ITEM 1. DESCRIPTION OF BUSINESS
In this report, we use the terms “Pernix Group,” “Pernix,” “the Company,” “we,” “us” and “our” to refer to Pernix Group, Inc. (formerly known as Telesource International, Inc.) and its consolidated subsidiaries. Unless otherwise noted, references to years are for calendar years. We refer to the calendar year ended December 31, 2012 as “2012” and the calendar year ended December 31, 2011, as “2011.”
Overview
Pernix Group is a global company managed from Lombard, Illinois and was originally formed in 1995 as Telesource International, Inc. In 2001, the Company was incorporated in Delaware and became an SEC registrant. As of December 31, 2012, Pernix Group employs 105 people and is 96.8% owned by Ernil Continental, S.A., BVI, Halbarad Group, Ltd., BVI, and Affiliates. The Company conducts its operations through the parent and its seven subsidiaries.
Pernix Group is a diversified contractor that is engaged in two primary operating business segments: Construction Services as a Design-Build General Contractor in the public and private markets and Power Generation Services as a builder, manager and investor in Power Projects as an Independent Power Producer and as a General Contractor. Pernix has full-scale construction and management capabilities, with subsidiaries in the South Pacific islands of Fiji and Vanuatu, in Niger, in United Arab Emirates and in the U.S. We provide our services in a broad range of end markets, including construction, construction management, power and facility operations and maintenance services. In addition to these two operating segments, the Corporate operations are a separately reported segment.
The construction and power segments offer diversified general contracting, design/build and construction management services to public and private agencies. We have provided construction and power services since 1995 and have established a strong reputation within our markets by delivering complex projects and providing innovative facility operations and maintenance solutions to clients world-wide with an unwavering commitment to safety, quality, social responsibility and total customer satisfaction. We have established internationally experienced, high-performance management teams with a proven track record of successfully completing complex projects around the globe and in some of the most remote locations on the planet. We have over fifteen years of experience providing all of our services in international territories. We believe that these attributes are the foundation of Pernix’s success.
As discussed below, the current management team has transformed the Company through the 2012 disposition of unprofitable business entities, implementation of efforts to become leaner in terms of leverage and stronger in formation of strategic relationships with customers, vendors and key government agencies. Since 2005 management has significantly reduced debt and increased equity, improved the profitability of its continuing operations and built its contract backlog. Pernix Group, Inc. management believes the Company has reached a “turning point” in its operations and future profitable operations are reasonably assured. Accordingly, the Company elected to effect a quasi-reorganization, as further discussed later in this report.
As part of a strategic plan formulated in early 2012, the Company embarked on a comprehensive review of its operating activities, leading to a decision to divest two operating units in 2012. Effective October 12, 2012, the Company sold 100% of its interest in Telesource CNMI, Inc. (TCNMI) in the Commonwealth of the Northern Mariana Islands to Marianas Energy Technology, Inc., a Commonwealth of the Northern Mariana Islands company. The buyer is an unrelated third party and the sale price was consistent with the fair market value at $1,000 settled in cash on the closing date of October 12, 2012 plus buyer assumption of all liabilities. For the period from January 1, 2012 through October 12, 2012, the loss from the TCNMI discontinued operations was $1.8 million. The gain on the sale of TCNMI was $1.1 million and was recorded in the fourth quarter of 2012 as Additional Paid In Capital in accordance with accounting rules for discontinued operations occurring in connection with a quasi-reorganization.
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For calendar year 2011, the income from TCNMI discontinued operations was $1.6 million consisting primarily of deferred tax benefits. Pernix Group, Inc. sold TCNMI to focus its efforts on construction services and power O&M /power construction operations that are expected to provide a higher return on investment and generate higher growth.
Until March 2012, we also operated an RF Transmitter Design, Manufacture and Installation segment through TransRadio SenderSysteme, Berlin, A.G. (TransRadio). TransRadio was acquired in 2009 to serve as a global platform for cross-selling construction segment services. TransRadio had been a supplier to Pernix Group in connection with a broadcast station construction project that was previously completed on the remote island of Tinian and the acquisition was complementary to the Company’s core operations and augmented revenue. However, due to the violence and political turmoil from the “Arab Spring” in the Middle East coupled with the poor economic conditions in Europe, orders for transmitters and antennae deteriorated and although the radio transmitter segment did win two contracts in March 2012, prior to the disposition, the Company did not know when historical levels of sales volumes would resume. On March 28, 2012, the Company consummated the sale of its 82% interest in TransRadio to Bevita Commercial Corporation, a related party, for $1.2 million in cash. For the period from January 1, 2012 through March 28, 2012, the effective date of the sale, the loss on the discontinued operations ($1.1 million) and sale ($0.8 million) of TransRadio was $1.9 million. TransRadio accounted for $3.6 million of 2011 consolidated net losses. If not for these losses, Pernix would have had net income of $2.3 million in 2012 and $5.4 million in 2011. The purpose of the sale was to curtail future losses attributable to TransRadio and to re-allocate capital and human resources to the Construction and Power segments.
Pernix Group has transformed its operations from a capital intensive, self-performing construction and power services company to a more agile, minimally leveraged design-build construction management services and facility O&M company that utilizes a more collaborative approach with strategic partners who possess niche capabilities. Pernix Group provides its customers with solutions that meet their time and budget constraints. In doing so, Pernix Group developed strong partner and customer relationships, which are the drivers behind contracts and sole source awards the Company received in 2011and 2012 totaling over $230 million.
Business Segments
General Construction
Our general construction services include comprehensive pre-construction planning and construction management services. As a general contractor, we have responsibility from award through the successful completion of each project we pursue.
We have developed an international network of suppliers and subcontractors that are capable of delivering products and services on a global basis. Together with these strategic partners, we utilize niche capabilities and experience that address customer design, budget and schedule requirements. All of our construction management team members have worked on complex international projects. We have the expertise required to successfully conduct full-scale construction projects anywhere in the world. We have demonstrated that we can execute the most technically and environmentally challenging projects within time and budget parameters while meeting the exacting quality and safety requirements of the project, thereby exceeding our clients’ expectations at every opportunity. Pernix Group has the ability to self-perform mechanical and electrical trades when doing so brings efficiencies and value to a project and our customers.
