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DISCONTINUED OPERATIONS

6 Months Ended

Jun. 30, 2019

Discontinued Operations and Disposal Groups [Abstract]

DISCONTINUED OPERATIONS

6. DISCONTINUED OPERATIONS

A discontinued operation is a component of the Company’s business that represents a separate major line of business that had been disposed of or is held for sale. Classification as a discontinued operation occurs upon disposal or when the operation meets the criteria to be classified as held for sale, if earlier. When an operation is classified as a discontinued operation, the comparative Consolidated Statement of Operations, Consolidated Statement of Cash Flows, and Consolidated Balance Sheets are presented as if the operation had been discontinued from the start of the comparative year. Based upon the authoritative guidance, the Company concluded that the operations of the liquid-filled and dry-type transformer business should be presented as discontinued operations as of June 30, 2019.

Overview

On June 28, 2019, the Company entered into the Stock Purchase Agreement, by and among the Company, the Disposed Companies, Nathan Mazurek, and the Buyer. Pursuant to the terms of the Stock Purchase Agreement, the Company agreed to sell (i) all of the issued and outstanding equity interests of Electrogroup to the Canadian Buyer and (ii) all of the issued and outstanding equity interests of Jefferson and JE Mexico to the US Buyer.

If the Equity Transaction is completed, Pioneer Power would sell to the Buyer all of the assets and liabilities associated with its liquid-filled transformer and dry-type transformer manufacturing businesses within the Company’s T&D Segment. However, Pioneer Power would retain its switchgear manufacturing business within the T&D segment, as well as all of the operations associated with its critical power solutions segment.

Consideration

The consideration payable by the Buyer in the Equity Transaction is a base cash purchase price of $60.5 million, as well as the issuance by the Buyer of a subordinated promissory note to Pioneer Power in the aggregate principal amount of $7.5 million (the “Seller Note”), in each case subject to adjustment pursuant to the terms of the Stock Purchase Agreement. Pursuant to the terms of the Stock Purchase Agreement, the Seller Note will bear interest at an annualized rate of 4.0%, to be paid-in-kind annually, and will have a maturity date of December 31, 2022. In addition, pursuant to the terms of the Stock Purchase Agreement, the Buyer will have the right to set-off amounts owed to Pioneer Power under the Seller Note on a dollar-for-dollar basis by the amount of any indemnifiable losses Buyer suffers as a result of certain actions or omissions by Pioneer Power or the Disposed Companies.

Covenants

The Company has agreed, subject to the terms of the Stock Purchase Agreement, to various covenants and agreements, including, among others, to conduct the business of the Disposed Companies in the ordinary course during the period between the execution of the Stock Purchase Agreement and the closing of the Equity Transaction in a manner consistent with past practice. The parties have also agreed to use their respective best efforts to take, or cause to be taken, all things necessary, proper or advisable to consummate the transactions contemplated by the Stock Purchase Agreement.

In addition, pursuant to the Stock Purchase Agreement, each of Pioneer Power, its affiliates and Nathan Mazurek, Pioneer Power’s President, Chief Executive Officer and Chairman of the Board of Directors, have agreed to a non-solicitation provision that generally prohibits such persons, for a three-year period, from, among other things, soliciting or attempting to hire employees of the Disposed Companies or the Buyer or engaging in the business operated by the Disposed Companies within certain geographic areas, subject to certain limitations and exceptions.

Closing Conditions

Each party’s obligation to consummate the Stock Purchase Agreement is subject to certain conditions, including, among others: (i) approval of the Stock Purchase Agreement by the holders of a majority of Pioneer Power’s outstanding common stock, which such approval was obtained by the written consent of certain Pioneer Power stockholders on June 28, 2019 (as discussed in more detail below), (ii) 20 days having elapsed since the mailing to the stockholders of the Company of the definitive information statement with respect to the approval and adoption of the Stock Purchase Agreement and (iii) the absence of any order or legal requirement issued or enacted by any court or other governmental authority preventing consummation of the Equity Transaction.

