Power Solutions International, Inc. (PSIX) 2014 Q2 法說會逐字稿

Good day, and welcome to the Power Solutions International Second 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, Lauren, and good afternoon everyone. We're pleased that you're joining us for the Power Solutions International First (sic) 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 Power Solutions website at www.PSIengines.com.

Before we begin, I'd like to remind you that the information in today's press release and 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 Securities and Exchange Commission. 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 this call can be accessed after the call ends and will be available for approximately one year.

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

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 the operating highlights and then Dan Gorey will discuss the details of our financial results. I will conclude with a discussion of our outlook for growth.

Results this quarter again demonstrate our key strengths of the PSI story. We have a growing opportunity for alternative fuel engine solutions and an ability to capture that opportunity by executing against a strong strategic growth plan.

This resulted in revenue that grew 40%, expanding gross margins, and adjusted EPS that grew 31%.

Oil and gas was a solid contributor to these results. As demand in oil and gas has materialized over the years, we enhanced our product line with unique advantages relevant to the market and directed our sales efforts to capture the flare gas opportunity. We see additional oilfield opportunities in compression, which Eric will discuss shortly.

Related to this, in the second quarter we announced our largest acquisition since the Company's founding, the purchase of Professional Power Products Inc., which we call 3PI. 3PI designs and manufactures large, highly customized power generation systems.

The combination with PSI accomplishes two key goals. First, we now can address new segments of power gen markets, especially the oilfield, where there are needs to be for very large power systems.

Second, both parties can leverage our existing relationships both on sales and the supply side. We are introducing 3PI to our customer network and they are bringing us into new opportunities within theirs and our customer base around the world. Eric will go over more detail on our integration activity and prospects going forward.

Let me also mention in our on-road effort, we understand there is some frustration because of our limited in what we can say about those efforts. Our engines are critical components in very strategic programs with large OEMs operating in very competitive environments. These OEMs need to protect their efforts. Our discussion could inadvertently reveal their marketing strategies, for instance.

They also need to stage new product introductions in order to reduce any negative effect on current product sales. We are partners with these potential customers and must help them by respecting the confidentiality of their efforts.

Having said this, I can tell you that in on-road, we are now in various stages of evaluation with around a dozen truck OEMs within the US with multiple-perspective customers that are large household names in truck manufacturing. They spent several days in our offices this spring auditing nearly everything you can think of in our operations. These OEMs take product partnerships seriously and do not evaluate only the engine. They need to feel comfortable with our total operations, including manufacturing processes, quality control, etc. They want to know that we manage our company well and will be a reliable supplier that is still [flagging] a decade from now.

We now turn the call over to our COO, Eric Cohen, to discuss Q2 operating highlights in detail. Eric?

Thank you, Gary. I want to offer more detail on several of our highest-priority growth opportunities and then I'll turn the call to Dan for financial results.

We closed the 3PI acquisition at the start of the quarter and have been busy integrating our operations. Importantly, we expect 3PI to run as an autonomous division for the foreseeable future. Their headquarters will remain in Darien, Wisconsin, which will be able to support their growth.

As Gary mentioned, we are going to market together in a synergistic manner which is quite valuable. To help capitalize on growth opportunities, we hired Brian [Cleary] into the newly created role of VP of Sales at PPPI. Brian has considerable experience in the power generation integration basis. His deep contact base is already driving new quotes to PPPI.

Also to support future operations, we hired John [Pomisoll] as new VP of Operations. John was previously leading operations and operational improvement at a competitor.

Finally, our VP of Marketing, Jeremy Lisseris, has been spending a lot of time at PPPI working on updating and integrating our marketing materials and go-to-market plans.

As you can imagine, this level of integration activity and the general disruptions associated with any acquisition can impact sales growth. As Dan will mention, PPPI sales this quarter were below the pace they demonstrated last year. This was not unexpected by us during the first few quarters after the acquisition.

We remain quite optimistic because we bought PPPI for what they can become for us, not strictly for what it is today. We see PPPI as a growth platform to expand our success in heavy-duty engines. We're working extensively to refine and expand their capabilities so that it can be an $80 million a year business for us down the road.