To minimize overhead costs and maintain a worldwide capacity to handle complex projects, we have adopted a strategy of affiliating ourselves with highly capable subcontractors and business partners strategically located around the world. By collaborating with “best in class” subcontractors and partners, Pernix Group is able to provide the best fit to fulfill our customers’ project requirements. In connection with an award from the U.S. Government, for example, we brought forward a team of companies that included 140 offices worldwide, over 60,000 employees, working on five continents. Our various joint venture partners, affiliates and business partners, combined with our own teams and internal resources, provide Pernix Group the ability to offer its customers a best in class solution to their construction needs, worldwide. These strategic partnerships not only assist Pernix Group in winning larger projects, but also mitigate cost, design and other risks, provide experience managing larger projects, expand
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relations with more subcontractors and vendors, and enhance the number and type of contract opportunities that Pernix can consider, qualify for, bid on and win.
Many of our construction projects are for governmental owners, such as the US Department of State’s Bureau of Overseas Buildings Operations (OBO) as well as select foreign governments. In most instances the bidding process requires an initial pre-qualification stage, followed by a proposal submission stage for qualified contractors. Pernix Group focuses its efforts in areas and on projects where we have a competitive advantage that is within our core competency. We minimize risk and develop winning strategies by thoroughly studying local markets, aligning ourselves with capable local or regional large prime-subcontractors, and establishing purchasing and logistics support locally, or regionally, whenever possible. Our performance history and record of client retention demonstrate the successful formula Pernix and its partners have developed to grow our business and achieve customer satisfaction. The aforementioned contracts awarded from OBO to Pernix and Pernix-Serka Joint Venture (PS JV) highlight our accomplishments. PS JV is a highly effective joint venture with Serka Insaat ve Ticaret, A.S. (Serka) that is 52% owned by Pernix and 48% by Serka. PS JV has an office in Vienna, Virginia, in close proximity to U.S. Government agencies in order to closely manage its customer relationships (including OBO) and to provide effective contract execution and oversight for its customers on its mission critical, fast-track work efforts in Iraq and elsewhere.
In early 2011, PS JV was awarded a multi-billion dollar Indefinite Delivery Indefinite Quantity (IDIQ) contract with OBO. This contract provides PS JV with the opportunity to bid on a significant number of task orders for Containerized Housing Units (CHU) to be built internationally. The size of each task order is dependent upon the scope of work and there is no guarantee that PS JV will win any particular task order, but the overall IDIQ program is for five years and totals $12.0 billion. The amount of the awards to any one contractor cannot exceed $500 million in one base year or option year and $2.5 billion over the life of the contract should all four option years be exercised. PS JV has actively responded to several Task Order Proposal Requests to bid under this IDIQ contract and has been awarded two contracts with revenue totaling over $200 million under this program during the 21 months from April 2011 through December 2012, as mentioned in the previous paragraph and outlined in detail below.
On January 13, 2012 the U.S. Department of State (DOS) awarded PS JV with a re-procurement contract having an estimated value of between $103 and $117 million for design and construction services work related to the former Sather Air Base in Iraq (n.k.a. the Baghdad Diplomatic Support Center). Significant design and construction work began during the first half of 2012. As of December 31, 2012, PS JV received award notices and modifications totaling $103.0 million on this project. On March 14, 2013, the Company received an additional modification for a $10.8 million office building.
On April 14, 2011, PS JV was awarded a $92.7 million project to be constructed in Baghdad, Iraq under the IDIQ contract. This Project was originally known as the Shield project and more recently was renamed the Baghdad Police Academy Annex. This Task Order provided PS JV with the opportunity to build Containerized Housing Units (CHU) in Iraq. Construction under this task order began in June, 2011 and since the original award, PS JV received modifications amounting to $9.8 million bringing the adjusted total contract value to $102.5 million. As of December 31, 2011, the contract was approximately 51% complete. In March 2012, we received a partial Termination for Convenience notice from OBO. The partial termination was due to OBO’s internal program changes and not the result of any performance issues by PS JV. The Task Order was over 70% complete upon receipt of the partial Termination for Convenience notice.
PS JV worked closely with the Department of State toward a fair resolution resulting in a negotiated settlement with OBO for total contract value of $102.5 million. Approximately $1.2 million remains in the backlog as of December 31, 2012 for estimated close-out and project management work through August 2013 when the warranty period expires. On May 3, 2012 a “Certificate of Substantial Completion” was received related to the list of construction activities under the scope reduction notice on the Shield project. The Company has not yet received a Final Acceptance Letter of the Contract. OBO remains a major customer vis-à-vis the award of the Sather task order to PS JV under the IDIQ contract during 2012 as well as the Niger rehabilitation contract awarded to Pernix Group, Inc. during August of 2011. In addition, in January 2013, the OBO exercised Option Year 2 under our base CHU IDIQ contract, extending the period within which additional Task Orders can be awarded to PS JV into January 2014.
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On September 30, 2011, the PS JV was awarded an additional contract for an $80.3 million project to be completed in Baghdad, Iraq for the construction of an embassy and other structures. On October 21, 2011, the Company received a “Suspension of Work” notice from the U.S. Department of State. Ultimately, the contract was “Terminated for Convenience” because the government decided to “re-scope” the project. In March, 2012, the OBO released a task order proposal request as the project was rebid as “re-scoped” and ultimately another company was awarded the re-scoped project. The breadth and depth of experience in embassy construction is significant to Pernix and is expected to be a key strategic component that the Company will utilize to bid on and win future work with the Department of State as they intend to build or rehabilitate up to 32 embassies in the 2012 through 2017 timeframe.
