Brett Maas - Hayden IR Nathan Mazurek - Chairman and CEO Tom Klink - CFO

Matt Koranda - ROTH Capital Partners Michael Potter - Monarch Capital Group

Good day, and welcome to the Pioneer Power Solutions, Inc. Third Quarter 2016 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Brett Maas of Hayden IR. Please go ahead sir.

Thank you, and good day and welcome to Pioneer Solutions' 2016 third quarter financial results conference call. 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 third quarter financial results. Before we can start, let me remind you this call is being broadcast over the internet and a recording of the call and the text of managements prepared remarks will be available on the company's website. During this call, management will be making forward-looking statements. These statements are based on current expectations and assumptions that 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 yesterday, and in a posted version of these prepared remarks, both of which apply their content of this call. I will now turn the call over to Nathan Mazurek, Chairman and CEO. Nathan, please go ahead.

Thank you, Brett. Good morning and thank you all for joining us today for our conference call. Our third quarter 2016 financial results clearly show that we are delivering on our commitment to increase profitability and unlock the growth potential of Pioneer. This marks the fourth sequential quarter of higher profitability and revenue growth. We have made the necessary changes to our business to return the company to consistent profitability and I am encouraged by our improving profit margins. But there is more we can and will do to further improve profitability going into 2017. During the first nine months of 2016, we reported $85.9 million in revenue, $0.12 in earnings per share, and have expanded our backlog to a record $41.5 million of committed orders to be delivered over the next 12 months. With the results -- with these results and our positive forward momentum, we are on target to achieve our full year 2016 guidance. The planned benefits from initiatives we began in late 2015 have been manifesting themselves throughout the year in the form of improved operational efficiencies and ultimately, better financial results. Manufacturing facility consolidation, reduced headcount, both operationally and at the corporate level, and better alignment with our supply change chains are yielding material fixed cost savings. On a non-GAAP basis, EBITDA improved by $1 million to nearly $2.1 million for the quarter. On a GAAP basis diluted earnings per share of $0.04 is much improved over the negative earnings we reported at the end of 2015 and the start of 2016. The results are trending in a positive direction and we remain focused on continuing this trend through our efforts to further expand our margins and improve profitability. More specifically, we are currently relocating the final remaining piece of our Canadian dry type manufacturing business to our lower-cost facility in Mexico. We expect to complete this move during the first half of 2017, thereby further improving overall gross and operating margin and positioning our medium voltage dry type business to become a significant revenue driver over the next few years. Simultaneously, we are working to scale the operation as well. We are seeing continued strong growth for our solutions, particularly in the distributed generation and data center end markets. And in addition, our service revenue continues to grow. This demand was the key component of the solid 18% revenue growth this quarter and helped us expand our backlog to an all-time record $41.5 million as of the end of the third quarter. Sequentially, we increased our backlog to $3.7 million, while recognizing double-digit revenue growth. We expect that distributed generation and data center end markets will continue to serve as growth drivers for us and we see additional opportunities to continue to expand our service offering. In addition the recent passage of propositions expanding Legal Cannabis in California, Nevada expected to drive business for us as well. The processing and warehousing facilities which will be constructed to meet the growing demand in States like these have air handling system very similar to those in data centers and additionally, require complicated and sensitive lighting systems. All requiring our customized power solutions. We have already bid on multiple projects that were waiting for this legislation to pass and expect to benefit from additional opportunities as this trend continues. Looking a little deeper at the results by operating segments, in our transmission and distribution solutions segment, we delivered a 33% increase in revenues year-over-year and nearly 1% improvement in our gross margin as a result of our shift towards higher margin switchgear products and away from lower margin business. The growth in the U.S. for both our transformer and switchgear business is more than upsetting the decline in our Canadian dry type distribution transformer business. A lower base of fixed cost made possible by facility consolidation and the shifting of work to lower cost locations coupled with solid sales growth are driving strong overall performance with in our T&D business. Our critical power solutions segment is also performing well amidst our shift away from a more equipment-centric business towards a more service-oriented business. This is resulting in somewhat lower revenue, but significantly higher margins and much greater absolute EBITDA dollars. Gross margin for the quarter was up 500 basis points to 20.5% as a direct result of higher service sales which provide a greater gross margin than equipment sales. Year-to-date we have generated almost $800,000 more in EBITDA from our critical power solutions segment than we did in the first nine months last year, an improvement of more than 332% demonstrating the progress we have made in improving the profitability of this business segment. We continue to believe additional earnings improvement is achievable and sustainable within this segment. I will now turn the call over to Tom Klink, our Chief Financial Officer to discuss our financial results in more detail and review our 2016 full year guidance and underlying assumptions.