As Gary mentioned, oil and gas has turned into a far better opportunity than we ever envisioned. This opportunity is robust for two reasons. First, the economic benefits are obvious when using flare gas that would otherwise be wasted. It eliminates the cost to buy and truck diesel fuel out to remote well sites. A recent Wall Street Journal article noted that nearly one-third of the natural gas production in North Dakota's Bakken Shale each year is burned off as flare gas. In April alone, it was over 10 billion cubic feet, valued at $50 million. That's free fuel with no transportation costs, and oilfield and E&P firms are taking notice.

The second driver is regulation. Authorities are also taking note of both the pollution issues and lost royalties on leased state and federal land. On June 1, the North Dakota state government implemented new rules requiring gas capture plans for new drilling. The EPA put new standards for flaring and venting in place in 2012 which are now being implemented, and the BLM is evaluating new regulations as well. We're confident that regulations toward the release or burning of excess gas will only get tighter, thus creating even more market opportunity for us.

Currently, our engines are going into large electrical generators designed to power microgrids and/or specific equipment at the well site. An additional opportunity developing for us is the power compression systems. These are used either to drive additional gas out of low-pressure wells or to drive gas down a collection pipeline. These compression systems are ubiquitous and generally run on locally generated electricity. Over time, we expect flare gas fuel generators to power more and more compression systems out in the field.

Moving on, let me motion progress at Green Power Dalian, our JV in China with MAT Holdings. Our production facility is built out, staff training is ongoing, and we are starting limited production. We have shipped our first customer orders, mainly for evaluation units, and are now producing small lots for three customers. Our sales staff is adding new customers as well so we expect the ramp to continue throughout the year.

Now, a quick comment regarding on-road. Gary mentioned that we cannot offer a lot of detail, even though there's a substantial amount of activity going on. We can tell you that we are in various stages of serious evaluation with large customers. The process is lengthy and there are many steps beyond simply buying a prototype engine, such as the operational audits that Gary mentioned.

I would note that our competitive position in on-road strengthened with the recently announced certification of our 8.8 liter for on-road use. Because we hold the certification for the engine, all of our OEM customers that utilize the 8.8 will automatically avoid emissions testing or other expensive solutions. This is a huge advantage for them to get to the market more quickly and inexpensively.

I also want to mention another nice benefit we are utilizing in our on-road effort. It turns out that there are quite a few grant programs available to help fund research related to natural gas-fueled engines. We are actively pursuing many research grants and hope to be awarded several of these. That money can help defray our R&D costs as we continue to pursue the on-road opportunity.

Finally, let me conclude with an exciting manufacturing initiative. As you know, we embrace continuous improvement across the Company, especially in our factory floor processes. In order to more efficiently move small parts to our production lines, we are implementing a two-bin [combine] inventory delivery system. The installation of this system is now partially completed and we anticipate that it will be fully operational by the end of the year.

Once this new system is operational, we effectively increase our engine production capacity by 25% with little CapEx and no need to hire more labor. That is a very cost-effective way for us to grow our capacity at a time of rapid growth. We are proud of our operations teams that have identified the strategy that inexpensively gives us room to grow.

I'll 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'd 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 second quarter 2014 financial performance. Net sales for the second quarter were $83.4 million, compared to $59.2 million last year. This represents a 41% increase in revenue.

Sales growth in the second quarter was due in part to strong growth in our heavy-duty power generation systems for the oil and gas end market.

The acquisition of Professional Power Products, or 3PI, which was effective April 1, was also a key contributor toward sales growth, contributing $7.3 million in sales for the second quarter.

Organic sales growth, excluding the acquisition of 3PI, was 29% in the quarter. In addition to strong sales contribution from the oil and gas end market, we also saw growth in aerial lift and after-market sales.

The Company saw sequential sales growth of 25% in the quarter, with organic growth of 14% and 3PI contributing 11%, sequentially.

Our gross margin for the second quarter was 18.5%, which compares to 18.9% in the second quarter last year. The decline in gross margins was caused by modest shifts in product mix in the quarter from Q2 last year and was also due to the inclusion of 3PI and the related purchase accounting.

Sequentially, though, our gross margin increased to 18.5% from 17.9% in the first quarter due to strong sales of our heavy-duty power systems to the oil and gas end market.

Operating expenses, which include research and development, selling and service, and general and administrative costs, came in at $9.5 million for the second quarter. The expenses were 11.4% of sales this quarter. This compares to last year's 12.4% of sales and the first quarter's 12.6% of sales.

Our R&D spending in the quarter was $3.7 million, up from $2.3 million in the second quarter last year. We continue to make significant investments in R&D to develop advanced technologies for future customer platforms as well as funding our on-road development.