In addition to the aforementioned IDIQ program awards, in the second quarter of 2011, the Company received an award notification from the OBO for an $18.1 million for an embassy rehabilitation project in Niger, Africa. On August 3, 2011 we received a Limited Notice to Proceed on the procurement and shipping of items that will be required for the project. On August 16, 2011 OBO exercised a bid alternate for this project valued at $6.6 million to renovate additional office spaces, bringing the total contract value for the Niger rehabilitation project to $24.6 million. Pernix established a limited liability company in Niger in connection with this contract. In early July, 2012, Pernix Group, Inc. received the Notice to Proceed (NTP) and Company representatives joined OBO representatives in Niger for a kick-off meeting to begin substantial construction on the project. Construction activity on this project began during the third quarter of 2012 and is expected to continue into the third quarter of 2014.
Our recent experiences with the OBO, have strategically strengthened our technical and management expertise and developed relationships that enable us to provide our clients with a broad spectrum of services that leverage the expertise and the construction resumes of our staff and our partners to the mutual benefit of all involved. In addition to PS JV, Pernix has also formed several additional strategic alliances with companies who possess niche capabilities in restoration work as well as critical mass that enables Pernix to be part of a consortium of contractors with the intention of bidding and working together on large scale projects which Pernix may not be able to access on a stand-alone basis.
During the third quarter of 2012, the Company established an office in Dubai (United Arab Emirates) to secure new and existing customers in light of significant anticipated demand for construction services forecasted in the region over the next decade. In connection with this effort, the Company organized Pernix Technical Works LLC (PTW), a limited liability company which is consolidated by Pernix Group, Inc. as the primary beneficiary of this variable interest entity. To provide a base for local operations, the Company entered into a lease agreement for office space for PTW. See Note 22 in our notes to the consolidated financial statements.
In 2006, the Company entered into a joint venture with SHBC, called Pernix/SHBC JV (formerly Telesource International, Inc./Sayed Hamid Behbehani & Sons Co., Joint Venture, L.P.). This joint venture operates out of the Company’s Lombard, Illinois office and is a limited partnership with an equity split of 51% for the Company and 49% for SHBC. The joint venture was created for the purpose of bidding on US Government construction and infrastructure development projects. In January 2007, the Pernix/SHBC JV received a final award and notice to proceed with a $42.6 million contract with subsequent change orders of $4.3 million to design and build a new embassy compound for the United States Department of State in Suva, Fiji. To execute this project, the Pernix / SHBC joint venture formed a wholly owned subsidiary in Fiji called Telesource SHBC (Fiji), Ltd. (TSF). In April of 2010 the Company was awarded a second contract of $8.1 million on the embassy compound in Fiji. As of December 31, 2011 both of the Suva projects reached substantial completion. TSF has since been merged into TFL and will continue to pursue construction projects in the region.
The Fiji projects reached substantial completion on time, and we intend to leverage our experience and track record in Fiji to bid on and obtain additional embassy and/or US Government projects as the Department of State intends to build, rehab or upgrade more than 32 embassy and consulate facilities in the 2013 — 2017 timeframe.
Design Build
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Pernix embraces the design/build model to ensure design excellence and successful completion of construction projects from analysis, architecture and permitting, through engineering, construction, completion and customer acceptance. By establishing a singular point of responsibility, we deliver on our promise to fulfill all project requirements and specifications on-time and on-budget.
We are committed to understanding the unique requirements and specifications of each project to provide a comprehensive single source solution. This value-added partnership leverages our ability to align and manage the best resources for all aspects of the project.
Construction Management
Pernix Group’s nearly two decades of experience has proven that early involvement in a project and its design is one of the keys to its success. Our proven approach works in line with our customers’ needs and expectations to develop a plan and an execution schedule that saves time and money and ensures timely completion of our projects. Our state-of-the-art Construction Management services provide a systematic project review, including a comprehensive construction and start-up schedule. By establishing a singular point of responsibility, we provide continuous updates on project milestones and ensure the safest working environment while we deliver projects on time and on budget.
Construction Segment Outlook
According to Global Construction 2020, construction is expected to outpace world economic growth in the next decade as Asian markets continue to develop rapidly and the US registers a sharp cyclical recovery. Construction today is a $7.2 trillion market and by 2020, it is estimated construction economic output will have grown by 70% to $12 trillion. A total of $97.7 trillion is expected to be spent on construction globally during the next decade and by 2020 construction may account for 13.2% of the world economic output. Forecasts show the most dynamic growth for construction over the next decade is expected to come from emerging markets. Conversely, construction in most developed countries will be constrained by large public deficits, austerity programs, muted population growth and limited economic expansion. The Company does not know if or when it may experience an impact related to the sequestration but it is possible and it could materially negatively affect the revenue and net income of the Company.
US construction is expected to stand out from most developed countries by registering a sharp cyclical rebound driven by a strong upturn in residential and non-residential construction. Population growth will help drive this growth along with cyclical factors. As a result of the aforementioned divergence between developed and developing market economies, emerging markets are expected to make up more than half of the global construction market by the end of this decade. In light of its experience, Pernix is uniquely qualified to perform in emerging markets which can be more remote and logistically challenging environments.
Power
Although virtually everyone in the world relies on it, the needs and resources required to generate power can vary widely from location to location. From the types of fuels used to the plethora of regulations governing the development and operation of power generation plants, Pernix Group understands the unique needs and requirements of different projects in diverse geographic locations. Pernix focuses on construction and facilities O&M for small to mid-size power plants and has the experience to build, operate, and maintain power plants as well as transmission and distribution grids and underground cable installation. We manage and operate many of the plants that we build. Due to our years of experience, we have developed strong relationships with engine and turbine manufacturers, suppliers of parts for power plants and distribution/ transmission systems, software developers and suppliers for control systems, Customer Information Systems (CIS), and Geographic Information Systems (GIS).
Pernix focuses on operating efficiency and reliability while maintaining safety, security and environmental stewardship. We accomplish this by partnering with our customers throughout all project phases to understand and
recognize the unique requirements of each customer and each project phase, and leverage our ability to align and manage the best resources for all aspects of each particular project. The Pernix Group power segment prides itself in being a steward of the environment and the assets entrusted to us by the communities in which our operators work and live. Pernix Group power segment employees are not absentee operators but ones who live and work in the community and depend upon the same power being provided to our customers.
