Brett Maas - Hayden IR Nathan Mazurek - President, CEO & Chairman Thomas Klink - CFO, Secretary, Treasurer & Director

Matthew Koranda - Roth Capital Partners Jay Harris - Axiom Capital Management

Good day, and welcome to the Pioneer Power Solutions First Quarter 2018 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Brett Maas from Hayden IR. Please go ahead.

Thank you, and welcome. The call today will be hosted by Nathan Mazurek, Chairman and Chief Executive Officer; Tom Klink, Chief Financial Officer. Following this discussion, there'll be a formal Q&A session open to participants on the call. We appreciate having the opportunity to review the first quarter financial results. Before we get started, let me remind you this call is being broadcast over the Internet and a recording of the call and the text of the management's prepared remarks will be made available on the company's website. During this call, management will make forward-looking statements. These statements are based on the current expectations and assumptions and are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary text regarding forward-looking statements contained in the earnings release issued earlier today and in the posted version of these prepared remarks, both of which apply to the content of the call. I'd now like to turn the call over to Nathan Mazurek, Chairman and CEO. Nathan, please go ahead.

Thank you, Brett. Good afternoon, and thank you all for joining us today for our conference call. While first quarter revenue and backlog demonstrate that our overall business is healthy, we are nevertheless dissatisfied with the results. During this call, I'll discuss the two primary factors which impacted our results, the steps we are taking to address these issues and the expected time frame for improvement. In addition, I will discuss the planned sale of our switchgear business and our strategic view regarding the remainder of our business units in light of this transaction. Our first quarter results were impacted by two primary factors. First, we experienced a less-than-ideal mix in both the liquid-filled and dry-type transformer business. Given the wide diversity of our customers and end markets as well as our obligations under long-term utility contracts, our delivered product profile can vary from quarter to quarter in terms of margin. Typically, in the course of 12 months, however, this blend normalizes, enabling us to meet our profitability targets for the year. Looking over the next few quarters, as evidenced by the nature of our backlog, this mix has already begun to adjust more favorably in the second quarter, and we anticipate delivering a more typical blend of products and consequently operating margins for the balance of the year. Second, the generation equipment segment of our Critical Power business continues to underperform. This issue is expected to take several quarters to remedy. We recognize that we were too aggressive in the initial rollout of our private - of our new private label generators last August. Specifically, based on a large equipment order which we won right at the inception of our private label generator launch, we added significant sales personnel in multiple new territories to try to meet what we expected would be strong initial demand. Wider customer adoption has taken longer than we anticipated, however, and the sales infrastructure we put in place resulted in higher costs than initial revenues could support. We are making adjustments in the sales organization to bring these costs in line with current volume levels. Order trends are encouraging, but it will take several quarters to reach the appropriate mix of revenue and expenses and to achieve the desired volume level. In contradistinction to equipment, the service side of our Critical Power division is robust. And we fully expect our service revenue in 2018 to exceed that of 2017. Our initial two-store pilot project with a large nationwide home improvement retailer is expected to expand to 50 stores in the next quarter, and we are optimistic about further expansion to this retailers' 2,000-plus stores based on a successful second stage. The long-term trends remain favorable. Our backlog continues to grow, and quotation activity in all our end markets remains strong. We fully expect our revenue and profitability to trend higher during the next several quarters. We reported backlog from continuing operations of $30.1 million at the end of March 2018. This is up sequentially from $28.9 million at the end of December 2017. This backlog is based on firm orders expected to be delivered in the future, the vast majority of which is expected to be delivered during calendar 2018. Finally, during the quarter, we signed a definitive agreement to divest our switchgear business. This transaction is an important part of our strategy to simplify our portfolio, reduce costs and focus on our core transformer business. We expect to realize - we expect to finalize this sale on or before June 30, 2018. As a result of this divestiture, we expect to be a more profitable business, carry less debt, giving us greater flexibility in our efforts to create shareholder value. At the same time, and in our view, the potential for accelerated growth and profitability of the switchgear business is enhanced by aligning its assets and capabilities with an advanced energy solutions provider such as CleanSpark. CleanSpark is a microgrid company with advanced engineering software and controls for innovative distributed energy resource management systems. Folding a specialized vendor-agnostic hardware solution into its solution set provides CleanSpark with a simplified business development model, more streamlined deployment and an opportunity for rapid growth. Through an early - through an equity position in CleanSpark, Pioneer's shareholders will be able to benefit from the future success of this business in the hands of a more appropriate operator. Subject to market and legal conditions and board approval, it is our intention to eventually distribute the shares and warrants to our shareholders as a dividend. In addition, it is important to note that we received approximately $10.3 million in total consideration for a business that has historically been generating negative EBITDA for us. This suggests that the current share price of Pioneer may reflect a lower value than the value of the individual business units, if they're viewed separately. With this transaction, as a backdrop, we are carefully evaluating path to unlock shareholder value, including dividends and/or the sale of part or all of the business units. Unlocking shareholder value remains our most important objective and as Pioneer's largest shareholder, I'm fully aligned with this effort. Until there is something definitive to report in this regard, I will refrain from further comments on this activity. We'll also not answer any questions about this process or - during the Q&A or about the sale of the switchgear business as this sale is still pending. With that, let me turn the call over to Tom to discuss the first quarter results.