Selling expense in the current quarter was $2.3 million, an increase from last year directly related to our increased sales volume.

General and administrative expense was $3.4 million for the quarter.

Operating income for the second quarter was $5.9 million, up from $3.8 million last year. Operating margin expanded nicely, to 7.1% in the quarter from 6.5% last year and from 5.3% in the first quarter.

Interest expense was $381,000 in the current quarter, compared to $241,000 last year due to a higher level of borrowings this year related to the acquisition of 3PI.

Other income and expense includes the revaluation of our warrant liability. As a reminder, our 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 $99,000 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 a quarterly basis.

On April 1, the Company closed on the acquisition of Professional Power Products. We acquired all of the outstanding stock for initial cash purchase price of $46 million. In addition, we will issue to the sellers contingent consideration between $5 million and $15 million in our common stock based on 3PI's 2014 operating results. This is based on a PSI stock price of $76.02 and resulted in the recording of a contingent consideration liability of $8.9 million as of the date of acquisition.

Beginning in this quarter, the Company is required to revalue the contingent consideration on a quarterly basis. For the second quarter, the Company recognized income of $900,000 due to the decrease in the estimated value of the contingent consideration.

The GAAP fully diluted income per share was $0.39 in the current quarter compared to a loss of $0.23 a year ago. Removing the effects of the warrant and contingent consideration revaluation, our adjusted EPS was $0.31 in our current quarter. This compares to $0.23 in our second quarter last year.

Now let's discuss the balance sheet and liquidity. Our balance sheet has $92 million in working capital, which includes about $6 million in cash. We have about $69 million in shareholders' equity as of June 30.

Our credit facility and term note borrowings were $75 million as of quarter end. We have availability of about $19 million as of June 30. We are in good standing with the bank and in compliance with all covenants. I 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.

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

Thanks, Dan. As we cross the halfway point in 2014, we are as confident as ever in our outlook. Our results this quarter demonstrate our ability to set aggressive goals and then achieve them with great execution.

Last quarter, we noted that our 2014 revenue guidance of $310 million to $330 million would need to be adjusted for the expected contribution from 3PI. We noted that, based on their historical results and our plans for growth together, we were comfortable with new revenue outlook for PSI of a range of sales of at least $330 million to $360 million. Now we have started to integrate the acquisition and have visibility on our combined sales pipeline. We are comfortable that PSI can achieve that guidance.

Accordingly, we are reiterating that we expect 2014 sales in that range, from $330 million to $360 million.

With that, Operator, let's open the call for questions.

(Operator Instructions) Eric Stine, Craig-Hallum.

Hi, everyone; nice quarter.

Thanks, Eric.

Maybe just starting with the Perkins engine. Done some checks and hearing some pretty significant pent-up demand there. How should we think about that for the remainder of this year in terms of the release of that product? And then also, as we get later in the year here, what your thoughts are around that for 2015.

The Perkins 4000 series gas engines?

Yes.

Those are still currently in development. The V8 is much further along. The V16 engines are in final development. We believe that we will be able to realize some sales in the fourth quarter. These are significant products for us. The V16 will have a selling price of over $300,000 and we have a number of customers that are ready to start to take samples and start to integrate them into their programs. So it's an exciting time for the Company, but I think we're still in the final development stage and testing so we have integrated those into 3PI packages. So they are more developed than just running on a [dyno].

Right. And I'll add to that, Gary, too. Just yesterday, I was walking through the gen set for the V16 and on the initial startup it was achieving close to what we wanted. And we'd expect that in September, those units would be going out for some early trials with some beta customers.

Okay; that's helpful. Maybe just turning to materials handling, NACCO ramping throughout this year, but maybe talk about some of the other programs you're working on. I know you have been for some time. And just thoughts about additional forklift opportunities in the next year.

Well, the Chinese market is obviously a big target for us. We have the JV in a position to help us reduce costs to address some of the domestic markets in China. We are currently selling probably eight of the top 10 Chinese manufacturers that are exporting engines back to the United States, so it's a natural progression for us to acquire some of their domestic business

We've developed a special product to address one of our competitor's products and I think that that's going to be very, very successful for us.

The NACCO business, we're starting to see pipeline for the Mitsubishi engine, filling up in 2015. So that integration is going very well. That partnership is fantastic and continues to get stronger. We will be one of their more strategic suppliers from 2015 from all the way from 1- to 9-ton trucks for spark-ignited product.

