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Power Solutions International, Inc. (NASDAQ:PSIX)

Q2 2014 Earnings Conference Call

August 07, 2014, 04:30 PM ET

Executives

Gary Dvorchak - Senior Vice President, ICR

Gary Winemaster - Chairman, President and Chief Executive Officer

Eric Cohen - Chief Operating Officer

Daniel Gorey - Chief Financial Officer

Analysts

Eric Stine - Craig-Hallum

Matt Riley - ROTH Capital

Aditya Satghare - FBR Capital Markets

Walter Liptak - Global Hunter

Alex Potter - Piper Jaffray

Greg McKinley - Dougherty & Company

Rudy Hokanson - Barrington Research

Rob Brown - Lake Street Capital Markets

Chris McDougall - Westlake Securities

Rob Ammann - RK Capital

Operator

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.

Gary Dvorchak

Thank you, Lauren, and good afternoon, everyone. We are pleased that you're joining us for the Power Solutions International second quarter earnings conference call. Speaking on the call today are Gary Winemaster, Chairman and Chief Executive Officer; Eric Cohen, Chief Operating Officer; and Daniel Gorey, Chief Financial Officer.

By now everyone should have access to our press release that we announced 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 undertake 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.

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 strength 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 oil field opportunities in compression, which Eric will discuss shortly.

Related to this, in the second quarter, we announced our largest acquisitions since the company's founding, the purchase of Professional Power Products, Inc. which we call PPPI. PPPI designs and manufacturers 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 oil field, where there needs to be from very large power systems. Second, both parties can leverage our existing relationships both on sales and the supply side.

We are introducing PPPI 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 are some frustration, because of our limited and 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 invertedly 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 their 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 U.S. 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 partnership seriously and do not evaluate only the engine. They need to feel comfortable with our total operations, including manufacturing processes, quality control, et cetera. They want to know that we manage our company well and will be a reliable supplier that is still thriving a decade from now.

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

Eric Cohen

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

As Garry mentioned, we are going to market together in a synergistic manner, which is quite valuable. To help capitalize on growth opportunities, we hired [ph] Brian Cleary into the newly created role of VP of Sales at PPPI.

Brian has considerable experience in the power generation integration business. His deep contact base is already driving new quotes to PPPI. Also to support further operations, we hired [ph] John Tomasso, as new VP of Operations. John was previously leading operations and operational improvement at a competitor.

Finally, our VP of Marketing, Jeremy Lessaris, 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 expected 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 are working extensively to refine and expand their capabilities, so there can be an $80 million year business for us down the road.

As Garry mentioned, oil and gas is turning to a far better opportunity than we have 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 buying 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 is just burned off as flare gas. In April alone, it was over 10 billion cubic feet valued at $50 million. That is free fuel with no transportation cost in oil field that any key firms are taking notice.

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's state government implemented new rules requiring gas-capture plans for new drilling. The EPA put new standards for flare inventing in place in 2012, which are now being implemented. And the BLM is evaluating new regulation as well.

We are confident that regulations toward the release or burning in 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 to the 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 mention 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 shift our first customer orders mainly for evaluation units and are 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. Garry mentioned that we can at offer a lot of detail, even though there is 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 behind certifying a prototype engine such as the operational audit that Garry 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 for other expensive solutions. This is a huge advantage for them to get to the market more quickly and inexpensively.

I also want to mention other nine benefit we are utilizing in our on-road effort. It turns out that there are quite a few grant programs available to help fund a research related to natural gas fueled engines. We are actively pursing with many research grants and hope to be awarded several of these. That money can help defray our R&D cost, 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 for our processes. In order to more efficiently move small parts to our production lines, we are implementing a two-bin Kanban 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 a 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?

Daniel Gorey

Well, 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 PPPI which was effective April 1 was also a key contributor to our sales growth, contributing $7.3 million in sales for the second quarter. Organic sales growth, excluding the acquisition of PPPI was 29% in the quarter.

In addition to strong sales contribution from the oil and gas end-market, we also saw a growth in aerial lift and aftermarket sales. The company saw a sequential sales growth of 25% in the quarter with organic growth of 14% and PPPI 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 margin was caused by modest shifts in products mix in the quarter from Q2 last year, and was also due to the inclusion of PPPI 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 cost, came in at $9.5 million for the second quarter. Operating expenses were 11.4% of sales this quarter. This compares to last year's 12.4% of sales and 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 PPPI.