Thank you, Nathan, and good afternoon, everyone. Before I get started, as Nathan discussed, on May 2, we signed an agreement to sell our switchgear business. Accordingly, this portion of our business was reclassified as discontinued operations for the first quarter reporting. The results presented in our press release and that I'm about to discuss reflects continuing operations only. Revenue was $23.5 million for the first quarter of 2018, down 6.3% compared to $25.1 million in the first quarter of last year, with the majority of this decrease from lower sales of generator equipment. Gross profit for the first quarter of 2018 was $4.4 million or 18.9% compared to $5.6 million or 22.2% gross margin in the year ago quarter. The gross margin was impacted by lower sales of generator equipment and an unfavorable product mix in both of our transformer business units. Selling, general and administrative expenses for the first quarter of 2018 decreased 3.3% on an absolute dollar basis to $4.2 million compared to $4.3 million in the first quarter of 2017. As a percentage of revenue, SG&A expenses were 17.9% of revenue in the first quarter of 2018 compared to 17.3% in the first quarter of 2017. Additionally, in the first quarter of 2017, we incurred restructuring expenses of $155,000 compared to no restructuring expenses in the current year. Finally, in the first quarter of 2018, we incurred a foreign exchange loss of $74,000 compared to an income from foreign exchange activity of $61,000 in the first quarter of 2017. Operating income from continuing operations for the first quarter of 2018 decreased to $156,000 compared to $1.1 million in the first quarter of 2017. Both of these amounts are inclusive of nonrecurring charges. For continuing operations, our effective tax rate for the first quarter of 2018 was 4.6% of pretax income as compared to 57.6% for the same quarter last year. The change in tax rate was primarily due to the U.S. tax reform completed in December of 2017 and the change in tax treatment for foreign-sourced income. Net loss from continuing operations for the first quarter of 2018 was $581,000 or $0.07 per basic and diluted share compared to a net income from continuing operations of $206,000 or $0.02 per basic and diluted share in the prior year's quarter. Adjusted EBITDA for the first quarter of 2018 was approximately $1.3 million compared to $2.4 million in the first quarter of 2017. Non-GAAP diluted EPS decreased to $0.12 in the first quarter of 2018 compared to $0.21 in the first quarter of 2017. Turning to the balance sheet and statement of cash flows. Including the 2014 and 2015 unpaid payroll tax liabilities being paid on an installment basis, our total interest-bearing debt at March 31, 2018, was $27.7 million compared to $29.3 million at December 31, 2017. For the 3 months ended March 31, 2018, we generated cash from operations of $1.1 million compared to 2017 where we also generated cash from operations of $1.1 million. As a reminder, our final installments for the 2014 and 2015 payroll tax liability, which initially had balances greater than $4 million, will be made during the second quarter of 2018. We continue to expect to generate single-digit growth in revenues from continuing operations and to increase adjusted EBITDA for the full year of 2018 compared to 2017. This concludes my remarks. I'll now turn the call back over to Nathan.

