think this is a similar situation where we have some great customers that are having packaging done by PPPI and the ability that they can control and support their requirements is really the strength of the company and the confidence that those companies have that it is a neutral position.

And it appears there are no further questions so I will turn the conference back over to our presenters for any additional or closing remarks.

Before we close I want to mention several upcoming conference appearances. On Monday, May 19, Eric will present and host meetings at the Westlake Securities Emerging Use of Natural Gas conference in New York. On Thursday, May 22, Eric and Dan will host meetings at the Barrington Research spring conference here in Chicago. On Wednesday, May 28, we will have two simultaneous appearances. Dan and I will present and host meetings at the Craig-Hallum conference in Minneapolis while Eric will host meetings and appear on a panel at the FBR Energy Technology Summit in New York.

With that, this concludes our call. Thank you for your interest in Power Solutions International. We look forward to our next conference call with you in August when we will report our second quarter results. Thank you.

This concludes today's presentation. Thank you for your participation.