Brett Maas - Investor Relations Nathan Mazurek - Chairman and Chief Executive Officer Thomas Klink - Chief Financial Officer

Good day, everyone, and welcome to the Pioneer Power Solutions’ Third Quarter 2018 Earnings Conference Call. Today's conference is being recorded. And at this time, I'd like to turn the call over to Mr. 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; and Tom Klink, Chief Financial Officer. Following the 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 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 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 earlier today and in the posted version of these prepared remarks, both of which apply to the content of this call. Finally, please note that the results management will discuss today relate to the Company's continued operations. Management will provide an update on the pending sale of the Switchgear business later in the call. But the results of this business classified as discontinued operations will not be discussed. 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. The third quarter financial results we released earlier today reflect the Pioneer business that is operating efficiently and profitably, delivering sequential revenue and margin growth, while continuing to build on our record backlog number for the second consecutive quarter. All three operating units performed well this past quarter, and all three are poised to build on the hard work of the last few years. These results validate our prior statements that the nature of our backlog had normalized, and that ensuing quarterly results would manifest this improvement. Indeed, this quarter, we benefit from a more typical mix of projects and product types, driving adjusted EBITDA to be well within our annual guidance. In particular, our Critical Power segment contributed more than $0.5 million in EBITDA this quarter, after generating only $80,000 in the first six months of the year, essentially completing a turnaround for an important strategic component of our business. Let me start with some general comments regarding our overall business before I turn the call over to Tom, in order to discuss the financial results in more detail. Our liquid-filled business has been running at near capacity for all of 2018. Our focus here is to drive mix as best as we can in order to optimize profitability. We are also beginning to expand our offering to include outsourced product from our Asian partner, enabling us to increase revenue without the CapEx and other risks normally associated with these additional sales. In our dry-type business, both our OEM Custom Magnetics segment and our Distribution segment remained robust. In addition, the move of our medium voltage operation to Mexico is now complete, and we do not expect any additional relocation-related cost to be incurred for this in the future. In its new more competitive location, the medium voltage business has doubled its order rate from 2017, and we expect that number to double again in 2019. In our Critical Power segment, new record EBITDA of more than $0.5 million in the quarter reflect the business where most of this segment's revenue was derived from service related work. We are pursuing equipment business only in instances where the product requirement is highly customized and complex. Our margins and EBITDA from this business reflect this change. This unit's quarterly revenue also reflects most of the installation revenue from our remote monitoring systems pilot program for 90 stores for a leading home improvement retailer, and we hope and expect to expand this program to more of this customer's 2,200 store locations in the United States. In short, our third quarter's $26 million in revenue is a topline increase, both year-over-year and sequentially. Concurrently, we significantly expanded our backlog. We entered the quarter with a record backlog of $41 million, up 34% compared to the third quarter last year. Over the last nine months, our backlog has increased in absolute numbers by nearly $12 million, setting a new backlog record for the last two consecutive quarters, and our backlog is continuing to steadily increase. We are seeing broad-based demand with particular strength in Canadian cannabis-related facilities and cryptocurrency mining projects. While demand for our products and services is spread over many end markets, a rebound in the oil and gas and mining sectors as well as the long-awaited U.S. Federal Government-led infrastructure spending would be incremental to the revenue growth we're already experiencing. In May of this year, we signed a definitive agreement to divest our Switchgear business to CleanSpark, Inc. After some delays, we now expect to finalize the sale just after midnight in January 1, 2019, enabling us to book the one-time gain and make payment of the resulting tax implication in a single tax year. As a result of this divestiture, Pioneer will be more profitable, more focused and financially more flexible business. It's important to note, the value of this sale will create upon closing. In exchange for certain assets of our Switchgear business, we will be receiving 7 million shares of CleanSpark, two tranches of warrants, totaling 2 million additional shares, a promissory note of approximately $1.7 million, and an equipment lease valued at about $1 million. Based on the closing price for CleanSpark's stock on November 7, the totality of this transaction would result in more than $17 million or over $1.90 per share for us in value being immediately added to our balance sheet. Clearly, this value is not reflected in Pioneer's current share price. We continue to believe CleanSpark can more effectively grow this business, creating additional long-term value for all its shareholders, including Pioneer. Once the six-month lockup expires on the 7 million shares, it remains our intent to distribute these shares to our shareholders in an appropriate manner, taking into account tax obligations and market and legal conditions. Until there is something more definitive to report, I will refrain from further comments on the CleanSpark transaction or any other M&A, and we will not answer questions about the CleanSpark transaction or any other sales process during the Q&A section of this call. With that, let me turn the call over to Tom to discuss our financial results.