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

[Operator Instructions]. We will take a question from Matt Koranda with Roth Capital Partners.

Just wanted to start off with a housekeeping-oriented question. Could you provide the breakout, I don't think I saw in the release, but did you provide the breakdown between T&D Solutions and Critical Power Solutions revenue?

Look, breakdown is approximately $2.5 million from Critical Power with the balance coming from T&D.

Okay. Got it. And then just in terms of the year-over-year decline in Critical Power, could you give us a little more color on sort of the drivers there? I assume maybe some onetime work Q1 last year that shouldn't necessarily repeat this year?

No. It's really all equipment. I mean, services is about the same. It's all decline on the equipment side of the business. Q1 of last year, we were still distributing Generac product.

Okay. Got it. That's helpful. And then just on the rollout of the private label gensets, I know you've mentioned it briefly in the prepared remarks, Nathan, but just wanted to get a sense for the changes that kind of happened since the introduction of that product. I know you guys came out the gates really strong with a nice order at the outset. But what has changed? I guess, could you sum up the biggest changes that happened between then and now that sort of caused for you to revise those expectations for that product a little bit lower.

Yes. I think that we need to understand better why we've won that kind of an order with the nature that it was. I'm not going to go into the details here. But that's what we should really be concentrating on replicating. That gives us size, it gave us margin, it was a much more negotiated value-added type proposition. I think we slipped back into bad habits of chasing kinds of the stuff that maybe some people are more comfortable with, and that's not a long-term profitable chase.

Okay. All right. Got it. And I guess, would it be fair to characterize the opportunity there as there is additional - there are additional projects in the pipeline that sort of are similar to that first order? And then I guess, how are you incentivizing the sales force to go after this particular opportunity?

Yes. I mean, hopefully I'm incentivizing them with fear. But we've realigned the incentive - it's really more a direction, meaning, we're just saying no to a lot of quotation and other activity that really doesn't lead to a value-added, negotiated project, that just doesn't. It has to meet certain revenue and profit targets. And its nature has to be one that we are really adding value to. If you just want to go into the bit spec world and just win something by $2, you win, you really lose. So that's what we're trying to move away from. Indeed, the backlog already has some more projects that imitate the Camp Ripley project that we did back in - towards the end of last year by its - the nature of the product, the nature of where it's going, it's application and the size of it. And that's where we've got to really push the business to go, and we probably need a more concentrating, focused group to do it.

Okay. I got it. Just on margin pressure, I know you guys called out sort of unfavorable mix in Q1 with some lower-margin transformer products. But just wondered if you could provide a little bit more color on the headwinds you faced there this quarter.

Yes.

And maybe in terms of labor, freight, material cost headwinds, were those a factor for the lower margin?

Yes, so maybe we didn't communicate it right. There really aren't - there are no headwinds. It's really kind of - we can't control the mix 100%. We do control what we do. Just high distributor sales on the dry-type, a lot of utility sales on the liquid-filled side and that's going to drive the margins lower. The good news is, is that from the sales, especially the transformer part of the business, the sales are pretty much the same as last year and the end markets are strong. And we see the year unfolding in an aggressive strong way. It happens from time to time that you get dealt a less than perfect hand the way the order book goes. Our capacity, like ultimately everybody, is constrained. And that's how it blended out this quarter.

Got it. Okay. As of now, limited stuff you can do to control the mix quarter to quarter and so that will actually [indiscernible].

Correct.

Okay. Got it. In terms of the bookings environment, I think I'm backing into sort of an implied booking looking kind of flattish year-over-year, but still like a strong over 1x book-to-bill. Just wanted if you could kind of characterize sort of puts and takes on the T&D side versus Critical Power, how that sort of played out versus your expectations during the quarter?