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Our power business segment includes construction and facilities O&M services. Specifically, Pernix Group provides plant engineering, design, procurement, construction, and operations & maintenance services from the power source through the distribution network on a worldwide basis. We have the capability to address a variety of power generating requirements from initial conceptual design to construction, through operating and maintaining diesel, hydro, and solar power facilities. Pernix differentiates itself within the power industry as we can scale to various size projects, ranging from small to mid-sized projects on a stand-alone project basis and large projects in association with our strategic partners. This flexibility in the scale of projects on which we work reflects the well thought out design, agility and efficiency in our operations. Pernix also has a wealth of experience in the upgrade of existing facilities to achieve additional capacity and operational efficiencies by upgrading and replacing outdated or worn out equipment while endeavoring to use existing equipment when possible. These upgrade projects typically produce significant cost savings to our customers and can often be carried out while the power plant continues to operate, resulting in even greater cost savings to our customers.
Power Plant Construction
Pernix Group’s general construction segment is complementary with our power plant construction offerings. We rely on our construction capability and strong affiliation with world-class design firms and subcontractors to provide comprehensive design-build and global power solutions. We have the resources to properly fit technology with our customers’ special requirements, budget and environmental considerations and restraints. Power plants are a significant investment and become a crucial part of a community’s survival, hence we take great care to understand what our customer requires, and ensure that the end product exceeds their expectations for today and contemplates their needs for the future. As noted in the construction segment discussion above, our state-
of-the-art construction management services provide a systematic project review, including a comprehensive construction and start-up schedule. Our power plant construction methodology is not limited to building a facility; we also provide start up and commissioning services to ensure that the equipment is fully integrated with all other operating systems as well the transmission/distribution system and power grid. Furthermore, we provide the appropriate training for startup as well as future operations and maintenance.
In this segment we have also developed significant working relationships and joint-venture partners in order to expand our offerings, bring efficiencies to our project and reduce costs to our customers. Pernix has strong relationships with many of the world’s leading engine and turbine manufacturers and relies on these relationships to ensure that product is delivered on time and within budget. The Company has also formed a strategic alliance with UEI Holdings, LLC. This arrangement enables Pernix to expand its offerings and adds significant capabilities. UEI Holdings has experience with diverse power sources and technologies and over the past 15 years has managed, commissioned, designed, or helped build over 50,000MW of power generation facilities. The relationship brings this capability to the world market, and coupled with our own internal resources, we feel confident that our customers and partners will greatly benefit from this alliance with UEI Holdings.
Operations and Maintenance
Pernix Group’s Power Operations and Management Services (O&M) provides an integrated scope of services to effectively maintain and manage all aspects of power operations. We partner closely with public and private entities to improve plant process, performance, reliability and customer service. Our focus is on reducing costs and ensuring a safe and efficient working environment for all involved.
Pernix’s O&M services include maintenance & operations, engineering, on-going reliability studies, construction management, recovery/rebuild, specialty services and rehabilitation. We perform an audit of a customer’s operations and provide a comprehensive plan, including timelines for assuming responsibility of the operation as well as initial and long-term maintenance requirements. Our intense focus on machine performance and OEM maintenance requirements ensures efficient and long term operation of equipment. In all cases Pernix tries to make every effort to hire and train local staff. This is part of our commitment to bring jobs and add value to the communities where we work and serve.
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Transmission and Distribution Systems
Pernix Group has experience building Transmission & Distribution (T&D) systems as well as maintaining and upgrading them to ensure efficient operation throughout the power infrastructure. Our experience includes working in climates that experience extreme weather conditions such as cyclones and monsoons. We have developed our own unique methods and systems for working under such conditions and our safety record is excellent. Safety is a major concern of any T&D maintenance program, and all projects start with proper training on equipment usage, communication and teamwork. Our safety records are receiving recognition from local governments and utilities, and we continually monitor and retrain our team to ensure the continued safety of all. Our staff includes engineers with many years of experience designing, implementing and maintaining these systems. We can maintain an existing system or we can upgrade a system to the most current T&D technologies.
Build, Own, Operate, Transfer (BOOT)
Pernix Group believes in utilizing the BOOT model to help our customers finance and manage their current and potential infrastructure projects. Up-front costs are eliminated and the customer ultimately attains ownership of the final product. This is very similar in concept to a toll road. BOOT makes it easy for the customer to execute badly needed projects now despite budget constraints which would otherwise require deferring such projects well into the future.
Organizations such as the World Bank, US EX-IM Bank and other international finance institutions (IFIs) have a history of lending money to aid customers in improving and privatizing their infrastructure. The BOOT model is another financial tool available to cash or budget constrained customers to achieve their infrastructure improvement goals. BOOT is one of several financing options that the Pernix Group may be able to offer our clients.
Current Power Operations
We invest in power projects as an independent power producer (IPP) or using the BOOT model. Our power projects to date have been in the North and South Pacific. Our Power Generation Services segment currently operates power plants in the Republic of the Fiji Islands (Fiji)and the Republic of Vanuatu (Vanuatu) and contributed $5.1 million, or 4.3% of our 2012 revenue. In addition, in December 2012, the Power segment was awarded a $1.6 million contract to install underground cable between Lungga Power Station and Ranadi Sub-Station in the Solomon Islands for the Solomon Islands Electricity Authority (SIEA).
Telesource (Fiji), Limited (TFL)
TFL, a wholly-owned subsidiary of Pernix, conducts our power generation activities in Fiji. TFL has a 20 year contract with the Fiji Electricity Authority (FEA) to operate and maintain two separate diesel fired power generation plants and to sell electrical power produced, on a wholesale level, at a contractually determined rate, without risk of fuel price fluctuation. The operations & maintenance (O&M) contract for this project expires in 2023 and includes management of a total of 74MW of diesel power generation capacity in Fiji.