Thank you, Nathan. Good morning everyone. Third quarter revenues were $29.4 million, up 17.9% when compared to $24.9 million in the third quarter of last year. In the quarter, the foreign currency translation had a negative impact on sales of approximately $500,000. Gross profit for the third quarter was $6.5 million, or a 22.2% gross margin compared to $5 million, or a 20.2% gross margin in the year ago quarter. For the quarter, selling, general, and administrative expense increased 3.6% on an absolute dollar basis to $4.8 million compared to $4.6 million in the third quarter of 2015. As a percentage of revenue, SG&A expenses decreased to 18.2% of revenue in the third quarter of 2016, down from 20.7% in the third quarter of 2015. The third quarter 2016 including $19,000 in restructuring, integration, and other non-recurring expenses compared to $3.4 million for these core categories in the third quarter of last year. Operating income for the third quarter of 2016 was $1.2 million including these non-recurring expenses compared to an operating loss of $3.3 million inclusive of these same non-recurring charges in the third quarter of 2015. Our effective income tax rate for the third quarter of 2016 was 17.9% of earnings before tax as compared to 25.6% for the same quarter last year. The tax rate was lower than our normalized effective tax rate due to losses in our U.S. operations and lower taxable income generated in Canada. Subsequent to quarter end, the Internal Revenue Service granted the company an abatement for $1.2 million in previously approved penalties related to the company's delinquent federal tax obligations. The abatement covers 100% of the accrued penalties from Pioneer Power Solutions at the corporate level, Pioneer CEP and Jefferson Electric. We will recognize the abatement's financial impact during our fourth quarter results. Net income for the quarter was $322,000, or $0.04 per basic and diluted share compared to a net loss of $3.6 million or a negative $0.48 per basic and diluted share in the prior year's quarter. Adjusted EBITDA was $2.1 million during the quarter, or 7.1% of revenue compared to $1.1 million, or 4.2% of revenue in the third quarter of 2016. Non-GAAP diluted EPS was $0.10 per share compared to $0.03 per share in the third quarter last year. Now turning to the nine-month financial results for the period ended September 30th, 2016. Revenues for the nine months were $85.9 million, up 7%, or $5.6 million from $80.3 million in the comparable period of 2015. Breaking this down by segments, T&D Solutions' revenue increased $8.5 million, or 13.3% compared to the first nine months of 2015. This increase was driven primarily by our low voltage transformer sales in the United States and medium voltage switchgear sales offset by lower sales of our Canadian dry type transformer products. Critical power solutions' revenue decreased $2.9 million, or 17.7% for the nine months ended September 30th, 2016 as compared to the same period in the prior year. Equipment sales were down $2 million year-over-year and service revenue was down $500,000 due to delay of work by two major customers. Segment revenue consisted of $7.6 million in power generation equipment sales and $5.8 million in service revenue. For the nine months ended September 30th, 2016, our gross profit increased to 20.6% or $18.9 million, a 22% gross margin compared to $15.7 million of gross profit or 19.5% gross margin for the year ago period. Year-to-date, our SG&A expenses were $13.5 million, or 17.6% of revenues compared to $15.1 million, or 20.8% of revenues in the year ago period. The decrease in SG&A was driven primarily by the cost savings realized from headcount reductions in both segments of our business and in corporate overhead. Operating income