So I think that we have -- from a forklift perspective, we probably have one competitor with -- one outstanding competitor, Nissan, that we're addressing. But the other companies, I think we have done very well and we continue to work hard to try and keep the business that we have.

Got it. And then, last one for me, just gross margins -- just how we should think about that throughout the remainder of the year given more forklift business coming on, but oil and gas offsetting it.

I'm really pleased, Eric, with the progress we made in Q2. I mean, we really saw nice gross margin expansion. I guess I'm still of the mind of being a little tempered in terms of expectations. To your point, we had a nice contribution from our heavy-duty line, and that certainly helped. As we begin to ramp up forklift, that will potentially have an impact on margins.

Having said that, we saw nice improvement -- remember, it's all about beginning with a piece of business and then working those costs down. So we saw some nice improvement between Q1 and Q2 in margins for material handling.

But having said that, I guess I'm still of the mind that we ought to be measured in terms of our expectation for (inaudible) margin in the near term, and I kind of think they're going to remain in that 18% to 18.5% range.

Okay, thanks a lot.

Sure.

Philip Shen, Roth Capital.

Hey guys, it's Matt Riley, on for Phil.

Okay; how are you?

Good, thank you. I just wanted to start off with the oil and gas opportunity. Obviously you have nice penetration within the power gen market here. And Eric, you had talked about the compression opportunity. Could you just kind of help us quantify that and next steps and timing?

When you look at the market in oil and gas, if you look at it by horsepower, about one-third of the engines, by horsepower, go for power generation and two-thirds go into compression. And so the opportunity there is that there's not a lot of engine options. And so our customers are asking us to also take what we've done on the power generation side and start applying that to compression.

It's a little bit of a different animal because you have things like torsional vibrations and other factors that you have to design for. But we're taking some of our engine solutions and applying it to more of that compression market.

And by compression, it's basically -- it could be compression where you're pushing pressure into a well to release the gas. Or it could be moving gas off the well once you get it out of the ground.

Okay. Thanks, Eric; that's helpful. Just touching on the NACCO contract, can you give us any sense for unit volumes -- your latest expectations there for 2014 and perhaps 2015 as well?

Well, from our partnership with NACCO, we're not in a position to give volumes. But I can say that we will be their majority supplier for spark-ignited engines, like I mentioned. I think we'll have the opportunity like from 1- to 9-ton, which is the lion's share of their business. So I think we will be in a position to be their largest supplier in 2015. I think we've done what we need to do for that relationship and we continue to work hard to earn that position.

All right; great, guys. I'll jump back in queue.

Aditya Satghare, FBR Capital Markets.

Thank you; good afternoon, all. So two questions. Firstly, you mentioned that you're working on your (inaudible) OEM programs. So when I think about the current R&D run rate, does it reflect all the expense needed to scale up those programs?

And then maybe a side note on that -- could you talk about the cumulative market opportunity you foresee with those (inaudible) programs?

Yes. In terms of the R&D expense, one thing to realize is that the R&D expense is an expense. There's also investment we make that can be capitalized. And so in terms of run rate, part of it really depends on how quickly programs accelerate. We could have -- what's happened recently, there's for example, a large strategic partner that we're working on a project with wanted us to accelerate a program.

So based on if customers want to accelerate a program, that would necessitate, obviously, some higher R&D. So I think that's something we just have to look at on a quarter-by-quarter basis.

In terms of the opportunity, though, the market opportunity we still see as there or even better recently. I think the price differential between natural gas and diesel still remains in effect. And all the main drivers pushing adoption more towards alternative fuels are still there. So at least we see the opportunity continuing to grow, if anything.

Got it. And then, my second question is, you mentioned your 3PPPI, the 3PI being a $80 million business going forward. What kind of scenario would we have to see for that to happen? Is it existing business and increased distribution and then does it then sort of go into the large oil and gas [operators] to get to that number, or how should we think about the scale as you develop revenues there?

Well, the markets they play in are essentially billion-dollar markets. So it's really a two-pronged approach. One is there's opportunities with existing customers, and many of the existing customers, we don't get all their business; we just get a small part of their business. So just going to existing customers and garnering a larger share of the business, there's an opportunity there.