Thank you, Nathan, and good afternoon, everyone. Before I get started, as Nathan discussed, in May of this year, we signed an agreement to sell our Switchgear business. Accordingly, this portion of our business has been reclassified as discontinued operations for third quarter and year-to-date reporting. The results presented in our press release and that I'm about to discuss reflects continuing operations only. Revenues were $26 million for the third quarter of 2018, up 5.5% on a sequential basis. Year-over-year, third quarter 2018 revenue compares to $25.5 million in the third quarter of 2017, an increase of 1.8%. The increase was driven by higher sales of the Company's liquid-filled transformer products and increased service revenues, which were partially offset by lower sales of generator equipment, resulting from a reduced focus on these unprofitable sales, service revenue from the maintenance of generators increased by 8.2% year-over-year. Gross profit for the third quarter of 2018 was $5.1 million or 19.8% of revenues, compared to $5 million or 19.7% of revenues in the year-ago quarter. Sequentially, gross profit was down marginally from $5.2 million or 21.2% of revenues in the second quarter of 2018. Selling, general and administrative expenses of $4.08 million or 15.7% of revenues for the third quarter of 2018 were down on both a dollar basis and as a percentage of revenue compared to $4.2 million or 16.3% of revenues in the year-ago period. Sequentially, SG&A expenses were also down on a dollar basis and as a percentage of revenue compared to $4.15 million or 16.9% of revenues in the second quarter of 2018. In the third quarter of 2018, we benefited from a foreign exchange gain of $889,000 compared to a gain of $194,000 in the third quarter of 2017. Operating income from continuing operations for the third quarter of 2018 was $1.9 million, a significant improvement on a sequential basis compared to $857,000 in the second quarter of 2018. Operating income from continuing operations was up significantly year-over-year compared to $1.1 million in the third quarter of 2017. For continuing operations, our effective income tax rate for the third quarter of 2018 was 34.5% of pretax income as compared to 170.4% for the same quarter last year. The change in the income tax rate was primarily due to the U.S. tax code changes enabled in December 2017, specifically as it relates to the taxation of foreign-earned income and the deductibility of interest expense. Net income from continuing operations for the third quarter of 2018 was $788,000 or $0.09 per basic and diluted share compared to a net loss from continuing operations of $219,000 or $0.03 loss per basic and diluted share in the year-ago quarter. Sequentially, third quarter 2018 net income from continuing operation compares favorably to a net loss from continuing operations of $78,000 or a $0.01 loss per basic and diluted share in the second quarter of 2018. Adjusted EBITDA for the third quarter of 2018 was $3 million compared sequentially to $1.8 million in the second quarter of 2018. Non-GAAP diluted EPS increased to $0.27 in the third quarter of 2018 compared to $0.16 in the second quarter of 2018. Year-over-year, adjusted EBITDA decreased 11%, down from $3.3 million in the third quarter of 2017. Now turning to the nine months financial results for the period ended September 30, 2018. Revenues for the nine months were $74 million compared to $77.8 million in the comparable period of 2017. This reduction is mostly from the strategic change at our Critical Power segment to no longer focus on generator equipment sales. These equipment sales were down $3.3 million year-over-year. For the nine months ended September 30, 2018, our gross profit was $14.8 million or 20% of revenues compared to $16.4 million or 21.1% of revenues in the year-ago period. Year-to-date, SG&A expenses were down 2% to $12.4 million or 16.8% of revenues compared to $12.7 million or 16.3% of revenues in the year-ago period. Operating income from continuing operations for the first nine months of 2018 was $3 million compared to $4 million in the first nine months of 2017. Our effective tax rate for the nine months ended September 30, 2018, was 81.1% of income before tax as compared to 19.1% for the first nine months of 2017. Net income from continuing operations was $128,000 or $0.01 per basic and diluted share compared to $1.7 million or $0.19 per basic and diluted share in the year-ago period. Our adjusted EBITDA for the first nine months of 2018 was $6 million compared to $8.8 million for the first nine months of 2017. Lastly, our non-GAAP diluted EPS was $0.55 per share compared to $0.79 per diluted share in the comparable 2017 period. Turning to the balance sheet and statement of cash flows, our total interest-bearing debt at September 30, 2018, was $27.2 million compared to $28.2 million at December 31, 2017. For the nine months ended September 30, 2018, we generated cash from operations of $567,000 compared to the first nine months of 2017, when we used cash from operations of $164,000. Our final installments for the 2014 and 2015 payroll tax liabilities, which initially had balances of greater than $4 million, were made during the second quarter of 2018. We continue to expect to generate high single-digit growth in revenues from continuing operations and to increase adjusted EBITDA for the year of 2018 compared to 2017. This concludes my remarks. I now turn the call back over to Nathan.