for the first nine months of 2016 was $3.7 million compared to an operating loss of $4.1 million in the first nine months of 2015. Our effective tax rate for the nine months ended September 30th, 2016 was 45.3% of earnings before tax as compared to 25.2% for the first nine months of 2015. This unusually high tax rate is related to the accrual for tax penalties not being deductible for income tax purposes and dividend taxes related to loans from our Canadian operations to the United States operations. If these items were not included in this period, the effective income tax rate would have been 4.1%. It is important to reiterate that the company has net operating losses and foreign tax credits that offset the effect of these items and the company does not anticipate paying income taxes for this calendar year. Net income increased to $1.1 million or $0.12 per basic and diluted share, up from a net loss of $4.6 million or a loss of $0.62 per basic and diluted share in the year ago period. Our adjusted EBITDA for the nine months was $6.2 million compared to $1.9 million for the first nine months of 2015. Lastly our non-GAAP diluted EPS was $0.29 per share, up from $0.01 per share -- diluted share in the comparable 2015 period. Turning to the balance sheet, our total debt at September 30th, 2016 was $26.7 million compared to $15.9 million at the end of 2015. This increase in debt was used for working capital purposes as we continue our sales growth and develop our supply channel from lower cost manufacturing areas. It is also of significance to note that Pioneer generated cash from operations during the third quarter of $3.2 million. We have made significant progress towards resolving the open items related to our payroll taxes that were discovered in the third quarter of 2015. In October 2016, the Internal Revenue Service granted the company an abatement for $1.2 million in previously accrued penalties related to the company's delinquent federal payroll tax obligations. This abatement covers 100% of the accrued penalties from Pioneer Power Solutions, Pioneer CEP, and Jefferson Electric. We will recognize the abatement's financial impact during our fourth quarter results. Turning now to guidance, we are reaffirming full year revenue and earnings guidance for 2016, which includes revenue between $117 million and $127 million of which $100 million to $107 million is expected to be derived from the T&D Solutions' segment and $17 million to $20 million from the critical power solutions reporting segment. This reflects the consolidation of our critical -- Pioneer critical power business into Pioneer CEP operations shifting more revenue into our T&D segment. Adjusted EBITDA will be between $8 million and $9.5 million and non-GAAP diluted EPS between $0.55 and $0.66 per share. As a reminder, our 2016 full year guidance is based on the following assumptions; no future acquisitions of foreign currency exchange rate of $0.72 U.S. per Canadian dollar and effective tax rate at 28%, share count of approximately 8.7 million shares, and we exclude the effect of any restructuring and non-cash charges arising out of our cost optimization plans. Our 2016 guidance is driven mostly by growth from our U.S. based businesses and is based on the strength of our sales pipeline, expected production cost savings, facility consolidation, and external factors which may or may not materialize in a way favorable to us. In Canada, we have assumed no meaningful improvement in business conditions and that performance of our liquid-filled transformer businesses will remain stable at its currently depressed level and that losses by our dry type transformer business will continue to be curtailed. This concludes my remarks and I will now turn the call back over to Nathan.