You're right. The book-to-bill was stronger. We are above one. The liquid-filled showed some nice orders for the quarter that were coming in to be shipped yet this quarter. Still no real activity in oil and gas. That is nonexistent sector for us right now. Perhaps with the recent increase in oil prices, there'll be something, but it will be beyond 2018 before that will have any significant impact in what we do. Dry-type, really there's not a whole lot of backlog that goes on in that environment. It's take-the-order-today-ship-it-tomorrow type of environment. And so we're not seeing any significant changes in that backlog up or down, it's kind of the same old. We did have some decent growth in our discontinued ops segment, I'm sorry, so that went up a little bit. And then lastly, the Critical Power backlog was pretty much flat year-on-year - quarter-to-quarter, I'm sorry.

Got it. Okay. So I guess, last question related to the fundamental business, and I'll sneak one more in here. But just with the backlog visibility you guys have, and I think it sounds like you have some confidence that margins sort of sequentially improve throughout the year, could you give us a sense for just sort of the cadence of margin improvement that we should expect going through the remainder of 2018? And just sort of how the - how we should be thinking about modeling that improvement from sort of the mid-single-digit EBITDA margin in Q1?

Right, yes. So normally in all of our segments, because of where they're located and where the customer base is, the first quarter tends to usually be the roughest, and it grows from there. There's just more activity that occurs. Concentrating on Critical Power to start, service revenue tends to be soft in Q1 growing in Q2, 3 and in the beginning of Q4 because people are available. The retail environment, we start now and we finish by the time Black Friday shows up. For the cell towers, nobody wants to pay for ATV service or snowmobile service in order to get to them in January and February and March. So there tends to be a limited amount. We have an increased backlog in service up there, so we're expecting strong sales in the coming quarters. And those sales carry a much higher margin than the equipments do. The backlog in liquid-filled is strong. The mix seems good at this point in time. We expect, in the short term, Q2 is definitely going to be a stronger quarter than Q1 in terms of Canadian dollar to Canadian dollar. What happens to the FX rate is to be determined. I can't control that. But that looks strong right now. It looks like it'll be stronger than last year anyways when we were about $0.02 lower than we are right now. Dry-type, again, backlog doesn't really show us a whole lot, but distribution really starts moving the PDU world, which we struggled with in Q1, was down on sales volume. That volume looks like it will come back, and we will start to reach some projects that have been put on hold during Q1, during the last nine months of this year.

Okay. That's helpful. And then just, I guess, lastly, I know you said no questions on the sale, but I have to just - I appreciate the sensitive nature of the timing of the transaction, but just one high-level one. Can you just give us a sense for sort of the hurdles that need to be completed here before the sale goes through by the end of the quarter, it looks like. I mean, are there diligence items that are still sort of need to be checked on CleanSpark's part? Or is it more just shareholder approval? Any sense for that would be helpful.

Again, I think we're not going to - we're just not going to comment on that. We don't foresee right now - there is nothing that - there's nothing extant that should stop us from meeting the June 30 date.

[Operator Instructions]. We'll take our next question from Jay Harris with Axiom Capital Management.

I have another question that I know you won't answer, but I'd like you to think about it. Does CleanSpark acquisition of your division changed the nature of their business? It's not clear how the business that they're buying from you will fit in with what they have been doing. So when you're ready to respond to that, I'd like to - we'd all like to hear it.

Okay. All right. I mean, I think we put out a joint release, and the CleanSpark [indiscernible] will do a great job messaging what it's about. But basically, we penetrated - from our side, we penetrated a lot of the distribute generation customers and end markets with our hardware. They're more of a control software business, and they see the opportunity to really marry the hardware and software with a really differentiated product in what's a very, very fast-growing undeveloped market for storage, microgrid, distributed energy resources. And I think that they will be very successful. We hope that they're going to be very successful doing that, really coming - they're already well regarded and our products are well regarded. And fusing them with a differentiated product in that particular market would put it into position to reap some greater rewards than we can do by ourselves.

And it appears there are no further questions. At this time, I'd like to turn the conference back to Mr. Maas for any additional or closing remarks.

Okay. Thank all for your time and support. This is Nathan. And we look forward to updating you all, again, on our next call. Thank you, operator.

Thank you. That does conclude today's conference, and thank you for your participation.