The Kinoya Power Plant, situated near Suva, the capital of Fiji, is part of the FEA grid and is the largest diesel based power plant in Fiji. In 1999, FEA awarded TFL the contract to expand the power plant to 12 MW. During the coup in 2000 disturbances at the hydro power generation facility led to rolling power cuts on the main island of Viti Levu. At that time, FEA modified the contract to move the 12MW machines to Vuda Power Plant, which is the second largest diesel-based power plant in Fiji, and added 20MW for the Kinoya Power Plant. As a testament to FEA’s satisfaction with TFL, TFL was awarded a 20 year O&M contract for both the Kinoya and Vuda Power Plants in 2003.
As a further testament to FEA’s satisfaction with TFL, in late 2005, FEA awarded TFL another O&M contract for a 30MW extension to the Kinoya Plant. The expansion of the Kinoya Power Plant was carried out in close coordination with FEA, Caterpillar, Inc. and the existing plant personnel, all the while ensuring the safety of employees and equipment and without interruptions to its regular operations. Furthermore, TFL has been asked to
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bid on a 20 MW Kinoya plant capacity expansion project in 2013. The Kinoya Power Plant is fully compliant with the environmental regulations of Fiji, World Bank Guidelines, and good engineering practice recommendations for ground level exhaust emissions.
Demonstrative of TFL’s outstanding O&M performance record, FEA, recently rated the TFL-managed Vuda and Kinoya power stations first and second out of five power stations in Fiji, and the FEA report stated that “
it is no coincidence that the two Telesource (Pernix) stations are ranked first and second. They have a dedicated technically based health, safety and environmental officer who is actively involved in carrying out frequent and regular in house risk management checks
”. FEA is the regulatory agency that is charged with protecting the long-term interests of consumers with regard to the price, quality, safety, and reliability of regulated services in Fiji and TFL takes pride in the positive recognition from FEA.
Vanuatu Utilities and Infrastructure Limited
Pernix Group set up a wholly-owned subsidiary in 2010 named Vanuatu Utilities and Infrastructure Limited (VUI) operating under the laws of Vanuatu. On January 1, 2011, VUI assumed responsibility for operating and maintaining a diesel power plant, hydro dam, and the entire T&D system for the city of Luganville and a15 kilometer land locked radius from the boundaries of the city of Luganville on the island of Espiritu Santo. Our scope includes all service connections, metering, billings, collections and customer service. In short, this is a turn-key utility operation. VUI operates under a short term Memorandum of Understanding (MOU) that became effective on January 1, 2011 and was scheduled to terminate on August 31, 2011. The MOU was extended by the Government of Vanuatu indefinitely on August 31, 2011 until a permanent concessionaire is selected. VUI has performed an assessment of the operations to determine the financial and operational metrics which will be the basis for negotiating a longer term 20 year concession deed and contract with the government of Vanuatu. Under the MOU, the Company receives various expense reimbursements and fees
during this period for assuming the operations from the prior service provider. Such reimbursements and fees are, to a certain extent, dependent upon the Company’s assessment of collectability, power usage and operational costs. The costs associated with earning the management fee are included in salaries and employee benefits and also in general and administrative expenses in the Statement of Income. As of the date of this report, VUI continues to operate and maintain the system under the MOU and awaits a decision from the government of Vanuatu on the longer term concession deed.
The Utilities Regulatory Authority monitors and reports on the performance of electric utilities in Vanuatu. These reports bring transparency to the performance of the power providers, having recently described how well VUI provided services to its customers since VUI began to manage the power structure on Vanuatu on January 1, 2011. This report found VUI to have performed well in all areas including network performance, safety performance, customer service, reliability and quality of supply, and legislative and regulatory compliance.
Power Segment Outlook
In the countries belonging to the Organization for Economic Cooperation and Development (OECD) - including countries in North America and Europe – energy saving practices and technologies are expected to keep power usage relatively flat, even as these countries achieve economic growth and even higher living standards. In contrast, non-OECD power demand is expected to grow by close to 65 percent due to growing prosperity and expanding economies. Billions of people will be working to advance their living standards, thus requiring more power. The need for power to make electricity is expected to remain the single biggest driver of demand. By 2040, electricity generation is expected to account for more than one half of the increase in global power demand.
Oil is expected to remain the largest single source of energy to 2040, growing around 25 percent. But the most significant shift in the energy mix occurs as natural gas displaces coal and is expected to become the second-largest fuel by 2025. Gas is expected to grow faster than any other major fuel source, with demand up 65 percent by 2040. An economical and clean fuel source, gas grows in importance as it helps meet rising power generation demand in the future. Because they are abundant in supply and more economical to develop than other fuel sources, oil, natural gas and coal will continue to play a major role in long-term energy supply. Together, these three fuels are expected to provide approximately 80 percent of total global energy by 2040.
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In recent years, a combination of two technologies in use for decades – horizontal drilling and hydraulic fracturing – has enabled the energy industry to economically access and produce natural gas and oil found in shale and tight rock. Horizontal drilling allows a well to be drilled horizontally underground for thousands of feet, providing greater access to reservoirs to enhance and maximize productivity and economic resource recovery. This drilling practice also reduces the environmental footprint by enabling the drilling of multiple wells from a single location. In hydraulic fracturing, a solution – primarily water and sand, mixed with a small amount of chemicals – is injected into the rock thousands of feet underground to open very thin cracks, allowing trapped natural gas and oil to migrate to the well. This technology has been used in more than one million wells worldwide for the past six decades. Together these two technologies have unlocked vast new supplies of natural gas and oil, which otherwise would not have been commercially viable. The results are changing the landscape of energy supply in North America, particularly in the United States. For example, six years ago, production from North Dakota’s Bakken region registered a 100-fold increase in the last six years. These new technologies present new opportunities for construction and distribution of power and Pernix Group’s power segment is well positioned to pursue these opportunities which are expected to be smaller in size and fit well with Pernix agile organizational structure.
Meanwhile, there is a growing demand to supplement or replace aging power generation equipment, and to improve efficiency by replacing government operators with private sector providers. In the U.S., two-thirds of the country’s installed plants are 25 or more years old and need to be replaced and re-powered, principally with new combustion turbines.