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

Thank you, sir. [Operator Instructions] And we'll go to Matt Koranda with ROTH Capital Partners.

Good morning Nathan and Tom.

Good morning Matt.

So, just wanted to start off with the record backlog, up pretty significantly year-over-year and I think it implies that bookings began to accelerate this quarter versus the first half of this year. May be could you talk about the primary drivers of that acceleration, Nathan, may be delve in some of the detail around either the data Center wins that you're seeing in there or other elements that are showing strength?

Yes. I mean the increase in the backlog really came from almost everybody, across all our businesses. Even the liquids-filled business increased their backlog as well. So, they are having a stronger second half of the year and look to a very strong first half of 2016. Switchgear was strong; Jefferson added the critical power business, all of it, so all the verticals really contributed.

Okay, got it. And then if we think about the election impact, obviously, you mentioned some items in your prepared remarks, but wanted to get your take on infrastructure spending and essentially if we see something on that front over the next several quarters, maybe what should we look for that would be most beneficial to you guys, help us understand what types of infrastructure spending bills would be most beneficial to you from a revenue and margin perspective?

Right. I mean we really know less, all right. Not clearly, but we know less I'm sure than anybody else on the call as to what's really going on unfold. In our little world, most beneficial would be things that are spent on, of course, grid optimization, anything as far as power is concerned, continue efforts on the renewable energy, high-speed rail, electric transit, wastewater treatment, all areas that we benefit across the entire company. Bridge and tunnel have a limited, if any, affect, roads, things like that, more civil projects have very little effect on us.

Okay, that's helpful. And then also just wanted to get your take on sort of how you guys are thinking about your Mexico production footprint, obviously, not a lot is known at this point, but maybe you could just talk about contingencies that you have available if there were some sort of tariff scenario that that occurred, would like to get your take on that.

Yes, I mean we're trying not to speculate and waste a lot of time. The President Elect has shown a lot of fluidity in his positions. So, I mean things change more often than they don't. But most of the U.S. dry type production for standard product is tied up not just us, but if you took the manufacturers and competitors, probably in excess of 80% of the capacity is it resides in Mexico right now. So, really that entire business segment is in the same boat. I mean any tariffs with it all of us sort of evenly. I don't know if we have to have any contingencies for that. We're getting a lot of our product from India as well. I don't know where that's going to fall in any of these scenarios, but as far as any kind of NAFTA-related rework or anything like that that I think were altogether. So, whatever happens sort of evenly, we're not unique in being in Mexico.

Okay, that's helpful. And then maybe just higher level, I know you guys are working on shutting some of the lower margin business and that's definitely showing through this year on year-on-year basis. But maybe -- could you help me understand just sequentially this year, it looks likes EBITDA margins have compressed from kind of the high watermark of 7.6% in Q1, down toward the 7.1% in Q3, is there some seasonality to that this year? Are we fulfilling some of the last of the lower margin business over the last couple of quarters? And that should be flushed by 2017? Just help us understand sort of cadence of EBITDA margins throughout this year?

Matt, this is Tom. We are fulfilling some of the lower margin business that was in the pipeline that was accepted. There will probably be some of that fulfillment that will occur in the fourth quarter as well and at that point, that should hopefully clear the pipeline of those types of projects that we took when our strategy was a little bit different than it is currently. It is our intent [ph] to continue to move the business units towards better and greater use of their facilities and to do with our -- with higher margin business. It was much easier to do that with our critical power because those projects are not nearly as long-term as some of the other divisions' projects that we had accepted in prior periods.

Yes, just to add Tom, I mean to add Matt, its Nathan again. The areas that we're still flushing through, you're looking at quarter-to-quarter, which of course, is correct, where the two primary areas were still flushing through lower margin business would be the Canadian dry type business and in the switchgear business. As those things unfold and we don't use the manpower and engineering resources and working capital to do the same bits of bad business, the operating margins will continue to improve. But there's no magic different things go through at different times, and the gestation periods. They don't always ship when they're supposed to.

Got it. That's very helpful guys. Maybe just follow-on to that. Could you speak to the backlog and sort of the margin profile of the revenue that's contained within that backlog? I would assume there are some higher margin business contained in there with maybe medium voltage and some of the dry type business. You've been talking about sort of improving, but maybe you could just speak to that for a moment.

Yes, any time liquid-filled business contributes to more backlog that's by its very nature that's our inconsistently most profitable business at the higher margins. The switchgear business is booking and a big part of their current backlog right now, it continues to trend towards better and better margin business. Critical power also you know when they're booking; their contribution to the backlog is at a higher piece. There's still drag from lower equipment sales booking at the critical power business and there's still some -- I don't want to call it junk, there's still some stuff that we should have avoided in the switchgear business. Less than there was before. So, that's why we're pretty confident and optimistic that as these jobs unfold, the overall margins should continue to improve and increase up.

Okay, got it. Maybe a couple modeling and outlook questions here. I know that SG&A ticked up a bit this quarter at $5.4 million, what was that uptick associated with? And then what's the right run rate to think about on a go-forward basis for SG&A, especially as we move into 2017?