In addition, the consummation of the Equity Transaction is subject to a financing condition. Certain lenders have entered into a debt financing commitment letter with the Buyer, and Mill Point Capital LLC entered into an equity commitment letter with the Buyer, in each case committing to provide the Buyer with funding to pay the aggregate consideration to be paid by the Buyer in connection with the Equity Transaction. The Buyer is not obligated to consummate the Equity Transaction unless it receives debt financing on substantially the terms provided for in the debt financing commitment letter or the Buyer is able to obtain alternative financing in amount sufficient to consummate the Equity Transaction.

If the Stock Purchase Agreement is terminated by the Buyer after all mutual conditions to closing have been satisfied, except that the Buyer has not obtained sufficient financing to consummate the Equity Transaction, the Buyer would be required to pay a $4.0 million reverse termination fee to Pioneer Power, subject to certain limitations set forth in the Stock Purchase Agreement. The reverse termination fee would also be payable by the Buyer in certain other limited circumstances described in the Stock Purchase Agreement

Termination Fee

Under the terms of the Stock Purchase Agreement, Pioneer Power is not permitted to, and may not authorize or permit its representatives to, directly or indirectly, solicit, initiate or knowingly take any action to encourage or facilitate the submission of an Acquisition Proposal (as defined in the Stock Purchase Agreement), or any inquiries relating to a potential Acquisition Proposal.

Notwithstanding this restriction, Pioneer Power may, prior to the closing of the Equity Transaction, respond to, and engage in discussions and negotiations concerning, a written unsolicited bona fide Acquisition Proposal submitted, and not withdrawn, by a party other than the Buyer that Pioneer Power’s board of directors believes, in good faith and after consultation with its outside legal counsel and its financial advisor, constitutes, or could reasonably be expected to result in, a Superior Proposal (as defined in the Stock Purchase Agreement).

If the Stock Purchase Agreement were to be terminated in connection with or as a result of Pioneer Power’s adoption of a Superior Proposal or entry into an Alternative Acquisition Agreement (as defined in the Stock Purchase Agreement), Pioneer Power would be required to pay a $4.0 million termination fee to the Buyer, subject to certain limitations set forth in the Stock Purchase Agreement. The termination fee would also be payable by Pioneer Power in certain other limited circumstances described in the Stock Purchase Agreement.

Indemnification

Pursuant to the Stock Purchase Agreement, Pioneer Power and the Buyer have each agreed to indemnify one another for any and all liabilities, losses, damages, claims, demands, suits, actions, judgments, fines, penalties, deficiencies, awards, taxes, assessments, costs or expenses (including reasonable attorney’s or other professional fees and expenses) (“Losses”) resulting from any inaccuracy or breach of the respective party’s representations and warranties or any breach or nonperformance of the respective party’s covenants and agreements in the Stock Purchase Agreement or its related ancillary agreements.

In addition, Pioneer Power has agreed to indemnify the Buyer and its affiliated parties for Losses resulting from, among other things, certain pre-closing tax matters, debt held by the Disposed Companies, transaction expenses, breaches of representations and warranties that are not covered by the Buyer’s representation and warranty insurance because the Buyer had knowledge of such breach (only to the extent such Losses would have been covered by the representation and warranty insurance had the Buyer not known of such breach) (“Interim Breaches”), certain matters related to Electrogroup’s operations, certain legal proceedings, certain matters related to Nexus Custom Magnetics, L.L.C., a wholly owned subsidiary of Jefferson, and certain matters concerning end-user software utilized by the Disposed Companies.

The indemnification obligations of Pioneer Power with respect to Losses of the Buyer resulting from inaccuracies or breaches of the Company’s representations and warranties, except for breaches of certain fundamental warranties, claims of fraud and breaches of representations, warranties or covenants relating to taxes, and claims for certain specific indemnities, are subject to (i) a true deductible equal to $330,000, (ii) a cap equal to 0.5% of the purchase price, and (iii) a per-claim threshold amount of $50,000. In addition, the indemnification rights of the Buyer with respect to Interim Breaches are subject to a cap equal to $5.0 million, and the indemnification rights of the Buyer with respect to Losses resulting from certain matters related to Electrogroup’s operations are subject to a true deductible equal to $500,000 and a cap equal to $5.0 million.

The indemnification obligations of the Buyer, except with respect to breaches of certain fundamental representations and warranties and claims of fraud, are subject to a true deductible equal to $330,000 and a cap equal to $3.3 million. In addition, each party’s total indemnification obligation is subject to a cap equal to the purchase price, except for claims of fraud.