As mentioned above, Pernix is unique within the power industry as we have constructed and operated power plants in some of the most remote locations in the world and we can readily scale to various size projects ranging from small to mid-sized projects, on a stand-alone project basis and large projects in association with our strategic partners. This flexibility in the scale of projects on which we serve reflects the well thought out design, agility and efficiency in our operations. Pernix also has a wealth of experience in the upgrade of existing facilities to achieve additional capacity and operational efficiencies by upgrading and replacing outdated or worn out equipment while being mindful to use existing equipment when possible. These upgrade projects can be carried out while the power plant continues to operate. These customer-focused transition efforts often produce significant cost savings to our customers. As noted above, TFL and VUI provide facility O&M services for diesel power plants under long term contracts or memos of understanding. The Company has the capability to provide renewable fuel options, including power design, construction and facility O&M services for hydro, solar and other green energy sources and is actively pursuing those opportunities in Fiji, Vanuatu, the Solomon Islands and other locations.
Discontinued Operations
Telesource CNMI, Inc.
On October 12, 2012 the Company sold its 100% interest in Telesource CNMI, Inc. (TCNMI) to an unrelated party. TCNMI had a history of significant construction and power projects. Through TCNMI, we built, operated and maintained a 20MW diesel fuel power plant on the Island of Tinian in CNMI. TCNMI is located on the Island of Saipan with operations on the Island of Tinian; both islands being part of CNMI, which is a U.S. Commonwealth. Since its incorporation in 1997, TCNMI executed over $80 million of construction work in CNMI. TCNMI financed, designed and built the 20MW diesel fuel power plant on the Island of Tinian on a 20 year BOOT basis.
The Company’s decision to sell its interest in TCNMI was approved by its Board of Directors and was intended to allow the Company to focus its efforts on operations that are expected to provide a higher return on investment and higher potential growth.
RF Transmitter Design, Installation and Service
In late 2009, we acquired a controlling interest in TransRadio SenderSysteme, Berlin, AG (TransRadio), a company engaged in the design, manufacture, distribution and installation of RF transmitter systems and related services to customers worldwide. In 2010, the Company purchased incremental interests in TransRadio, bringing the Company’s total ownership of the subsidiary to 82%. TransRadio offers products and customized solutions and services for VHF/FM Broadcast transmitters, long wave communication, AM — long and medium wave broadcast, Digital Radio Mondial (DRM) systems and turnkey solutions including design, pre-construction, construction
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management and commissioning. TransRadio’s RF transmitters have been produced since 1918 and the name TransRadio is an internationally recognized brand name with countless broadcast equipment installations throughout the world. TransRadio transmitters are sold internationally with their primary markets in Europe, Africa and Asia.
TransRadio was acquired to serve as a global platform for cross-selling construction segment services. The acquired company was a supplier to Pernix Group in connection with a broadcast station construction project that was previously completed on the remote island of Tinian. This acquisition was complementary to the Company’s core operations and augmented revenue. However, due to the violence and political instability of the “Arab Spring” in the Middle East coupled with the poor economic conditions in Europe, orders for transmitters and antennae have deteriorated and although the radio transmitter segment did win two contracts in March 2012, prior to the disposition, the Company did not know when historical levels of sales volumes would resume.
In March 2012, the Pernix Group management team requested and received approval from the Pernix Board of Director’s to pursue an expedited divestiture of the 82% interest in TransRadio. This divestiture is intended to curtail losses that have been generated by the radio transmitter segment and will allow the Pernix management team to focus its efforts on the Construction and Power Generation Services segments which it intends to grow organically and through acquisitions. The Company executed a stock sale and transfer agreement for its equity interest in TransRadio on March 26, 2012 and closed the transaction on March 28, 2012.
Our Business Strategy
Our business strategy as a diversified contractor focuses on expanding our public (government funded or sponsored) as well as private general construction, power construction and facilities O&M service segments. Key elements of our strategy include:
Capitalize on opportunities in other geographic locations
Pernix has built its reputation on completing difficult projects in the most remote areas of the globe. For example, the Company’s resume’ includes constructing a broadcasting station on the remote island of Tinian; managing the global logistics necessary to construct the US Embassy in Suva, Fiji and the Containerized Housing Projects in Iraq, and finding and training a local workforce to bring electricity to regions in Vanuatu that had never had electric service before. Pernix possesses the ability to help our clients understand, define and complete extraordinary projects of varying scale. Pernix Group understands what is required to execute and complete the most challenging projects regardless of whether the challenge is geographical, political, mechanical, or any combination of the above. While many of our competitors are not equipped nor experienced to manage technically challenging projects in remote geographic locations; Pernix Group specializes in and thrives on such challenges.
We intend to leverage our leading positions in the general construction, power construction and facilities operations and management capabilities to continue to expand our services and revenue. We believe that the need for infrastructure upgrades, governmental facilities as well as diesel-fired, hydro and solar power will result in continued opportunities in our core markets. All of our business segments have unique integration opportunities particularly in the construction and O&M markets. With our ability to manage projects internationally, successful track record and our global resources, we believe we are well-positioned to compete for projects in these global markets.
Utilize our long-standing relationships with industry specialists
We have long-standing relationships with a number of industry specialists worldwide. These relationships have been established to enhance our ability to satisfy our clients and deliver comprehensive solutions for customer needs. By collaboratively consolidating knowledge bases, skill sets, resources and contacts, we believe we have the ability to efficiently export our leading edge technical skills to any region in the world in which our clients may need them. We also continually develop new relationships that provide us with the necessary agility and expertise to meet needs of new and existing customers as their needs evolve.
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Expand and foster positive relationships with governments, public agencies and private entities worldwide
We will continue to focus on maintaining and expanding our relationships with governments, public agencies and private entities worldwide. We believe that the best way to develop new contacts and opportunities is to consistently exceed existing customer expectations; something we strive to do with every opportunity to serve. We will find new opportunities through promoting our Company’s resume and our reputation in the marketplace to targeted customers. These efforts will be supplemented by market intelligence gathering and providing customized solutions based upon an understanding of the specific needs of each governmental agency and each private customer. Upon identifying these opportunities we will continue to expand our network of international contacts and communicate our capabilities which in turn, will further expand our client base, as evidenced by our recent award in the Solomon Islands.