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 bottomline. 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 encouraged 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 an initial cash purchase price of $46 million. In addition, we will issue to the seller's contingent consideration between $5 million and $15 million in our common stock based on PPPI's 2014 operating results. This is based on a PSI stock price of $76.02 and resulted in the recording of the contingent consideration liability of $8.9 million as of the date of acquisition.

Beginning 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 decreased in the estimated value of 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 our covenants. I believe cash generated from operations as well as availability on our line of credit will be sufficient for our near-term operating and capital needs.

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

Gary Winemaster

Thanks, Dan. As we crossed the halfway point of 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 PPPI. 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.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Eric Stine of Craig-Hallum.

Eric Stine - Craig-Hallum

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

Gary Winemaster

The Perkins 4000 Series gas engines?

Eric Stine - Craig-Hallum

Yes.

Gary Winemaster

Both 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. I mean 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 program. 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 in the PPPI packages. So they are more developed than just running on a dyno.

Daniel Gorey

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.

Eric Stine - Craig-Hallum

Maybe just turning to materials handling, metal ramping throughout this year, but maybe talk about some of the other programs you are working on .I know you have been for some time, and just thoughts about additional forklift opportunities into next year?

Gary Winemaster

The Chinese market is obviously a big target for us. We have the JV in a position to help us, reduced cost to address some of the domestic markets in China. We are currently selling probably eight of the top 10 Chinese manufacturers to our exporting engines back to the United States, so it's a natural progression for us to acquire some of their domestic business. We have developed a special product to address one of our competitors' products, and I think that that's going to be very, very successful for us.

The macro business we're starting to see pipeline, Ford/Mitsubishi engine filling up in '15. So that integration is going very well. That partnership is fantastic and continues to get stronger. And we will be one of their more strategic suppliers from '15, from all the way to one to nine ton trucks for spark-ignited product.

So I think that we have from a focus 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.

Eric Stine - Craig-Hallum

And then last one from 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 that?

Gary Winemaster

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

Having said that we saw a nice improvement, remember I mean it's all about beginning with a piece of business and then working those cost down. So we saw some nice improvement between Q1 and Q2 in margins for material handling. But having said though, I guess I am still reminded, we are to be measured in terms of our expectation for all the market in the near-term and I'd kind of think they're going to remain in that 18% and 18.5% range.

Operator

Our next question is from Philip Shen of ROTH Capital.

Matt Riley - ROTH Capital

It's Matt Riley on for Phil. I just want to start off with the oil and gas opportunity. Obviously, you have nice penetration within the power gen market here. I mean, Eric, you talked about the compression opportunity. Could you just kind of help us quantify that in kind of next steps and timing?

Eric Cohen

Yes. When you look at the market in oil and gas, I mean 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 is 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. We started 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, but we're taking some of our engine solutions, and applying it for more of that compression market in. But compression is basically -- it could be compression where you're pushing pressure into a well to release the gas or could be moving gas off the well once you get out on the ground.

Matt Riley - ROTH Capital

Just touching on the NACCO contract. Can you give us any sense for unit volumes, your latest expectations there for 2014 and perhaps '15 as well?

Gary Winemaster

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

Operator

We'll take our question from Aditya Satghare with FBR Capital Markets.

Aditya Satghare - FBR Capital Markets

So two questions, right. Firstly, you mentioned that you're working on 12 truck OEM programs, right, so when I think about the current R&D run rate, does it reflect all the expensing you did to scale up those programs? And then maybe sort of a side note on that, I mean could you talk about the cumulative market opportunity you're pursuing with those small programs?

Eric Cohen

So in terms of the R&D expense, one thing to realize is that the R&D expense is an expense. There is 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 is, for example, a large strategic partner that we're working on project with lined us to accelerate a program. So based on, if customers want to accelerate a program that will necessitate, obviously, some higher R&D. So I think that's something, we just have to look at on a quarter-to-quarter basis.

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

Aditya Satghare - FBR Capital Markets

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

Daniel Gorey

Well, the markets that play-in are essentially $1 billion markets, and so it's really a two kind two pronged. One is, there is 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 through existing customers and garnering a larger shares of their business, there's an opportunity there.

On top of that, there is many other customers, market segments and OEMs that the company has never sold to, that we now with the additions of some of their people we brought on, had very strong contacts there. And we're not really into a competitive position to talk about those, because that is proprietary right now. But we really identified where we can go and build up to scale the business for that size.