On top of that, there's many other customers, market segments, and OEMs that the Company's never sold to that we now, with the addition of some of the people we've brought on, have very strong contacts there. And we're not really in a competitive position to talk about those because it's proprietary right now. But we've really identified where we can go and build up and scale the business to that size.

All right; thank you. Thanks for the update.

Walter Liptak, Global Hunter.

Hi, thanks. Nice quarter, guys. I want to ask about the revenue guidance. Obviously, you've got your production schedules for the third quarter that are probably pretty close to set. Why the range in revenue? I guess the way I'm looking at it is you've got -- if you take what's remaining, about $180 million if you go on the low end, or at the higher end about $210 million. So somewhere between $90 million and $105 million per quarter of revenue.

What could go right? What could go wrong? I wonder if we could get some color on that.

I would characterize the range as somewhat tight, I guess from my perspective, Walt. And so I think that when we think about it -- again, we're going to deliver as much as we can deliver. But we think about a range and we think about the midpoint of the range as being kind of the target and again, business is very --

We've got a lot of wonderful things going on here and some great potential. So I have absolutely no confidence that we're not going to deliver in the longer term. What we don't have is pinpoint precision on a quarter-by-quarter basis. And so that's really the reason for the range. But I think the team here is optimistic. We clearly believe that we're going to be able to execute to our plan and within the guidance that we gave.

Okay, great. And kind of along those lines, on the answer you had regarding gross margin, what are the things that could go right or wrong on the gross margin lines? Is it a pricing issue or is it a throughput issue to meet the higher end of that range?

Again, I think we're -- I don't foresee any wild swings in gross margin in Q3 or Q4. I was pleased to see the margin expansion and it's really nice to see the leverage that this Company has as we start to see increased volume.

So I think the general message is that I'm pleased, we as a team are very pleased with what we've seen. And when we play that out into 2015 and beyond, I think it suggests that when we talked about getting our gross margins into the low 20s, I think it's very doable.

Having said that, in the short term the business is dynamic, there's lots of end markets. And with that there's going to some movement around gross margin. But again, I don't feel that it's going to be severe movements. I really think we're talking about 50 basis points one way or another.

So as an example, if we sell a little bit more into the oil and gas market, margins may tick up. If material handling business picks up a little bit more relative to the rest of the business, could put a little bit of pressure in the short term on those margins.

But again, I don't think we're talking about a lot of movement one way or the other.

Okay, good. And then I guess, Gary, one for you. On this call you kind of led off with discussion of on-road, which I think is -- I can't remember that has happened in the past. Are we to take it that you're spending more of your time working on on-road, and are you more or less enthusiastic? Are we getting closer to an on-road order at this point?

We are getting closer to an announcement. I mean, we're hoping in the third quarter that we will have something that we can tell the market. We've had a number of audits that went extremely well, and I think that when you are one of the highest-scoring companies that was audited, I think that it gives you great confidence that the process will move in your direction.

So we feel very positive about that. The products are doing very well under test. And so now we're moving forward. I mean, those things that I said about confidentiality and how we have to make sure that we don't disrupt their current sales efforts -- those are real. And so I'm very bullish on what we talked about and I think that we've got good product, good processes. The quality of our engines are very good. And for those that have been to our facility, it's a world class. So we represent very, very well to those partners.

And I think they brought some of their teams in here and have come back with great confidence. So I think we're in a position that -- where we want to be. It's just a matter of as we get closer to the year, they'll make some announcements. And when they do, we will be able to get into greater detail.

Okay, got it; sounds good. Thank you.

Alex Potter, Piper Jaffray.

Hi, thanks. Was wondering first -- I don't know if you could maybe do this or not. But if you look at the $330 million to $360 million revenue guide, would it be possible to break that out into buckets and tell us maybe approximately how much of that is coming from each of your different end markets?

I couldn?t do that, Alex. We typically don't break out -- I think from time to time we give indications of the percentages of revenue related to various end markets. We kind of do that on an annual basis. But -- as an example, last year we did about 25% of our business in oil and gas, about 20% in material handling. But I'm not in position to be able to break those out in detail now for the quarter.

Okay, fair enough. Would you say that at this point, you think it's fair to assume that you'll have at least some -- I guess call it material revenue -- to talk about in 2015 coming from on-highway?

I think that'd be fair to say. One of the programs I'd mentioned before was a significant on-road OEM customer that's booking us to pull forward a program and launch it some time in 2015.

I don't suppose you could disclose the rough size of something like that at this point -- units or revenue or anything like that?