Thank you, Tom. With a record backlog, growing demand for our solutions and a profitable business, I am very bullish about Pioneer's potential. We stated our expectations that the second half of 2018 would be significantly better than the first half, and that projection is proving accurate. Based on our record backlog, we expect continued sequential improvements and are optimistic that 2019 will be a record year for revenue and profit at Pioneer. Operator, I'd now like to open the call for questions.

Thank you, sir. [Operator Instructions] And we will take our first question from Matt Koranda with ROTH Capital Partners.

This is Mike on for Matt. So first, can I start off with just a housekeeping item? Can you provide the revenue breakdown between T&D Solutions and Critical Power?

Sure. Do you want it for the quarter or for the nine months?

For the quarter, please.

All right. So for the three months ended, T&D Solutions was $22.6 million, Critical Power was $3.3 million, with rounding, it's $26 million.

Okay, great. And then I'm calculating a strong book-to-bill for the quarter, over one, with implied bookings up year-over-year and flat quarter-over-quarter. Could you characterize some of the puts and takes on the T&D side versus Critical Power and how that played out versus your expectations during the quarter?

Yes. I mean, to go backwards, it played out sort of in line with our expectations. The book-to-bill rate has been very high at T&D Solutions, both on the liquid-filled and on the dry-type side of the business. Really spread overall kinds of end markets. I mean, for us it's everywhere. All the markets that we're active in, industrial, utility, general commercial markets have been strong. The only area where the comparison is weaker is really in Critical Power, and that's really part of our exit – not really exit but the reformatting of the generator side of that business. We've taken down several million dollars of generator equipment sales that was essentially losing money for us on a companywide basis, and this was the first quarter that really reflected Critical Power's almost a completely pure service and service-related business, and the profit outcome was very much in line with what we expected it eventually to be.

Okay, great, that's helpful. And looking at backlog and the cadence of revenue growth – revenue and margin growth, can we still expect an improvement from Q3 to Q4? And is there any visibility into 2019 yet?

Right. So in the T&D Solutions, part of it – the service business, the Critical Power business is right now pretty steady. A lot of that is under a long-term agreement. So what you see this quarter, although it has its own quarterly ups and downs because of weather and Christmas-related issues, where retailers don't have stuff done during that period of time, but that's kind of how it should play out over the next several quarters on the Critical Power side. On the T&D Solutions side, so we have very strong visibility on the liquid-filled, so about half the business or less than half the business, where we're already into April of 2019, pretty robust and strong for the fourth quarter and for the first quarter of – and the first quarter of 2019. On the dry-type side, we don't have that kind of visibility. Although as I mentioned I think in the prior remarks, is our medium voltage business, for example, is now booking – you talked about book-to-bill, it's booking at double the rate that it did last year. So last year was about, at this point in time, three quarters of the year, it booked a little under $1 million. It's up at $2 million, and we expect that to continue to double even further into 2019. All of that lends itself and support the continued sequential revenue growth.

Okay, great. And then last one from me. Can you just give a little color on what drove the sequential decline in gross margins for the quarter?

Yes. The declines in gross margins were from the dry-type group. They really have three different segments they deal with, and so least profitable segment, being our brand label segment, was outsized compared to the other segments that are traditionally being sold there. So that ends up, as dry-type has become a bigger and bigger portion of what we do, the largest division that had a negative impact on those. We expect that to turn around as we increase the amount of the medium voltage activity that we do in the fourth quarter and going forward as well as some pickups on our OEM segment, which traditionally has greater gross margins, but then also has greater SG&A costs as well.

All right, great. That’s it from me. Thanks for taking my questions.

All right, Mike. End of Q&A

[Operator Instructions] And gentlemen, it appears there are no further phone questions at this time, and I'd like to turn it back over to management for closing remarks.

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

And this concludes today's conference call. Thank you for your participation. You may now disconnect.