Operator

We'll go to Walter Liptak with Global Hunter.

Walter Liptak - Global Hunter

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 am looking at it, 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 it's similar between $90 million to $105 million per quarter of revenue. What could go right, what could go wrong? I wonder if we can get some color on that.

Gary Winemaster

I mean, I would characterize the range is somewhat tight, I guess from my perspective, Walt. And so I think that when we think about, and 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 is being kind of the target. And again, business is very up, but weak. 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 plans and within the guidance that we gave.

Walter Liptak - Global Hunter

And kind of along those lines, on the answer that you have regarding gross margin. What are the things that could go right or wrong on the gross margin line? Is it a pricing issue or sort of throughput issue to meet the higher end of that range?

Daniel Gorey

Again, I don't foresee any wild swings 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 volumes. So I think the general message is that that I am 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 its a just that when we talk about getting our gross margins into below 20s, I think it's very doable.

Having said that on the short-term the business is dynamic, there is lots of end markets. And with that there is going to be some movement around gross margins. 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 the other.

So as an example, I mean if we saw a little bit more into the oil and gas market, margins may tickup. If the material handling business picks up a little bit more relative to the rest of the business, it could put a little bit of pressure in the short-term on gross margins. But again, I don't think we're talking about the lot of the movement one way or the other.

Walter Liptak - Global Hunter

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 it happened in the past. Are we to take that you're spending more of your time working on on-road? And are you more or less enthusiastic or are we getting closer to an on-road order at this point?

Gary Winemaster

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 one of the highest scoring companies that was audited, I think its 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 and 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've 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.

Operator

We'll go to Alex Potter with Piper Jaffray.

Alex Potter - Piper Jaffray

I was wondering first, I don't know if you could maybe do this or not. But if you look at that $330 million to $360 revenue guidance, 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?

Gary Winemaster

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

Alex Potter - Piper Jaffray

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?

Gary Winemaster

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

Alex Potter - Piper Jaffray

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

Gary Winemaster

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 their names not disclosed.

Alex Potter - Piper Jaffray

On this compression opportunity, you're talking about in oil and gas. Interested in the displacement size that we're talking there, is that more in the Perkins, PPPI-type displacement size or either across the board?

Gary Winemaster

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

Alex Potter - Piper Jaffray

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

Gary Winemaster

It's really case-by-case and customer specific. There is 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, some times customers want to order their own tanks rather systems, and then they would do it in those cases.

Operator

We'll take our next question from Greg McKinley of Dougherty & Company.

Greg McKinley - Dougherty & Company

Again, on on-road, could you talk about your products portfolio that you have developed to serve that market? Obviously, the 8.8 liter, but maybe also talk about some of the smaller on-road engine systems you're working on? And then comparing contrast for us maybe how those systems will perform for your customer base versus their other options in the market?

Eric Cohen

Well, we are providing the 8.8 liter, but we also provide the 4.8 liter and 6 liter GM engines. As the largest third-party engine supplier, for a 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 diesel.

They are much lighter and fit into a wider range of applications, both in 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.

Greg McKinley - Dougherty & Company

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

Gary Winemaster

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.

Greg McKinley - Dougherty & Company

And then getting back to PPPI for a moment, you talked about just into 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 resolve to, and we get more onto that, call it $30 million-ish revenue run rate when you acquire the business.

Gary Winemaster

I think we've mentioned when we acquired the business that the integration was going to take this year, and that almost all of that would be completed by the end of the year. And so what we would see is, by the end of the year one of the heavy-lifting should be completed. Because going into the acquisition, the idea that is we bought it because we saw the potential to significantly grow the business. And so we're really putting in 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.

Operator

We'll take Rudy Hokanson with Barrington Research.

Rudy Hokanson - Barrington Research

Could you maybe talk a little bit more about the opportunities for PPPI in the oil and gas field, especially since the main thrust or a 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 and gas field and what you hope to deal with them over the next one to two years on that matter?

Gary Winemaster

Keep in mind, PPPI 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 we're seeing with some of their customers is 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, two to three megawatt solutions, they are 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 of their sweet spot, which is larger than these 1 megawatt systems.

Rudy Hokanson - Barrington Research

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

Gary Winemaster

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 or the packing opportunities.