SG&A ticked up on a few headcount changes, a few professional fees cost that we incurred on some projects that were going forward. I think you'll see it tick back down into that that $5.2 million level or so. Part of the SG&A, Matt, is also commissions and freight on our sales. So as that ratchets up, the -- that will drive that backup as well. But from a fixed cost standpoint, we don't expect any further fixed cost increases in SG&A this year or into the first half of next year.

Okay. And then just help me with the EPS guidance, help me square this. So, I think non-GAAP EPS guide is $0.55 to $0.66, so if I take the lower end of guidance even at $0.55, I guess that implies about $0.26 in EPS during Q4, which is nearly what you've generated for the first nine months. So, just help me understand sort of the moving pieces to EPS, is there a tax benefit in there in Q4 or expecting a material uptick in probability here?

We're expecting to be as profitable as we have been in the first four quarters -- our first three quarters of this year. So, I mean our trailing 12 right now is at -- above $8 million with the EP -- or the [Indiscernible] calculation and the abatement of tax penalties that will have some favorable impact to what we're doing there and that should lower hopefully our effective tax rate from where it's been to get us to the guidance range.

Okay, got it. Help me understand the abatement, then Tom, maybe how will that flow through the P&L in Q4? It's all non-cash I would assume, but it provides you a potential tax benefit here, so just help us understand the moving pieces in Q4 and how will that will look?

Right. The $1.2 million is all accrued in the balance sheet, so we will reduce liabilities by the $1.2 million, we'll recognize other income of $1.2 million. That impact will not be taxable income. So, our effective tax rate for the fourth quarter we expect to be exceptionally low, driving down the nine month's rate, I think we're currently at 45% plus. I would expect us to be more normalized for the year, below 27%, 28% and overall for the fourth quarter, almost the non-existent tax calculation at zero would be my guess.

Okay. I think maybe one or two more here. I know that you guys had called out, do you expect further benefits from the final move to Reynosa, bringing some of the last bit of the dry type transformer business there. Maybe could you discuss the magnitude of revenues that are associated with that move in terms of products? And will you be building safety stock as that move takes place or has already occurred?

Right. So, that's an engineered products, so it's not really -- it's not a standard product. We had moved -- at the end of last year, we had really moved the standard business either to Mexico or to India. So, this is the business that we had really bought [Indiscernible] for and this is the business that we want to continue to grow. Probably for this year, it would be about $3 million in revenue. The expected cost, let's use round numbers, will probably be with everything about $1 million and the expected savings are also at about $1 million over 12 month period. But more important than the payback on making this move is really it turns a very profitable business for us and makes it a much more competitive and opens up a lot more opportunities for us to really grow the business where the average ticket price as opposed to being small order -- like in the small dry types of, I don't know, $2,500, these -- the ticket prices are on average $25,000 apiece, at much -- we're rewarded for the engineering and the custom works of the margins are much higher. That the -- I guess that's what's compelling or impelling the move.

Okay. I'll take the rest of mine offline here guys. Thank you.

You're welcome. Take care, Matt.

Thank you. [Operator Instructions] We'll go next to Michael Potter of Monarch Capital Group.

Hey guys. Congratulations on another very strong quarter. Just a couple of quick questions. Nathan you mentioned about the opportunity in Cannabis in the processing facilities that we're already seeing multiple bid activities. Can you give us what kind of a sense or range of what the average opportunity is for these facilities to -- at least to Pioneer?

Yes, excellent question. They are related really to everything that goes along with these processing centers. These processing centers have very sophisticated air handling systems. They have very sophisticated and sensitive lighting systems. So, their application of their powers an important -- it's an important cost and it's important feature of what's going on in the facility. We're taking it really across all the verticals for us. It's both on the outdoor substation, it's what's going on inside the facility, it's even -- there is by law, at least, in the State of California, all of them must have backup power because these air handling systems cannot go down from a worker's safety point of view. So, there's the service component. From an equipment point of view, to answer your specific question, they are probably $500,000 and up per processing or refrigerator warehousing center. That's how we look at them depending on the complication of -- the complicated nature of the substation and then there are other service-oriented opportunities following the construction of these facilities. But year ago, I was frankly dismissive of these kinds of opportunities when our people would talk about it and so forth and thankfully, I was wrong. And these guys were right to stick and to work with a lot of these the startup companies that are extremely well-capitalized and are -- really have these projects extremely ready-to-go and to be built and funded and constructed so that they could get on with their businesses.