No, unfortunately we can't. We've signed NDAs with many of these customers and until they're ready to announce it, they don't want us to discuss the programs or even the size of opportunities, even if their name's not disclosed.

Okay, fair enough. On this compression opportunity that you're talking about in oil and gas, interested in the displacement size that we're talking there. Is that more in the Perkins 3PIs type displacement size or is it across the board?

No, it's really targeted for our existing heavy-duty NG line. So you're talking the 8-liter to the 22-liter-type engines.

Okay, very good. And then the last question I had is -- don't know how much granularity you'd be willing to disclose here, either, but I guess I'll give it a shot. So what -- when we're talking about the on-highway business, what is your, I guess, off-engine fuel system strategy? Is that something that you guys are doing in-house -- are you buying the tanks and all the valves and so on, all the other gadgetry that would be used to bring the tank to the engine, or are you giving that to somebody else?

It's really case by case and customer-specific. If there's a customer that wants us to deliver a complete solution, in those cases we would order the tanks and coordinate the entire system. In other cases, sometimes customers want to order their own tanks or other system and then they would do it in those cases.

Okay, very good; thanks.

Greg McKinley, Dougherty & Company.

Yes, thank you. Again, on on-road. Could you talk about your product portfolio that you've developed to serve that market? Obviously the 8.8, but maybe also talk about some of the smaller on-road engine systems you're working on.

And then compare and contrast for us maybe how those systems will perform for your customer base versus their other options in the market.

Well, we are providing the 8.8 but we will also provide the 4.8 and the 6-liter GM engines. As the largest third-party engine supplier, or customer, of GM, we have a strong relationship there and are very comfortable with those products. It's a unique opportunity because of the power density of those engines compared to some of the gasified diesels. They're much lighter and fit into a wider range of applications, both in the United States and North America but also in China.

So we feel that the integrated solutions that we have with transmissions, automatic transmissions, have put us in a very, very strategic position to realize some opportunities in that light- to medium-duty range.

Thank you. And then, in terms of certification and when those 4.8s and 6.0s will actually be available for customers, can you give us a sense on product readiness?

Well, for the alternative fuels, the propane and CNG, those certifications are now in place. So we are going to offer gasoline as an alternative and we are now just waiting for those certifications.

Okay, thank you. And then, getting back to 3PI for a moment, you talked about just some of the natural integration processes that occur when an acquisition like this happens. How quickly can some of the -- I don't know if it's manufacturing or selling interruptions that occur through integration -- be resolved to maybe get more onto that call it $30-ish million revenue run rate when you acquired the business?

Yes, I think we mentioned when we acquired the business that the integration was going to take this year. That almost all of it would be completed by the end of the year. So what we would see is by the end of the year, a lot of the heavy lifting should be completed.

Because going into the acquisition, the idea of it is we bought it because we saw the potential to significantly grow the business. And so really put into place the systems, the people, and the things we needed to do to build a good foundation to scale the business. And so most of that, we would see would be in place and completed by the end of the year.

Thank you.

Thank you.

Rudy Hokanson, Barrington Research.

Good afternoon. Could you talk a little bit more about the opportunities for PPPI in the oil and gas field, especially since the main thrust or strategic theme is using the natural gas there. And as I understood it, some of the horsepower that you were hoping to sell into the oil and gas field from PPPI was diesel-driven, not natural gas, but you were going to be working on that.

I know they have some natural gas engines, but could you clarify a little bit more how PPPI is going to be marketed into the oil-gas fields and what you hope to do with them over then next one to two years on that matter?

Yes. Keep in mind, 3PI is really a neutral packager and works with many of the engine OEMs. And historically their business is about a quarter into the oil and gas space already. So what you're seeing with some of their customers is both some diesel applications for oil and gas but some of the very large systems.

And then, these are larger engines than what we provide. So for example, 2 to 3 megawatt solutions they're packaging on natural gas for the oil and gas field. So they're seeing a very fast growth in those areas. And again, especially some areas that are more their sweet spot, which is larger than these 1 megawatt systems.

Okay. So again, it's just a matter of presenting the array to the customer and then letting the customer chose either the natural gas or diesel-driven and then working with the current suppliers that PPPI is working with. That's it -- it's not coming up with a brand new kind of configuration or working with an outside supplier on a new configuration or you developing a new configuration in the larger engines that aren't driven by natural gas right now?