So I think it's a trend. I mean 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 are 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 towards gas.

But I mean we've seen a pickup 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 I think we're going to take advantage of all these opportunities that come forward.

Operator

We'll take our next question from Rob Brown of Lake Street Capital Markets.

Rob Brown - Lake Street Capital Markets

I just wanted to dig in a little bit more to the guidance, and sort of could you help us understand the jump from sort of $80 million this quarter up to almost $100 million in Q3 and Q4. And is that the ramp in the macro business, is that more oil and gas? But just curious, trying to understand what drives your delta?

Eric Cohen

As we've kind of shared about before, we've got a number of growth drivers here, which were all really exciting growth drivers. Some are fully in gear, right, 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 order bus his 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're trying to look at oil and gas and material handling along with the acquisition of PPPI, all should be kind of major pillars of growth that get us to the target that we would like and will achieve in on the balance of the year.

Rob Brown - Lake Street Capital Markets

And then on the material handling contract, can you tell us have you switched over sort of to your own block here or is that are you still delivering some of the stuff over the prior situation?

Gary Winemaster

It's still mixed. We'll have phase-in completely done by the end of the year. So I mean the real reason for us to do that integration was just the preparation of the production getting ready for that type of volume. So now that one high volume line is producing more than a 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 provided the processes and gone through the audits. So I think the market is ready. I mean the product have 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.

Operator

We'll go to Chris McDougall at Westlake Securities.

Chris McDougall - Westlake Securities

Shifting back to the on-road opportunity, I want 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 from a common platform from those fields?

Gary Winemaster

One of the things that is 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 offered to these 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.

Chris McDougall - Westlake Securities

So just to kind of support that, 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?

Eric Cohen

Well, I think that inside of the company there maybe one application that is dedicated to one fuel more than others. But I think that that 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 maybe markets that just want gasoline or duel fuel. And the fact that our systems are able to run duel fuel gasoline, CNG, or CNG and LP gives us the ultimate flexibility for the OEM.

Chris McDougall - Westlake Securities

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

Gary Winemaster

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 it's kind of unique. The gasified diesels don't necessarily come down and offer the same opportunities for alternate fuels as with the weight requirements as our engines would do. So I would say that we do believe that we'll be the sole provider for those customers that we win.

Chris McDougall - Westlake Securities

And then just lastly on the compression side. So just kind of your on-the-market or 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 units? And then, the permitting requirement, I understand a lot of the electric compressors are used today, because it's just so much easier to permit versus when there burns hydrocarbon. So what would be the extra permitting requirements of the customers?

Gary Winemaster

So the idea is to work with the compressor OEMs to provide the engine, and then they provide the compressor, the overall systems. So we're not going to get into that side of it. So there is numerous both 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, there is some trends where people are using electrical, basically electric motor for compressions versus a natural, burning hydrocarbons in a compressor. From our standpoint, 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 up tick underneath for power generation, and that fits in well with our engines. So we see that there is trends and we can play on either side of it.

Operator

Our next question comes from Rob Ammann of RK Capital.

Rob Ammann - RK Capital

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

Daniel Gorey

And again, I think I mentioned that the purchase accounting is 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, we saw that write-up of the inventory and that did have a direct impact on us in the quarter. That moderates a bit overall in Q3 and tends to step down in '15 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, we'll probably be living with this for the next several years on a quarterly basis.

Rob Ammann - RK Capital

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

Daniel Gorey

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 $4.82 million, if I remember correctly, but let's call it $0.5 million to make it easy. So that $0.5 million moves down to something like $300,000. I don't have these numbers in front of me. But in the general spirit of the question, so 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 is that write-offs step down, will pick up in additional amortization. But overall, 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 PPPI, and you look at the business, the EBITDA margin, which I think is a good measure of performance, we're 10% in quarter. So despite all the great work that Eric's doing and the rest of the team here heading up that integration, we're still at 10% EBITDA margins for a business that we just acquired. So I am excited about what they delivered, but more importantly what PPPI is going to become.

Rob Ammann - RK Capital

And from a gross margin standpoint, to x 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.

Daniel Gorey

Yes. It does.

Operator

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.

Gary Winemaster

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 Jefferies 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 will report the third quarter results. Thank you very much.

Operator

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

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Source: Power Solutions International's (PSIX) CEO Gary Winemaster on Q2 2014 Results - Earnings Call Transcript
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