Continue to pursue our acquisition strategy
We intend to consider acquisitions to grow our general construction, power construction, and facilities O&M businesses. The Pernix Group management team has defined what it considers to be desired potential target characteristics including: companies of a scale and scope that will provide manageable growth that can be readily integrated, will be accretive to earnings, and will facilitate new client relationships. Ideal targets will also expand Pernix Group’s domestic presence and diversify and balance the Company’s profile, credit risk and provide more consistency to Pernix Group’s revenue and earnings streams. We will search for other successful companies whose growth can be enhanced through a synergistic combination of respective resources. This approach will expand, strengthen and diversify our market leadership positions geographically and technically across end markets. We believe that the trend towards consolidation in the industries in which we operate will produce candidates that align with our acquisition strategy.
Strengthen and support human capital
Our experienced employees and management are our most valuable resources. Attracting and retaining key personnel has been and will remain critical to our success. Pernix Group’s CEO and V.P. of Construction each bring over 25 years of significant institutional and industry experience to the Company. In addition, the Company hired a new V.P. Power effective January 31, 2013 that brings over 30 years of progressive industry experience in the energy and independent power business, having led successful development of more than 2,350 MW of power generation both in the U.S. and internationally. He has broad ranging experience structuring complex power projects, including EPC contract negotiations, fuels supply, asset management, project development, project and plant acquisitions, operations, owner's construction oversight, program management, and project finance. During his distinguished career, he has worked with power utilities, equipment manufacturers, independent power producers, construction firms and consulting firms. In his new capacity, he will be responsible for growing and managing Pernix's power business, including O&M contract execution and construction of new power generating facilities and related infrastructure in the U.S. and overseas. His role will include long-range/strategic planning, new project sourcing and evaluation, project pre-qualification and bidding, project finance and execution of awarded mandates. Additionally, he will oversee the company's existing power operations in the Pacific region.
Our customers benefit from the extensive experience of the Pernix team members; we have engineers at Pernix with project experience in 50 different countries. Recent management team hires in the Finance and Administration areas have brought Pernix Group approximately 50 years of experience in investment banking, “Big 4” public accounting, and Fortune 250 finance departments. In addition, the Company is actively pursuing additional business development and operations managers in the construction segment. A large percentage of our employees have technical and professional backgrounds and undergraduate and/or advanced degrees. We believe that we attract and retain talented employees by offering them the opportunity to work on highly visible and technically challenging projects in a stable work environment. Our non-engineering level employees are hourly workers, while our engineering and supervisory staffs are full-time employees with monthly salaries. All of our employees are non-union workers, although we may employ union subcontractors from time to time. As of December 31, 2012, we employed 105 people.
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We will continue to focus on providing our personnel with training and other personal and professional growth opportunities, performance-based incentives, opportunities for stock ownership and other competitive benefits in order to strengthen and support our human capital base. In late 2011, the Pernix Board of Directors approved an incentive stock option plan, with the first options granted in January 2012. Management has broadened participation in the incentive stock option plan as specified by the management team based on performance.
Effective December 12, 2012, the Board appointed Don J. Gunther to fill the Board seat recently vacated by Mr. Jeffrey Adams. Mr. Gunther, brings a wealth of construction and energy knowledge to the Board. He is currently serving as Chairman of the Board of INgage Networks, a high-tech company that is a leading enterprise networking organization and is a director of WPX Energy, Inc., an oil and gas exploration and production company. Until his retirement in 1999, Mr. Gunther was Vice Chairman and Director of the Bechtel Group, where he had responsibility for all of the global industry units and all corporate functions, including project management, engineering, procurement, construction, information services, information technology and contracts.
Our Business Segments
The following table sets forth the revenue attributable to our business segments for the periods indicated (1):
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Year End December 31,
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2012
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2011
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General Construction
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$
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114,872,655
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$
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51,841,103
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Power Generation Services
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5,150,811
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6,188,448
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Corporate
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—
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—
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Total revenue from Continued Operations
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$
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120,023,466
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$
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58,029,551
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Revenue from Discontinued Operations
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2,178,038
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11,811,299
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Total Revenue
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$
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122,201,504
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$
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69,840,850
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![[OFLX_10K004.GIF]](http://content.edgar-online.com/edgar_conv_img/2013/04/01/0001376474-13-000116_OFLX_10K004.GIF)
(1)
For additional financial information including net income by segment, see Note 23 in the notes to our consolidated financial statements.
Our Clients
The General Construction segment has one customer, the U.S. Department of State. The loss of this customer would have a material adverse impact on the Company’s consolidated financial performance. This customer represents 95% of the consolidated total revenues of $120.0 million. The Company does not know if or when the Department of State will experience an impact related to the sequestration but it is possible and it could materially negatively affect the revenue and net income of the Company.
As of December 31, 2012, the Power Generation Services segment has three primary customers: the FEA, the Government of Vanuatu and Solomon Islands Electric Authority (SIEA). In 2012, none of these customers individually account for more than 10% of the consolidated total revenues. On August 2, 2011, a diesel engine at one of our sites in Fiji was significantly damaged by a component failure resulting in an interruption of 10MW of power production at a diesel power plant operated and maintained by TFL under the FEA contract. In 2011, TFL recorded the expense associated with the deductible and other engine related failure expense items in the amount $0.6 million. In addition, TFL accelerated certain maintenance activities into 2011 from 2012. Meanwhile, the insurance proceeds from the insurer were recorded in early 2012 as they were not received by TFL nor confirmed by the insurer until that time. The incident reduced pretax income in 2011 by $1.5 million including insurance deductibles and maintenance expenses, and enhances 2012 results by the amount of the insurance proceeds recorded in 2012 of $0.6 million plus the benefit of the reduced maintenance load that was accelerated into 2011. As of March 2012 all anticipated insurance proceeds have been received or confirmed by the insurer in writing.