Well, a lot of this is a trend in the market. As we're seeing -- most of the oil and gas historically has been diesel. So what we're providing is a different product. We're providing trailer-mounted units which -- the market trend is to look at larger trailer-mounted -- whether it be gas or diesel, that's determined by the customer. But we have the ability to provide gas trailer-mounted units for the packaging opportunities.

So I think -- it's a trend. We're not driving the trend. I think we're in a position to react to it and I think that the key customers that we have, they're the ones out there that are doing the selling. So I think that we're going to be in a position to react as the market starts to mature and starts to trend toward gas. But I mean, we've seen a pick-up in the quotations for gas against diesel.

So I think that the ability and the strength of the Company is to be flexible and develop solutions that are unique. And I think that that's what we're doing and we're going to take advantage of all these opportunities that come forward.

Okay, thank you for clarifying that. I appreciate it.

(Operator Instructions) Rob Brown, Lake Street Capital Markets.

Good afternoon. Just wanted to dig in a little bit more to the guidance -- and could you help us understand the jump from $80 million this quarter up to almost $100 million in Q3 and Q4 (inaudible) I guess. Is that the ramp in the macro business? Is that more oil and gas? Just (inaudible) can understand what drives that delta.

Yes, Rob, as we kind of chatted about before, we've got a number of growth drivers here which are all real exciting growth drivers. Some are fully in gear, like oil and gas. Some are yet to come, like on-road.

But it's really a combination. I mean, as an example -- and again, this wasn't a major driver of growth for the quarter but it was worth noting. We had really nice growth in the [oil lift] this quarter. So we've got a number of building blocks, and some are greater contributors to growth than others depending on the quarter.

But we kind of look at oil and gas and material handling, along with the acquisition of 3PI, all to be kind of major pillars of growth that get us to the targets that we would like, and will achieve, in the balance of the year.

Okay. And then, on the material handling contract, is that -- could you tell us, have you switched over to your own blocks yet or are you still delivering some of the stuff that was the prior situation?

It's still mixed. We'll have phase-in completely done by the end of the year. So lines are all -- I mean, the real reason for us to do that integration was just a preparation of the production, getting ready for that type of volume. So now that one high-volume line is producing more than 100 units a day, and as we start to trend into the end of the year, we'll be ready to do 200 units a day.

So I think that -- we've provided all the samples and I think that we've provided the processes and gone through the audits. So I think the market is ready. I mean, the product had been well received. We have very competitive performance and pricing and I think we're ready to trend like we've planned all along to be in full production of the Mitsubishi product by the end of the year.

All right; thank you. I'll turn it over.

Chris McDougall, Westlake Securities.

Hello, gentlemen, thanks for taking the question and congrats on a good quarter. So shifting back to the on-road opportunity, I wanted to understand how many of those evaluation projects are working on just natural gas or just propane. And then, are there some that are looking at both natural gas and propane, where they could source kind of a common platform from you for those fuels?

Well, one of the things that really separates our company from our competitors is that all of our engines run on all of the fuels. Our spark-ignited engines will run on CNG, LNG, propane, and gasoline. So I think what we afford to those companies that we're talking to is the ability to design one engine in and have the flexibility to offer all the fuels to their customers.

As you look at the difficulty and the complexity of this integration and this whole courtship process with these OEMs, to have the ability to do all of the fuels is very, very valuable, and unique to our Company. So I think that that's going to be very positive. And I think when they've done their audits, it's an all-fuels recognition and puts us in a valuable place.

Yes. So just to kind of support that thesis more, of the programs you mentioned, kind of 10 to 20 range, how many of those are evaluating you for all fuels versus just one of the fuels?

Well, I think that inside of the company there may be one application that is dedicated to one fuel more than others. But I think that they'll all have the opportunity to have offerings of all fuels. So there are going to be certain markets or segments in North America that will want LPG in rural areas and CNG in urban areas. And there may be markets that just want gasoline or dual fuel. And the fact that our systems are able to run dual fuel, gasoline-LP, gasoline-CNG, or CNG and LP gives us the ultimate flexibility for the OEM.

Okay. And then, on the on-road also, as you look to get one of those programs, or maybe multi of those programs signed up, is the anticipation that if you win the business it'll be as the sole engine system provider for that fuel?

I think for the segment that we're talking about, we believe that we would be the sole supplier. For the light-duty or medium-duty, I think that we offer something that is kind of unique. The gasified diesels don't necessarily come down and offer the same opportunities for alternate fuels with the weight requirements as our engines do.

