PSIX has a non-distressed equity valuation despite a preponderance of very distressing issues:
I. A revenue recognition review leading to an inability to file their last two 10-Qs, departure of COO and CFO within an 8 month period
II. Increasing reliance on agressive "Bill and Hold" revenue recognition where revenue is recognized before products are even shipped
III. Excessive debt with impending covenant measurement dates
IV. A low quality low ROIC business model
V. A promotional CEO with a history of huge misses to guidance, and expectations and valuation that imply significant business improvement in the 2H’16 and 2017 time periods.
I believe within the next several months the true earnings power of PSIX will likely be apparent and the combination of debt covenants, a need for dilutive financing, and perhaps an accounting restatement will lead to a significant decline in the share price.
Assembler of diesel alternative engines that run off of propane, gasoline, or natural gas for the forklift, power generation and on-road markets.
Revenue Guidance: $350-375, consensus $355m, O&G revenue of $50m or 14% of guided revenue
COO Eric Cohen departs with little explanation on 5/17/16, just 8 days after the company’s Q1 conference call.
PSIX was scheduled to report Q2 results on 8/4 but instead announced that day, “the postponement of its second quarter 2016 earnings release and conference call, originally scheduled for today, Thursday, August 4, 2016, to allow for more time to finalize its quarterly financial results. The Company will issue a press release announcing a rescheduled date for the earnings release and conference call.”
When they were unable to file a 10-Q by 8/15 they stated, “The Company has not completed its financial statements in light of an ongoing review of allegations made by a former employee. The Board and the Company take all allegations that concern its financial reporting seriously and initiated an independent review to assess whether there is any merit to them. The review is primarily focused on certain transactions involving revenue recognition.
A review of the 2015 10-K reveals significant growth in an aggressive revenue recognition method called “Bill and hold” where the PSIX recognizes revenue before shipping the product. See below description from 10-K.
" The Company recognizes revenue upon transfer of title and risk of loss to the customer, which is typically when products are shipped, provided there is persuasive evidence of an arrangement, the sales price is fixed or determinable and management believes collectability is reasonably assured. As of December 31, 2015 and December 31, 2014, the Company had recognized revenue associated with approximately $21.4 million and $3.2 million of undelivered product, respectively. "
Recognition of revenue for undelivered product is very aggressive accounting and the significant growth of this balance Y/Y is a serious red flag that the revenue recognition issues alleged by the ex-employee (believed to be Eric Cohen) are very real.
It is likeley the accounting review expands in scope beyond the bill and hold revenue recogntion as the company has put out very little information on the topics of the review. However, just the $18m in incremental bill and hold revenue recognized in 2015 could have made a material contribution to EBITDA over the TTM period.
Another indication of irregular accounting issues is that CFO Dan Gorey announced retirement on 8/5/15. Within a 8 month period, PSIX lost both its CFO and COO. At best these departures are evidence of a limited opportunity set for PSIX but could also be signs of accounting issues.
DSO and Days inventory have risen significantly over a multi-year period, often a sign of low earnings quality
FCF has been consistently negative over a multi-year period despite reporting very positive ebitda at times
PSIX carries an excessive debt load that isn’t supported by earnings power of the business,
The company’s previously reported TTM EBITDA as of Q1’16 was $7.1m versus net debt of $135m (19x levered) yet the company still has another 23 turns of equity value.
In order to meet 10/31 covenant of $12.3m in EBITDA business has to get significantly better from ttm reported and potentially overstated EBITDA.
Credit facility facts:
6/28/16 entered into a $135m senior secured credit facility
$60m with TPG at libor + 9.75%
Wells line reduced from $125 to 75m, eliminates fixed charge covenant
The first covenant measurement date of 10/31 has passed us and PSIX has until the end of November to report financials to TPG. I believe when they do they will violate the minimum EBITDA covenant.
TPG Special Lending has shown a willingness to assert increasing levels of control. They already decreased the borrowing base by $12.5m due to PSI’s inability to file the Q2 10-Q, and I believe will not simply allow PSIX to continue unscathed after their likely upcoming covenant violation.
The Amendments provide for certain waivers under the Credit Agreements related to the previously announced allegations made by a former employee and the Company's delay in filing its Second Quarter Form 10- Q. Additionally, the TPG First Amendment requires the establishment of a separate reserve of $12.5 million against borrowing base availability under the TPG Agreement until the Company's Second Quarter Form 10- Q is filed, at which time the amount of the reserve is reduced to $7.5 million, which also reduces availability under the Wells Fargo Agreement by the same respective amounts.
I think this is relevant because it shows that TPG is willing to take action to minimize its risk, as opposed to just waiving the covenant.
PSIX has 30 days after the close of the month to file monthly financials with their lenders for covenant calculation purposes so I believe we will likely be notified of a covenant violation within the next few weeks.
Valuation takes into account none of the risks discussed above as the stock is fully valued on peak EBITDA levels.
Stock trades 9x peak ebitda, and 12x 2017 consensus EBITDA which assumes EBITDA grows by 3x from the TTM reported amount
No history of positive FCF
CEO has history of huge cuts to guidance
2015 guidance given in May of 2015 was for $500-520m in revenue, the final total was $389m
2016 guidance/consensus implies significant improvement in 2H results with Q4 estimates for essentially doubling versus Q1’16 the last reported quarter available.
Below is a sell side model demonstrating the ramp in revenues required to hit guidance.
I believe that more likely than not when financials are released again, PSIX 2016 revenue will be significantly shy of the $355 consensus and full year EBITDA will be below the $12m covenant level required for Q4.
Low quality business model:
Fundamentally not a good business.. Burned $70m in FCF over last 15 quarters and $11m ttm, low gross margins between 6-20%, significant operating working capital requirements
PSIX equity is not pricing in any of the aforementioned risks. I believe a covenant violation will likely be announced in the near term, a costly restatement is certainly possible, and consensus and guidance imply a huge 2H’16 and 2017 improvement which I believe will not materialize. When these catalysts play out PSI shares will materially re-rate and the company could be forced to find toxic sources of financing in order to stay afloat. Despite a high short interest, I am locating shares around 10%.
Disclosure, we are short PSIX but may buy or sell at any time.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.