The RF Transmitter Design, Installation and Service segment has various major customers, none of which individually accounted for more than 10% of the consolidated total revenues in 2012 or 2011.
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The Company executed a stock sale and transfer agreement for its equity interest in TransRadio on March 26, 2012 and closed the transaction on March 28, 2012. The loss on the sale and loss from operations of TransRadio was $1.9 million in 2012 and was recorded in the first quarter of 2012 and is reflected in the statement of income as loss from discontinued operations. The comparable 2011 loss attributable to the discontinued operations of TransRadio was $3.6 million.
Joint Ventures
Some of our larger contracts may operate under joint ventures or other arrangements under which we team with other reputable companies, typically companies with which we have worked for many years. This is often done where the scale of the project dictates such an arrangement or when we want to strengthen either our market position or our technical skills. One example of such an arrangement is PS JV, our joint venture with Serka. During 2011 and 2012, several such joint ventures and strategic alliances were established and we continue to develop more strategic relationships.
Competition
The professional, technical and management support services markets we serve are highly fragmented and we compete with a large number of regional, national and international companies. Certain of these competitors have greater financial and other resources than we do. Others are smaller, more specialized, and concentrate their resources in particular areas of expertise. The extent of our competition varies according to the particular markets and geographic area. The degree and type of competition we face is also influenced by the type and scope of a particular project. Our clients make competitive determinations based upon qualifications, experience, performance, reputation, technology, customer relationships and ability to provide the relevant services in a timely, safe and cost-efficient manner. Pernix Group utilizes partnerships and other key strategic relationships to obtain an advantage with regard to niche specialization, to obtain flexibility with regard to scale and scope of projects it may be involved with
thereby enhancing the combined resumes of Pernix and its partners. Pernix Group will continue to focus on providing the “best in class” procurement and contract execution processes as well as world class customer service in an agile fashion.
Insurance and Risk Management
We maintain insurance covering professional liability and claims involving bodily injury and property damage. We consider our present limits of coverage, deductibles, and reserves to be adequate. Wherever possible, we endeavor to eliminate or reduce the risk of loss on a project through the use of quality assurance/control, risk management, workplace safety and similar methods. Risk management is an integral part of our project management approach and our project execution process.
Regulation
We are regulated in a number of fields in which we operate. In the United States, we primarily deal with the United States Department of State to bid and execute on the construction of U.S. embassies, containerized housing unit task orders and other projects. When working with this agency, we must comply with laws and regulations relating to the formation, administration and performance of contracts. These laws and regulations, among other things:
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require certification and disclosure of all cost or pricing data in connection with various contract negotiations;
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impose procurement regulations that define allowable and unallowable costs and otherwise govern our right to reimbursement under various cost-based U.S. government contracts; and
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restrict the use and dissemination of information classified for national security purposes and the exportation of certain products and technical data.
We are also subject to various government laws, regulations and/or applicable laws pertaining to the protection of the environment, primarily in the areas of water and air pollution, i.e. Council on Environmental Quality, the Environmental Protection Agency (EPA) and FEA. These laws and regulations in many cases require a lengthy and complex process of obtaining and maintaining licenses, permits and approvals from local agencies. As regulations
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are enacted or adopted in any of these jurisdictions, we cannot predict the effect of compliance therewith on our business. Our failure to comply with any applicable requirements could result in delays in proceeding with any projects under development or require modifications to operating facilities. During periods of non-compliance, our operating facilities also may be forced to shut down until the instances of non-compliance are corrected and/or be subject to fines or penalties. We are responsible for ensuring compliance of facilities with applicable requirements and, accordingly, we attempt to minimize these risks by dealing with reputable contractors and using appropriate technology to measure compliance with the applicable standards.
Presently, neither the Customer Choice Act nor other similar proposed legislation dealing with U.S. power policies directly impact us because the legislation and restructuring plan pertain to the retail market or new contracts in wholesale markets. However, we could be impacted in the future by, among other things, increases in competition as a result of deregulation. Compliance with federal, state, local and foreign laws enacted for the protection of the environment have had no significant effect on our capital expenditures, earnings, or competitive position to date. We are actively monitoring these developments in power proceedings in order to evaluate the impact on existing projects, and also to evaluate new business opportunities created by the restructuring of the electric utility industry and technological developments therein.
Contract Backlog
Backlog represents the amount of revenue the Company expects to realize from work to be performed on uncompleted construction contracts in progress at December 31, 2012, and from construction contractual agreements on which work has not yet begun. The following summarizes changes in backlog on construction contracts during the fiscal year ended December 31, 2012:
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Balance at December 31, 2011
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$
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70,996,164
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New construction contracts / amendments to contracts in 2012
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111,708,446
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Less: construction revenue earned as of December 31, 2012
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(114,803,035
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)
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Balance at December 31, 2012
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$
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67,901,575
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Management anticipates that $55.4 million of the $67.9 million backlog as of December 31, 2012, will be recognized as revenue during 2013 and $12.5 million will be recognized as revenue after 2013. The table does not include a $10.8 million modification received on March 14, 2013, that will generate incremental revenue related to new office space for the Sather project awarded to PS JV, a $2.0 - $3.0 million sole source award offered to PS JV by OBO on March 1, 2013 or the $1.6 million contract executed between SIEA and Pernix Group on February 20, 2013. Finally, the table does not include revenue associated with our long term contract or memo of understanding for power operating and maintenance services or construction segment stipend income of $0.1 million year to date as the stipend income is related to contracts that were not ultimately awarded to the Company as they are not directly related to core construction work. As previously discussed, the Company received a notice of scope reduction on the Shield task order (n.k.a. Baghdad Police Academy Annex) during 2012 and approximately $1.2 million remains in the backlog as of December 31, 2012 for related estimated close out and project management work through August 2013 when the warranty period expires. On May 3, 2012 a “Certificate of Substantial Completion” was received related to the list of construction activities under the scope reduction notice on the Shield project.