So I would say that we do believe that we'll be the sole provider for those customer that we win.

Okay, great; thanks. And then this last thing on the compression side. Describe your go-to-market strategy there. Is it working with the existing compression OEMs on adding a gas compressor option, or is it bringing the whole compressor unit?

And then, the permitting requirements. I understand a lot of the electric compressors are used today because it's just so much easier to permit versus one that burns hydrocarbon. So what would be the extra permitting requirements of the customers?

No, the idea is to work with the compressor OEMs to provide the engine and then they provide the compressor, the overall system. So we're not going to get into that side of it. So there's numerous compressor OEMs and companies we're working with that are providing complete packages.

In terms of the permitting, again, that ends up being kind of regional-specific. And so our customers really take that on themselves.

And then, you mentioned electrical. We kind of see -- there are some trends where people are using electrical, basically electric motor, for compressions versus an actual -- burn hydrocarbons in a compressor. From our standpoint we win either way because if it's a basic compressor system we have some nice solutions.

However, if it's a well site that's moving towards electric -- again, using electric motors down the well for generating compression -- what happens is it generates greater electricity needs. So on those sites, we're seeing an uptick on the need for power generation and that fits in well with our engines. So we see that there's trends and we can play on either side of it.

Okay, great. Thanks; thanks again and congrats on a strong quarter.

Thanks.

Robert Ammann, RK Capital.

Hi, congrats on a nice quarter. A quick question on 3PI purchase accounting impact. I saw the $0.5 million from inventory step-up for fair value in the cash flow statement. Was there any other sort of accounting impact we should be thinking about that flowed through the P&L in the quarter?

Yes. And again, I think I mentioned that the purchase accounting's particularly punitive in the early quarters of an acquisition. There was about $1 million of purchase accounting impact in the quarter. Now, having said that, some of it's going away but a lot of it, we're going to live with.

But we did have -- to your point, you saw the write-up of the inventory and that did have a direct impact on us in the quarter. That moderates a bit over all in Q3 and tends to step down in 2015 a bit. But again, due to the purchase accounting rules, the lion's share of that $1 million -- I can't recall now if it's $700,000, let's say -- will probably be living with us for the next several years on a quarterly basis.

And I think on the cash flow statement it was about $0.5 million, that inventory step-up. So that's the sort of level it would be similar to in Q3 or maybe slightly less, then largely gone by the beginning of 2015?

The complexity of it here is it moves around. So what's going to happen is that we'll see -- and I think the number was $482,000, if I remember correctly. But let's call it $0.5 million to make it easy. So the $0.5 million moves down to something like $300,000. I don't have these numbers in front of me, so --

But in the general spirit of the question, it may move down to about $300,000 in Q3 and then goes down to zero. Having said that, we get almost an equal impact by an increase in amortization on the SG&A line. So while we'll see some improvement then on the margin side as that write-off steps down, we'll pick up additional amortization.

But over all, if we start to think about the number gross, it does move down by several hundred thousand dollars from Q2, as we reported, to Q3 and will step down a bit more after that in 2015.

I think the important thing, at least from my takeaway, is if you strip out the purchase accounting of 3PI and you look at the business, the EBITDA margins -- the EBITDA margins, which I think is a good measure of performance, were 10% in the quarter. So despite all the great work that Eric's doing, and the rest of the team here, heading up that integration, we still had 10% EBITDA margins for a business that we just acquired.

So I'm excited about what they delivered; but more importantly, what 3PI's going to become.

Yes, and from a gross margin standpoint, too. Ex that inventory step-up, you probably would have been right around 19% gross margin. And that's a headwind, that portion of that, at least if it goes away here in a future couple of quarters.

Yes, it does.

Great; thank you.

Okay.

And it appears there are no further questions at this time. I'd like to turn the call back to Gary Winemaster for any additional or closing remarks.

Okay, thank you. Before we close, I want to mention an upcoming conference appearance. Next Monday, August 11, we will be presenting, hosting, one-on-one meetings at the Jeffrey's Industrial Conference in New York City. In September, we will be presenting at three other conferences which we will announce later this month.

This concludes our call. Thank you for your interest in Power Solutions International. We look forward to our next conference call with you in November, when we'll report the third quarter results. Thank you very much.

Again, that does conclude today's conference. We thank you for your participation.