Is the law -- are the regulations and laws governing these facilities, are they already in place and being implemented?

Yes, they are in place and the State of California in preparation for this. They wanted to make sure that -- if it was -- if Proposition 64 [ph] pass, they wanted to make sure that the industry then was ready to go, so that they could benefit from the taxes frankly that these businesses are going to throw off. Very, very strict workers' safety laws. They are very concerned without proper air circulation, people working in these facilities get the proverbial contact high and while we think it's amusing, then they end up failing drug tests or they end up doing things that are unsafe or driving when they shouldn’t and all those kinds of things. So, in order to really operate in State of California, can't speak to Nevada and Arizona yet, but where the big population is and where the big demand is and where a lot of growing frankly of the product and processing of the product is going to be. These are very, very serious facilities. The debate the last year has been between the big -- what they consider the big companies going into this and the small guys and small guys were arguing that they are going to be shut out of business because they just cannot afford to build facilities like this. Ultimately, benefits companies like us that it's going to be in the hands of more well-capitalized and larger businesses.

Okay, terrific. So, hopefully, we'll hear more about this over the coming -- over the coming months.

Yes.

With regards to our manufacturing in India, obviously, that's worked up very well for us this year and are -- is there any plan to increase the SKUs that we are currently sourcing from India?

Yes, good question. We are -- SKUs implies -- you're right, you're along the right lines in place some sort of the standard type of product. What we're doing, our goals for 2017 is not so much in the standard product, but we're going to be doing some engineered product for the first time, both on the dry and even on the liquid side. Where that business fits and conforms really to the scope of abilities that our partner there has. That really opens up much larger markets for us, markets that we have not competed in because we were not competitive either manufacturing in Mexico or Canada for those particular markets and that's going to be a big part of what's going to be driving 2017 and 2018.

Okay. And in regards to 2017, how does your visibility looks so far entering the year -- entering the New Year?

Right. So, before I answer, we're probably going to -- or at least we're targeting to officially come out of the guidance for 2017 little bit before the end of this calendar year where we're going to detail it more specifically. But to your question, for our longer lead businesses, basically switchgear, oil-filled transformer, even the power -- medium voltage dry types, they are all expected to have very robust first quarters. We're really in the process of finishing the second quarters for the oil-filled transformer business and for the switchgear business. The dry type business continues to just -- we don't have that kind of visibility, but the barring severe economic downturn, we don't see any in abatement in its continued progress as well. On the service side, the service component of the critical power business continues to increase. Verizon just awarded to us, not three weeks ago, an additional 117 cell towers to service. They are currently bidding a lot of either retailer or self-service provider type opportunities. Each one of those starts at the hundreds, if not, close to thousands of outside [ph]. And that's really -- in the end of the day, that's the concentration of that business. The large multi-location users, which for us turns out to be retail and self-service providers. I mean I'm sorry, Mike, just to add, I mean for this year, we've always talked about Target being really the first marquee customer that Titan or our critical power business got even before we bought the business and Verizon will well exceed Titan's revenue for calendar 2016 this year. So, you see the move really has been -- we're -- they're doing a great job on the self-service provider side.

So, Verizon alone--

Verizon alone will be more than Target, yes, this year.

Okay. All right, terrific. I'll get back in queue. Thanks guys.

Thank you, Michael.

Thank you. And with no further questions, I'd like to turn the conference back over for any additional or closing remarks.

All right. Thank you all for your time and support. And we look forward to updating you again on our next scheduled call.

Thank you for your participation. That does conclude today's conference. You may now disconnect.