The Buyer has obtained a customary representation and warranty insurance policy insuring the Buyer against losses resulting from a breach of representations and warranties by Pioneer Power and the Disposed Companies, and the Buyer is required to use commercially reasonable efforts to utilize the representation and warranty insurance to cover any Losses resulting from such a breach. In addition, in rather than seeking recovery from Pioneer Power, the Buyer is required to setoff amounts owed to Pioneer Power under the Seller Note on a dollar-for-dollar basis by the amount of any indemnifiable losses Buyer suffers as a result of certain actions or omissions by Pioneer Power or the Disposed Companies.

Other Provisions

The Stock Purchase Agreement also contains customary representations and warranties, certain termination rights of both parties, including termination by mutual written consent of the parties, and provisions governing certain other matters between the parties.

The foregoing description of the Stock Purchase Agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the Stock Purchase Agreement, a copy of which is filed as Exhibit 2.1 on Form 8-K filed with the Security and Exchange Commission on July 1, 2019 and is incorporated by reference herein.

Operating results of liquid-filled and dry-type transformer manufacturing businesses previously included in the T&D Segment, have now been reclassified as discontinued operations for all periods presented.

The components of assets and liabilities that are attributable to discontinued operations are as follows (in thousands):

		June 30,				December 31,
		2019				2018
Assets of discontinued operations:
Cash and cash equivalents		$	6			$	11
Accounts receivable - trade, net			15,397				12,944
Inventories, net			20,131				23,632
Income taxes receivable			—				566
Prepaid expenses			604				514
Property, plant and equipment, net			4,300				4,406
Right of use asset			1,928				2,124
Deferred income taxes			78				134
Intangible assets, net			3,377				3,460
Goodwill			5,557				5,557
Assets of discontinued operations		$	51,378			$	53,348

Liabilities of discontinued operations:
Bank overdrafts		$	793			$	1,690
Accounts payable and accrued liabilities			20,278				18,894
Income taxes payable			655				778
Pension deficit			3				148
Other long-term liabilities			2,090				2,187
Liabilities of discontinued operations		$	23,819			$	23,697

During the quarter ended June 30, 2019 the Company’s Reynosa Facility was damaged by a flood resulting in damages to inventory. While management continues to evaluate the extent of the damaged inventory, as of June 30, 2019 the Company has recognized a loss of $3.3 million based upon an estimate of inventory damaged and unsalable as a result of the flood. This loss has been partially offset by $2.4 million of insurance proceeds that the Company expects to receive. While the net loss on inventory damaged amounting to approximately $913 has been reflected within the Cost of goods sold in discontinued operations, the corresponding insurance receivable of $2.4 million has been recognized as an asset from continuing operations. The amount of damaged inventory and insurance proceeds are based upon the management’s best estimate, and the actual amount of damaged inventory and insurance proceeds may differ from such estimates.

The following table presents the discontinued operations of the liquid-filled and dry-type transformer manufacturing businesses in the Consolidated Statement of Operations (in thousands):

		Three Months Ended June 30,								Six Months Ended June 30,
		2019				2018				2019				2018
Revenues		$	19,003			$	21,599			$	40,684			$	42,530
Costs and Expenses
Cost of goods sold			16,047				16,874				33,886				33,749
Selling, general and administrative			2,275				2,832				4,715				5,395
Foreign exchange loss (gain)			143				197				(491	)			272
Interest expense			275				520				550				948
Other expense (income)			—				(1	)			48				96
Total costs and expenses			18,740				20,422				38,708				40,460
Income before provision for income taxes			263				1,177				1,976				2,070
Income tax expense			131				315				533				476
Income from discontinued operations, net of income taxes		$	132			$	862			$	1,443			$	1,594

The following table presents the discontinued operations of the liquid-filled and dry-type transformer manufacturing businesses in the Consolidated Statements of Cash Flows (in thousands):

		Six Months Ended June 30,
		2019				2018
Net cash provided by operating activities		$	2,793			$	1,580
Net cash used in investing activities			(97	)			(57	)
Net cash used in financing activities			(2,607	)			(1,685	)
Effect of foreign exchange on cash and cash equivalents			(94	)			152
Increase in cash and cash equivalents		$	(5	)		$	(10	)